Factoring, basically discounting and recovery of acknowledged receivables, has not taken off as much in India as it has worldwide. Tushar Buch, CEO and MD, SBI Global Factors, discusses the concept and why it is so exciting for India right now, in a chat with Pankaj Joshi.
How has the environment been for your business for the past 5-10 years?
The concept of ‘factoring’ has been around for decades. It started in 1991, on a recommendation by the Kalyan Sundaram committee. However, it has not gained the acceptance it should have for a variety of reasons. Firstly there was a regulatory vacuum for a long period, which was addressed by the Factoring Regulation Act coming into force from April 1, 2012. The Act made the process simple and enforceable – once an assignment has been created in favour of the factoring agency, buyer has been notified and the whole thing registered with Central Registry of Securities (CERSAT), the matter is watertight. Then buyer liability can be discharged only by payment. Another benefit was that the Act specified that assignment transactions are exempt from stamp duty, which would otherwise have been levied 0.5-1 per cent on ad valorem basis.
Prior to the Act, in the 2005-10 period, factoring grew on the basis of credit insurance-backed products. The issue here was that insurance backing made lenders somewhat reckless and they used to get into factoring transactions without commensurate due diligence. The 2008 liquidity crisis, and the consequent counter-party transaction trust diminution, saw a change in this scenario. Credit insurance literally went for a toss and therefore factoring transactions backed by such insurance became NPAs overnight. It was at this time that Global Trust Factors (promoted by Exim Bank) was merged with our company, and we became SBI Global Factors.
The main issue in this merger was that the portfolio we got was almost entirely NPAs. There was a time when the SBI group had practically taken a call that this was not a suitable business for the group. Still, we survived and here we are. We put up arguments against exiting the business – firstly, losses were partly because of lack of regulatory structure and then there was the credit insurance angle to the NPAs basket. We could see a new regulatory environment in the pipeline and that gave us the confidence to keep going. In FY2010 we had losses of Rs 50 crore on income of Rs 150 crore, driven mostly by write-offs and provisions. This financial year we estimate an income of Rs 100 crore but we will be profitable.
How did the path to profitability evolve?
First of all was the conviction in our business. Let us take a minute to understand the value proposition. ‘Factoring’ as a product offering has much going for it – it generates credit amount without any guarantee or any letter of credit (LC). The product offers a lot to all parties – a small person can focus on getting and executing orders from bigger clients because he knows the order has finance tied up at back end. For the larger entity, we would offer a solution which combines finance as well as collection. Any vendor or service provider can assign receivables to the factoring agency and no other security is needed.
From our viewpoint, in due diligence the most important thing is transaction status – are buyer and seller at arm’s length? The second important thing is acknowledgment of delivery of value by the seller – once that is certified without dispute, our work is smooth. What we had to do was find the markets, the users for which factoring would be relevant.
Which markets did you tap?
One big stream was the international organisation of factors (Factors Chain International or FCI). It has 400 factor members worldwide and that offers a massive benefit for factoring international trade. First is the on-ground counterparty knowledge access which the local member over there brings. Second is the overseas member, having assessed his local risk, is bound to give us a cover for the amount. This cover is a safeguard against both buyer insolvency and protracted default scenarios, but does not extend to disputes over delivery.
Look at the value the FCI network offers to a buyer. Apart from the on-ground due diligence about the overseas counterparty, there is documentation and process guidance, there is active collection service and liaison throughout the process. None of these are offered in normal channels like Export Credit Guarantee Corporation of India.
Again, in case of the party default, the FCI member will first honour the guarantee under the general rules for international factoring mechanism and arbitration, which is rare, would happen within the FCI network. The protocol and business ethics within FCI are very high and till date there may have been around 15-20 arbitration cases. The guarantee being honoured is a great underpinning for the Indian counterparty. For this, his FCI fees cost is 0.35 per cent of the invoice value and against that there is no LC/ insurance/ guarantee charge to be incurred. He gets high-level service in a single window.
We knew this was a good deal and we set out to market it. Today the FCI network business, which was initiated from December 2013, accounts for Rs 350-370 crore or 10 per cent of our total revenues, that also with nil NPAs. Through this, lots of industries in India – pharma API, engineering products, textiles – which have good product quality are able to generate and increase their export businesses.
To be fair, this network also has some limitations, mainly about country risk. Across FCI, the preferred basket is of roughly 50 nations. Beyond that, the network is reluctant to deal with other counter parties. Secondly, the FCI network is not keen to take up cases where buyer is too small, with limited credit history, not eligible for credit insurance etc.
How do you look at the domestic market potential and how are you placed?
From the Indian market perspective, we are in a very good place. Confidence in India is rising, this product had negligible market share and most importantly we are well-capitalised. Our capital adequacy is around 36 per cent, against the RBI stipulation of 15 per cent. The group vision has contributed to sustenance of our business since we started operations in 2001. Now hopefully we will scale up.
Locally, the focus was to look for creditworthy clients who could not access bank finance. We understood lack of asset collateral was a key differentiator and this led us to seek and grow many different activity segments through offering finance – logistics, facility management, and digital businesses. Our requirements were simple – a track record of continuous transactions with reputed clients. We finance many small vendors to Apple and Samsung (like say service centres) by factoring their invoices. In the logistics space, we know many companies that would have a fleet of 5-10 cars on standby and those invoices are good for factoring.
Companies with infra contracts can avail of bank finance for machinery and to some extent for material. Still, typically they have minor working capital component and large LC/ bank guarantee based components in their limits. What we do is take a small part of the bank guarantee component, and use it as the base for the company to procure material, which is then submitted for factoring. In effect, the company can monetise its guarantee limit and save on the working capital limit usage.
If you ask for our market share, with Rs 3,500 crore volume we would have perhaps 30 per cent stake of standalone players. Banks also are into factoring and there is no formal data available for their operations. If you look at the opportunity, there are media reports which say 90-92 per cent of MSMEs lack access to formal finance. In value terms the gap is 50 per cent plus, or somewhere close to Rs 2,000 crore. Factoring here is massively relevant because risk is passed on from the small vendor to the large buyer.
Now if you look at why factoring has not taken off in a big way, first is the typical mentality question. Factoring is without recourse to asset in case of default, so in case of short-sighted promoter mentality, our NPA risk goes up hugely. Secondly, there was a traditional mindset of resistance among the large buyer client universe towards factoring. In case of bilateral contracts, they could squeeze vendors and would not pay one payment out of 12. In tripartite registered agreements, this is not possible.
Here an important development is the RBI initiative for setting diverse online trade receivables discounting systems (TReDS) – an electronic exchange. Different players (RXIL, A-TREDS) are active today and aggregate turnover in this limited period is Rs 600 crore. For large corporate, registration on this platform is recommendatory and for PSUs there is a directive. On this platform, vendor financing is done on reverse auction basis, which benefits the small vendors. This single step has worked a lot to take away the resistance mindset of the large buyer community. We are very enthusiastic about this step as a way to broaden the market.