NBFCs in India: Non-Banking Financial Companies Explained

Introduction: The Shadow Banking System

When Meera in Jaipur needed ₹50,000 to start her tailoring business, banks asked for collateral she didn’t have. It was a local NBFC that gave her a group loan, helping her start her entrepreneurial journey. When Rajesh in Chennai wanted to buy a second-hand car, the dealership offered on-the-spot finance through an NBFC partnership. When a small manufacturer needed working capital but couldn’t navigate complex bank procedures, an NBFC came to the rescue.

Non-Banking Financial Companies (NBFCs) are often called “shadow banks” because they do much of what banks do—lend money, facilitate payments, manage investments—but they’re not banks. They fill crucial gaps in India’s financial system, reaching customers and segments that traditional banks often miss.

What is an NBFC?

Definition

An NBFC is a company registered under the Companies Act that provides banking services (loans, advances, acquisition of shares, hire-purchase, insurance, etc.) without holding a banking license. They cannot accept demand deposits (like savings accounts that can be withdrawn anytime).

Legal Framework

RBI Definition (Section 45-I of RBI Act): An NBFC is a company which is:

• A financial institution (principal business is lending, investment, etc.)
• Not a bank
• Not engaged in agriculture, industrial activity, or sale/purchase of goods

What NBFCs CAN Do

✅ Provide loans and advances ✅ Accept fixed deposits (with restrictions) ✅ Invest in securities ✅ Provide hire-purchase financing ✅ Offer insurance services ✅ Manage portfolios ✅ Operate payment systems (some)

What NBFCs CANNOT Do

❌ Accept demand deposits (savings accounts) ❌ Issue cheques to customers ❌ Be part of payment and settlement system (generally) ❌ Maintain SLR/CRR (most categories) ❌ Participate in RBI’s liquidity facilities (most)

Why NBFCs Exist: The Gap Fillers

The Credit Gap

India’s banking system, despite its reach, leaves gaps:

Underserved Segments:

• Small businesses without collateral
• Self-employed individuals
• Rural and semi-urban customers
• Used vehicle buyers
• Small-ticket personal loans
• Microfinance borrowers

Complex Bank Procedures:

• Lengthy documentation
• Slow approval processes
• Rigid eligibility criteria

NBFCs Fill These Gaps

Flexibility:

• Simpler documentation
• Faster approvals
• Customized products
• Higher risk appetite

Specialization:

• Focused on specific segments
• Deep expertise
• Tailored solutions

Reach:

• Less formal channels
• Agent networks
• Partnership models

Types of NBFCs

Based on Liability (Deposit Taking)

1. NBFC-D (Deposit-Taking)

• Can accept public deposits
• Stricter regulations
• Liquidity requirements
• Declining category (RBI discouraging)

2. NBFC-ND (Non-Deposit Taking)

• Cannot accept public deposits
• Funds from banks, bonds, equity
• Majority of NBFCs are this type

3. NBFC-ND-SI (Systemically Important)

• Non-deposit taking
• Asset size > ₹500 crores
• Additional regulations due to size

Based on Activity Type

1. Investment Company (IC)

• Principal business: Investment in securities
• Examples: Holding companies

2. Loan Company (LC)

• Provides loans (not hire-purchase or equipment)
• General lending NBFC

3. Asset Finance Company (AFC)

• Finances physical assets
• Vehicle finance, equipment leasing
• Real/physical assets supporting loans

4. Infrastructure Finance Company (IFC)

• Infrastructure lending specialist
• Minimum 75% assets in infrastructure
• Examples: L&T Finance, PFC

5. Systemically Important Core Investment Company (CIC-ND-SI)

• Holding company of group
• 90%+ assets in group company equity
• Limited external activity

6. Infrastructure Debt Fund (IDF-NBFC)

• Long-term debt for infrastructure
• Minimum 5-year lending
• Refinances bank loans

7. NBFC-Factor

• Factoring business (receivables financing)
• 50%+ income from factoring

8. Mortgage Guarantee Company (MGC)

• Mortgage guarantee business
• 90%+ income from this activity

9. NBFC-Account Aggregator (NBFC-AA)

• Consent-based data sharing
• No lending, only data aggregation
• Recent category (2016)

10. Peer-to-Peer Lending Platform (NBFC-P2P)

• Online lending marketplace
• Connects lenders and borrowers
• Regulated since 2017

Scale-Based Regulation (2021 Framework)

RBI introduced a four-tier structure:

Upper Layer (NBFC-UL)
    │ (Systemically significant, additional regulations)
    │
Middle Layer (NBFC-ML)
    │ (Deposit-taking, CICs, IFCs, larger NBFCs)
    │
Base Layer (NBFC-BL)
    │ (Most NBFCs, ₹1000 cr asset base)
    │
P2P, AA, NOFHC
    (Non-lending NBFCs, separate regulations)

Major NBFCs in India

Large NBFCs

Housing Finance Companies (HFCs)

Now regulated by RBI (transferred from NHB in 2019):

Microfinance Institutions (MFIs)

How NBFCs Raise Money

Unlike Banks (No Deposits)

NBFCs can’t take demand deposits, so they rely on:

1. Bank Borrowings

• Term loans from banks
• Working capital facilities
• Largest source for many NBFCs

2. Bonds (NCDs, CPs)

• Non-Convertible Debentures (NCDs)
• Commercial Paper (CP)
• Market borrowings

3. Fixed Deposits (for NBFC-D)

• Only deposit-taking NBFCs
• Higher rates than banks
• Higher risk for depositors

4. Securitization

• Selling loan portfolios
• Direct Assignment (DA)
• Pass-Through Certificates (PTC)

5. External Commercial Borrowings (ECB)

• Foreign currency loans
• For eligible NBFCs

6. Equity Capital

• Fresh equity issuance
• IPOs, QIPs, Rights issues

Asset-Liability Management (ALM)

Challenge: NBFCs face ALM mismatches:

• Borrow short-term (1-3 years)
• Lend long-term (5-10 years)
• Creates liquidity risk

IL&FS Crisis (2018):

• Infrastructure lender defaulted
• Triggered NBFC liquidity crisis
• Banks reduced lending to NBFCs
• Contagion across sector

Post-Crisis Reforms:

• Stricter ALM norms
• Liquidity Coverage Ratio (LCR)
• Asset classification alignment with banks

NBFC Regulations

Registration

All NBFCs with assets ₹100 crores+ must register with RBI.

Process:

1. Incorporate company
2. Apply to RBI with business plan
3. Meet net owned fund requirements
4. Obtain Certificate of Registration (CoR)

Key Regulations

1. Capital Requirements

2. Capital Adequacy (CRAR)

3. Liquidity Requirements

• NBFC-ND-SI: Maintain LCR
• ALM guidelines for all
• Stricter post-IL&FS crisis

4. Asset Classification (Aligned with Banks)

5. Concentration Norms

• Single borrower: 20% of Tier 1 capital
• Group: 25% of Tier 1 capital
• CRE (real estate): 20% of total assets

Scale-Based Regulation (2021)

Upper Layer:

• Identified by RBI based on size, activity
• Higher capital requirements
• Stricter governance

Middle Layer:

• Deposit-taking NBFCs
• Larger non-deposit NBFCs
• All Government NBFCs

Base Layer:

• Lighter regulations
• Less systemic importance

NBFC vs Banks: Key Differences

NBFCs and Financial Inclusion

Reaching the Unbanked

NBFCs play crucial role in financial inclusion:

Microfinance:

• NBFC-MFIs serve 6+ crore borrowers
• Average loan size: ₹30,000-50,000
• Self-Help Group linkages
• Women empowerment focus

Rural Finance:

• Two-wheeler loans in villages
• Tractor financing
• Agri-equipment loans
• Crop loans (some NBFCs)

MSME Finance:

• Unsecured business loans
• Invoice financing
• Working capital
• Supply chain finance

Success Stories

Bajaj Finance:

• Started as consumer durable financier
• Now full-service NBFC
• 70+ million customers
• EMI card concept pioneer

Muthoot Finance:

• Gold loan specialist
• Made gold a liquid asset
• 5,600+ branches
• Serves 25+ crore customers

Cholamandalam:

• Vehicle finance leader
• Used vehicle expertise
• Strong rural presence
• Technology-driven disbursement

Risks in NBFC Sector

For NBFCs

1. Liquidity Risk

• ALM mismatches
• Dependency on wholesale funding
• Refinancing risk

2. Credit Risk

• Higher-risk segments
• Economic downturns impact
• Concentration risks

3. Regulatory Risk

• Changing regulations
• Increasing compliance burden
• RBI scrutiny

4. Interest Rate Risk

• Borrowing cost changes
• Margin compression
• Competition pressure

For Depositors (NBFC-D)

No Insurance:

• DICGC doesn’t cover NBFC deposits
• Entire amount at risk if NBFC fails

Higher Risk:

• NBFC balance sheets less robust than banks
• Smaller, less diversified

Due Diligence Essential:

• Check credit rating
• Understand business model
• Verify RBI registration

For Borrowers

Higher Interest:

• Generally higher than bank rates
• Cost of convenience

Recovery Practices:

• Some NBFCs aggressive
• RBI cracking down

Data Privacy:

• Digital lenders collect data
• Privacy concerns

Recent Regulatory Changes

Harmonization with Banks

Asset Classification:

• 90-day NPA norm (aligned with banks)
• Earlier some had 180-day window

Scale-Based Regulation:

• Four-tier structure
• Risk-based supervision

Board Governance:

• Independent directors mandatory
• Audit committee requirements

Digital Lending Guidelines (2022)

Key Changes:

• No direct third-party disbursement
• Loans only to borrower’s verified account
• All fees upfront disclosure
• Cooling-off period for loans

Impact on:

• Fintech-NBFC partnerships
• Digital lending platforms
• Buy Now Pay Later products

Microfinance Regulations (2022)

Key Changes:

• Household income limit: ₹3 lakh (rural), ₹6 lakh (urban)
• 50% cap on FOIR (income going to repayments)
• No prepayment penalties
• Standardized borrower assessment

How to Choose an NBFC

For Deposits

Check:

• RBI registration (verify on RBI website)
• Credit rating (AAA/AA preferred)
• Track record (years in business)
• Financial statements
• Interest rate vs risk

Warning Signs:

• Unrealistically high rates
• Pressure to deposit quickly
• Unclear documentation
• No proper office

For Loans

Compare:

• Interest rate (use IRR/APR, not flat rate)
• Processing fees
• Prepayment charges
• Hidden costs

Check:

• RBI registration
• Customer reviews
• Recovery practices record
• Digital loan apps ratings

Red Flags

⚠️ Collecting cash deposits ⚠️ Agents promising impossible returns ⚠️ No proper documentation ⚠️ Harassing recovery calls before due date ⚠️ Accessing phone data without consent

Future of NBFCs

Trends

1. Digital Transformation:

• Digital lending growth
• Video KYC adoption
• API integrations
• Data analytics

2. Consolidation:

• Smaller NBFCs merging
• Bank acquisitions of NBFCs
• Scale becoming essential

3. Regulatory Convergence:

• More alignment with bank norms
• Higher compliance costs
• Level playing field emerging

4. Specialization:

• Niche segment focus
• Co-lending with banks
• Embedded finance

5. Capital Markets Access:

• More NBFCs going public
• Bond markets deepening
• Institutional funding growing

Challenges Ahead

Competition:

• Banks improving
• Fintechs disrupting
• Big Tech entering

Costs:

• Funding costs higher than banks
• Compliance costs increasing
• Technology investments needed

Regulation:

• Increasing scrutiny
• Stricter norms
• Less regulatory arbitrage

Key Takeaways

1. NBFCs are critical – Fill gaps left by banks
2. Diverse types – From MFIs to infrastructure lenders
3. No demand deposits – Key difference from banks
4. Higher rates – Both for deposits and loans
5. Less regulated – But gap narrowing fast
6. Liquidity risk – Major concern, IL&FS lesson
7. No deposit insurance – Depositors beware

Disclaimer

This article is for educational purposes only. NBFC regulations change frequently. Before investing in NBFC deposits or taking NBFC loans, conduct thorough due diligence. Verify RBI registration. This is not financial advice.

Frequently Asked Questions

Q: Are NBFC deposits safe? A: They carry higher risk than bank deposits as they’re not insured. Check credit ratings and choose carefully.

Q: Can NBFC give cheque book? A: No, NBFCs cannot issue cheques to customers.

Q: Is Bajaj Finance a bank? A: No, Bajaj Finance is an NBFC, though it’s often larger than many banks.

Q: Why do NBFCs charge higher interest? A: Higher funding costs, higher-risk customers, and smaller scale.

Q: Can NBFC convert to bank? A: Yes, with RBI approval. Examples: Kotak Mahindra, Bandhan.

Q: How to check if NBFC is registered? A: Search on RBI’s COSMOS database or check RBI website.

NBFCs are the unsung heroes of Indian finance—reaching where banks can’t, serving whom banks won’t, and filling crucial gaps in our financial ecosystem. Understanding them helps you navigate India’s complex financial landscape.