RBI cancels license of two NBFCs, 22 others surrender permit, Why NBFCs are failing?

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The Reserve Bank of India (RBI) on April 13 said it has cancelled the licence of two non-banking finance companies (NBFC) and 22 NBFCs surrendered their licences. The RBI cancelled the certificate of registration of BRD Securities Ltd and Lakshmi Finance Pvt Ltd.

Further, Way2Wealth Capital Pvt. Ltd, Dearborn Barter Pvt Ltd, Emsons Leasing Company Private Ltd, and 19 others surrendered their licence.

These entities surrendered their licences because some companies exited NBFC business, some ceased to be a legal entity due to amalgamation/ merger/dissolution/voluntary strike-off, and meeting the criteria prescribed for unregistered Core Investment Companies (CIC) that do not require registration.

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What is NBFC?

A non-banking financial institution (NBFI) or non-bank financial company (NBFC) is a financial institution that does not have a full banking license or is not supervised by a national or international banking regulatory agency. NBFC facilitate bank-related financial services, such as investment, risk pooling, contractual savings, and market brokering.

NBFCs perform functions similar to that of banks but there are a few differences-

  • an NBFC cannot accept demand deposits;
  • an NBFC is not a part of the payment and settlement system and as such,
  • an NBFC cannot issue cheques drawn on itself, and
  • deposit insurance facility of the Deposit Insurance and Credit Guarantee Corporation is not available for NBFC depositors, unlike banks.

What is NBFC crisis & How it happens?

  • NBFCs borrow money from banks or sell commercial papers to mutual funds to raise money.
  • This money is then given as a loan to small and medium enterprises, retail customers and so on.
  • But when NBFCs face liquidity crunch i.e. shortage of money, this leads to NBFC CRISIS.

The NBFC business model itself is flawed. It raises short-term funds which are then lent out as long-term loans. For example, an NBFC raises money by selling 6-month debt papers and on-lends this as a car loan with a tenure of 5 years. Now, every time the NBFC has to renew the 6-month debt paper or raise fresh loans to repay the old debt paper. This cycle continues but the cycle gets broken by the default of some firms. This creates fear among banks, mutual funds that more such entities could default. Due to this many institutions refused to give money to NBFCs. This leads to NBFC crisis.

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