How does a non-bank finance company differ from a banking institution?

In the age of digitalisation, one thing that has become easily accessible is a loan. Whether you want a home loan, business finance, personal loan, or credit card, you just need to open your smartphone, download your preferred financial institution’s app, fill out the application form, upload KYC and income proof, and await approval.

But when choosing your ideal lender for better working capital in financial management, do you know you have a choice between a banking institution and a non-bank finance company? Many believe both these lenders are similar, but in reality, they are very much different.

Let’s understand how.

Difference Between Bank and Non-Bank Finance Company

Banks and NBFCs differ mainly in terms of regulation and deposit taking abilities. Let’s understand them. 

1. Regulation

The RBI governs banks under the Banking Regulation Act of 1949 and the RBI Act of 1934. These acts give the RBI the power to issue licenses, set prudential norms, conduct inspections, impose penalties, and take corrective actions on banks. The RBI also issues various circulars, guidelines, and notifications to regulate the functioning of banks.

NBFCs need to get registration under the Companies Act of 2013 and be regulated by the RBI under the RBI Act 1934. However, the RBI has a different degree of control over NBFCs than it has over banks.

2. Public Deposits

Banks can accept public demand deposits (such as savings and current accounts). These deposits are payable on demand or short notice. Not only that, bank deposits are insured up to Rs 5 lakhs per depositor under the Deposit Insurance and Credit Guarantee Corporation (DICGC).

NBFCs cannot accept demand deposits from the general public. They are not allowed to issue cheques or drafts. NBFCs can only accept term deposits (such as fixed and recurring deposits) from the public, payable after a fixed period. However, these deposits are not insured by the DICGC.

However, since deposit-taking also exposes banks to liquidity and solvency risks, they have to maintain a minimum cash reserve ratio (CRR) and statutory liquidity ratio (SLR) with the RBI to meet the withdrawal demands of the depositors.

Types of Non-Bank Finance Companies and Banking Institutions

Non-Bank Finance Company:

• Life insurance companies: Life insurers provide life insurance products to individuals and groups and are regulated by the IRDAI. Life insurers must maintain a minimum paid-up capital of Rs 100 crore to start operations.

• Non-life insurance companies: These companies provide general insurance products, such as health, motor, property, and liability insurance, to individuals and businesses.

• Asset management companies: These companies invest pooled client funds into various asset classes and offer mutual funds, exchange-traded funds, and portfolio management services. The SEBI regulates them.

• Venture capitalists: They provide capital to startups and small businesses with high growth capability in swap for equity stakes. 

• Nidhi companies: They are formed as public limited companies to cultivate the habit of thrift and savings among their members and provide loans to their members only. 

Banking Institutions:

• Cooperative Banks: They are organised under the state government’s act and provide short-term loans to the agriculture sector and other allied activities. They are owned and managed by their members, mostly farmers, small businessmen, and artisans. 

 

• Commercial Banks: They accept deposits from the general public and lend money to various sectors of the economy, such as industry, trade, and services. They are owned and managed by private or public entities.

 

• Regional Rural Banks (RRBs): They operate in rural areas and cater to the needs of the rural population. The central government, the state government, and a sponsor bank jointly own them. 

 

• Specialised Banks: These banks specialise in a particular sector or activity, such as export-import, industrial development, and housing. They are owned and managed by the central government or other entities. Some examples include NABARD, EXIM Bank, and National Housing Bank.

 

• Payments Banks: These banks offer limited banking services, such as accepting deposits, issuing prepaid cards, and facilitating remittances, but do not lend money. They are owned and managed by private entities. 

 

• Small Finance Banks: They provide basic banking services to the underserved population of society, such as small farmers and micro and small enterprises. They are owned and managed by private entities.

Conclusion

Banks and NBFCs are both essential components of our economy. They help us safeguard our money, earn interest on our income, and provide support through loans in times of need. The main differences between banks and NBFCs are deposit taking, deposit protection, ratio compliance, and core services. You should consider all these aspects of both financial institutions to make wise financial choices.