Microfinance Institutions (MFIs) and Non-Banking Financial Companies (NBFCs) are key players in financial services, though they have separate frameworks. They have gained precedence across India, being instrumental as financial agencies that fund the have-nots and impoverished communities.
Many of India’s population cannot get collateral-supported loans, so they are frequently routed to MFI and NBFC. While most banks adhere to stringent RBI regulations, these institutions come to serve financially deprived people with easy funding as their USP.
This article delves into the key differences between MFI and NBFC, revealing their unique aspects, functions, and importance in the Indian financial backdrop.
An Overview of NBFC
NBFC (Non-Banking Financial Company) pertains to a company registered under the Companies Act and is controlled by the Reserve Bank of India within the RBI Act, 1934. The operations concern lending and include offering advances and loans, savings and investment products, credit facilities, handling stock portfolios, trading at the money market, and money transfer.
NBFCs are involved in leasing, hire purchase, venture capital finance, infrastructure funding, and housing finance. They are permitted to receive deposits but solely term deposits. However, deposits that are repayable on demand are not endorsed by NBFCs.
The 3 types of NBFCs comprise:
- Asset companies
- Investment companies
- Loan companies
NBFCs cannot release self-drawn cheques or accept saving deposits, unlike banks. Moreover, money deposited in a NBFC is without guarantee like banks and its banking functions are also limited.
An Overview of MFI
Microfinance Institutions (MFIs) serve as dedicated financial setups that offer micro-loans to those strapped for cash and deprived groups, focusing on income-creation activities. The basic purpose of MFIs is to assist financial inclusion by securing credit for micro businesses and people with nil access to banking facilities.
Under the RBI Guidelines, MFIs are classified as Non-Banking Financial Companies – Micro Finance Institutions (NBFC-MFIs). The RBI outlines NBFC-MFI as a non-deposit-approving NBFC that stores a minimum proportion of 85% of its assets through microfinance loans. These microfinance loans are fixed at a definite limit for them to be used by impoverished segments. They consider borrowers having an annual income falling below specific thresholds, considering whether they inhabit urban or rural locations.
Distinction Between MFI and NBFC
Non-Banking Financial Companies (NBFCs) and Microfinance Institutions (MFIs) are financial units but vary in their purpose and responsibility as they work under distinct regulatory systems. These are the key distinctions between them:
1. Diverse Services Offered
The realm of MFIs includes microloans, insurance, and savings deposits. Their ambit covers low-income populations who lack banking facilities. They intend to support financial participation and eradicate poverty.
NBFCs are financial entities that offer multiple banking services akin to banks, like asset financing, loans, wealth supervision, investment recommendations, and infrastructure financing. Nevertheless, in the way banks do, NBFCs cannot approve demand deposits.
2. Management by Regulatory Authorities
Microfinance Institutions (MFIs): Based on the country, MFIs may be controlled by central banks or separate financial regulatory authorities. In a few instances, they may also function as non-profit organizations or be supervised under exclusive microfinance laws. MFIs are governed by less strict regulation and frequently infringe the “Fair Practices Code”,
NBFCs are governed by the financial regulatory establishment or the central bank of their operating nation. The Reserve Bank of India (RBI) is the managing authority of the NBFC as laid down by the RBI Act of 1934 and they transact their business under the Companies Act of 2013. They must follow regulations linked to capital sufficiency, governance, lending procedures, and reporting norms.
3. Maintaining Transparency Standards
NBFCs are regarded as more trustworthy about keeping transparency within the system, while MFIs frequently fail to retain transparency in the long term.
4. Identifying Target Customers
Microfinance Institutions (MFIs): MFIs generally target needy persons, especially in disadvantaged or rural locations, deprived of banking privileges. They normally lend microcredit loans to assist these people in setting up or developing small enterprises.
NBFCs have a widespread customer following, consisting of enterprises, people, and corporate entities. Their services can involve specific industries or domains, like vehicle funding, home promotion loans, or equipment leasing.
5. Securing Funding Sources
MFIs mainly raise funds through grants, loan financing from financers or banks, contributions, and at times, customer deposits.
NBFCs obtain funds by releasing bonds, investors’ equity, bank loans, and bills of exchange. They may even endorse public deposits sometimes, although this varies depending on the regulations in their jurisdiction.
6. Deciding Loan Amounts
NBFCs can grant large loan amounts to individual and corporate clients, based on their needs. On the contrary, MFIs usually provide a reduced threshold of financial credit to individuals on account of their restricted scale of operations.
7. Assessing Risk Profile
Microfinance Institutions (MFIs): MFIs usually deal with small loan amounts and concentrate on looking after clients with restricted collateral or credit history. Consequently, they can have a high-risk portfolio and often adopt specific procedures that can lower risks linked to funding low-income segments.
NBFCs may cover an extensive bracket of financial transactions and reach out to a diverse clientele. Their risk tolerance is subjective to the range of services they proffer, the economic climate, and their operating sectors.
8. Divergent Business Models
The business models of NBFCs and MFIs vary in terms of services provided, target clientele, and overall financial strategies.
Wrapping Up
The MFIs and NBFCs play crucial roles in India’s financial ecosystem, each targeting separate market segments and meeting unique purposes. While NBFCs operate at a wider scale and are more stringently controlled, MFIs concentrate on serving the most neglected communities, but with less strict regulation and restricted access to funding.
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