A Non-Banking Financial Company is a crucial player in promoting economic growth in India by catering to the diverse financial needs of individuals and businesses not served by traditional banks. As the functions of NBFCs expand within the Indian Economy, the Reserve Bank of India took a significant step by issuing the Master Direction – IT (Information Technology) Structure for the NBFC sector in 2017. These directions establish the Information Technology Framework for NBFCs, aiming to enhance security, efficiency, and streamline processes, ultimately benefiting both NBFCs and their clientele.
However, this regulatory development presents a challenge, particularly for smaller NBFCs and Fintech Start-ups. Understanding the evolving regulatory frameworks and functions of NBFCs in India is essential to deal with the financial system effectively and ensure compliance with regulatory norms.
Understanding the Meaning of NBFC
NBFCs often take the lead in providing innovative financial services, especially customised for Micro, Small, and Medium Enterprises, aligning with their unique business requirements. These financial intermediaries play a vital role in the country’s economic development by contributing to employment generation, credit facilitation, transportation, wealth creation in rural areas, and providing financial assistance and guidance during emergencies, including insurance matters.
NBFCs primarily engage in accepting deposits, offering credit, and act as intermediaries in channelling limited financial resources into capital formation. They complement the functions of banks by meeting the growing financial needs of the corporate sector and providing credit to the unorganised and small local borrowers. However, NBFCs do not extend services related to industrial activity, sale, agriculture, purchase, or construction of immovable property. NBFC registration is governed by Indian Banking industry rules and regulations despite their distinction from traditional banks.
Their core focus areas include business-related loans and advances, acquisition of various financial instruments, hire-purchase, chit business, leasing, and insurance business. While the banking sector remains a vital force in aiding infrastructural development and supporting various economic aspects, the functions of NBFCs hold significant importance, augmenting the economy in the right direction and contributing to a more inclusive financial landscape.
Functions of NBFCs in India
Non-Banking Financial Companies offer a wide range of financial services. Some of the essential functions of NBFCs in India are:
1. Retail Financing
NBFCs provide short-term funds to individuals and businesses for various purposes, such as loans against gold, shares, and property, primarily for consumption needs. These loans cater to the immediate financial requirements of borrowers and this forms one of the primary functions of NBFCs in India.
2. Infrastructural Funding
One of the most significant sectors where leading NBFCs are actively involved is infrastructural funding. A substantial portion of funds is allocated to this sector, encompassing projects like railways, metros, real estate developments, ports, flyovers, airports, and more. One of the most important functions of NBFCs in India is that they contribute significantly to the growth and development of critical infrastructure in the country.
3. Hire Purchase Services
NBFCs facilitate hire purchase services, a method by which sellers provide products or goods to buyers without transferring ownership. Buyers make payments in instalments, and once all payments are completed, ownership of the goods automatically transfers to the buyer. This service helps individuals and businesses acquire essential assets without a large upfront payment.
4. Trade Finance
Another one among the important functions of NBFCs in India is that they offer trade finance solutions, particularly distributor or dealer finance, to support businesses in managing their vendor finance, working capital requirements, and other business loans. These services enable businesses to maintain liquidity and manage their supply chains efficiently.
5. Asset Management Companies
NBFCs operate as Asset Management Companies, which include fund managers responsible for investing funds pooled from small investors. These fund managers actively manage the investments, primarily in equity shares, to generate returns for investors. AMCs play a vital role in the mutual fund industry, offering investment opportunities to a broad range of investors.
6. Venture Capital Services
Certain NBFCs engage in venture capital services by investing in small businesses at their initial stages. While these investments carry higher risks, they also have the potential for substantial returns in the future. NBFCs provide crucial funding to startups and early-stage companies, fostering entrepreneurship and innovation.
7. Leasing Services
Among the major functions of NBFCs in India is also that NBFCs offer leasing services, analogous to renting but with distinct features. They provide properties and assets to small and sometimes larger businesses that may not have the resources to purchase them outright. Leasing contracts typically have fixed durations, allowing businesses to access assets for a specified period, enhancing their operational capabilities.
What is the Role of NBFCs in Economic Transformation of India
Significance and role of NBFCs can be attributed to several factors that set them apart from traditional banks:
1. Impressive Growth Trajectory
Between 2006 and 2013, the NBFC sector outpaced the banking sector in terms of growth rate. With an average annual growth rate of approximately 23%, NBFCs have consistently contributed to the nation’s economic expansion. This growth demonstrates their increasing importance in driving economic progress.
2. Promoting Inclusive Development
NBFCs cater to a diverse clientele, spanning both rural and urban areas. They actively finance small-scale companies and entities, a critical driver of growth in rural regions. Moreover, NBFCs facilitate small-ticket loans for affordable housing projects, fostering comprehensive development across the country. Their commitment to serving a wide spectrum of customers contributes significantly to social and economic inclusivity.
3. Resilient Sector
The NBFC sector has exhibited robust growth even during economic slowdowns. Despite challenging economic conditions, NBFCs have continued to expand and innovate, showcasing their resilience as a crucial pillar of the Indian economy.
4. Infrastructure Financing
NBFCs make substantial contributions to India’s infrastructure development, a fundamental requirement for a rapidly growing nation. These projects demand substantial funds and yield profits over extended periods, making them inherently risky for traditional banks. In recent years, NBFCs have surpassed banks in financing infrastructure projects, playing a pivotal role in shaping India’s future.
5. Enhanced Profitability and Cost Efficiency
Compared to the banking sector, NBFCs are renowned for their cost-efficient operations, resulting in increased profitability. Lower operational costs enable NBFCs to offer competitive interest rates on loans, making them an attractive option for borrowers. This cost advantage has propelled the credit growth of NBFCs, with more clients choosing them over traditional banks.
The functions of NBFCs in India have emerged as game-changers that have become indispensable to the nation’s economy. Their remarkable growth, commitment to inclusive development, resilience in challenging times, focus on infrastructure financing, and cost-effective operations make them key drivers of economic transformation.
Final Thoughts
Non-Banking Financial Companies have emerged as transformative forces within the Indian economy. Their extraordinary growth rates, surpassing traditional banks, demonstrate their increasing significance. The functions of NBFCs in India range from fostering comprehensive development by extending financial services to a diverse clientele, spanning both rural and urban areas. Their support for small-scale enterprises and affordable housing projects contributes significantly to inclusive growth.
Additionally, the sector’s resilience, even during economic downturns, underscores its importance in maintaining financial stability. NBFCs’ substantial contributions to infrastructure financing fill a crucial void left by risky banks. Also, the cost-efficiency of NBFCs enables them to offer competitive loans, attracting a growing client base and helping Indi’s economic growth and development.
Aishwarya Agrawal
Ms. Aishwarya Agrawal is a graduate from Hidayatuallah National Law University, Raipur [HNLU Raipur]. Aishwarya holds a great interest in adding value to the legal fin-tech sector. She joined "StartupFino" with a motive to help budding lawyers in their day-to-day journey in the field of Law.
