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Factoring and ing (1)

Factoring and ing (1)

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Published by: Abhishek Verma on Dec 13, 2011
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FACTORING AND FORFAITING

FACTORING AND FORFAITING
Factoring is of recent origin in Indian Context. Kalyana Sundaram Committee recommended introduction of factoring in 1989. Banking Regulation Act, 1949, was amended in 1991 for Banks setting up factoring services. SBI/Canara Bank have set up their Factoring Subsidiaries: SBI Factors Ltd., (April, 1991)  CanBank Factors Ltd., (August, 1991). RBI has permitted Banks to undertake factoring services through subsidiaries.

WHAT IS FACTORING ?
Factoring is the Sale of Book Debts by a firm (Client) to a financial institution (Factor) on the understanding that the Factor will pay for the Book Debts as and when they are collected or on a guaranteed payment date. Normally, the Factor makes a part payment (usually upto 80%) immediately after the debts are purchased thereby providing immediate liquidity to the Client.

PROCESS OF FACTORING

CLIENT

CUSTOMER

FACTOR

a) b) c) A Financial Intermediary That buys invoices of a manufacturer or a trader. at a discount.So. The parties involved in the factoring transaction are:- a) b) c) Supplier or Seller (Client) Buyer or Debtor (Customer) Financial Intermediary (Factor) . and Takes responsibility for collection of payments. a Factor is.

SERVICES OFFERED BY A FACTOR 1. if any. Purchase of Receivables with or without recourse. Follow-up and collection of Receivables from Clients. due to his relationship with Buyer & Seller. Help in getting information and credit line on customers (credit protection) Sorting out disputes. 2. . 4. 3.

Factor maintains the customer‟s account and follows up for payment. Client sells the customer‟s account to the Factor and notifies the customer. Customer remits the amount due to the Factor. . Factor makes part payment (advance) against account purchased.PROCESS INVOLVED IN FACTORING Client concludes a credit sale with a customer. after adjusting for commission and interest on the advance. Factor makes the final payment to the Client when the account is collected or on the guaranteed payment date.

receipt of goods by buyer. . to the Factor.  Once the invoice is honoured by the buyer on due date.MECHANICS OF FACTORING  The Client (Seller) sells goods to the buyer and prepares invoice with a notation that debt due on account of this invoice is assigned to and must be paid to the Factor (Financial Intermediary).  The Client (Seller) submits invoice copy only with Delivery Challan showing  The Factor. The balance is retained as Retention Money (Margin Money). the Factor follows up the payment and sends regular statements to the Client. This is also called Factor Reserve.  The drawing limit is adjusted on a continuous basis after taking into account the collection of Factored Debts. credited to the Client‟s Account. the Retention Money  Till the payment of bills.usually upto 80% of invoice value). after scrutiny of these papers. allows payment (.

50% to 1. For making immediate part payment. interest charged. it is called discount. Interest is higher than rate of interest charged on Working Capital Finance by Banks. If interest is charged up-front.50%) Commission is collected up-front. .CHARGES FOR FACTORING SERVICES Factor charges Commission (as a flat percentage of value of Debts purchased) (0.

TYPES OF FACTORING  Recourse Factoring Non-recourse Factoring Maturity Factoring Cross-border Factoring    .

 Interest is charged from the date of advance to the date of collection.  Credit Risk is with the Client.  Factor purchases Receivables on the condition that loss arising on account of non-recovery will be borne by the Client. factoring is done with recourse.  In India.RECOURSE FACTORING  Upto 75% to 85% of the Invoice Receivable is factored. .  Factor does not participate in the credit sanction process.

 Higher commission is charged.NON-RECOURSE FACTORING  Factor purchases Receivables on the condition that the Factor has no recourse to the Client.  In USA/UK. . factoring is commonly done without recourse.  Credit risk is with the Factor. if the debt turns out to be nonrecoverable.  Factor participates in credit sanction process and approves credit limit given by the Client to the Customer.

MATURITY FACTORING  Factor does not make any advance payment to the Client.  Nominal Commission is charged. .  No risk to Factor.  Guaranteed payment date is usually fixed taking into account previous collection experience of the Client.  Pays on guaranteed payment date or on collection of Receivables.

and Importer. if any. Factor covers exchange risk also. Import Factor collects payment and remits to Export Factor who passes on the proceeds to the Exporter after adjusting his advance. Import Factor..CROSS .  Exporter (Client) enters into factoring arrangement with Export Factor in     his country and assigns to him export receivables. . Export Factor enters into arrangement with Import Factor and has arrangement for credit evaluation & collection of payment for an agreed fee. Notation is made on the invoice that importer has to make payment to the Import Factor. viz. Export Factor. Where foreign currency is involved.  It is also called two-factor system of factoring. a) b) c) d) Exporter.BORDER FACTORING  It is similar to domestic factoring except that there are four parties.

. 3. Notice of assignment is provided to customers of the Client. No notice of assignment provided to customers of the Client. FACTORING Pre-payment made against all unpaid and not due invoices purchased by Factor. 2. BILL DISCOUNTING Bill is separately examined and discounted. 1. 2. Financial Institution does not have responsibility of Sales Ledger Administration and collection of Debts. Factor has responsibility of Sales Ledger Administration and collection of Debts. 3.FACTORING vs BILLS DISCOUNTING 1.

In India. it is done with recourse. Financial Institution can get the bills re-discounted before they mature for payment. 5. . 4. (contd…) 4. 5.FACTORING vs BILLS DISCOUNTING BILLS DISCOUNTING Bills discounting is usually done with recourse. FACTORING Factoring can be done without or without recourse to client. Factor cannot re-discount the receivable purchased under advanced factoring arrangement.

STATUTES APPLICABLE TO FACTORING Factoring transactions in India are governed by the following Acts:- a) Indian Contract Act b) c) d) e) Sale of Goods Act Transfer of Property Act Banking Regulation Act. . Foreign Exchange Regulation Act.

Factoring requires assignment of debt which attracts Stamp Duty. . Cost of transaction becomes high. Problems in recovery.WHY FACTORING HAS NOT BECOME POPULAR IN INDIA Banks‟ reluctance to provide factoring services Bank‟s resistance to issue Letter of Disclaimer (Letter of Disclaimer is mandatory as per RBI Guidelines).

FORFAITING “Forfait” is derived from French word „A Forfait‟ which means surrender of fights. Forefaiting is a mechanism by which the right for export receivables of an exporter (Client) is purchased by a Financial Intermediary (Forfaiter) without recourse to him. It is different from International Factoring in as much as it deals with receivables relating to deferred payment exports. while Factoring deals with short term receivables. .

FORFAITING (contd…) Exporter under Forfaiting surrenders his right for claiming payment for services rendered or goods supplied to Importer in favour of Forefaiter. Credit Sale gets converted as Cash Sale. . Forfaiting is arrangement without recourse to the Exporter (seller) Operated on fixed rate basis (discount) Finance available upto 100% of value (unlike in Factoring) Introduced in the country in 1992. Bank (Forefaiter) assumes default risk possessed by the Importer.

MECHANICS OF FORFAITING EXPORTER IMPORTER FORFAITER AVALLING BANK HELD TILL MATURITY SELL TO GROUPS OF INVESTORS TRADE IN SECONDARY MARKET .

.ESSENTIAL REQUISITES OF FORFAITING TRANSACTIONS Exporter to extend credit to Customers for periods above 6 months. unless the Exporter is a Government Agency or a Multi National Company. Co-acceptance acts as the yard stick for the Forefaiter to credit quality and marketability of instruments accepted. Exporter to raise Bill of Exchange covering deferred receivables from 6 months to 5 years. Repayment of debts will have to be avallised or guaranteed by another Bank.

Avalled notes sold at a discount to a Forefaiter on a NONRECOURSE basis.IN FORFAITING: Promissory notes are sent for avalling to the Importer‟s Bank. Forfaiter holds the notes till maturity or securitises these notes and sells the Short Term Paper either to a group of investors or to investors at large in the secondary market. Exporter obtains finance.      . Avalled notes are returned to the Importer. Avalled notes sent to Exporter.

Finance available upto 100% (as against 75-80% under conventional credit) without recourse. Absolves Exporter from Cross-border political or conversion risk associated with Export Receivables. It does not reflect as debt in Exporter‟s Balance Sheet. . Provides Fixed Rate Finance and hence risk of interest rate fluctuation does not arise.CHARACTERISTICS OF FORFAITING Converts Deferred Payment Exports into cash transactions. providing liquidity and cash flow to Exporter. Acts as additional source of funding and hence does not have impact on Exporter‟s borrowing limits.

Forfait financer is responsible for each of the Exporter‟s trade transactions. Saves on cost as ECGC Cover is eliminated. Provides long term credit unlike other forms of bank credit. Forfait transactions are confidential. no need to commit all of his business or significant part of business.) Exporter is freed from credit administration.CHARACTERISTICS OF FORFAITING (contd…. Hence. . Simple Documentation as finance is available against bills.

Service Charges:.5% per annum.payable to Exim Bank.Ranges from 0. Documentation Fee:.5% to 1.Discount rate based on LIBOR for the period concerned. Discount Fee:.Payable to Forfaiter by Exporter in consideration of forefaiting services. Commission:.COSTS INVOLVED IN FORFAITING Commitment Fee:.where elaborate legal formalities are involved. .

No services are provided Always without recourse By Bills Extent of Finance Usually 75 – 80% of the value of the invoice Credit Worthiness Factor does the credit rating in case of nonrecourse factoring transaction Services provided Day-to-day administration of sales and other allied services Recourse Sales With or without recourse By Turnover .FACTORING vs. FORFAITING POINTS OF DIFFERENCE FACTORING FORFAITING 100% of Invoice value The Forfaiting Bank relies on the creditability of the Avalling Bank.

Sales Administration 5. Term 6. Charge Creation Not Done Short Term Hypothecation . Scrutiny 2. Extent of Finance 3. Recourse Individual Sale Transaction Upto 75 – 80% With Recourse FACTORING Service of Sale Transaction Upto 80% With or Without Recourse Done Short Term Assignment FORFAITING Individual Sale Transaction Upto 100% Without Recourse Not Done Medium Term Assignment 4.COMPARATIVE ANALYSIS BILLS DISCOUNTED 1.

000/-) RBI Guidelines are vague. Depreciating Rupee No ECGC Cover High cost of funds High minimum cost of transactions (USD 250.WHY FORFAITING HAS NOT DEVELOPED Relatively new concept in India. . Exim Bank alone does. Long term advances are not favoured by Banks as hedging becomes difficult. Very few institutions offer the services in India. Lack of awareness.

.  Facilitator obtains quote from Forfaiting Agencies abroad and communicates to Exporter.  Export Contract to provide for Importer to furnish avalled BoE/DPN.  Exporter has to enter into commercial contract.  Exporter approaches importer for finalising contract duly loading the discount and other charges in the price.  Execution of Forfaiting Agreement with Forefaiting Agency.  Exporter has to confirm the Firm Quote.STAGES INVOLVED IN FORFAITING: Exporter approaches the Facilitator (Bank) for obtaining Indicative Forfaiting Quote. Exporter approaches the Bank (Facilitator) for obtaining quote from Forfaiting Agencies.  If terms are acceptable.

LC would be required to be established.)  Forfaiter commits to forefait the BoE/DPN. LC would be required to be established.  On maturity of BoE/DPN.  Export Documents are submitted to Bank duly assigned in favour of Forfaiter.(contd….  Bank sends document to Importer's Bank and confirms assignment and copies of documents to Forefaiter. Otherwise.  Importer‟s Bank confirms their acceptance of BoE/DPN to Forfaiter.  Forfaiter commits to forefait the BoE/DPN only against Importer Bank‟s Coacceptance.STAGES INVOLVED IN FORFAITING:.. only against Importer Bank‟s Coacceptance.  Forfaiter remits the amount after deducting charges. Forfaiter presents the instrument to the Bank and receives payment. . Otherwise.

 Forfaiter remits the amount after deducting charges. Forfaiting Agency presents the instruments to the Bank and receives payment .STAGES INVOLVED IN FORFAITING:.)  Export Documents are submitted to Bank duly assigned in favour of Forfaiter  Importer‟s Bank confirms their acceptance of BoE/DPN to Forfaiter.(contd…..  On maturity of BoE/DPN.

. Overseas Buyer is notified of this arrangement. viz. invoice and shipping documents duly assigned and receives advance there-against (upto 80%). Exporter submits original documents. Export Factor submits the details of Buyer to the Import Factor. Import Factor decides on the credit cover and communicates decision to Export Factor. Exporter is then free to ship the goods to Buyers directly. .STAGES INVOLVED IN EXPORT FACTORING Exporter (Client) gives his name. address and credit limit required to the Export Factor. Export Factor enters into Factoring Agreement with Exporter.

) Export Factor despatches all the original documents to Importer/Buyer after duly affixing “Assignment Clause” in favour of the Import Factor. releases the balance of proceeds to Exporter. Import Factor follows up and receives payment on due date and remits to Export Factor. Export Factor. on receipt of payment. Export Factor sends copy of invoice to Import Factor in the Debtor‟s country.. .STAGES INVOLVED IN EXPORT FACTORING (contd….

THANK YOU .

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