K Reddy, owner of a micro enterprise in Pune, has pending receivables of over ₹1 crore from his buyers. The relationship was quite robust until the end of 2012, when the orders started drying up and payments started getting delayed. Reddy, however, hung onto his buyers even as the credit cycle started getting delayed from the normal 45 days to about four months. He, however, never thought about approaching an entity called factors because he is not aware of their existence.
What is FactoringFactors are entities that pay such stressed units a certain upfront amount of receivables (up to 80 per cent) that SMEs expect from their buyers for selling their products. In turn, the SMEs assign their receivables to the factors, which then pursue the buyers and recover the amount. After pocketing the profit and recovering costs, factors pay back the balance to the SMEs. SMEs benefit because they get capital immediately, which in turn can be used to generate more business, or so is the idea. However, due to lack of awareness and several other impediments, factoring as a concept never really took off in India despite the first factoring company – SBI Factors – setting up their shop in 1991. It was not until 2011 that the Factoring Regulation Act was passed that set out certain rules to do this business. Not surprisingly, only five factoring companies have set up business in India in the past 23 years. Last week, the Reserve Bank of India, set out guidelines for setting up of and operating the Trade Receivables Discounting System (TReDS), to facilitate financing of bills of MSMEs drawn on corporate and other buyers, including the Government Departments and PSUs. TReDS will be an electronic trade platform where the sellers will place their receivables and interested financiers will pick it up and chase the buyers.
However, in absence of key enabling mechanisms it is unlikely that too many financiers will be interested in funding these receivables.
One of the impediments clearly is the absence of recovery tools such as Debt Recovery Tribunals (DRTs) and SARFAESI, which do not allow factoring entities to go after the buyer with full force. Second, buyers treat factors as extra-terrestrial entities between them and the SMEs. Buyers simply do not accept the receivables assigned by the SMEs to a factoring entity and even arm twist the SME from assigning the bills to factors. According to Arun Kumar Agarwal, Managing Director & CEO, SBI Global Factors, “Buyers are flouting all norms. They don’t even tell us how much they owe to the SMEs.”
We have approached the RBI to look into buyers not accepting the notice of assignment of receivables, Agarwal adds. “Responsibilities of debtors/buyers in honouring the Notice of Assignment (NoA) accepted by them must have absolute binding regulatory and also in court of law,” according to Ravichander Varadarajan, MD and CEO of India Factoring.
ReceivablesChandrakant Salunkhe, Founder President of Small & Medium Business Development Chamber of India, says even the SMEs that are aware do not approach a factor because the rate of interest that a factor charges is “quite high.”
“Why should a SME bear the brunt of delayed payments…the factors must recover the interest fees and other costs from the buyers,” he adds.
Agarwal is of the opinion that making it mandatory for receivables above a certain limit to be handled by factoring companies, will help the sector grow besides smooth out the cash flows for SMEs. India’s factoring business is less than 0.5 per cent of the total global factoring business.
“Other measures like lower cost of funds to factoring companies, priority sector advance status for Factoring services offered to MSMEs and credit insurance for domestic and cross-border factoring will enable existing players to expand significantly and also attract newer players in the market,” according to India Factoring’s Varadarajan.