Financial institutions cater to all segments of the society when it comes to monetary matters. You can get all of the services under one roof, whether it is investing, depositing money, borrowing money, or securing your health or life. They provide a common platform for individuals, businesses, and even the government to conduct transactions.
Banks and Non-Banking Financial Institutions are the two broad categories of financial institutions. Many people mix them up, but they are not the same when it comes to services, rules and regulations, charges, and so on. Let's learn about the difference between banks and NBFCs in detail.
Difference Between NBFC and Bank
When comparing NBFC vs bank, you will notice that both provide lending services; other than that, they differ significantly. Here are some crucial differences.
| Feature | Non-Banking Financial Company (NBFC) | Bank |
| Regulation | Regulated by the Reserve Bank of India (RBI) to a certain extent, primarily by the Companies Act, 2013 | Regulated by the Reserve Bank of India (RBI) |
| Primary Function | Provides financial services like loans, credit facilities, leasing, hire purchase, etc. | Provides financial services and accepts deposits from the public |
| Deposit Taking | Cannot accept demand deposits (like current or savings accounts) from the public | Can accept demand deposits from the public |
| Government Insurance | Cannot offer government-backed deposit insurance | Typically offers government-backed deposit insurance up to a certain limit (e.g., DICGC in India) |
| Access to Payment Systems | Limited access to payment and settlement systems | Full access to payment and settlement systems |
| Capital Adequacy Ratio | Lower capital adequacy ratio requirements compared to banks | Higher capital adequacy ratio requirements |
| Lending Restrictions | More flexibility in lending activities compared to banks | Subject to strict lending restrictions and regulations |
| Risk Profile | Generally higher risk profile due to non-deposit-taking business model | Generally lower risk profile due to deposit-taking and stricter regulatory oversight |
| Focus | Often specializes in specific financial services or sectors | Offers a wide range of financial services to both retail and corporate customers |
What are NBFCs?
NBFC, or Non-Banking Financial Companies, is a registered company that falls under the purview of the RBI Act of 1934. The Reserve Bank of India (RBI) regulates them, but they are not permitted to accept demand deposits. The primary function of an NBFC is to lend funds, offer savings and investment products, sell health, life, and auto insurance, manage portfolios, and so on. In order to engage in NBFC activities, you must first obtain an NBFC registration certificate.
Functions of Non-Banking Financial Companies (NBFCs)
Non-Banking Financial Companies (NBFCs) serve several functions in the financial sector, including:
- Financial Intermediation: NBFCs act as intermediaries between lenders and borrowers, facilitating credit extension and financial services.
- Credit Facilitation: They provide various types of loans and advances, such as personal loans, vehicle loans, business loans, etc., to individuals and businesses who may not have access to traditional banking services.
- Investment Activities: NBFCs invest in various financial assets such as stocks, bonds, debentures, and other securities, contributing to capital market development.
- Asset Financing: They specialize in financing assets like vehicles, equipment, and machinery, often through leasing and hire purchase arrangements.
- Wealth Management: Some NBFCs offer wealth management services, including portfolio management, investment advisory, and financial planning.
- Risk Management: NBFCs manage and mitigate financial risks through hedging, derivatives, and other risk management strategies.
- Microfinance: Many NBFCs focus on providing microfinance services to underserved and economically weaker sections of society, promoting financial inclusion.
- Housing Finance: NBFCs provide housing loans and finance for real estate development, contributing to the growth of the housing sector.
- Foreign Exchange Services: Some NBFCs engage in foreign exchange services, including forex trading, currency exchange, and hedging.
- Electronic Fund Management: NBFCs facilitate electronic fund transfers, payment services, and other financial transactions, often leveraging technology for efficiency.
These functions make NBFCs crucial players in the financial ecosystem, complementing traditional banking services with specialized offerings and catering to diverse financial needs.
What are the different types of NBFCs?
The list of NBFCs is extensive. To keep it short, we have chosen the most common types below.
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Microfinance Companies
Microfinance institutions, as the name implies, provide small loans, typically less than Rs 1,00,000. They cater to low-income individuals, entrepreneurs who lack collateral, or have just started their entrepreneurial journey. Microfinance institutions registered as NBFCs must have a minimum net owned fund of Rs 5 crores. According to the rules, the lender cannot lend more than 10% of the applicant's total assets.
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Insurance companies
Insurance companies provide financial coverage for tragic events that may occur in a person's life. These companies provide insurance for automobiles, health, life, home, and even loans. Insurance companies are regulated by the statutory body- Insurance Regulatory and Development Authority of India (IRDAI).
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Stock-broking companies
Stock broking companies are those that allow customers to buy and sell equities. They are governed by the Securities and Exchange Board of India (SEBI). A full-fledged stock brokerage firm's functionality does not stop there; they also offer advisory, research, and trading services for currencies, commodities, and mutual funds.
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Asset Management Companies (AMCs)
AMCs are firms that pool funds from investors with similar goals and invest them in various asset classes. AMCs provide mutual fund schemes, with each portfolio consisting of several company stocks and debt instruments. The mutual fund schemes are managed by professional fund managers with years of experience. They are regulated by the SEBI.
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Venture Capital (VC) companies
You may be familiar that most financial institutions do not provide start-ups with business loans. VC firms are present in the system to address such issues. They are essentially private equity investors investing funds in start-ups with high growth potential. They also assist these businesses in making industry connections. VCs are under the purview of the SEBI.
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Nidhi Companies
Nidhi companies have limited functionality, and their transactions are limited to their members only. They can accept time deposits from their members and provide borrowing services to them. The RBI does not require these companies to operate under a license issued by them. The concept of Nidhi companies is common in southern India.
What are banks?
Banking institutions are regarded as the apex organisation that controls the majority of India's financial system. They act as a go-between for borrowers and depositors. The primary functionality of banks includes accepting deposits, clearing cheques, managing withdrawals, granting credit, and paying interest. Banks work under the direct supervision of the RBI.
Functions of Bank
Banks serve several essential functions in the economy, including:
Financial Intermediation: Banks connect borrowers (individuals, businesses) who need funds with savers who have excess funds to lend. They facilitate the flow of money from savers to borrowers, thereby promoting economic growth.
- Deposit Taking: Banks accept deposits from individuals and businesses, providing a safe place to store money. These deposits are often used to fund loans and investments.
- Lending: Banks provide loans and credit to individuals, businesses, and governments. This includes personal loans, mortgages, business loans, and financing for infrastructure projects.
- Payments: Banks facilitate domestic and international payments through services like wire transfers, electronic funds transfers (EFT), and issuing debit and credit cards. They play a crucial role in enabling transactions and commerce.
- Investment Banking: Larger banks often offer investment banking services, which include underwriting securities (like stocks and bonds), assisting with mergers and acquisitions, and providing advisory services to corporations.
- Risk Management: Banks help manage financial risks for individuals and businesses through products like insurance, hedging, and derivatives.
- Currency Exchange: Banks provide foreign exchange services, allowing businesses and individuals to exchange currencies for international trade and travel purposes.
- Credit Creation: Banks create money through the process of credit creation. When they issue loans, they effectively increase the money supply, which can stimulate economic activity.
- Financial Advice: Many banks offer financial advisory services to help customers manage their investments, savings, and financial planning.
- Community Development: Banks can contribute to community development by financing local businesses, affordable housing projects, and other initiatives that promote economic and social welfare.
These functions collectively make banks critical institutions in modern economies, facilitating economic growth, financial stability, and societal development.
What are the different types of banks?
The six most common types of banks in India are as follows:
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Central bank
Central bank refers to the RBI. It was founded on April 1st, 1935, and its primary functions include issuing currency, establishing guidelines for other banks, implementing monetary policies, and managing the country's financial system under government supervision.
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Cooperative banks
Cooperative banks were established with the goal of promoting social welfare. They are guided by the provisions of the state government act. Their primary function is to provide short-term funds to people involved in agriculture and related services. Cooperative banks are organised into three tiers, as shown below.
- Tier 1: State-level bank
- Tier 2: District-level bank
- Tier 3: Rural-level bank
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Commercial banks
These banks are established and regulated under the provisions of the Banking Companies Act of 1956. They have a unified structure and serve both urban and rural areas. Commercial banks are classified into three types: public sector, private sector, and foreign banks. Public deposits are their primary funding source, which they channel through loan products to generate revenue.
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Specialised banks
This type of bank is introduced by the Central bank in order to serve a specific market segment. Small Industries Development Bank of India (SIDBI), National Bank for Agricultural and Rural Development (NABARD), and EXIM bank are the most common examples of specialised banks. SIDBI provides financial assistance to small businesses and assists them in purchasing modern equipment. NABARD provides credit to rural areas, small handicraft businesses, etc.
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Payment banks
Payment banks have grown in popularity in India in recent years. They are tailored by the RBI and only accept deposits; no loans or credit cards can be issued on this account. The maximum deposit allowed in the payment bank account is Rs 1,00,000. They also provide services like mobile banking, net banking, and debit card usage.
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Regional Rural Banks (RRBs)
RRBs are commercial banks established to provide credit to the rural and agricultural sectors. These institutions are governed by the Regional Rural Bank Act of 1976. In the context of ownership, the central government owns 50%, commercial banks 35%, and state governments own a 15% stake.
What are the differences between banking and non-banking financial institutions?
When comparing NBFC vs bank, you will notice that both provide lending services; other than that, they differ significantly. Here are some crucial differences.
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Constitution
NBFCs are established as per the provisions of the Companies Act of 1956. Banks are registered and regularised as per the Banking Regulation Act of 1949.
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Acceptance of deposits
Banks are allowed to accept demand deposits. It means that if someone keeps their money in a bank, they can withdraw it whenever they want. However, this feature is only available with certain products, such as savings and current accounts. Banks also accept term deposits, such as fixed and recurring deposits. On the other hand, NBFCs can only offer term deposits, with corporate FDs being their most common product.
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Reserve ratio
Banks are required to maintain a cash reserve ratio (CRR) of 4% of total deposits. The RBI requires them to do so in order to process any big withdrawal request without delay. On the contrary, NBFCs do not need to keep cash reserves.
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Deposit insurance facility
The deposit made in the bank is insured up to Rs 5,00,000. It means you receive up to the specified amount in case of the bank's liquidation or licence revocation. The insurance covers both principal deposits and interest earnings in equal capacity. The insurance facility is provided by the Deposit Insurance and Credit Guarantee Corporation (DICGC). However, when it comes to NBFCs, they cannot receive this advantage.
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Foreign investment
Banks can make the foreign investment up to 74% of their total paid capital, with the remainder held by residents. However, this concept does not apply to foreign banks' wholly-owned subsidiaries. On the other hand, NBFCs are permitted for 100% foreign investment.
Also Read: How to Choose the Best NBFC for a Personal Loan? Conclusion
Banks and NBFCs are both integrated parts of our economy. It assists us in keeping our money safe while also allowing us to earn interest over our earned money and providing assistance through loans during times of crisis. The main differences between banks and NBFCs are deposit acceptance, deposit security, ratio maintenance, and core services. You must consider all these facets of both the
financial institutions to make smart financial decisions.
Frequently Asked Questions
1. What is an NBFC?
An NBFC (Non-Banking Financial Company) is a financial institution that provides banking services like loans, advances, acquisition of shares/stocks/bonds/debentures/securities issued by Government or local authority.
2. What is a Bank?
A bank is a financial institution licensed to receive deposits and make loans. It acts as an intermediary between depositors and borrowers.
3. How are NBFCs different from Banks?
NBFCs cannot accept demand deposits like banks and do not form part of the payment and settlement system.
4. Do NBFCs provide banking services?
Yes, NBFCs provide a range of financial services similar to banks, such as loans, credit facilities, asset management, and wealth management services.
5. Are NBFC deposits insured like bank deposits?
No, deposits with NBFCs are not insured under deposit insurance schemes as with banks.
Disclaimer: Hero Fincorp, a leading financial institution, offers a range of services under regulatory frameworks. We provide comprehensive financial solutions, including investments, deposits, loans, and insurance. Differentiating between banks and NBFCs is crucial, as they vary in services, regulations, and protections. Consult our experts for detailed financial advice.
