What are the differences between banks and NBFCs?

Financial institutions cater to all segments of the society when it comes to monetary matters. You can get all of the services under one roof, whether it is investing, depositing money, borrowing money, or securing your health or life. They provide a common platform for individuals, businesses, and even the government to conduct transactions.
 
Banks and Non-Banking Financial Institutions are the two broad categories of financial institutions. Many people mix them up, but they are not the same when it comes to services, rules and regulations, charges, and so on. Let's learn about the difference between banks and NBFCs in detail. 
 

What are NBFCs?

NBFC, or Non-Banking Financial Companies, is a registered company that falls under the purview of the RBI Act of 1934. The Reserve Bank of India (RBI) regulates them, but they are not permitted to accept demand deposits. The primary function of an NBFC is to lend funds, offer savings and investment products, sell health, life, and auto insurance, manage portfolios, and so on. In order to engage in NBFC activities, you must first obtain an NBFC registration certificate.
 

What are the different types of NBFCs?

 
The list of NBFCs is extensive. To keep it short, we have chosen the most common types below.
 

1. Microfinance Companies

   Microfinance institutions, as the name implies, provide small loans, typically less than Rs 1,00,000. They cater to low-income individuals, entrepreneurs who lack collateral, or have just started their entrepreneurial journey. Microfinance institutions registered as NBFCs must have a minimum net owned fund of Rs 5 crores. According to the rules, the lender cannot lend more than 10% of the applicant's total assets.
    

2. Insurance companies

   Insurance companies provide financial coverage for tragic events that may occur in a person's life. These companies provide insurance for automobiles, health, life, home, and even loans. Insurance companies are regulated by the statutory body- Insurance Regulatory and Development Authority of India (IRDAI).
    

3. Stock-broking companies

   Stock broking companies are those that allow customers to buy and sell equities. They are governed by the Securities and Exchange Board of India (SEBI). A full-fledged stock brokerage firm's functionality does not stop there; they also offer advisory, research, and trading services for currencies, commodities, and mutual funds.
    

4. Asset Management Companies (AMCs)

   AMCs are firms that pool funds from investors with similar goals and invest them in various asset classes. AMCs provide mutual fund schemes, with each portfolio consisting of several company stocks and debt instruments. The mutual fund schemes are managed by professional fund managers with years of experience. They are regulated by the SEBI. 
    

5. Venture Capital (VC) companies

   You may be familiar that most financial institutions do not provide start-ups with business loans. VC firms are present in the system to address such issues. They are essentially private equity investors investing funds in start-ups with high growth potential. They also assist these businesses in making industry connections. VCs are under the purview of the SEBI. 
    

6. Nidhi Companies

   Nidhi companies have limited functionality, and their transactions are limited to their members only. They can accept time deposits from their members and provide borrowing services to them. The RBI does not require these companies to operate under a license issued by them. The concept of Nidhi companies is common in southern India.
    

What are banks?

 
Banking institutions are regarded as the apex organisation that controls the majority of India's financial system. They act as a go-between for borrowers and depositors. The primary functionality of banks includes accepting deposits, clearing cheques, managing withdrawals, granting credit, and paying interest. Banks work under the direct supervision of the RBI. 
 

What are the different types of banks?

 
The six most common types of banks in India are as follows:
 

1. Central bank

   Central bank refers to the RBI. It was founded on April 1st, 1935, and its primary functions include issuing currency, establishing guidelines for other banks, implementing monetary policies, and managing the country's financial system under government supervision.
    

2. Cooperative banks

   Cooperative banks were established with the goal of promoting social welfare. They are guided by the provisions of the state government act. Their primary function is to provide short-term funds to people involved in agriculture and related services. Cooperative banks are organised into three tiers, as shown below.
    
   • Tier 1: State-level bank
   • Tier 2: District-level bank
   • Tier 3: Rural-level bank
    

3. Commercial banks

   These banks are established and regulated under the provisions of the Banking Companies Act of 1956. They have a unified structure and serve both urban and rural areas. Commercial banks are classified into three types: public sector, private sector, and foreign banks. Public deposits are their primary funding source, which they channel through loan products to generate revenue.
    

4. Specialised banks

   This type of bank is introduced by the Central bank in order to serve a specific market segment. Small Industries Development Bank of India (SIDBI), National Bank for Agricultural and Rural Development (NABARD), and EXIM bank are the most common examples of specialised banks. SIDBI provides financial assistance to small businesses and assists them in purchasing modern equipment. NABARD provides credit to rural areas, small handicraft businesses, etc.
    

5. Payment banks

   Payment banks have grown in popularity in India in recent years. They are tailored by the RBI and only accept deposits; no loans or credit cards can be issued on this account. The maximum deposit allowed in the payment bank account is Rs 1,00,000. They also provide services like mobile banking, net banking, and debit card usage.
    

6. Regional Rural Banks (RRBs)

   RRBs are commercial banks established to provide credit to the rural and agricultural sectors. These institutions are governed by the Regional Rural Bank Act of 1976. In the context of ownership, the central government owns 50%, commercial banks 35%, and state governments own a 15% stake.
    

What are the differences between banking and non-banking financial institutions?

 
When comparing NBFC vs bank, you will notice that both provide lending services; other than that, they differ significantly. Here are some crucial differences. 
 

• Constitution

  NBFCs are established as per the provisions of the Companies Act of 1956. Banks are registered and regularised as per the Banking Regulation Act of 1949. 
   

• Acceptance of deposits

  Banks are allowed to accept demand deposits. It means that if someone keeps their money in a bank, they can withdraw it whenever they want. However, this feature is only available with certain products, such as savings and current accounts. Banks also accept term deposits, such as fixed and recurring deposits. On the other hand, NBFCs can only offer term deposits, with corporate FDs being their most common product.
   

• Reserve ratio

  Banks are required to maintain a cash reserve ratio (CRR) of 4% of total deposits. The RBI requires them to do so in order to process any big withdrawal request without delay. On the contrary, NBFCs do not need to keep cash reserves.
   

• Deposit insurance facility

  The deposit made in the bank is insured up to Rs 5,00,000. It means you receive up to the specified amount in case of the bank's liquidation or licence revocation. The insurance covers both principal deposits and interest earnings in equal capacity. The insurance facility is provided by the Deposit Insurance and Credit Guarantee Corporation (DICGC). However, when it comes to NBFCs, they cannot receive this advantage.
   

• Foreign investment

  Banks can make the foreign investment up to 74% of their total paid capital, with the remainder held by residents. However, this concept does not apply to foreign banks' wholly-owned subsidiaries. On the other hand, NBFCs are permitted for 100% foreign investment.
   

Also Read: How to Choose the Best NBFC for a Personal Loan?
 

To conclude

Banks and NBFCs are both integrated parts of our economy. It assists us in keeping our money safe while also allowing us to earn interest over our earned money and providing assistance through loans during times of crisis. The main differences between banks and NBFCs are deposit acceptance, deposit security, ratio maintenance, and core services. You must consider all these facets of both the financial institutions to make smart financial decisions.