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MSMEs to get more access to cash with proposed change in factoring law, experts say

The proposed Factoring Regulation (Amendment) Bill, 2020, is expected to increase competition in the business of factoring, in which companies can get immediate cash by selling their receivables at a discount.

July 21, 2021 / 07:37 PM IST


The lower house of Parliament, Lok Sabha, will consider an important amendment to the decade-old Factoring Regulation Act, which is expected to give micro, small and medium enterprises (MSMEs) better access to funds and help them recover from the liquidity crunch caused by the pandemic.

The proposed Factoring Regulation (Amendment) Bill, 2020, which will be discussed in the ongoing monsoon session of Parliament, seeks to widen the scope of Non Banking Financial Companies (NBFCs) that can engage in the factoring business that helps companies get immediate cash by selling their receivables at a discount.

"Factoring business at present is limited to RBI-licensed seven NBFCs whose principal business is factoring. The amendment proposed in the bill will do away with the said requirement of principal business and this will open up the factoring market to a whole lot of NBFCs from the current 7 NBFCs. This will give these NBFCs access to Trade Receivables Discounting System (TRDS) platform," said Ashish Pahariya, Associate Partner, DSK Legal.

"The MSMEs are expected to be a major beneficiary of this regulatory change as they will have a significant number of financiers for bill discounting on TRDS platform. Increased competition in the factoring business will help MSME in decreasing factoring cost and overcoming their cash flow woes and free-up working capital," he added.

Pahariya said the central bank would need to change its regulations and fast pace the registration process for NBFCs.

According to Krishnan Sitaraman, Senior Director and Deputy Chief Ratings Officer, CRISIL Ratings, “One of the reasons why factoring business did not up pick up in India is that under extant norms, NBFCs into factoring need to have more than half their assets and half their income coming in from factoring.

With the proposed amendments which are expected to relax the entry conditions for factoring, more NBFCs will be able to engage in the factoring business”, Sitaraman observed.

“MSMEs are a prime beneficiary of factoring, and having access to factoring will help them improve their cash flow and liquidity position and smoothen their working capital cycle,” Sitaraman noted.

Commenting on the outlook, he observed that, “NBFCs getting into factoring may want to an adequate level of due diligence before talking on board new clients and if the track record is good, then over time factoring volumes should pick up.”

Under factoring, an entity can sell its receivables (dues from customers) to a factor such as an NBFC to fulfill immediate working capital and cash flow requirements which otherwise gets hampered  due to delay in payments.

As per the existing law, for an NBFC to engage in factoring, its financial assets in the factoring business and income from it should both be more than 50 percent of its gross assets and net income or greater than a threshold.

The Bill seeks to remove this threshold which was notified by the Reserve Bank of India.

"With more NBFCs permitted to do factoring business, there would be increased funding avenues for MSMEs . However, given the historical stress seen by some NBFCs in this sector, NBFC might be more cautious in growing this product," said Manushree Saggar, Vice President, ICRA.

According to Mathew Chacko, Partner, Spice Route Legal; the proposed amendments under Factoring Bill will benefit those companies which have repeat customers.

“It is a huge advantage to the companies which have predictable cash flows and have limited debt,'' noted Chacko.

He further observed that under the existing legislation, there was a lack of clarity regarding the factoring business which kept many NBFCs away from it; however with the proposed amendments which relax the norms to engage in factoring and provide clarity, a greater number of NBFCs may consider factoring a core part of their business.

The Factoring Regulation (Amendment) Bill, 2020, was introduced in the Lok Sabha by finance minister Nirmala Sitharaman in September last year to amend the  Factoring Regulation Act, 2011.

The Bill seeks to amend the definitions of "assignment", "receivables" and "factoring business".

The Bill empowers the Central Bank to make regulations relating to the manner of granting registration certificates to a factor, the manner of filing of transactions among others.

After the bill was introduced in the Lok Sabha, in the same month, the Speaker referred the Bill to Parliamentary Standing Committee on Finance for examination.

The panel led by BJP MP Jayant Sinha submitted its report in February this year. It observed that the factoring credit constitutes only 2.6 percent of the total formal MSME credit/loans in India and that only 10 percent of the of the total receivable market is currently covered under formal bill discounting system.

It also concluded that the factoring and bill discounting mechanism remain underutilised.

Some of the other observations made by the committee noted that by expanding the number of NBFCs which can participate in factoring business will bring forth gigantic regulatory responsibility for the RBI.

The panel emphasised that the central bank would need to "build up sufficient regulatory staff/resources for efficient supervision of factoring activities, so that the intent and purpose of the proposed amendments to address the lingering issues involving factoring industry, particularly the chronic delays in payment and liquidity crunch faced by enterprises is effectively addressed".

The report also suggested that India needs to adapt to global practices in order to bring domestic factoring on par with their global counterparts and it would help improve the availability of credit for MSMEs.

"This is a highly welcome move, at present banks and NBFC Factors only could participate in factoring. On TReDS M1xchange 37 financiers participate to finance invoices of MSMEs that are suppliers to A rated corporates, however only 5 financiers participate to finance receivables of MSME that are suppliers to B rated corporates. With NBFCs participation, receivables of MSME suppliers for B rated corporates will also get liquidity and bring relief to huge challenge of delayed payments," said Sundeep Mohindru, CEO & Founder M1Xchange.

Mohindru further noted that it will help MSMEs access working cash flows fast at reasonable rates and invest in the growth of their businesses without waiting for their dues to be cleared against prolonged credit periods.

Girish Rawat, Partner, L&L Partners said that the bill is likely to improve the availability of working capital for the MSME and may accelerate their growth."

Shreeja Singh
first published: Jul 21, 2021 06:05 pm