The Recess Factor
In the recent months, Small Industries Development Bank of India (SIDBI) has decided to undertake factoring services for small scale industries and the Export Credit Guarantee Corporation (ECGC) has decided to explore maturity factoring. SBI Factors, traditionally a domestic player, too is readying to enter the field.
What is surprising is that the market seems to be expanding even though the major traditional players -- SBI Factors and Canbank Factors -- have failed to capitalise on these opportunities. The traditional market for factoring has been static for the past few years at around Rs 1,500 crore, with SBI Factors and Canbank Factors sharing it almost equally.
This is strange, considering that the ground for factoring services was cleared exactly a decade ago when the Kalyanasundaram Committee submitted its recommendations. The Committee had been set up by the Reserve Bank of India (RBI) under the chairmanship of C S Kalyanasundaram, the former managing director of the State Bank of India.
In the decade that followed the recommendations of the Kalyanasundaram Committee, the progress in factoring services, either in the number of service providers or in the volume of business, has been far from impressive. And this is despite the large potential market that factoring has in this country.
Factoring - a tool to finance receivables - offers certain benefits to companies. A client of a factor can convert invoices into cash up to 80 per cent of its value without having to wait for the usual credit period of 30 days or more, thus providing it with liquidity. The factor also takes over the responsibility of maintaining the sales ledger and collecting the dues.
The client is required to inform his customers (buyers) that the payments for the invoices have to be made to the factor. The factoring service provided in India is with recourse, which means that the ultimate responsibility for the money is on the factors client, and not on the clients customers. This makes it almost akin to bill discounting.
Factoring is still a virgin territory in India even though there is immense potential in view of large volume of trade, says S C Varma, chief manager, SBI Factors. This outfit made a modest beginning in 1991 as SBI Factors and Commercial Services Ltd - a company owned by SBI, Union Bank of India, State Bank of Saurastra, State Bank of Indore and Small Industries Development Bank of India. And the reasons, according to him, are several.
One, in spite of the importance attached to factoring services following the Kalyanasundaram Committee report, the government did not bother to provide logical support to it. So the assignment of invoices by the client to the factor has no statutory sanction. As a result, customers of a factors client do not cooperate with the factor, points out Varma. This makes the position of the factor uncertain.
As Deepak Rao of Coopers and Lybrand consultants explains, this requires amendment to the Sale of Goods Act. Unless this happens, factor can not claim a legitimate place in the market, he adds.
Then there is the problem of stamp duty. Until recently, states governments used to charge a hefty stamp duty of 3 per cent on the amount involved in assignment of invoices. Even though the intensity of the problem has partially come down, the danger is that states governments may raise them any time in the future .
Thirdly, and surprisingly, the parent banks tend to discourage their clients from going to factors that are their own subsidiary companies. Factoring not only converts credit sales into ready cash but also provides substantial funds to help smooth flow of cash into the production cycle of the banks clients. This ensures improved liquidity of clients, which the banks always look for. Yet, the banks tend to discourage their clients from going to a factor for fear of losing the client, says Varma. It is for this reason that banks often show reluctance to issue letter of disclaimer to factors.
Then there is also the question of reliable information on the clients customers. Since there is no organised body undertaking this kind of database, which is quite common abroad, the factor has little background to rely on while checking the customers of its clients. Abroad, Dunn and Bradstreet, for example, has a strong database on which the factor can rely, points out Varma.
The absence of such a database provider reduces the confidence level of the factors here. This has made it necessary for the factors to have recourse on the client, and not on his customers as done elsewhere in the world. If credit protection in the form recourseless factoring is not available, there is no point in having factoring, points out Deepak Rao. His firm, Coopers & Lybrand, a firm of consultants suggested ECGC go in for factoring.
Another point, and quite an important one at that, relates to the cost of factoring services. The total cost covers the cost of funds, screening charges, collection and sales ledger maintenance charges, cover for credit protection and other overheads. Taking all these factors into account, the total cost that a factor normally charges to the client works out to about 19 per cent. This rate is certainly higher than the rate charged by banks on the normal finance provided to its customers.
However, the argument in favour of the factor is that this is a value added service. In fact, the Kalyanasundaram Committee anticipated this problem and stated: The factors will have to operate at a level of efficiency much higher than that with which banks are currently handling the receivables of their customers. Companies and entrepreneurs, however, do not seem to think so, if the volumes of business are anything to go by.
Even as domestic factoring awaits a pick up in the demand for its services, a few new players have decided to go for niches in this market. The Small Industries Development Bank of India (SIDBI) is one of them. It has decided to initiate factoring for small units both in the domestic market as also the export variety.
While the small units always needed factoring kind of services because most of them suffer on account of liquidity, the enlarged definition of the SSI sector makes it all the more necessary, says Shailendra Narain, managing director, SIDBI. And he is quite conservative about the size of the business - he expects to do a turnover of Rs 1,200 crore in three years.
The organisation expects to start export factoring as well. It has applied for membership of Factors Chain International (FCI), a Netherlands-based association of factoring companies. FCIs membership allows SIDBI to seek help from a foreign factor whenever the need arises for information on a company in the foreign market.
According to Shailendra Narain, the Singapore-based DBS Factors will be closely associated with SIDBI for staff training and providing software and other technology support. However, a formal tie-up is not being considered right now, he adds. SIDBI has also applied to the Reserve Bank of India (RBI) for permission to undertake export factoring.
Currently there is only one company in the private sector that undertakes export factoring. And though the existing factoring companies have earmarked a fixed per cent of their business on this line, it has not really picked up. Since small scale units account for nearly 45 per cent of the countrys export, there is good scope for export factoring for small units, Narain says.
Explaining the need for export factoring, Umang Rathod, a senior executive of Foremost Factors, says: Typically an export factoring company in India gives 80 per cent as prepayment and also gives a 100 per cent credit protection cover on receivables in the event of the buyers inability to pay due to insolvency or any other financial constraints. Foremost Factors happens to be the only company today offering export factoring, having started its operations about a year back. Its client base is still small and business is yet to be significant.
What about the cost? According to Rathod, the cost to the client currently works out to about 18 per cent of the value of the invoices, a large component being the cost of funds at 12 per cent, and the other being the cost of insurance at 4 per cent. Even at this rate, export factors services are cheaper than that of the bank, says Rathod, because the latter insists on cover with the ECGC which in any case the client has.
If there is one aspect that requires close attention in export factoring, it is the information on the foreign customers. We have to carefully scan the size, the capability, product, market, industry figures, balance sheet and the track record of the foreign customers of our clients, points out Rathod.
And how big can the market be? About 40 per cent of Indias trade being on the basis of documents against acceptance, that could be regarded as the ceiling for export factoring. That leaves scope for at least five major factors, according to Rathod. The world export factoring, incidentally, is worth $396 billion. Private export factors can also give better terms to clients than the ECGC or banks, because the latter group tends to fix the premium rates according to countries while private parties usually charge them according to the risk profile of the customer.
On the other hand, ECGC proposes to go for maturity factoring. Under this type, there is no financing ab initio but the amount of each invoice is made over to the client at the end of the credit term or at an agreed maturity date, less the factors charges. Coopers & Lybrand have suggested a specialised cell for this purpose, but sources do not rule out a separate company.
The real boost to export factoring will come only after the rupee is made convertible on capital account. It will open up barriers in the growth of trade and will make it imperative for exporters to seek factors help. And on the domestic wicket, cost remains the major factor.