Bank vs NBFC: The Deposit, and What Follows From It

A bank may take deposits from the public and a finance company may not, and that single difference produces every other difference in this guide. The deposit settles what money costs each of them, how far each can lever its own capital, how wide the margin looks and what each is exposed to when conditions change. Both invented institutions here return the same on net worth, by completely different routes.

Most answers to this question arrive as a list. One is a bank, one is not; one has branches, one has an application; one is old, one is new. Because the items on such a list are not independent of each other, a list is easy to remember and teaches nothing. A single line and then eight consequences of it come below, in the order the consequences actually arrive.

There is one order that works, and it runs in a single direction. Trace the funding before the lending, and every later block reads as a consequence rather than as another item on a list. Where the money on the funding side came from is the first question, and answering it properly answers most of the others at the same time.

What is the one difference between a bank and a finance company?

Suvarna Commercial Bank Limited, an invented bank, may take deposits from the public. People place money with it, and they can ask for that money back, on demand or on a date the two of them agreed. Suvarna Commercial Bank lends some of that money out and it holds the rest in other forms, and its whole shape as a business follows from where the money came from.

Rukmini Finance Limited, also invented, is a non-banking financial company (NBFC): it lends money and takes no deposits. Nobody walks in and places savings with it. Rukmini Finance funds itself in the market instead, going to parties who lend in size, agrees a rate and a date, takes the money and repays it on that date whatever else is happening. The deposit is not one difference among several, but the difference the others descend from.

Picture two shops on the same street. The first keeps a jar behind the counter where regulars leave money they are not carrying home, and any of them can come back and take it out on a slow Tuesday afternoon. The second borrows once a year from one wholesaler, on a stated rate and a stated date, and the wholesaler decides afresh each year whether to lend again. Both shops run on money that is not theirs. The two shops do not run on the same money, and nothing else about them is unaffected by that.

The conditions on which a bank is licensed and may take a deposit at all, and the conditions on which a finance company is registered and may lend at all, are set by the Reserve Bank of India at rbi.org.in, and both of them move. Each requirement of that kind has an authority who sets it, and only that authority's own source carries the value on any given day.

What is a deposit, looked at from both sides of it?

A reader who only ever looks at one side of a deposit comes away thinking cheap money is a gift. It is not. Look at it from both sides and the trade appears immediately.

From the side of the person who placed it, a deposit is a claim on the bank. The money is theirs, they can ask for it back on the agreed terms, and what they hold in exchange for handing it over is a promise from the institution. From the side of the bank, the very same rupee is a liability. The deposit funds the assets the bank holds, it sits on the funding side of the balance sheet, and it has to go back when it is asked for. Same rupee, two names, and which name applies depends only on which side of the counter the observer is standing on.

Here is the trade, and it is the reason the comparison matters: money raised from the public in small amounts is cheaper than money raised in the market, and what comes attached to it is a set of requirements that the market's money does not carry. The cheaper liability and the requirements come together, or neither comes. There is no version where an institution keeps one and skips the other.

Four of those attached items are drawn below as rows, each with its value left out. The reserve a bank holds against the deposits it takes, the share of its deposits that sits in specified liquid assets, and which lenders may reach the central bank's liquidity facilities and on what terms, are all set by the Reserve Bank of India at rbi.org.in. The fourth is the cover a depositor has if a bank fails, what it applies to and what it does not, and that one belongs to the Deposit Insurance and Credit Guarantee Corporation at dicgc.org.in. Deposit cover is the one requirement in the comparison that belongs to a second authority, and no value goes into that row either.

How is each of them funded, and what do the two funding sides look like side by side?

Now the figures. Suvarna Commercial Bank Limited holds total assets of Rs 2,40,000 crore, funded by deposits of Rs 1,92,000 crore and net worthThe institution's own money on the funding side. Net worth carries no repayment date and nobody has to be paid back out of it, and that is what makes it the cushion the rest of the funding sits on. of Rs 24,000 crore. Divide: Rs 1,92,000 crore over Rs 2,40,000 crore is 80.0 per cent of total assets.

Rukmini Finance Limited holds assets under managementHow large the book a lender is running has grown to. The book stands in for total assets on a lender without a bank balance sheet, and it is the denominator under most of what follows. of Rs 18,000 crore, and behind that book sit Rs 14,400 crore borrowed in the market and Rs 3,600 crore of its own net worth. Divide again: Rs 14,400 crore into Rs 18,000 crore gives 80.0 per cent of the book. The two shares are identical to the decimal, and the identity is worth stopping on.

The last two rows are where a careful reader stops and suspects a mistake. Read them again. Rs 2,40,000 crore of total assets over Rs 24,000 crore of net worth is 10.0 times at the bank. Rs 18,000 crore of assets under management over Rs 3,600 crore of net worth is 5.0 times at the finance company. Two institutions funded 80.0 per cent by borrowing, one levered 10.0 times and the other 5.0 times, and there is no contradiction anywhere in those four figures.

The four figures read as a contradiction, and the confusion is the most useful one in the whole comparison. Clearing it up takes three steps, and the resolution is worth checking against the two divisions rather than taken on trust.

Both are funded 80.0 per cent by borrowing, so why is one levered twice as far?

Three steps, and all three are needed.

Step one, the definition that does the work

Leverage is assets over equity. It is not assets over borrowed money and it never was. So the 80.0 per cent is not an input to the leverage calculation at any point, and no amount of staring at it will produce a leverage figure. The borrowed share is the whole trick, and it is the sort of trick that only works once.

Step two, the division, done twice

At the bank: net worth of Rs 24,000 crore over total assets of Rs 2,40,000 crore is 10.0 per cent, and one divided by 10.0 per cent is 10.0 times. At the finance company: net worth of Rs 3,600 crore over assets under management of Rs 18,000 crore is 20.0 per cent, and one divided by 20.0 per cent is 5.0 times. Leverage is the reciprocalOne divided by a number. The reciprocal of one quarter is four, and the reciprocal of one fifth is five, so a share that halves produces a reciprocal that doubles. of the equity share of assets, and nothing else on the funding side decides it.

Step three, why the equity shares differ when the borrowed shares do not

Here is the step that actually resolves it. At the finance company, 80.0 per cent of borrowings plus 20.0 per cent of net worth is 100.0 per cent of assets under management, and the funding side is complete with two lines on it. Everything that funds that book is one of those two things.

At the bank, 80.0 per cent of deposits plus 10.0 per cent of net worth is 90.0 per cent of total assets, and the funding side is not complete. Work the subtraction: Rs 2,40,000 crore of assets less Rs 1,92,000 crore of deposits less Rs 24,000 crore of net worth leaves Rs 24,000 crore of funding. The record does not say what that funding consists of, and it states no relationship between it and any other figure printed above. The subtraction gives the amount. Naming it is beyond any reader of this record.

Consider a cake cut for a wedding. Somebody says that 80.0 per cent of it went to the guests. The claim is perfectly true and it says exactly nothing about how the last fifth was divided between the household, the neighbours and the box in the fridge. Leverage is struck entirely on the part that a share of one named funding line is silent about. Such a share is not a leverage figure. That single rule is worth more than either institution here, and it is the sentence to carry away.

What does money cost each of them, and how firm are the figures?

Rukmini Finance Limited has Rs 14,400 crore of borrowings behind its book, and the rate on that money is stated in this record rather than worked out from anything: 8.50 per cent for the year. Multiply the two and the interest bill comes to Rs 1,224 crore. One rate, one period, one amount, and nothing derived.

The bank's cost of fundsThe rate an institution pays for the money on its funding side, always for a stated period. Settled earlier as a measure that generalises across lenders, and used here rather than rebuilt. has to be derived, and the derivation is imperfect, so the imperfection is stated at the place it happens rather than in a footnote. Suvarna Commercial Bank paid Rs 11,160 crore of interest in the year. Rs 11,160 crore over deposits of Rs 1,92,000 crore is 5.8125 per cent a year, and prints as 5.81 per cent at two places. Because the record does not say what the rest of the funding is, that division puts the interest on all of the bank's interest-bearing funding over the deposits alone, so 5.81 per cent a year is an upper boundA figure known to be no smaller than the quantity actually wanted. An upper bound fences the answer from above without measuring it, and quoting it as though it were the measurement is the error it exists to prevent. on what the deposits cost and not the cost of the deposits.

Now the gap, and it is worth being exact about. 8.50 per cent a year less 5.8125 per cent a year is 2.6875 percentage pointsThe plain difference between two percentages. Going from 5.00 per cent to 8.50 per cent is a rise of 3.50 percentage points. A rise of 3.50 per cent is not the same statement., which prints as 2.69 points at two places. And because 5.81 per cent a year is an upper bound rather than a measurement, the true gap between the two funding costs is wider than the printed 2.69 points on any honest split of the bank's funding, never narrower.

The gap is not a verdict. The finance company pays more for its money because it may not take deposits, and that is the price of the line drawn in the first block. Two funding structures are being described here, not judged.

Why is one margin so much wider, and may the two margins be compared at all?

Take the finance company first. Its book of Rs 18,000 crore earns at 14.50 per cent for the year, so Rs 2,610 crore comes in, and Rs 1,224 crore goes back out on the funding side. The subtraction leaves net interest incomeWhat is left of interest earned after interest paid, before any operating cost, credit cost or tax. Settled in the banking material before this and used here rather than rebuilt. of Rs 1,386 crore, and set against that same book it reads 7.70 per cent of assets under management.

The bank next. Rs 18,600 crore comes in and Rs 11,160 crore goes out, leaving net interest income of Rs 7,440 crore, and that figure reads 3.65 per cent when it is set against earning assetsThe assets that actually carry interest, being advances plus investments here. Earning assets are a narrower base than total assets, and total assets also hold things that earn nothing. of Rs 2,04,000 crore, being advances of Rs 1,44,000 crore plus investments of Rs 60,000 crore.

Now the warning, and it goes in the same breath as the two figures or it does not go at all: 7.70 per cent is struck on assets under management and 3.65 per cent is struck on earning assets, those two bases are not the same quantity, and lining the two numbers up as though they measured one thing is the commonest error made with this pair. The gap looks like a difference in performance and part of it is a difference in denominator. On total assets of Rs 2,40,000 crore the bank's same Rs 7,440 crore reads 3.10 per cent. A base alone can move a number that nobody has recalculated.

While the bank's figures are in view, here is the second bound. Interest earned of Rs 18,600 crore over advances alone of Rs 1,44,000 crore reads 12.92 per cent a year. The division hands the income from the investments to the advances, so 12.92 per cent is an upper bound on the advance yield and not the yield. A wider margin is what a costlier liability and a differently shaped book produce together, and it is not evidence of skill at either institution.

Both return the same on net worth. Does that make them the same business?

Both institutions return 9.375 per cent on net worth. The equality is deliberate, and two identical figures with no explanation beside them would read to a careful person as a slip of the pen.

Decompose both, and neither figure may be quoted anywhere without both of its limbs beside it. At the bank: profit after tax of Rs 2,250 crore over total assets of Rs 2,40,000 crore is 0.9375 per cent, its return on assetsProfit after tax over assets, one of the two limbs the return on net worth breaks into. How that decomposition works was settled in the material on lender economics and is applied here rather than taught here., and 0.9375 per cent on assets of 10.0 times net worth is 9.375 per cent on net worth. At the finance company: profit after tax of Rs 337.50 crore over assets under management of Rs 18,000 crore is 1.875 per cent, and 1.875 per cent on assets of 5.0 times net worth is 9.375 per cent on net worth.

One earns half as much on each rupee of assets, carries twice as many of those rupees against its own money, and lands on the identical answer, so anybody ranking lenders by the answer alone has two very different businesses looking like twins.

The rounding trap in the reported figures

Reported figures on this pair read 0.94 per cent and 10.0 times at the bank, 1.88 per cent and 5.0 times at the finance company, and 9.38 per cent on net worth at both. The reported limbs multiplied at either institution give 9.40 per cent, not 9.38 per cent, and the natural conclusion is that a slip has been made somewhere. It has not. Each reported figure is rounded to two places for reading, and the product of two rounded numbers is not the same thing as the rounded product. The exact limbs reproduce the answer without any trouble: 0.9375 times 10.0 is 9.375, and 1.875 times 5.0 is 9.375, and 9.375 per cent is what both reported figures are a rounding of.

The comparison goes no further than that. A lender carrying more assets against each rupee of its own money has not thereby been careless, and a lender charging a wider spread has not thereby been clever. One year with nothing going wrong in it settles neither question.

What is each of them exposed to, and is it the same thing in different sizes?

The bank's Rs 1,92,000 crore of deposits is money from many people in small amounts, placed with an institution they can ask it back from, carrying the requirements and the cover named in the second block. The finance company's Rs 14,400 crore of borrowings is money from a smaller number of larger lenders, at a rate and on a date, and not one line of the second block applies to it.

A lender without deposits is exposed to the market it borrows from deciding not to lend to it again, and that is a different thing from what a bank's funding side is exposed to rather than a larger version of the same thing. Think of two vegetable sellers on the same street. The first takes small floats from thirty regular customers who each trust her and can ask for their money any evening. The second takes one large advance each season from one wholesaler. The first has thirty relationships to keep and a queue that can form at her stall. The second has one conversation a year that either happens or does not, and if it does not, nothing else about her stall matters that season. Neither is safer as a matter of arithmetic. The two sellers are exposed to different events.

Which lenders may reach the central bank's liquidity facilities, and on what terms, is set by the Reserve Bank of India at rbi.org.in and it moves, and the current terms are read at that source.

Exposure is not an event. The record above holds one year in which nothing goes wrong, so every line names what each institution is exposed to and never what happened to either.

So what is this comparison actually for?

Not for ranking. The useful question in front of any lender is not which of two is better, it is where the money on its funding side came from. Answered properly, that one question already settles what the money costs, how far it can be levered, how wide the margin will look and which events the institution is exposed to. One question, four answers.

The whole machine, in one line each. The deposit is the difference. The deposit is cheaper and carries requirements the market's money does not. Leverage is the reciprocal of the equity share, so the borrowed share says nothing about leverage. A derived rate is a bound and not a measurement. A margin without its base is not a comparable number. And a return on net worth without both of its limbs is a ranking waiting to mislead somebody.

One refusal closes the comparison, and it has been sitting under every block. Neither model is the better one on this evidence. The record holds one year, no failure and no cycle, and neither invented institution is evidence about what its funding model achieves.