Have you heard about Nidhi companies and wondered if they are a smart investment option in India? As a unique form of NBFC (non-banking financial company), Nidhis offer both advantages like easier compliance and risks like limited scope.
Specifically structured to encourage savings habits among community members, Nidhi firms enable small loans for personal needs in return for fixed deposits. But their operations are restricted to registered members only.
This means while they escape extensive RBI regulations applicable to mainstream NBFCs, their business is also capped by severe limitations in accessing external capital or customers. Supplementing your long-term investment portfolio with a Nidhi firm’s deposits and loans can make sense – but only within certain parameters.
This comprehensive guide on Nidhi companies explains everything you need to know: what exactly they are, how their mutual benefit structure functions, key upsides like faster loans, downsides like constrained growth, legal restrictions imposed, and ultimately – expert advice on whether including exposure to a Nidhi company aligns well with your overall investment strategy and goals.
Table of Contents
What is a Nidhi Company and How Does It Function?
A Nidhi company is a specialized type of Non-Banking Financial Company (NBFC) that is registered under Section 406 of the Indian Companies Act, 2013. Their sole business purpose and function is to accept fixed deposits from and provide small loans exclusively to their registered members.
The core objectives of Nidhi companies are:
- Promote regular savings behavior and thriftiness among lower and middle income individuals/families
- Provide easy and fast access to loans for personal consumption needs of their members
- Enforce financial discipline through close tracking of loans and repayments
For example, Nidhis provide customized loans of Rs 50,000 to Rs 10 lakhs for expenses like home repairs, medical emergencies, children’s education fees, family weddings, etc. Repayment terms range from 12-60 months based on individual borrower’s cash flows.
Unlike mainstream banks and NBFCs, Nidhi firms restrict all their transactions like fixed deposits, lending activities, share transfers etc. only to members who hold shares in the company. They cannot accept deposits from or lend funds to any external parties outside the registered member base.
For instance, Sid is a salaried professional and shareholder in Lucky Nidhi Limited located in his city. When his mother urgently needs a spinal surgery worth Rs 3 lakhs, Sid applies for and swiftly gets approval for a 3-year loan at 12% interest since he is an existing member. The entire process takes less than a week as Lucky Nidhi Limited already has his KYC documents.
This closed operating structure allows Nidhi companies to function under dedicated Nidhi Rules with limited oversight from the RBI. Their compliance burden is easier but this also constrains their growth prospects as both deposits and loans stay restricted to member circles only.
Key Advantages of Investing in a Nidhi Company
While restrictive in nature, the Nidhi investment model offers some unique benefits:
Less Stringent Compliance
As Nidhis deal only with members’ money, they escape the regulations governing other NBFCs. This enables easier setup and compliance.
For instance, Nidhi registration process is simpler with no RBI approvals needed to kickstart operations post company incorporation. The dedicated Nidhi Rules also lead to relatively lighter ongoing reporting norms instead of strict RBI regulations applicable on NBFCs. This ensures contained overheads and better cost efficiency.
Overall, the exclusive member-only orientation allows Nidhi companies to steer clear of cumbersome NBFC guidelines around capital adequacy, risk weightage of assets etc. Their operations stay focused on efficient member service rather than intensive regulatory requirements imposed by RBI on NBFCs.
Lower Capital Requirements
To register a Nidhi, promoters need only Rs. 5 lakhs minimum paid-up share capital. This requirement goes up to Rs.10 lakhs within one year, along with enrolling at least 200 members.
In contrast, NBFCs need about Rs. 2 crores base capital for securing license as per RBI.
So the substantially lower capital barrier for Nidhi entry makes them way more affordable for promoters to establish. Raising funds also gets easier by issuing various classes of equity shares to members.
Loans Only to Members
One prime reason Nidhis see lower defaults is loans are only disbursed to registered members of the company. This provides members higher stake in timely repayment.
Defaulting on loans can lead to loss of membership rights along with dividends and interest on deposits. Essentially, loans carry peer accountability as members know each other within their locality.
Their own deposits and company’s stability depend on everyone repaying diligently. This vested interest ensures peer pressure on avoiding delayed repayments.
Nidhi companies enjoy perpetual succession status under Indian company laws. This means the entity continues operations uninterrupted even after original promoters retire or pass away.
As older members get replaced by new members over time, the Nidhi company persists independently. Members may come and go but company existence continues perpetually.
This structure offers stable long-term visibility for deposits and loans – attractive for those seeking non-volatile investment options compared to market-linked returns.
Potential Limitations to Consider
While Nidhi firms have unique advantages, some restricting factors persist:
Restrictions on Deposits and Loans
- Nidhis can only source deposits from registered members, limiting funding avenues
- Loans also only issued to member shareholders
- Fixed deposits capped at 5 years maximum tenure
These innate constraints exist as Nidhis are mutual benefit companies intended exclusively for members. However, they do limit the scope for credit expansion and income generation.
For instance, longer tenure retail bonds/deposits often yield higher interest for NBFCs. But Nidhis cannot tap into wider public deposits and caps apply too. This impacts their revenue generating potential.
Unlike banks or other NBFCs, Nidhi companies cannot openly advertise their deposit or lending schemes to the general public. This makes customer acquisition tougher.
Promotion is limited to member circles only and dependent on existing customers to spread awareness. Reaching deposit mobilization targets requires strategic grassroots member enrollment initiatives.
Dependency on Membership Growth
Due to the above constraints, healthy membership growth becomes imperative for Nidhis to expand their deposit and loan activity.
Stagnant membership will strain company treasury as redemptions continue while new deposits dry up. This risk gets compounded if loans also enter default. Thus, a sustainable member acquisition plan must run parallel to daily operations.
Legal and Regulatory Restrictions
While easier in compliance than mainstream NBFCs, Nidhi firms do face strict restraints in their functions as listed below:
- Cannot operate chit funds, leasing or insurance activities – only lending/borrowing
- Banned from issuing any preference shares, debentures etc.
- Cannot allow members to open current accounts
- Lending/borrowing only among registered members
- No brokerage for mobilizing deposits
- Assets backing deposits cannot be pledged
These limitations safeguard member interests but also stem any ambitions of hypergrowth or large-scale operations. Nidhis best serve local community needs rather than mass expansion plans.
Expert Opinions: Is Investing in a Nidhi Company Recommended?
Industry experts have mixed views on whether Nidhis make a good investment option when comparing expected returns with major mutual funds or sovereign schemes.
“For business people seeking regular working capital needs, the ease of availing collateral-free loans from Nidhi firms at nominal ~12% interest is attractive vs 18-20% from money lenders in the informal market.” – Ketan Shah, Angel Investor
However, their limitations prevent scale as expressed by equity research head Sandeep Sabharwal:
“While useful for loans requiring low paperwork, Nidhis cannot beat the flexibility and superior returns possible from other fixed income assets like debt funds, FDs, bonds etc. Their constrained scope keeps corpus low, limiting ability to deliver above market returns.”
So in essence, Nidhi companies meet specific credit requirements through faster processing and possible community accountability. But they may not offer superior returns with limited investment options for depositors.
FAQs on Nidhi Companies
What returns can one expect from Nidhi deposits?
Returns vary from 8-15% based on deposit tenure. As they depend only on lending income, massive returns cannot be sustained. Indicative benchmarks:
- 1-2 year deposits: ~8-10%
- 3-5 year deposits: ~12-15%
What are the charges if loans become delinquent?
Usual penal interest rates are 24-36% per annum on unpaid dues. Legal action may also commence under Nidhi Rules.
Can anyone become a member?
Yes, general public can buy shares up to maximum limit to qualify as member eligible for deposits and loans. Different classes of equity shares carry differential voting rights.
What is the process and documents required?
Required KYCs: ID + Address proof. Further documents based on deposit or loan amount – same as NBFC requirements mandated by RBI.
In Summary: Assessing if Nidhi Companies Align With Your Investment Goals
While Nidhi firms offer certain convenience propositions in terms of debt access, their limited scope often constrains returns potential for investors. Evaluate carefully based on:
Investment Objective – Require regular income or long-term capital growth
Risk Appetite – Open to some risk for higher returns?
Time Horizon – Short term liquidity needs or long term corpus building?
** alternate options** – Compare potential returns from Nidhis vis-a-vis other fixed income assets before deciding to invest.
If easy loans and community accountability matter more than scale or superior returns, investing in a local Nidhi firm may serve your purpose.
Reach out to the investment experts at filingwala.com for personalized guidance on assessing debt instruments for your unique portfolio needs. With decades of experience in Indian markets, we can best advise you on right-fit investment options tailored to your financial goals and risk tolerance levels.