Needed, a firm TreD

Last week, Parliament passed the Factoring Regulation (Amendment) Bill, amending the 2011 law on factoring services. Factoring is essentially a bills discounting facility for MSMEs that cannot conveniently access working capital from banks even as their working capital cycle can typically extend to more than 240 days. Banks offer cash credit, a revolving working capital loan that includes bills discounting. In the case of factoring, the bills are assigned or sold to the financier, as a result of which the supplier does not incur a debt. The essential aim of the amendments is to enhance NBFC participation in the sector. NBFCs with no prior footprint in the factoring business can register as factors with the Reserve Bank of India. The changes are along the lines of the recommendations made by the UK Sinha panel on MSMEs, set up by the RBI in January 2019. The panel recommends enhanced participation of NBFCs on the Trade Receivables Discounting System (TreDS), a platform where invoices, accepted by buyers, are auctioned to factors who will bid for them. The seller or buyer will make their choice of the bid.

However, the TreDS system, which began in 2017, has not exactly made waves, having discounted invoices just above ₹15,000 crore from 25,000 MSMEs so far. The non-TreDS factoring services to MSMEs are estimated at four times this figure. However, all this is just a drop in the ocean, as far as the credit needs of MSMEs are concerned. MSMEs, which account for 45 per cent of manufacturing output and 40 per cent of exports, accessed just 6 per cent of outstanding gross bank credit of ₹100 lakh crore (₹6 lakh crore) and under a fifth of advances to industry (₹31 lakh crore) as of September 2020. For factoring to emerge as a viable form of finance to MSMEs, deeper ecosystem changes are required. The TreDS platform, like the formal banking system, is unable to reach out to suppliers and buyers who are not at the top of the ratings pyramid. Factors are unwilling to discount bills owed by a less than A-rated entity in the absence of trade credit insurance. It is precisely these entities, with their shaky liquidity which need to be a part of the factoring universe. At present they are more in the non-TreDS segment. The IRDA, which issued trade credit insurance guidelines in April, needs to ensure early implementation. There is also a lack of awareness among MSMEs regarding factoring services, particularly with respect to exports. As for fostering competition in factoring, NBFCs cannot readily compete in costs with banks.

Banks provide packaged services, including the scope for restructuring debt. They generally discount bills on the basis of recourse to the buyer, as on the TreDS platform, whereas non-TreDS factoring is often based on recourse to the seller. For factoring to work for MSMEs, the buyer must pick up the tab. TreDS must become the dominant factoring vehicle. Finally, factoring services have to be priced competitively for MSMEs which cannot access bank credit easily.

COMMENT NOW