The Hindu Business Line : Structured financing in a new light

Last week, we saw how structured financing is different from balance-sheet-based funding and how it benefits traders, lenders and the community at large.

There are different forms of structured financing for commodities. Receivable-backed financing is one of the most popular. Factoring and forfaiting are variations of this.

Factoring is often used synonymously with accounts-receivable financing. Factoring is a form of commercial finance whereby a business sells its accounts receivables (bills raised on debtors) at a discount. The factoring company undertakes to collect the receivables from the debtor and often pays the business in advance. It is thus off-balance-sheet financing. It is neither a form of debt nor equity.

Forfaiting involves medium-term capital goods financing. It means selling a bill of exchange, at a discount, to a third party (the forfaiter), who collects the payment from an essentially overseas customer through a collateral bank, and thus assumes the underlying responsibility of exporters, simultaneously providing trade finance for importers by converting a short-term loan into a medium-term one.

In other words, forfaiting is the discounting of international trade receivables on a ‘without recourse’ basis.

It is also possible to have inventory financing where the lender finances on the basis of the value of stocks a business holds. Warehouse Receipts financing is possible in cases where goods are stored in a warehouse and the warehouse keeper issues a receipt of storage, mentioning essential details.

Current Status

What is the status of commodity financing in India? The Indian economy continues to register rapid growth. There is huge expansion in commodity trade, with rising production, consumption and often imports, to meet supply shortfall. The market is in transition, moving away from a regime of controls and restrictions to a market-driven system. This creates a huge demand for funds to finance transactions.

Much of India’s growth will be commodity-intensive — agricultural products, industrial metals, energy products and so on. Although commodity trade is growing, most banks show little interest.

Commercial banks are flush with funds but have kept away from financing commodity transactions for reasons that seem partly historical and partly attitudinal.

Need for innovation

Commercial banks, especially public sector banks, have been comfortable with funding brick-and-mortar projects. Their main focus has been on borrowers who run production-oriented businesses. Banks have attained certain expertise in funding such projects.

However, when it comes to the commodity business, there is palpable unease. The wariness may be due to lack of experience and expertise.

It could also be a matter of culture or mindset. There has been a marked lethargy in developing innovative banking products to meet specific needs of customers. Surely, many banks have been launching new products; but given the expansion of trade and complexity of business financing, more needs to be done, experts believe. Importantly, banks seem to have limited research back-up. Commodity markets are turning increasingly complex, both in India and globally.

Fluctuating production and volatile prices characterise trade. Non-fundamental factors impact markets. A lender’s response to such a dynamic situation calls for focussed attention on the way the market functions.

For transactions-based structured financing, in-depth knowledge and understanding of the commodity and the market is necessary. In addition, tie-ups with service providers is imperative. Therefore, commercial banks need to develop product and market knowledge; and build a network of service providers to facilitate smooth flow of business.

Several foreign banks operating in the country offer structured financing for commodity transactions. Indian banks are losing out and must seize the opportunity.

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