Factoring is a financial service provided by specialised agents to help
manufacturers and traders etc. to manage their receivables. It is a process of
selling receivables to a third party on a discount. The supplier (exporter) assigns
his accounts receivables in favour of the factor and gives notice of assignment
to the debtor. It has been popular in developed countries. The factors
undertake collection/accounting and management of debts of their clients.
Factor may either lend against accounts receivables or by purchasing invoices.
He will take responsibility of collecting debt. The factoring service may be
offered with or without recourse. Factoring with recourse refers to right of the factor to claim bad debts from his client, whereas in
without recourse factoring, the risk of bad debt will be borne by the factoring
agent himself.
Bill culture has not been fully developed in our country and about 80
per cent of trade transactions are on
'open account system'. All units particularly small & medium size
units have to make considerable efforts to realise the sale proceeds without
much success creating financial difficulties for such units. Many a units under
small scale sector have become sick only because of delay/ non‑realisation
of their dues from large units. Introduction of factoring services will, therefore,
prove very beneficial for such units as
it will free the units from hassels of collecting receivables to enable
them to concentrate on product development and marketing.
The idea of introducing factoring services in India was first floated by
working group on money market headed by Mr. N. Vaghul in 1987. Reserve Bank
then constituted a study group in January, 1988 for examining the introduction
of factoring services, headed by Mr. C.S. Kalyansundaram, former managing
director of SBI, which delivered its report in December, 1989. The
recommendations of the Kalyansundaram committee were accepted by Reserve Bank.
The salient features of factoring services are given below:
Modern factoring involves a continuing arrangement under which a
financing institution assumes the credit and collection functions for its
client, purchases its receivables as they arise (with or without recourse to him
for credit losses), maintains the sales ledger, attends to other book keeping
relating to such accounts receivable and performs other auxiliary functions.
The various services rendered by factors for domestic sales are of six types as
stated below
(i) Full Factoring
(ii) Recourse Factoring
(iii) Maturity Factoring
(iv) Advance Factoring
(v) Undisclosed Factoring,
and
(vi) Invoice Discounting
The functions or ingredients of full factoring services are
• Financing, by way of
pre‑payment of the receivables;
• Sales Ledger
Maintenance;
• Collection of
receivables/ Recovery of bad debts; and
• Credit Protection
against bad debts.
When pre‑financing is provided but no credit protection is guaranteed
by the factor, (i.e., the client will be required to refund the amount pre‑financed
together with interest thereon in the event of failure/insolvency of the
debtor), it is recourse factoring.
When no pre‑financing of the receivables is done, but the factor
undertakes to pay the amount due only on the maturity of the credit period, it
is maturity factoring.
For international trade a two‑factor system may be used. Export
factor will provide financing and other services as required by the exporter.
The import factor will undertake the credit assessment of importers, establish
credit lines on them wherever possible, undertake control of receivable and
take whatever steps are necessary to collect outstanding dues.
1. The
pricing of various services by factors will depend on various aspects such as
credit worthiness of the customer, his track record, quality of portfolio,
turnover, average size of invoices etc. However, the base level would depend on
the various costs to be borne by the factoring organisation, the most important
element being cost of funds.
2. The
price for the financial services was suggested to be around 16% p.a. and
aggregate price for all other services might not exceed 2.5% to 3% of the debts
serviced.
Banks having considerable experience in financing and collections of
receivables should be associated with Factoring Services. These services may be
undertaken by banks by floating subsidiaries and initially such organisations may
be floated on zonal basis.
It is envisaged that the suppliers will be able to obtain financial
services both from banks and factoring organisations, it is therefore,
necessary to provide for proper linkages between banks and factors. There
should be arrangements where under banks and factors furnish to each other
information relating to parties which approach more than one agency. It is also
envisaged that there could be a three party tie‑up, the debt being
assigned to factors by suppliers and former borrowing from banks.
Alternatively, the supplier would borrow from bank(s) and avail of debt
protection, collection and sale ledger management services from a factor.
Besides, there are other areas also in which banks and factors should
collaborate for better working capital management, in view of specialised
knowledge, skills and contacts of the factors.
1.
SSI units have been facing constraints in their
operations on account of inadequacy of working capital caused by delays in
receiving payments for their supplies. A large number of SSI units is managed,
by their promoters and/or persons with technical orientation who are unable to
pay continuous attention to the areas of debt collection, accounting and
working capital management. By and large, such units do not have an
organisational set‑up and/or expertise in the area of credit management
to attend to follow up and recovery of dues from buyers.
2.
SSI units perceive that Factors with their
systematic, specialised and professional approach, would be in a position to
assist them in debt collection. The credit protection services of Factors would
entitle them to be assured of payment on a fixed date, as also protection
against customer's default.
3.
As regards financing of receivables while
Factors would provide another source of finance to SSI units, they cannot be
expected to offer finance at concessive rates, as is presently being done by
banks to eligible units. For continued availment of concessive finance, linkage
between banks and Factors is suggested.
4.
While the potential demand for factoring
services from SSI sector is estimated to be sizeable it would take some time before this demand could crystallize.
5.
Factoring for SSI units could prove to be
mutually beneficial to both Factors and SSI units and Factors shou1d make every
effort to orient their strategy to crystallize the potential demand from this
sector.
(i) Indian
law does not at present, comprehensively deal with various aspects involved in
factoring business. As such, it should be necessary to promote special
legislation to support the establishment and operations of efficient and viable
factoring organisations.
(ii) To
enable a Factor to be in a position to collect the debts in its own right, it
must take in assignment of book debts of clients. Existing provision of section
13 of the Transfer of Property Act, 1882 are quite inadequate to protect the
interests of the Factor.
(iii) To
make factoring economically viable, it is essential that the assignment of book
debts in favour of Factor is exempted from stamp duty. Various states should,
therefore, be requested to remit the stamp duty. If however, complete remission
of stamp duty is not acceptable, assignments upto specified amount or sales
from specific sectors, may be exempted from such duty.
(iv) The
Civil Procedure Code may be amended to clarify that the factored debts can be
recovered by resort to summary procedure under Order 37 of the Code in terms of
which defendent is not entitled, as of right, to defend the suit, which he can
do in ordinary suits.
The banks with the prior approval of the Reserve Bank of India could
form subsidiary companies for undertaking factoring services. The subsidiaries
formed should primarily be engaged in this activity and such other activities
as are incidental thereto.
Alternatively, banks may opt to undertake factoring services departmentally,
for which prior approval of the RBI is not necessary. The banks should,
however, report to the RBI together with the names of the branches from where
this activity is taken up. The banks should comply with the following
prudential guidelines when they undertake factoring services departmentally:
(i) As
this activity requires skilled personnel and adequate infrastructural facilities, it should
be undertaken only by certain select branches of banks.
(ii) This
activity should be treated on par with loans and advances and should
accordingly be given risk weight of 100% for calculation of capital to risk
asset ratio.
(iii) The
facilities extended by way of factoring services would be covered within the
exposure ceilings with regard to single borrower (15% of the Bank's capital
funds, 20% in case of infrastructure projects) and group of borrowers (40% of
the bank's capital funds, 50% in case of infrastructure projects).
(iv) Banks
should maintain a balanced portfolio of factoring services vis-a‑vis the
aggregate credit. Their exposure to such activity should not exceed 10% of
total advances.
(v) Banks
undertaking factoring services departmentally should carefully assess the
client's working capital needs taking into account the invoices purchased.
Factoring service should be extended only in respect of those invoices which
represent genuine trade transactions. Banks should take particular care to
ensure that by extending factoring services, the client is not over financed.
The Reserve Bank has approved the Scheme evolved by the Export Credit
Guarantee Corporation of India Ltd., for providing a non‑fund based
export factoring service to the exporters who are ECGC policy holders. Under
the scheme the ECGC will undertake non‑fund based export factoring as an
in‑house service. It will grant by an endorsement to the policy, 100 per
cent credit protection for bills drawn on approved overseas buyers. The ECGC
will, however, confine only to export factoring and will not undertake domestic
factoring.
The maturity factoring scheme as designed by ECGC has certain unique
features and may not exactly fit into the conventional mould of maturity
factoring. The changes devised are intended to give the clients benefits of
full factoring services through a maturity factoring scheme, thus effectively
addressing the needs of exporters to get pre‑finance (advance) on the
receivables for their working capital requirements. One of the major deviations
in this regard is the very important role and the special benefits envisaged
for banks under the scheme.
The ECGC will conclude a tripartite agreement with the exporter and his
authorised dealer to the effect that:
a)
In the event of non‑payment in any factored bill, the ECGC would
unconditionally pay the authorised dealer the value of the bill immediately
after the expiry of 30 days from the due date of the bill on the bank's advice
of non‑payment.
b)
In consideration of the above unconditional
guarantee, the authorised dealer will discount the bills without recourse to
the exporter except as indicated at (d) below.
c)
The exporter will authorise the authorised
dealer to deduct the ECGCs factoring charges (which should be 1 per cent to 1.5
per cent) from the proceeds of each bill and remit it to the ECGC.
d)
If non‑payment of the bill is due to the
fault of the exporter, the authorised
dealer will still be paid by the ECGC as per the guarantee contained in
the tripartite agreement, but the ECGC would have recourse to the exporter,
e)
The exporter, as also this bank, will be
associated with the efforts to recover the debt from the foreign buyer and all
necessary expenses will be borne by the ECGC.
f)
Till such time the payment is made by the
overseas buyer or the ECGC, the interest payment on post‑shipment credit
would be as per the Reserve Bank's directives issued from time to time.
g)
In the event of failure of the exporter to
realise the export proceeds in the stipulated time the ECGC will obtain
direction from the Reserve Bank in their turnover entitling them to recover the
amount from the foreign party.
ECGC would facilitate easier availability of bank finance to its
factoring clients by rendering such advances to be an attractive proposition to
banks. The Factoring Agreement that would be concluded by ECGC with its
clients has an in‑built provision incorporating an on‑demand
guarantee in favour of the bank without any payment or compliance or other
requirements to be satisfied by the bank.
·
Option to give easier credit terms to customers
‑ Better protection than a ILC without the need to insist on establishing
a Letter of Credit;
·
Can offer more friendly delivery terms like,
direct delivery to the customer (as against DP/DA) without any risk;
·
Reduced foreign bank handling charges on
documents;
·
Substantial cost savings on monitoring and
follow up (telephones, faxes, follow‑up visits) of receivables, overdue
bank interest on delayed collections and recovery expenses relating to bad
debts;
·
Increase export sales by being able to offer
more competitive terms to customers;
·
Better security than Letters of Credit;
·
Elimination of uncertainties relating to
realization of accounts receivables resulting in better cash management to meet
working capital requirements;
·
Complete freedom from monitoring and follow up
of receivables and bad debt recovery blues;
·
With complete freedom from chasing receivables,
can devote full attention to procurement/ production, marketing and sales and
growth of business.
The Reserve Bank of India has directed
banks to ensure that double
financing of the same asset through factoring and bank finance does not take
place.
In a factoring business, a borrower sells his receivables to his factor
to raise immediate liquidity. The factor buys receivables like bills from the
borrower with an option of recourse or on a non‑recourse basis.
The cost of funds with a recourse option is higher by around one per
cent to two per cent over the commercial
banks cash credit rates.
In a recourse option the institution factoring a bill can go back to the
company in case receivables do not come through.
The cost is much higher in transactions without a recourse option as the
risk element in the event of dishonour
of bill fills on the factor.
The RBI has directed that banks and factors should share information
about common borrowers to avoid a situation where a company might have taken
working capital for an asset from a bank and also got it factored with a
factoring institution.
The format in which such information is to be provided may be decided
by the banks or the Indian Banks' Association.
Banks have been directed to issue letters of disclaimer to the factor on
book debts factored to facilitate assignment of debt. A letter of disclaimer
indicates the title of receivables.
The factors in turn should route the proceeds of prepayment and final
adjustment through the borrower's bank.
In case of consortium financing, the proceeds will now be routed through
the leader of the consortium. While in case of multiple banking it is left to
each bank to protect its interest.
The regulatory authority, to avoid double financing, has clarified that
the factors should insist on a no‑objection certificate from the borrower
bank before extending financial assistance.
The norms for inventory and receivables have also been tightened. Banks
have been asked to take a view based on the production and processing cycle.
Borrowers should declare separately the extent of book debts proposed to
be factored and those against which bank finance is to be obtained in their
projection for assessment of bank credit.
Banks, while arriving at the maximum permissible bank finance, have been
empowered to deduct from current assets the receivables proposed to be
factored. This would have to be done before arriving at minimum requirement of
net working capital and working capital gap.
Alternatively, amounts to be received from factors is to be essentially
considered as a source of fund while
arriving at the 'cash gap' or
'cash surplus' position.
That apart, the borrower's bank now has to obtain from the borrower
periodical certificates regarding factored receivables to put a stop to double
financing.
Furthermore, it is now mandatory on factors to intimate the limits
sanctioned to the borrower to the concerned banks and details of debts factored
to avoid double financing. This could be cross checked with the certificate
obtained by banks from borrowers.
Factors and the banks, however, need not exchange their assessment of
credit rating of the borrowers amongst them.
The extent of finance obtained from factors need not come within the
purview of the credit monitoring arrangement.
The Small Industries Development Bank of India (SIDBI) introduced its
own direct factoring services in 1997‑98 to help the Small Scale Sector
in timely recovery of their sales proceeds. Factoring scheme of SIDBI is a comprehensive package of receivables
management service including advance
against invoices and other allied services such as collection of proceeds from
the purchaser, administration of sales ledger etc. The service aims to solve
the small scale sector's problem of early recovery of their sale proceeds from
big purchasers, and thus ensuring them of adequate liquidity at all times. The
salient features of SIDBI's scheme for Domestic Factoring are as below:
·
Purpose: To provide factoring services to the
manufacturers in SSI sector supplying their produce on credit terms to various
purchasers in the domestic market with a view to assisting them in their
receivable management as also providing them with finance against the
receivables factored.
·
Eligible Borrowers: Facilities are extended to existing units in SSI sector ‑ with
good track record of performance and sound financial position supplying
components/parts/accessories/sub‑ assemblies etc. on short term credit to
well established purchaser units. They should have been in operation for at
least three years and have earned profits and/or declared dividend during the
two years prior to taking up the scheme.
·
Norms: Sales of the unit should preferably be spread over a minimum of 5
customers with maximum sales concentration in a single buyer being less than
30%. Maximum credit period shall be of 90 days.
SAs observed by SIDBI, the factoring products will in no way overlap its
present services. Thus, while the services under existing Bill Discounting
Scheme of the Bank cover the supplies made by SSI unit against the Bills of Exchange,
factoring would cover open account sales as well.