The difference between Banks and NBFCs

What is a Non-Banking Financial Company (NBFC)?

A Non-Banking Financial Company (NBFC) is a company registered under the Companies Act, 1956 engaged in the business of loans and advances, acquisition of shares/ stocks/ bonds/ debentures/ securities issued by Government or local authority or other marketable securities of a like nature, leasing, hire-purchase, insurance business, chit business but does not include any institution whose principal business is that of agriculture activity, industrial activity, purchase or sale of any goods (other than securities) or providing any services and sale/purchase/construction of the immovable property.
A non-banking institution which is a company and has principal business of receiving deposits under any scheme or arrangement in one lump sum or in instalments by way of contributions or in any other manner is also a non-banking financial company (Residuary non-banking company).

NBFCs are mostly private owned financial institutions regulated by the RBI and other government entities. Both of them perform an exceptional role in their respective domains. A comparison between the two is always important from the angle of monetary policy as well as the interest of depositors and investors.
In recent years, the RBI is putting high regulations on NBFCs. Some of the regulations are as hard as that of banks. Extension of SARFAESI clause and putting more capital requirements are some of them. Actually, there is a trend of imposing almost all regulatory requirements of banks in the NBFC sector. This is because the failure of big NBFCs is dangerous to the economy as well. The NBFCs are nicknamed as the shadow banking sector.
NBFCs are regulated by the RBI under the RBI Act of 1935 from 1997 onward. They have to: register with the RBI, keep minimum capital, some of them have to maintain SLR and still some of them have to keep the CRAR (Capital to Risk Asset Ratio) etc. Other strict norms are also detailed by the RBI. Important NBFCs are identified by the RBI by categorizing them into systemically important NBFCs, deposit-taking NBFCs, NBFC- MFI etc.

NBFCs are doing functions similar to banks. What is the difference between banks & NBFCs?

NBFCs lend and make investments and hence their activities are akin to that of banks; however, there are a few differences as given below:

NBFC cannot accept demand deposits;
NBFCs do not form part of the payment and settlement system and cannot issue cheques drawn on itself;
The deposit insurance facility of Deposit Insurance and Credit Guarantee Corporation is not available to depositors of NBFCs, unlike in case of banks.

Deposit acceptance

Firstly, banks can do almost all financial services and products generally authorized to them. They can accept demand deposits (demand deposits have high liquidity and is considered as good as money). NBFCs can’t accept demand deposits.
The NBFCs can provide only specifies functions devoted to them. There are few deposits (other types of deposits) accepting NBFCs, but they are very strictly regulated by the RBI. The NBFCs are allowed to accept/renew public deposits for a minimum period of 12 months and a maximum period of 60 months. There are only 254 deposit-taking NBFCs out of 12000 registered NBFCs. Regarding interest rate, the maximum rate of interest an NBFC can offer is 12.5%. The interest may be paid or compounded at rests not shorter than monthly rests. The repayment of deposits by NBFCs is not guaranteed by RBI.

Regulation

Second, from the angle of financial regulation, banks are strictly regulated by the RBI as they deal with public deposits. The NBFCs also have to follow RBI’s strict regulations but the extent of control is less compared to the banks. But in recent times, there is regulatory convergence between banks and NBFCs. This means that the regulatory norms are now coming look-alike for both (though with slight differences). Following are the main differences between banks and NBFCs.

Why demand deposits acceptance is an important factor separating banks and NBFCs?

A demand deposit is a bank account which allows the account holder to withdraw his money from the account at his will and by any means without notice to the bank. Demand deposits are unique because of two features: (i) liquidity and (ii) accessibility.

Liquidity

The demand deposits balances are like ready to use the money of the account holders in banks. Hence, they are usually considered as money and form the greater part of the narrowly defined money supply of a country. In the definition of Narrow Money, the demand deposits come as the main component.
M₁ = Currency with the Public + Demand Deposits with the Banking System + ‘Other’ Deposits with RBI
There are M0, M1, M2, M3 and M4. The degree of ‘moneyness’ decreases from M0 to M4. M0 is the reserve money which is constituted mainly by currency supply in the economy.
Here, from the monetary policy angle, demand deposit becomes very important. An institution that accepts demand deposits should be strictly controlled and regulated by the RBI. Hence, NBFCs which are nicknamed as shadow banks are not permitted to accept it.
Similarly, when commercial banks issue cheques, it will lead to a multiplier effect on the money supply. Such power is absent for NBFCs as they can’t issue cheques.

Accessibility

The demand deposits can be accessed through any form (ATM, direct banking etc.). Hence the banks have to discharge them as soon and on the spot. Here also the NBFCs as a financial intermediary has limitations.

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