Difference between Banks and NBFCs

Banks and NBFCs are the primary financial institutions in any financial system. Without a doubt, a layman or beginner in finance and banking may be confused between banks and non-banking financial companies. As both banks and NBFCs lend and invest in various sectors, their activities are pretty similar. However, there are critical differences between these two financial intermediaries. In this article, we will look at an overview of banks and NBFCs. Later, we will also discuss the difference between banks and NBFCs.

What are banks? 

Banks are financial institutions with the authorization to provide banking services by the government. They offer banking services to the public. So, banks conduct a diverse range of banking activities, including accepting deposits, providing credit and withdrawal management, interest payments, cheque clearance, and other general utility services to the public. Moreover, they are the apex financial institutions that dominate the country's overall ecosystem. They are financial intermediaries as they act as mediators between depositors and borrowers. Therefore their primary function is to ensure a smooth flow of money.

In India, there are various banks such as public sector banks, cooperative banks, private sector banks, and foreign banks. Their primary functions are:

  • Giving loans
  • Credit creation
  • Deposit mobilization 
  • Secure and time-bound money transfer 
  • Offer public utility services. 

What are NBFCs? 

NBFCs are companies registered under the Companies Act of 1956 or 2013. The Reserve bank of India regulates them under the RBI Act of 1934. Although NBFCs are not banks, they still carry out equally important banking activities such as: 

  • Lending loans and advances
  • Acquisition of securities (sovereign or private), shares, bonds, stocks, debentures, and other similar negotiable securities
  • Leasing and trade financing 
  • Asset Management 
  • Trading in money market instruments
  • Management of stock portfolio 
  • Investment products
  • Retail Financing
  • Hire - purchase
  • Insurance and chit business

Generally, non-banking financial companies are private. However, when the government-owned entities merge with them, in such cases, they become Non-Banking Financial Intermediaries. Non-banking financial companies need to register themselves with the RBI and maintain minimum capital. However, some NBFCs also have to keep statutory liquidity ratio (SLR) and Capital to Risk Asset Ratio (CRAR).

Difference between Banks and NBFCs

NBFCs are privately-owned companies regulated and monitored by RBI and other government entities such as the Ministry of Corporate Affairs and IRDAI. Both banks and NBFCs perform exceptionally well in their respective fields. However, a comparison between NBFCs and banks is always significant to deeply understand various angles of monetary policy and the interest of depositors and investors.

Here are the key differences between banks and NBFCs in India

  1. Banks are government-authorized financial institutions working to provide banking services to their customers. On the other hand, NBFCs are the companies that offer banking services to the public without owning a bank license.
  2. NBFCs are registered under the Companies Act of 1956. In contrast, banks are registered under the Banking Regulation Act of 1949.
  3. NBFCs can accept and renew public deposits for a fixed period of a minimum of 12 months and a maximum period of 60 months. However, there are no such time limits for banks. Moreover, there are differences even between the fixed deposits of banks and NBFCs. 
  4. The critical difference lies in the fact that the agencies rate fixed deposits of NBFCs. However, this is not true for demand deposits of banks. So, it is advisable to check the ratings before depositing in an NBFC. AAA-rated NBFCs are excellent in terms of safe and timely interest payments.
  5. Also, they cannot take repayable deposits on demand, i.e., demand deposits (neither current account nor savings account). Demand deposits are highly liquid. However, banks can accept demand deposits, including current accounts as well as savings accounts.
  6. Fixed deposits held with NBFCs do not come under deposit insurance. The reason for this is that NBFCs are not covered under the payment and settlement system of RBI. So, when an NBFC fails, depositors have no credit guarantee for their savings with that NBFC. However, deposits held with almost all banks (except Primary Agricultural Credit Societies, i.e., PACS) come under the Deposit Insurance and Credit Guarantee Scheme. Deposit Insurance and Credit Guarantee Corporation of India will pay a sum of Rs. 5 lakhs (Principal amount plus interest) to the depositors of the banks. 
  7. Non-banking financial companies do not have permission to issue Demand Drafts. However, banks can issue demand drafts.  
  8. NBFCs do not have permission to issue cheques drawn on themselves. However, banks have permission to do so. When a bank issues a cheque, this has a multiplier effect on the money supply. 
  9. Another critical difference between NBFCs and banks is the issuance of credit cards. NBFCs generally do not issue credit cards, while banks do so quite frequently.
  10. In foreign direct investment up to 100%, FDI is allowed for NBFCs. Alternatively, the maximum limit on FDI for the banking sector is 74%.
  11. Most NBFCs do not need to maintain reserve ratios, i.e., cash reserves and statutory liquidity ratios. However, maintaining CRR and SLR is mandatory for all the banks in India. 
  12. There is no priority sector lending requirement for NBFCs. However, banks need to follow PSL targets. These PSL targets vary for different banks, i.e., 40% for public sector banks, 75% for Regional rural banks, and small finance banks. 
  13. Banks also play an important role in credit creation, while NBFCs do not. 
  14. Most NBFCs do not provide transaction services as banks do. Some of these transaction services include an overdraft facility, issuance of traveler’s cheque, fund transfer.  
  15. Moving on to financial regulation, while banks are strictly monitored by the RBI, NBFCs, on the other hand, are also regulated but comparatively under a less rigid framework. 

Here, we have compiled the key differences between banks and NBFCs in a tabular form:

Area of Comparison

Banks

NBFCs

Definition

Banks are financial institutions that have authorization from the government. So, they offer banking services to the public.

NBFCs are companies registered under the Companies Act of 1956 or 2013. Moreover, they are regulated by the Reserve bank of India under the RBI Act of 1934.

Incorporated Under

Banks are registered and monitored by RBI under the Banking Regulation Act of 1949.

NBFCs are registered under the Companies Act of 1956. Also, a company needs to get an NBFC license from RBI.

FDI Limits

74%

100%

Payment & Settlement System

Applicable

Not Applicable

Demand Deposits

Accept        

Don’t accept

Reserve Ratios

Compulsory 4% CRR, 18% SLR

No CRR

SLR of 15% for deposit accepting NBFCs

Deposit Insurance

Covered

Not covered

Credit Creation

Involved

Not involved

Provisioning

Applicable

Applicable

SARAFESI

Applicable

Applicable

CRAR  Maintenance

Applicable

15% CRAR for Deposit accepting NBFCs and Non-Deposit accepting but Systemically Important NBFCs. Systemically important NBFCs are considered too big to fail.

In conclusion, non-banking financial companies play an excellent role in the economy by carrying out numerous economic activities. Lastly, the NBFCs ecosystem comprises a heterogeneous group of companies offering various types of services. These services include microfinance, insurance, personal and infrastructural loans, finance infrastructure, etc.
 


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