UNIT 19 FACTORING, FORFAITING AND Bill Discounting

BILL DISCOUNTING
Objectives
After reading this unit, you will be able to :
1. explain the meaning and scope of Factoring, Forfaiting and Bill
Discounting Serices!
". appreciate operations in respect of Factoring and Forfaiting Serices!
#. distinguish between Factoring and Forfaiting Serices! appreciate arious
aspects of Discounting and $ediscounting of %ommercial Bills!
&. understand the reasons for 'rowth of Factoring and Forfaiting Business in
(. )ndian mar*et! and understand deelopments in %ommercial Bill +ar*et in
)ndia.
Stuctue
)ntroduction
Factoring Serices
,ypes of Factoring Serices
,erms and %onditions of Factoring %ontract
Factoring: Adantages and Disadantages
+echanism of Factoring
+ain %haracteristics of Factoring Serices
-xport Factoring
Factoring Serices in )ndia
Forfaiting: An )ntroduction
Benefits of Forfaiting Serices
+echanism of Forfaiting Serices
+ar*et 'rowth
Forfaiting Serices in )ndia
Difference Between Factoring and Forfaiting Serices
Bill Discounting: An )ntroduction
Benefits of Finance ,hrough Bill Discounting
Scheme of $ediscounting of Bills
Deelopments in %ommercial Bill +ar*et in )ndia
$easons for .on/Deelopment of Bill +ar*et in )ndia
$eitalising Bill +ar*et in )ndia
Fun! B"se! Sevices
INTRODUCTION
0e hae seen in the preious unit how enture capitalists come to the rescue of
entrepreneurs by proiding ris* bearing capital *nown as enture capital. )t is
usually a long term inestment either in the form of e1uity, conentional loans,
conditional loans and conertible loans. 2enture capital has potential for
significant growth and financial returns. )n the present unit we will be discussing
in detail three serices used for financing short/term, trade, i.e. factoring,
Forfaiting, and bill discouting.Factoring serices hae become 1uite popular all
oer the world now, with more than 344 companies offering these serices.
Factoring is a contract li*e any other sale purchase
agreement regulated under the law of contract Forfaiting is a source of trade
finance which enables exporters to get funds from the institution called forfaitee
on transferring the right to recoer the debts from the importer.Another source of
short/term trade financing *nown as bill discouting where one party accepts the
liabilities of trade towards the third party.5et us now discuss about all these three
serices in the subse1uent sub sections of this unit.
19#$ FACTORING S%R&IC%S
Factoring serices started in the 6nited States of America in the 13"4s and were
introduced to the other parts of the world in the 1374s. ,oday there are more
than 344 companies offering factoring serices in more than (4 countries.
Factoring serices hae become 1uiet popular all oer the world.Factoring is a
financial serice coering the financing and collection of accounts receiables in
domestic as well as in international trade. Basically factoring is an arrangement
in which receiables on account of sale of goods or serices are sold to the factor
at a certain discount. As the factor gets title to the receiables on account of the
factoring contract, he becomes responsible for all credit control, sales ledger
administration and debt collection from the customers.
Functions o' t(e F"cto
Broadly spea*ing the main functions of the Factor are as under :
18 ,o proide finance against boo* debts, say upto 34 per cent of the inoice
alue
immediately. ,hus the client gets funds immediately for his wor*ing capital.
"8 ,o collect cash against receiables on due date from the customers of the
clients
and furnish reports to the client.
#8 ,o underta*e sales ledger administration 9i.e. accounting wor*8 for the client in
respect of client:s transactions with its customers.
&8 6nder the non/recourse factoring arrangement, if the customer become
financially insolent and cannot pay up, the Factor proides protection to the
client against bad debts on all approed inoices. ,hus the Factor proides debt
insurance facility to the client against possible losses arising from insolency or
ban*ruptcy of the customer.
(8 Factor also proides other information such as sales analysis and oerdue
inoice analysis which enable the client to run the business more
effectiely.Besides, the Factor also proides releant expertise in the areas of
mar*eting,finance, etc., to the client.
F"ctoing, Fo'"iting "n! Bill Discounting )"ties to F"ctoing Cont"ct
,here are three parties inoled generally in a factoring contract, i;.,
18 Buyer of goods (i.e. customer) who has purchased goods or serices on
credit
and as such has to pay for the same once the credit period gets oer.
"8 Seller of goods (i.e. client) who has supplied goods or proided serices to
the
customers on credit terms.
#8 Factor who purchase the inoices 9receiable8 from seller of goods and
collect the money from the customers of his clients.
19#* T+)%S OF FACTORING S%R&IC%S
,he arious types of factoring arrangements can be classified into the following
categories.
18 Full Servicing Factoring: ,his is also *nown as without recourse factoring
serice. )t is the most comprehensie type of factoring arrangement offering all
types of serices, namely: 9a8 Finance, 9b8 Sales ledger administration, 9c8
%ollection, 9d8 Debt protection, and 9e8 Adisory serices. ,he most important
characteristic of this type of factoring serice is that it gies protection against
bad debts to the client. )n other words, in case the customer fails to pay, the
factor will absorb the losses arising from insolency or ban*ruptcy of the client:s
customers.
"8 Recourse Factoring: )n such a type of factoring arrangement, the factor
proides all types of facilities except debt protection. ,hat means, in other words,
the client is responsible for any bad debts arising from insolency of the client:s
customers.
#8 Maturity Factoring: 6nder this type of factoring arrangement, except for
proiding finance, all other facilities are proided to the client. As far as finance is
concerned, the client is paid at the end of a pre/determined date or maturity date
whether or not the customers hae settled their dues in respect of credit sales.
&8 Invoice Discounting: )n such type of arrangement, only finance is proided,
and,hence, no other serices are offered in respect of receiables.
(8 gency Discounting: 6nder this arrangement, the facilities of finance and
protection against bad debt are proided by the factor. As against this, the sales
ledger administration and collection of boo* debts are carried out by the client
himself.
,he aforesaid classification of arious factoring arrangements along with the type
of
serices proided under each classification is shown in the %hart 13.1.
C("t 19#1, T-.es o' Sevices )ovi!e! b- F"ctos
Types of Factoring Finance Collection of Sales Ledger Credit
Accounts Arrangement Administration Protection
1. Full factoring 9without recourse8
". 0ith recourse factoring
#. +aturity factoring
&. )noice discounting
(. Agency factor
7. ,erms and %onditions of
Factoring %ontract
Fun! B"se! Sevices T%R/S AND CONDITIONS OF FACTORING
CONTRACT
Factoring contract is li*e any other sale purchase agreement regulated under the
law of contract. ,he terms and conditions on which factor agrees to purchase the
debts from seller are mutually settled *eeping in iew the business connections
and customs. .eertheless, some of the important aspects which are supposed
to be born in mind and incorporated in factoring agreements are as follows :
18 <ffer to sell debts from time to time arising out of business transactions, on
such terms and conditions as are stipulated in the agreement. ,he offer shall
specifically mention about the inoices relating to each debt as an eidence of
the deliery of goods or rendering of serices to the customer.
"8 Acceptance of the offer shall be comprehensie, coering all interests in the
purchased debts, with all remedies for enforcing the debts and rights of unpaid
seller being ested in the factor.
#8 %ondition to hae no recourse to the supplier by the factor in the case of
nonrecourse
factoring contract on the failure of the customer to pay the dues.
&8 =ower of attorney from the firm to the factor so as to empower the factor to the
factor.
(8 =ayment of purchase price of debts.
78 .otice of sale of assignment of debt be endorsed on inoices sent to customer
to
entitle the factor to recoer their dues and issue discharge receipt of the
customers.
>8 .on/collection of dues by the firm : Firm 9client8 not to collect dues from
customers assigned to the factors.
?8 .otice of credit allowed to customer to be gien to the factor.
38 0arranties and coenants.
148 Factoring commission, charge, fees and mode of payment.
118 Durations of agreement.
1"8 .otice of termination.
1#8 @urisdiction of court to entertain dispute between the parties.
,he aboe conditions may be elaborated in iew of the business practices and
incorporated in the letter of confirmation to be issued by the factor of the client
and be accepted by the client through a Board $esolution. )t is always safe to
enter into formal agreement between the parties so as to coer all assignment of
debts and powers to affect recoery thereof in legal way.
19#0 FACTORING, AD&ANTAG%S AND DISAD&ANTAG%S
Bene'its o' F"ctoing to Clients
18 6nder the factoring arrangement the client receies prepayment upto ?4/34
per cent of the inoice alue immediately and the balance amount after the
maturity period. ,his helps the client to improe cash flow position which enables
him to hae better flexibility in managing wor*ing capital funds in an efficient and
effectie manner. Besides this, such arrangement also improes the ability of the
client to deelop sales to credit worthy customers.
F"ctoing, Fo'"iting "n! Bill Discounting
"8 )f the client aails the serices of the factor in respect of sales ledger
administration and collection of receiables, he need not hae any administratie
set up for this purpose. .aturally this will result into a substantial saing in time
and cost of maintaining own sales ledger administration and collecting
receiables from the customer. ,hus, it will reduce administratie cost and
time.As a result of this, the client can spare substantial time for improing the
1uality of production and tapping new business opportunities.
#8 0hen without recourse factoring arrangement is made, the client can eliminate
the losses on account of bad debts. ,his will help him to concentrate more on
maximi;ing production and sales. ,hus, it will result in increase in sales,increase
in business and increase in profit.
&8 ,he client can aail adisory serices from the factor by irtue of his expertise
and experience in the areas of finance and mar*eting. ,his will help the client to
improe efficiency and productiity of his organi;ation. Besides this, with the help
of data base, the factor can readily proide information regarding product
designAmix, prices, mar*et conditions etc., to the client which could be useful to
him for business decisions.
,he aboe mentioned benefits will accrue to the client proided he deelops a
better business relationship with the factor and both of them hae mutual trust in
each other.
Dis"!v"nt"ges o' F"ctoing
18 )mage of the client may suffer as engaging a factoring agency is not
considered
a good sign of efficient management.
"8 Factoring may not be of much use where companies or agents hae one time
sales with the customers.
#8 Factoring increases cost of finance and thus cost of running the business.
&8 )f the client has cheaper means of finance and credit 9where goods are sold
against adance payment8, factoring may not be useful.
19#1 /%C2ANIS/ OF FACTORING
O.e"tion o' F"ctoing Sevices
,here are three parties to a domestic factoring arrangement:
18 ,he client who is supplier or seller of goods and serices.
"8 ,he customer who is a debtor or buyer of goods and serices proided by the
client.
#8 ,he factor who is a financial institution or intermediary between client and
customer who proides the factoring serices.)n normal business, the client sells
the goods to the customer on credit. Be sends inoices to the customer directly
and also collects payment directly from the customer as shown in the following
diagram.
%5)-., %6S,<+-$
9Supplier of goods andAor 9Buyer of goods andAor serices serices8
18 'oods are sent on credit along with inoices to the customer.
"8 =ayment is made by the customer to the client on due date.
Fun! B"se! Sevices
18 %ustomer places an order with the client for goods andAor serices on credit.
"8 %lient Deliers the goods and inoice with a notice to pay to the factor.
#8 %lient sends of inoice to the factor.
&8 Factor proides finance 9pre/payment8 to the client say ?4/34 per cent of the
inoice alue on the production of a copy of inoice.
(8 +onthly statement of accounts are sent to the customer and follow/up if
inoice
remains unpaid by due date.
%5)-.,
9Supplier of goods andAor serices8
%6S,<+-$
9Buyer of goods andAor serices8
FA%,<$
inoices to the customer, he offers to sell to the factor, the boo* debts on
standard
form, supported by copies of inoices and deliery orders.,he factors buys the
boo* debts and immediately ma*es the agreed upon adance payment 9.ormally
upto ?4/34 per cent of the inoice alue8 to the client. ,he remaining balance 9i.e.
14/"4 per cent of the inoice alue8 will paid to the client after the factor has been
paid by the customer on maturity date depending on the type of factoring
arrangement.6sing the inoices submitted, the factor maintains the sales ledger
for the client and statements of accounts are sent to the customer on a monthly
basis. ,he factor ta*es oer the collection of boo* debts, and reminders are sent
when the inoices are oerdue. %lient is *ept informed of all the factoring
transactions through monthly andwee*ly reports proided by the factor.
Cost o' F"ctoing
,hese are two types of costs in factoring serices
1. Serice Fee or %harges
". Discount %harges
0hen a client enters into an agreement with a factor then a third party namely
the
factor is also introduced and their relationship can be shown here as under :
78 %ustomer pays money to the factor on due date 9i.e. collects boo* debts8.
>8 Factor ma*es the balance payment of the inoice alue to the client. <nce the
goods or serices are deliered or supplied to the customer by the client, he
sends inoices to the customer in the normal way. Boweer, all the inoices must
bear the notification that the inoices hae been assigned in faour of the factor
and accordingly payment must be made to the factor. After the client has sent the
F"ctoing, Fo'"iting "n! Bill Discounting
18 Service Fee: Serice fee is leied for the wor* inoled in administering the
sales ledger as well as protection against bad debts. )t is calculated as a
percentage of gross alue of the inoices factored and is assessed on the
following criteria:
a8 'ross annual sales olume!
b8 .umber of customers!
c8 .umber of inoices and credit notes! and
d8 Degree of ris* represented by the customer.
,he serice fee for domestic factoring ranges from 4.#4 per cent to 4.>( per cent
and
it would be higher when non/recourse arrangements are made.
"8 Discount !"arge (interest c"arge): ,he discount charge is leied on the
adance proided by the factor and is computed on the basis of prime lending
rate of
ban*s plus premiums for credit ris* basis. )t is calculated on a day/to/day basis
on
the adances outstanding and ranges from 1 to # per cent aboe the reference
ban*:s prime lending rate.
19#3 /AIN C2ARACT%RISTICS OF FACTORING
S%R&IC%S
,he main characteristics of factoring are noted below :
18 Factoring is a money mar*et instrument.
"8 Boo* debts represented by inoices are assigned in faour of a factor.
#8 Since, factoring is not a negotiable instrument, customer:s consent is re1uired
about the factoring arrangement under which he will ma*e a repayment directly
to the factor but not to the client.
&8 Dual pricing structure comprising discount charges and serices charges is
followed.
(8 6nder without recourse factoring credit insurance facility is offered to the
client.
)n iew of this cost of factoring serices is more under without recourse
factoring as against with recourse factoring.
78 +argin is *ept in the range of ( per cent to "4 per cent. )n other words, usually
about ?4 to 3(C of the inoice alue is proided as pre/finance by the factor to
the supplier which is *nown as prepayment.
>8 $emaining amount of the alue of inoice is paid to the client after collection of
money from the customer and after deducting his own charges.
Activit- 1
State whether the following statements are ,rue or False
i8 Factoring serice is considered only in respect of receiables arising on
account
of credit sales. ,rueAFalse
ii8 Factoring serices can be offered with recourse only. ,rueAFalse
iii8 +aturing factoring does not inole finance ,rueAFalse
i8 Factoring inoles assignment of boo* debt by client in faour
of the factor. ,rueAFalse
>"
Fun! B"se! Sevices 19#4 %5)ORT FACTORING
-xport factoring serices are offered to the exporters 9clients8 who sell their
products
or serices to the importers 9customers8 in other countries on open account
terms
haing a credit period ranging from 74 to 1?4 days. Before the goods are shipped
to
the customer, export factor is expected to inestigate the customer:s
creditworthiness
and assume responsibility for collecting all amounts owed as well as affording
credit
protection. -xport factor can offer benefits of export factoring both to the
exporters
as well as to the importers. ,he mechanism of export factoring is similar to that of
domestic factoring, the exception being the exporter and importer belong to two
different countries.
Four different types of arrangements are possible for export factoring :
a8 ,wo Factor System
b8 Single 9Direct8 Factoring System
c8 Direct -xport Factoring
d8 Direct )mport Factoring
6nder the two factor system, which is more in ogue in international factoring,
both the export factor in the exporter:s country and the import factor in the
importer:s country will be inoled in proiding international factoring serices to
the clients 9exporters8. Since both are integral part to the two factor system,
naturally the functions of the factors will be diided between the export factor and
import factor. ,he mechanism of the two/factor system in international factoring
alongwith the functions of export and import factor are illustrated in Figure 13.1.
Figue 19#1, /ec("nis6 o' t7o F"cto S-ste6
%8.ote I6.ote
%8.ot F"cto I6.ot F"cto
%opy )noice
Stage ))
=repayments
Stage )))
Statements
Stage 2
=ayments
Stage 2)
'oods and )noices
Stage )
%opy )noices
Stage )2
=ayments
Stage 2))
=ayment of %ommission
Stage 2)))
!ountry !ountry B
s s
s s
s
s s
s
>#
F"ctoing, Fo'"iting "n!
Bill Discounting
,he main function of the export factor relate to :
l Assessment of the financial strength of the exporter.
l =repayment to the exporter after proper documentation, regular audit and post
sanction control.
l Follow/up with the import factor.
l Sharing of commission with the import factor.
,he main functions of the import factor are as under :
l +aintenance of boo*s of the exporter in respect of sales to the debtors of his
country.
l %ollection of boo* debts from importers and remitting proceeds of the same to
the export factor.
l =roiding credit protection under non/recourse factoring arrangement in case of
financial inability on part of any of the debtors of his country.
Nee! 'o %8.ot F"ctoing
+any exporters find it difficult to ealuate creditworthiness of potential importers
due to lac* of information and data. Further, on account of arious reasons, they
also experience difficulties to recoer dues from import customers on maturity
dates. ,his poses the problem of credit ris*. All these problems in respect of
export trade can be soled by offering export factoring serices to the exporters.
6se of such serices will help exporters to sell goods or offer serices in abroad
on open account terms and eliminate credit ris* as well. Such facilities will help
exporters to expand the business with the existing customers and search new
mar*ets for the business.
)ec"utions to be t"9en b- t(e %8.ot F"cto
)f at all any institution intends to launch export factoring serices, it must ta*e,
among
others, following precautions:
18 )n iew of the aailability of export finance by ban*s at concessional rate to the
exporters, export factor has to proide prepayment facility against purchase of
export receiables under factoring serices at competitie rates. For this
purpose, factors hae to mobilise funds at most affordable cost.
"8 +ost of exporters may demand export factoring with without recourse facility.
,herefore, a factor must be in a position to offer this facility alongwith other
serices as a part of factoring serices pac*age. For this, he can ta*e help of
factoring company operating in importers countries 9*nown as import factor8 for
absorbing credit ris*.
#8 Factors may re1uire to become a member of any one of the international
chains li*e Amsterdam based Factors %hain )nternational 9F%)8. F%) facilitates
dealings between the two factors in different countries 9where the local laws and
usages and practices may be different8 by setting up of appropriate business
standards for bilateral dealings between -xport Factor and )mport Factor. )n iew
of this, export factor will re1uire to follow uniform rules to operate in the
international mar*et.
RBI Gui!elines 'o F"ctoing Sevices
,he $B) has issued guidelines subDect to which ban*s can underta*e factoring
serices through departmentally. ,hese guidelines are as under :
18 Ban*s should frame an appropriate policy on factoring serices with the
approal of their Boards.
Fun! B"se! Sevices
"8 As actiities li*e factoring serices re1uires s*illed personnel and ade1uate
infrastructure facilities, it should be underta*en only by certain select branches
of ban*s. ,his will hae to be suitably published for the benefit of ban*s
customers.
#8 ,he actiities li*e factoring serices shall be treated on par with loans and
adances and therefore should accordingly be gien the ris* weight of 144C for
calculation of capital to ris* asset ratio. Further the guidelines on income
recognition, asset classification and proisioning norms would also be applicable
to the portfolio of factoring.
&8 ,he facilities extended by the prepayment under the factoring serices would
be
coered within the exposure selling fixed upto "(C of ban*:s capital funds to an
indiidual borrower and (4C of ban*:s capital funds to a group of borrowers.
(8 Ban*s shall maintain a balanced portfolio of financing receiables under
factoring serices is/a/i; the aggregate credit portfolio. ,he exposure
towards prepayment in respect of purchase of receiables under factoring
serices should not exceed 14C of total gross adances as on the date of
preious balance sheet.
19#9 FACTORING S%R&IC%S IN INDIA
,hough factoring serices hae been introduced since 1331 in )ndia still it is 1uite
new in the sense that factoring product is not widely *nown in many parts of the
country. $ecognising the utility of factoring serices for small and medium si;e
industrial and commercial enterprises in )ndia, for the first time the 2aghul
%ommittee which submitted its report on the +oney +ar*et, recommended the
deelopment of a system of factoring of open account sales particularly for the
small scale industrial units. ,his committee further obsered that both ban*s and
non/ban* financial institutions in the priate sector should be encouraged to set
up institutions for proiding factoring serices. 5ater, the Ealyanasundaram
%ommittee, which was appointed by the $esere Ban* of )ndia 9$B)8 in 13??
specifically for exploring the possibilities of launching factoring serices in )ndia,
found an abundant scope for such serices and hence strongly adocated for the
introduction of factoring serices in )ndia. ,his committee also obsered that
ban*s were ideally suited for proiding factoring serices to the industries in the
economy. Boweer, the said %ommittee expressed the iew that to begin with
only four or fie ban*s either indiidually or Dointly should be allowed on ;onal
basis to underta*e factoring serices. ,he recommendations of
Ealyanasundaram %ommittee were accepted by the $B).
Subse1uently a suitable amendment was made in the Ban*ing $egulation Act
13&3,
so as to allow ban*s to set up subsidiary company for underta*ing factoring
serices.,o begin with, the $B) permitted both the State Ban* of )ndia and
%anara Ban* to start factoring serices through their own subsidiaries.
Accordingly, two factoring
companies in )ndia, i.e. SB) Factors and %ommercial Serices 5td. and %anban*
Factors 5td! sponsored by the State Ban* of )ndia and %anara Ban* respectiely,
commenced operations in 1331. )n the beginning they were allowed to operate in
0estern and Southern Fone of )ndia respectiely. Boweer, later on, the $B)
lifted
these area restrictions on their operations and accordingly, both these
companies
were gien permission to expand and operate their business in other parts of the
country. )n iew of this, they can operate on all/)ndia basis. )n 133# the $B)
allowed all the scheduled commercial ban*s to introduce factoring serices either
departmentally or through a subsidiary set/up. Besides SB) Factors and
%ommercial
Serices and %anban* Factors 5td., there are a few non/ban*ing finance
companies
such as Formost Factors 5td., 'lobal ,rade Finance =t. 5td. 9a subsidiary of
-G)+
F"ctoing, Fo'"iting "n!
Bill Discounting
Ban*8 and )ntegrated Financial Serices 5td., which are also in the business of
domestic factoring in )ndia. <f these, 'lobal ,rade Finance =t. 5td. and Formost
Factors 5td. hae underta*en the business of export factoring also. Besides
these non/ban*ing finance companies, Small )ndustries Deelopment Ban* of
)ndia 9S)DB)8, Bong*ong and Shanghai Ban*ing %orporation hae been offering
factoring serices to their clients. Almost all of them hae been proiding
factoring serices to the SS) and non/SS) units.
Activit- $
)dentify the reasons for the need of an )mport Factor.
19#1: FORFAITING, AN INTRODUCTION
Forfaiting is the purchase of receiables alongwith aalised negotiable
instruments li*e promissory note or bills of exchange 9without recourse to any
preious holder of the instruments8 due on a specific date to be matured in future
and arising from the exports of goods on credit. ,hus, Forfaiting is a source of
trade finance which enables exporters to get funds from the institution called
forfaiter on transferring the right to recoer the debts from the importer. ,he debt
instrument is purchased by the forfaiter at an appropriate discount. ,his facility is
always proided with non/recourse feature. .ormally all exports of capital goods
and other goods made on medium to long term credit are considered for
proiding finance through Forfaiting arrangement..ow/a/days, in many
deeloped countries, a forfaiter proides a finance een in respect of commodity
exports wherein the credit period is upto 1?4 to #74 days. 9)t is estimated that
about 1( to "4 per cent of Forfaiting mar*et worldwide is represented by
transactions inoling commodity exports upto 1?4 to #74 days8.
Fe"tues o' " Fo'"iting A"nge6ent
18 )t is a specific form of export trade finance.
"8 -xport receiables are discounted at a specific but fixed discount rate.
#8 Debt instruments most commonly used in Forfaiting arrangement are a bill of
exchange and a promissory note.
&8 =ayment in respect of export receiables which is further eidenced by bill of
exchange or promissory notes, must be guaranteed by the importers: ban*. ,he
most usual form of guarantee attached to a Forfaiting agreement is an aal.
(8 )t is always without recourse to the seller 9i;. -xporter8.
78 Full alue of export receiables i.e. 144 per cent of the contract alue is ta*en
into account.
>8 .ormally the export receiables carrying medium to long term maturities are
considered.
Cost o' Fo'"iting Sevices
A Forfaiting serice is subDected to arious costs such as commitment fee,
discount
rate and documentation fee. <f these, discount rate, which is fixed, forms a
larger
Fun! B"se! Sevices
2alue of bills less discount amount 9cash payment8
portion of cost of Forfaiting serice. ,he discount rate charged by the forfaiter is
based on the following elements :
l A charge for the credit extended or finance proided. ,his is the main element
and is roughly e1uialent to the forfaiter:s own costs of raising the money.
l A charge based on the ris* of interest rate and exchange rate moements in the
currency in which the credit is extended.
l A charge based on the soereign ris*, political ris* and transfer ris* e.g. the
probability of a change of goernment and imposition of exchange controls
preenting the discharge of the debt.
l A charge based on the credit ris* attached to the importer as well as aalor.
19#11 B%N%FITS OF FORFAITING S%R&IC%S
,he benefits accruing to the exporter are numerous. Few of these benefits are
stated below:
18 -xporter can conert export transaction under deferred payment arrangement
into a cash transaction. ,hus he can improe his own li1uidity position.
"8 Since the forfaiter ta*es all ris*s, naturally exporter is relieed of the ris*s
arising out of the default by the buyer 9importer8 as also the political and
exchange ris*.
#8 Since the Forfaiting is a fixed rate contract, the exporter is hedged against
interest rate ris* and exchange rate ris*.
&8 -xporter gets finance upto 144 per cent of the contract alue 9which is to be
reduced to the extent of Forfaiting cost8.
(8 -xporter is freed from credit administration and collection problems.
19#1$ /%C2ANIS/ OF FORFAITING S%R&IC%S
,he communication channels and module of transactions in Forfaiting are shown
in
the Figure 13.".
Figue 19#$, /ec("nis6 o' Fo'"iting
%8.ote I6.ote
Fo'"ite I6.otes
B"n9
Forfaiter Agreement 9(8
Sale of export bills with endorsement of
aailised negotiable instrument 978
Agreement with the Ban* for
aailised negotiable instrument 9#8
Agreement 918
Deliery of goods / export 9"8
=resentation of bills on maturity 9?8
Deliery of bills of exchange or
promissory note with guarantee
from the importers ban* 9&8
=ayment on +aturity of
negotiable instrument
F"ctoing, Fo'"iting "n!
Bill Discounting
Details are as under :
18 %ommercial contract between exporter and importer.
"8 Deliery of goods by exporter to importer on credit.
#8 %ontract between importer and his ban* to hae guarantees which will be
gien
in respect of payment against negotiable instrument on due date.
&8 Deliery of aailised negotiable instrument either bill of exchange or
promissory
note to the exporter.
( H 78 Forfaiting contract between exporter and forfaiter under which aailised
negotiable instrument will be endorsed without recourse in faour of the
forfaiter.
>8 %ash payment of discounted aailised negotiable instrument by forfaiter to
exporter 9face alue of bill less discount amount8.
?8 =resentation of aailised negotiable instrument to the importer:s ban*.
38 =ayment on presentation of aailised negotiable instrument on maturity.
Activit- *
%omplete the following statements:
i8 Factoring does not inole the use of any negotiable instrument
whereas ...........
......................................................................................................................
ii8 Farfaiting serices inole cost such as ...........................................................
iii8 )n factoring usually ?4/34 per cent of the inoice alue is paid to the client
whereas in Forfaiting ......................................................................................
19#1* /AR;%T GRO<T2
During the period 13>4/13?4, both the primary and secondary mar*ets in and for
nonrecourse trade paper increased considerably. Specialist ban*s in addition to
traditional
deposit and clearing ban*s deeloped Forfaiting departments, usually within their
trade finance departments.5ater, specialist Forfait Bouses were set up and there
was a perceptible geographic growth and shift of the mar*et from
Swit;erlandA.orthern )taly to 0estern 'ermany and more mar*edly to 5ondon. )n
13?& 5ondon Forfaiting %ompany =5%, the only publicly owned and 6.E. Stoc*
mar*et 1uoted specialist Forfaiting %ompany, was set up.,he primary forfait
mar*et has deeloped along side state bac*ed credit export schemes,
sometimes as a competition and sometimes as an adDunct to the state credit
export schemes. Between mar*et professionals a secondary mar*et also eoled
in forfait paper, which in effect securities these exporter receiables. During the
period 13?4/34 an increasing awareness of the forfait mar*et was deeloped in
many
deeloped countries among business community.
19#1= FORFAITING S%R&IC%S IN INDIA
$ecognising the utility of Forfaiting serices to )ndian exporters, the $B) decided
to ma*e aailable such serices to the exporters. At the beginning the $B)
authori;ed -G)+ Ban* in 133" to offer Forfaiting serices. ,he role of the -G)+
Ban* has been that of a facilitator between the )ndian exporter and the oerseas
Forfaiting agency. Scheduled commercial ban*s hae also been permitted to
offer Forfaiting serices by acting as an agent or a facilitator between )ndian
exporter and the Forfaiting agency operating in some other country. ,hat means
in other words,
Fun! B"se! Sevices scheduled commercial ban*s can underta*e Forfaiting
serices as a part of fee based financial serices. A subsidiary of -G)+ ban*
namely! 'lobal ,rade Financial Serices =riate 5td. has been engaged in
proiding Forfaiting serices to the
exporters in )ndia. As per the $B):s A D %ircular .o. # Dated February 1#, 133",
discount fee, documentation fee and any other costs leied by a forfaiter must be
transferred to the oerseas buyer. )n iew of this, the exporter, who intends to
aail Forfaiting facility, should finalise the export contract in a manner which
ensures that the amount receied in foreign exchange by him after payment of
Forfaiting discount and other fees is e1uialent to the price which he would
obtain if goods were sold on cash payment terms. )f the ban*s are able to act as
an agent to structure Forfaiting deals *eeping in iew the re1uirements of our
)ndian exporters, then there will be demand for such product. For this,
commercial ban*s and others may hae to introduce a lot of flexibility while
acting as an agent or a facilitator in this regard. For example, the minimum alue
of the Forfaiting transaction may be re1uired to be *ept at a reasonable leel.
)nstead of acting simply as an agent, with the permission from the $B), ban*s
and financial institutions in )ndia must explore the possibility of ta*ing up
Forfaiting actiity as a fund based actiity. 0ith the dissemination of *nowledge
about Forfaiting among )ndian exporters, it may be possible to create awareness
about it and subse1uently demand for the same.
19#10 DIFF%R%NC%S B%T<%%N FACTORING AND
FORFAITING S%R&IC%S
18 Factoring serices is mainly meant for financing and collecting of receiables
arising from short term credit transactions say upto 1?4 days. As against this,
Forfaiting is meant for financing credit transactions of haing deferred credit
period of more than 1 year.
"8 Factoring arrangement can be with recourse or without recourse depending on
the terms of factoring contract between a client and a factor. As against this,
Forfaiting transaction is always without recourse where forfeiter absorbs credit
ris* also.
#8 Factoring serices can be considered either for domestic transaction or for
export transaction. As against this Forfaiting transaction is always considered for
export transactions only.
&8 Factoring is done on the strength of sales inoices only. 0hereas Forfaiting
inoles use of aailised negotiable instruments li*e bill of exchange or
promissory note.
(8 )n a factoring arrangement, a margin of ( to "4 per cent is *ept. )n other
words, finance is proided immediate on the purchase of inoice to the extent ?4
to 3( per cent of inoice alue. As against this! a forfaiter discounts the entire
sale alue of the export transaction without *eeping any margin.
78 Factoring serices include sales ledger, administration, collection of
receiables
and other adisory serices. <n the other hand, Forfaiting is a pure financial
arrangement.
>8 Factoring is done on whole turnoer basis, whereas, Forfaiting can be done on
transaction basis.
19#11 BILL DISCOUNTING, AN INTRODUCTION
Bill financing is considered to be an appropriate form of financing trade and
business.
6nder this form of financing, seller of the goods draw a bill of exchange on the
buyer
F"ctoing, Fo'"iting "n! Bill Discounting
9who accepts and returns the same to the drawer8. Subse1uently seller of the
goods discounts the bill of exchange with ban* or finance company and aail the
finance accordingly. <nly those bills which arise out of genuine trade
transactions are considered by the ban*s and finance companies for discounting
purpose.
)"ties to " Bill o' %8c("nge
=arties to a bill of exchange are as follows :
A8 T(e !"7e 9seller of the goods8
0ho draws the bill.
0ho ensures that the bill is accepted and paid according to its tenor.
0ho promises to compensate the holder or any endorser of the bill if it is
dishonoured.
B8 T(e !"7ee 9buyer of the goods8
,he person on whom the bill is drawn.
0ho has shown assent by signing across the bill for payment at maturity
9thus becoming the acceptor8
,he person who assumes legal obligation to pay the bill.
%8 T(e )"-ee
,he person to whom or to whose order the bill is payable.
D8 T(e %n!ose
,he payee or any endorsee who signs the bill on negotiation.
)f the bill is negotiated to seeral persons who signs it in turn becomes an
endorser.
,he endorser is liable as a party to the bill.
)f the bill of exchange is not endorsed then drawer and payee will be the same
person.
B%N%FITS OF FINANC% T2ROUG2 BILL DISCOUNTING
Following are the benefits of bill discounting for the drawer :
%heaper form of %redit: Ban*s usually discount bills at a rate lower than the rate
charged for cash credit. )n iew of this, drawer of the bill can reduce its cost of
funds by raising the funds through discounting of bills with ban*s. Better Funds
+anagement: Bills seems to hae certainty of payment on due dates and this
helps to hae efficient wor*ing capital management. )t also leads to greater
financial discipline as bills are discounted only against genuine trade transactions
as compared with ban* oerdraft facilities which may be utilised for any other
purpose.
Following are the benefits of proiding finance against bills for the ban*er.
No Ris9 in Len!ing, By proiding finance against bill, the ban* can ensure
safety of
funds lent. As a bill is a legal negotiable instrument with the signatures of two
concerned parties, enforcement of a claim is easier. Further, with recourse to two
parties, it implies a lower credit ris*. )n other words, if the acceptor of the bill fails
to ma*e payment on the due date the ban* can claim the whole amount form the
drawer of the bill.
Fun! B"se! Sevices 'reater 5i1uidity: A ban*er who is in need of funds can
rediscount bills with arious financial institutions as approed by the $B). ,hus
ban* can raise the funds easily and 1uic*ly against the bills which are
discounted..o change in the alue of the bill: As a security, the alue of a bill is
not subDect to fluctuations which are found in case of alues of tangible goods
and financial securities. ,he amount payable on account of a bill is fixed and the
acceptor is liable for the whole amount.
)ec"utions 'o Bill Discounting
Before approing a bill for discounting the following should be ensured by the
ban*er :
l ,he signature as well as credit limit of the ban*:s borrowers hae been erified.
9.eed to ensure that limit for bill discounting has been sanctioned by the credit
manager8.
l ,he nature of the transaction is mentioned on the bill and all inoice details are
proided. ,here is a need to erify and ensure that bill is drawn against a
genuine trade transaction. 9i.e. bill coers only sale of goods transactions8.
l ,he original tenor of the bill does not exceed 1"4 days if Bill Discounting Facility
is to be aailed of.
l ,he payment instructions and maturity date are clearly mentioned on the bill.
,he bill is drawn in faour of or endorsed to the discounting ban*.
l All material alterations hae been authenticated.
l .otice of dishonour and presentment hae been waied.
19#14 SC2%/% OF R%DISCOUNTING OF BILLS
)n order to ma*e commercial bill an actie instrument in the secondary money
mar*et, the $B) introduced bill rediscounting scheme in .oember 13>4 and the
same was reised from time to time. ,he features of reised rediscounting
scheme are as under :
18 ,he ban*, which originally discounts the usance bill, will hae to issue an
instrument *nown as IDeriatie 6sance =romissory .oteJ in faour of the ban*
or other approed financial institution with which it is rediscounting the bills. Such
usance promissory note should be payable not more than 34 days from the date
of rediscounting. 9'oernment has exempted stamp duty on deriatie usance
promissory note8.
"8 ,he usance promissory note should be bac*ed by unencumbered usance bills
of
exchange arising out of genuine commercial transactions eidencing sale of
goods.
#8 ,he negotiation of the usance promissory note shall be restricted to the
participants in the Bills $ediscounting scheme as approed by the $B).
&8 $ediscounting of bills must be for a minimum period of 1( days.
D%&%LO)/%NTS IN CO//%RCIAL BILL /AR;%T IN INDIA
-en though the role of commercial bill mar*et as an important segment of
money mar*et was recognised as early as in 13#4s, deliberate efforts were not
made to ensure deelopment of commercial bill mar*et till 13(".
F"ctoing, Fo'"iting "n! Bill Discounting Bill /"9et Sc(e6e o' 190$
)n @anuary 13(", the $esere Ban* of )ndia 9$B)8 introduced a Bill +ar*et
Scheme under section 1>9&89%8 of the $B) Act, 13#&. ,his scheme was
introduced with the obDectie of proiding li1uidity to ban*s in the form of demand
loans against the security of usance promissory notes or bills drawn on and
payable in )ndia of their constituents proided they arose out of bonafide
commercial or trade transactions. )n order to aail refinance under the aboe
section, the scheduled ban*s were re1uired to conert a portion of the demand
promissory notes obtained by them from their constituents in respect of loans,
oerdrafts and cash credit granted to them into usance promissory notes
maturing within 34 days. ,he accommodation which was initially restricted to
licensed scheduled commercial ban*s haing deposits of $s. 14 crore or more,
was later extended to all the licensed scheduled commercial ban*s irrespectie
of si;e of deposits. ,he scheme howeer, did not deelop into a genuine bill
mar*et as it was primarily intended for proiding accommodation from $B)
toban*s.
Bill /"9et Sc(e6e 'o %8.otes
)n 13(?, the $B) extended the Bill +ar*et Scheme to export bills also to
encourage ban*s to extend credit facilities to exporters on a more liberal basis.
,he ban*s, howeer, could not aail of these facilities as exporters were reluctant
to draw usance promissory notes as re1uired by the $B), after haing tendered
to ban*s for purposes of negotiation, documentary usance export bills which the
ban*s sent abroad for acceptance and collection. )n 137#, the $B) introduced a
new -xport Bills credit scheme whereby adances could be made by the $B) to
scheduled ban*s against their promissory notes only and upon their declaration
of holdings of eligible usance export bills drawn in foreign currencies or )ndian
rupees and discounted or negotiated by them.
Ne7 Bill /"9et Sc(e6e
,he next significant measure ta*en by the $B) for promotion of a bill mar*et was
in .oember 13>4 when on the recommendation of a Study 'roup chaired by +.
.arasimham, it introduced the .ew Bill +ar*et Scheme 9.B+s8. ,his schemes
was an improement oer the earlier scheme in that only genuine trade bills,
maturing within 34 days, arising out of bonafide commercial or trade transactions
inoling sale or despatch of goods were made eligible for rediscounting with the
$B) by all licensed scheduled commercial ban*s.
19#$: R%ASONS FOR NON>D%&%LO)/%NT OF BILL /AR;%T IN INDIA
Despite arious measures ta*en by the $B) to actiate bill mar*et, the same is
yet to
be fully deeloped in )ndia. ,he arious reasons can be identified in this regard.
Few
of these reasons are gien below :
18 $eluctance of industry as well as trade and 'oernment underta*ings as well
as departments to moe towards bill financing since it does re1uire obserance
of strict financial discipline. )n other words, industries and 'oernment
departments are not prepared to subDect themseles to the strict commitment to
honour financial obligations on the agreed date.
"8 ,he procedural delay inoled in the creditor getting a prompt legal remedy in
case of dishonoured bills.
Fun! B"se! Sevices #8 0ith the era of globalisation and reforms in the
economy, the domestic mar*et has become highly competitie and has turned
into a buyer:s mar*et. As a result, sellers of goods are not able to bring around
the buyers to accept bill of exchange for sale of goods on credit. From the
buyer:s point of iew, they would li*e to retain the character of the transaction as
a pure credit transaction with simple debtor/creditor relationship rather than
eleate it to a negotiable instrument. &8 <perational and procedural constraints in
the discounting and rediscounting of bills.l 5ac* of uniformity in the documents to
be submitted for aailing bill discounting facility.
l 0ide geographical spread of the buyers
l Delay on the part of drawers ban* in sending the bills for presentationA
acceptance
l Delay on the part of drawee in accepting the bills within a reasonable time
frame.
l Delay in remittance of proceeds by the ban* at the drawee:s end.
l Delay in the approal of new customers 9drawees8 in the absence of reliable
credit information especially in respect of small and medium si;e enterprises as
well as unlisted and unincorporated entities.
(8 %ost of aailing credit through bill discounting is perceied to be high
compared to cost of cash credit facility. )n addition to the discounting charges,
collection and handling charges are also leied. )n iew of this, effectie cost of
bill discounting turns out to be rather high especially in case of bills of smaller
amount.
19#$1 R%&ITALISING BILL /AR;%T IN INDIA
Since the introduction of the .ew Bill mar*et scheme, the $B) has introduced
seeral measures to encourage use of commercial bills and thus widen the
commercial bill mar*et in )ndia. Few of these measures are stated below :
l Simplification of the rediscounting procedures by dispensing with the actual
lodgement of bills in respect of bills below the face alue of $s. 14 lacs and
replacing it with deriatie bills. ,he minimum amount of bill at $s. (444A/
prescribed under the scheme was also done away with.
l =romotion of Drawee Bills Scheme, by ma*ing it mandatory for ban*s to extend
atleast "( per cent of the cash credit limit to borrowers in the form of bills and
re1uiring ban*s to ensure that their corporate borrowers financed their domestic
credit purchases from SS) units, atleast to the extent of "( per cent, by way of
acceptance bills drawn on them by their suppliers, and adising ban*s to monitor
the compliance of this re1uirement through a suitable monitoring system 9,hese
mandatory stipulations were subse1uently withdrawn with effect from
"nd .oember, 13338.
l $emission of Stamp duty by the 'oernment of )ndia on bills of exchange
drawn
on or made by or in faour of a commercial ban* or a co/operatie ban* and
payable not more than three months after date or sight.
l ,he licensed scheduled commercial ban*s hae been allowed to rediscount bills
with a few financial institutions such as 5ife )nsurance %orporation of )ndia
95)%8, 'eneral )nsurance %orporation of )ndia 9')%8 and its subsidiaries and
6nit ,rust of )ndia 96,)8 and such other financial institutions, incorporated in
?#
F"ctoing, Fo'"iting "n! Bill Discounting
)ndia, as may be approed by the $B) on a reference made to it. 9)n fact the
$B) has enlarged the list of approed institutions for rediscounting bills8.
l )n 13?1, in addition to all )ndia financial institutions, $B) allowed +utual Funds
to participate in Bill $ediscounting mar*et thus augmenting the supply of funds in
the secondary mar*et.
l ,he Discount and Finance Bouse of )ndia 5td. 9DFB)8 was set/up by the $B)
Dointly with public sector ban*s and All )ndia Financial )nstitutions to deelop
secondary mar*et for commercial bill.
l ,o simplify the procedure for rediscounting of bills by ban*s and to enable
multiple rediscounting of bills, the $B) has introduced a reised procedure under
which deriatie usance promissory notes drawn by ban*s for suitable maturities
upto 34 days on the strength of underlying bills discounted by the ban*s:
respectie branches can be rediscounted with other ban*s, approed financial
institutions and primary dealers. ,he 'oernment of )ndia has exempted the
payment of stamp duty on these usance promissory notes.
l Delin*ing interest rates applicable on discounting of bills from the prime lending
rates of ban*s thus giing commercial ban*s the freedom to charge mar*et
determined interest rate on bills.
19#$$ SU//AR+
)n this unit we hae discussed the financial serices namely Factoring, Forfaiting
and
bill discounting. Factoring inoles financing and collection of accounts
receiables in
domestic as well as international trade. ,his serice is rendered by the factor
who
proides finance against boo* debts, collects cash against receiables,
underta*es
sales ledger administration, proides protection against bad debts, etc. ,here are
three
parties to a factoring contract: buyer of goods, who has to pay for goods bought
on
credit terms, seller of goods, who has to reali;e credit sales from buyer. and the
factor, who acts as an agent and reali;es the sales from the buyuer.
Forfaiting is a source of trade finance which enables exporters to get funds from
the
forfaiter on transferring the right to recoer the debts from the importer. )t denotes
the purchase of trade bills or promissory notes by a ban* or financial institution,
without recourse to seller. Bill discouting is a source of short/term trade finance.
)t is
*nown as acceptance credit, where on party accepts liability of trade towards
third
party.
19#$* ;%+ <ORDS
F"ctoing, is a financial serice coering the financing and collection of accounts
receiables in domestic as well as international trade.
F"cto, acts as agent in realising credit sales from buyer and passes on the
realised
sum to seller after deducting his commission.
Fo'"iting, denotes the purchase of trade bills or promissory notes by a ban* or
a
financial institution without recourse to sell