Factoring and Forfaiting Notes M.Com Sem-IV - Sukumar Pal
Factoring and Forfaiting Notes M.Com Sem-IV - Sukumar Pal
Factoring and Forfaiting Notes M.Com Sem-IV - Sukumar Pal
M.Com. Semester-IV
Genesis
The word factor has been derived from the Latin word ‘factare’ means ‘to make or to do’ or ‘to get things
done’. Factoring originated in countries like USA, U. K., France, etc. where specialised financial institutions
were established to assist firms in meeting their working capital requirements by purchasing their receivables.
Factoring was a well-developed activity in England in the 14th century, where it evolved with the growth of the
wool industry. The job of the factors centred on their functions as sales agents, or commission merchants, for
textile mills. In addition to that Factors also assumed some critical financial functions on behalf of the mills.
They offered credit advice on how much to sell on account to potential customers. They also guaranteed
payments to the mills, assuming full responsibility for the creditworthiness of the mills’ customers. Thus, in
essence, factoring was fully reflected economically in the financial component of the factoring business as is
existed 600 years ago. The difference between today and 600 years ago is that the sales or ‘agenting’, component
has been purged from the factoring relationship. But factoring as it is typically practised in both developed and
developing economies, can still be viewed as a bundle of activities.
Factoring is of a recent origin in the Indian context. In 1988, the Reserve Bank of India (RBI) constituted
a High Powered Committee to examine the scope for offering factoring services in the country. In 1989, the
committee submitted its report strongly recommending the case for setting up factoring subsidiaries. Following
the announcement of the guidelines, the State Bank of India and Canara Bank have set-up their factoring
subsidiaries – SBI Factors & Commercial Services Limited and Can Bank Factors Limited.
Mechanism
Under the factoring arrangement, the seller does not maintain a credit or collection department. The job,
instead is handed over to a specialised agency, called the ‘Factor’. After each sale, a copy of the invoice and
delivery challan, the agreement and other related papers are handed over to the Factor. The Factor, in turn,
receives payment from the buyer on the due date as agreed, whereby the buyer is reminded of the due date
payment account for collection. The Factor remits the money collected to the seller after deducting and adjusting
its own service charges at the agreed rate. Thereafter, the seller closes all transactions with the Factor. The seller
passes on the papers to the Factor for recovery of the amount. The following steps show the mechanism of the
factoring process:
1. The seller or client sells its product or service to a customer and issues an invoice for the value of the goods
or service.
2. A copy of the invoice and a cover sheet is submitted (by fax or otherwise) to the Factor for approval.
3. The factor collects credit history and financial information from the buyer (customer) for overall credit
assessment.
4. The factor makes a decision on the individual buyer’s credit, based on each buyer’s financial information
and other relevant data.
5. The factor informs the client of the guarantee decision and issues a guarantee number for each purchase
order.
6. The client delivers the goods to the buyer.
7. The factor deposits the cash advance (usually 70-80%, sometimes up to 90%) to the client’s bank account
via electronic deposit or otherwise. This is the first of two payments the client receives when factoring an
invoice.
8. The client sends the factor an assignment of accounts along with copies of the invoices and the delivery
documents to the factor. The client sends the invoice to the buyer. The invoice should have instructions
informing the buyer to pay the factor.
9. The buyer pays the factor for the invoice on around the due date.
10. When full payment is received, the factor withholds a small factoring service fee, and returns the balance, or
reserve (the amount not advanced), back to the client. The reserve is the second payment the client receives
from the factor for the invoice.
Figure – 1: Process of Factoring
(1) Credit sale of goods
Client Customer
(2) Notifies the customer
Functions of a Factor
A factor offers the following services:
(i) Collection facility of accounts receivables
(ii) Sales-ledger administration
(iii) Credit protection
(iv) Short-term funding
(v) Advisory services.
Sales-Ledger Administration
The factor maintains a sales ledger for each client. The ledger is maintained under one of the following
methods:
(i) Open-item method
(ii) Balancing method.
Under the open-item method, each receipt is matched against the specific invoice and therefore the customer’s
account clearly reflects the various open invoices which are outstanding on any given date. Under the Balancing
method, the transactions are recorded in the chronological order, the customer’s account is balanced periodically
and the net amount outstanding is carried forward. When accounts are maintained manually the balancing
method is easy to operate. However, the open-item method permits better control because collection efforts can
be focused on identifiable debts. Since most of the factors employ mechanized accounting systems for sales-
ledger maintenance, the open-item method is widely followed. In addition to the sales-ledger, the factor also
maintains a customer-wise record of payments spread over a period of time so that any change in the pattern of
payment can be easily picked up.
Credit Protection
When receivables are purchased under a non-recourse factoring arrangement, the factor establishes a line
of credit or defines the credit limit up to which the client can sell to the customer. The credit line or limit
approved for each customer will depend upon the customer’s financial position, his past payment record and the
value of goods sold by the client to the customer. Operationally, the monitoring of the credit utilized by a
customer poses some problem to the client because he has turned over the ledgering work to the factor. To
overcome this difficulty, some factors define the monthly sales turnover for each customer which will be
automatically covered by the approved credit limit.
For example, if the approved credit limit for a customer is Rs.3 lakh and the average collection period is say 45
days, sales up to Rs.2 lakh (3 45
x30
)per month will be automatically covered. Instead of setting a limit on the
monthly sales turnover, some factors provide periodic reports to their clients on customer-wise outstanding and
ageing schedules to enable the client to assess the extent of credit utilization before any major sale is made.
To assess the creditworthiness of a customer, the factor relies on a number of sources. They include:
i. Credit ratings and reports
ii. Bank reports and Trade references
iii. Analysis of financial statements
iv. Prior collection experience
v. Customer visits.
Short-term Funding
A factor usually pays for a part of the debts purchased immediately and charges interest on the part
payment made for the period between the date of purchase and the collection date/guaranteed payment date. The
factor does not provide hundred percent finance and maintains a margin called the factor reserve. The factor
reserve is a safety net for protecting the factor against contingencies such as sales returns, disputed debts, etc.
70% to 80% of the assigned debts are usually granted as advances to the client by the factor. The factor is usually
wary of financing recourse receivables because he does not participate in the credit-granting decision. Therefore,
he prefers to purchase such receivables with the clear understanding that no advance payment will be made
against such receivables. In the case of ‘with recourse factoring’, the advance provided by the factor would have
to be refunded by the client in the event of non-payment by the buyer. In the case of ‘without recourse (non-
recourse) factoring’ there would be no question of the advance being returned to the factor.
Advisory Services
These services are spin-offs of the close relationship that develops between a factor and the client. Given the
specialized knowledge of the factor about the market(s) in which the client operates, he is in a better position to
advise the client on
the customers’ perceptions of the firm’s products,
changes required for in the marketing strategies,
emerging trends and ways of responding to these trends,
Audit of the process adopted for invoicing, delivery and sales return, etc.
In addition, the factor can help the client in areas which fall outside the purview of the factoring services. For
example, if the factoring organization happens to be the subsidiary of a commercial bank, it may provide an
introduction to the credit department of the bank or to the other subsidiaries of the bank which are involved in
providing other financial services like leasing, hire purchase or merchant banking. Given the in-depth knowledge
of the factor about the character and capacity of the client, the recommendation or introduction provided by the
factor considerably strengthens the client’s position in dealing with these financial intermediaries.
Factoring Fees
The company that provides the factoring facility normally makes two main charges which are often as follows:
(a) Administration Charge (or service Charge)
This is a fee for managing the client’s credit sales ledger if the client is factoring or for maintain the client’s
account if the client is invoice discounting. This is expressed as a percentage of the value of the sales
invoices that the client raises. The fee typically ranges from 0.2% to 3.5%.
(b) Discount Charge
This is a charge, similar to interest, that is levied in respect of the funds that the client actually uses. It is
normally between 1.0% and 3.5% over bank base rate.
In addition to the above, there may be additional charge that factoring company makes.
Forms of Factoring
Depending upon the features built into the factoring transaction, there can be different forms of factoring
arrangements. These are as follows:
a. Recourse factoring
b. Non-recourse factoring
c. Maturity factoring
d. Advance factoring
e. Invoice discounting
f. Full factoring
g. Bank participation factoring
h. Disclosed and undisclosed factoring
i. Supplier guarantee factoring
j. Domestic and Export/Cross-border/International factoring.
The following features are, of course, common to most of the factoring arrangements:
(i) the factor is responsible for collection of receivables;
(ii) the factor maintains the sales ledger of the client.
The additional feature(s) built into the different types of factoring arrangements are discussed here:
Recourse Factoring
The factor purchases the receivables on the condition that the loss arising on account of irrecoverable
receivables will be borne by the client. For example, assume that a factor has advanced an amount of Rs.2.4 lakh
against a receivable of Rs.3 lakh which turns out to be irrecoverable. Under a recourse factoring arrangement, the
factor can recover the sum of Rs.2.4 lakh from the client. Put differently, under a recourse factoring arrangement,
the factor has recourse to the client if the debt purchased turns out to be irrecoverable.
Non-Recourse Factoring
As the name implies, the factor has no recourse to the client if the debt purchased turns out to be
irrecoverable. Since the factor bears the losses arising on account of irrecoverable debts (receivables), the factor
charges a higher commission (the additional commission is called the del credere commission). Also, the factor
participates actively in the credit-granting process and decides/approves the credit lines extended to the
customers of the client. While non-recourse factoring is the most common form of factoring in countries like the
USA and the UK, in the Indian context, factoring is done with recourse to the client.
Maturity Factoring
Under this type of factoring arrangement, the factor does not make any advance payment. The factor pays
the client either on a guaranteed payment date or on the date of collection. The guaranteed payment date is
usually fixed taking into account the previous ledger experience of the client and a period for slow collection
after the due date of the invoice.
Advance Factoring
Under this arrangement, the factor provides an advance varying between 75-85 percent of the value of
receivables factored. The balance is paid upon collection or on the guaranteed payment date. As we have already
seen, the factor charges interest from the date on which advance payment is made to the date of actual collection
or the guaranteed payment date. The rate of interest is usually determined depending upon (i) the prevailing
short-term rate of interest; and (ii) the client’s financial standing and (iii) volume of turnover.
Full Factoring
A factoring arrangement which combines the features of non-recourse and advance factoring
arrangements is called Full Factoring or Old Line Factoring. Put differently, full factoring provides the entire
spectrum of services – collection,credit, protection, sales-ledger administration and short-term finance.
Bank Participation Factoring
This arrangement can be viewed as an extension of advance factoring. Under this arrangement, a
commercial bank participates in the transaction by providing an advance to the client against the reserves
maintained by the factor. For example, assume that a factor has advanced 80 percent of the value of factored
receivables and the commercial bank provides an advance limited to 50 percent of the factor reserves. The client
is required to fund only 10 percent of the investment in receivables, the balance 90 percent being provided by the
factor and the commercial bank.
Disclosed and undisclosed factoring
Disclosed factoring is the arrangement under which the exporter enters into a factoring agreement with the
financial house and assigns the benefit of the debts created by the sale transaction to them. The importer is then
notified and effects payment to the factor. The arrangement is usually on a non-recourse basis. This means that
the factor cannot claim the assigned funds from the exporter if the importer fails to pay, in other words, he
assumes the credit risk in the transaction. Those debts that are not approved by the factor are assigned on a
recourse basis, so he can claim against the exporter in case of any default of the importer. Recourse factoring is
more accurately described as invoice discounting. Factoring arrangements are usually made on a whole turnover
basis. This arrangement connotes an obligation of the exporter to offer all his receivables to the factor who
receives a commission undisclosed factoring, which is usually undertaken on a recourse basis and does not
involve the importer. The agreement is made between the factor and the exporter and the importer remains bound
to pay as agreed under the sales contract. In receipt of payment, the exporter holds the funds in a separate bank
account as trustee for the factor.
Supplier Guarantee Factoring
This arrangement was developed by the American factors primarily to help their importers/distributors
involved in executing import orders on behalf of their customers. The typical steps involved are as follows:
i. The customer places an import order with the distributor.
ii. The distributor seeks the approval of the factor for extending credit to the customer.
iii. On receiving the credit approval from the factor, the distributor makes arrangements for shipping the supplies
directly to the customer.
iv. The factor guarantees payment to the foreign supplier in respect of the specific shipment. Upon shipment, he
credits the account of the distributor and debits the account of the customer for an amount equal to the invoice
value of the goods shipped plus distributor’s commission.
v.Instead of making an advance payment to the distributor against the customer’s account that has been factored,
the factor pays the supplier directly for the invoice value of the goods shipped.
vi. The factor follows up with the customer, collects the amount due and makes the final payment to the
distributor after deducting his commission and guarantee charges.
Thus, apart from offering the usual services, the factor guarantees payment to the supplier on behalf of his client
(the distributor) thereby engendering greater confidence in supplier-distributor dealings.
Domestic and Export/Cross-border/International factoring
The mechanics of Cross-border Factoring (also referred to as an international factoring or export
factoring) is similar to domestic factoring except that there are usually four parties to the transaction – exporter,
export factor, import factor and importer. Under this system of factoring referred to as the two factor system of
factoring, the exporter (the client) enters into a factoring agreement with the export factor domiciled in his
country and assigns to him export receivables as and when they arise. The payments against the factored debts
are made exactly in the same way as under a domestic factoring facility. If the sale value is denominated in the
currency of the importer’s country, the factor usually covers the exchange risk associated with the remittances.
The export factor enters into an arrangement with a factor based in the country where the importer resides
(import factor) and contracts out the tasks of credit checking, sales ledgering and collection for an agreed fee.
The debt is usually not assigned to the import factor. The relationship between the import factor and the importer
(the customer) is clarified by a notation on the sales invoice that the payment is to be made directly to the import
factor. The import factor collects the amount from the customer and remits it to the export factor.
International factoring
The UNIDROIT convention defines international factoring as “an agreement between an exporter and factor
whereby the factor purchases the trade debt from the exporter and provides the services such as finance,
maintenance of sales ledger, collection of debts, and protection against credit risks”. There are various forms of
international factoring. It basically depends on the exporters’ needs and cost bearing capacity, and security to the
factors. These are “Two factor system”, “Direct export factoring”, Direct Import Factoring” and “Back to Back
factoring”. Among these types the two factor system gives some added benefits.
(a) The two factor system
An international factoring transaction involves a number of elements that differentiate it from a domestic
factoring transaction. Possibly the most important differentiations are the different languages of the parties to
the sales contract and the difficulty in assessing the credit standing of a foreign party. As an answer to these
considerations the two-factor system was developed. This entails the use of two factors, one in each country,
dealing with the exporter and the importer respectively. The export factor on obtaining the information from
the exporter on the type of his business and the proposed transaction will contact the import factor
designated by the importer and agree with the terms of the deal. The importer advances funds to the import
factor who then transmits them to the export factor, minus his charges. In the two-factor system the import
factor and the importer do not come into direct contact. The system involves three agreements, one between
the exporter and the importer, one between the export factor and the exporter and one between the factors
themselves. It is important to bear in mind that the import factor’s obligations are to the export factor alone
and they include determining the importer’s credit rating and the actual collection of the debts. The import
factor assumes the credit risk in relation to approve debts and is responsible for the transfer of funds to the
export factor. On the other hand, the export factor is responsible to the import factor for the acceptance of
any recourse. The two-factor system is supported by the existence of chains of correspondent factors. These
are established for the purpose of facilitating the cooperation between the import and the export factors by
the development of common rules and accounting procedures. There are members of factoring chains in
most major trading nations. Some of them restrict their membership to one factor per country (Closed
Chains), while others are open to the participation of multiple factors in the same country (Factors Chain
International). The two-factor system has various advantages. The main ones concentrate around efficiency
and speed. The import factor is in a better situation to assess the credit capabilities of the importer and
communicate effectively with him. He knows the legal and business environment in the country and is in a
position to take swift action in case of any default. It facilitates the international trade by speeding up the
circulation of funds. The speedier the flow of funds from the buyer to the seller, the smaller the risk of
exchange rate fluctuations between the date of shipment and the date of payment. Finally, the use of this
system can help in reducing the exchange risk involved in international trade transaction.
The use of the import factor alleviates the pressure on the export factor and streamlines the procedure. The same
elements make the system preferable to the exporter who is sparing the inconvenience of dealing with a
foreign factor. Further, there is the possibility of the client receiving lower discount charges if the import
factor makes payments at the rate of discount charge in his country (if these are lower than the ones in the
exporter’s home jurisdiction).
Organizations facilitating the “Two Factor System”
There are different institutions currently working in the world to support the mechanism. Among those two
organizations, the prominent ones are the IFG (International Factors Group) and the FCI(Factors Chain
International). These are associations of factoring organizations or factors from all over the world. The
International Factors Group was founded in 1963 as the first international association of factoring
companies. The original mission of IFG was to help factoring companies to conduct cross-border business
acting as correspondents for each other. This is still the core activity of IFG today FCI is a global network of
leading factoring companies, whose common aim is to facilitate international trade through factoring and
related financial services. FCI's mission is to become the worldwide standard for international factoring.
Invoice Discounting
Strictly speaking, this is not a form of factoring because it does not carry the service elements of
factoring. Under this arrangement, the factor provides a prepayment to the client against the purchase of book
debts and charges interest for the period spanning the date of pre-payment to the date of collection. The sales
ledger administration and collection are carried out by the client. The client provides the factor with periodical
reports on the value of unpaid invoices and the ageing schedule of debts. This facility is usually kept confidential
i.e., the customers (whose debts have been purchased by the factor) are not informed of the arrangement.
Therefore, this arrangement is also referred as ‘Confidential Factoring’. A variant of the invoice discounting is
the Protected Invoice Discounting arrangement where the factor bears the credit risk of the receivables
purchased. Put differently, the factor purchases the debts without recourse but does not offer the services of
sales-ledger administration and debt collection. Invoice discounting in general and protected invoice discounting
in particular are offered to clients with a sound financial position and with no serious problem of debt collection
and debt write-offs. If the invoice discounting facility is not confidential in nature, the customers of the client are
advised to make payment directly to the factor and this facility is referred to as ‘Bulk Factoring’. The need for
this facility arises when the factor finds that the client does not fulfill the criteria laid down for invoice
discounting and requires the security associated with direct payments from the customers. Bulk factoring offered
with a non-recourse feature is referred to as ‘Agency Factoring’ in some countries, because the client acts as an
agent of the factor in collecting the debts.
Advantages of Factoring
Factoring is becoming popular all over the world on account of various services offered by the institutions
engaged in it. Factors render services ranging from bill discounting facilities offered by the commercial banks to
total takeover of administration of credit sales including maintenance of sales ledger, collection of accounts
receivables, credit control, protection from bad debts provision of finance and rendering of advisory services to
their clients. Thus factoring is a tool of receivables management employed to release the funds tied up in credit
extended to customers and to solve problems relating to collection, delays and defaults of the receivables. A firm
that enters into factoring agreement is benefited in a number of ways, some of the important benefits are outlined
below:
1. Cost Savings: Factoring allows for the elimination of trade discounts. Besides, it also helps in reduction of
administrative cost and burden, save on high bank charges and expenses, facilitating cost savings.
2. Reduction of time and money used for debt collection: The factors provides specialised services with
regard to sales ledger administration and credit control and relieves the client from the botheration of debt
collection and thus the client saves the management time, money and effort in collecting the receivables and
in sales ledger management. He can concentrate on the other major areas of his business and improve his
efficiency.
3. Increase the liquidity position of the business: The advance payments made by the factor to the client in
respect of the bills purchased increase his liquid resources. He is able to meet his liabilities as and when they
arise thus improving his credit standing position before suppliers, lenders and bankers.
4. Assessment of Customers’ creditworthiness: The client organisation can use the factor’s credit control
system to help assess the creditworthiness of new and existing customers. The factor’s assumption of credit
risk relieves him from the tension of bad debt losses. The client can take steps to reduce his reserve for bad
debts.
5. Competitive terms to offer: It provides flexibility to the company to decide about extending better
competitive terms to their customers.
6. Improvement of Cash Flow: The Company itself is in a better position to meet its commitments more
promptly due to improved cash flows.
7. Better purchase planning and availability of cash discount: Better purchase planning is possible.
Availability of cash helps the company to avail cash discounts on its purchases. It enables the company to
meet seasonal demands for cash whenever required.
8. Increase the Efficiency ratio: As it is an off balance sheet finance, thus it does not affect the financial
structure. This would help in boosting the efficiency ratios such as return on asset etc.
9. Acceleration of production cycle: With cash available for credit sales, client organisation’s liquidity will
improve and therefore, its production cycle will be accelerated.
10. Updated information flow: It ensures better management of receivables as factor firm is specialised agency
for the same. The factor carries out assessment of the client with regard to his financial, operational and
managerial capabilities whether his debts are collectable and viability of his operations. He also assesses the
debtor regarding the nature of business, vulnerability of his operations; and assesses the debtor regarding the
nature of business, vulnerability to seasonality, history of operations, the term of sales, the track record and
bank report available on the past history.
11. Enhancement of return: Factoring is considered attractive to users as it helps enhance return.
12. Freeing up working capital: Many companies have the majority of capital tied up in inventory. Accounts
receivable funding allows a company to free up capital tied up in inventory.
Limitations
The above listed advantages do not mean that the factoring operations are totally free from any limitation. The
attendant risk itself is of very high degree. Some of the main limitations of such transactions are listed below:
1. It may lead to over-confidence in the behaviour of the client resulting in over-trading or mismanagement.
2. The risk element in factoring gets accentuated due to possible fraudulent acts by the client in furnishing the
main instrument “invoice” to the factor. Invoicing against non-existent goods, pre-invoicing (i.e. invoicing
before physical dispatch of goods), duplicate-invoicing (i.e. making more than one invoice in respect of single
transaction) are some commonly found frauds in such operations, which had put many factors into difficulty
in late 50’s all over the world.
3. Lack of professionalism and competence, underdeveloped expertise, resistance to change etc. are some of the
problems which have made factoring services unpopular.
4. Rights of the factor resulting from purchase of trade debts are uncertain, not as strong as that in bills of
exchange and are subject to settlement of discounts, returns and allowances.
5. Small companies with lesser turnover, companies having high concentration on a few debtors, companies with
speculative business, companies selling a large number of products of various types to general public or
companies having large number of debtors for small amounts etc. may not be suitable for entering into
factoring contracts.
We considered it essential to include another emerging market and the status of our desired business in it, as it
gives the reader an idea about the problems, environment, solutions, and essentially creates a benchmark to
understanding the basic characteristics of factoring in emerging markets. In spite of the various differences
between the Russian and Indian credit markets, we believed the overall goal, nature and structure of companies
entering such markets and the logistics of factoring would follow similar patterns. In the 1980ís, India was
witness to a virtual deregulation of its capital market, giving birth to a number of innovative financial
instruments and schemes were born. The policy of the power-that-be helped in the development of the money
market and capital market movers tried to transplant successful schemes of the west. However, despite all of their
efforts over the years, the small-scale sector was unable to recover its dues from the medium and large industries
particularly in the public sector, and thus the small-scale units faced a liquidity bind because of their inability to
collect dues. Available market data revealed that funds locked up in book debts were increasing at a faster rate
than growth in sales turnover or inventory build ups. Clearly, factoring was the only remedy available. While the
Worldwide factoring turnover was nearly $ 500 billion (1998), the factoring market in India is relatively non-
existent with only a few small p layers, although the market demand is estimated to be around a $ 1 billion
(according to a State Bank of India report). In India, factoring is considered as a source of short-term financing
and is viewed purely as a financing function ñ as a source of funds to fill the void of bank financing for
receivables for small-scale and other industries. This often leads to a catch 22 situation and in launching of
factoring services in India; the thrust should be on the twin areas of receivables management and credit
appraisals, especially since the small-scale sector lacks these sophisticated skills. Recent government efforts have
tried to maintain a thrust of the continuing momentum of economic reforms that have been announced in the
Union budget, as well as the Credit Policy (such as tax breaks for exporters and importers, terms of trade etc.).
During the year, the Reserve Bank of India (RBI) has tried to boost liquidity and reduce the cost of funds to
banks, by reducing bank rates, cutting CRR is and reducing the repo rate. It further announced the reduction of
interest rates on export financing and rationalizing the former. In light of this news, several agencies have
boosted export financing and also tightened their provisions, so as to better 21 support and help the core of
Indian exports, the small and medium scale business sector; such as the following:-The Export Import Bank of
India (Exim Bank), a pioneer in the forfaiting business in India and having detailed knowledge of the Indian
market, recently announced a tie up with West deutsche Landes Bank Girozentrale (West LB), Germany is 4th
largest banking group, to offer factoring and forfaiting services to Indian exporters. This would be a logical step
as structured trade financing is still in its infant stage in India. West LB is a major international player in the
business of factoring and forfaiting and other trade finance projects. In addition to the above, the International
Finance Corporation (IFC) has evinced interest in taking up a stake in the venture, aiming at around 25%, with
West LB having 40% and Exim Bank having 35%. A relatively small initial equity base is planned, along with
the commitment of other financially strong equity holders to provide lines of control at competitive prices when
required and give the new firm adequate financial advantage. With the setting up of this organization, it will no
longer be necessary for Indian exporters to approach foreign institutions for their financing needs. The setting up
of a new multi-product company offering export factoring and forfaiting under one umbrella will be particularly
beneficial to small and medium enterprise (SME) exporters, who are the backbone of the country’s exports.
Thus in lieu of the recent rise in international trade movements and in an effort to capitalize on the market,
several key players in the Indian market, such as the Exim Bank, the State Bank of India and other financial
agencies have stepped on the pedal to bolster their efforts and plans towards factoring and financing. Of course,
we have to keep in mind that the presence of an efficient and strong legal system is the single most important
factor in fostering the growth and success of factoring, and factoring as it is becoming clear, can only thrive in
conjunction with a favourable legal framework and judicial support ñ which India, along with Russia, still needs
to perfect!
Major Factoring Companies in India
Can Bank Factors Limited
SBI Factors and Commercial Services Pvt. Ltd.
The Hongkong and Shanghai Banking Corporation Ltd
India Factoring and Finance Solutions Pvt Ltd
Global Trade Finance Pvt. Limited
Foremost Factors Ltd.
Export Credit Guarantee Corporation of India Ltd.
Citibank NA, India Ltd.
Forfaiting
The forfaiting owes its origin to a French term ‘a forfait’ which means to forfeit (or surrender) ones’ rights on
something to someone else. Forfaiting is a mechanism of financing exports:
a. by discounting export receivables
b. evidenced by bills of exchanges or promissory notes
c. without recourse to the seller (viz; exporter)
d. carrying medium to long-term maturities
e. on a fixed rate basis up to 100% of the contract value.
In other words, it is trade finance extended by a forfaiter to an exporter seller for an export/sale
transaction involving deferred payment terms over a long period at a firm rate of discount. Forfaiting is generally
extended for export of capital goods, commodities and services where the importer insists on supplies on credit
terms. Recourse to forfaiting usually takes place where the credit is for long date maturities and there is no
prohibition for extending the facility where the credits are maturing in periods less than one year.
Forfaiting is a form of trade financing undertaken to facilitate export transactions. The process of
forfaiting thus has a lot of significance as it undertakes to solve the cash flow problems of the party taking the
benefit of factoring. In a forfaiting transaction, the exporter surrenders his right for claiming the payment for
services rendered or goods supplied to the importer in favour of the forfaiter. A deed is prepared stating the same
and the exporter receives cash payment from the facilitator. All the transactions of forfaiting are performed with
the support of a bank, which assumes the default risk possessed by the importer. The exporter before extending
finance for a forfaiting transaction looks into several critical aspects of the underlying goods or commodity. For
example, the bank would pay special attention towards the durability/perish ability nature of the goods,
authentication of the product (date of manufacturing, product code, etc.), packaging arrangements and other
precautions adopted during the stage of shipment etc. After these checks and verifications, the banker provides
the exporter with the funds. In other words, the forfaiting transaction helps an exporter with instant cash and
eliminates his cash flow problems. Forfaiting is a relatively new concept. It is a specialized form of factoring,
which is undertaken on export transactions on a non-recourse basis. This, however, does not mean that factoring
and forfaiting are one and the same type of trade financing.
Parties to Forfaiting
There are five parties in a transaction of forfaiting. These are
i. Exporter
ii. Importer
iii. Exporter’s bank
iv. Importer’s bank
v. The forfaiter.
The forfaiter assumes the following risks that arise in making the guarantee:
Economic risk of the insolvency of the debtor or his guarantor.
Country risk, which consists of the political risk, which particularly includes the conversion and transfer risk.
Exchange Risk- The risk of exchange rate fluctuations.
Collection Risk (loss of the receivables in the post, enforceability of the receivable).
Interest Risk- The risk of interest rate fluctuations during the credit period of the transaction.
Transfer Risk- The risk of an inability to convert local currency into the currency in which debt is
denominated.
Characteristics
The main characteristics of forfaiting are:
100% financing without recourse to the seller of the obligation,
The importer’s obligation is normally supported by a local bank guarantee (or ‘aval’).
The debt is usually evidenced by Bills of Exchange, Promissory Notes or a Letter of Credit.
Contracts in any of the world’s major currencies can be financed.
Finance can be arranged on a fixed (normal) or floating rate basis.
Documentation is very simple, requiring evidence of underlying transaction (copies of shipping documents)
and certain confirmations from obligor/guaranteeing bank.
Transactions can be concluded on a fixed or floating interest rate basis.
Exporter receives funds upon presentation of necessary documents, shortly after shipment.
Costs of forfaiting
The forfaiting transaction has typically three cost elements:
1. Commitment fee, payable by the exporter to the forfaiter ‘for latter’s’ commitment to execute a specific
forfaiting transaction at a firm discount rate within a specified time.
2. Discount fee, interest payable by the exporter for the entire period of credit involved and deducted by the
forfaiter from the amount paid to the exporter against the availised promissory notes or bills of exchange.
3. Documentation fee.
Since the last few decades, factoring and forfaiting have gained immense importance, as one of the
major sources of export financing. For a layman, these two terms are one and the same thing. Nevertheless, these
two terms are different, in their nature, concept and scope. The first and foremost distinguishing point amidst
these two terms is that factoring can be with or without recourse, but forfaiting is always without recourse. Have
a glance at this article, to know about some more differences between factoring and forfaiting.
Comparison Chart
Basis for Factoring Forfaiting
Comparison
Meaning Factoring is an arrangement that converts Forfaiting implies a transaction in which the
the receivables into ready cash and the seller forfaiter purchases claims from the exporter
doesn't need to wait for the payment of in return for cash payment.
receivables at a future date.
Advantages of Forfaiting
(i) Avoid Export Credit Risks
The exporter is completely free from may export credit risks that may arise due to the possibility of interest
rate fluctuations or exchange rates fluctuations or any political upheaval that may affect the collection of
bills. Forfaiting acts as an insurance against all these risks.
(ii) Simple and Flexible
All the benefits those are available to a client under factoring are automatically available under forfaiting
also. However, the greatest advantage is its simplicity and flexibility. It can be adopted to any export
transaction and the exact structure of fiancé can also be determined according to the needs of the exporter,
importer and the forfaiter.
(iii) Speedy Transaction
Fast, tailor-made financing solutions.
Commitments can be issued within hours/days depending on country.
(iv) Transaction simplicity
Because the financing is guaranteed against Promissory Notes or Bills of Exchange, the documentation is
concise and straightforward, permitting rapid completion of the deal.
Relieves the exporter from administration and collection problems.
No restrictions on origin of export.
(v) Cent per cent Finance
The exporter is able to convert his deferred transaction into cash transaction through a forfaiter. He is able to
get 100 per cent finance against export receivables.
(vi) Avoids Export Credit Insurance
In the absence of forfaiting, the export has to go for export credit insurance. It is very costly and at the same
time it involves very cumbersome procedures. Hence, if an exporter goes for forfaiting, he need not purchase
any export credit insurance.
(vii) Increase in Cash Flow
Forfaiting converts a credit-based transaction into a cash transaction. Therefore, Balance Sheet is not
burdened by accounts receivables, bank loans or contingent liabilities.
(viii) Enhancement of Competitive Advantage
Ability to provide supplier credit-based transaction into a cash transaction.
Ability to do business in countries where the credit risk would otherwise be too high.