Non-Banking Financial Company

Also called: NBFC · Topic: Banking Regulation, NPAs and Financial Stability · NCERT: Beyond NCERT

Meaning

A Non-Banking Financial Company (NBFC) is a company registered under the Companies Act whose main business is lending, investing or financing assets. It is regulated by the RBI under Chapter IIIB of the RBI Act, 1934, and it must register under Section 45-IA. It is not a bank. It cannot take demand deposits, it cannot issue cheques drawn on itself, and any deposits it holds get no deposit insurance.

Why it matters:

• NBFCs lend to people and firms that banks often miss.
• Their rules are lighter than bank rules.
• They usually fund long-term loans with short-term borrowing. So when one NBFC fails, the trouble can spread to banks and mutual funds, as the IL&FS default (2018) and the DHFL collapse (2019) showed.

Principal-business (50-50) test. A company is an NBFC only if both conditions hold:

• Financial assets / Total assets > 50%
• Income from financial assets / Gross income > 50%

Explanation

How an NBFC works and how it differs from a bank

• An NBFC borrows money from banks, from markets (for example through commercial paper, which is a short-term unsecured note) and, in some cases, from the public as deposits. It then lends or invests that money.
• Three legal limits make it different from a bank:
• No demand deposits. It cannot open savings or current accounts that can be withdrawn at any time.
• No cheques drawn on itself. So it is not part of the payment and settlement system.

• No DICGC cover. DICGC (Deposit Insurance and Credit Guarantee Corporation) insures bank deposits. It does not insure deposits placed with an NBFC.

• Because it takes no demand deposits, an NBFC does not create money through deposits the way a universal bank does (credit creation, Class 12).

Worked example: the 50-50 test

• Company A has total assets of Rs 500 crore. Rs 300 crore of this is loans and investments, which is 60%. Condition 1 is met.
• Its gross income is Rs 80 crore. Rs 44 crore of this comes from interest and dividends, which is 55%. Condition 2 is met.
• Result: Company A is an NBFC and must register with the RBI.
• If its financial income were only Rs 36 crore (45%), it would fail the test, even with 60% financial assets. Both conditions must hold.

Types of NBFC

• NBFC-ICC (Investment and Credit Company): general lending and investing.
• NBFC-MFI: gives microfinance loans (small loans to low-income borrowers).
• Housing Finance Company (HFC): home loans. Its regulation moved from NHB to RBI in 2019.
• Infrastructure finance company: long-term loans for roads, power and similar projects.
• Core Investment Company (CIC): mainly holds shares in its own group companies.

Scale-based regulation (SBR)

• Scale-based regulation means the rules get tighter as an NBFC grows larger and more important to the whole system.
• It was announced in October 2021 and took effect in October 2022.

Layer	Who is in it	Rules
Base	Small NBFCs	Light
Middle	All deposit-taking NBFCs and larger non-deposit NBFCs	Moderate
Upper	NBFCs the RBI names as systemically important	Must list within 3 years and keep CET1 of 9%
Top	Ideally empty	Used only if an upper-layer NBFC becomes a serious risk

• CET1 (Common Equity Tier 1): the best-quality capital, mainly shareholders' money and retained profits. It absorbs losses first.
• Listing means the NBFC's shares trade on a stock exchange. This forces it to disclose more and to answer to investors.
• PCA (Prompt Corrective Action) now also applies to NBFCs. Under PCA, the RBI puts limits on a weak NBFC once its capital or asset quality crosses set thresholds.

What makes an NBFC fragile: asset-liability mismatch (ALM)

• Asset-liability mismatch is the gap between how long the NBFC's loans last (its assets) and how long its own borrowings last (its liabilities).
• How a liquidity crisis builds:
• The NBFC funds long loans with short borrowing.
• It must roll over that borrowing (borrow again) every few months.
• If markets panic and nobody lends to it, it cannot repay.
• A liquidity crisis follows, even if its loans are good.

Worked example: ALM gap

• An NBFC gives Rs 1,000 crore of 15-year housing loans. Borrowers repay about Rs 70 crore a year.
• It funded these loans with Rs 1,000 crore of 3-month commercial paper.
• Every 3 months it must raise Rs 1,000 crore of new money. In the same 3 months it gets back only about Rs 17.5 crore.
• If buyers stop buying its paper, the funding gap is about Rs 982 crore in one quarter.

In India

• Regulator and law: the RBI regulates NBFCs under Chapter IIIB of the RBI Act, 1934. Registration is under Section 45-IA. HFCs moved from NHB to the RBI in 2019.
• IL&FS default (September 2018):
• It funded long infrastructure loans with short-term money.

• When it defaulted, trust in NBFCs broke and credit to NBFCs froze.

• DHFL (2019):

• It funded long-term housing loans with commercial papers.

• It was the first financial service provider taken to the IBC under Section 227. Section 227 lets the government notify financial firms for insolvency resolution. Normally the Insolvency and Bankruptcy Code (2016) does not cover them.

• Contagion (trouble spreading from one firm to others):

• Mutual funds and banks held NBFC paper.
• So NBFC losses hit them too.

• Funding then dried up for all NBFCs, even the healthy ones.

• Bank-NBFC link: banks are the largest lenders to NBFCs, so NBFC stress can come back to banks as NPAs (loans that are not being repaid).

• RBI circular of 16 November 2023 [1]:
• Risk weights on bank loans to NBFCs rose by 25 percentage points above the level linked to the NBFC's credit rating, wherever that risk weight was below 100% [1].
• Loans to HFCs and NBFC loans that count as priority sector were exempt [1].
• Banks had to review their credit standards by 29 February 2024 [1].
• These risk weights were partly rolled back in 2025 (check the current position).

Worked example: risk weight

• A risk weight decides how much of a loan counts when the bank works out the capital it must hold under the Basel norms.
• A bank lends Rs 100 crore to an AA-rated NBFC at a 30% risk weight. Its risk-weighted assets are Rs 30 crore. At an 11.5% total capital requirement, it must hold about Rs 3.45 crore of capital.
• After the 2023 increase, the risk weight is 55%. Risk-weighted assets become Rs 55 crore, and the capital needed becomes about Rs 6.3 crore.

• The same loan now needs almost twice the capital, so banks lend less readily to NBFCs.

• Digital lending: the RBI (Digital Lending) Directions, 2025, issued on 8 May 2025, apply to NBFCs (including HFCs) as well as to banks [2]:

• No loan may be paid into a third-party account [2].
• The Key Fact Statement must show the APR (Annual Percentage Rate, the all-in yearly cost of the loan) [2].
• Borrowers get a cooling-off period of at least 1 day [2].

• A Default Loss Guarantee (DLG) is capped at 5% of the amount disbursed [2].

• Global scale: non-bank financial intermediaries hold about half of global financial assets (2025). Their share has grown from about 40% to nearly 50% since the 2008 crisis [3].

Don't confuse with

• Commercial bank: a bank takes demand deposits, issues cheques and has DICGC cover. An NBFC can do none of these three things.
• Shadow banking: a wider term for all bank-like lending outside regular banking, including NBFCs and money-market funds. The FSB now calls it non-bank financial intermediation (NBFI). An NBFC is one part of it, not the same thing.
• Small finance bank (SFB): an SFB is a licensed bank. It can take deposits with no cap and can later become a universal bank. An NBFC is not a bank, though some NBFCs have become SFBs.
• Neobank: a digital-only provider with no banking licence of its own. It works through a licensed partner bank. It is not an NBFC registered under Section 45-IA.

Prelims Hooks

• NBFCs are regulated under Chapter IIIB of the RBI Act, 1934 and registered under Section 45-IA.
• 50-50 test: financial assets must be above 50% of total assets AND financial income must be above 50% of gross income. Meeting only one condition is not enough.
• Trap: an NBFC cannot take demand deposits, cannot issue cheques drawn on itself, and its depositors get no DICGC cover.
• HFC regulation moved from NHB to RBI in 2019.
• SBR (announced October 2021, effective October 2022) has four layers. The top layer is ideally empty. Upper-layer NBFCs must list within 3 years and keep CET1 of 9%.
• DHFL was the first financial service provider taken to the IBC under Section 227.

Mains Points

• Inclusion vs stability:
• NBFCs reach borrowers that banks miss, such as micro firms, the thin-file poor and home buyers in small towns.
• But lighter rules and the lack of deposit insurance place this risk outside the safety net.

• Scale-based regulation tries to balance the two: light rules for small NBFCs, bank-like rules (listing, CET1, PCA) for systemic ones.

• Asset-liability mismatch and contagion (IL&FS 2018, DHFL 2019):

• Using short-term market money to fund long-term loans can turn one default into a funding freeze across the whole system.

• Policy responses: ALM and liquidity norms, PCA for NBFCs, Section 227 IBC resolution, and higher risk weights on bank loans to NBFCs [1].

• Bank-NBFC link as a macroprudential lever:

• A macroprudential tool protects the whole financial system, not just one lender.
• The November 2023 risk-weight increase [1] slowed fast NBFC credit growth. The trade-off is less credit now against fewer NPAs later.
• Non-banks hold about half of global financial assets and often disclose little [3], so gaps in monitoring them are a worldwide problem.
• The Digital Lending Directions 2025 [2] add consumer protection for NBFCs that lend through apps.

Related concepts

• Differentiated banking
• Payments bank
• Small finance bank
• Neobank
• Scale-based regulation
• Shadow banking
• Asset-liability mismatch
• Digital lending

Read more

• Beyond universal banks: differentiated banks, NBFCs and shadow banking