NBFCs and traditional banks form the backbone of India’s financial system, serving the common purpose of mobilising funds and extending credit across the economy. Despite this shared objective, the two differ significantly in their legal structure, regulatory oversight, and operational approach. Banks operate under a more stringent regulatory regime as they accept public deposits and provide payment services, while NBFCs are regulated separately and enjoy greater operational flexibility in designing and delivering financial products.
In recent years, NBFCs have witnessed rapid growth by addressing credit gaps that traditional banks often find difficult to serve. By focusing on specialised lending, quicker loan processing, and alternative credit assessment methods, NBFCs have expanded financial access to MSMEs, self-employed individuals, and emerging sectors. These differences make it important for borrowers, investors, and policymakers to clearly understand how NBFCs and banks function, as each plays a distinct yet complementary role in promoting financial inclusion, innovation, and economic development.
In this article, CA Manish Mishra talks about NBFCs vs Traditional Banks: Key Differences & Benefits.
Conceptual Meaning and Legal Identity
This section explains the fundamental nature of traditional banks and Non-Banking Financial Companies (NBFCs) by highlighting their core functions and the legal framework under which they operate. Understanding their conceptual meaning helps clarify what each institution is meant to do, while their legal identity defines the laws, regulators, and permissions that govern their activities.
Traditional Banks
Traditional banks are financial institutions that are legally authorised to accept deposits from the public, including demand deposits such as savings and current accounts that can be withdrawn at any time. They operate under licences issued by the Reserve Bank of India (RBI) and are governed by the Banking Regulation Act, 1949. Because banks handle public deposits and provide payment services, they are subject to strict regulatory oversight. Banks are an essential part of the payment and settlement system, enabling fund transfers, cheque clearing, and digital transactions. They also play a crucial role in monetary policy transmission by creating credit, influencing interest rates, and managing liquidity in the economy.
Non-Banking Financial Companies (NBFCs)
Non-Banking Financial Companies (NBFCs) are companies incorporated under the Companies Act, 2013, whose primary business involves financial activities such as lending, investment, leasing, or hire purchase. They are regulated by the RBI under the Reserve Bank of India Act, 1934. Unlike banks, NBFCs are not permitted to accept demand deposits, issue cheques drawn on themselves, or directly participate in payment and settlement systems. Their role is mainly focused on credit intermediation and specialised financial services. This allows NBFCs greater operational flexibility, particularly in serving niche and underserved segments, while still remaining under RBI supervision.
Licensing and Regulatory Framework
This section explains how banks and NBFCs are regulated in India and highlights the differences in licensing requirements, regulatory control, and supervisory intensity.
Regulatory Structure for Banks
Banks are required to obtain a banking licence from the Reserve Bank of India (RBI), which is granted only after detailed scrutiny of factors such as minimum capital adequacy, promoter credibility, ownership structure, governance framework, and long-term business viability. Once licensed, banks must comply with strict regulatory requirements, including maintaining the Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR), fulfilling priority sector lending obligations, and adhering to Basel norms for capital adequacy and risk management. Due to their role in accepting public deposits and their systemic importance to the economy, banks are subject to continuous RBI supervision, regular inspections, and extensive reporting requirements.
Regulatory Structure for NBFCs
Non-Banking Financial Companies (NBFCs) are required to obtain a Certificate of Registration (CoR) from the RBI before starting their financial activities. While NBFCs are regulated by the RBI, they operate under a comparatively flexible framework since they are not required to maintain CRR or SLR. However, regulatory oversight over NBFCs has increased significantly in recent years, especially following liquidity stress events. To strengthen supervision, the RBI has introduced a Scale-Based Regulation (SBR) framework, classifying NBFCs into Base, Middle, Upper, and Top Layers based on their size, complexity, and risk profile, with higher layers subject to stricter compliance and governance norms.
Deposit Acceptance and Investor Protection
This section explains the fundamental difference between banks and NBFCs in terms of public deposit acceptance and the level of protection available to investors.
Deposit Acceptance by Banks
Banks are authorised to accept deposits from the public in the form of savings accounts, current accounts, and fixed deposits. These deposits are safeguarded under deposit insurance mechanisms up to the prescribed limit, which builds strong public trust and ensures financial stability. The ability to raise low-cost deposits gives banks a significant funding advantage, enabling them to maintain liquidity and extend credit at comparatively lower interest rates.
Deposit Acceptance by NBFCs
NBFCs are generally restricted from accepting public deposits. Only a small category of NBFCs, subject to RBI approval and strict regulatory compliance, may accept term deposits. Such deposits do not carry the same statutory insurance protection as bank deposits, making them relatively riskier for investors. Consequently, NBFCs depend largely on borrowings, debentures, and other market-based funding sources, which increases their cost of capital.
Lending Practices and Product Flexibility
This section highlights the contrast between banks and NBFCs in terms of lending methodology, credit assessment, and product innovation.
Lending Approach of Banks
Banks operate within highly regulated and standardised lending frameworks that emphasise risk control and regulatory compliance. Loan approvals are based on detailed credit appraisals, documentation, and adherence to internal and regulatory guidelines. While this structured approach promotes financial stability and protects depositor interests, it often results in slower decision-making and limited adaptability for borrowers who do not fit traditional credit profiles or formal income criteria.
Lending Approach of NBFCs
NBFCs adopt a more flexible and market-driven approach to lending. They focus on designing customised financial products to suit the needs of MSMEs, startups, and self-employed individuals who may lack conventional credit records. By using alternative data, technology-enabled underwriting, and streamlined approval processes, NBFCs are able to deliver faster credit solutions. This adaptability allows them to address gaps in traditional banking and meet the evolving financing needs of diverse customer segments.
Compliance and Corporate Governance
This section explains the governance standards and compliance obligations applicable to banks and NBFCs, highlighting the increasing convergence of regulatory expectations.
Governance Framework for Banks
Banks are governed by a highly stringent compliance and governance framework due to their systemic importance and responsibility toward public deposits. They are required to constitute mandatory board-level committees such as audit committees, risk management committees, and nomination and remuneration committees. Banks must appoint independent directors, compliance officers, and internal auditors to ensure strong oversight and internal controls. Regular regulatory inspections, supervisory reviews, and reporting obligations are conducted by regulators to safeguard depositor interests, maintain financial stability, and prevent systemic risks.
Governance Framework for NBFCs
Governance requirements for NBFCs have been significantly strengthened in recent years, particularly for large and systemically important entities. Such NBFCs are now required to adopt enhanced disclosure standards, robust internal control systems, and structured risk governance frameworks similar to those applicable to banks. These measures have improved transparency, accountability, and risk management across the NBFC sector, reducing regulatory gaps and strengthening overall financial resilience.
Capital Adequacy and Risk Management
This section explains how banks and NBFCs manage financial risks through capital adequacy requirements and regulatory risk management norms.
Capital and Risk Norms for Banks
Banks are required to comply with Basel capital adequacy norms, which mandate maintaining sufficient capital buffers to absorb losses arising from credit, market, and operational risks. These norms ensure that banks remain financially sound even during economic downturns. In addition, banks must conduct regular stress testing and asset quality reviews to assess their ability to withstand adverse scenarios. Such continuous monitoring strengthens risk management, protects depositors, and contributes to overall financial system stability.
Capital and Risk Norms for NBFCs
NBFCs are also required to maintain minimum capital adequacy ratios as prescribed by the Reserve Bank of India. In recent years, regulatory norms for NBFCs have become more stringent, especially for systemically important entities. These NBFCs must comply with enhanced liquidity risk management frameworks, stricter asset classification, and provisioning requirements. As a result, the regulatory standards for large NBFCs have moved closer to those applicable to banks, improving resilience and reducing systemic risk.
Role in Financial Inclusion and Economic Development
This section highlights how banks and NBFCs contribute differently yet complementarily to financial inclusion and overall economic growth.
Contribution of Banks
Banks play a foundational role in India’s economic development by mobilising public savings and channelising them into productive sectors of the economy. They provide long-term financing for infrastructure projects, large industries, and priority sectors while also implementing various government schemes related to social welfare, subsidies, and financial inclusion. With an extensive branch and digital network spread across urban and rural areas, banks ensure wide access to formal financial services, including savings, credit, and payment facilities.
Contribution of NBFCs
NBFCs have emerged as key drivers of financial inclusion by reaching segments that are often underserved or excluded from traditional banking. They focus on niche markets such as vehicle finance, housing finance, consumer credit, and MSME lending, offering customised and accessible financing solutions. By catering to self-employed individuals, small entrepreneurs, and informal sector participants, NBFCs promote grassroots economic growth, entrepreneurship, and employment generation, thereby complementing the role of banks in the financial system.
Recent Regulatory Developments and Trends
This section explains the key regulatory changes affecting NBFCs and banks and how these reforms are shaping India’s financial system.
Recent Updates for NBFCs
The Reserve Bank of India has significantly strengthened the regulatory framework for NBFCs to address liquidity risks and enhance financial stability. Tighter liquidity risk management norms have been introduced to ensure that NBFCs maintain adequate buffers to meet short-term obligations. The RBI has also mandated enhanced disclosure requirements to improve transparency and enable better risk assessment by regulators and investors. A major reform is the introduction of scale-based regulation, under which NBFCs are categorised into different layers based on size and risk profile. Larger and systemically important NBFCs are now subject to stricter supervision, while smaller NBFCs continue to enjoy operational flexibility.
Recent Updates for Banks
Banks have undergone several regulatory reforms aimed at strengthening governance, improving asset quality, and adapting to technological advancements. Increased focus has been placed on digital banking frameworks and cybersecurity measures to address growing technology-related risks. Regulatory initiatives have also targeted better governance practices, stronger internal controls, and improved management of non-performing assets. These changes reflect the evolving financial landscape, where technology adoption and regulatory oversight go hand in hand to ensure stability and customer protection.
Comparative Benefits: NBFCs vs Banks
This section explains the advantages of banks and NBFCs by highlighting how each institution caters to different financial needs and customer segments.
Key Benefits of Banks
Banks offer a high level of safety and reliability because they are subject to strict regulatory supervision and depositor protection mechanisms. Their ability to accept public deposits and participate in the payment and settlement system allows customers to securely save money, make payments, and conduct everyday financial transactions. With strong regulatory backing and systemic importance, banks provide stability and trust, making them ideal for individuals and businesses seeking secure savings, long-term financial relationships, and a wide range of integrated financial services.
Key Benefits of NBFCs
NBFCs are recognised for their speed, operational flexibility, and customer-focused approach. They specialise in offering customised financial products designed to meet the needs of underserved and niche segments such as MSMEs, startups, self-employed individuals, and first-time borrowers. By using innovative credit assessment models and faster approval processes, NBFCs improve access to credit where traditional banking systems may face limitations. Their innovation-driven model complements banks by filling gaps in the financial system and expanding financial inclusion.
Conclusion
NBFCs and traditional banks operate within distinct regulatory and legal structures, yet both are essential to the smooth functioning of India’s financial ecosystem. Banks provide a stable foundation through deposit protection, regulated lending, and robust payment systems, ensuring trust and continuity in financial transactions. NBFCs complement this structure by offering flexibility, faster credit delivery, and innovative financial products tailored to specific sectors and customer groups that may not be adequately served by conventional banking channels.
Ongoing regulatory reforms have strengthened oversight, governance, and risk management standards across both sectors, bringing greater balance and resilience to the financial system. As regulatory expectations continue to evolve, the convergence of stability from banks and innovation from NBFCs enhances financial inclusion and supports sustainable economic development. Together, these institutions play a critical role in meeting the diverse financial needs of individuals, businesses, and emerging sectors in India.
Frequently Asked Questions (FAQs)
Q1. What is the main difference between NBFCs and traditional banks?
Ans. The primary difference lies in their legal authority and operational scope. Banks are authorised to accept demand deposits such as savings and current accounts and are part of the payment and settlement system. NBFCs, on the other hand, cannot accept demand deposits or issue cheques and primarily focus on lending and investment activities under a different regulatory framework.
Q2. Under which laws are banks and NBFCs regulated in India?
Ans. Banks are regulated under the Banking Regulation Act, 1949, and supervised by the Reserve Bank of India (RBI). NBFCs are incorporated under the Companies Act, 2013, and regulated by the RBI under the Reserve Bank of India Act, 1934.
Q3. Can NBFCs accept public deposits like banks?
Ans. Generally, NBFCs are not permitted to accept demand deposits. Only certain NBFCs, with prior RBI approval and subject to strict compliance conditions, may accept term deposits. Unlike bank deposits, NBFC deposits do not enjoy statutory deposit insurance protection.
Q4. Why are banks subject to stricter regulations than NBFCs?
Ans. Banks handle public deposits and play a central role in the payment system, making them systemically important. To protect depositors and financial stability, banks are subject to stricter capital adequacy, liquidity, and governance norms compared to NBFCs.
Q5. How do NBFCs provide more flexibility in lending compared to banks?
Ans. NBFCs can design customised loan products, use alternative credit assessment models, and process loans faster. This flexibility allows them to serve MSMEs, startups, self-employed individuals, and customers with limited credit history more effectively than traditional banks.
Q6. What is scale-based regulation for NBFCs?
Ans. Scale-based regulation is a framework introduced by the RBI that categorises NBFCs into different layers based on size, activity, and risk profile. Larger and systemically important NBFCs are subject to stricter regulatory and governance norms, similar to banks, while smaller NBFCs enjoy relatively greater flexibility.
Q7. Are NBFCs required to maintain CRR and SLR like banks?
Ans. No, NBFCs are not required to maintain Cash Reserve Ratio (CRR) or Statutory Liquidity Ratio (SLR). Banks must maintain both, which impacts their fund deployment and liquidity management.
Q8. How are capital adequacy requirements different for banks and NBFCs?
Ans. Banks must comply with Basel capital adequacy norms and maintain higher capital buffers. NBFCs are also required to maintain minimum capital adequacy ratios prescribed by the RBI, though these requirements may vary based on the NBFC’s size and category.
Q9. Are NBFCs safer than banks for borrowers?
Ans. From a borrower’s perspective, NBFCs are not inherently riskier. Both banks and NBFCs are regulated by the RBI. However, NBFCs may charge higher interest rates due to higher cost of funds and greater risk exposure.
Q10. How do banks and NBFCs contribute to financial inclusion?
Ans. Banks support financial inclusion through deposit mobilisation, payment services, and government-backed schemes. NBFCs contribute by extending credit to underserved and unbanked segments, including MSMEs, informal workers, and rural borrowers.
Q11. What compliance obligations do NBFCs have under RBI regulations?
Ans. NBFCs must comply with RBI norms on capital adequacy, asset classification, provisioning, governance, disclosures, and liquidity risk management. Larger NBFCs face enhanced compliance obligations similar to banks.
Q12. How has RBI strengthened NBFC regulation in recent years?
Ans. RBI has introduced tighter liquidity norms, enhanced disclosure requirements, and scale-based supervision for NBFCs. These reforms aim to improve stability and reduce systemic risk without limiting innovation.
CA Manish Mishra