Answer By law4u team
Both Banks and Non-Banking Financial Companies (NBFCs) are important pillars of the Indian financial system. They both provide financial assistance and credit facilities, but their functions, powers, and regulations differ significantly. Banks are the traditional financial institutions directly linked with the Reserve Bank of India (RBI) and the payment system of the country, while NBFCs operate more as lending and investment entities without having full banking privileges. Meaning and Nature A Bank is a government-licensed financial institution that performs all major banking activities like accepting deposits, lending money, transferring funds, issuing credit and debit cards, and offering payment and settlement facilities. Banks act as intermediaries between depositors and borrowers and are fundamental to the country’s monetary policy and credit system. An NBFC (Non-Banking Financial Company), on the other hand, is a company registered under the Companies Act that provides financial services similar to banks, such as granting loans, hire purchase, leasing, and investment in securities, but it does not hold a banking license. NBFCs are regulated by the RBI under the Reserve Bank of India Act, 1934, but their functions are limited compared to those of banks. Acceptance of Deposits Banks can accept demand deposits, which means customers can deposit their money in savings or current accounts and withdraw it whenever they wish, either by cheque, ATM, or online transfer. This facility gives banks an important role in managing the country’s liquidity and money supply. NBFCs, however, are not allowed to accept demand deposits. They can, in some cases, accept fixed-term deposits (for a specific tenure) if permitted by the RBI, but they cannot offer current or savings accounts. Therefore, an NBFC cannot provide deposit and withdrawal facilities like banks. Payment and Settlement System Banks form an essential part of India’s payment and settlement network. They are authorized to issue cheques, provide fund transfer systems like NEFT, RTGS, IMPS, and UPI, and allow people to make payments or receive money instantly. NBFCs do not have access to this payment system. They cannot issue cheques drawn on themselves or offer payment transfer services. Their primary business is lending and investment, not handling the transfer or storage of public funds. Credit and Lending Function Both banks and NBFCs provide credit, but in different ways. Banks perform credit creation, which means they create money in the economy through the process of accepting deposits and issuing loans. When banks lend, the total money supply in the system increases. NBFCs cannot create money or credit in the same way. They lend money from their own capital or from funds raised through borrowings, debentures, or equity. Their capacity to lend depends on the capital they hold, not on deposits from the public. Regulation and Legal Framework Banks are governed by the Banking Regulation Act, 1949, and supervised by the Reserve Bank of India (RBI). They must follow strict regulations concerning capital adequacy, liquidity, cash reserves, and other financial norms. NBFCs are governed by the Reserve Bank of India Act, 1934, and are also registered under the Companies Act, 2013. Although the RBI regulates NBFCs, the regulatory intensity is lighter compared to banks. NBFCs are monitored mainly to ensure financial stability and consumer protection, but they do not have the same obligations as banks regarding liquidity reserves. Deposit Insurance and Public Safety Money deposited in banks is insured under the Deposit Insurance and Credit Guarantee Corporation (DICGC), which protects deposits up to ₹5 lakh per depositor per bank. This means if a bank fails, the depositor can recover up to ₹5 lakh through DICGC insurance. NBFCs do not have such deposit insurance protection. Any investment or deposit with an NBFC is entirely at the investor’s risk. This is one reason why banks are considered safer for saving money compared to NBFCs. Foreign Investment Rules Foreign Direct Investment (FDI) in private sector banks is permitted up to 74%, with 49% under the automatic route and the remaining through government approval. For NBFCs, FDI up to 100% is allowed automatically, provided the NBFC follows the minimum capital norms and complies with RBI guidelines. This makes NBFCs more flexible and attractive for foreign investors. Reserve Requirements (CRR and SLR) Banks must maintain certain reserves like the Cash Reserve Ratio (CRR) and the Statutory Liquidity Ratio (SLR) as per RBI guidelines. This ensures that a part of their deposits is always kept aside as liquid cash or government securities to protect the banking system’s stability. NBFCs are not required to maintain CRR or SLR. However, the RBI has imposed certain liquidity coverage norms on large NBFCs to ensure they can meet short-term obligations. Services Offered Banks provide a wide range of services such as opening savings, current, and fixed deposit accounts, issuing credit and debit cards, providing home and business loans, foreign exchange services, remittances, and online payment systems. NBFCs, while not offering deposit or payment services, are heavily involved in lending activities like personal loans, gold loans, vehicle loans, housing finance, microfinance, asset leasing, and investment in shares, bonds, or mutual funds. Many NBFCs specialize in serving customers or businesses who may not qualify for traditional bank loans. Participation in Monetary Policy Banks are a central part of India’s monetary policy framework. They help the RBI in implementing policies related to money supply, inflation control, and interest rates. The RBI can directly influence banks through repo rates, reverse repo rates, and reserve requirements. NBFCs are not a part of the monetary transmission mechanism in the same way. They play a supportive role in the credit market but do not directly influence or implement monetary policy decisions. Examples Prominent examples of banks include State Bank of India (SBI), HDFC Bank, ICICI Bank, Axis Bank, and Punjab National Bank. Examples of NBFCs include Bajaj Finance, Muthoot Finance, Shriram Transport Finance, HDB Financial Services, Tata Capital, and Mahindra Finance. Role in the Economy Banks are the foundation of India’s financial and monetary structure. They handle public deposits, manage liquidity, and support large-scale credit and investment across sectors. NBFCs complement the banking sector by catering to niche markets such as small businesses, rural populations, self-employed individuals, and low-income borrowers who may find it difficult to get loans from banks. They help promote financial inclusion by reaching areas and communities where banks have limited presence. Risk and Regulation Intensity Banks face stricter regulatory scrutiny because they hold public money and are directly linked with the stability of the national economy. Their operations are closely monitored by the RBI to prevent bank failures and systemic crises. NBFCs, although regulated, have more operational flexibility but also carry a higher level of financial risk. Their failure may not directly threaten the monetary system but can still impact market confidence and credit availability, as seen during major NBFC liquidity crises in the past. Conclusion In conclusion, while both banks and NBFCs perform the role of financial intermediaries by lending money and supporting economic activities, their powers, regulations, and scope differ greatly. Banks are authorized to accept deposits, provide payment services, and create credit, forming the backbone of the financial system. NBFCs are financial service providers that primarily focus on loans, investments, and asset financing, without being part of the payment or deposit framework. Banks are safer, more regulated, and directly connected to the central bank, while NBFCs are more flexible, innovative, and cater to specialized financial needs. Together, they create a balanced ecosystem - banks ensuring financial stability, and NBFCs ensuring financial reach and inclusion across India.