FACTORING & FORFAITING

factoring

forfaiting

Factoring Services - ConceptFactoring services started in US in early 1920s

and were introduced to other parts in 1960sFactoring is a financial service covering the

financing and collection of accounts receivables in domestic as well as in international trade

Basically, factoring is an arrangement in which receivables on account of sale of goods or services are sold to the factor at a certain discount. As the factor gets the title to the receivables on account of the factoring contract, factor becomes responsible for all credit control, sales ledger administration and debt collection from the customers

Factoring Services - ConceptA study group appointed by

International Institute for the Unification of Private Law (UNIDROIT), Rome 1988 defines

“factoring means an arrangement between a factor and his client which includes at least two of the following services to be provided by the factor; i) finance, (ii) maintenance of accounts, (iii) collection of debts and (iv) protection against credit risk

How old is the concept of factor ?

Factoring  has been in existence long before ago during the reign  of Mesopotamian King Hammurabi . Then it gets extended to 14th century during British Rule specially in textiles industries ,but it gained its importance in 1905 from Canada ,especially in American colonies .Now it is no more concentrated in America but have widespread to other countries also  

At that time factoring was used as a mode of advancing funds to the seller ,before they received the payment from the buyer  for the rawmaterials they sold. 

But with industrial revolution factoring concept have changed  as a mode of giving credit .The concept got revolutionized during 80’s with the growth of banking sector .And now the concept is gaining importance day by day because of the added advantages the corporates gained from factoring . 

It is generally a well defined arrangement where financial institution engaged in factoring business provide an array of services like recording, collecting, controlling and protecting the book debts for its clients including the purchase of his bills receivable.

Factoring system in india

In india the idea of providing factoring services was first thought of by the vaghul working group that recommended that banks and NBFC should be encouraged to provide factoring services to tide over their financial crunch arising out of delays in the realisation of their bad debts.

The RBI subsequently constituted a study group under the chairmanship of Mr.C.S.Kalyanasundaram,former MD of SBI,to examine the feasibility of starting factoring services in 1988.

On the recommendation of the committee ,the banking regulation act was amended in july 1990 with view of enabling commercial banks to take up factoring services by forming separate subsidiaries.

The RBI is of the view that: The banks shouldn’t directly undertake the business of factoring. The banks may set up separate subsidiaries or invest in factoring

companies jointly with other banks. A factoring subsidiary may undertake the factoring

business.But,they should not finance other factoring companies. The banks can invest in the shares of factoring companies not

exceeding 10% of the paid up capital and reserve of the bank concerned.

In february ,1994,the RBI has further stipulated that:

The RBI has permitted all the banks to enter into factoring business departmentally.

Factoring activities should be treated on par with loans and advances and should accordingly be given risk weight of 100%for calculation of capital to risk asset ratio

A bank’s exposure shall not exceed 25% of the bank’s capital funds to an individual borrower and 50% to a group of borrowers .factoring should be covered within the above exposure ceiling along with equipment leasing and hire purchase finance.

Factoring services should be provided only in respect of those invoices which represent genuine trade transactions.

Contd………………………..

Factoring in India started with the establishment of

1. SBI Factors and commercial services Pvt limited in 1991 2.Can Factors Ltd., a subsidiary of Canara Bank also formed in 1991

.  3.HSBC Factoring   4 ECGC – Export credit guarantee corporation of India –Specialised

in the business of export credit insurance since 1957 in order to reduce  risk involved in export sales.

5. CITI Bank   6. Foremost factors limited- Foremost factor private ltd is

established as a joint venture with National bank of America in 1997.Presently major shareholders are Mohan Group of companies and IFCI .

7. Global Trade Finance (P) Ltd GTF commenced operations in September 2001, as a joint venture under the promoters - Export Import Bank of India (Exim Bank); West LB, Germany; and IFC, Washington (the private sector arm of World Bank).

In December 2004, the shareholding pattern changed to  40% with Exim Bank; 38.5% with FIM Bank, Malta; 12.5% with IFC, Washington; and 9% with Bank of Maharashtra.

Presently major shareholder are SBI and Bank of Maharastra

Factoring Services - MechanismBuyer

Buyer negotiates terms of purchasing the material with the seller

Buyer receives delivery of goods with invoice and instructions by the seller to make payment to factor on due date

Buyer makes payment to factor in time or gets extension of time or in the case of default is subject to legal process at the hands of the factor

Factoring Services - MechanismSeller

MoU with the buyer in the form of letter exchanged between them or agreement

Sells goods to the buyer as per MoU/agreement

Delvers copies of invoice, delivery challan, MoU, instructions to make payment to factor given to buyer

Seller receives 80 percent or more payment in advance from factor on selling the receivables from buyer to factor

Seller receives balance payment from factor after deduction of facto’s service charges etc.

Factoring Services - Mechanism

FactorFactor enters into agreement with seller for rendering

factoring servicesOn receipt of copies of sale documents as referred to above

makes payment to seller of the 80 percent of the price of the debt

Factor receives payment from the buyer on due dates and remits money to seller after usual deductions

Factor also ensures that the following conditions met to give full effect to factoring arrangementsInvoice, bills or other documents drawn by the seller should

contain a clause that these payments arising out of transaction as referred to or mentioned in might be factored

Seller should confirm in writing to the factor that all the payments arising out of these bills are free from any encumbrances, charge lien, pledge, hypothecation or mortgage or right of set-off or counter claim from another

Seller should execute a deed of assignment in favor of the factor to enable him to recover the payment at the time or after default

Seller should confirm that all conditions to sell-buy contract between him and the buyer have been complied with and the transactions complete

Seller should procure a letter of waiver from a bank in favor of factor in case the bank has a charge over the assets sold to buyer and the sale proceeds are to be deposited in the account of the bank

Mechanism of factoring

International factoringFactoring services are very popular for domestic business.They are gradually entering into export business also because of following reasons:

As there is considerable delay in receiving payments from the importers.

To ensure their profitabilityTo maintain and expand their businessIt comes really handy to them to find the required resources.

;

Two-Factor System of FactoringThere are usually four parties to a

cross-border/international factoring transactionsExporter (client)Importer (customer)Export Factor Import Factor

Two factor system results in two separate but inter-linked agreementsBetween exporter and export factorBetween export factor import factor/

Two-Factor System of FactoringUsually export and import factors belong

to a formal chain of factors with well-defined rules governing the conduct of business.

Import factor provides a link between export factor and the importer and serves to solve the international barriers like language problem, legal formalities and so on. He also underwrites customer trade credit risks, collects receivables and transfers funds to the export factor in the currency of the invoice

Functions of factors are divided between export factor and import factor

Two-Factor System of Factoring

StepsExporter informs the export factor about the export of

goods to a particular import-client domiciled in a specified country.

Export factor writes to import factor (domiciled in the country of the importer) enquiring about the credit-worthiness, reputation and so on of the importer

On getting satisfactory information from the import factor, exporter delivers the goods to the importer and the relevant invoices, bills of lading and other supporting documents are delivered to the export factor. Export receivables on a non-recourse basis are factored

Export factor does credit checking, sales ledgering and collection to the import factor

Import factor collects the payment from the importer and effects payments to the export factor on assignment/maturity/collection as per the terms of assignment in the currency of the invoice

Finally, the export factor makes payment to the exporter upon assignment or maturity or collection depending upon the factoring agreement between them

Exporter Importer

Country A Country B

Export Factor Import Factor

Goods and invoices – Stage I

Copy Invoice Stage II

Prepayments Stage III

Copy Invoices Stage IV

Statements Stage V

PaymentsStage VI

Payments Stage VII

Payment of Commission Stage VIII

Factoring Services - ConceptParties to factoring – client, customer

and factorCost of factoring

Service fee (for administrating the sales ledger as well as protection against bad debts – as a percentage of invoice value or number of invoices)

Discount charges (advance provided by factor and is interest which is PLR plus or minus)

Types of Factoring ServicesRecourse and Non-recourse Factoring

Advance and Maturity FactoringFull FactoringDisclosed and Undisclosed Factoring

Seller and Buyer based factoringDomestic and International factoring

Functions of factoringPurchase and collection of debts

Sales ledger managementCredit investigation and undertaking of credit risk

Provision of financeRendering consultancy services

Benefits of factoringFinancial servicesCollection serviceCredit risk serviceProvision of expertised “sales ledger

management servicesConsultancy serviceEconomy in servicingTrade benefitsMiscellaneous service

: Changing scenario of Factoring

business in India       SBI Factors purchases the 91 % stake in  Global

Trade Finance to gain a market share of around 75 % in factoring business by april 2008.

HSBC is going to provide factoring business for SME’s

Specially in Mumbai, New Delhi, Kolkata, Pune, Bangalore and Chennai.SME with turnover of more than 5 crore can avail the facility of factoring from HSBC .

  HSBC ties up with New India Assurance for credit risk insurance .

  With the increasing demand for factoring services, foreign players such as Development Bank of Singapore (DBS) and GE Capital have shown their keen interst to  getting into the factoring business in India. Both DBS and GE Capital have global exposure in the factoring business. 

       Many global players in the field of banking(Standard Chartered Bank, Citi Bank ,etc ) are coming forward to India to carry on factoring business in SME segment since the scope for financing large corporates is reaching saturation point. SME sector plays a major role in India’s present export performance, contributing to 45-50% of the Indian exports. Global Trade Finance has dedicated most of its facilities to the SME sector. 

        With the growth of factoring business ,credit insurance is also getting edge day by day today specially for the global factors who are operating in India . 

      According to Factors Chain International, the observer of all factoring companies, India with just eight companies clocked a total turnover of Rs. 19,860.5 crore in 2006 way below Japan’s Rs. 4,15,789.1 crore Taiwan’s Rs. 2,23,152. 6 crore and China’s Rs. 7,97,77.1 crore in Asia. The Indian factoring market has grown by 176 per cent from Rs. 7,196.7 crore to Rs. 19,860.5 crore between 2002 and 2006. Global leaders are the UK, France and Italy.

Contd…..

Challenges faced by global  factors operating in India

Indian Market is attractive ,but to get into it is not so easy for foreign markets There are various reasons for this . 

   .Factoring is a new concept which is not widely known among Indian business community . Because of the banks' failure to "educate'' potential customers on its benefits. 

   Debt recovery is very slow in India as compared to other developed countries .Comparision of duration of debt recovery case resolution in (calendar days).India – 1420 days where as on Average OECD – 351 days  

   Huge competition from Indian banks in this field .     Increased interest rates impact sales either through increased

financing costs or through reduced sales. Foreign factors faces lot of risk through a higher cost of capital and increased business risk as the credit risk of customers increases. And  the ideal solution is credit insurance .( Because of credit insurance with Atradius  ,Global Trade Finance's turnover grew 121% in its 2007 fiscal year and its total market share grew to 25% from 20% including a 70.4% share of export factoring and a 62.7% share of import factoring.) But  credit insurance is a newer concept in India .Where as ECGC started only  export credit insurance in 1957 .

Contd………..    In India assignment of debt is a very

complicated process and involves stamp duty .Stamp duty varies from state to state in India . As a result the process becomes expensive by nature. 

   No clear laws exist in India regarding transfer/assignment of debt,bankruptcy ,debt recovery etc as in other countries ,so foreign operators have to face lots of problems . 

   Also proper information access is very slow in India. 

   NBFC operating as factors is a difficult proposition in India as compared to banking sector as there is no protection under Debt Recovery Tribunal or securitization act .

which kind of business may opt for factoring .   Business concern having high turnover,but now factors

are also encouraging smaller concerns .    The customers size should be more .otherwise it would

be a costly affair .   Where the customers accept standard payment terms

of the company.     Where the customers accept to pay within reasonable

credit period.

Factoring is not available for the business concern where : The customers is a general public not the commercial

customers .     The invoice size is very small .     Too many disputes involved .    It is not sound ,not trustworthy and unreputable.    Customers are not prompt payment makers or make

payment in parts .So factoring is possible for those companies where the customers are basically prompt in making payment .

Factoring Vs Other means of financing

           Factoring – Using own’s funds to finance            Refactoring – Using other modes for financing like bank

lines of credit, investor participations and the equity of the firm.

a.   Most of the firms uses bank credit for financing ,but here the firm is under pressure to pay off the debts .Which is not in factoring.

b.   Again factoring only uses Time value of money concept –getting advances before the need is raised which is not in other case .

c.   Bank credit needs many norms to be followed ,so it is difficult to get finance from banks sometimes .Raising money from public is also a costly affair .

d.    Again Banks normally analyse a customer’s last audited financial statements to assess the working capital finance requirements for cash credit. A factor provides funding based on the current and projected sales volume and is, therefore, more in line with the needs of the business.

e.     Bank requires you to provide collateral security for providing credit facility . This is not required under factoring.

f.    Factoring offers funding up to 90 per cent of invoice value whereas a bank provides between 60 and 75 per cent funding

Contd…

   Factoring can be a valuable alternative for securing vital working capital, when a bank may be unable to provide financing due to some of the following situations:

 Start Up business with a limited track record .  Rapid growth drives consistent increased capital needs. History of operating Losses.  Minimal or Deficit net worth.  Tax Liens in place.  Past personal/business Bankruptcy or credit issues. In brief Factors make funding decisions based on the

credit-worthiness of your customers; a bank makes credit decisions based on your company's financial history, cash flow and collateral. Because factoring is not a loan, no liability appears on your balance sheet. Most importantly, a factor makes funding decisions in days or hours-while banks generally take weeks or even months

Factoring Vs Bills Discounting

Similarities – manyDifferences

Bill discounting is always with recourse, factoring can be either with or without recourse

In bill discounting drawer undertakes the responsibility of collecting the bills and remitting the proceeds to financing agency, whereas a factor usually undertakes to collect the bills of the client

Bill discounting facility implies only provision of finance but a factor also provides other services like sales ledger maintenance and advisory services

Discounted bills may be rediscounted several times before they mature for payment. Debts purchased for factoring cannot be rediscounted, they can be refinanced

Factoring implies the provision of bulk finance against several unpaid trade generated invoices in batches, bill financing is individual transaction-oriented – each bill is separately assessed and discounted

Factoring is an off-balance mode of financingBill discounting does not involve assignment of debts as

is the case with factoring

ForfaitingForfaiting is a form of financing of

(export) receivables pertaining to international trade. It denotes the purchase of trade bills/promissory notes by a bank/financial institution without recourse to the seller. The purchase is in the form of discounting the documents covering the entire risk of non-payment in collection. All risks and collection problems are fully the responsibility of the purchaser (Forfaiter) who pays cash to seller after discounting the bills/notes.

ForfaitingSteps

In pursuance of a commercial contract between an exporter and importer, the exporter sells and delivers the goods to the importer on a deferred payment basis

Importer draws a series of promissory notes in favour of the exporter for payment including interest charge. Alternatively, the exporter draws a series of bills which are accepted by the importer. Bills/notes are sent to the expoerter. The promissory notes/bills are guaranteed by a bank which may not necessarily be the importer’s bank. The guarantee by the bank is referred to as an AVAL defined as an endorsement by a bank guaranteeing payment by the buyer (importer)

Forfaiting Steps

Exporter enters into a fortaiting arrangement with a forfaiter which is usually a reputed bank including exporter’s bank. Exporter sells the availed notes/bills to the bank (forfaiter) at a discount without recourse. The agreement provides for the basic terms of the arrangement such as cost of forfaiting, margin to cover risk, commitment charges, days of grace, fee to compensate the forfaiter for loss of interest due to transfer and payment delays, period of forfaiting contract, installment of repayment, usually bi-annual instalment, rate of interest and so on. The rate of interest or discount charged by the forfaiter depends upon the terms of the note/bill, the currency in which it is determined, credit rating of the avalling bank, country risk of the importer etc

Payment to forfaiter to the exporter of the face value of the bill/note less discount

Forfaiter may hold these notes/bills till maturity for payment by the importer’s bank. Alternatively, he can securitize them and sell the short-term paper in the secondary market as high-yielding unsecured paper

ForfaitingSummary

Specific form of export trade financeExport receivables discounted – full value of

export bill consideredDebt instruments most commonly used are

bills of exchange and promissory notesPayment in respect of export receivables

which is further evidenced by bills of exchange/promissory notes must be guaranteed by importers bank. Usual form of guarantee is an Aval

Forefaiting is always without recourseSource of trade finance which enables

exporters to get funds from the institution called forfaiter on transferring the right to recover the debts from the importer

Factoring Vs ForfaitingForfaiter discounts the entire value – 100 %

finance where as a Factor – 75-80%Avalling bank provides unconditional and

irrevocable guarantee – critical factor in forfaiting – in factoring decision is based on credit rating of the exporter (non-recourse)

Forfaiting is pure financial arrangement – Factoring includes ledger administration, collection, advise etc

Factoring is short-term finance whereas forfaiting finances notes/bills arising out of deferred credit transactions spread over 3 years

A factor does not guard against exchange rate fluctuations, whereas forfaiter charges a premium for such risk

Thank you submitted by:

Sunanda yadav-149 Sonali Rout-

Jagabandhu Mahato-145Rakesh SinghRaghavendra

Chinmayee Pandey