Understanding NBFCs - The Next Big Thing In Indian Finance

In India, Non-Banking Financial Companies, or NBFCs, have become an increasingly popular source of funding for individuals and businesses alike, especially with the audience in SME and the MSME markets. In fact, with players like LendingKart Finance, IDFC First Bank, and Poonawalla Fincorp in the market, NBFCs have become almost synonymous with quick and easy financial processes. That being said, what exactly are they, and how do they work?

What Is NBFC?

Simply put, an NBFC is a financial institution that offers banking services without holding a banking license. This means that while they can offer many of the same financial services as traditional banks, they are not allowed to accept deposits from customers. Instead, they rely on borrowing from banks, financial institutions, or other sources to fund their operations.

NBFCs can offer a wide range of financial services, including loans, insurance, investment advice, and more. They often specialize in serving a particular niche, such as small business loans or rural development. In recent years, NBFCs have become an increasingly important source of financing for businesses and individuals who might not be able to obtain loans from traditional banks due to stricter lending criteria.

Types Of NBFCs

Based on their size, activities, and type of ownership, NBFCs in India are categorized differently. Here, we shall discuss some of the most common types of NBFCs in India:

1. Asset Finance Company (AFC): An Asset Finance Company is a financial institution that specializes in providing loans for purchasing assets such as machinery, equipment, and vehicles. They provide loans for both individuals and businesses and use the asset itself as collateral. 

2. Investment Company (IC): An IC is an NBFC that primarily invests the pooled resources of multiple individuals in shares, bonds, and other marketable securities. The goal of an investment company is to provide investors with a diversified portfolio that maximizes returns while minimizing risks.

3. Loan Company (LC): A loan company is a financial institution that specializes in providing loans to individuals or businesses. They make money by charging interest on the loan, which is paid back over a specified period

4. Infrastructure Finance Company (IFC): An Infrastructure Finance Company is a non-banking financial institution that primarily funds long-term infrastructure projects such as roads, ports, airports, and other public utilities. They raise funds from banks, the government, and capital markets to lend to infrastructure projects. 

5. Microfinance Institution (MFI):
   A microfinance company is a financial institution that provides financial services, such as small loans and savings accounts, to low-income individuals and underserved communities who typically lack access to traditional banking services.

How Does An NBFC Work?

NBFCs typically lend money to individuals or businesses that want easy and quick disbursal of a loan, or don't have access to traditional bank loans. NBFCs use their own capital, borrow from banks or financial institutions, or issue bonds and debentures to raise funds. They lend money at a higher interest rate than banks, as they are taking on more risk by lending to borrowers who may not meet the strict criteria of traditional banks.

NBFCs are required to maintain a certain level of net owned fund (NOF) and adhere to different regulatory guidelines such as capital adequacy ratio (CAR) and asset-liability management (ALM). The RBI oversees the operations of NBFCs by conducting regular inspections, on-site examinations, and off-site surveillance.

Apart from providing loans, NBFCs also offer other financial services such as insurance, leasing, and hire-purchase, enabling them to have a variety of income sources. Some NBFCs also offer tailor-made financial solutions to cater to the unique requirements of their clients, making them a much more approachable financial avenue in comparison to traditional banks.

Conclusion

NBFCs have become a vital part of the Indian financial sector, playing a crucial role in promoting financial inclusion, supporting economic growth, and meeting the diverse credit needs of businesses and individuals. With their innovative business models, customer-centric approach, and technology-driven solutions, NBFCs have emerged as a credible alternative to traditional banks, offering a range of financial products and services that cater to the changing needs and aspirations of modern India.