factoring

forfaiting
Factoring Services - Concept
Factoring services started in US in early 1920s and
were introduced to other parts in 1960s
Factoring 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 - Concept
A 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.
Contd………………………..
 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.
 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 - Mechanism
Buyer
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 - Mechanism
Seller
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
 Factor
 Factor enters into agreement with seller for rendering factoring services
 On 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 arrangements
 Invoice, 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 factoring
Factoring 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 profitability
To maintain and expand their business
It comes really handy to them to find the required
resources.

;
Two-Factor System of Factoring
There are usually four parties to a cross-
border/international factoring transactions
Exporter (client)
Importer (customer)
Export Factor
Import Factor
Two factor system results in two separate but
inter-linked agreements
Between exporter and export factor
Between export factor import factor/
Two-Factor System of Factoring
Usually 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
 Steps
 Exporter 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
 Country A Country B
Goods and invoices – Stage I
Exporter Importer

Copy Invoice Stage II Payments

Stage VI

Prepayments Stage III

Statements Stage V

Export Factor Copy Invoices Stage IV Import Factor

Payments Stage VII

Payment of Commission Stage VIII

Factoring Services - Concept
Parties to factoring – client, customer and
factor
Cost 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 Services
Recourse and Non-recourse Factoring
Advance and Maturity Factoring
Full Factoring
Disclosed and Undisclosed Factoring
Seller and Buyer based factoring
Domestic and International factoring
Functions of factoring
Purchase and collection of debts
Sales ledger management
Credit investigation and
undertaking of credit risk
Provision of finance
Rendering consultancy services
 Benefits of factoring
Financial services
Collection service
Credit risk service
Provision of expertised “sales ledger management
services
Consultancy service
Economy in servicing
Trade benefits
Miscellaneous 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. 
 Contd…..
       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.
 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 – many
 Differences
 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 financing
 Bill discounting does not involve assignment of debts as is the case with
factoring
Forfaiting
Forfaiting 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.
 Forfaiting
Steps
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
Forfaiting
 Summary
Specific form of export trade finance
Export receivables discounted – full value of export bill
considered
Debt instruments most commonly used are bills of
exchange and promissory notes
Payment 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 recourse
Source 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 Forfaiting
 Forfaiter 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-145
Rakesh Singh
Raghavendra
Chinmayee Pandey