Factoring as a tool of obtaining quick access to short-term export financing and mitigating risks related to payment delays and defaults by overseas buyers is gaining traction the world over. Countries like Brazil, China, Germany and Taiwan have leveraged factoring to grow their exports. Despite the many advantages of factoring and a growing demand for exports credit among Indian MSMEs, factors like lack of awareness, a perception of high interest rates and cumbersome documentation processes, have prevented the growth of factoring services in India. To bring matters into perspective, less than a percentage point of India's exports are backed by factoring services. However, factors are optimistic about the future and are taking steps to raise awareness about their services amongst the Indian foreign trade community. Will factoring finally gain acceptance in India? The Dollar Business investigates the curious case of India's factoring industry.
A manufacturer of cotton t-shirts, Dinesh Chauhan of Delhi-based N. R. Traders, was in the final stages of negotiation to procure a sizeable order of t-shirts from Italy. A small manufacturer Chauhan was unable to raise the funds that would be required to fulfill the order and lost out on the opportunity to leap into the big league of t-shirt exporters. Had it been any other country, Chauhan would have thought of export factoring as a way to raise this short-term finance. But sadly, for both Chauhan and for India, he had no idea that this option even existed. [Of course, we've told him already!]
If you talk to export firms in India, be it large or small, about export factoring, it is more than likely that they will either be unaware of export factoring as a means of finance, or if by chance they do have a clue, they will be amongst those apprehensive about the process and expenses incurred to avail it. By the factoring industry's own estimates, only about 30-35% of Indian exporters are aware of export factoring. It is not that exporters in India do not avail export financing – the fact remains that they are very much in need of services that a factor can provide – but their awareness about the benefits of factoring remains low. According to the ICC (International Chamber of Commerce) Trade and Finance report 2016, up to 80% of global trade is supported by some sort of credit finance. For any industry, whether it is an MSME-intensive or a large-scale one, banks have been the traditional means for raising capital against collateral or some type of asset. Having said that, many small companies are unable to raise the needed capital because of a lack of assets. In such a situation, factoring has supported many exporters across the globe with a financing solution. However, factoring has not yet gained acceptance in India in the way it has in other major exporting nations like China, France, Italy and Germany.
Traditional finance options such as loans, overdraft facilities, pre-shipment and
post-shipment credit, continue to rule the roost in India's trade financing circles.
Even a seasoned Indian exporter like Amit Kumar Drolia, Director of D. R. Coats and Resins, a Mumbai-based manufacturer and exporter of resins, is apprehensive about export factoring. “The (export) factoring process is complicated and the rate of interest is too high. But that said, if factors can synchronise application procedure and balance the costs, we would be open to looking at export factoring,” says Drolia. When it comes to trade finance, whether domestic, import or export, a majority from the Indian trade community echo Drolia’s sentiments and still prefer to go through traditional financing channels.
Experts though say that embracing factoring services could give a real boost to India's exporters like it has done in many countries where factoring has gained acceptance. So, what exactly is factoring and what advantages does it hold over the many other forms of financing? And most importantly, why haven’t Indian exporters warmed up to this form of trade finance?
Traditionally, when it comes to credit services, one can divide them into two types – fund-based credit and non-fund-based credit. Fund-based credit encompasses traditional lending methods such as loans, overdraft facilities, cash and pre-shipment and post-shipment finance while non-fund based credit includes letters of credit (LOC) and bank guarantees. While letter of credit and overdraft are the most popular forms of financing amongst the Indian trade community, world over, sellers (domestic and international) have found more benefits going the factoring way. Reasons - ease of process and credit guarantee (irrespective of the buyer’s repayment time).
In simple terms, factoring is a means for a seller to raise short-term finance by selling its receivables to a third party (referred to as a factor) at a certain discount in return for immediate liquid cash. The credit is usually for a period of 90-120 days. The transaction is conducted based on the assignment of the seller’s receivables. The sale can be both domestic as well as international. In domestic factoring, there are three parties involved in the transaction – namely the buyer, seller and the intermediary (the factor) while in international factoring there is a seller, an import factor, an export factor and a buyer. While the export factor is located in the seller’s country, the import factor is based in the country of the buyer.
Today, importers and exporters across the globe are increasingly turning to factoring because of the many benefits it offers, says Vaibhavi Thakkar, Co-Founder and CEO, Blend Financial Services Ltd., a company that provides factoring services in many parts of the globe. She explains, “Importers are increasingly being reluctant to open letters of credit as they are required to provide margin and security to their banks and exporters are wary of exporting on open account terms for obvious reasons. But, at times, in order to get the order and keep their operations going, exporters are forced to trade on open account exposing them to payment risks. In letters of credit, several banks need to get involved making the transaction cumbersome and costly.”
Other trade finance methods also have their share of disadvantages says Thakkar. “With factoring, on one hand the importer does not have to open a letter of credit and the exporter is also able to cover his payment risk as well as have cash flow. On the other hand, purchase order financing is not easily available and is not really an alternative to factoring, and export credit insurance, even if available, will not resolve the cash flow issues,” she explains.
What's more? Factoring is today a well accepted method of open account receivables financing across the globe and is regulated by a stringent set of rules and procedures. Factors Chain International (FCI), the global association of independent factoring members, helps members operate by co-developing a standard set of best practices to follow the rules and regulations.
FCI is an international body headquartered in Amsterdam. Set up in 1968, it is today a network of factoring members from around the world. More than 90% of factoring organisations from across the world are members of FCI. India currently has seven major institutions that are members of FCI.
So how does factoring works? When it comes to export factoring, factors under FCI provide for a two-factor process. Let us take an example, say a domestic company A is involved in manufacturing of porcelain mugs (with an order worth $100,000) for company B based out of Europe. If both the buyer and the seller agree on using factoring, then the seller approaches one of the factors based out of his country. This will be the export factor. The seller contacts the export factor, fills the required documents and provides the details of the buyer and the receivables to the export factor.
The export factor then contacts his corresponding import factor in the country of the importer and requests an approval. The import factor does a due diligence on the buyer and sends an approval. Once an approval is received, the export factor advises the seller to start processing the order. The exporter then ships the goods and provides the export factor with the receivables documents. The export factor provides 80-90% of the total receivables in the form of liquid cash. Once the pre-decided lending period (usually in the range of 90 days to 150 days) comes to an end, the import factor will contact the importer (buyer) and follow up on the receivables. The money is then passed on to the export factor who releases the balance amount to the seller after deducting the fees and interest rates that are predetermined based on the duration of the service. Sounds sensible, logical and fairly straightforward. And that's precisely why it's even harder to imagine that factoring hasn't still taken off in India.
A Nascent Market
Under RBI’s Kalyanasundaram Committee, the feasibility of factoring in India was discussed for the first time in 1989. And it was only in 1991 that RBI started giving out licenses for factoring with State Bank of India Global Factors Ltd. (SBIGFL) becoming the first licensée.
Until 2011, the absence of laws for factoring made the process difficult for factoring companies and kept many exporters away from adopting the factoring route. The Factoring Regulation Act, 2011, which was finally approved in January 2012, for the first time set out rules that governed the factoring industry. Under the factoring act, non banking financial institutions (NBFCs) were allowed to provide factoring facilities. The factoring law also helped streamline the process and tackle (to a large extent) the problem of non-performing assets (NPAs) and double financing.
Still, compared to the rest of the world, India's volumes when it comes to factoring is nothing worth writing home about. According to FCI data, India’s total turnover from factoring in CY2015 was €3,700 million (€2,500 million from domestic factoring and €1,200 million from international factoring). This increased 4.9% to reach €3,881 (€3,493 million from domestic factoring and €388 million from international factoring, respectively) in CY2016. What is of particular concern here is that international factoring numbers have crashed.
So, what ails the industry? Vikas Jha, Senior Vice President and Head – Product Management, DBS Bank Ltd., says, “Most exporters and sellers still treat factoring as an additional working capital finance channel and hence given the operational intensiveness of factoring vis-à-vis a normal short-term loan, exporters prefer the latter. In other markets, factoring has been offered for decades and hence knowledge and awareness levels are far higher.” However, Kailashkumar Varodia, Chief Financial Officer of Receivables Exchange of India Limited (RXIL), feels that this has a lot to do with the laws governing financing. “Globally, cash credit or overdraft facility are not easily available. Post-shipment finance happens through factoring and their legal system is strong to back such a facility. In India, cash credit and overdraft facility is more acceptable to a borrower as well as to bankers.” Even debtors, he says, are not keen to accept the assignment and are not ready to pay directly to factors. There are other issues too. “Some are worried about double financing, even though that cannot happen under the present regulations. Many people are just not aware about factoring,” he adds.
MSMEs across the globe, especially in Europe and China, have embraced
factoring as an ideal working capital management solution.
Ravi Valecha, Head of Business, Product and International Factoring at India Factoring and Finance Solutions, feels that the lack of understanding has a lot to do with the limited number of players in factoring. He says, “There are no significant players in the market. And even those under operations function on a very small scale. So, unlike the banking industry, which everybody understands, people are yet to catch up with the concept of factoring because of the lack of awareness.”
Within factoring, the numbers also hint an incline towards domestic factoring rather than export factoring. What is behind this trend?
Factoring is a comprehensive financial solution that provides receivables
management services along side short-term capital.
This has more to do with a lack of options. Valecha agreeingly states, “We see a likewise demand for both export factoring and domestic factoring. The lower numbers for India's export factoring are because we have fewer players. So, if there are fewer providers, how will the number of customers go up?” A factoid here - as against 7 factoring institutions in India there are 190 in Germany!
The FACTORING WORLD
The state of affairs outside India though is completely different, with factoring gaining wide-spread acceptance across continents (with the possible exception of Africa). Overall, China and Europe continue to be the largest in terms of turnover from factoring – both domestic and international. According to data from FCI’s 2016 Annual Review, in CY2015, the factoring turnover from China was as high as €226.60 billion for the domestic market and €126.28 billion for the international market (both export and import). Europe too saw an impressive 6.4% overall growth to reach €1,557 billion in CY2015 from €1,463 billion in CY2014. Unfortunately, despite the positive trends in Europe, Asia and America saw a decline by 8% and 6%, respectively. This decline has been attributed to decline in sales, retail prices and commodity prices. Another region that has seen a steady growth has been Latin America, with countries like Brazil, Argentina, Mexico and Chile contributing big time to this growth. Interestingly, like in India, the world over, domestic factoring accounts for 78% of the total business.
SECURITY AND SPEED
So, what are the factors behind the growth of factoring as a financial solution? Talking about the benefits of factoring, Varodia of RXIL says, “Under exporting factoring, the transactions are on open account terms so there is no letter of credit or bill of exchange involved. Through this, the cost of issuance of LoC may be saved.” The two-factor export factoring system offered by FCI also has its advantages as an import factor cover is available on the overseas buyer. This means the risk of credit default gets covered and the seller is not required to take credit insurance. Amit Kaul, Senior Vice President – IT, International Factoring and HR at IFCI Factors, concurs. “On the due date, the responsibility of the collection of dues from the buyer is on the import factor. The import factor ensures that the payment comes to us on the due date. Since import factors are based out of the same location as the buyer, speak the same language and are aware of the regulations in the buyer's country, we are not worried about a payment default. In fact, everything is taken care of in the country of importer by the factoring company who is our partner, as the factor is a member of FCI” he explains.
The other main advantage of factoring over other export financing options, according to Varodia, is that finance is available in invoice currency and interest is charged based on London Inter Bank Offered Rate (LIBOR) which is cheaper compared to rupee funding. “Under export factoring, the interest charged is LIBOR-based (depending upon invoice currency). For example, if the client takes a bank loan in rupee terms from a traditional bank the interest rate will range from 10 to 12%. However, interest rate for export factoring ranges from LIBOR plus 200 basis points to LIBOR plus 500 basis points (2-5%), which is definitely cheaper than what traditional banks offer,” explains Varodia.
Despite this, exporters perceive that factoring is more expensive than a bank loan. Obviously, because there is a communication gap between factors and exporters, and the duty of educating exporters on why factoring can be more cost effective falls squarely on the shoulders of India's factoring institutions!
Also, with factoring the immediate availability of liquid cash proves to be of great advantage to an exporter as the funds (up to 90% of receivables) are available as soon as the discounting takes place. Its utility, according to many, can be beneficial, especially for MSMEs that find it difficult to raise banking finance. In fact, RBI's concept paper on trade receivables and credit exchange for financing micro, medium and small enterprises highlights that MSMEs in India face problems of inadequate finance. It adds that in the case of MSMEs, there is a requirement for the quick conversion of trade receivables into cash. And that factoring comes as a solution to this problem of Indian MSMEs.
Another element that differentiates factoring from other forms of credit is that orders can be finalised on an open account basis, an arrangement which is usually not possible to get into for a smaller organisation in other forms of financing. This helps MSMEs offer flexible payment options to its prospective buyers. And not just that. As per Tushar Buch, MD & CEO of State Bank of India Global Factors Ltd. (SBIGFL), under export factoring, the exporter also benefits from the knowledge he/she gains about the buyer’s credit history – and the buyer’s credit assessment is done by the import factor based out of the buyer’s country rather than a credit agency stationed in the seller’s country.
The price tag
For any financial credit service, an important deciding factor for exporters and importers is the cost, and rightly so. Often an argument against export factoring has been “high costs"; some considering it to be as or sometimes even more expensive than a bank loan. But, "before comparing it to other means for raising working capital, understanding that factoring does not replace existing working capital financing solutions is important," says Varodia. Factoring, he says, is not a replacement but rather a supplement or support to the existing working capital financing solutions for exporters.
Buch too believes that factoring is much more than just a trade financing option. "It involves providing collection and receivables management service, due diligence on the buyer and taking a vigilant look at the transaction structure," he adds. Interestingly, the cost of these value-added services makes factoring costs appear to be on the higher side when compared to a bank loan. However, due to a much leaner structure and better operational efficiency, operating expenses of a factoring organisation tends to be lower and can partially offset the higher cost of funds.
Poised for take-off
It is obvious that factoring as a trade finance option has many advantages and is cost-effective. While large companies may be able to work out cheaper options through foreign currency debt instruments and therefore may not warm up to factoring, it is baffling that MSMEs who are unable to access funding through traditional channels have not yet embraced factoring.
Both parties are equally at fault. Actually, all three. MSMEs are averse to trying out a new option, one that could mitigate risk of delays and defaults in payments. India's factors on the other hand, have not promoted their services among the segment that could most benefit from their services. Since regulations governing factoring came into effect only in 2012, the government also must take a share of the blame. But things are slowly changing for the better. Products are now being structured specifically for MSMEs and trade bodies like FICCI and ASSOCHAM, in conjunction with factors, are holding workshops and seminars to spread awareness.
FCI too has been providing its share of assistance. "We help our Indian members to send their employees to receive certifications. We have participated in the ASSOCHAM Global Factoring summit in Mumbai. Next year, we are organising an export factoring promotion conference,” shares Lee Kheng Leong, Asia Chapter Director of FCI. The conference, he adds, "aims to create awareness amongst exporters on the use of export factoring to enable them to sell on open account terms without risks associated with open account sales.”
Factoring is a great tool at the disposal of exporters, and one that can help improve their cash flows and manage their working capital better. It not only allows an exporter to ship risk-free on open account terms to an overseas buyer, but also helps in collection of receivables through an import factor based out of the buyer’s country. It is high time that Indian exporters, particularly MSMEs, embrace it wholeheartedly.
One must remember that in today's fast-moving world of international trade, buyers are not interested in a deal that puts the financial burden on their shoulders (as has been the case with traditional financing options like LCs). The sooner an exporter realises this, the better it is for his business. After all, no business can afford to lose a deal to its competitor! Need we say more?
TDB: Is it true that exporters shy away from factoring because they perceive the process to be cumbersome?
Tushar Buch (TB): Contrary to this perception, the simplicity of the process and the time and cost effectiveness that it offers are the biggest advantages of factoring. Alongside, export factoring offers additional advantages compared to exporting under an ECGC policy as the exporter benefits from the knowing about the buyer’s credit assessment too.
TDB: Are there products for which factoring is not suitable?
TB: Depending on the destination, the approval process may take up to eight weeks. So, broadly speaking, factoring is not suitable for perishable goods and goods whose value is hard to assess like diamonds, jewellery, etc. India’s Factoring Regulation Act 2011 also prohibits factoring of agricultural products and commodities. But other than these, as long as goods are not being shipped to an associate, all other arrangements of sale on open account basis can be considered for sanction of export factoring.
TDB: Many people think that factoring isn’t MSME friendly. Are you doing anything to help MSMEs embrace factoring?
TB: SBIGFL encourages MSME exporters to avail factoring services. As a member of Factors Chain International (FCI), SBIGFL has tie-ups with more than 400 factors, globally. And being a part of SBI Group, we have board-approved policies to assess credit requirements. Also, SBIGFL has foreign currency lines of credit to fund export invoices in USD, Euro and GBP. In fact, SBIGFL, in most cases, is happy to sanction factoring limits by merely taking an assignment deed for receivables factored and registering their charge with the ROC for limits sanctioned to MSMEs.
TDB: Why do you think factoring services have found less acceptance in india compared to other countries?
TB: Although SBI and Canara Bank had promoted their factoring arms way back in 1991, factoring has never been a mainstream financial service – mostly because of the absence of a legislation. However, with the enactment of Factoring Regulation Act in 2011, the necessary legal framework is now in place for factoring volumes to grow. Unfortunately, the severe global economic downturn, which we have been experiencing for the last 4-5 years, has also been preventing the growth. And, in addition, reservations on part of corporate and PSU buyers to accept assignment of receivables made in favour of factors, issues with the legal system and preponderance of banking have been restricting the growth. But, of late, due to some initiatives that were taken by Reserve Bank of India (RBI) and associations like FCI and ASSOCHAM, awareness about factoring and its superiority as a receivable management service is being recognised. So, going forward, we expect to see higher volumes.
TDB: Exporters are of the opinion that compared to bank loans, factoring isn't a cost-effective option. Is this true?
TB: Factoring is much more than just a financing transaction. It involves providing collection and receivables management service, due diligence on the buyer and taking a vigilant look at the transaction structure. The cost of these value-added services makes factoring costs appear to be on the higher side when compared to a bank loan. Moreover, the cost of funds to a bank is generally lower because they have CASA deposits. On the other hand, the factoring company relies on market borrowings or lines of credit from a bank as principle sources of its funds. However, due to a much leaner structure and better operational efficiency, the operating expenses of a factoring organisation tends to be lower and can partially offset the higher cost of funds.
TDB: How does factoring help exporters in case of non-compliance by an importer?
TB: Exporting goods involves managing associated risks, particularly the challenge of getting paid on time. The exporter, besides facing these challenges, which may be termed as credit risks, also faces uncertainty due to say economic or political conditions in the importer’s country. These are sovereign risks. In addition, differences in language, local laws, etc., add to the challenges faced by the exporter. There are no easy solutions. Opting to use services of an export factor, however, can be of immense help to an exporter. In this regard, the General Rules for International Factoring (GRIF) to which members of Factors Chain International (FCI) adhere, ensure that in case of buyer insolvency, the exporter receives payment of his factored invoices under a guarantee mechanism. Thus, other than in case of commercial disputes, an exporter would have his or her receivables secured.
TDB: What advantages does SBIGFL offer its clients?
TB: SBIGFL is a pioneer in Indian factoring services. Being an SBI Group company, its clients stand to benefit from its culture of good corporate governance, transparency in dealings and robust policies approved by a knowledgeable and experienced board. All these translate into a responsive and fair partner for sellers of goods and services in India. SBIGFL enjoys highest external credit rating (AAA for long term borrowings and A1+ for its CP program). This translates into better pricing.
TDB: What are the advantages of availing factoring services from IFCI Factors Ltd.?
Amit Kaul (AK): To start with, we have partners in almost 150 countries (we however do not have partners in Africa and a few Middle Eastern countries) and we deal with almost 400 companies. This helps us get the credit cover decisions very quickly and we understand all the legal systems followed by the Factoring Chain International (FCI). We also have many FCI certified employees and experts, who can provide customised solutions to our consumers and help get quick services from our export factors. In addition, we are a 100% subsidiary of IFCI Limited, the oldest development finance institution in India. I can confidently say that in this niche financial product none of our competitors have the expertise and connections
like we have.
TDB: Why should an Indian exporter consider factoring services?
Amit Kaul (AK): Of late, buyers in many countries want to do away with the traditional way of doing business and opt for factoring – though I must say that factoring is still in a nascent stage in India. With factoring, exporters will get funding immediately on their post-shipment sales. If we factor the export receivables of a company in India, the import factor guarantees payment even when the buyer fails to make the payment. So, the exporters have the comfort that all their proceeds are credit covered and credit guaranteed. The next advantage is that the export bills are instantaneously converted into liquid cash. Also, on the due date, collection of the payments from the buyer are the responsibility of the import factor.
TDB: Is it true that export factoring is more advantageous for established exporters than SMEs or first-time exporters?
AK: On the contrary, I feel that factoring is more advantageous for SMEs or first-time exporters because of the challenges they face in securing funding. The big exporters can avail the funding against collaterals, while SMEs are unable to procure such funding. So, factoring institutions provide funding for these exporters without collaterals or security. Or, in case they sell to a first-time buyer who has no payment history, there is a guarantee that they will receive the payment. Thus, factoring institutions give SMEs a sense of security.
TDB: For an exporter, what advantages does factoring provide in case an importer fails to pay for the consignment?
AK: In such cases, the interest will have to be borne by the exporter. But, in the case of payment delay, the import factor will follow up and make sure the payment is received. If it is not received within 60 days after the due date, the import factor will make the payment as a part of the credit guarantee. When there is a late payment a penal interest rate is charged. When the delay goes beyond the limit, then the payment has to be borne by the import factor.
TDB: There is a perception among MSMEs that the documentation process is complicated. What is IFCI Factors doing to reach out to this sector?
AK: We have been working with Google to target clients in the SME sector. Alongside, we are working with the Government of India that has introduced a scheme through a company they have floated called National Credit Guarantee Trustee Company Ltd. (NCGTC). This company will give credit guarantee for all export and domestic receivables up to 66% of the total funded amount. We have also simplified the legal forms for our SME clients. But, we must remember that 90% of our SME clients are being funded without any guarantee, whatsoever. We have always been working with SMEs and we want them to be a part of India's economic growth.
TDB: Awareness about factoring amongst exporters has been minimal. What is being done in this regard?
AK: Five years ago, only about 5-10% of our exporters were aware of factoring, which have now increased to 30-35%. However, still very few exporters are using the service. The government has been supportive. IFCI Factors is tying up with associations like ASSOCHAM and FICCI to reach out to SMEs. There is a huge potential for the product but it will take another one or two years to raise it to the level we want it to be. I am very optimistic about export factoring.
I would also want to point out that earlier many exporters would manipulate the bills and double the funding and that was a problem for factors. However, the factoring law introduced a centralised registry for registering all invoices, which were being factored by any company and that ensured that no double financing happens in this arena.
TDB: Factoring can be both with or without recourse. Which is more popular in India?
AK: When RBI started giving licenses, they were giving licenses only for export factoring with recourse. Of late, they have permitted companies to go ahead and do non-recourse factoring. Currently, 90-95% of all the export factoring in India is still with recourse on the client and will continue to be so till Indian factoring laws become more stringent.
Vaibhavi Thakkar (VT): There are many reasons that are stopping export factoring from gaining popularity – notably, the easy availability of cash credit/overdraft facility from banks without much hassles on the documentation front. Another major reason has been non-cooperation or refusal to sign 'Notice of Assignments' by buyers who usually are mid to large corporates. Also, losses incurred by Indian factors on account of ‘accommodation’ transactions led to the loss of appetite for aggressive growth. As for Blend, we actively promote the offerings of all financial institutions that cater to Indian exporters. We also engage with exporters and create awareness on the multiple benefits of availing export factoring facilities.
TDB: What can India learn from other Asian countries like China where markets for factoring has grown significantly?
VT: Factoring is performing very well in China, particularly after the Accounts Receivables Law was passed in 2007. Countries like Japan and South Korea also have high factoring volumes. In fact, in China, the Commerce Ministry initiated policies aimed at developing factoring companies with a focus on the SME sector and that has paid rich dividends. India can learn how a good legislative framework can facilitate factoring. Factoring can help in developing the SME sector which is a key driver of India's economy.
TDB: Blend also operates in Africa. Has factoring gained acceptance in Africa?
VT: There is a very low penetration of factoring in Africa. This is due to several reasons including lack of awareness about the factoring product, near absence of a legal and regulatory framework, and infrastructural issues. However, we are tirelessly working along with other institutions to improve this scenario significantly. We expect that Africa will witness good growth rates in factoring in the near future.
TDB: There is a perception that factoring is more advantageous for established exporters than smaller or first-time exporters. What are your thoughts?
VT: In factoring, transaction history does play a significant role. Hence, the observation is largely correct as far as witnessing regular orders is concerned. However, the requirement of the order being large does not hold much water. If the factor is confident of the buyer (importer), depending on the factor's specific product structure, factoring can be availed by startups with limited vintage and small order sizes as well.
TDB: We understand that factoring is more expensive than a bank loan. Why should an exporter opt for factoring?
VT: A bank loan will normally not come without adequate security or collateral, which is a challenge for SMEs. Though costs may vary from one factoring company to another, still as the exporter will have a natural hedge, the funding normally would be much easier. In addition, it gives the exporter an opportunity to grow the volumes of his or her business, significantly. Also, a major advantage of factoring is that it does not generate loan on the firm’s balance sheet thus there are no loans to repay. Exporters are also assured that in case of a non-compliance, they are fully covered to the extent the invoice has been factored as the payment would be made by domestic factor and the import factor, respectively.
TDB: Is factoring a suitable option for MSMEs? How easy is to apply for ECGC Ltd.'s factoring services?
V. Dharmarajan (VD): ECGC’s factoring scheme is intended to benefit the exporters classified in the Micro, Small and Medium Enterprises (MSME) category as defined in MSMED Act 2006 – mainly medium and small manufacturing exporters who are not in a position to afford collateral security. The documentation process is simple, transparent and MSME friendly.
TDB: What are the advantages of export factoring?
VD: If you look at the non-recourse export factoring service in particular, it usually involves taking over the complete management of the business accounts receivable, including administration, confirmation, collection of invoices, and maintaining records of all transactions between the seller and the buyer. It’s a seamless and comprehensive service.
Thanks to our non-recourse export factoring, exporters can have immediate cash-flow access of up to 85% of the value of debtor invoices, which can be used as working capital without requirements of collateral. ECGC provides a seamless transaction interface between the exporter and the buyer as an outsourced debtor administration thus saving associated costs.
In addition, with this type of factoring the exporter can increase sales by offering to sell on credit, which the business may have been unable to fund otherwise, by taking advantage of creditor discount terms. It also helps them improve their credit rating by paying creditors promptly and enhance his/her ability to capitalise on larger orders. The exporter also has an option to free up property from being tied up as security.
TDB: Many organisations that offer export factoring are struggling mainly due to the lack of awareness. What is ECGC doing in this regard?
VD: ECGC markets its schemes through its wide network of branch offices. ECGC’s documentation process is very simple and easy to understand. Moreover, the exporters receive education on the nuances of ECGC’s factoring scheme. All the queries of the exporters are addressed. Transparency and clarity is maintained throughout the process.
TDB: How can one apply for ECGC factoring services?
VD: ECGC enters into an agreement with the exporters to purchase the export receivables without recourse and assumes credit risk. If the buyer defaults, the payments for undisputed liability will be made by ECGC. Interested exporters may fill in the application form with the requisite documents and fee and submit those to ECGC.
Our current factoring scheme is basically intended for the MSME sector. Once the requisite documents and fee are submitted, client assessment and buyer assessment is done by ECGC and/or our appointed Credit rating agencies. However, some commodities which are not amenable to factoring, such as gems and jewellery, are excluded.
TDB: ECGC is a member of FCI. What role does FCI play in promoting factoring services?
VD: FCI was founded to promote the potential for cross-border factoring and introduce the concept of factoring in countries where it is not available. The organisation works to develop a framework for international factoring that would allow factoring companies located in the country of the exporter and the importer to work together.
TDB: According to you, why have factoring services not picked up in India yet?
Vikas Jha (VJ): Lack of product awareness is the key reason for restricted growth. Most exporters/ sellers still treat factoring as an additional working capital finance channel and, hence, given the operational intensiveness of factoring vis-à-vis a normal short-term loan, exporters/ sellers prefer the latter. In other markets, factoring has been offered for decades and hence the knowledge and awareness levels are far higher. Also, the Factoring Regulation Act was passed by Government of India only in 2012, so we’re still a young industry.
TDB: How beneficial is factoring for MSMEs?
VJ: Factoring can be equally used by both large exporters as well as MSME exporters. From an MSME perspective, this would help them in getting cash faster and in making working capital management more efficient. Given that factors finance on the basis the underlying transaction, due diligence on past track record with respect to receivables is key. Banks/ factors prefer debtors with a good past track record. Further, factoring is operationally more intensive than a short-term loan. So, if the deal sizes are very small, the operating cost could become high. RBI has promoted the receivables exchange (TReDS) which aims to digitalise the operational flow and would help in reducing the operational cost associated with factoring transaction for MSME supplier with small ticket deal sizes.
TDB: Is it true that the documentation process for factoring is tedious, especially for MSMEs?
VJ: The exporter needs to share details of the transaction; debtor, sales contract, payment terms and their track record. This would enable us to understand the transaction flow and help us propose a suitable solution to them. The focus of the factor is on understanding the receivable track record, performance of the seller and industry in which they operate and once the credentials are established, approvals are fast and are comparable with a loan approval process.
And while there are no restrictions on the goods that we can cover under our factoring solution, higher dilution ratio, sales to individual/ group companies, consignment sales are not preferred. The primary documents required are receivable purchase agreement and Notice of Assignment served by sellers bank to the debtor.
TDB: Are there any challenges that an exporter can face with regards to export factoring?
VJ: Currently, there are two key challenges. First, the credit limits on all or a majority of debtors along with cost of such credit cover is dependent on debtor location, debtor credit rating, debtor country and debtor country rating. Second, sales contract with a ban on assignment is a challenge. Given that factoring is based on assignment of receivables, it would then require consent from the debtor. This increases the turnaround time for execution of export factoring transactions.
TDB: What are the advantages of export factoring over export forfaiting?
VJ: At the concept level both are similar but the structuring is different. Factoring can be with or without recourse to seller while forfaiting is always without recourse. The seller can avail of collections, ledger management apart from credit protection and liquidity in case of factoring.
TDB: Would you agree that lack of awareness is responsible for the slow growth of factoring services in India? What is Yes Bank doing in this regard?
Asit Oberoi (AO): In a way, yes! But, factoring professionals and trade associations are making sincere efforts and representations to create awareness about factoring. The enactment of the Factoring Regulation Act has potentially removed the major impediments that the factoring sector faced in the country. However, there are also other issues like availability of credit insurance in factoring business that can give the impetus to the growth of factoring business in India.
Recent step taken by the regulator to set up Trade Receivable Discounting System (TReDS) is a welcome move for domestic factoring. Alongside, Yes Bank is one of the strategic stakeholders in Receivables Exchange of India Ltd. (RXIL), which is co-promoted by National Stock Exchange of India Ltd. (NSE) and Small Industries Development Bank of India (SIDBI), and operates the TReDS platform. With these enablers in place and given the size of the economy, India is poised to become one of the largest markets for factoring in Asia.
TDB: Is it correct to say that export factoring favours the established exporters over MSMEs?
AO: Large or established exporters have an edge in terms of overseas market intelligence and mature treasury operations. But, there is an increasing trend towards catering to the MSME segment with banks offering factoring, which was earlier offered mostly by NBFC factors.
Standard documentation is required for factoring across all segments. But with the increased awareness of the legal framework, more participation across Banks/ NBFCs, and investments in technology, more MSMEs are opting for factoring. And to provide the impetus to the MSME segment, Yes Bank has been focused on providing working capital solutions to meet their composite financing needs and is also taking initiatives to create awareness on factoring services and its benefits.
TDB: What all should an exporter be aware of before opting for factoring services?
AO: Financing costs would primarily involve foreign currency lending cost and credit cost or underwriting cost charged by the import factor. And usually, there is a premium charged for offering non-recourse factoring versus a traditional bank loan. I must mention that factoring, as a product, meets the requirements of an exporter to avail open account financing on a continuous basis and combines credit risk protection and collection services. Factoring solution is best suited to clients who offer open account payment terms to their buyers as it provides an alternate source of borrowing. The location coverage is primarily driven by the Bank’s credit appetite in the geographical location through its correspondent bank tie-ups. Further, banks do not cover regions covered under sanctions.
TDB: How does factoring protect an exporter in case of non-compliance with payment terms by an importer?
AO: Factoring covers payment risk of the overseas importer. In the event of a non-compliance by the importer, the exporter’s liability or obligation would be governed as per the terms and conditions of the factoring facility agreement, which may stipulate financial recourse. It is pertinent to note that performance risk is always borne by the exporter. But, these risks can be offset by availing non-recourse financing.
TDB: How is factoring as a business performing in India vis-à-vis other Asian countries?
Lee Kheng Leong (LKL): I would say that in India international factoring is still at its infancy. India’s international factoring volume of €388 million in 2016 is low compared to the top Asian factoring countries of China, Taiwan, Hong Kong and Singapore. And, as such, I see it as a potential not fully tapped rather than a problem.
TDB: What can India learn from countries where factoring is growing fast?
LKL: Export factoring business comes primarily from SME exporters who are selling on open accounts and need export factors to mitigate the risk of non-payment, finance working capital requirement, as well as need a method to collect receivables. Typically, in most of the countries where factoring has been successful, the export factors educates the exporters on the need to sell on open accounts to secure sales. Once the exporters are convinced about its benefits, there will be growth.
TDB: How would you rate the performance of export factoring service providers in India? What kind of assistance does FCI provide to bolster their performance?
LKL: In India, the State Bank of India (SBI) Global Factors Ltd. and India Factoring and Finance Solution Pvt. Ltd. have just become full members of FCI as they have met the minimum volume of export factoring. Also, Development Bank of Singapore (DBS) and Standard Chartered Bank (SCB) are doing quite well. SCB is a full member of FCI, and recently RBI has agreed to allow the bank to do export factoring. This will create a conducive environment for international factoring in India and help the sector grow.
FCI will continue to provide assistance to all countries including India as this is part of our mission. Members can take up our factoring courses to acquire the necessary factoring expertise. Recently, we participated in the ASSOCHAM Global Factoring summit in Mumbai. Next year too we will be organising an export factoring promotion conference.
TDB: The growth of factoring has been slow in India. What are the factors that are stopping it from growing in India?
LKL: I think this will change. But, yes, traditionally, most companies are comfortable in selling on letters of credit, and this is the same for the Indian exporters. However, more and more buyers are asking for open account terms and Indian exporters have to accede to the importers’ demand otherwise they will lose out to the other competitors in Asia.
One of the problems exporter faced in selling on open account is the availability of export factors. This is no longer a problem in India as there are now seven FCI members providing export factoring services and we expect more Indian banks to join FCI in the coming years.
TDB: How do you foresee the future of export factoring as an industry in India?
LKL: By virtue of the size of the Indian economy, which is the third largest in Asia, there is no reason why your factoring volume cannot rival any of the top factoring countries in Asia. In fact, I have always said that India is a sleeping giant which will awaken soon. What is required now is a concerted effort to promote international factoring in India. This could be done by way of workshops, seminars and conferences.
TDB: Despite being a popular financing option globally, factoring has not found much acceptance in India. Why?
Kailashkumar Varodia (KV): In India, though factoring services were started in 1991, the Factoring Regulation Act was introduced only in 2011. In addition, globally, cash credit and overdraft facilities are not easily available and hence the finance happens through factoring. Also their legal system is strong to back such a facility. However, in India, cash credit and overdraft facilities are more acceptable to the borrower. Debtors do not easily accept the assignment and are not ready to pay directly to factors. Even the banks have apprehensions about factoring and consider it as a competitor. On top of that, many are unaware of the services.
TDB: Is there any restriction on the types of goods financed under factoring?
KV: As such, there is no restriction or criteria on the type of goods or segment. But, export factor will not be able to finance against the goods sold on a consignment basis and goods sold to associates or subsidiary of the seller. Sellers can approach factors like SBI Global Factors, India Factoring and IFCI Factor for their individual export factoring limit. The documentation is similar to that of the banks and it takes nearly 3-4 weeks to complete the sanction process. Disbursement against particular invoices will happen on the same day, or the next day if the documents are submitted during the later part of the day.
TDB: Why should an exporter opt for factoring when it is considered more expensive than a bank loan?
KV: I agree that factoring is little more expensive compared to bank finance. But, one must understand that factoring is not a product to replace bank finance, rather it is a support/ supplementary to the existing working capital. However, in some cases, it might be cheaper than bank finance. For instance, if the client has limits, in rupee terms, from their existing bankers, the interest rate will range from 10-12%. But under export factoring, since the interest charge are LIBOR-based, the interest rate for export factoring range from LIBOR plus 200 basis points to 500 basis points, which is cheaper compared to rupee funding. Export factoring is post-shipment finance which will give three type of services: finance, cover and follow-up (management of receivable) by the factor. So, export factoring is more suitable for the continuous business relationship of buyer and seller on open account terms.
TDB: Critics say factoring is more beneficial for established exporters and that the process can be tedious for MSMEs?
KV: Yes, compared to a first-time exporter, an established exporter will have more advantages. This is because the factors analyse the payment performance of the buyer. Thus, in the case of a new buyer, this can prove to be a challenge as there is no prior information available.
To answer your second question, the process is not tedious. But it's a little detailed as financing is against invoices and the export factor is not taking any collateral for such a facility. Also, many a times, delay happens due to non-receipt of the insurance cover on time or delay in acceptance of assignment by the buyer. But in such cases, talks can be initiated with FCI for a quick response to cover a request from the export factor. And, it is also possible for the factor to simplify the documentation process for MSMEs without deviating from their regulations, processes and procedures.
TDB: What advantages does export factoring have over conventional export credit options?
Ravi Valecha (RV): Usually, exporters depend on banks for export finance, which comes with a recourse facility. However, when it comes to export factoring, its main advantage is that it offers a total product suite that provides multiple benefits – the main being a non-recourse facility on an unsecured product. In an usual banking scenario, the exporter has to take an ECGC cover to protect against the buyer’s default, which is a different organisation. So, exporters have to deal with two different organisations. But as a bundled offering, factoring offers collection service in case of a non-payment – which is not the case with the banks. Also, factoring offers credit protection in the buyer’s country. So, there are many advantages of factoring.
TDB: We understand exporters have shied away from factoring because it is more expensive than bank finance. What makes factoring an expensive financing option?
RV: Obviously, the cost of factoring is higher than bank financing. But the bank does not provide credit protection, collection facility or unsecured finance. If we were to provide like-to-like finance, then there would be a case for comparison. But, there are at least five to six differences on top of the finance option that the banks offer. So, factors demand a little premium.
TDB: Are there sectors that factoring does not cover?
RV: Well, from a sector’s point of view, there are some dos and don’ts. For instance, gems and jewellery sector is not covered because of the underlying value which requires a certain level of expertise – it’s hard for the institution to evaluate the value of their goods. And, globally, there are only a few banks that offer finance to gems and jewellery sector. But, if we pick men’s shirt, it’s easier to estimate its value and factoring becomes easy.
TDB: There are some non-FCI institutions that offer factoring services. Are there any advantages of seeking a service from an institution that comes under FCI?
RV: Just like the International Chamber of Commerce’s (ICC) banking division is responsible for laying down rules and regulations for international trade, Factors Chain International (FCI) regulates all the factoring of open account transactions. So, when you are involved in factoring under FCI, you are operating in a regulated environment. And if you factor outside FCI, then it’s like taking services from an unregulated setup.
TDB: What reasons would you attribute to the slow growth of export factoring in India?
RV: There are no significant players in Indian market. And even those under operations function on a very small scale. So, unlike the banking industry, which everybody understands, people are yet to catch up with the concept of factoring because of the lack of awareness.
TDB: How would you sum up the benefits of factoring for Indian exporters?
RV: I would like to conclude with an example. When you a have question about investments, you reach out to an investment consultant or a private banker. In the same way, for receivables, you will need to reach out to an expert – and not a banker. Banks treat finance against receivables and stock in the same manner, while they are actually two different things. And be assured that we will do our best to guide you