Non-Banking Financial Companies (NBFCs) and Their Regulation

A Non-Banking Financial Company, or NBFC, is a company that does banking-like work, such as giving loans or making investments, but does not hold a banking licence. Think of companies that give gold loans, two-wheeler loans, tractor loans, microfinance loans or home loans. They lend money just like a bank, but you cannot open a savings account with them or get a chequebook from them. In India, most NBFCs are registered and regulated by the Reserve Bank of India (RBI).

Why do NBFCs exist?

Banks cannot reach every borrower. A small shopkeeper in a village, a truck driver who wants to buy a second-hand truck, or a woman who needs a ₹30,000 microloan for a tailoring business may not have the papers a bank asks for. NBFCs are often quicker, more flexible and closer to such customers. They fill these gaps and spread credit (loans) to people and places banks do not serve well. This is why NBFCs are important for financial inclusion, which means bringing everyone into the formal financial system.

Where did NBFC regulation come from?

The rules grew step by step:

• 1963: Parliament added Chapter IIIB to the RBI Act, 1934. This gave the RBI powers over non-bank companies that take deposits from the public.
• 1997: After some NBFCs collapsed and depositors lost money in the mid-1990s, the RBI Act was amended. Section 45-IA made it compulsory for every NBFC to register with the RBI and to have a minimum Net Owned Fund (NOF), which is the company's own money after removing losses and some intangible items.
• 1999: The minimum NOF for new NBFCs was raised to ₹2 crore. The RBI also set out the Principal Business Criteria (explained below).
• 2018-2019: In September 2018, IL&FS (Infrastructure Leasing and Financial Services), a very large infrastructure finance group, failed to repay its debts. Lenders panicked and stopped giving money to many NBFCs. Then DHFL, a large housing finance company, also failed. This showed that big NBFCs can shake the whole system.
• August 2019: Through the Finance Act, 2019, the regulation of Housing Finance Companies (HFCs) was moved from the National Housing Bank (NHB) to the RBI. HFCs are now treated as a type of NBFC.
• November 2019: The government notified rules under Section 227 of the Insolvency and Bankruptcy Code, 2016 so that large NBFCs (assets of ₹500 crore or more) could go through a formal insolvency process. DHFL was the first NBFC sent by the RBI to the National Company Law Tribunal (NCLT) under these rules, on 29 November 2019.
• October 2021: The RBI issued the Scale-Based Regulation (SBR) framework (effective 1 October 2022). Under it, the bigger and riskier an NBFC is, the stricter its rules.

How does the RBI decide that a company is an NBFC?

It uses the Principal Business Criteria, often called the 50-50 test. A company is treated as an NBFC when:

• its financial assets (loans, investments) are more than 50% of its total assets, and
• its income from financial assets is more than 50% of its gross income. Both conditions must be met. So a car maker that also gives some car loans is not an NBFC, because lending is not its main business.

How is an NBFC different from a bank?

This is a favourite UPSC trap. An NBFC:

• cannot accept demand deposits, that is, savings and current accounts. (Only some NBFCs with special RBI permission can take fixed deposits for a fixed term.)
• is not part of the payment and settlement system, so it cannot issue cheques drawn on itself.
• cannot offer deposit insurance. Bank deposits are insured by the Deposit Insurance and Credit Guarantee Corporation (DICGC) up to ₹5 lakh per depositor per bank. NBFC deposits get no such cover.
• does not have to keep the Cash Reserve Ratio (CRR) with the RBI, which banks must do.

The layers under Scale-Based Regulation

Picture a building with four floors. The higher the floor, the tighter the rules:

• Base Layer: small non-deposit-taking NBFCs with assets below ₹1,000 crore, and some special types like peer-to-peer lending platforms. Lightest rules.
• Middle Layer: all deposit-taking NBFCs (whatever their size), non-deposit-taking NBFCs with assets of ₹1,000 crore or more, and some types like Housing Finance Companies and Infrastructure Finance Companies.
• Upper Layer: the biggest NBFCs, whose failure could hurt the whole system. They face bank-like rules, and must list on a stock exchange within three years of being placed in this layer. Under the original framework, the top 10 NBFCs by size were always in this layer, plus others picked by a scoring method. As of June 2026, the RBI has finalised a simpler test: NBFCs with assets of ₹1 lakh crore or more go into the Upper Layer, and government-owned NBFCs that cross this line are now included too (though they need not list). The threshold is to be reviewed every three years.
• Top Layer: kept empty in normal times. The RBI can move an Upper Layer NBFC here if it sees a very serious risk from it.

Under SBR, lending NBFCs like NBFC-ICC (Investment and Credit Companies), microfinance NBFCs and factoring NBFCs must raise their minimum NOF step by step to ₹10 crore by 31 March 2027.

Main types of NBFCs

Some common types the RBI registers:

• NBFC-ICC (Investment and Credit Company): general lending and investment.
• NBFC-MFI (Microfinance Institution): small loans to low-income households, without collateral.
• HFC (Housing Finance Company): home loans.
• IFC (Infrastructure Finance Company): loans for roads, power and other infrastructure.
• CIC (Core Investment Company): mainly holds shares in its own group companies.
• NBFC-P2P (Peer to Peer lending platform) and NBFC-AA (Account Aggregator): newer, technology-based types.

Who regulates the "NBFCs" the RBI does not?

To avoid two regulators for the same company, some finance companies are exempt from RBI registration:

• Insurance companies: IRDAI (Insurance Regulatory and Development Authority of India).
• Stock brokers, merchant bankers, venture capital funds: SEBI.
• Chit fund companies: state governments (under the Chit Funds Act, 1982).
• Nidhi companies: Ministry of Corporate Affairs (under the Companies Act).

India's position and examples

NBFCs are now a large source of credit for vehicles, gold loans, microfinance, small businesses and housing. Banks are among the biggest lenders to NBFCs, so trouble in one quickly reaches the other. The RBI uses tools to manage this link. For example, in November 2023 it raised the risk weights on bank loans to NBFCs by 25 percentage points to slow fast lending growth.

Banks then had to set aside more capital for such loans. It restored the older risk weights from 1 April 2025.

Commonly confused concepts

• NBFC vs NBFI: An NBFC is a company registered as such with the RBI. NBFI (Non-Bank Financial Intermediary) is a wider, global term. It covers every non-bank that moves money from savers to users: NBFCs, mutual funds, insurance companies, pension funds and more.
• NBFC vs Shadow banking: "Shadow banking" is an older, informal term for bank-like lending done outside the banking system, often with lighter rules. In India, NBFCs are regulated, so many experts prefer the neutral term NBFI.
• NBFC vs Small Finance Bank / Payments Bank: Small Finance Banks and Payments Banks hold banking licences, so they can take savings deposits. Several NBFCs and microfinance companies converted into Small Finance Banks.
• Deposit-taking (NBFC-D) vs non-deposit-taking (NBFC-ND): only NBFC-Ds can take public fixed deposits, and they face tighter rules.

Issues, criticism and the way forward

• Asset-liability mismatch: Many NBFCs borrow short-term money but give long-term loans. When short-term lenders stop lending, as after IL&FS in 2018, the NBFC runs out of cash even if its loans are sound.
• Close links with banks and mutual funds: NBFCs borrow heavily from banks and through bonds and commercial papers bought by mutual funds. A shock in one sector can spread to the others.
• Governance and recovery practices: Some NBFCs, especially in microfinance and digital lending, have faced complaints about high interest rates and harsh recovery methods.
• Regulatory arbitrage: If rules for NBFCs are much lighter than for banks, risky business may shift to NBFCs. SBR tries to close this gap for big NBFCs.
• Way forward: Experts and the RBI stress closer supervision of large NBFCs, better liquidity management, stronger governance, harmonising rules with banks where risks are similar, and better data on how NBFCs are linked with the rest of the financial system.

Concepts to Know

• Net Owned Fund (NOF): The company's own capital (owners' money plus reserves) after subtracting accumulated losses and some intangible assets. It is the cushion that absorbs losses.
• Risk weight: A number that tells a bank how risky a loan is. The higher the risk weight, the more of its own capital a bank must keep aside against that loan.
• Commercial paper: A short-term IOU (a promise to repay, usually within a year) that companies sell to raise money quickly.
• Insolvency: When a company cannot pay its debts. The IBC sets a process to either rescue the company or sell its assets to repay lenders.
• Financial inclusion: Making sure every person, including the poor and those in villages, can use formal financial services like accounts, loans and insurance.