A non-banking financial company cannot

Q: What is the answer to CAPF 2022 Paper I Q107?

D. Correct — D, seek demand deposits from public and cannot issue cheques. Read the stem carefully, because it asks what a non-banking financial company is barred from doing, not what it does. The Reserve Bank draws the line between a bank and an NBFC at three places, and two of them are in this option: an NBFC cannot accept demand deposits, meaning money repayable on demand such as a savings or current account balance, and it is not part of the payment and settlement system, so it cannot issue cheques drawn on itself. The third difference is that the deposit insurance cover of the Deposit Insurance and Credit Guarantee Corporation, which protects a bank depositor, is not available to an NBFC depositor. The other three options describe ordinary NBFC business rather than a prohibition.

(a)give loans
(b)make investments
(c)borrow from bank
(d)seek demand deposits from public and cannot issue cheques

Answer

Why

Correct — D, seek demand deposits from public and cannot issue cheques. Read the stem carefully, because it asks what a non-banking financial company is barred from doing, not what it does. The Reserve Bank draws the line between a bank and an NBFC at three places, and two of them are in this option: an NBFC cannot accept demand deposits, meaning money repayable on demand such as a savings or current account balance, and it is not part of the payment and settlement system, so it cannot issue cheques drawn on itself. The third difference is that the deposit insurance cover of the Deposit Insurance and Credit Guarantee Corporation, which protects a bank depositor, is not available to an NBFC depositor. The other three options describe ordinary NBFC business rather than a prohibition.

Why the others are wrong

(a)give loans — Lending is the core of what an NBFC does. Vehicle finance, gold loans, consumer durable finance and infrastructure finance are all NBFC businesses, and NBFC credit is a large share of retail lending in India.
(b)make investments — The statutory definition of a non-banking financial company itself covers the acquisition of shares, stocks, bonds, debentures and government securities, so investment is permitted rather than barred.
(c)borrow from bank — Borrowing from banks is one of the principal ways an NBFC funds itself, along with debentures, commercial paper and, for those permitted to take them, fixed deposits. Bank exposure to NBFCs is a standard item in the Reserve Bank's sectoral credit data.

Concept

A non-banking financial company is a company registered under the Companies Act whose principal business is lending, investment in securities, hire-purchase, insurance or the receiving of deposits under a scheme. It is registered with and supervised by the Reserve Bank, and it does much of what a bank does on the asset side. What it may not do is take demand deposits and operate in the payment system, and those two restrictions are the whole of the legal distinction that the question is testing.

Questions of this type are lost by answering the wrong question. Three of the four options are true statements about NBFCs, and a candidate skimming for something true will pick one of them; the stem says 'cannot', so the answer has to be the one thing on the list an NBFC is not allowed to do. The reason for the two prohibitions is worth holding on to. Demand liabilities and cheque issue are what make an institution part of the money-transmission machinery, and that machinery is protected by reserve requirements, deposit insurance and a lender of last resort. An NBFC has none of those, so it is kept out of both. Term deposits are a different matter — deposit-taking NBFCs may accept them for fixed periods under Reserve Bank conditions, which is why the prohibition is worded around deposits repayable on demand.

Key facts

An NBFC cannot accept demand deposits, cannot issue cheques drawn on itself, and its depositors do not get Deposit Insurance and Credit Guarantee Corporation cover.
NBFCs are registered under the Companies Act and regulated by the Reserve Bank of India under the Reserve Bank of India Act, 1934.
Lending, investment in securities, hire-purchase and asset finance are all ordinary NBFC activities.
Bank borrowing, debentures and commercial paper are the main funding sources for NBFCs.
Since October 2022 the Reserve Bank has supervised NBFCs through a scale-based framework of base, middle, upper and top layers.

Where a bank and an NBFC part company

Demand deposits→A bank may take them. An NBFC may not — this is the first half of option (d).

Cheques drawn on itself→A bank is inside the payment and settlement system. An NBFC is not, so it cannot issue such cheques.

Deposit insurance→A bank depositor is covered by the Deposit Insurance and Credit Guarantee Corporation. An NBFC depositor is not.

Lending and investment→Both do it. This is why options (a) and (b) describe permitted business rather than a bar.

Borrowing from banks→Allowed, and a principal funding route for NBFCs — option (c) is ordinary practice.

Only the first three rows are prohibitions, and option (d) names two of them.

Study next

Types of NBFCs — asset finance, loan companies, infrastructure finance, microfinance and core investment companiesThe Reserve Bank's scale-based regulatory framework for NBFCsDeposit insurance in India and the working of the Deposit Insurance and Credit Guarantee CorporationThe payment and settlement system — RTGS, NEFT and UPI, and who may participateFinancial inclusion and the role of small finance banks and payments banks

Common traps

Answering the true statement rather than the prohibition. Three options here are accurate descriptions of NBFC business.
Assuming NBFCs may take no deposits at all. Some may accept term deposits; what is barred is deposits repayable on demand.
Believing an NBFC deposit carries the same insurance as a bank deposit. It does not.

As a 'cannot' or 'not correct' item on NBFC powers, as a bank-against-NBFC comparison, or as a statement pair on their regulation.

Related PYQs

UPSC_2010_GS1_Q252010Open & attempt →

With reference to the Non-banking Financial Companies (NBFCs) in India, consider the following statements: 1. They cannot engage in the acquisition of securities issued by the government. 2. They cannot accept demand deposits like Savings Account. Which of the statements given above is/are correct?

(a) 1 only
(b) 2 only
(c) Both 1 and 2
(d) Neither 1 nor 2

Answer(b) 2 only

The same two ideas, split into a statement pair. Buying government securities is permitted, which is the point option (b) here rests on, while taking demand deposits is not, which is the point option (d) rests on.

CDS_GK_2022_II_Q82022Open & attempt →

Which one of the following statements about Non-Banking Financial Companies (NBFCs) is not correct?

(a) NBFCs cannot accept demand deposits.
(b) NBFCs cannot give loans.
(c) NBFCs cannot issue cheques drawn on themselves.
(d) NBFCs cannot offer deposit insurance facility of Deposit Insurance and Credit Guarantee Corporation.

Answer(b) NBFCs cannot give loans.

The same three restrictions, printed as options and inverted into a 'not correct' item in the very same examination year. Lending is the false prohibition there and the false prohibition in option (a) here.

Practice

practice — not a real PYQ
Deposits placed with a non-banking financial company are protected by which of the following?
- (a)The Deposit Insurance and Credit Guarantee Corporation
- (b)The Securities and Exchange Board of India
- (c)No deposit insurance scheme
- (d)The Insurance Regulatory and Development Authority
Answer(c) No deposit insurance scheme — the Deposit Insurance and Credit Guarantee Corporation cover extends to bank deposits, not to NBFC deposits.
practice — not a real PYQ
Which authority registers and supervises non-banking financial companies in India?
- (a)Ministry of Corporate Affairs
- (b)Reserve Bank of India
- (c)Securities and Exchange Board of India
- (d)National Bank for Agriculture and Rural Development
Answer(b) Reserve Bank of India — NBFCs are incorporated under the Companies Act but registered with and regulated by the Reserve Bank.