What is The Differences Between Banks and NBFC’s?

A country can’t function efficiently without having in place, a sound, and effective banking system. India is currently pegged as the fastest-growing trillion-dollar economy in the world while also being ranked as the sixth-largest. As per the International Monetary Fund (IMF) projection, India is poised to become the fifth-largest economy overtaking the United Kingdom in 2019. In addition, the Indian banking sector is also on course to become the fifth largest by 2020 – as per a report published by KPMG-Confederation of Indian Industry (CII).

Banks and NBFCs (Non-Banking Financial Companies) are financial institutions that form the backbone of the financial system of any country. While in essence, they provide a similar set of services, there are key differentiating factors which separate one from the other. Before we get into the nitty-gritty of the differences, let’s take a look at the role banks and NBFC’s play in nation-building.

Banks

Banks have long been the traditional institution entrusted and authorized by the country’s government to execute a gamut of financial functions & services including accepting deposits, granting credit, managing withdrawals, paying interest, clearing cheques amongst others. Considered to be the apex financial organization, banks are also responsible for performing a series of general services for the benefit of the public. In that regard, here are some of the many functions carried out by a bank:

Banks have an integral role to play in the economic development of our country as well as in ensuring the smooth functioning of the economy. One of the primary functions of a bank is to connect with those who need capital. Banks can do this by collecting the surplus savings of the people and making them available for investment in productive enterprises. In essence, they double up as a financial intermediary between the depositors and borrowers.

Banks usually collect these funds from the following sources: checking or current accounts, Savings Accounts, time deposits as well as short-term borrowings from other banks and equity capital. A bank earns money on these borrowings by reinvesting these funds and earning interest on longer-term assets.

Banks help in safeguarding and protecting the valuables of a customer. Besides, they also help in appraising and certifying their true market value

Banks help in facilitating internal and international trade. Since a major proportion of this trade is executed on credit, banks take it upon themselves to provide references and guarantees, on behalf of their customers. This guarantee is the foundation on which sellers can supply goods on credit.

NBFCs

While banks have for long been viewed as the traditional institution for carrying out financial transactions, the reality is that they aren’t the only institution that performs these functions. Non-Bank Financial Companies or NBFCs represent one of the most important components of a financial system and act as the missing link by bridging the gap left by traditional banks. NBFCs can be better described as establishments that provide financial services and banking facilities without meeting the legal definition of a bank. They also help in catering to the diverse financial needs of customers– especially the micro, small and medium enterprises (MSMEs) – that might have been excluded by the bank.

The contribution of NBFCs to the Indian economy has grown in leaps and bounds in recent years. From just 8.4 percent in 2006, it has crossed 14 percent mark in March 2015 – as per a Kotak Securities analysis.

One of the key advantages of NBFC’s is their distribution reach as they help in reaching sectors where traditional banks do not lend– these are sectors which form the cradle of entrepreneurship and innovation. However, it needs to be mentioned that NBFCs are still bound by the Indian banking industry rules and regulations.

The NBFC sector in India has now come to be recognized as one of the systemically crucial components of our economy as it has consistently shown year-on-year growth. Furthermore, NBFCs have a very vital role to play in the core development of infrastructure, transport, employment generation, wealth creation opportunities, as well as in lending financial support for economically weaker sections. Last but not least, NBFCs also make a huge contribution to the state exchequer.

That said, let’s take a look at some of the differences between a bank and NBFC:

Distinct Set of Differences Between a Bank and NBFC

A Bank is authorized to accept deposits in the form of cash from customers. However, NBFCs aren’t allowed to accept customer cash deposits. In the same vein, while customers can open a Savings or Checking/Current Account at a bank, NBFCs aren’t licensed to open Savings or Checking/Current accounts on behalf of their customers.

At present, Foreign Direct Investment (FDI) of up to 74 percent can be invested in Private Banks with the government’s approval. In the case of Public Sector Banks, the current limit is only 20 percent. Under the current rules, 100 percent FDI is permitted in NBFCs.

A bank is registered under the Banking Regulation Act, 1949 and therefore needs to comply by its regulations accordingly. On the other hand, an NBFC is incorporated under the Companies Act, 1956 and have to adhere to the regulations governed by it.

Banks are authorized to issue ATM cards for their customers, whereas NBFCs are not permitted to do so.

Banks are authorized to issue Credit Cards such as an SBI Credit Card. However, this is dependent on the eligibility of its consumers. On the contrary, NBFCs aren’t allowed to issue Credit Cards to their consumers.

There’s also a major difference between the two in terms of ratings. While schemes offered by banks are not subject to ratings by rating agencies, schemes provided by NBFC’s, on the other hand, are assessed for their risks by rating agencies. For instance: a rating of AAA is deemed to be excellent while a rating of DDD is usually pegged as a poor rating.

Deposits made in banks are insured up to a maximum of Rs. One lakh by Deposit Insurance and Credit Guarantee Corporation of India. In the case of NBFCs, if there’s a default, the investor can stand to lose their principal.

In case of loans offered by banks, interest rates are determined by RBI and fixed as per their regulations. While loans offered by NBFCs also have to adhere to the rules and regulations laid down by RBI, they are authorized to offer flexible rates.

Banks provide an array of transaction services to the benefit of the customers, while NBFC does not facilitate similar services.

While banks aren’t allowed to offer investment schemes such as Mutual Funds and Systematic Investment Plans, NBFCs which are operated by banks and other private companies can offer these schemes for investment purposes.

While banks are not directly permitted to offer insurance schemes and can do so only in collaboration with insurance companies, NBFCs are authorized to offer insurance policies.

The Bottom Line

Despite the various set of differences between banks and NBFC’s, they both have a massive role to play in the economic progress and development of the country. While banks will always be the backbone of the economy, NBFCs are equally important as they cater to a variety of customers that would only serve to push the economy in the right direction.