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MFS-IV Chapter - Factoring  Factoring: The Concept…

“Factor is a financial intermediary/institution/company which assumes the responsibility of collection of receivables arising out of credit sales of their clients and in return charges commission for its services”.     So, A Factor Company essentially means… A Financial Intermediary/Institute/Company/Bank That buys trade invoices of a manufacturer or a trader, at a discount, and Takes responsibility for collection of payments. “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/finance to the Client”.

• • • • • Client makes a credit sale to a customer. Client hand over/sells the customer’s bills to the Factor and notifies the customer about the same. Factor makes partly payment (advance) against account purchased, after adjusting for commission and interest on the advance. Factor maintains the customer’s account and take follows up for payment. Customer remits the amount due to the Factor.

Factor makes the final payment to the Client when the account is collected or on the guaranteed payment date

 Charges for Factoring Services:
• • • • Factor charges Commission (as a flat percentage of value of Debts purchased) (0.50% to 1.50%) Commission is charged up-front. For making immediate partly payment, interest charged. Interest is higher than rate of interest charged on Working Capital Finance by Banks. If interest is charged up-front, it is called Discount.

 Functions of a Factor:
1. Administration of sales ledger - Maintains the client’s sales ledger - Gives periodic reports - Current status of his receivables - Receipts of payments from customers - Customer-wise record of payments - Change in payment pattern 2. Provision of collection facility - Undertakes to collect receivables on behalf of the client - Relieving the clients from problems involved in collection - Enables the clients to reduce cost of collection 3. Financing Trade Debts: • • Purchase the book debts of his clients and provide up to 80% finance against bills/book debts. This service is provided where debts are factored without recourse. Within fixed credit limit, the factor undertakes to purchase all trade debts of the customer without recourse. Factor assumes the risk of default (Bad Debts). 5. Advisory Services: • • Specialized knowledge and experience Customers’ perception/ changing needs and fashion 4. Credit Control And Credit Protection:

MFS SEM-IV (2010-12)

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6. Importer. the Exporter. In India. Import Factor. Factor pays a specified portion (75% to 80%) in advance. Seller. Disclosed Factoring:    Name of factor is disclosed in sales invoice.. Less RISK for Factor and charges nominal commission. Buyer. Import factor underwrites customer trade credit risk. Name of factor is NOT disclosed in sales invoice. Balance being paid upon collection from the customer. 7. Credit Risk is borne by the Client. Factor domiciled in the same country. Full Factoring / Old Line Factoring:  Features of almost all the factoring services.recovery of receivables is borne by the factor. Advance Factoring: 4. Factor does not make any advance payment to the Client.  Entire spectrum of services. Recourse Factoring:              Factor does not assume credit risks associated with receivables. 5. Export / Cross Border / International Factoring:  Usually Four Parties Involved Viz. 3. Domestic Factoring: 9. Factor Pays on date of collection/agreed future date. The client has to pay interest on advance payment. Factoring is done with recourse. Factoring is commonly done without recourse.• • Change in marketing strategies Emerging trends about market/ competitiors  Types / Forms of Factoring: 1. sales ledger administration. 4.   Advantages of Factoring: 1. Off-balance Sheet Finance Reduction of Current Liabilities Improvement in Current Ratio – (due 2 reduction in CL as Credit Sale is converted into Cash Sale) Higher Credit Standing: cash flow acceleration and timely payment of liabilities More time for Planning and Production Reduction of Cost and Expenses Additional Source of Finance MFS SEM-IV (2010-12) Page 2 . Undisclosed Factoring: 8. collection. collects receivables and transfers fund to export factor . 2. Export Factor. Maturity Factoring / Collection Factoring: 5. 2. Import Factor Provides Link Between Export Factor and Importer. 6. 7. OR The loss arising out of non . Non-Recourse Factoring: 3. Charges a higher commission Credit risk is assumed by Factor In USA/UK. credit protection. Factor assumes credit risks associated with receivables.   Two Agreements. short-term finance etc.

Converts exporter‟s credit sale into cash sale. It does not reflect as debt in Exporter‟s Balance Sheet.80% under conventional credit) without recourse. Hence. TRANSFER & COMMERCIAL RISK PROTECTS FROM EXCHANGE RATE FLUCTUATIONS EASY DOCUMENTATION COMPETITIVE ADVANTAGE: ELIMINATE RISKS: • PROVIDES TRANSACTION SPEED & SIMPLICITY: – MFS SEM-IV (2010-12) Page 3 . Absolves Exporter from Cross-border Political OR Conversion Risk associated with Export Receivables. Provides Fixed Rate Finance and hence risk of interest rate fluctuation does not arise. Cost of transaction becomes high. Discounting the documents covering the entire risk of non-payment in collection. POOR COLLECTION MECHANISM. Provides long term credit unlike other forms of bank credit. High cost of credit information Other Issues: – – – – NON-MAINTENANCE OF PROPER BOOKS AND RECORDS. The forfeiting owes its origin to a French term „forfeit‟ which means to hand over/give up (or surrender) one‟s rights on something to someone else. POOR ADMINISTRATION OF SALES REGISTER. Forfaiting 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. Export business can be done more efficiently. Forfait financer is responsible for each of the Exporter‟s trade transactions. Exporter is freed from credit administration. providing liquidity and cash flow to Exporter. Saves on cost as ECGC Cover is eliminated. - -  • • • • • • • • • • • Characteristics of Forfaiting: Converts Deferred Payment Exports into cash transactions. Lack of awareness. Credit period can range from 3 to 5 years. PROBLEMS IN RECOVERY. WHY FACTORING HAS NOT BECOME POPULAR IN INDIA? OR OPERATIONAL PROBLEMS OF FACTORING IN INDIA • • • • • • Banks‟ reluctance to provide factoring services Factoring requires assignment of debt which attracts Stamp Duty. Finance available upto 100% (as against 75 .  - FORFAITING: THE CONCEPT “Forfeiting refers to financing of receivables pertaining to international trade”. Forfait transactions are confidential. Acts as additional source of funding and hence does not have impact on Exporter‟s borrowing limits.  • • • KEY Advantages of FORFAITING SERVICE IMPROVES CASH FLOW: – – – – CONVERTS A CREDIT BASED TRANSACTION INTO A CASH TRANSACTION ENABLES TO PROVIDE SUPPLIER’S CREDIT POLITICAL. Simple Documentation as finance is available against bills.

High Rupee Fluctuation High cost of funds High minimum cost of transactions (USD 250. Scope of service Service is available for domestic and export receivables.–  • RELIEVES FROM ADMINISTRATIVE & COLLECTION PROBLEMS FORFAITER’S CHARGES The DISCOUNT charged by the Forfaiter depends upon:         Cost of Forfaiting/Documentation Charges Margin to cover risk Management charges Fees for delayed payment Period of Forfaiting contract Credit rating of Avalling Bank Country/Currency Risk of the importer Installment of repayment etc…  FACTORING vs. 1 2 3 Bills Discounting Versus Factoring: Bills Discounting Always With Recourse Only provision of finance B/E can be rediscounted Factoring With or without Recourse Other services also Cannot be rediscounted MFS SEM-IV (2010-12) Page 4 .  • • • • • • • WHY FORFAITING HAS NOT DEVELOPED Relatively new concept in India. Exim Bank is one of the major player and very few other co’s involved.  Sr. Lack of awareness.000/-) RBI Guidelines are vague (unclear). No. Very few institutions offer such services in India. Transactions should be of a minimum value of USD 250. Usually available for export receivables only denominated in any freely convertible foreign currency.000. FORFAITING FACTORING Usually 75 – 80% of the value of the invoice Factor does the credit rating in case of nonrecourse factoring transaction FORFAITING 100% of Invoice value The Forfaiting Bank relies on the creditability of the Availing Bank No services are provided POINTS OF DIFFERENCE Extent of Finance Credit Worthiness Services provided Day-to-day administration of sales and other allied/advisory services Recourse With or without recourse Always without recourse Size of transaction Usually no restriction on minimum size of transactions that can be covered by factoring.

apart from banking services relating to receipts/payments on behalf of the government. Banker. -.  The NBFCs are regulated under the provisions of Chapter III. improvement in the efficiency of distribution networks. 1. management and administration of government public debt is a major function of the RBI. SUPERVISING AUTHORITY/REGULATOR AND SUPERVISOR  As a regulator and supervisor. BANKER’S BANK OR CENTRAL BANK  As a banker’s bank.  It is.B of the RBI Act.4 . with a judicious denomination mix. Sector Banks Foreign Banks New Generation Banks Old Generation Banks Regional Rural Banks (RRBS) Co-operative & special purpose Banks Co-operative Banks Development Financial Institutions MEANING OF BANK    “BANK IS A FINANCIAL INTERMEDIARY WHICH MOBILISE SAVINGS OF INVESTORS AND CHANNELIZE THESE SAVINGS IN TO INVESTMENT” “BANK IS LINK BETWEEN MONEY SAVERS AND MONEY SEEKERS” “BANK IS A FINANCIAL INSTITUTION WHICH IS ENGAGED IN THE BUSINESS OF PURCHASING AND SELLING OF MONEY” RESERVE BANK OF INDIA (RBI): THE APEX BANK (CENTRAL BANK)   THE RBI IS THE NERVE-CENTRE OF THE MONEY MARKET AND THE MAIN REGULATOR OF THE BANKING SYSTEM. BANKERS' BANK. the RBI has a special relationship with banks. Currency management by the RBI involves efforts to achieve self-sufficiency in the production of currency notes/coins. Bodies for meeting their short term cash flow mismatches. the RBI prescribes the broad parameters within which the banking and financial system functions.  As a central bank. It controls the volume of SLR and CRR and determines their creditcreation ability.Each bill is separately discounted Series of transactions 5 6 Not off-balance sheet mode of financing Generally not cross-border Off-balance sheet mode of financing May be cross-border INDIAN BANKING SYSTEM RESERVE BANK OF INDIA Scheduled Commercial Banks Public Sector Banks Pvt.    MFS SEM-IV (2010-12) Page 5 . NOTE ISSUING AUTHORITY/ISSUER OF CURRENCY RBI has sole right to issue Currency Notes of all denominations (except the one rupee notes and coins). THE FUNCTIONS/ROLES OF THE RBI COMPRISE: 1. SUPERVISORY AUTHORITY. 3. 5.  As a GOVT. NOTE ISSUING AUTHORITY (ISSUE OF CURRENCY). The currency notes issues by the RBI are legal tender throughout INDIA. the RBI controls the volume of reserves of the banks and determines their deposit-credit creation ability.Individual transaction.  For providing various services. the banker of the last resort means provide credit to commercial banks as and when they need. PROMOTER OF THE FINANCIAL SYSTEM AND 6. in effect. the RBI charges commission from GOVT. RBI provides short term loan and advances to various govt. 4. 3. GOVERNMENT BANKER.  It regulates and supervises the banking system. the issue. withdrawal and destruction of notes. GOVERNMENT BANKER  As the government banker. technology up gradation and enhancement in the security features of currency notes. under the provisions of the Banking Regulation Act.  The currency notes have 100 per cent backing of eligible assets. 4. 2. REGULATOR OF MONEY AND CREDIT (MONETARY AUTHORITY). 2.

it only distributes bank resources in favour of the Government/public sector.  The B/R technique regulates the cost/availability of finance to banks/FIs. BANK RATE (B/R):  The B/R is the standard rate (i) at which the RBI buys/rediscounts bills of exchange/other eligible commercial papers and (ii) that RBI charges from commercial banks for offering short term advances. the CRR has been used by the RBI very actively. It is generally lower than the B/R.UTI. 6. They are very safe transactions.  The RBI promoted institutes like IDBI. with an agreement to repurchase the same at a mutually decided future date and price. on an agreed date and at a predetermined price. CASH RESERVE RATIO (CRR):  The CRR refers to the cash which banks have to maintain with the RBI as a percentage of their net demand and time liabilities to ensure safety and liquidity of bank deposits. yields on Government securities/T-bills and volume/ cost of credit. TYPES OF DEPOSITS/ACCOUNTS  Deposits of banks are classified into: (i) DEMAND DEPOSIT. CASH RESERVE RATIO (CRR ).  CRR IS THE PRIMARY RESERVE REQUIREMENT.  At present REPO RATE is 6%. RBI has setup various DFI/PFI. Monetary policy refers to the use of the techniques of monetary control to achieve the broad objectives of maintaining price stability and ensuring an adequate flow of credit to productive sectors so as to assist growth. NIDC.  The seller sells specified securities.  The terms of the contract are in terms of a repo rate. STATUTORY LIQUIDITY RATIO (SLR) AND REPO. REPOS :  A repo/reverse repo/ready forward/ repurchase (buy-back) is a transaction in which two parties agree to sell and repurchase the same security. IFCI.  SLR investment is in the form of G-Sec. PROMOTER OF THE FINANCIAL SYSTEM  Over a time. TYPES OF REPOS: Two types of repos are currently in operation in India: INTER-BANK REPOS and RBI REPOS. the buyer purchases the security with an agreement to resell the same to the seller.RBI issue licenses for the establishment of new banks/setting up new branches/prescribe minimum capital and reserve rules/ inspect working of banks/ investigate any complaints and irregularities/ approve or force amalgamation /reconstruction/liquidation of banks. Repos have a maturity of 1-14 days. Likewise.  At present CRR is 6%. the RBI can affect the reserve position of banks. representing the money market borrowing/lending rate. SLR is not a technique of monetary control. EXIM BANK. IRBI. TFCI. the RBI formulates and conducts the monetary policy. DICGC. ICICI.  Strictly speaking.  At present BR is 6%.   DEPOSIT PRODUCTS  Deposit products are the major source of bank funds. They are poised to emerge as a major tool of monetary policy in India. The two components of deposit products are: (i) Various types of deposits and (ii) Operations of deposit accounts. Through the OMOs. SIIC. ECGC AND SO ON.  The same transaction is 'REPO' from the viewpoint of the seller and 'REVERSE REPO‘ from the angle of the buyer. BANK RATE (BR). SIDC. MFS SEM-IV (2010-12) Page 6 .  As an instrument of policy. Repo is also known as ready forward as it is a means of funding by selling a security held on a spot basis and repurchasing the same on a forward basis. REGULATOR OF MONEY AND CREDIT/ MONETARY AUTHORITY  As the central bank of the country.       The instruments of monetary control used by the RBI are: OPEN MARKET OPERATIONS (OMOs). STATUTORY LIQUIDITY RATIO (SLR):  The SLR enables the RBI to impose a secondary and supplementary reserve requirement. 5.  OMOs CAN BE ONE OF THE MEASURES ADOPTED BY RBI TO CONTROL INFLATION IN THE ECONOMY.  At present SLR is 25%.  OPEN MARKET OPERATIONS (OMOS):  The OMOs involve sale and purchase of Government securities and T-bills.

    7. The option to receive interest on quarterly/ monthly basis also is available at the discretion of the depositors. At present FD RATE is 6 TO 7. They comprise of (i) FIXED and (ii) RECURRING deposits. Prepayments of deposits at lower rate of interest are also permitted. ration card. Loans against the deposit are permitted. NOMINATION: MFS SEM-IV (2010-12) Page 7 .     3. OPERATIONAL ASPECTS OF DEPOSITS  The operational aspects of deposits are: (I) Opening/Closing Accounts. They are non-interest bearing.       6. • • • • • • 4. banks have to comply with the RBI-prescribed KYC procedure in terms of establishing the identity and residential address of the depositor by special documentary evidence.  A person who wants to open a deposit account has to (i) fill up and sign the prescribed application form (ii) furnish (a) Introductory reference from an existing depositor of the bank. (II) Deposit Insurance And (III) Nomination. the bank may levy service charges. No overdraft facility is available on such deposits At present SAVING BANK RATE is 3.    TERM/FIXED DEPOSIT AND HYBRID/FLEXI DEPOSIT. RECURRING/CUMULATIVE DEPOSITS: Recurring/ cumulative deposits are a variant of savings deposit. The interest on such deposits is higher vis-à-vis saving deposits. the deposits can be renewed for another term at the prevailing rate of interest. Withdrawals are on demand. On maturity.(ii) (iii) 1. HYBRID/FLEXI DEPOSITS: “THE NEW INNOVATION” The hybrid/flexi deposits are a fusion of demand and fixed deposits. Such deposits may be either with cheque book facility or with no cheque book facility. SAVINGS DEPOSITS: As a product. voters ID card. • • 5. Balance in excess of a specified level in a savings deposit is automatically transferred (sweep transfer) to the predetermined term deposit of a pre-determined maturity. DEMAND DEPOSITS Demand deposits. The interest rates are regulated by the RBI. The interest is pre-fixed and almost equal to the fixed deposit rate. Overdrafts of different durations. short term/regular. DEPOSIT INSURANCE:  Banks deposits to the extent of Rupees ONE Lakh per account are insured by the DICGCI of the RBI.5%. are of two types: (i) current and (ii) savings. OPENING/CLOSING ACCOUNTS:  While opening new accounts. A pre-fixed amount at a pre-fixed frequency (monthly/quarterly) for a pre-specified period (12 to 120 months) can be deposited.  2. There are no restrictions on withdrawals/deposits in current accounts. are permitted. telephone/electricity bills and so on (c) A photograph and (d) A minimum initial deposit. The repayment on maturity includes principal and the accrued interest. In case of accounts which do not have sufficient balances. Loans against the security of fixed deposits may be availed of. There are restrictions on the number of withdrawals and the minimum balance to be maintained. funds are automatically transferred back through reverse sweep. savings deposits encourage saving habits among the depositors. Withdrawals are permitted by cheques in favour of self/other parties. (b) Acceptable proof of his identity/residential address such as passport. repayable to depositors on demand. license.5%. CURRENT DEPOSITS/ACCOUNTS: The primary objective of current deposits is not soliciting savings but convenience of the large customers who are relieved of handling payments. TERM/FIXED DEPOSITS: Term/fixed deposits are repayable on pre-fixed maturity. FIXED DEPOSITS : Fixed deposits are for a fixed period specified at the time of making the deposits. In the event of a shortfall in the savings component. The minimum period of deposit is 7 days.

Hypothecation and IV. LATER ON RENAMED AS BASE RATE (AT PRESENT IT IS 7.  Overdraft is drawing from a current account in excess of credit balance.  MODES OF SECURITY ON SECURED ADVANCES BY BANKS Secured advances of banks have charge against assets in various modes: I. HYPOTHECATION: Hypothecation refers to a charge on movable goods/ commodities in which possession and ownership of the assets charged to banks remains with the borrower. On a periodic basis. – – II.  Bills purchase/ discounting is a specific-asset credit facility. Mortgage. MORTGAGE: Mortgage is a charge on Immovable Property offered as security for a loan.16) I. 11. The credit facilities in this category are: Letter of Credit and/or BANK Guarantees. NON-FUND-BASED:    The non-fund-based credit facilities do not involve outlay of funds. – – – IV. TERM LOANS/PROJECT FINANCE TERM LOANS  Term/project loan involves a detailed project appraisal of the borrower. Borrower has the right to sell/use them.  To ensure safety of funds loan agreements contain some positive/negative covenants/ conditions. It is secured by mortgage of property. Various types of Mortgage*** (Refer pp. Lien II. borrower has to submit stock statement of goods to the bank. The nominees would be paid the outstanding amount in the event of the death of the depositor. PLEDGE: Pledge is DELIVERY of Movable Property (say inventory of goods) from borrower to the bank to secure a debt.  LOAN PRODUCTS AND OTHER INSTRUMENTS The loan products of banks are their assets.  A demand loan is a one-time facility subject to periodic/lumpsum principal repayment together with monthly/quarterly interest payments. Interest is payable on the actual drawls. They are contingent liabilities and banks would be liable to honour its commitments. Lien refers to the right of bank to retain assets of the borrowers and sell them under the specified circumstances.  Nomination facility is available to the depositors in all types of deposits.  PRIME LENDING RATE (PLR). There are three aspects of loan/advance products of banks:  Credit facilities given to customers. LIEN: Lien means lender’s claim on assets offered as security for a loan. It is a running account for drawing of funds with three elements: credit limit/line of credit. their possession is given to the bank who can sell them in the event of default in repayment. Pledge III. CASH CREDIT / OVERDRAFT/DEMAND LOAN/BILLS DISC. – III.  (a) (b) (c) (d) WORKING CAPITAL FINANCE : The working capital finance is provided by way of Cash Credit Overdraft Demand Loan And Bills Purchased/Discounted.  Mode of security/creation of charge on secured loan/advances and  Instruments used by customers in banking transactions LOAN PRODUCTS /CREDIT FACILITIES The credit facilities from banks are divided into: a) Fund-based and b) Non-fund-based. While the ownership in the goods lies with the borrower. A. – – MFS SEM-IV (2010-12) Page 8 .  Cash credit is a unique credit facility. A.  FUND BASED The fund-based credit facilities provide funds for (i) working capital and (ii) term/project finance for capital expenditure. drawing power and actual drawls.5 TO 8%) B.

Generation Of Statement Of Accounts C. Utility Payments like telephone/electricity bills and so on. *** (PLZ. Account Balance Enquiry D. the merits of ATM are round the clock accessibility.  The two elements of retail banking are: 1. Channels of retail banking services delivery and 2. 11. automatic accounting of transaction and cost effectiveness   TELE-BANKING: Tele-banking enables customers access their accounts for information/ transaction.19 TO 11. Issue Of Travellers Cheques G. As a service delivery channel. INSTRUMENTS USED IN BANKING TRANSACTIONS The instruments issued by banks for use by customers in banking transactions are: – Bankers Draft – Travelers Cheques And – Dividend/ Interest Warrants  RETAIL BANKING PRODUCTS  Retail banking refers to banking products/services offered to primarily individual customers of various types.23 FOR FURTHER DETAILS) MFS SEM-IV (2010-12) Page 9 .   (i) (ii) (iii) (iv) (v) (vi) The popular retail banking products are: Cards Home Loans Auto Loans Commercial Durable Loans Personal/Unsecured Loans Educational Loans. convenient locations. Some banks offer cash delivery/collection to select customers. Cash Dispensing B.  (i) (ii) (iii) CHANNELS OF RETAIL BANKING SERVICES: ATM Telebanking and Internet banking. Deposit Of Cash/ Cheques F. Request For Cheque Book E. REFER PP. Retail banking products. But cash deposits/withdrawals are not available through such services. AUTOMATED TELLER MACHINE (ATM):  A full-fledged ATM can perform the following functions: A. INTERNET BANKING: Banks can enlarge their market area through internet banking without building new offices.