Difference Between NBFC and Micro Finance Institution in India

Difference Between NBFC and Micro Finance Institution in India. The financial sector of India has undergone substantial changes, yet accessibility to banking services, particularly in rural areas, remains a challenge. Traditional banks and ATMs are often scarce in these regions, creating a void that Non-Banking Financial Companies (NBFCs) and Micro Finance Companies (MFCs) step in to fill. While both entities provide important  financial services, especially to underserved populations, they operate with distinct characteristics and regulatory frameworks. Knowing about these differences is important for appreciating their roles in promoting financial presence across the country.
What is a Non-Banking Financial Company (NBFC)?
A Non-Banking Financial Company (NBFC) is a financial institution that, while similar to a bank, does not hold a full banking license. NBFCs are registered under the Companies Act, 2013, and are regulated by the Reserve Bank of India (RBI) under the RBI Act, 1934. Their core activities include lending credit and advances, offering savings and investment products, and engaging in money market operations, stock portfolio management, and money transfers. Beyond these primary functions, NBFCs also specialize in areas such as infrastructure finance, leasing, housing finance, hire purchasing, and venture capital finance.
A main difference between NBFCs and traditional banks lies in their deposit-taking capabilities. NBFCs are permitted to accept only term deposits, meaning deposits that are repayable after a fixed period, and are strictly prohibited from accepting demand deposits (deposits repayable on demand, such as savings or current accounts). Furthermore, unlike banks, NBFCs cannot issue cheques drawn on themselves. Despite these limitations, NBFCs play a vital role in the financial system by providing a wide array of financial services to a broader spectrum of customers, including individuals and corporations, in both urban and rural settings. NBFCs are broadly categorized into three types: loan companies, asset companies, and investment companies, each focusing on specific financial activities.
What are Microfinance Institutions (MFIs)?
Micro Finance Companies, commonly referred to as Micro Finance Institutions (MFIs), operate on a smaller scale compared to NBFCs, with a primary focus on extending financial services to the economically disadvantaged sections of society who typically lack access to mainstream banking. These institutions aim to empower individuals, particularly in rural areas, by providing small loans for income-generating activities. The credit provided by MFIs is significantly lower in value compared to that offered by NBFCs, often falling within the range of INR 10,000 to INR 20,000 per person, primarily to help them start or expand small businesses.
Historically, some MFIs have faced scrutiny for practices such as charging high interest rates and disbursing credit to newly formed entities without adequate scrutiny. There have also been instances where MFIs have been found to violate directives regarding loan disbursement and recovery methods, sometimes deviating from the "Fair Practices Code" issued by regulatory authorities. Recognizing these challenges, state governments are actively encouraging and facilitating the conversion of existing Micro Finance Companies into NBFCs that operate under the strict guidelines of the RBI. This transition is also desired by many MFIs themselves, as obtaining NBFC status grants them better access to various funding options from banks and enhances their credibility and operational transparency.
Differences Between NBFCs and Micro Finance Companies
While both NBFCs and MFIs serve as important alternatives to conventional banks, especially in underserved regions, they exhibit several key differences in their operational scope, regulatory compliance, and target audience.
Geographical Reach and Target Audience
NBFCs have a broader geographical reach and operate pan-India, serving both urban and rural populations. They cater to a diverse client base, including individuals, small and medium enterprises (SMEs), and large corporations, depending on their specific focus.
In contrast, Micro Finance Companies primarily focus on the poorer sections of society residing in rural and semi-urban areas. Their mission is specifically targeted at financial inclusion for those who are traditionally excluded from the formal banking system.
Interest Rates Imposed
The majority of NBFCs adhere to the interest rate ceilings and guidelines recommended by the RBI, ensuring that their lending practices are fair and transparent. This adherence provides a degree of protection for borrowers.
Micro Finance Companies, on the other hand, have historically been observed to impose more stringent or higher interest rates on their borrowers. While efforts are being made to bring them under tighter regulatory oversight, instances of high-interest charges have been a concern.
Compliance and Code of Conduct
Nearly all NBFCs operate under strict adherence to the code of conduct issued by the RBI. They are committed to abiding by the rules and regulations, striving to offer hassle-free services and maintain transparency in their operations.
Micro Finance Companies have, at times, been found to alleviate RBI compliances, particularly concerning loan recovery methods. There have been reported violations of the "Fair Practices Code" issued by governing authorities, raising concerns about their ethical conduct in some instances.
Transparency in Operations
NBFCs are generally more reliable when it comes to maintaining transparency within their financial systems and operational procedures. Their larger scale of operation and regulatory framework necessitate a higher degree of accountability.
Micro Finance Companies, especially those operating without full NBFC status, have sometimes struggled to maintain consistent transparency in the longer run, particularly regarding their lending and recovery practices.
Loan Disbursal Amount
NBFCs have the capacity to disburse substantial amounts of loans to both corporate entities and individuals, depending on the specific financial needs and the type of NBFC. This flexibility allows them to cater to a wider range of financial requirements.
Micro Finance Companies, due to their specific mandate and often limited funding, offer a significantly lower threshold of financial credit to individuals. This is a deliberate operational restriction designed to support micro-entrepreneurship.
Potential as an Alternative to Traditional Banks
NBFCs can be considered a more relevant and robust alternative to conventional banks, especially when it comes to the quick disbursement of credit, particularly in urgent situations. Their operational flexibility often allows for faster processing compared to traditional banks.
Micro Finance Companies, while vital for financial inclusion, operate under more government restrictions and have a more confined scope. Therefore, they do not possess the same potential to replicate the full range of services offered by traditional banks.
Scope of Operation
NBFCs generally have a much wider scope of operation, covering diverse financial products and services across various sectors of the economy. They can engage in activities ranging from lending to investment and financial advisory.
Micro Finance Companies operate in a more confined zone, focusing primarily on micro-credit and related services for a specific demographic. This specialized focus means they have very little access to a wider audience or a broader range of financial products.
Conclusion
Both NBFCs and Micro Finance Companies play an indispensable role in India's financial ecosystem, particularly in bridging the gap in financial accessibility for underserved populations. They offer alternatives to mainstream banks, facilitating easier access to credit, especially for those who face numerous hurdles in availing loans from traditional institutions.
While NBFCs serve a broader audience with a wider range of services and higher credit limits, adhering closely to RBI guidelines, Micro Finance Companies are crucial for empowering the economically disadvantaged through micro-credit. The challenges faced by some MFIs regarding high-interest rates and non-compliance with fair practices highlight the ongoing need for stronger regulatory oversight and their transition into regulated entities like NBFCs.
If you have any queries or need any support, then you can book a consultation with Compliance Calendar LLP Experts through email at info@ccoffice.in or Call/Whatsapp at +91 9988424211.
Frequently Asked Questions (FAQs)
Q1. What is the primary difference between an NBFC and a Micro Finance Company?
Ans.  The key difference lies in their scope and target audience. NBFCs offer a wide range of financial services—including lending, asset financing, and investments—to diverse customers, including corporates and individuals, and operate under strict RBI regulations. In contrast, MFIs focus specifically on providing small loans (microcredit) to economically weaker sections of society, primarily in rural and semi-urban areas, often without full regulatory oversight.
Q2. Can both NBFCs and MFIs accept deposits from the public?
Ans. NBFCs can accept term deposits, which are repayable after a fixed period, but they are prohibited from accepting demand deposits (like savings or current accounts). MFIs are generally not allowed to accept any kind of deposits from the public, focusing solely on extending microloans.
Q3. Why do some MFIs charge higher interest rates than NBFCs?
Ans. Some MFIs have been found to charge higher interest rates because they cater to high-risk borrowers in underserved markets and may lack the scale and funding options that NBFCs have. Additionally, less regulatory oversight and operational inefficiencies contribute to these higher rates. However, there’s a growing push to convert MFIs into NBFCs to bring them under stricter RBI regulation and ensure fair lending practices.
Q4. Are MFIs considered a substitute for banks like NBFCs are?
Ans. While both NBFCs and MFIs help fill the gap left by traditional banks, NBFCs have a broader operational scope and can cater to a wider clientele with faster credit processing, making them a closer substitute for banks. MFIs, due to their specialized focus and smaller loan amounts, are not fully equipped to replace the comprehensive services offered by banks.
Q5. What regulatory challenges do MFIs face compared to NBFCs?
Ans. MFIs often face challenges in maintaining transparency, fair lending practices, and ethical loan recovery. Many operate without full RBI regulation, leading to occasional non-compliance with fair practice codes. By contrast, NBFCs are strictly regulated under the RBI Act, 1934, which mandates compliance with interest rate ceilings, disclosure norms, and operational transparency.

The financial sector of India has undergone substantial changes, yet accessibility to banking services, particularly in rural areas, remains a challenge. Traditional banks and ATMs are often scarce in these regions, creating a void that Non-Banking Financial Companies (NBFCs) and Micro Finance Companies (MFCs) step in to fill. While both entities provide important financial services, especially to underserved populations, they operate with distinct characteristics and regulatory frameworks. Knowing about these differences is important for appreciating their roles in promoting financial presence across the country.

What is a Non-Banking Financial Company (NBFC)?

A Non-Banking Financial Company (NBFC) is a financial institution that, while similar to a bank, does not hold a full banking license. NBFCs are registered under the Companies Act, 2013, and are regulated by the Reserve Bank of India (RBI) under the RBI Act, 1934. Their core activities include lending credit and advances, offering savings and investment products, and engaging in money market operations, stock portfolio management, and money transfers. Beyond these primary functions, NBFCs also specialize in areas such as infrastructure finance, leasing, housing finance, hire purchasing, and venture capital finance.

A main difference between NBFCs and traditional banks lies in their deposit-taking capabilities. NBFCs are permitted to accept only term deposits, meaning deposits that are repayable after a fixed period, and are strictly prohibited from accepting demand deposits (deposits repayable on demand, such as savings or current accounts). Furthermore, unlike banks, NBFCs cannot issue cheques drawn on themselves. Despite these limitations, NBFCs play a vital role in the financial system by providing a wide array of financial services to a broader spectrum of customers, including individuals and corporations, in both urban and rural settings. NBFCs are broadly categorized into three types: loan companies, asset companies, and investment companies, each focusing on specific financial activities.

What are Microfinance Institutions (MFIs)?

Micro Finance Companies, commonly referred to as Micro Finance Institutions (MFIs), operate on a smaller scale compared to NBFCs, with a primary focus on extending financial services to the economically disadvantaged sections of society who typically lack access to mainstream banking. These institutions aim to empower individuals, particularly in rural areas, by providing small loans for income-generating activities. The credit provided by MFIs is significantly lower in value compared to that offered by NBFCs, often falling within the range of INR 10,000 to INR 20,000 per person, primarily to help them start or expand small businesses.

Historically, some MFIs have faced scrutiny for practices such as charging high interest rates and disbursing credit to newly formed entities without adequate scrutiny. There have also been instances where MFIs have been found to violate directives regarding loan disbursement and recovery methods, sometimes deviating from the "Fair Practices Code" issued by regulatory authorities. Recognizing these challenges, state governments are actively encouraging and facilitating the conversion of existing Micro Finance Companies into NBFCs that operate under the strict guidelines of the RBI. This transition is also desired by many MFIs themselves, as obtaining NBFC status grants them better access to various funding options from banks and enhances their credibility and operational transparency.

Differences Between NBFCs and Micro Finance Companies

While both NBFCs and MFIs serve as important alternatives to conventional banks, especially in underserved regions, they exhibit several key differences in their operational scope, regulatory compliance, and target audience.

Geographical Reach and Target Audience

NBFCs have a broader geographical reach and operate pan-India, serving both urban and rural populations. They cater to a diverse client base, including individuals, small and medium enterprises (SMEs), and large corporations, depending on their specific focus.

In contrast, Micro Finance Companies primarily focus on the poorer sections of society residing in rural and semi-urban areas. Their mission is specifically targeted at financial inclusion for those who are traditionally excluded from the formal banking system.

Interest Rates Imposed

The majority of NBFCs adhere to the interest rate ceilings and guidelines recommended by the RBI, ensuring that their lending practices are fair and transparent. This adherence provides a degree of protection for borrowers.

Micro Finance Companies, on the other hand, have historically been observed to impose more stringent or higher interest rates on their borrowers. While efforts are being made to bring them under tighter regulatory oversight, instances of high-interest charges have been a concern.

Compliance and Code of Conduct

Nearly all NBFCs operate under strict adherence to the code of conduct issued by the RBI. They are committed to abiding by the rules and regulations, striving to offer hassle-free services and maintain transparency in their operations.

Micro Finance Companies have, at times, been found to alleviate RBI compliances, particularly concerning loan recovery methods. There have been reported violations of the "Fair Practices Code" issued by governing authorities, raising concerns about their ethical conduct in some instances.

Transparency in Operations

NBFCs are generally more reliable when it comes to maintaining transparency within their financial systems and operational procedures. Their larger scale of operation and regulatory framework necessitate a higher degree of accountability.

Micro Finance Companies, especially those operating without full NBFC status, have sometimes struggled to maintain consistent transparency in the longer run, particularly regarding their lending and recovery practices.

Loan Disbursal Amount

NBFCs have the capacity to disburse substantial amounts of loans to both corporate entities and individuals, depending on the specific financial needs and the type of NBFC. This flexibility allows them to cater to a wider range of financial requirements.

Micro Finance Companies, due to their specific mandate and often limited funding, offer a significantly lower threshold of financial credit to individuals. This is a deliberate operational restriction designed to support micro-entrepreneurship.

Potential as an Alternative to Traditional Banks

NBFCs can be considered a more relevant and robust alternative to conventional banks, especially when it comes to the quick disbursement of credit, particularly in urgent situations. Their operational flexibility often allows for faster processing compared to traditional banks.

Micro Finance Companies, while vital for financial inclusion, operate under more government restrictions and have a more confined scope. Therefore, they do not possess the same potential to replicate the full range of services offered by traditional banks.

Scope of Operation

NBFCs generally have a much wider scope of operation, covering diverse financial products and services across various sectors of the economy. They can engage in activities ranging from lending to investment and financial advisory.

Micro Finance Companies operate in a more confined zone, focusing primarily on micro-credit and related services for a specific demographic. This specialized focus means they have very little access to a wider audience or a broader range of financial products.

Conclusion

Both NBFCs and Micro Finance Companies play an indispensable role in India's financial ecosystem, particularly in bridging the gap in financial accessibility for underserved populations. They offer alternatives to mainstream banks, facilitating easier access to credit, especially for those who face numerous hurdles in availing loans from traditional institutions.

While NBFCs serve a broader audience with a wider range of services and higher credit limits, adhering closely to RBI guidelines, Micro Finance Companies are crucial for empowering the economically disadvantaged through micro-credit. The challenges faced by some MFIs regarding high-interest rates and non-compliance with fair practices highlight the ongoing need for stronger regulatory oversight and their transition into regulated entities like NBFCs.

If you have any queries or need any support, then you can book a consultation with Compliance Calendar LLP Experts through email at info@ccoffice.in or Call/Whatsapp at +91 9988424211.

Frequently Asked Questions (FAQs)

Q1. What is the primary difference between an NBFC and a Micro Finance Company?

Ans. The key difference lies in their scope and target audience. NBFCs offer a wide range of financial services—including lending, asset financing, and investments—to diverse customers, including corporates and individuals, and operate under strict RBI regulations. In contrast, MFIs focus specifically on providing small loans (microcredit) to economically weaker sections of society, primarily in rural and semi-urban areas, often without full regulatory oversight.

Q2. Can both NBFCs and MFIs accept deposits from the public?

Ans. NBFCs can accept term deposits, which are repayable after a fixed period, but they are prohibited from accepting demand deposits (like savings or current accounts). MFIs are generally not allowed to accept any kind of deposits from the public, focusing solely on extending microloans.

Q3. Why do some MFIs charge higher interest rates than NBFCs?

Ans. Some MFIs have been found to charge higher interest rates because they cater to high-risk borrowers in underserved markets and may lack the scale and funding options that NBFCs have. Additionally, less regulatory oversight and operational inefficiencies contribute to these higher rates. However, there’s a growing push to convert MFIs into NBFCs to bring them under stricter RBI regulation and ensure fair lending practices.

Q4. Are MFIs considered a substitute for banks like NBFCs are?

Ans. While both NBFCs and MFIs help fill the gap left by traditional banks, NBFCs have a broader operational scope and can cater to a wider clientele with faster credit processing, making them a closer substitute for banks. MFIs, due to their specialized focus and smaller loan amounts, are not fully equipped to replace the comprehensive services offered by banks.

Q5. What regulatory challenges do MFIs face compared to NBFCs?

Ans. MFIs often face challenges in maintaining transparency, fair lending practices, and ethical loan recovery. Many operate without full RBI regulation, leading to occasional non-compliance with fair practice codes. By contrast, NBFCs are strictly regulated under the RBI Act, 1934, which mandates compliance with interest rate ceilings, disclosure norms, and operational transparency.