From Concentration to Diversification: Navigating Retail Deposits and Refinance Window for NBFCs
Introduction
Leading non-banking financial companies (‘NBFCs’) have recently urged the Reserve Bank of India (‘RBI’) to seek permission to raise retail deposits, arguing this would level the playing field with banks and aid policy-rate transmission. NBFCs have also renewed a separate demand for a dedicated refinance window, modelled on the National Housing Bank (‘NHB’), to support micro, small and medium enterprises (‘MSMEs’) and priority-sector lending. Both demands track the Atmanirbhar Bharat goal of diversified domestic funding for NBFCs. Their significance is underscored by the credit extended by them, which stood at 14.6 per cent of GDP at end-March 2025.
Yet the RBI has long resisted retail deposits even for well-rated NBFCs, even as it flags their dependence on bank borrowings. RBI’s Trend and Progress of Banking in India 2023–24 report notes that, despite gains in asset quality and capital adequacy, NBFCs remain concentrated in bank funding. Moderating bank credit has pushed larger NBFCs toward costlier foreign borrowings, while smaller ones have turned to borrowing from peers, with direct consequences for MSME and priority-sector credit.
This funding strain is precisely what the twin demands- retail deposits and a refinance window, seek to address. This article advances a critique of these twin demands by, first, analysing the existing financing framework for NBFCs and where it falls short; second, exploring the implications and challenges of allowing NBFCs to raise retail deposits and access a dedicated refinance window; third, suggesting calibrated reforms to diversify NBFC funding and strengthen financial stability; and finally, assessing whether these proposals are coherent and market-ready within India’s current regulatory framework.
The Current Regulatory Framework
In terms of the type of liabilities, the RBI classifies NBFCs into deposit-taking NBFCs (‘NBFCs-D’) and non-deposit-taking NBFCs (‘NBFCs-ND’). In practice, retail deposit-taking remains a narrowly available privilege. Barring a limited number of entities with legacy licences, most NBFCs are currently prohibited from accepting public deposits, and Reserve Bank of India (Non-Banking Financial Companies – Acceptance of Public Deposits) Directions, 2025 impose restrictions on NBFCs-D. Those permitted to do so are subject to extensive regulatory requirements, including capital adequacy requirements [¶ 17], liquid asset maintenance [¶¶ 10-11], exposure restrictions [¶ 63], asset-liability management discipline as governed by the Reserve Bank of India (Non-Banking Financial Companies – Asset Liability Management) Directions, 2025, and enhanced reporting obligations [¶¶ 12-13, 18(3), 60-61, 64].
The entry thresholds are themselves stringent. Deposit-taking NBFCs must maintain an investment-grade credit rating of at least ‘BBB’ from a SEBI-registered credit rating agency [¶¶ 12-14]. Furthermore, the quantum of deposits is capped at 1.5 times net owned funds [¶ 17], with permissible tenures ranging from 12 to 60 months [¶ 16] and interest rates capped at 12.5 per cent per annum [¶ 19]. These conditions reflect the regulator’s cautious approach to depositor protection, recognising the distinct risk profile of NBFC balance sheets vis-à-vis banks.
The regulatory framework for refinancing reveals a clear asymmetry. Housing finance companies (‘HFCs’), although classified as NBFCs, continue to access refinance from the NHB, a wholly government-owned institution established to support the housing finance sector. NHB effectively serves as a liquidity backstop by refinancing housing loans extended by HFCs and other primary lenders. In contrast, no comparable refinance facility exists for other NBFCs, despite their significant role in financing MSMEs and priority sectors, revealing a structural gap in the current funding framework. Therefore, NBFCs are demanding the establishment of a dedicated refinance institution for them on the NHB-like model.
Analysing the Demand to Allow Accepting Retail Deposits
The twin demands of NBFCs to allow raising retail deposits and for establishing a dedicated refinance institution arise from a common structural constraint, which is the sector’s continued dependence on banks and market-based funding. Bank borrowings and debentures together account for over 70 per cent of NBFCs’ liabilities, exposing them to funding volatility. Market instruments such as non-convertible debentures and commercial papers remain sensitive to liquidity cycles, while bank lending to NBFCs is shaped by prudential limits within the banking system. In this context, retail deposits are viewed as a means to diversify funding sources, reduce concentration risk, and stabilise funding costs.
Even under the existing restrictive regime, public deposits account for 12.5 per cent of the liabilities of deposit-taking NBFCs as of end-March 2025, though this channel is heavily concentrated, with five NBFCs accounting for 96.9 per cent of aggregate deposits. Proponents argue that broader access to retail deposits would reduce NBFCs’ dependence on banks, provide a more durable liability base, and allow growth to be less contingent on banking sector risk appetite. Direct access to retail funding would allow NBFCs’ cost of funds to adjust more transparently and consistently in line with RBI rate movements.
From a balance-sheet perspective, the sector’s capital position provides some comfort. NBFCs remain well capitalised, with a capital-to-risk-weighted assets ratio of 24.9 per cent as of September 2025, well above the regulatory minimum of 15 per cent. A diversified liability structure could further reinforce sectoral resilience, particularly for larger NBFCs subject to scale-based regulation. Retail deposit mobilisation introduces market discipline by transforming the NBFC’s liability structure into a broad base of reputation-sensitive creditors. Unlike institutional lenders, retail depositors typically lack the bargaining power to bring contractual protections or the capacity for oversight to protect their interests. This makes their threat of exit a powerful deterrent against managerial imprudence. This dynamic pushes for a shift toward proactive governance and enhanced transparency. To mitigate the risk of a confidence-induced run, NBFCs are compelled to adopt rigorous internal controls. They must also provide superior disclosure standards that signal institutional resilience to the public. Ultimately, the necessity of maintaining depositor trust forces the entity to protect its franchise value. This aligns its risk appetite with the long-term stability expected by household savers.
However, these potential gains coexist with material prudential and consumer protection concerns. Retail deposits introduce bank-like run risks without the institutional safeguards that accompany banking licences. In the absence of the Deposit Insurance and Credit Guarantee Corporation (‘DICGC’) style insurance, retail investors bear the full credit risk of NBFCs’ failure. Other safeguards, such as capital adequacy ratio, only lower the probability of NBFC failure. They do not guarantee recovery once failure occurs, since they cushion the institution, not the depositor. Deposit insurance works differently, it pays depositors directly from a pre-funded corpus, regardless of the institution’s remaining capital. NBFC depositors currently lack this layer of protection under the DICGC framework.
From a regulatory perspective, the existing framework under the Reserve Bank of India (Non-Banking Financial Companies – Acceptance of Public Deposits) Directions, 2025 already incorporates extensive safeguards, including stringent eligibility criteria, disclosure obligations, interest rate caps, and liquidity requirements. In that sense, the concern is not the absence of regulatory protection or inadequate disclosure standards. Rather, if access to retail deposits is widened, the challenge lies in ensuring consistent and effective compliance with these norms. Maintaining a retail deposit franchise entails substantial operational costs, including compliance, disclosures, customer servicing, marketing, and statutory liquid asset requirements. For smaller and mid-sized NBFCs, these fixed costs can significantly dilute the funding advantage of retail deposits. Normatively, this creates a prudential risk; if the cost of compliance exceeds an entity’s operational margins, it may compromise governance or take excessive risks to offset the expense. This suggests that retail deposit-taking is practically feasible only for middle and upper-layer NBFCs with sufficient scale and institutional capacity to sustain a robust regulatory and consumer-protection framework.
Liquidity risk further complicates the picture. NBFCs typically engage in medium to long-term lending, while retail deposits, unless supported by a diversified and stable depositor base, can be withdrawal-sensitive. This can trigger run dynamics, a behavioural phenomenon where a loss of confidence prompts depositors to withdraw funds simultaneously, fearing the institution will run out of cash. Existing asset-liability management norms calibrated for wholesale-funded models may not fully capture depositor run dynamics. Consequently, a heightened maturity mismatch could occur when an NBFC funds long-term, non-liquid assets such as five-year MSME loans using short-term, withdrawal-sensitive retail deposits. In certain unexpected situations, such as the emergence of stress in financial markets or distrust with a particular NBFC or group of NBFCs in the market, mass withdrawals by retail depositors can create an immediate funding gap, as the underlying loans cannot be liquidated quickly to meet cash demands.
This mismatch amplifies systemic stress by triggering a liquidity freeze across the broader financial ecosystem. Because NBFCs are deeply interconnected with banks and capital markets, a funding struggle at one institution prompts lenders to reflexively tighten credit lines for the entire sector. This contagion effect turns an isolated liquidity imbalance into a market-wide scarcity of credit, increasing borrowing costs for all borrowers.
Analysing the Demand for a Dedicated Refinance Institution
Moving on to the demand for a dedicated refinance institution for NBFCs, which has emerged as a persistent policy proposal. A refinancing institution is a secondary lender that provides liquidity to primary lenders, such as banks, rather than the public. It ensures these primary lenders have stable, long-term capital to fund specific sectors like housing or MSMEs. NBFCs are demanding access to a refinance institution precisely because existing funding sources are limited, and they tend to disappear during downturns instead of supporting NBFCs when credit is most needed. Bank funding to NBFCs declined materially in recent years amid tightening risk appetites and regulatory recalibrations, prompting concern that credit flow to MSMEs and other underserved segments could be disrupted, especially during systemic stress. This was underscored in industry consultations ahead of the 2026–27 Union Budget, where representative bodies urged the creation of a refinance window on the lines of NHB to ensure continuous liquidity support and bolster credit flows to priority sectors.
A refinance institution addresses several structural vulnerabilities simultaneously. First, it can provide counter-cyclical funding, i.e. it can supply capital specifically when market conditions tighten and private lending shrinks, acting as a stabiliser. Second, by offering this stable liquidity, the facility directly mitigates run dynamics by replacing withdrawal-sensitive retail deposits with institutionally managed, tenure-matched funds. Third, this shift protects household savers from credit risk while ensuring NBFCs do not face liquidity rationing during stress. Fourth, such a mechanism could reduce overall funding costs and maturity mismatches by extending long-term, durable funds, thereby encouraging NBFCs to maintain robust asset-liability profiles without excessive reliance on short-term market sources or foreign borrowings. Initially, this facility could be restricted to priority sectors like MSMEs, infrastructure, or green projects. By narrowing the scope to these specific sectors, the institution can operate with a leaner capital base while still providing critical support to NBFCs. This targeted approach ensures the scheme remains fiscally feasible and manageable during its foundational phase.
That said, a dedicated refinance institution is not without concerns. Its creation would require clear legal mandates, strong governance, and careful calibration of risk-sharing. Without strict eligibility criteria and end-use restrictions, refinance support could weaken market discipline and encourage excessive leverage by acting as an implicit safety net. This occurs when private investors, assuming the institution will provide a liquidity backstop, reduce their rigorous oversight and due diligence of the NBFC’s balance sheet. Such an environment creates a moral hazard, where NBFCs are incentivised to take on excessive leverage or riskier loan portfolios, knowing they are partially insulated from the financial consequences of a downturn.
There is also a risk that over-reliance on institutional refinance may concentrate credit exposure in already stressed sectors. While the low cost of these funds is attractive, it may inadvertently encourage NBFCs to abandon diversification by funnelling capital predominantly into areas that are already grappling with financial instability. To mitigate this, NBFCs must remain cautious in their approach; they should not allow the availability of cheap liquidity to drive excessive lending into segments with high default rates or structural stress. Failure to maintain this discipline makes both the NBFC’s balance sheet and the refinancing institution itself vulnerable to synchronised shocks within those industries, potentially turning a sectoral downturn into a systemic crisis. These considerations highlight that while a refinance window can address funding gaps, its design and supervision would be critical to prevent moral hazard and systemic spillovers.
Suggestions and Policy Considerations
Any proposal to permit NBFCs to mobilise retail deposits must be approached with calibrated caution, balancing funding diversification against depositor protection and systemic stability. Retail deposit access should therefore be introduced gradually and restricted, at least initially, to well-capitalised, highly rated NBFCs in the middle and upper layer, which are already subject to enhanced supervisory oversight. The RBI’s scale-based regulatory framework provides a natural basis for linking deposit-taking privileges to size, governance standards and compliance maturity, ensuring that only institutions with bank-like resilience access household savings.
Expanding retail deposit-taking must be accompanied by higher standards of transparency and governance. Existing NBFC disclosures are largely supervisory and do not sufficiently address retail depositor information asymmetry. Deposit-taking NBFCs should accordingly be required to provide simplified, depositor-oriented disclosures on asset quality, concentration risks and liquidity, alongside periodic stress-test results simulating deposit outflows and credit stress. Such disclosures would enable depositors to assess resilience based on fundamentals rather than interest rates or brand perception.
The absence of deposit insurance remains a key consumer-protection concern. Instead of extending blanket coverage, policymakers could explore limited and conditional insurance mechanisms for select NBFCs meeting enhanced capital, liquidity and governance thresholds. Insurance exposure should be capped at an entity level or a small proportion of total deposits and paired with risk-based premiums, ensuring that insurance operates as a safety net in stress scenarios rather than an implicit guarantee.
Stronger liquidity and asset–liability management norms are equally critical. While NBFCs already comply with the RBI’s Asset Liability Management Guidelines, these are calibrated for wholesale-funded balance sheets and do not fully reflect the withdrawal sensitivity of retail deposits. Retail deposit-taking NBFCs should therefore be subject to tighter maturity gap limits, enhanced liquidity coverage requirements and higher holdings of high-quality liquid assets, directly curbing excessive maturity transformation.
Regulatory safeguards should be complemented by depositor awareness initiatives, mandating NBFCs to educate retail investors on the risk–return profile of NBFC deposits vis-à-vis bank fixed deposits. In parallel, retail deposits need not be the sole solution. The establishment of a dedicated NHB model refinance institution for NBFCs, which was also earlier recommended by the Parliamentary Standing Committee on Finance in its 45th Report,[1] could provide a stable source of liquidity to the sector. Such a mechanism would be particularly beneficial for smaller NBFCs engaged in MSME and priority-sector lending, while limiting the premature exposure of household savings to NBFC balance-sheet risks.
The Parliamentary Standing Committee made such a recommendation following the Ministry of Finance’s rejection of NBFCs’ request for establishing a refinance institution with a criterion laid down for them. Despite these benefits, the Ministry of Finance, in its written reply have not agreed to the suggestion and clarified its position that the existing refinance institutions are under stress because of paucity of funds. The Ministry further provided that, in view of the very large number of NBFCs, it would not be possible to extend refinance facilities to them. Ministry’s reply shows that it did not consider setting certain criteria for NBFCs to be eligible to seek refinancing from a refinance institution. Putting some criteria would firstly limit the number of NBFCs, and secondly, it would reduce the tendency to go for public deposits, lure the public, and try to dupe them.[2] Therefore, NBFCs would naturally endeavour to get refinancing from an institution, as it would provide a stable, low-cost, merit-based alternative for liquidity.
Way Forward
NBFCs’ dual demands, for retail deposit access and a dedicated refinance institution, reflect their growing centrality to India’s credit ecosystem, particularly in financing MSMEs and priority sectors. A calibrated reform combining both offers the more coherent path forward. Permitting deposit acceptance for adequately capitalised upper and middle layer NBFCs with sound corporate governance would diversify their liability base and aid monetary transmission, while a dedicated refinance institution would extend countercyclical liquidity to base and middle layer NBFCs lacking the scale to access retail funding directly. This differentiated architecture would strengthen sectoral resilience and deepen financial intermediation without compromising depositor protection or systemic stability.
[1] Parliamentary Standing Committee on Finance, Financial Services Sector: Realities and Challenges (13th Lok Sabha, 45th Report, 2003) 105.
[2] Parliamentary Standing Committee on Finance, Financial Services Sector: Realities and Challenges (13th Lok Sabha, 45th Report, 2003) 103.
*Siddhant Samaiya is a fourth-year student at the National Law Institute University, Bhopal.