Factoring and trade platforms...the road ahead

Factoring in India find its roots way back in 1991, when SBI Factors and Commercial Services P Ltd, a subsidiary of State Bank of India was formed (Initially, RBI mandated that Banks need to obtain license and form a standalone factoring company to conduct this business in India). Canara Bank was the other public sector Bank that also simultaneously and enthusiastically, launched its own factoring subsidiary. Though it was a new concept in the country, it was expected that the Factoring industry would grow rapidly, especially as it was aimed to provide the small and medium businesses easier access to working capital facilities, without the need of a tangible security. But roadblocks faced by the industry (starting with lack of legal regulations around Factoring, minimal marketing by the factoring companies, shortage of adequate players and significant lack of awareness), disappointingly slowed the momentum for over a decade. When RBI removed the restriction of setting up a standalone company, foreign banks and other Indian private sector banks also entered the fray, setting up factoring divisions within the Bank or just offering this product as a part of their trade finance portfolio of products. Nevertheless, the financing volumes under the core factoring product (if one were to keep aside the more lenient variety - the invoice discounting structure), remains small compared to other developed markets.

Over the last decade there are been quite a few developments, including the implementation of Factoring Act, the advent of new age lending companies, access to data and a reliance on technology by the new age startups for origination and credit evaluation, all of which has resulted in renewed interest in the product. The government has, in all fairness, tried to give an impetus to its growth by introducing the Trade Receivables Discounting System (TReDS) and mandating public sector companies and banks to register in these platforms.

To further assist in the growth of this industry, in recent times, the government has recently taken the following initiatives:

1.      It has passed a factoring amendment bill in the parliament, opening the doors of the TReDS platform to NBFCs other than factoring companies. Presumably, it meant that NBFCs does not have to be a factoring company to undertake factoring services.

2.      The IFSCA has expressed its intention to promote the setting up a ITFS platform in the Gift City that will enable players to undertake financing of export and import trade transactions.

It will be interesting to watch how these initiatives will spur the growth, if at all, of Factoring, both as a standalone product and as a medium leading to the success of the TReDs platforms. Factoring companies and Banks have been present in the platform. So, presumably, it is not for lack of lenders that the growth in business in the platforms have not been exponential. The platforms face the challenge that the larger and better rated Corporates accepting invoices in the platforms have been fewer. These may stem from reluctance of the Corporates to publicly acknowledge their suppliers, or reluctance to lose its strength and flexibility in repayment, or just the need for a better product pricing from its suppliers, if the suppliers are benefiting on interest pricing owing to acceptance of invoices by the Buyer. Whatever be the reasons, these challenges have to be addressed for volumes to grow. Until then, the second or even third tier Buyers will use the platform as an indirect means to fund its own working capital. The credit risk on such Buyers would be higher and Banks may be reluctant to provide an unsecured exposure on them. Therefore, the need for NBFCs, with higher risk appetite to be present in the platform. The platforms may run the risk of evidencing a higher level of defaults. Though the platforms do not have a skin in the game of lending, it will certainly impact the volumes in the long run. There are no ready solutions that I can offer at this stage. Maybe the platforms should seek the help of industry associations to promote the culture of supporting suppliers by making payments through the trade platforms. The platforms should also aim to think of various aspects of risk mitigation, including analysis of the performance of the buyers, develop a rating module that can be shared with and assist the lenders and possible credit insurance tie up, that can provide a value add to lenders.

The international platform will also have to be a step above those available in other international markets. India being a regulated market for foreign currency, the platform will have to coordinate with the lenders and authorised dealers to ensure that the laws of the land relating to currency and its management, are adhered to. I am sure the regulators have thought through the details on how these would work, though these are not publicly available. As the Credit insurers are now ultra conservative in providing fresh limits during these uncertain times, the challenges of credit risk mitigation in the trade platforms will also a hurdle to grow the international business. Notwithstanding the above, these are certainly interesting days ahead for the Factoring Business.