Ensuring adequate financing and liquidity for small businesses is a problem India has grappled with for long. Large businesses and even the government delay payments often. Formal finance has left many small enterprises untouched. And small businesses are left walking a tight-rope balancing their production cycles and working capital requirements.
Attempts to solve this problem, via platforms such as TReDS, have seen modest success at best. The government’s now hoping the Factoring Regulation (Amendment) Bill, 2021, which permits all non-bank lenders to offer services via trade receivable platforms, will help ease liquidity constraints for small and medium enterprises.
The bill, passed on July 27, is based on the recommendations of the eight-member UK Sinha Committee, set up by the Reserve Bank of India to review the financing framework for micro, small and medium-sized enterprises in 2019.
The new factoring law will allow MSMEs to access 9,000 NBFCs for factoring invoices, as opposed to just seven that are presently allowed to do the business, Finance Minister Nirmala Sitharam said while discussing the bill in Rajya Sabha. The move, she said, will broaden the credit facilities for MSMEs and ensure a smoother working capital cycle.
The law comes at a point when the market is volatile and lenders are wary of giving unsecured or long-term loans to MSMEs, said Aseem Dhru, managing director and chief executive at SBFC Finance Pvt. “But with factoring getting opened up for NBFCs, they can lend short-term funds to MSMEs,” Dhru said. “The risk here’s lower as the receivables are to be recovered from debtors, who are usually large corporates.” It also expands the pool of lenders from which MSMEs can access credit, he said.
Presently, there are three electronic trade receivable discounting, or TReDS, platforms in India. These include Receivables Exchange of India Ltd., Invoicemart by A TReDS and M1xchange.
Using these platforms, small businesses can submit bills for goods sold to larger corporations. Lenders pay small businesses a certain amount upfront, after some discounting, based on the assumption that the larger corporate will make good on the payment within a certain period of time.
At the end of an agreed period, which can be anywhere between 30-180 days, the platform collects the dues from the large corporate and settles the same with the lender. For receivables acquired under factoring, however, if the lender doesn’t get repaid within 90 days of the due date the credit is treated as non-performing.
To be sure, invoice discounting is slightly different from factoring as it allows the financier or factor, which could be a bank or NBFC, to take the ownership of receivables at a discount from the assignor or the vendor. The factor then collects the payment from the debtor or the company that owes the money to the vendor.
Factoring is superior to invoice discounting, said Sundeep Mohindru, chief executive officer at M1Exchange. “It ensures MSMEs have healthier cash flows as delays in receivables and the onus of collection is transferred to the financier, while the financier also has greater comfort as it takes charge of receivables,” he said.
According to Mohindru, NBFCs are getting a “golden goose” and they should make the best of it.
Manish Lunia, co-founder of FlexiLoans.com, an SME-focused NBFC that specialises in supply-chain finance, agreed that the opportunity is large and added the TReDS platform will give greater comfort to financiers.
“Linkage to MSME documentation, the authenticity of documents, linkage of GST and e-invoicing, these are some of the many benefits of using TReDS,” he said. “This brings a lot of comfort to those smaller NBFCs that aren’t specialists in invoice discounting.”
Further, factoring would also give greater power to NBFCs to recover dues from debtors.
“Factoring gives a lot of powers to the financier to recover the loan, which was earlier not there with bill discounting,” he said. “In bill discounting, our customer was the vendor, but with factoring I assume the rights to recover from the larger corporate, which was earlier not allowed.”
FlexiLoans.com looks to increase its disbursements towards invoice discounting from Rs 40 crore a month to Rs 100 crore by the end of this calendar year. “About half of our supply chain financing could happen through factoring.”
The move also benefits NBFCs with no experience of supply chain finance to enter the business. For instance, SBFC Finance, Dhru said, will now look to enter the factoring market, expanding its current suite of lending products.
“The basic problem of factoring has been that the RBI insisted that factoring should be done via NBFCs that have 50% of their income coming from factoring. This was a big roadblock that has now been removed,” he said. “Presently, we are not doing supply chain financing, but are looking at this opportunity.”
Even as TReDS provides a ready platform for NBFCs to start the factoring business, the business may not be lucrative for small and mid-sized NBFCs if the invoices are not priced appropriately.
“As the market has so far remained dominated by NBFC Factors (the seven NBFCs that were earlier allowed to do the business) and banks, the pricing of invoices usually ranges between 8-12% per annum for nearly 70% of all factoring arrangements on TReDS,” said Lunia. This rate is lower than the existing cost of funds for most small and mid-sized NBFCs, he said.
However, if this pricing, or simply put the rate of discounting, improves to 12-16% per annum, there is a clear opportunity, Lunia said.
Agreed Dhru. In factoring, the risk is priced based on the quality and size of the debtor, he said. “Small and mid-sized NBFCs may want to target demand coming from debtors who are MSMEs or lower-rated corporates, and the pricing will need to reflect the higher risk.”
Further, for a wider range of NBFCs to participate, the TReDS platform will also need to widen the base of debtors on its platform.
Besides, small and mid-sized NBFCs will also need to evolve their systems to do the factoring business, Mohindru said. “Factoring is essentially a short-term credit line of 60-90 days,” he said. “So, it’s a very fast rotation paper. NBFCs will have to learn how to do the business by upgrading their infrastructure and software systems to suit the requirement.”
Therefore, NBFCs will need to train their risk officers, legal and credit appraisal teams to evaluate and take credit calls for factoring invoices. “While most large NBFCs are prepared and may go live in two-weeks to a month, small and mid-sized ones may take much longer,” said Mohindru.