The Indian economy over the past few decades has gone through a period of rapid financialization and economic development. This has resulted in the growth of many different types of financial institutions in the country that act as agents of savings and deposits or suppliers of credit and finance. However, the activities that financial institutions engage in differ significantly from their non-financial counterparts.
By simple comparison, financial institutions largely deal with the handling of financial assets such as deposits, loans and securities among others, while non-financial firms deal with a variety of other real assets such as machinery, consumer goods, real estate and so on. It is, however, clearly evident that financial institutions will naturally rely on services than real assets for their operations. Hence if we were to simply define or classify financial institutions, they can be divided into the following classes –
- Regulatory
- Intermediaries
- Non – intermediaries
- Others
Both banking and non-banking institutions fall under the group of financial intermediaries. Simply put, the term intermediaries refer to the institution’s role as an intermediate between savers and investors. They lend and mobilize funds at the same time. However, to achieve the purpose of this article it is necessary to differentiate between banking and non-banking institutions under the umbrella of financial institutions.
Distinguishing between banking and non-banking institutions
Banking and non-banking institutions share certain similarities on some fronts. The distinction between the two arises mainly from the nature of the liabilities they hold and the structure of their assets.
A non-banking financial company (NBFC) is a normal business entity registered under the Companies Act, 1956 1 which functions for the purpose of providing financial services which are distinct and separate from standard banking services. In other words, NBFCs are those institutions that accept nonchequeable deposits so it can be used for purpose of lending or investing. NBFCs do not have a banking license and is not supervised by national or international banking regulatory agencies.
Relevant Legal Definitions
Clause – e of Section 45 – I of the RBI Act, 1934 2 lays down the definition of non-banking financial companies as –
“Non-banking institution” means company, corporation or Co-operative society. The definition is looking at every detail as it starts with the word “means”.
The definition is hence, very simple in its nature. It considers only three kinds of entities as NBFCs, as it can be interpreted from the definition. This hints at the fact that other forms of entities such as sole proprietorships, partnerships or Hindu businesses are beyond the scope of the given definition.
Role of Non-Banking Financial Companies
Below mentioned are some of the important roles a non-banking financial company plays in the economy.
- Mobilization of Funds – NBFCs play a major role in the economy of converting sales into investments. If NBFCs are not present in the financial sector, doing this will become extremely improbable. Hence a major role played by these institutions is also stimulating economic development rather than just generate profits for themselves.
- Employment Generation – Every country’s government will have the macroeconomic aim of increasing jobs in the country. NBFCs play a major role in this premise as they often work in coordination with the government and successfully disburse funds to private sectors who in turn generate a lot of employment opportunities in the country.
- Long-Term Credit – Traditional banks are generally not keen to hand out long-term loans or other forms of credit to industries easily. This is due to banks holding a larger volume of shorter repayable deposits which can’t be used by the bank for long-term lending purposes. However, NBFCs play a major role by making long-term credit more readily available. This, in turn, helps finance large scale projects with heavy financial requirements, hence boosting economic development as well.
- Developing the Financial Sector – NBFCs are crucial players of the financial sector in any country. They perform a wide array of financial functions, ranging from providing credit to large-scale project runner to even providing capital to smaller start-up firms. The economy hence relies on NBFCs to a large extent to provide liquidity in the market.
- Raising the standards of living – NBFCs are a useful tool for the government to improve standards of living as they are often in possession of large grants from foreign players. These funds not only stimulate economic growth themselves, but it can also be used to further pass on the funds to industries and stimulate business, in turn improving the standards of living.
Having developed an understanding of the definition and role of non-banking financial companies in the economy, it can be said without doubt that they play a pivotal role in providing stability, liquidity and vibrancy to the same. Though their mandate differs from that of a traditional bank, NBFCs reprise their importance by being a more stable, flexible and consistent source of funds. Hence, the financial sector has and continues to rely on NBFCs even in the current global economic platform.
References
- Companies Act, 1956 – Act No. 1 of 1956
- Reserve Bank of India Act, 1934 – Act No. 2 of 1934
- The given clause is the original phrase from the act.