Non-Banking Financial Companies (NBFCs), established in the 1960s, were started to serve the financial needs of investors and savers that were not being serviced by the existing banking system. Since then, they have become vital to India’s financial ecosystem, filling critical gaps left by traditional banks. Over the past decade, NBFCs have significantly increased their share in the credit portfolio, growing from one-sixth of the total bank credit in 2013 to more than one-fourth now. They cater to underserved markets, including micro, small, and medium enterprises (MSMEs), rural populations, and first-time borrowers, by expanding credit access and fostering economic activity.
Key Differences Between NBFCs and Banks
NBFCs lend and make investments and hence their activities are akin to that of banks; however there are a few differences as given below:
- An NBFC cannot accept demand deposits;
- They do not form part of the payment and settlement system 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.
According to TeamLease RegTech’s NBFC report; from a regulatory standpoint, NBFCs are not as strictly regulated by the RBI as commercial banks. However, from a compliance management perspective, they are no different from any other form of service. However, the rapid growth of this sector has necessitated enhanced regulatory scrutiny to address vulnerabilities in governance, risk management, and compliance.
NBFC’s Regulatory Landscape
The major overarching acts, rules and regulations that regulate NBFCs include:
- The Reserve Bank of India Act 1934 which provides the framework for regulation.
- The Companies Act 2013 governs the incorporation and operation of NBFCs as companies. It majorly sets out the legal framework for their operations.
- The SBR framework categorizes NBFCs into four layers — Base Layer, Middle Layer, Upper Layer, and Top Layer — based on their asset size, systemic importance, and whether they accept deposits.
- Securities and Exchange Board of India (SEBI) Regulations apply to NBFCs engaged in capital market activities. Foreign Exchange Management Act (FEMA), 1999 governs foreign investment in NBFCs, especially regarding external commercial borrowings and foreign direct investments.
- Financial Inclusion and Consumer Protection Regulations focus on consumer protection, financial literacy and responsible lending practices.
Recent Regulatory Developments
In recent years, regulators have intensified their oversight over the sector to ensure resilience and sustainable growth. A series of regulatory measures have been introduced to mitigate systemic risks, promote transparency, and strengthen governance frameworks. Among the most recent developments are:
- In a notification dated August 12, 2024, RBI amended certain regulations applicable to Housing Finance Companies, and NBFCs to ensure harmonization between HFC Master Directions and SBR Master Directions. These amendments shall be effective from January 01, 2025.
- On July 15, 2024, the Reserve Bank of India (RBI) issued the Master Directions on Fraud Risk Management in Non-Banking Financial Companies (NBFCs). These directions are intended to strengthen the framework for preventing, detecting, and reporting fraud in NBFCs, including housing finance companies (HFCs). The directions superseded the 2016 Master Direction: Monitoring of Frauds in NBFCs (Reserve Bank) Directions.
- RBI issued the revised Master Circular on ‘Bank Finance to Non-Banking Financial Companies (NBFCs)’ on April 24, 2024. This circular consolidates all instructions issued up to 23.04.2024. The purpose is to outline the RBI’s regulatory policy regarding the financing of NBFCs by banks.
- The Reserve Bank of India (RBI) issued the Master Direction – Reserve Bank of India (Filing of Supervisory Returns) Directions 2024 on February 27, 2024. The new directions aim to streamline the reporting process and reduce the burden on regulated entities.
- Master Directions on Information Technology Governance, Risk, Controls, and Assurance Practices (November 7, 2023) mandates NBFCs to implement effective IT governance structures, risk management protocols, and control mechanisms to ensure the security and reliability of their information systems.
Challenges in the NBFC Sector
The scrutiny intensified in response to systemic challenges that emerged during the sector’s rapid expansion. High interest rates charged by some companies led to concerns about consumer exploitation, especially in rural and underserved markets. Unsustainable growth models, often prioritizing aggressive loan disbursement over prudent risk management, resulted in rising NPAs and weakened financial health. Instances of mismanagement, regulatory non-compliance, and high-profile fraud cases exposed gaps in governance and operational transparency, prompting stricter oversight.
Despite these challenges, Non-Banking Financial Companies remain indispensable to India’s economic ambitions, contributing significantly to financial inclusion and local economic development. In 2021, NBFCs held a credit-to-GDP ratio of 13.7%, projected to rise to 17% by FY 2025. Their share of total credit has consistently remained between 21% and 24% from FY 2017 to FY 2024, underscoring their pivotal role in expanding financial access.
Additionally, strict adherence is emphasized in the RBI’s regulations on NBFC gold loans. These regulations must be incorporated into the lending policies and operational procedures of NBFCs. The RBI ensures that these companies adhere to the established requirements by conducting regular audits and assessments to track compliance. Among other repercussions, noncompliance may lead to fines and restrictions on lending activities.
Technological advancements have further bolstered the sector by leveraging Artificial Intelligence (AI), Machine Learning (ML), and big data analytics to improve credit assessments, fraud detection, and customer outreach. This technological edge enables quicker loan approvals and better risk management, especially in targeting underserved segments like MSMEs and women entrepreneurs.
Building a Resilient and Transparent NBFC Sector
Effective collaboration between regulators, policymakers, and industry stakeholders is essential to fostering innovation while managing risks. By addressing vulnerabilities and embracing robust governance practices, NBFCs can continue to drive financial inclusivity and contribute to India’s journey toward becoming a $5 trillion economy. The recent regulatory crackdowns, though challenging, are a necessary step toward creating a resilient and transparent financial ecosystem that supports sustainable development and economic prosperity.
