NBFC (Non-Banking Financial Company) And Its Classification

What is NBFC (Non-Banking Financial Company)?

NBFC is a company registered under the Companies Act, 1956/2013 engaged in the business of loans and advances, acquisition of shares/stocks/bonds/debentures/securities issued by Government or local authority or other marketable securities of a like nature, leasing, hire-purchase, insurance business, chit business but does not include any institution whose principal business is that of agriculture activity, industrial activity, purchase or sale of any goods (other than securities) or providing any services and sale/purchase/construction of immovable property.

RBI's Definition of NBFC

As per Section 45I(f) of Reserve Bank of India Act, 1934, "Non-Banking Financial Company" means:

• a financial institution which is a company;
• a non-banking institution which is a company, and which has as its principal business the receiving of deposits, under any scheme or arrangement or in any other manner, or lending in any manner;
• such other non-banking institution or class of such institutions, as the Bank may, with the previous approval of the Central Government and by notification in the Official Gazette, specify.

For understanding NBFC, it is very important that we first understand the terms "Financial Institution" and "Principal Business."

Financial Institution

Section 45I(c) of the Act, defines "Financial Institution" to mean any non-banking institution which carries on as its business or part of its business any of the following activities, namely:

1. the financing, whether by way of making loans or advances or otherwise, of any activity other than its own.
2. the acquisition of shares, stock, bonds, debentures, or securities issued by a government or local authority or other marketable securities of a like nature.
3. letting or delivering of any goods to a hirer under a hire-purchase agreement as defined in clause (c) of section 2 of the Hire-Purchase Act, 1972.
4. the carrying on of any class of insurance business;
5. managing, conducting or supervising, as foreman, agent or in any other capacity, of chits or kuries as defined in any law which is for the time being in force in any State, or any business, which is similar thereto;
6. collecting, for any purpose or under any scheme or arrangement by whatever name called, monies in lumpsum or otherwise, by way of subscriptions or by sale of units, or other instruments or in any other manner and awarding prizes or gifts, whether in cash or kind, or disbursing monies in any other way, to persons from whom monies are collected or to any other person, but does not include any institution, which carries on as its principal business,

• agricultural operations; or
• industrial activity; or
• the purchase or sale of any goods (other than securities) or the providing of any services;
• the purchase, construction or sale of immovable property, so however, that no portion of the income of the institution is derived from the financing of purchases, constructions or sales of immovable property by other persons;

Principal Business

The term "Principal Business" is not defined by the Reserve Bank of India.

Financial activity as principal business is when:

• Company's financial assets constitute more than 50% of the total assets AND
• Income from financial assets constitute more than 50% of the gross income.

This test is popularly known as 50-50 test and is applied to determine whether a company is into financial business or not.

Thus, in order to identify a particular Company as an NBFC, we need to consider both, assets, and the income from the latest audited balance sheet to decide principal business.

Key Difference Between Banks and NBFC

NBFCs lend and make investments and hence their activities are akin to that of banks; however, there are a few differences as given below:

Banks can

• Maintain Demand Deposits (Savings/ Current Accounts)
• Form a part of Payment and Settlement Mechanism and can issue cheques drawn on itself.
• Deposit Insurance facility of Deposit Insurance and Credit Guarantee Corporation is available to Banks.

NBFCs can

• Accept only Term Deposits
• Does not form part of Payment and Settlement Mechanism and cannot issue cheques drawn on itself.
• Deposit Insurance facility of Deposit Insurance and Credit Guarantee Corporation is not available to depositors of NBFCs, unlike in case of Banks.

Both Banks and NBFCs are Financial Intermediaries.

NBFC Classification

NBFCs are classified based on Liabilities, Assets and Size.

Liabilities Based Classification

• NBFCs having Public Deposits (NBFCs-D)
• NBFCs not having Public Deposits (NBFCs-ND)

Asset Based Classification

• Core Investment Companies
• Loan Companies
• Micro Finance Institutions
• Asset Finance Company
• Investment Company
• Infrastructure Finance Companies
• Factor
• Infrastructure Debt Funds

Size Based Classification

• Non-Deposit taking NBFCs with the assets of Rs. 100 Crores and above are classified as Systematically Important Non-Deposit Taking NBFCs (NBFC-ND-SI)
• Non-Deposit taking NBFCs with the assets below Rs. 100 Crores are classified as Non-Systematically Important Non-Deposit Taking NBFCs (NBFC-ND-NSI)

Revised Structure/ Classification under Scale Based Regulation

Under Scale Based Regulation, NBFCs are classified in four layers based on their size, activity, and perceived riskiness. NBFCs in the lowest layer shall be known as NBFCs-Base Layer (NBFCs-BL). NBFCs in middle layer and upper layer shall be known as NBFCs-Middle Layer (NBFCs-ML) and NBFCs- Upper Layer (NBFCs-UL), respectively. The Top Layer is ideally expected to be empty and will be known as NBFCs-Top Layer (NBFCs-TL).

References to NBFC-ND, NBFC-ND-SI and NBFC-D: From October 01, 2022, all references to NBFC-ND (i.e., non-systemically important non deposit taking NBFC) shall mean NBFC-BL and all references to NBFC-D (i.e., deposit taking NBFC) and NBFC-ND-SI (systemically important non-deposit taking NBFC) shall mean NBFC-ML or NBFC-UL, as the case may be.