How Does Non-Banking Financial Companies (NBFC) Work?

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How Does Non-Banking Financial Companies (NBFC) Work?

A Non-Banking Financial Company (NBFC) is a company registered under the Companies Act 1956 engaged in the business of loans and advances, and acquisition of shares/ stocks/ bonds/ debentures/ securities. These must be issued by a government, local authority or other marketable securities. Also, they receive deposits under any scheme or arrangement in a lump sum or instalments by way of contribution.

According to Section 45-IA of the RBI Act, 1934, the NBFC must fulfil the criteria to set up a business, obtain a certificate of registration from the bank, and net owned funds of Rs 25 lakhs (it was Rs. 2 crores since April 1999). In the Indian financial system, the NBFCs play an important role in filling the gap in financial markets. There are multiple types of NBFCs such as:

• Asset Finance Companies
• Infrastructure Finance Companies
• Investment Companies
• Loan Companies
• Microfinance Institutions
• Systemically Important Core Investment Companies

How NBFC Raise Funds?

The NBFCs do not deposit the money of customers into savings or current accounts like the banks. So, they raise funds through different sources. Below are several methods that an NBFC can choose to collect the money. 

1. Long-Term Loan on Low-Interest

Most of the time, NBFCs take money for the long term from banks at lower interest rates and the banks provide them the loan due to having access to the deposits of current and saving accounts. These loans can be secured or unsecured.

However, the NBFC repay the loans because of their structured schedule. After the repayment of the loan, the NBFC record it in their balance sheet along with their assets. To get a large sum of funds they must maintain a good credit rating.

2. Foreign Direct Investment (FDI)

In the NBFC, FDI invests money in different forms such as stocks, and shares, convert the loan into shares and share skill sets among others. The RBI is in charge of overseeing the Foreign Exchange Management Act, of 2000.

3. Securitization of Loans

The NBFCs use the method of securitization to increase the amount of lending money. Pooling the group of loans and selling them as a security reduce the amount of risk they carry, receive immediate funds and improves their cash flow. The investors of these securities can get a diverse range of high interest but can also face complex structure, misrepresentation of loan quality and the possibility of the loans not being repaid.

4. Issue Commercial Papers

NBFCs raise funds by issuing commercial papers for short-term periods. These are promissory notes issued by financial companies for a tenure that ranges from 3 to 12 months. The NBFCs with a net worth of INR 100 crores are eligible to list commercial papers.

5. Issue Bonds

By issuing bonds, the NBFCs can easily avail the money at a low cost. Also, the rating of the NBFC helps in deciding the coupon rate. After the maturity of the bonds, repayment of interest schedules is made by the NBFCs. Some NBFCs issue bonds to retail investors as well.

Services of Non-Banking Financial Institutions

Unlike the banks, NBFC doesn’t hold a banking license. There is a difference between the banks and NBFCs. This allows them to be more flexible in their operations and provide financial services to the specific segment which is neglected by the banks. They fill the gaps by providing services such as:

• Financial Inclusion: The people who don’t get financial services from banks, will get it from NBFC. These include small businesses, micro-entrepreneurs, and individuals in rural areas. This reduces the gap and promotes economic growth.
• Product Innovation: The NBFCs are known for their different innovative products that cater for the unique needs of the customers. Borrowers can customise the loan, investment option, risk profiles, etc.
• Competition: It is creating healthy competition in the financial sector and for that, they are pushing banks to offer better services and lower interest rates. Lastly, it gives benefits to consumers by providing them with more choices and better deals.

Conclusion

Overall, the NBFC is a part of the Indian financial system that offers important services and promotes financial inclusion. After registering the company, NBFC must follow the guidelines to better business operations. In case, the NBFC defaults in the payments of any amount taken, then the consumer can go to the National Company Law Tribunal or the Consumer Forum to file a suit against the company.

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