February 04, 2022
NBFC Investment and Credit Company – Can Now Factor
In a move that endeavors to foster growth and development in the startup sector by way of extending credit facilities to small enterprises, the Central Government has provided relaxation for undertaking the factoring business governed by the Factoring Regulation Act, 2011 (“the Act”). The Central Government by way of the Registration of Factors (Reserve Bank) Regulations, 2022 (“Factor Registration Regulations”) and the Registration of Assignment of Receivables (Reserve Bank) Regulations, 2022 (“Assignment Registration Regulations”) (collectively referred to as the “Amending Regulations”) has provided necessary impetus to small enterprises for lining up credit.
The Amending Regulations came into effect on January 17, 2022 and strive to (i) broaden the ambit of companies that can carry out the business of factoring; and (ii) introduce administrative efficacy in the process of assigning receivables as governed by the Act.
Prior to the Amending Regulations, the entities which could undertake the business of factoring were very few. In fact, the number of Non-Banking Financial Companies (“NBFCs”) eligible to conduct factoring business post the implementation of the Factor Registration Regulations has increased exponentially from 7 (seven) to 182 (one hundred and eighty two).1 The primary objective of the Amending Regulations is to establish an efficient framework governing the provision of working capital and credit facilities to micro, small and medium enterprises (“MSMEs”) in order to proliferate their growth.
The system of factoring was introduced in India to address the primary obstacle faced by start-ups, which is the lack of access to adequate capital. Trade receivables factoring is a form of financing that permits business to convert their outstanding invoices into working capital which they can then utilize for their business operations. This is typically done by way of assignment of trade receivables of the assignor to the factor/NBFC for monetary consideration.
While the Act was introduced with the intention of augmenting the working capital available to MSMEs through trade receivables factoring, as of last year, factoring comprises of only 2.6% of the total MSME credit in India2. The primary reason for this low percentage is the ineligibility of several NBFCs to participate as factors under the Act. It is estimated that only 10% of the receivable market in India is covered under the Act while the rest of the receivable financing market falls within the purview of conventional cash credit overdraft arrangements.
The Government sought to reduce the regulatory compliance governing factoring transactions and broaden the scope of NBFCs permitted to function as factors under the Act. Accordingly, the Amending Regulations were introduced, and the implementation of such regulations are of utmost importance given the severe hit taken by the start-up sector as investments in Indian start-ups witnessed a severe decline by 81% from 2019 to 2020 due to the repercussions of the COVID-19 pandemic3. We identify some of the key takeaways from the Amending Regulations:
ANALYSIS & CONCLUSION
The pivotal objective behind the Amending Regulations is to boost the start-up sector by enhancing the access of working capital to MSMEs. However, the extent to which the Amending Regulations will assist in realizing this objective is yet to be established.
The primary issue with the Amending Regulations is that it imposes more stringent regulations for the operation of eligible NBFCs. Accordingly, while the Factor Registration Regulations have broadened the scope of eligible NBFCs by including NBFC-ICC, such a NBFC-ICC will not be eligible to continue to undertake the business of factoring unless it undertakes factoring of trade receivables as its primary business (i.e. at least 50% of its gross income should be derived from the factoring of trade receivables).
In a similar vein, the eligibility criterion for NBFC-Factors under the Factor Registration Regulations have tightened. For instance, any NBFC seeking to operate as a NBFC-Factor must have total assets worth at least INR 10,000 crores – a threshold which serves more to inhibit rather than invite NBFCs to undertake such factoring business.
At the moment, the Central Government has rightly acknowledged that change is required in the regulatory framework governing factoring of trade receivables. However, whether the implementation of the Amending Regulations will bring about such change is yet to be seen.
You can direct your queries or comments to the authors
4 Regulation 2(4), Registration of Factors (Reserve Bank) Regulations, 2022,
5 Regulation 5(2)(a), Registration of Factors (Reserve Bank) Regulations, 2022,
6 Regulation 5(2)(b), Registration of Factors (Reserve Bank) Regulations, 2022,
7 Regulation 3, Registration of Factors (Reserve Bank) Regulations, 2022,
8 Regulation 5(2)(d), Registration of Factors (Reserve Bank) Regulations, 2022,
9 Regulation 5, Registration of Factors (Reserve Bank) Regulations, 2022,
10 Regulation 4, Registration of Factors (Reserve Bank) Regulations, 2022,
11 Regulation 5(6), Registration of Factors (Reserve Bank) Regulations, 2022,
12 Regulation 2(5), Registration of Factors (Reserve Bank) Regulations, 2022,
13 Regulation 3(1), Registration of Assignment of Receivables (Reserve Bank) Regulations, 2022,
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