Chapter-03

Non-Banking Financial Institutions

1. Definition of Non-Banking Institutions

Non-Banking Institution” - means a company , corporation or co-operative society and which
has as its Principal Business the receiving of deposits, under any scheme or arrangement or in
any other manner, or lending in any manner;

2. Classification of NBFCs
 Asset Finance Company
 Equipment Leasing
 Hire Purchase Finance
 Investment Company
 Loan Company
 Core Investment Companies
 Infrastructure Finance Companies
 Micro Finance Institutions
 Infrastructure Debt Funds

Asset Finance Company (AFC) would be defined as any company which is a

financial institution carrying on as its principal business the financing of physical assets
supporting productive / economic activity.

Investment Companies (IC) means any company which is a financial institution

carrying on as its principal business of acquisition of securities.

Loan Companies (LC) means any company which is a financial institution carrying
on as its principal business the providing of finance whether by making loans or
advances or otherwise for any activity other than its own but does not include an Asset
Finance Company.

Infrastructure Finance Companies (IFC) IFC means a non‐banking finance company

which deploys at least 75 per cent of its total assets in infrastructure loans
3. Merchant banking
3.1. Definition:

Banking Business activity of an financial advisory that accepts deposits and channels
those deposits into lending activities, either directly or through capital markets. Few
Services Offered: a) Savings/Current account b) Home/Personal loan c) Mutual fund
d) collect cheques, drafts & notes. Merchant banking primarily involves financial
advice and services for large corporations and wealthy individuals. Merchant banks
 do not provide regular banking services to the general public. Merchant banks invest
their own capital in client companies & provide services for mergers and acquisitions.

A merchant bank is sometimes said to be a wholesale bank, or in the business of

wholesale banking. It’s because merchant banks tend to deal primarily with other
merchant banks and other large financial institutions.

3.2. Services:
 Corporate counseling.
 Project counseling.
 Working capital finance.
 Portfolio Management.
 Restructuring strategies.
 Credit Syndication.
 Lease Financing.
 Some Other Services.
i. Corporate Counseling: Set of activities undertaken for efficient running of an
enterprise. Identifying areas of growth & diversification. Guiding clients on
aspects like locational factors, organizational size, investment decision, choice
of product.
ii. Project counseling: It’s a part of corporate counseling & deals with analysis
of project viability. Comprises of preparation of project report & deciding
finance pattern for cost of project. Filling up of application form with
significant information for obtaining funds.
iii. Working Capital Finance: Meeting the day-to-day expenses of an enterprise
is working capital finance. Assessment of working capital requirements.
Preparing necessary application to negotiation for sanction of appropriate
credit facilities.
iv. Portfolio Management: Making decisions for the investment of cash
resources of a corporate enterprise in marketable securities. Decides quantum,
timing & type of security to be bought. Help in achieving maximum return
with minimum risk by proper combination of securities.
v. Restructuring Strategies: Deals with Mergers & Acquisitions. It’s a
specialized service of Merchant bankers wherein they act as middle-men in
negotiating between two companies. Offers expert evaluation regarding
identification organizations with matching characteristics. Obtaining approvals
from various authorities.
vi. Credit Syndication: Relates to activities connected with credit procurement
& project financing. Estimates total cost of the project Drawing up of financial
plan which conforms requirements of promoters & their collaborators.
Selecting institutions for participation for financing.
vii. Lease Financing: It’s an important alternative source of financing a capital
outlay. Involves letting out assets on lease for use by the lessee for a particular
period of time. Providing advice on viability of leasing & choice of favorable
rental structure.
 viii. Other Services: Relief to Sick Industries: Rejuvenating old lines & ailing
units by appraising technology, process etc. Evolving rehabilitation packages
acceptable to financial institutions/banks. Exploring possibilities of mergers &
acqusitions.
ix. Mutual Funds: It’s collective investment scheme that pools money from
several investors & channels them into productive investments. Investing
money in diversified portfolio of shares & debentures. Assuring Investors
return in terms of capital appreciation.

4. Difference between Commercial & Merchant banks

Sl.
No.
Commercial Banking Merchant Banking
1. Catering needs of common Catering needs of corporate man, firms.
2. Anyone can open an A/c. It cannot be done.
3. Less exposed to risk More exposed to risk
4. Related to secondary markets. Related to Primary
5. It’s management oriented It’s asset oriented. markets
6. Plays the role of financers Plays different roles like underwriting,
portfolio etc.

Merchant Bank
A bank that primarily deals with companies, investments and foreign trade
In modern terms, a merchant bank is a firm or financial institution that invests equity capital
directly in businesses and often provides those businesses with advisory services. A merchant
bank offers the same services as an investment bank; however, it typically services smaller
clients and makes direct equity investments in them.

Investment Bank vs. Merchant Bank

Although there is somewhat a thin line between traditional merchant banks and investment
banks, the financial institutions differ in several ways.
First, merchant banks serve small-scale companies that may not be big enough to attract
funding from venture capitalists and other large investors. Merchant banks offer such
companies creative credit products such as bridge financing, equity financing, and mezzanine
financing. They place equity with other financial institutions and take ownership of small but
promising companies.
Investment banks, on the other hand, focus on underwriting and selling securities through
initial public offerings (IPO) and share offerings. Unlike merchant banks that focus on small
companies with potential for growth, an investment bank’s clientele comprises large
companies with enough resources to finance the sale of securities to the public. Investment
banks advise their clients on mergers and acquisitions, buyouts, and capital restructuring,
among other services.
Second, traditional merchant banks mainly focus on international financing activities
including trade finance, foreign corporate investment, and foreign real estate investment.
Some of these activities may be shared with investment banks, but there are other functions
like issuing letters of credit and international funds transfer that are predominantly carried out
by merchant banks.
Investment banks focus on raising funds for corporations and governments and issuing debt
or equity on the market. This is a transition from their traditional roles of underwriting and
selling securities. Investment banks also help in mergers and acquisitions as well as buying
and selling large companies.

Functions of Merchant Banks

1. Equity Underwriting
Large companies often employ the services of merchant banks in acquiring capital through
the stock market. Equity underwriting is achieved by evaluating the amount of stock to be
issued, the value of the business, the use of proceeds, and the timing of issuance of the new
stock. Merchant banks handle all the necessary paperwork and liaison with the appropriate
marketing division to advertise the stock.
2. Credit Syndication
Merchant banks help in processing loan applications for short and long-term credit from
financial institutions. They provide these services by estimating total costs involved,
developing a financial plan for the entire project, as well as adopting a loan application for
commercial lenders.
Also, they assist in choosing the ideal financial institutions to provide credit facilities and act
on the terms of the loan application with the financiers. Merchant banks also ensure the
lender’s willingness to participate, organize bridge finance, and engage in legal formalities
regarding investment to be approved and checking the working capital requirements.
3. Portfolio Management
Merchant banks provide portfolio management services to institutional investors and other
investors. They help in the management of securities to enhance the value of the underlying
investment. Merchant banks may assist their clients in the purchase and sale of securities to
help them attain their investment objectives.