What it means
Banks take deposits from the public and lend them out, and they are regulated heavily for that reason. A non-banking financial company sits next to the banking system, lending to customers that banks may find too small, too risky or too specialised, for example vehicle buyers, small businesses or microfinance borrowers.
Because they do not usually accept demand deposits (money that can be withdrawn at any time), they fund themselves differently. Typical sources are bank loans, bonds, commercial paper, securitisation (selling bundles of loans to investors) and in some cases long-dated deposits within regulatory limits.
This funding model creates a particular risk. Short-term borrowing used to finance long-term loans can leave the company short of cash if lenders stop rolling over their funds, so liquidity management and access to backup credit lines are central to the business.
For business readers the term matters in two ways. A company seeking financing may be offered credit by an NBFC that moves faster than a bank, although often at a higher interest rate.
Investors and lenders also look at NBFCs as counterparties, so understanding their capital strength and asset quality is part of due diligence. Regulation varies by country.
In India, the central bank regulates NBFCs and has tightened its oversight over time, while other countries use terms such as non-bank financial institution or shadow banking, and the rules differ widely. Business owners should therefore check the lender's licence and regulator before signing a facility.
A final nuance is size. Some NBFCs are small local lenders, while others are very large and linked closely to banks, which means failures can spread through the wider financial system.
In practice
Real-world examples.
Example
A small manufacturer needs $300,000 to buy a new machine. The bank takes weeks to decide, so the owner uses an NBFC that approves the loan in days, accepting a slightly higher rate in exchange for speed. The owner also compares the total cost of the loan, including fees, before signing.
Example
A used-vehicle dealer arranges customer financing through a partner NBFC. The dealer sells more vehicles because buyers who would struggle to get a bank loan can still be approved.
Example
A fund manager reviewing a corporate bond issued by a lender looks at its funding sources, its proportion of overdue loans and its capital ratio before deciding whether the extra yield is worth the risk.
Formula
Calculation
Net interest spread = Average yield on loans - Average cost of funds
Worked example: an NBFC lends $200,000,000 to small businesses at an average interest rate of 14% a year. It funds the loans through bank borrowing and bonds that cost 9% a year on average.
Yield on loans = 14% and cost of funds = 9%
Net interest spread = 14% - 9% = 5%
Annual interest income = $200,000,000 x 0.14 = $28,000,000
Annual interest cost = $200,000,000 x 0.09 = $18,000,000
Net interest income = $28,000,000 - $18,000,000 = $10,000,000
That spread must cover operating costs and loan losses, so if credit losses reach 3% of the loans ($6,000,000), the company is left with $4,000,000 before operating costs.Case study
Seen in the real world.
Sunrise Credit Finance is an illustrative, fictional non-bank lender that built a book of $500,000,000 in vehicle loans, funded mostly by short-term borrowing. For several years the model worked, because lenders were happy to refinance each maturing loan.
When market conditions tightened, some funding providers declined to renew, and the company had to repay $80,000,000 within three months while its borrowers continued to pay only gradually over several years. The finance team drew on credit lines and sold part of its loan book to raise cash.
In this illustrative story, the board afterwards lengthened its borrowing maturities and held a larger liquidity buffer, accepting a lower profit margin in exchange for greater stability. Its lenders responded by agreeing to extend maturities on part of their loans.
Watch out
Common mistakes.
- Assuming an NBFC is as safe as a bank, when it does not offer the same depositor protections in most countries.
- Ignoring the funding structure, when reliance on short-term borrowing is the main source of risk.
- Treating all NBFCs as the same, when they range from tiny lenders to very large institutions with different risk profiles.
Questions
People also ask.
Can an NBFC accept deposits?
In some countries it can accept limited term deposits within regulatory rules, but it cannot offer the full range of banking services such as current accounts and cheque facilities.
Who regulates NBFCs?
In India it is the central bank, and in other countries it may be a banking, securities or dedicated financial regulator.
Why do borrowers use them?
They often offer faster decisions, flexible terms and access to customers that banks decline, at a cost of higher interest rates and, in some cases, stricter collection practices that borrowers should understand in advance.
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