What Are Nonbank Financial Companies?

Nonbank financial companies (NBFCs), also known as nonbank financial institutions (NBFIs) are financial institutions that offer various banking services but do not have a banking license. Generally, these institutions are not allowed to take traditional demand deposits—readily available funds, such as those in checking or savings accounts—from the public. This limitation keeps them outside the scope of conventional oversight from federal and state financial regulators.

Examples of NBFCs include investment banks, mortgage lenders, money market funds, insurance companies, hedge funds, private equity funds, and P2P lenders.

 

NBFC Controversy

Advocates of NBFCs argue that these institutions play an important role in meeting the rising demand for credit, loans, and other financial services. Customers include both businesses and individuals—especially those who might have trouble qualifying under the more stringent standards set by traditional banks.

Not only do NBFCs provide alternate sources, proponents say, they also offer more efficient ones. NBFCs cut out the middleman, the role banks often play, to let clients deal with them directly, lowering costs, fees, and rates, in a process called disintermediation. Providing financing and credit is important to keep the money supply liquid and the economy humming.

 

Pros

• Alternate source of funding, credit
• Direct contact with clients, eliminating intermediaries
• High yields for investors
• Liquidity for the finance system

 

Cons

• Non-regulated, not subject to oversight
• Non-transparent operations
• Systemic risk to finance system, economy

 

Real-World Example of NBFCs

The fastest-growing segment of the non-bank lending sector has been in peer-to-peer (P2P) lending.

The growth of P2P lending has been facilitated by the power of social networking, which brings like-minded people from all over the world together. P2P lending websites are designed to connect prospective borrowers with investors willing to invest their money in loans that can generate high yields.

P2P borrowers tend to be individuals who could not otherwise qualify for a traditional bank loan or who prefer to do business with non-banks. Investors have the opportunity to build a diversified portfolio of loans by investing small sums across a range of borrowers.

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