RBI clarifies issues related to the business of factoring

By Babu Sivaprakasam, Deep Roy and Megha Agarwal, Economic Laws Practice
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The Factoring Regulation Act, 2011, enabled banks and non-banking financial companies registered as factors to undertake the business of factoring. The enactment of the Factoring Regulation Act was the first step taken by the government to regularize and facilitate the business of factoring in India. However, since banks and non-banking financial companies were both subject to the guidelines of the Reserve Bank of India (RBI) on matters pertaining to prudential norms and exposure requirements, there were glaring loopholes and unresolved issues regarding the conduct of the business of factoring by such entities.

Some of these issues were highlighted in this column in the February issue of India Business Law Journal. The RBI has taken steps to resolve these issues and provide clarity by way of its circular titled “Provision of Factoring Services by Banks – Review”, dated 30 July.

Clarifications

The circular has recognized three types of factoring services: (i) factoring “without recourse”, where banks will have no recourse against the assignor (owner of the receivable), except in the case of misrepresentation or non-performance of obligations by the assignor; (ii) factoring “with recourse”, where the sale of the receivables by the assignor to the banks would not amount to a true sale on the books of the assignor; and (iii) factoring with “limited recourse”, where the conditions of recourse may be contractually agreed between the bank and the assignor.

Babu Sivaprakasam
Babu Sivaprakasam

The circular prescribes the exposure norms in relation to the different kinds of factoring. In the case of factoring with recourse, the exposure is to be reckoned on the assignor and in the case of factoring without recourse, the exposure is to be reckoned on the debtor (person liable to pay the receivable). Thus, the circular has provided clarity on who the borrower would be and how provisioning would need to be done.

The circular’s provisions are in line with the recommendations made by the Technical Committee on Services/Facilities to Exporters, set up by the RBI and chaired by G Padmanabhan, in its report dated 29 April 2013. However, such reckoning of exposure assumes more importance as the circular stipulates that if a receivable acquired under factoring is not paid within 90 days of the due date, the entity on which the exposure was booked is to be treated as a non-performing asset.

Banks are mandated to ensure that factoring services are provided only for genuine trade transactions. Banks are also required to ensure that the pre-payment amount offered for the receivables is not more than 80% of the invoice value. The limits for underwriting commitments in without recourse factoring transactions are to be fixed by the banks’ boards. In order to avoid the risks of double financing, the circular prescribes that banks and factors should exchange information about common borrowers (that is, the assignor). For such purposes, banks could also resort to the information available at the Central Registry of Securitisation Asset Reconstruction and Security Interest of India.

For the purposes of accounting, factoring transactions would be treated as part of loans and advances. Banks are also required to conduct know your customer (KYC) checks in respect of all factoring services.

Export factoring

The Technical Committee’s report in 2013 suggested that the RBI should permit banks to undertake export factoring on a non-recourse basis. Prior to the RBI’s circular titled “Export factoring on non-recourse basis”, dated 16 July 2015, authorized dealer banks in India could only provide export factoring services to exporters on a with recourse basis.

Deep Roy
Deep Roy

Export factoring usually involves arrangements with international factoring companies such as Factors Chain International, International Factors Group, etc. Such companies envisage structures where the correspondent factor (import factor) can take up 100% of the payment risk of the importer abroad.

By way of the 16 July circular, the RBI has taken a step further to recognize the factoring of export receivables on a non-recourse basis and the concept of import factors, with the intent of enabling exporters to improve their cash flow and meet their working capital requirements.

The 16 July circular recognizes that the export factor (authorized dealer bank) can have a back-to-back arrangement with an import factor (located abroad). The export factor is required to conduct KYC, credit evaluation and due diligence on the exporter.

The two July circulars have provided the much required boost to trade financing structures in India. The country’s trade finance market is heading towards a more mature trajectory with complex structures being devised. Regulations such as those provided in the circulars help reaffirm and steer such structures in the right direction. The RBI always succeeds in introducing adequate risk management processes to ensure that the desired checks are in place.

Babu Sivaprakasam is a partner, Deep Roy is an associate partner and Megha Agarwal is an associate at Economic Laws Practice. This article is intended for informational purposes and does not constitute a legal opinion or advice.

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