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What is a 'Non-Banking Financial Company - NBFC'

Non-banking financial companies, or NBFCs, are financial institutions that provide certain types of banking services, but do not hold a banking license. Generally, these institutions are not allowed to take deposits from the public, which keeps them outside the scope of traditional oversight required under banking regulations. NBFCs can offer banking services such as loans and credit facilities, retirement planning, money markets, underwriting, and merger activities.

BREAKING DOWN 'Non-Banking Financial Company - NBFC'

NBFCs were officially classified under the Dodd-Frank Act as companies predominantly engaged in financial activity when more than 85% of their consolidated annual gross revenues or consolidated assets are financial in nature. This classification encompasses a wide range of companies offering bank-like services, including credit unions, insurance companies, money market funds, asset managers, hedge funds, private equity firms, mobile payment systems, microlenders and peer-to-peer lenders.

NBFCs and the Rise of Shadow Banking

In 2007, NBFCs were given the moniker of “shadow banks” by Paul McCulley, an executive of Pacific Investment Management Company LLC (PIMCO), to describe the expanding matrix of institutions contributing to the easy-money lending environment that led to the subprime mortgage meltdown. Investment bankers Lehman Brothers and Bear Stearns were two of the more notorious NBFCs at the center of the meltdown. As a result of the ensuing financial crisis, traditional banks found themselves under tighter regulatory scrutiny, which led to a prolonged contraction in lending activities. This gave rise to a number of non-bank institutions that were able to operate outside the constraints of banking regulations.

In the decade following the financial crisis of 2007-08, NBFCs have proliferated in large numbers and varying types, playing a key role in meeting the credit demand unmet by traditional banks. The fastest growing segment of the non-bank lending sector has been 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 such as Lending Club Corp. (NYSE: LC) and Prosper.com 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. Although P2P lending only represents a small fraction of the total loans issued in the United States, it has gotten 65 times larger since 2009, rising from $25 million to $1.7 billion in loans by March 2015.

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