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

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

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

PROCESS INVOLVED IN
FACTORING
Client concludes a credit sale with a customer.
Client sells the customer’s account to the Factor and notifies the customer.
Factor makes part payment (advance) against account purchased, after
adjusting for commission and interest on the advance.
Factor maintains the customer’s account and 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.

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
receipt of goods by buyer, to the Factor.
 The Factor, after scrutiny of these papers, allows payment (,usually upto 80%
of invoice value). The balance is retained as Retention Money (Margin Money).
This is also called Factor Reserve.
 The drawing limit is adjusted on a continuous basis after taking into account
the collection of Factored Debts.
 Once the invoice is honoured by the buyer on due date, the Retention Money
credited to the Client’s Account.
 Till the payment of bills, the Factor follows up the payment and sends regular
statements to the Client.

CHARGES FOR FACTORING
SERVICES
Factor charges Commission (as a flat percentage of value of Debts
purchased) (0.50% to 1.50%)
Commission is collected up-front.
For making immediate part 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.

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

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

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

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

CROSS - BORDER FACTORING
 It is similar to domestic factoring except that there are four parties, viz.,
a) Exporter,
b) Export Factor,
c) Import Factor, and
d) Importer.
 It is also called two-factor system of factoring.
 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.
 Import Factor collects payment and remits to Export Factor who passes on
the proceeds to the Exporter after adjusting his advance, if any.
 Where foreign currency is involved, Factor covers exchange risk also.

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

FACTORING
vs
BILLS DISCOUNTING (contd…)
BILLS DISCOUNTING
4. Bills discounting is usually
done with recourse.
5. Financial Institution can get
the bills re-discounted
before they mature for
payment.
FACTORING
4. Factoring can be done
without or without recourse
to client. In India, it is done
with recourse.
5. 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) Sale of Goods Act
c) Transfer of Property Act
d) Banking Regulation Act.
e) Foreign Exchange Regulation Act.

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).
Problems in recovery.
Factoring requires assignment of debt which attracts Stamp Duty.
Cost of transaction becomes high.

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.
Bank (Forefaiter) assumes default risk possessed by the Importer.
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.

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.
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, 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.

IN FORFAITING:-
 Promissory notes are sent for avalling to the Importer’s Bank.
 Avalled notes are returned to the Importer.
 Avalled notes sent to Exporter.
 Avalled notes sold at a discount to a Forefaiter on a NON-
RECOURSE basis.
 Exporter obtains finance.
 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.

CHARACTERISTICS OF
FORFAITING
Converts Deferred Payment Exports into cash transactions, providing
liquidity and cash flow to Exporter.
Absolves Exporter from Cross-border political or conversion risk associated
with Export Receivables.
Finance available upto 100% (as against 75-80% under conventional credit)
without recourse.
Acts as additional source of funding and hence does not have impact on
Exporter’s borrowing limits. 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 (contd….)
Exporter is freed from credit administration.
Provides long term credit unlike other forms of bank credit.
Saves on cost as ECGC Cover is eliminated.
Simple Documentation as finance is available against bills.
Forfait financer is responsible for each of the Exporter’s trade
transactions. Hence, no need to commit all of his business or
significant part of business.
Forfait transactions are confidential.

COSTS INVOLVED IN
FORFAITING
Commitment Fee:- Payable to Forfaiter by Exporter in
consideration of forefaiting services.
Commission:- Ranges from 0.5% to 1.5% per annum.
Discount Fee:- Discount rate based on LIBOR for the period
concerned.
Documentation Fee:- where elaborate legal formalities are
involved.
Service Charges:- payable to Exim Bank.

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

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

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

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

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

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

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

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

Factoring and forfaiting

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