Difference Between Banks and NBFCs – Which is Good for MSME?

While taking a new loan for business expansion, MSMEs and new businesses often find themselves stuck between choosing a bank or NBFC. While the history of banks in India dates back to the 1770s, when the 1st ever bank was established, the history of NBFCs is relatively new, as they were introduced as recently as the 1960s. So, what are non-banking financial companies? Which is better for MSMEs for taking a new loan or financial assistance: Banks or NBFCs? We will share our opinion and viewpoints on this burning question, but before, we will talk about the difference between banks and NBFC, and explain what is NBFC sector.

What are NBFCs?

NBFC or Non-Banking Financial Company is a registered company, which offers these services:

  • Purchase and selling of Shares & Stocks
  • Insurance products
  • Loans for individuals and businesses
  • Sale and purchase of Bonds
  • Chit-Fund business

NBFCs are registered under the Companies Act, 1956 but fully regulated by RBI guidelines and policies. The entities or institutions cannot be an NBFC in India, whose primary business is –

  • Agriculture
  • Industrial activities
  • Sale and purchase of any goods, except that of shares and stocks
  • Services
  • Sale and purchase of the real estate

The need for NBFCs was realized in the 1960s when existing banking platforms failed to provide the desired financial services to large industrial firms. Soon, NBFCs started attracting large deposits from the manufacturing sector, and this gave birth to a new structure of financial services run by non-banks. As of 2020, there are approximately 10,000 NBFCs registered with the Reserve Bank of India.

Difference Between Banks & NBFCs

Although there is a Difference between banking and non-banking financial institutions in terms of services offered and organizational structure, they both cater to similar needs of the businesses. Banks offer these services:

  • Savings Accounts
  • Current Accounts
  • Fixed Deposits
  • Business and personal loans, auto loans, home loans
  • Mortgages
  • Credit and Debit cards

Meanwhile, NBFCs primary services include:

  • Payday loans
  • Pawnshops
  • Hedge funds
  • Currency exchange (now most of the banks provide this service too)
  • Insurance firms
  • Cheque-Cashing services
  • Finance Leasing and more

While a banking license is a must for operating a bank, NBFCs do not require any such license and can function without them. While banks may accept only 74% of investments from foreign entities, NBFCs can receive 100% foreign funding. While banks are highly regulated and mandated to follow the rules as prescribed under banking licenses, NBFCs operate in a sort of unregulated environment. Although RBI rules regulate them, for them, the compliance of rules is not that strict, compared to banks. Another big difference is: banks can create credit scores and ratings for the customers, but NBFCs cannot do that.

Who are Typical Customers of NBFCs

While banks serve a selective and distinct set of customers with a credit history and ratings, NBFCs have a diversified customer base, and the scope is greater than banks. And this is where the main NBFC and bank difference comes in.

Take, for example, Mr. X, whose credit rating is poor, and banks have refused to grant him a loan for buying a new home. He may divert to an NBFC, that will be glad to offer him a loan, albeit at their own conditions. Or say, Mr. X has a low monthly income, and cannot afford to maintain a minimum balance for a savings account in a bank. He may approach an NBFC, and open a new account without any minimum balance requirement.

One of the drawbacks of an NBFC is a high-interest rate for loans, compared to banks. But, there is an assurity of the loan being approved, unlike banks.

What is Better for MSMEs: Bank or NBFCs?

This is a subjective question, and a lot of factors need to be considered, which depends on case to case basis. But broadly speaking, banks can provide loans at low interest compared to NBFCs, but they are unable to serve the MSME sector in a way that is desired for fast growth. And this is the reason NBFCs are booming in India and providing more and more credit support to the MSMEs and new businesses.

As per 2019 data, out of 6.3 crore MSMEs in India, only 8% were able to get credit assistance and loans from formal credit channels (read banks), and the rest 92% are either self-funded or dependent on NBFCs for getting financial help.

As per FY2017 data, there is an urgent need for up to Rs 25 lakh crore credit support for MSMEs in India, which banks are unable to fulfill and oblige. And this shows in the data as well. Market share of PSBs (Public Sector Banks), when it comes to providing loans and credits to businesses has fallen by up to 5% between 2014-19, as more and more small scale businesses are looking out to NBFCs for getting instant credit and loans, as and when required.

There are several technical and practical reasons why banks and formal credit channels are not able to serve the MSME sector in India, which is desperately demanding financial help and loans:

  • Insufficient credit data related to micro, small, and medium businesses in India, which means assessing such businesses for granting loans by banks is tough.
  • Less tailor-made financial products for the MSME sector, since the banks are not even aware of their needs.
  • Lengthy procedures, formalities, and turn-around time for getting loans from banks, especially PSBs.
  • MSMEs and small-scale entrepreneurs are not able to provide collateral to the banks, which leads to more rejections.

As shared earlier, every case is different, when it comes to choosing between a bank or NBFC for a small-scale entrepreneur running an MSME unit. We will suggest consulting a finance and funding expert for the MSME sector, and taking guidance on financial assistance and credit for your business. And this you can do right here at Udyami Helpline.in, which is a micro-advisory platform powered by business experts and veterans who can guide you, mentor you, and provide you with the right information, at the right time. Book an appointment with MSME Expert for Loans, and clear all your doubts right away.