An often heard question from the laymen is what is the difference between a bank and a non banking finance company? Say for example, what would be the difference between ICICI Bank and Mahindra Finance. Yes, banks and other non banking financial institutions differ in some functional area.
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
- NBFC cannot issue Demand Drafts like banks
- Deposit insurance facility of Deposit Insurance and Credit Guarantee Corporation is not available to depositors of NBFCs, unlike in case of banks.
- While banks are incorporated under banking companies act, NBFC is incorporated under company act of 1956.
What is an NBFC?
"A non-bank financial company (NBFC) is a company registered under the Companies Act of 1956, carrying out activities of loans and advances, acquisition of shares/stocks/bonds/debentures/securities issued by the government or a local authority or other negotiable securities of a similar nature, of leasing, hire purchase, insurance, chit, but does not include any institution primarily engaged in farming, industrial activity, the purchase or sale of goods (other than securities) or the provision of services and the sale/purchase/construction of the real estate. - RBI.
Non-banking financial companies play an exceptional role in the economy by carrying out numerous type of financial activities. The NBFCs are a heterogeneous group providing several services ranging from microfinance to insurance. They provide insurance, grant loans to MFIs, finance infrastructure, etc.
NBFC gold lending, chits, etc. are popular examples of NBFC.
Other features of NBFCs are:
- The NBFCs are allowed to accept/renew public deposits for a minimum period of 12 months and maximum period of 60 months. They cannot accept deposits repayable on demand.
- The deposits with NBFCs are not insured.
- The repayment of deposits by NBFCs is not guaranteed by RBI.
Difference in fixed deposits of NBFCs and Banks
Now we all know that both banks and NBFCs accept fixed deposits. However, there are some differences between both. For example, NBFC fixed deposits are generally rated by the rating agencies in the country. On the other hand the fixed deposit of banks are not rated by the rating agencies.
Another difference between the NBFC and bank fixed deposit is the insurance. Bank fixed deposits are insured, while NBFC fixed deposits are not insured.In fact, if there is a default of Rs 1 lakh and less the Deposit Insurance and Credit Guarantee Corporation of India pays the insurance amount on a bank deposit.
On the other hand if a NBFC defaults on its payments, you would lose your principal and insurance amount, which is why you should opt for highly rated safe fixed deposits only.
Also, another thing worth mentioning is that NBFCs tend to offer higher interest rates as compared to bank deposits.
Is there a lending difference between banks and NBFCs?
As far as lending is concerned banks tend to target corporates as well as retailers. On the other hand NBFCs are more geared towards the retail sector. For example, this could be in vehicle finance, consumer loans etc. You do not see them lending to big power projects as an example.
Another difference is in issue of credit cards. Banks tend to frequently issue credit cards of different types depending on the needs of the customers, while NBFCs do not.
Rating: Another key difference
Rating is another key difference between banks and NBFCs. For example, the deposits of NBFCs are rated, while the deposits of banks are not. The latter is considered as very safe, while the former is not. One also needs to remember that the deposits from Non Banking Finance Company are not guaranteed while that of banks are. It is a good idea to hence check the ratings of NBFCs before you invest. In general the good quality ones are AAA rated, which ensures the safety and timely payment of interest and principal amount. Hence, do check the same before investing.
Acceptance of deposit:
First, banks can provide almost all of the financial services and products that are generally permitted to them. They can accept demand deposits (demand deposits have high liquidity and are considered as good as money). NBFCs cannot accept demand deposits.
NBFCs can only provide specific functions dedicated to them. There are few deposits (other types of deposits) accepting NBFCs, but they are very strictly regulated by the RBI. NBFCs are authorized to accept/renew public deposits for a minimum period of 12 months and a maximum period of 60 months. There are only 254 deposits taking NBFCs out of 12,000 NBFCs registered. Regarding the interest rate, the maximum interest rate that an NBFC can offer is 12.5%. Interest may be paid or compounded at rest periods not less than the monthly rest periods. Refund of deposits by NBFCs is not guaranteed by RBI.