An Overview of Indian Financial System

Financial System of any country consists of financial markets, financial intermediation and financial instruments or financial products. This paper discusses the meaning of finance and Indian Financial System and focus on the financial markets, financial intermediaries and financial instruments. The brief review on various money market instruments are also covered in this study. 

INDIAN FINANCIAL SYSTEM The economic development of a nation is reflected by the progress of the various

economic units, broadly classified into corporate sector, government and household sector.  While performing their activities these units will be placed in a surplus/deficit/balanced budgetary situations.

There are areas or people with surplus funds and there are those with a deficit.  A financial system or financial sector functions as an intermediary and facilitates the flow of funds from the areas of surplus to the areas of deficit.  A Financial System is a composition of various institutions, markets, regulations and laws, practices, money manager, analysts, transactions and claims and liabilities.

Financial System;

The word "system", in the term "financial system", implies a set of complex and closely connected or interlined institutions, agents, practices, markets, transactions, claims, and liabilities in the economy.  The financial system is concerned about money, credit and finance-the three terms are intimately related yet are somewhat different from each other. Indian financial system consists of financial market, financial instruments and financial intermediation.

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These are briefly discussed below; FINANCIAL MARKETS A Financial Market can be defined as the market in which financial assets are

created or transferred. As against a real transaction that involves exchange of money for real goods or services, a financial transaction involves creation or transfer of a financial asset. Financial Assets or Financial Instruments represents a claim to the payment of a sum of money sometime in the future and /or periodic payment in the form of interest or dividend.

Money Market- The money market ifs a wholesale debt market for low-risk, highly-liquid, short-term instrument.  Funds are available in this market for periods ranging from a single day up to a year.  This market is dominated mostly by government, banks and financial institutions.

Capital Market -  The capital market is designed to finance the long-term investments.  The transactions taking place in this market will be for periods over a year.

Forex Market - The Forex market deals with the multicurrency requirements, which are met by the exchange of currencies.  Depending on the exchange rate that is applicable, the transfer of funds takes place in this market.  This is one of the most developed and integrated market across the globe. Credit Market- Credit market is a place where banks, FIs and NBFCs purvey short, medium and long-term loans to corporateandindividuals.

Constituents of a Financial System

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FINANCIAL INTERMEDIATION Having designed the instrument, the issuer should then ensure that these

financial assets reach the ultimate investor in order to garner the requisite amount.  When the borrower of funds approaches the financial market to raise funds, mere issue of securities will not suffice.  Adequate information of the issue, issuer and the security should be passed on to take place.  There should be a proper channel within the financial system to ensure such transfer. To serve this purpose, Financial intermediaries came into existence. Financial intermediation in the organized sector is conducted by a widerange of institutions functioning under the overall surveillance of the Reserve Bank of India. In the initial stages, the role of the intermediary was mostly related to ensure transfer of funds from the lender to the borrower.  This service was offered by banks, FIs, brokers, and dealers.  However, as the financial system widened along with the developments taking place in the financial markets, the scope of its operations also widened. Some of the important intermediaries operating ink the financial markets include; investment bankers, underwriters, stock exchanges, registrars, depositories, custodians, portfolio managers, mutual funds, financial advertisers financial consultants, primary dealers, satellite dealers, self regulatory organizations, etc. Though the markets are different, there may be a few intermediaries offering their services in more than one

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market e.g. underwriter.  However, the services offered by them vary from one market to another.

Intermediary Market Role

Stock Exchange Capital Market Secondary Market

to securities

Investment Bankers

Capital Market, Credit Market

Corporate advisory services, Issue of securities

Underwriters Capital Market,

Money Market

Subscribe to unsubscribed portion of securities

Registrars, Depositories, Custodians

Capital Market

Issue securities to the investors on behalf of the company and handle share transfer activity

Primary Dealers Satellite Dealers

Money Market Market making in

government securities

Forex Dealers Forex Market Ensure exchange

ink currencies

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FINANCIAL INSTRUMENTS Money Market Instruments The money market can be defined as a market for short-term money and

financial assets that are near substitutes for money. The term short-term means generally a period upto one year and near substitutes to money is used to denote any financial asset which can be quickly converted into money with minimum transaction cost. Some of the important money market instruments are briefly discussed below;

1.Call/NoticeMoney 2.TreasuryBills3.Termoney4.CertificateofDeposit5. Commercial Papers

Call /Notice-Money Market Call/Notice money is the money borrowed or lent on demand for a very short period. When money is borrowed or lent for a day, it is known as Call (Overnight) Money. Intervening holidays and/or Sunday are excluded for this purpose. Thus money, borrowed on a day and repaid on the next working day, (irrespective of the number of intervening holidays) is "Call Money". When money is borrowed or lent for more than a day and up to 14 days, it is "Notice Money". No collateral security is required to cover these transactions.

Inter-Bank Term Money Inter-bank market for deposits of maturity beyond 14 days is referred to as the term money market. The entry restrictions are the same as those for Call/Notice Money except that, as per existing regulations, the specified entities are not allowed to lend beyond 14 days.

Treasury Bills. Treasury Bills are short term (up to one year) borrowing instruments of the union government. It is an IOU of the Government. It is a promise by the Government to pay a stated sum after expiry of the stated period from the date of issue

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(14/91/182/364 days i.e. less than one year). They are issued at a discount to the face value, and on maturity the face value is paid to the holder. The rate of discount and the corresponding issue price are determined at each auction.

Certificate of Deposits Certificates of Deposit (CDs) is a negotiable money market instrument nd issued in dematerialised form or as a Usance Promissory Note, for funds deposited at a bank or other eligible financial institution for a specified time period. Guidelines for issue of CDs are presently governed by various directives issued by the Reserve Bank of India, as amended from time to time. CDs can be issued by (i) scheduled commercial banks excluding Regional Rural Banks (RRBs) and Local Area Banks (LABs); and (ii) select all-India Financial Institutions that have been permitted by RBI to raise short-term resources within the umbrella limit fixed by RBI. Banks have the freedom to issue CDs depending on their requirements. An FI may issue CDs within the overall umbrella limit fixed by RBI, i.e., issue of CD together with other instruments viz., term money, term deposits, commercial papers and intercorporate deposits should not exceed 100 per cent of its net owned funds, as per the latest audited balance sheet.

Commercial Paper CP is a note in evidence of the debt obligation of the issuer. On issuing commercial paper the debt obligation is transformed into an instrument. CP is thus an unsecured promissory note privately placed with investors at a discount rate to face value determined by market forces. CP is freely negotiable by endorsement and delivery. A company shall be eligible to issue CP provided - (a) the tangible net worth of the company, as per the latest audited balance sheet, is not less than Rs. 4 crore; (b) the working capital (fund-based) limit of the company from the banking system is not less than Rs.4 crore and (c) the borrowal account of the company is classified as a Standard Asset by the financing bank/s. The minimum maturity period of CP is 7 days. The minimum credit rating shall be P-2 of CRISIL or such equivalent rating by other agencies. (for more details visit www.indianmba.com faculty column)

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Capital Market Instruments The capital market generally consists of the following long term period i.e., more than one year period, financial instruments; In the equity segment Equity shares, preference shares, convertible preference shares, non-convertible preference shares etc and in the debt segment debentures, zero coupon bonds, deep discount bonds etc.

Hybrid Instruments Hybrid instruments have both the features of equity and debenture. This kind of instruments is called as hybrid instruments. Examples are convertible debentures, warrants etc.

MERCHANT BANK

Merchant Bank an outlines Merchant banking is basically a service banking, concerned with providing non-fund based services of arranging funds rather than providing them. The merchant banker merely acts as an intermediatory, whose main job is to transfer capital from those who own it to those who need it. With the increase in the complexities and requirements of modern business, the role of a merchant banker has undergone a substantial change. The merchant banker now acts as an institution which understands the requirements of the entrepreneur promoters on the one hand and financial institutions, banks, stock-exchange and money markets on the other.

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 The services of a merchant banker can be summarized as follows:

1. Project counseling: A merchant banker helps an entrepreneur in conception of idea, identification of projects, preparation of projects, feasibility reports, fixing locations, obtaining money, sanctions/approvals from State and Central Government departments.

2. Sponsor of issue: Merchant banker act as sponsor of issues rather than sources of finance. They prepare prospectus, get the approval from Securities and Exchange Board of India (SEBI), and engage underwriters, brokers for issue.

3. Credit syndication: Merchant bankers undertake preparation of project files, loan applications for financial assistance on behalf of promoters from different financial institutions for meeting long-term as well as working capital requirements of their clients.

4. Servicing of issues: Merchant bankers keep register of share-holders and debentures holders of their clients-companies-act as paying agents for the dividends, debentures interest. They also arrange for safe custody of securities on behalf of their clients.

5. Investment management

Merchant bankers render advice in matters pertaining to investment decisions, effects of taxation and inflation on gilt edged and other securities. They also undertake the functions of buying and selling securities for their client companies.

6. Arrangement for fixed deposits

Merchant bankers help companies to raise finance by way of fixed deposits from the public. For this purpose, they not only provide required guidance but also act as brokers for mobilization of public deposits.

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7. Other specialist activities

These include:

(a) Corporate counseling for financial institutions, rehabilitation and reconstruction of old/ailing or sick industrial units.

(b) Services to Non Resident Indians for suitable investment opportunity in India.

(c) Assistance in negotiations of foreign collaboration.

(d) Arranging technology, finance and risk/venture capital.

Merchant Banking Organization in India: Merchant Banking services are provided by the following organizations in India:

(a) Indian commercial banks, such as the State Bank of India, Canara Bank, Bank of Baroda have floated wholly owned subsidiaries, namely State Bank of India Capital Markets Ltd., (SBICAP), Canbank Financial Services Ltd. (Canfina), Bank of Baroda Fiscal Services Ltd. (BOB Fiscal) respectively for carrying out merchant banking activities.

(b) Most of the foreign banks are offering merchant banking services.

(c) All India financial institutions, such as Industrial Credit and Investment Corporation of India (ICICI), International Finance Corporation (IFC), and Industrial Development Bank of India (IDBI) have also entered in this field. (d) Private consultancy firms, such as DSP Financial consultants, Credit Capital Finance Corporation Ltd., J.M. Financial and Investment services Ltd.

(e) Technical consultancy organizations.

(f) Professional merchant banking houses, such as Visual meteorological conditions (VMC) Project Technologies are also slowly coming up in India.

Regulation of Merchant Banks

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At present, merchant banks in India are subject to supervision by two types of authorities.

(i) The Reserve Bank of India (RBI) supervises those merchant banks which are subsidiaries or are affiliates of commercial banks. If the merchant banks were to raise deposits, they would have to follow the guidelines issued by the RBI.

(ii) Since the beginning of 1993, the merchant banking has been statutorily brought

under the regulatory framework of the Securities Exchange Board of India (SEBI)

to ensure greater transparency in their working and make them accountable.

(a) The merchant bankers are now to be authorized by SEBI. (b) They will have

To follow the stipulated capital adequacy norms. (c) They have to abide by a code of conduct which specify a high degree of responsibility towards investors in respect of pricing and premium fixation of issues and disclosures in the prospectus or offer letter for issues.

State Bank of Indias Merchant Banking Group is strongly positioned to offer perfect financial solutions to your business. They specialize in the arrangement of various forms of Foreign Currency Credits for Corporates.They provides the resources, convenience and services to meet the needs by arranging Foreign Currency credits through: Commercial loans,Syndicated loans

Lines of Credit from Foreign Banks and Financial Institutions ,FCNR loans,Loans from Export Credit Agencies,Financing of Imports. They are internationally the most Preferred Bank by Export Credit Agencies for Guarantees in case of the Indian Clients or Projects. State Bank of India being

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an Indian entity has no India exposure ceiling. Their Primary focus is on Indian Clients. State Bank of Indias seasoned Team of professionals provides with Insightful credit Information and helps to maximize the Value from the transaction.

Their products and services:

1] Arranging External Commercial Borrowings (ECB)

2] Arranging and participating in international loan syndication

3] Loans backed by Export Credit Agencies

4] Foreign currency loans under the FCNR (B) scheme

5] Import Finance for Indian corporates

CANARA BANK is also one of the leading Merchant Bankers in India, offering specialized services to Banks, State owned Corporations, Local Statutory bodies and corporate sector.

They are Category I Merchant Banker authorized by Securities and Exchange Board of India for Issue Management (Public / Rights / Private Placement Issues), Underwriting of Issues, Consultancy / Advisory Services to an issue including Corporate Advisory Services etc.

They are also SEBI registered Bankers to an Issue with network of dedicated Capital Market Service Branches to handle "Capital Market related assignments".

They are undertaking project appraisals connected with resource raising plans from Capital Market/ Debt Markets and facilitate tie-ups with Banks / Financial Institutions and Potential Investors.

Their uniqueness is extending services under single window concept covering the following areas:

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1. Merchant Banking 2. Commercial Banking 3. Investments 4. Bankers to Issue - Escrow Bankers 5. Underwriting 6. Loan Syndication

They are one of the leading Merchant Bankers in India, involving various types of industries, banks, statutory Bodies etc. and have an edge in handling Private Placement issues - both retail & target Investors.

Spectrum of services

1. Equity Issue (Public/Rights) Management,Debt Issue Management 2. Private Placement ,Project Appraisal 3. Corporate Advisory Services, Mergers and Acquisitions 4. Buy Back Assignments, Share Valuations, Issue management services,

Project Appraisal 5. Capital structuring, Preparation of offer document 6. Tie Ups (placement) Formalities with SEBI / Stock Exchange 7. Underwriting Promotion /Marketing of Issues, Collecting Banker /

Banker to an issue 8. Post Issue Management Refund Bankers .Debenture Trusteeship

Project appraisal capability

They have a separate industrial advisory division / project finance division consisting of experienced and technically qualified personnel for appraisal of all industrial projects and an exclusive agricultural consultancy services section for appraising agro based projects.

Marketing edge/ products to retail investors

They keep the list of Potential Investors - Institutions, Provident, Pension & Gratuity Funds, High Net worth Individuals and others updated and continuously assess their investment appetites and help issuers in effective marketing of the products.

Leasing Finance

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Asset Finance: A method of lending in which lenders look primarily to the cash flow from a particular asset for repayment.Features of Asset Finance:Usually no additional collateral required apart from the asset financed. Asset’s ability to generate cash flow is important in the lending decision.Compare with Asset Based Lending: A flexible form of finance which allows businesses to secure funding against debtors (via invoice discounting and factoring), stock, plant and machinery and property.Conditional Sale: A sale of goods in which the buyer gains immediate possession of the goods but the seller retains title until the buyer performs a condition, especially payment of full purchase price (United Kingdom).• Installment Sale: A conditional sale in which the buyer makes a down payment followed by periodic payments and the seller retains title or a security interest until all payments have been made (South Africa).• Credit Sale: An agreement for the sale of goods, the purchase price being payable by 5 or more installments, not being a conditional sale agreement. Under such agreements the ownership of goods passes to the buyer at once, and he may therefore pass on good title to another person (United Kingdom).Finance Lease: A fixed term lease used by a business to finance capital equipment. The Lessor’s service is usually limited to financing the asset, and the lessee pays maintenancecosts and taxes and has the option of purchasing the asset at the lease – end for a nominal price._ Hire Purchase: is decisively a financing transaction. A Hire - Purchase agreement is an agreement to finance the acquisition of goods. However, a H.P. may be different from a FL with regard to purchase options, use thereof ( e.g. consumer goods or for consumers). HP is a common law concept, remains in statute books but it has either: never/ rarely been used or a historical concept._ Operating Lease: A lease of property, especially equipment for a term that is shorter than the property’s useful life. Under an operating lease, the

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lessor is typically responsible for paying taxes and other exFinance Lease: A fixed term lease used by a business to finance capital equipment. The Lessor’s service is usually limited to financing the asset, and the lessee pays maintenance costs and taxes and has the option of purchasing the asset at the lease – end for a nominal price._ Generally speaking, a lease is a contract between two parties whereby one party (the “lessor”) lets another party (the “lessee”) use an asset in exchange for regular periodic payments. A lease separates ownership of an asset from it’s use.The Business logic of leasing: One does not have to own an asset to use it for production and to generate profits. Legally & Historically: A lease (as with a Hire Purchase) is a contract of bailment. There are different types of bailment’s. A bailment is an entrustment of goods/ a party (the “bailor”) gives possessory rights to goods to another party the “bailee”) A FL is a financing device/ mechanism - Financial lessors, are normally financial intermediaries. Financial lessors are not vendors, even though a leasing company may be a captive. i.e., a subsidiary of an equipment supply company e.g. Caterpillar FinancialServices Inc., IBM Global Financing, Ford Motor Credit etc)• A finance lease is not a sale or an agreement to sell; although a transfer of title to the goods may take place at end of the lease term - compare with England and India where legally a lease does not contain a purchase option. However, this is more of a legal fiction todistinguish a lease from a Hire Purchase

A finance lease is not a pledge or a mortgage of assets by a borrower (lessee) to a creditor (lessor) in return for credit advance. The assets/ goods do not belong to the lessee, but to the lessor.• Amortization of all or substantially the whole of the cost of the asset (plus element of profit). Compare with practical experiences in the United States, i.e., large equipment

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suppliers; Convention on International Financial leasing; Ghana legislation.• Typically written for capital and business assets; not for consumer type assets. Hire Purchase and remnants thereofUNIDROIT – International Institute for Unification of Private Law,(http://www.unidroit.org) based in Rome, Italy. UNIDROIT is not part of the UN system. States are members - Tanzania is not. In Africa: Tunisia, South Africa and Nigeria are members.• UNIDROIT activities include to harmonize private law amongst and between states. In 1988 UNIDROIT was instrumental in drafting the Convention on International Financial Leasing (“the Ottawa Convention”). Tanzania has not ratified the Convention. The Ottawa Convention provides a framework for cross border leasing between States that are party to it. The Convention recognizes financial leasing as a “three party arrangement

Currently, a UNIDROIT Advisory Board is involved in the preparation of a preliminary model law on leasing with developing countries in mind. The Advisory Board is comprised of eminent leasing lawyers around the world:– U.S.A (drafters of Article 2AU.S. Uniform Commercial Code), Tunisia, Nigeria, France, Columbia, U.S. Equipment Leasing Association – “ELA”), International Finance Corporation etc., represented_ Philosophy – Leasing is a powerful economic tool for both developing and developed countries alike; harmonization of leasing laws required in order to facilitate greater capital investment._ The process: Advisory Board prepared the preliminary draft model law, the draft has to be approved before formal adoption. Once adopted, it will be a “model law”, and can and will need to be adapted to local needs and conditions.

This question is particularly relevant in common law countries. The answer depends on

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various factors.Arguments Against a leasing law:-_ Leasing is a contractual arrangement; and can be defined under contract terms. _ The absence of a law provides greater flexibility to parties to structure lease deals._ Common law/ case law should provide the legal framework for leasing. Refer the case of India

Arguments For a leasing law:_ Legislation/ legislative guidance provides certainty & clarity for lease transactions/ parties.Compare United Kingdom experience, and the practical experiences in Tanzania._ Countries with no law require a strong judiciary knowledgeable and sympathetic tofinancial leasing and to financiers; adherence to common law principles – Compare India._ Economic and policy considerations – Economic benefits of leasing and appropriate investment climate for both local and foreign investment for leasing Some common law countries with codified leasing law/s: United States, Ghana, Srilanka, Egypt. United Kingdom has a legislative framework (various legislation relevant toleasing) _ Other common law countries in the process of reviewing or enacting laws: –Uganda, Nigeria, Tanzania._ Non – common law countries: – China, Central Asia Republics (Uzbekistan, Kazakhstan),Ukraine, Ethiopia, France, Brazil, among othersA finance lease transaction raises the following legal issues:_ Finance leasing is a financing transaction.The leasing company/ lessor is a financial intermediary supplying finance through a leaseagreement. The lessor in FL is not responsible for quality and fitness for purpose of leased

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equipment.‘Hell or high water clauses.’ A lease agreement between lessor and lessee becomesirrevocable once signed. Logic: Financial leasing is a financing arrangement equivalent toa term loan. Lessor’s paramount right is to receive lease rental payments

Rights and duties of parties; (Legal) allocation of financial risk.A finance lease as a tripartite arrangement: (a) Equipment vendor/ supplier; (b) Leasingcompany (independent lessor/ bank department/ bank subsidiary/ captive lessor); and (c’)lessee.Equipment quality claims (defects) must be addressed directly to the vendor. Lessor willavoid equipment claims. Right of lessee to direct equipment quality claims to supplierdirectly should be clear. Lessor’s primary duty to the lessee is of ‘quiet enjoyment’ of the leased property. (Disputes of the above nature in the Tanzanian legal system).Lessor can assign the lease agreement – transferability promotes growth of financial markets. Lessee should not create rights in favour of third parties without lessor’s consent, e.g. Subleasing. _ Third party liability & Insurance Third party injury and death arising from use of leased assets. Occurrence of damage to leased assets.Insurance of leased assets, and loss payee Registration of interests in leased assets Lessor’s assertion of legal title. Constructive notice to third party purchasers, mortgagees, pledgees etc. Notification of assets under lease may be done with - in Tanzania with Registrar of Documents/ Titles - Chattels Transfer Act. • Enforcement of lease contracts and repossession of leased assets Efficient mechanisms for recovery of leased assets and financier’s investment required, where lessees default on lease payments.

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Summary Procedure should be available under Tanzania Civil Procedure Code Act, 1966 for recovery of debts arising from finance lease Agreements Prudential guidelines are required for Banks, Financial, and other deposit taking institutions that carry on the business of leasing. _ Although there is usually limited justification for guidelines for non – deposit taking institutions carrying out leasing operations. Capital adequacy requirements, corporate governance and light regulation for non – deposit taking leasing companies may be necessary dependant on the level of a country’s development. There are advantages and disadvantages of regulation for these types.

_ Existing Guidelines for Banks: Investment in moveable property Concentration of credit Debt/ equity ratio Capital adequacy requirements Objectives of Central Bank Supervision: • To protect public from undue harm. _ Promote confidence in the financial system. _ Promote the role of the financial system towards economic development._ Prevent public finances being hit by a major financial crisis.Purpose of regulation of leasing companies:_ Prevent mortality of leasing companies._ Avoid damages to creditors and funding sources to leasing companies.

_ Avoid damages to lessees, and suppliers._ Require accountability from shareholders, directors and managers.Important issues to consider:Matching Assets and liabilities maturities Matching Exposure to exchange rate fluctuations Matching exposure to interest rate fluctuations (All of the above are considered by BASEL as Market Risks). Master Lease Agreement Allows for leasing of goods from time to time. Contains principal provisions (terms & conditions), pursuant to which all business between lessor and lessee can be conducted.• Lease Agreement Can be used where a Master Lease is not required. May ordinarily contain provisions such as: subject matter of lease, rent, delivery and operation of goods, payment, notification, and reporting, maintenance, insurance, default and remedies for default, assignment, hell or high water, disclaimer provisions, early termination, purchase option.

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Finance Lease Schedule Financial terms including, advance rentals if any, lessors capitalized costs, basic term, basic term commencement date, taxes, option payment etc.

• Maintenance Agreement Between lessee and third party manufacturer, supplier or dealer or other party providingmaintenance services. Specifies terms and conditions by which assets are maintained.Assets maintained from time to time based on usage or after periodic intervals. Maintenance charge may be fixed or variable Buy – Back Guarantee Usually between lessor and third party manufacturer providing the buy-back guarantee. Lessor requires vendor to repurchase the asset at a determined price or price ascertained at a certain formula.• OTHER DOCUMENTS – LANDLORD’S WAIVER, LENDER’S WAIVER, AGENCY AGREEMENT,Personal Guarantees Landlord’s WaiverA Landlord’s Waiver is required where a lessee leases goods from a lessor, and the goodsare affixed to immovable property that belongs to a third party, the landlord. The landlordin this case should provide a waiver that as long as the goods are under financial lease, theleased property shall not become part of the land, and that the landlord shall not have anyrights to the same.LENDER’S WAIVERThis may be required where the lessee is a corporate entity that has issued debentureswhich charge the company’s property to other third party lenders. A lessor of goods for

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financial lease may require the lessee company (to which it leases goods) to obtain aWaiver from those other lenders that the property under finance lease shall not form part ofthe Company’s assets. These are useful instruments in countries where movable assetregistries are underdeveloped/ inefficient. By obtaining a Lenders Waiver a lessor willeffectively ring fence/ isolate the leased assets from the pool of company assetPERSONAL GUARANTEES:Leasing companies in less developed leasing markets may require additional security for afinance lease. In these markets, it is common for leasing companies to require the lessee toprovide a personal guarantee made by a third party in respect of the finance leaseagreement. The Guarantor, under a Guarantee Agreement, will guarantee to the lessorpayment of outstanding lease payments in event of the lessees’ default on the finance lease.The personal guarantee should be backed by realizable property/ assets.

AGENCY AGREEMENTThis Agreement may be necessary if the Lessor wishes to appoint the Lessee his agent forthe purchase of goods from the vendor, and if the lessor does not wish his identity knownFINANCE LEASING ACTIVITIESForms of Business in which Finance Leasing Companies may engage:1. A finance leasing company may engage in the following activities:

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(i) finance leasing and business activities incidental to finance leasing;(ii) issuing and taking guarantees related to finance leasing;(iii) other transactions as authorized by the Authority; and(iv) taking and registering lease agreements and security in respect of finance leasing.ELIGIBLE LEASE PROPERTY2. Tangible movable property may be leased under a finance leasing transaction, including, but not limited to, the following: (i) Machinery, equipment and instruments; (ii) Vehicles, aircraft, ships, boats, boatyard equipments; (iii) Motors, and navigation equipment for vehicles, aircrafts, ships and boats;(iv) Household consumer durables; and(v) Movable property that by its location within a building or by being attached to land forms a part of the building or the land.(vi) Movable property that is attached to other movable property.3. Unless a law or agreement provides otherwise, for the purposes of this law and the recognition and enforcement of the rights of lessors and lessees, movable property that is attached to or installed in a building or land or other movable property is deemed to retain its separate identity and does not become part of the land, building or other movable property to which it is attached.Restrictions on finance leasing business4. The total value of property leased to one person or company, including a subsidiary or related company, by a finance leasing company shall not exceed 25% of the total paid-in-capital of the leasing company.5. The maximum value of property leased by a finance leasing company to one shareholder shall not in individual cases exceed 10% of the shareholder’s equity in the finance leasing company and the total value of property leased to shareholders, members of the board of directors, executive director, chief executive officer or officers of the company cumulatively shall not exceed 25% of the total paid-in-capital of the

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company. Property leased to above mentioned persons shall not be on terms and conditions other than those generally applicable nor should these persons be permitted to serve in any capacity in the company if the lease payments or any other amount due from them to the finance leasing company remains unpaid for more than three months.6. A finance leasing company shall not solicit, receive or accept deposits from the public but this restriction shall not apply to term deposits of more than one year from institutions and/or companies.LICENSING AND REGULATION OF FINANCE LEASING COMPANIES LICENSING7. No person, whether natural or legal, shall carry on the business of finance leasing unless the person holds a license issued by the Authority8. A person seeking a license shall submit an application to the Authority with the following information and documents:(i) founding agreement or shareholder agreement, if any;(ii) the Memorandum of Association and Articles of Association of the company, or, if a partnership, the Partnership Agreement;(iii) a business plan including financial feasibility, marketing plan, operational plan and other relevant information;(iv) information on the method of raising funds and projected financial statements for the next three years; (v) the names and addresses of the directors of the company, the chief executive officer and senior management personnel; and (vi) such other information or documents as the Authority may require.9. The Authority shall notify the applicant of its decision to grant or deny the application within 45 days from the receipt of a completed application for a license.Commencement of Business10. A finance leasing company shall commence its business within six months from obtaining a license, unless an extension of time has been granted by the Authority.

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Restrictions on Use of Name11. The name of a finance leasing company shall use as part of its name the words “finance leasing company”.12. No one shall use in business activity the words “finance leasing company”, “finance lease”, “financial lease” “lease finance” or words of similar connotation without having a license under these regulations.13. The name of the finance leasing company and its registered office shall not be changed without the approval of the AuthorityRegulatory Powers of the Authority14. The Authority shall regulate, supervise and inspect the business of finance leasing companies and may issue orders and directions as may be necessary for these purposes.15. The Authority may suspend or revoke the license granted to a finance leasing company for any one or more of the following reasons:(i) the company has not commenced business within six months of the grant of license and no extension has been granted by the Authority;(ii) the company has violated any law or regulation governing the operation of thecompany; (iii) the company is unable to effectively carry on finance leasing activities;(iv) the company voluntarily terminates its operation after receiving approval for such termination;(v) the company ceases to carry on finance leasing business in the Maldives; or(vi) the company is insolvent or is subject to bankruptcy or liquidation proceedings or a receiver of its assets has been appointed.Termination of Business16. A finance Leasing company whose license is suspended or revoked or which voluntarily terminates its operation before or at the expiration of its license shall wind down its operations or conduct its liquidation process, if necessary, in accordance with the laws of the Republic of the Maldives.

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27. A finance leasing company that voluntarily terminates its operations prior to the expiration of its license shall do so only after receiving the approval in writing of the Authority.18s. The suspension or revocation of a license or the termination of business of a finance leasing company shall not affect the validity and enforceability of leases under which the company is the lessor existing at the date of suspension, revocation or termination.

Factoring in India

What is factoring?

Factoring is a financial option for the management of receivables. In simple definition it is the conversion of credit sales into cash. In factoring, a financial institution (factor) buys the accounts receivable of a company (Client) and pays up to 80%(rarely up to 90%) of the amount immediately on agreement. Factoring company pays the remaining amount (Balance 20%-finance cost-operating cost) to the client when the customer pays the debt. Collection of debt from the customer is done either by the factor or the client depending

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upon the type of factoring. We will see different types of factoring in this article. The account receivable in factoring can either be for a product or service. Examples are factoring against goods purchased, factoring for construction services (usually for government contracts where the government body is capable of paying back the debt in the stipulated period of factoring. Contractors submit  invoices to get cash instantly), factoring against medical insurance etc. Let us see how factoring is done against an invoice of goods purchased.

Factor

Client

Customer

Pays the amount (In recourse type customer pays through client)

credit sale of goods

Invoice

Submit invoice copy

Payment up to 80% initially

Pays the balance amount

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Characteristics of factoring

1. Usually the period for factoring is 90 to 150 days. Some factoring companies allow even more than 150 days.

2. Factoring is considered to be a costly source of finance compared to other sources of short term borrowings.

3. Factoring receivables is an ideal financial solution for new and emerging firms without strong financials. This is because credit worthiness is evaluated based on the financial strength of the customer (debtor). Hence these companies can leverage on the financial strength of their customers.

4. Bad debts will not be considered for factoring.

5. Credit rating is not mandatory. But the factoring companies usually carry out credit risk analysis before entering into the agreement.

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6. Factoring is a method of off balance sheet financing.

7. Cost of factoring=finance cost + operating cost. Factoring cost vary according to the transaction size, financial strength of the customer etc. The cost of factoring vary from 1.5% to 3% per month depending upon the financial strength of the client's customer.

8. Indian firms offer factoring for invoices as low as 1000Rs

9. For delayed payments beyond the approved credit period, penal charge of around 1-2% per month over and above the normal cost is charged (it varies like 1% for the first month and 2% afterwards).

Different types of Factoring

1. Disclosed and Undisclosed 2. Recourse and Non recourse

A single factoring company may not offer all these services.

Disclosed

In disclosed factoring client's customers are notified of the factoring agreement. Disclosed type can either be recourse or non recourse.

Undisclosed

In undisclosed factoring, client's customers are not notified of the factoring arrangement. Sales ledger administration and collection of debts are undertaken by the client himself. Client has to pay the amount to the factor irrespective of whether customer has paid or not. But in disclosed type factor may or may not be responsible for the collection of debts depending on  whether it is recourse or non recourse.

Recourse factoring

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In recourse factoring, client undertakes to collect the debts from the customer. If the customer don't pay the amount on maturity, factor will recover the amount from the client. This is the most common type of factoring. Recourse factoring is offered at a lower interest rate since the risk by the factor is low. Balance amount is paid to client when the customer pays the factor.

Non recourse factoring

In non recourse factoring, factor undertakes to collect the debts from the customer. Balance amount is paid to client at the end of the credit period or when the customer pays the factor whichever comes first. The advantage of non recourse factoring is that continuous factoring will eliminate the need for credit and collection departments in the organization.

Factoring companies in India

Canbank Factors Limited: http://www.canbankfactors.com

SBI Factors and Commercial Services Pvt. Ltd: http://www.sbifactors.com

The Hongkong and Shanghai Banking Corporation Ltd: http://www.hsbc.co.in/1/2/corporate/trade-and-factoring-services

Foremost Factors Limited: http://www.foremostfactors.net

Global Trade Finance Limited: http://www.gtfindia.com

Export Credit Guarantee Corporation of India Ltd: https://www.ecgc.in/Portal/productnservices/maturity/mfactoring.asp

Citibank NA, India: http://www.citibank.co.in

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Small Industries Development Bank of India (SIDBI): http://www.sidbi.in/fac.asp

Standard Chartered Bank: www.standardchartered.co.in

Click here to contact the Factors Chain International members from India

Domestic Factoring - For sales within India

Steps in Domestic Factoring:

Customer ( Buyer) places the order with Client (Seller)

Client (Seller) obtains a prepayment limit from IFCI Factors Limited

(Formerly Foremost Factors Limited).

Client (Seller) delivers goods/services to the customer

(Buyer). 

Copies of Invoices, along with a Notice to Pay, are submitted to IFCI Factors Limited (Formerly Foremost

 

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Factors Limited) 

IFCI Factors Limited (Formerly Foremost Factors Limited) makes a prepayment advance to the Client

(Seller).

IFCI Factors Limited (Formerly Foremost Factors Limited) follows up

on payment with the Customer (Buyer)

Customer (Buyer) makes payment to IFCI Factors Limited (Formerly

Foremost Factors Limited).

IFCI Factors Limited (Formerly Foremost Factors Limited) makes the balance payment to the Client

(Seller).

Multi Service Package

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At IFCI Factors Limited (Formerly Foremost Factors Limited), the Domestic Factoring facility comprises of the following:

Instant Prepayments:Advances are made to the client based on agreed prepayment percentages on submission of invoices. Balance payment is made on the receipt of payment from the buyer.

Sales Ledger Administration:Under a domestic factoring agreement, IFCI Factors Limited (Formerly Foremost Factors Limited) operates the Sales Ledger for the Clients, monitoring the invoices issued and payments received. IFCI Factors Limited (Formerly Foremost Factors Limited) also provides you with valuable MIS to enable you to take better informed credit and pricing decisions.

Collection of Payments:IFCI Factors Limited (Formerly Foremost Factors Limited) follows up on payment through correspondent factor, with the Customer (Buyer) and makes the balance payment to its Client (Seller).

Advisory Services:IFCI Factors Limited (Formerly Foremost

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Factors Limited) also offers advisory services to its clients such as credit assessment for domestic buyers. 

 

Export Factoring - For sales outside India.

For your exports, International Factoring works to your advantage by providing you funding, credit assessment, credit protection and collection services.

IFCI Factors Limited (Formerly Foremost Factors Limited) will help you enhance your competitiveness in the global market with overseas credit protection. We are a member of Factors Chain International (FCI), an organisation of factoring companies headquartered at Amsterdam, Netherlands. FCI boasts of more than 160 factoring companies in nearly 60 countries spread across the six continents. Our International network of correspondent factors go a long way in helping you to overcome all distance and language barriers and establish an easy flow of communication with your customers. Using EDIFACT, the standard international electronic data interchange factoring network via satellite, IFCI Factors Limited (Formerly Foremost Factors Limited) gives you speedy and reliable reporting on your overseas customer accounts.

  Sharper Competitive Edge

Entrusting your international accounts to us will provide you with the following benefits: 

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Commercial Credit Risk Management:

IFCI Factors Limited (Formerly Foremost Factors Limited) facilitates open account trading without credit risk by arranging credit protection on agreed terms. In a highly competitive global market, this helps you to procure orders by offering more attractive terms to your customers.

Overseas Payment Collection:

IFCI Factors Limited (Formerly Foremost Factors Limited) follows up on payment through its network of Factors with your Customer (Buyer).

Prompt Prepayments:

We provide initial prepayment against your invoices at an agreed prepayment percentage with the balance being paid on receipt of payment from buyer.

Sales Ledger Administration:

IFCI Factors Limited (Formerly Foremost Factors Limited) maintains the sales ledger for its clients, monitoring the invoices raised and payments received and accordingly performs the necessary follow up for collections. We also provide you with valuable MIS to enable you to take better informed decisions related to pricing, credit terms, debtor quality and so on.

Opportunity for Growth:

The credit protection provided by IFCI Factors Limited (Formerly Foremost Factors Limited) enables you to build your business with

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international buyers (who are otherwise unwilling to open Letters of Credit) while keeping your credit exposures covered. Instant prepayments against your receivables provide you with the necessary resources required for funding your business growth.

Advisory Services:

IFCI Factors Limited (Formerly Foremost Factors Limited) also offers advisory services to its clients including credit assessment for its overseas buyers through its own network and that of its correspondent factors.

Introduction to Factoring

Factoring is a flexible alternative to traditional forms of funding. It allows you to respond quickly to changes in market conditions and matches your cash flows with your business requirements, thereby facilitating increased production and sales.

Factoring enables you to: Instantly turn your receivables to cashAvail credit protection for your receivablesTake well informed credit decisionsOutsource your sales ledger administration 

Factoring thus not only helps you in expanding your business, but also provides you with an efficient collection mechanism and protection against bad debts.

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Types of Factoring

Domestic Factoring:  

For open account credit sales of goods and services made within India. Services offered primarily comprise of funding, sales ledger administration and collections.

  International Factoring:

For open account credit sales of goods and services to overseas buyers. Services offered primarily comprise of funding, credit protection, sales ledger administration and collections

Factoring vis-à-vis Bills Discounting: A Comparison

Apart from factoring a source of receivables, working capital financing is bill discounting arrangement offered by banks and finance companies.

Similarities: Factoring is somewhat similar to bills discounting in the sense that both these services provide short term finance. Again discount account receivables which the client would have otherwise received from the buyer at the end of the credit period.

Differences: Nonetheless, the two receivables financing arrangements differ in important respects.

1. Bill discounting is always with recourse whereas factoring can be either with recourse or without recourse.2. In bill discounting the drawer undertakes the responsibility of collecting the bills and remitting the proceeds to the financing agency, while the factor usually undertakes to collect the bills of the client.

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3. Bills discounting facility implies provision of finance and only that, but a factor also provides other services like sales ledger maintenance and advisory services.4. Discounted bills may be rediscounted several times before they mature for payment. Debts purchased for factoring cannot be rediscounted, they can only be refinanced.5. Factoring implies the provision of bulk finance against several unpaid trade generated invoices in batches; bill financing is individual transaction oriented i.e. each bill is separately assessed and discounted.6. Factoring is an off balance mode of financing7. Bills discounting does to involve assignment of debt as is the case with factoring.

Forfaiting: Forfaiting is a form of finance of 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 nonpayment in collection. All risks and collection problems are fully the responsibility of the purchaser (forfeiter) who pays cash to the seller after discounting the bills/notes. The salient features of forfaiting as a form of export related financing are summarized below:

.–

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Bill Discounting Factoring

1. Individual Transaction

2. Each bill has to be individually accepted by the drawee which takes time.

3. Stamp duty is charged on certain usance bills together with bank charges. It proves very expensive.

4. More paperwork is involved.

5. Grace period for payment is usually 3 days.

6. Original documents like MTR, RR, and Bill of Lading are to be submitted.

1. Whole turnover basis. This also gives the client the liberty to draw desired finance only.

2. A one time notification is taken from the customer at the commencement of the facility.

3. No stamp duty is charged on the invoices. No charges other than the usual finance and service charge.

4. No such paperwork is involved.

5. Grace periods are far more generous

.6. Only copies of such documents are necessary.

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7. Charges are normally up front.     7. No upfront charges. Finance charges are levied on only the amount of money withdrawn. 

What is Forfaiting ? “ Forfait” is derived from French word “a forfait” which means

forfeiting or surrender of rights

It is a Mechanism Of Financing Exports

o by discounting export receivables

o evidenced by Bills of Exchange or Promissory Notes

o without recourse to the seller (viz exporter)

o carrying medium to long term maturities

o on a fixed rate basis (discount)

o upto 100 per cent of the contract value

FORFAITING.. It is a highly flexible technique that allows an Exporter to grant

attractive credit terms to foreign Buyers, without tying up cash flow or assuming the risks of possible late payment or default. Simultaneously, the Exporter is fully protected against interest and/or currency rates moving unfavourably during the credit period Forfaiting is a highly effective sales tool, which simultaneously improves cash-flow and eliminates risk.

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SIX PARTIES IN FORFAITING Exporter (India) Importer (Abroad) Exporter’s Bank (India) Importer’s/ Avalising Bank (Abroad) EXIM Bank (India ) Forfaiter (Abroad)

FORFAITING : 8 STEPS Commercial contract : Exporter & Foreign Buyer

Commitment to Forfait BE , Pro Notes

Delivery of Goods by Exporter to Buyer

Delivery of BE / PN to Bank to EXIM Bk

Endorsement of BE / PN without recourse

Cash Payment/ thro’ a Nostro Account

Presentation of BE / PN to Buyer on maty

Payment of Debt Instrument on maturity

BENEFITS TO EXPORTERS Converts a Deferred Payment export into a cash transaction, improves

liquidity

Frees Exporter from cross-border political or commercial risks associated

Finances upto 100 percent of export value

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It is a “ Without Recourse ” finance

Hedges against Interest and Exchange Risks

BENEFITS TO THE IMPORTER The Importer can match repayments to projected revenues, allowing

for grace periods.

The Importer can obtain 100% financing, and avoid paying out cash in advance.

The Importer can pay interest on a fixed rate basis for the life of the credit, which will make budgeting simpler and safer.

The Importer can access medium to long term financing which may be prohibitively expensive or completely unavailable locally.

The Importer may be able to take advantage of export subsidy schemes which are often available from the Exporter's government.

DRAWBACKS OF FORFAITING Non-availability for short Periods

Non-availability for financially weak countries

Dominance of western currencies

Difficulty in procuring international bank’s guarantee

DIFFERENCE BETWEEN FACTORING AND FORFAITING 1.Suitable for ongoing open account sales, not backed by LC or

accepted bills or exchange.

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2. Usually provides financing for short-term credit period of upto 180 days.

1. Oriented towards single transactions backed by LC or bank guarantee.

2. Financing is usually for medium to long-term credit periods from 180 days upto 7 years though shorterm credit of 30–180 days is also available for large transactions.

DIFFERENCE BETWEEN FACTORING AND FORFAITING 3.Requires a continuous arrangements between factor and client,

whereby all sales are routed through the factor.

4. Factor assumes responsibility for collection, helps client to reduce his own overheads.

3. Seller need not route or commit other business to the forfaiter. Deals are concluded transaction-wise.

4. Forfaiter’s responsibility extends to collection of forfeited debt only. Existing financing lines remains unaffected.

DIFFERENCE BETWEEN FACTORING AND FORFAITING 5. Separate charges are applied for

—   financing

—   collection

—   administration

—   credit protection and

—   provision of information.

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5. Single discount charges is applied which depend on

—   guaranteeing bank and country risk,

—   credit period involved and

—   currency of debt.

Only additional charges is commitment fee, if firm commitment is required prior to draw down during delivery period.

DIFFERENCE BETWEEN FACTORING AND FORFAITING 6. Service is available for domestic and export receivables.

7. Financing can be with or without recourse; the credit protection collection and administration services may also be provided without financing.

6. Usually available for export receivables only denominated in any freely convertible currency.

7. It is always ‘without recourse’ and essentially a financing product.

LIST OF SOME FORFAITERS Standard Bank, London

Hong Kong Bank

Indo Aval

ABN AMRO Bank

Meghraj Financial Services

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Triumph International Finance India Ltd.,

Natwest Bank

West LB + EXIM Bk + IFC : GTF, India

Why we need Factoring? For Smooth cash flow

For meeting working capital needs

Overcome the situation from high cost of capital and reduced profit

Factoring Services - Concept Factoring is defined as ‘a continuing legal relationship between a

financial institution (the factor) and a business concern (the client), selling goods or providing services to trade customers (the customers) on open account basis whereby the Factor purchases the client’s book debts (accounts receivables) either with or without recourse to the client and in relation thereto controls the credit extended to customers and administers the sales ledgers’.

Factoring functions.. It is purchasing & collection the client’s a/c’s receivables (with or

without recourse),

Sales Ledger management

Credit investigation & undertaking of risks

Provision of finance against debts

Rendering consultancy services

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Factoring Services - Concept Client Customer Factor Order placed Deliver of goods Client submits invoice Factor-Prepayment Monthly statements Customer pays Funding Process

Fax the copy of invoice to factor

Factor processes the invoice

Get up to 80% of the invoice in 24 hours

20% kept in reserve account

Factor receives the payment from customer

Factor deducts fee from reserve account

Factor forwards the balance from reserve

Exporter Importer Country A Country B Export Factor Import Factor Goods and invoices – Stage I Copy Invoice Stage II Prepayments Stage III Copy Invoices Stage IV Statements Stage V Payments Stage VI Payments Stage VII Payment of Commission Stage VIII Benefits Of Factoring

Financial Services

Collection Service

‘ Credit Risk’ Service

Provision of expertise ‘sales ledger management’ service

Consultancy service

Economy in Servicing

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Off-balance sheet financing

Trade Benefits

Miscellaneous service

FACTORING, FORFAITING AND Bill DiscountingBILL DISCOUNTINGFund Based Services 19.1 INTRODUCTIONWe have seen in the previous unit how venture capitalists come to the rescue ofentrepreneurs by providing risk bearing capital known as venture capital. It is usuallya long term investment either in the form of equity, conventional loans, conditionalloans and convertible loans. Venture capital has potential for significant growth andfinancial returns. In the present unit we will be discussing in detail three services usedfor financing short-term, trade, i.e. factoring, Forfaiting, and bill discouting.Factoring services have become quite popular all over the world now, with more than900 companies offering these services. Factoring is a contract like any other salepurchaseagreement regulated under the law of contract.Forfaiting is a source of trade finance which enables exporters to get funds from theinstitution called forfaitee on transferring the right to recover the debts from theimporter.

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Another source of short-term trade financing known as bill discouting where oneparty accepts the liabilities of trade towards the third party.Let us now discuss about all these three services in the subsequent sub sections ofthis unit.

Functions of the FactorBroadly speaking the main functions of the Factor are as under :1) To provide finance against book debts, say upto 90 per cent of the invoice valueimmediately. Thus the client gets funds immediately for his working capital.2) To collect cash against receivables on due date from the customers of the clientsand furnish reports to the client.3) To undertake sales ledger administration (i.e. accounting work) for the client inrespect of client’s transactions with its customers.4) Under the non-recourse factoring arrangement, if the customer becomefinancially insolvent and cannot pay up, the Factor provides protection tothe client against bad debts on all approved invoices. Thus the Factor providesdebt insurance facility to the client against possible losses arising frominsolvency or bankruptcy of the customer.5) Factor also provides other information such as sales analysis and overdueinvoice analysis which enable the client to run the business more effectively.Besides, the Factor also provides relevant expertise in the areas of marketing,finance, etc., to the client.67Factoring, Forfaiting and

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Bill DiscountingParties to Factoring ContractThere are three parties involved generally in a factoring contract, viz.,1) Buyer of goods (i.e. customer) who has purchased goods or services on creditand as such has to pay for the same once the credit period gets over.2) Seller of goods (i.e. client) who has supplied goods or provided services to thecustomers on credit terms.3) ‘Factor’ who purchase the invoices (receivable) from seller of goods andcollect the money from the customers of his clients.TYPES OF FACTORING SERVICESThe various types of factoring arrangements can be classified into the followingcategories.1) Full Servicing Factoring: This is also known as without recourse factoringservice. It is the most comprehensive type of factoring arrangement offering alltypes of services, namely: (a) Finance, (b) Sales ledger administration, (c) Collection,(d) Debt protection, and (e) Advisory services. The most important characteristic ofthis type of factoring service is that it gives protection against bad debts to the client.In other words, in case the customer fails to pay, the factor will absorb the lossesarising from insolvency or bankruptcy of the client’s customers.2) Recourse Factoring: In such a type of factoring arrangement, the factorprovides all types of facilities except debt protection. That means, in other words, the

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client is responsible for any bad debts arising from insolvency of the client’scustomers.3) Maturity Factoring: Under this type of factoring arrangement, except forproviding finance, all other facilities are provided to the client. As far as finance isconcerned, the client is paid at the end of a pre-determined date or maturity datewhether or not the customers have settled their dues in respect of credit sales.4) Invoice Discounting: In such type of arrangement, only finance is provided, and,hence, no other services are offered in respect of receivables.5) Agency Discounting: Under this arrangement, the facilities of finance andprotection against bad debt are provided by the factor. As against this, the salesledger administration and collection of book debts are carried out by the clienthimself.The aforesaid classification of various factoring arrangements along with the type ofservices provided under each classification is shown in the Chart 19.1.TERMS AND CONDITIONS OF FACTORINGCONTRACTFactoring contract is like any other sale purchase agreement regulated under the lawof contract. The terms and conditions on which factor agrees to purchase the debtsfrom seller are mutually settled keeping in view the business connections and

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customs. Nevertheless, some of the important aspects which are supposed to be bornin mind and incorporated in factoring agreements are as follows :1) Offer to sell debts from time to time arising out of business transactions, on suchterms and conditions as are stipulated in the agreement. The offer shallspecifically mention about the invoices relating to each debt as an evidence ofthe delivery of goods or rendering of services to the customer.2) Acceptance of the offer shall be comprehensive, covering all interests in thepurchased debts, with all remedies for enforcing the debts and rights of unpaidseller being vested in the factor.3) Condition to have no recourse to the supplier by the factor in the case of nonrecoursefactoring contract on the failure of the customer to pay the dues.4) Power of attorney from the firm to the factor so as to empower the factor to thefactor.5) Payment of purchase price of debts.6) Notice of sale of assignment of debt be endorsed on invoices sent to customer toentitle the factor to recover their dues and issue discharge receipt of thecustomers.7) Non-collection of dues by the firm : Firm (client) not to collect dues fromcustomers assigned to the factors.8) Notice of credit allowed to customer to be given to the factor.9) Warranties and covenants.10) Factoring commission, charge, fees and mode of payment.11) Durations of agreement.

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12) Notice of termination.13) Jurisdiction of court to entertain dispute between the parties.The above conditions may be elaborated in view of the business practices andincorporated in the letter of confirmation to be issued by the factor of the client andbe accepted by the client through a Board Resolution. It is always safe to enter intoformal agreement between the parties so as to cover all assignment of debts andpowers to affect recovery thereof in legal way. FACTORING: ADVANTAGES ANDDISADVANTAGESBenefits of Factoring to Clients1) Under the factoring arrangement the client receives prepayment upto 80-90 percent of the invoice value immediately and the balance amount after the maturityperiod. This helps the client to improve cash flow position which enables him tohave better flexibility in managing working capital funds in an efficient andeffective manner. Besides this, such arrangement also improves the ability ofthe client to develop sales to credit worthy customers.69Factoring, Forfaiting andBill Discounting2) If the client avails the services of the factor in respect of sales ledgeradministration and collection of receivables, he need not have any administrativeset up for this purpose. Naturally this will result into a substantial saving in time

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and cost of maintaining own sales ledger administration and collectingreceivables from the customer. Thus, it will reduce administrative cost and time.As a result of this, the client can spare substantial time for improving the qualityof production and tapping new business opportunities.3) When without recourse factoring arrangement is made, the client can eliminatethe losses on account of bad debts. This will help him to concentrate more onmaximizing production and sales. Thus, it will result in increase in sales,increase in business and increase in profit.4) The client can avail advisory services from the factor by virtue of his expertiseand experience in the areas of finance and marketing. This will help the client toimprove efficiency and productivity of his organization. Besides this, with thehelp of data base, the factor can readily provide information regarding productdesign/mix, prices, market conditions etc., to the client which could be useful tohim for business decisions.The above mentioned benefits will accrue to the client provided he develops abetter business relationship with the factor and both of them have mutual trust ineach other.Disadvantages of Factoring1) Image of the client may suffer as engaging a factoring agency is not considereda good sign of efficient management.

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2) Factoring may not be of much use where companies or agents have one timesales with the customers.3) Factoring increases cost of finance and thus cost of running the business.4) If the client has cheaper means of finance and credit (where goods are soldagainst advance payment), factoring may not be useful.Factoring, Forfaiting andBill Discounting1) Service Fee: Service fee is levied for the work involved in administering thesales ledger as well as protection against bad debts. It is calculated as apercentage of gross value of the invoices factored and is assessed on thefollowing criteria:a) Gross annual sales volume;b) Number of customers;c) Number of invoices and credit notes; andd) Degree of risk represented by the customer.The service fee for domestic factoring ranges from 0.30 per cent to 0.75 per cent andit would be higher when non-recourse arrangements are made.2) Discount Charge (interest charge): The discount charge is levied on theadvance provided by the factor and is computed on the basis of prime lending rate ofbanks plus premiums for credit risk basis. It is calculated on a day-to-day basis onthe advances outstanding and ranges from 1 to 3 per cent above the referencebank’s prime lending rate. MAIN CHARACTERISTICS OF FACTORING

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SERVICESThe main characteristics of factoring are noted below :1) Factoring is a money market instrument.2) Book debts represented by invoices are assigned in favour of a factor.3) Since, factoring is not a negotiable instrument, customer’s consent is requiredabout the factoring arrangement under which he will make a repayment directlyto the factor but not to the client.4) Dual pricing structure comprising discount charges and services charges isfollowed.5) Under without recourse factoring credit insurance facility is offered to the client.In view of this cost of factoring services is more under without recoursefactoring as against with recourse factoring.6) Margin is kept in the range of 5 per cent to 20 per cent. In other words, usuallyabout 80 to 95% of the invoice value is provided as pre-finance by the factor tothe supplier which is known as prepayment.7) Remaining amount of the value of invoice is paid to the client after collection ofmoney from the customer and after deducting his own charges.EXPORT FACTORINGExport factoring services are offered to the exporters (clients) who sell their productsor services to the importers (customers) in other countries on open account termshaving a credit period ranging from 60 to 180 days. Before the goods are shipped to

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the customer, export factor is expected to investigate the customer’s creditworthinessand assume responsibility for collecting all amounts owed as well as affording creditprotection. Export factor can offer benefits of export factoring both to the exportersas well as to the importers. The mechanism of export factoring is similar to that ofdomestic factoring, the exception being the exporter and importer belong to twodifferent countries.Four different types of arrangements are possible for export factoring :a) Two Factor Systemb) Single (Direct) Factoring Systemc) Direct Export Factoringd) Direct Import FactoringUnder the two factor system, which is more in vogue in international factoring, boththe export factor in the exporter’s country and the import factor in the importer’scountry will be involved in providing international factoring services to the clients(exporters). Since both are integral part to the two factor system, naturally thefunctions of the factors will be divided between the export factor and import factor.The mechanism of the two-factor system in international factoring alongwith thefunctions of export and import factor are illustrated in Figure 19.1. Mechanism of two Factor SystemExporter Importer

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Export Factor Import FactorCopy InvoiceStage IIPrepaymentsStage IIIStatementsStage VPaymentsStage VIGoods and InvoicesStage ICopy InvoicesStage IVPaymentsStage VIIPayment of CommissionStage VIIICountry A Country BRBI Guidelines for Factoring ServicesThe RBI has issued guidelines subject to which banks can undertake factoringservices through departmentally. These guidelines are as under :1) Banks should frame an appropriate policy on factoring services with theapproval of their Boards.

Fund Based Services 2) As activities like factoring services requires skilled personnel and adequateinfrastructure facilities, it should be undertaken only by certain select branchesof banks. This will have to be suitably published for the benefit of bankscustomers.

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3) The activities like factoring services shall be treated on par with loans andadvances and therefore should accordingly be given the risk weight of 100% forcalculation of capital to risk asset ratio. Further the guidelines on incomerecognition, asset classification and provisioning norms would also be applicableto the portfolio of factoring.4) The facilities extended by the prepayment under the factoring services would becovered within the exposure selling fixed upto 25% of bank’s capital funds to anindividual borrower and 50% of bank’s capital funds to a group of borrowers.5) Banks shall maintain a balanced portfolio of financing receivables underfactoring services vis-a-viz the aggregate credit portfolio. The exposuretowards prepayment in respect of purchase of receivables under factoringservices should not exceed 10% of total gross advances as on the date ofprevious balance sheet. FACTORING SERVICES IN INDIAThough factoring services have been introduced since 1991 in India still it is quitenew in the sense that factoring product is not widely known in many parts of thecountry. Recognising the utility of factoring services for small and medium sizeindustrial and commercial enterprises in India, for the first time the Vaghul Committeewhich submitted its report on the Money Market, recommended the development of asystem of factoring of open account sales particularly for the small scale industrial

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units. This committee further observed that both banks and non-bank financialinstitutions in the private sector should be encouraged to set up institutions forproviding factoring services. Later, the Kalyanasundaram Committee, which wasappointed by the Reserve Bank of India (RBI) in 1988 specifically for exploring thepossibilities of launching factoring services in India, found an abundant scope for suchservices and hence strongly advocated for the introduction of factoring services inIndia. This committee also observed that banks were ideally suited for providingfactoring services to the industries in the economy. However, the said Committeeexpressed the view that to begin with only four or five banks either individually orjointly should be allowed on zonal basis to undertake factoring services. Therecommendations of Kalyanasundaram Committee were accepted by the RBI.Subsequently a suitable amendment was made in the Banking Regulation Act 1949,so as to allow banks to set up subsidiary company for undertaking factoringservices.To begin with, the RBI permitted both the State Bank of India and Canara Bank tostart factoring services through their own subsidiaries. Accordingly, two factoringcompanies in India, i.e. SBI Factors and Commercial Services Ltd. and Canbank

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Factors Ltd; sponsored by the State Bank of India and Canara Bank respectively,commenced operations in 1991. In the beginning they were allowed to operate inWestern and Southern Zone of India respectively. However, later on, the RBI liftedthese area restrictions on their operations and accordingly, both these companieswere given permission to expand and operate their business in other parts of thecountry. In view of this, they can operate on all-India basis. In 1993 the RBIallowed all the scheduled commercial banks to introduce factoring services eitherdepartmentally or through a subsidiary set-up. Besides SBI Factors and CommercialServices and Canbank Factors Ltd., there are a few non-banking finance companiessuch as Formost Factors Ltd., Global Trade Finance Pvt. Ltd. (a subsidiary of EXIM75Factoring, Forfaiting andBill DiscountingBank) and Integrated Financial Services Ltd., which are also in the business ofdomestic factoring in India. Of these, Global Trade Finance Pvt. Ltd. and FormostFactors Ltd. have undertaken the business of export factoring also. Besides thesenon-banking finance companies, Small Industries Development Bank of India(SIDBI), Hongkong and Shanghai Banking Corporation have been offering factoring

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services to their clients. Almost all of them have been providing factoring services tothe SSI and non-SSI units.

19.10 FORFAITING: AN INTRODUCTIONForfaiting is the purchase of receivables alongwith avalised negotiable instrumentslike promissory note or bills of exchange (without recourse to any previous holder ofthe instruments) due on a specific date to be matured in future and arising from theexports of goods on credit. Thus, Forfaiting is a source of trade finance whichenables exporters to get funds from the institution called forfaiter on transferring theright to recover the debts from the importer. The debt instrument is purchased by theforfaiter at an appropriate discount. This facility is always provided with non-recoursefeature. Normally all exports of capital goods and other goods made on medium tolong term credit are considered for providing finance through Forfaiting arrangement.Now-a-days, in many developed countries, a forfaiter provides a finance even inrespect of commodity exports wherein the credit period is upto 180 to 360 days. (Itis estimated that about 15 to 20 per cent of Forfaiting market worldwide isrepresented by transactions involving commodity exports upto 180 to 360 days).Features of a Forfaiting Arrangement1) It is a specific form of export trade finance.

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2) Export receivables are discounted at a specific but fixed discount rate.3) Debt instruments most commonly used in Forfaiting arrangement are a bill ofexchange and a promissory note.4) Payment in respect of export receivables which is further evidenced by bill ofexchange or promissory notes, must be guaranteed by the importers’ bank. Themost usual form of guarantee attached to a Forfaiting agreement is an aval.5) It is always without recourse to the seller (viz. Exporter).6) Full value of export receivables i.e. 100 per cent of the contract value is takeninto account.7) Normally the export receivables carrying medium to long term maturities areconsidered.

BENEFITS OF FORFAITING SERVICESThe benefits accruing to the exporter are numerous. Few of these benefits are stated below:1) Exporter can convert export transaction under deferred payment arrangementinto a cash transaction. Thus he can improve his own liquidity position.2) Since the forfaiter takes all risks, naturally exporter is relieved of the risksarising out of the default by the buyer (importer) as also the political andexchange risk.3) Since the Forfaiting is a fixed rate contract, the exporter is hedged againstinterest rate risk and exchange rate risk.4) Exporter gets finance upto 100 per cent of the contract value (which is to bereduced to the extent of Forfaiting cost).

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5) Exporter is freed from credit administration and collection problems.MECHANISM OF FORFAITING SERVICESThe communication channels and module of transactions in Forfaiting are shown in

Mechanism of ForfaitingExporter ImporterForfaiter ImportersBankForfaiter Agreement (5)Sale of export bills with endorsement ofavailised negotiable instrument (6)Agreement with the Bank foravailised negotiable instrument (3)Agreement (1)Delivery of goods - export (2)Presentation of bills on maturity (8)

Delivery of bills of exchange orpromissory note with guaranteefrom the importers bank (4)

Payment on Maturity ofnegotiable instrumentFactoring, Forfaiting andBill DiscountingDetails are as under :1) Commercial contract between exporter and importer.

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2) Delivery of goods by exporter to importer on credit.3) Contract between importer and his bank to have guarantees which will be givenin respect of payment against negotiable instrument on due date.4) Delivery of availised negotiable instrument either bill of exchange or promissorynote to the exporter.5 & 6) Forfaiting contract between exporter and forfaiter under which availisednegotiable instrument will be endorsed without recourse in favour of theforfaiter.7) Cash payment of discounted availised negotiable instrument by forfaiter toexporter (face value of bill less discount amount).8) Presentation of availised negotiable instrument to the importer’s bank.9) Payment on presentation of availised negotiable instrument on maturity. MARKET GROWTHDuring the period 1970-1980, both the primary and secondary markets in and for nonrecoursetrade paper increased considerably. Specialist banks in addition to traditionaldeposit and clearing banks developed Forfaiting departments, usually within theirtrade finance departments.Later, specialist Forfait Houses were set up and there was a perceptible geographicgrowth and shift of the market from Switzerland/Northern Italy to Western Germanyand more markedly to London. In 1984 London Forfaiting Company PLC, the onlypublicly owned and U.K. Stock market quoted specialist Forfaiting Company, was set up.

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The primary forfait market has developed along side state backed credit exportschemes, sometimes as a competition and sometimes as an adjunct to the state creditexport schemes. Between market professionals a secondary market also evolved inforfait paper, which in effect securities these exporter receivables. During the period1980-90 an increasing awareness of the forfait market was developed in manydeveloped countries among business community. FORFAITING SERVICES IN INDIARecognising the utility of Forfaiting services to Indian exporters, the RBI decided tomake available such services to the exporters. At the beginning the RBI authorisedEXIM Bank in 1992 to offer Forfaiting services. The role of the EXIM Bank hasbeen that of a facilitator between the Indian exporter and the overseas Forfaitingagency. Scheduled commercial banks have also been permitted to offer Forfaitingservices by acting as an agent or a facilitator between Indian exporter and theForfaiting agency operating in some other country. That means in other words,

Fund Based Services scheduled commercial banks can undertake Forfaiting services as a part of fee basedfinancial services. A subsidiary of EXIM bank namely; Global Trade FinancialServices Private Ltd. has been engaged in providing Forfaiting services to the

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exporters in India. As per the RBI’s A D Circular No. 3 Dated February 13, 1992,discount fee, documentation fee and any other costs levied by a forfaiter must betransferred to the overseas buyer. In view of this, the exporter, who intends to availForfaiting facility, should finalise the export contract in a manner which ensures thatthe amount received in foreign exchange by him after payment of Forfaiting discountand other fees is equivalent to the price which he would obtain if goods were sold oncash payment terms. If the banks are able to act as an agent to structure Forfaitingdeals keeping in view the requirements of our Indian exporters, then there will bedemand for such product. For this, commercial banks and others may have tointroduce a lot of flexibility while acting as an agent or a facilitator in this regard. Forexample, the minimum value of the Forfaiting transaction may be required to be keptat a reasonable level. Instead of acting simply as an agent, with the permission fromthe RBI, banks and financial institutions in India must explore the possibility of takingup Forfaiting activity as a fund based activity. With the dissemination of knowledgeabout Forfaiting among Indian exporters, it may be possible to create awarenessabout it and subsequently demand for the same.

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DIFFERENCES BETWEEN FACTORING ANDFORFAITING SERVICES1) Factoring services is mainly meant for financing and collecting of receivablesarising from short term credit transactions say upto 180 days. As against this,Forfaiting is meant for financing credit transactions of having deferred creditperiod of more than 1 year.2) Factoring arrangement can be with recourse or without recourse depending onthe terms of factoring contract between a client and a factor. As against this,Forfaiting transaction is always without recourse where forfeiter absorbs creditrisk also.3) Factoring services can be considered either for domestic transaction or forexport transaction. As against this Forfaiting transaction is always consideredfor export transactions only.4) Factoring is done on the strength of sales invoices only. Whereas Forfaitinginvolves use of availised negotiable instruments like bill of exchange orpromissory note.5) In a factoring arrangement, a margin of 5 to 20 per cent is kept. In otherwords, finance is provided immediate on the purchase of invoice to the extent80 to 95 per cent of invoice value. As against this; a forfaiter discounts theentire sale value of the export transaction without keeping any margin.6) Factoring services include sales ledger, administration, collection of receivablesand other advisory services. On the other hand, Forfaiting is a pure financialarrangement.

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7) Factoring is done on whole turnover basis, whereas, Forfaiting can be done ontransaction basis. BILL DISCOUNTING: AN INTRODUCTIONBill financing is considered to be an appropriate form of financing trade and business.Under this form of financing, seller of the goods draw a bill of exchange on the buyer

Factoring, Forfaiting andBill Discounting(who accepts and returns the same to the drawer). Subsequently seller of the goodsdiscounts the bill of exchange with bank or finance company and avail the financeaccordingly. Only those bills which arise out of genuine trade transactions areconsidered by the banks and finance companies for discounting purpose.Parties to a Bill of ExchangeParties to a bill of exchange are as follows :A) The drawer (seller of the goods)l Who draws the bill.l Who ensures that the bill is accepted and paid according to its tenor.l Who promises to compensate the holder or any endorser of the bill if it isdishonoured.B) The drawee (buyer of the goods)l The person on whom the bill is drawn.l Who has shown assent by signing across the bill for payment at maturity(thus becoming the acceptor)l The person who assumes legal obligation to pay the bill.C) The Payee

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The person to whom or to whose order the bill is payable.D) The Endorserl The payee or any endorsee who signs the bill on negotiation.l If the bill is negotiated to several persons who signs it in turn becomes anendorser.l The endorser is liable as a party to the bill.If the bill of exchange is not endorsed then drawer and payee will be the sameperson.19.17 BENEFITS OF FINANCE THROUGH BILLDISCOUNTINGFollowing are the benefits of bill discounting for the drawer :Cheaper form of Credit: Banks usually discount bills at a rate lower than the ratecharged for cash credit. In view of this, drawer of the bill can reduce its cost offunds by raising the funds through discounting of bills with banks.Better Funds Management: Bills seems to have certainty of payment on due datesand this helps to have efficient working capital management. It also leads to greaterfinancial discipline as bills are discounted only against genuine trade transactions ascompared with bank overdraft facilities which may be utilised for any other purpose.Following are the benefits of providing finance against bills for the banker.No Risk in Lending: By providing finance against bill, the bank can ensure safety offunds lent. As a bill is a legal negotiable instrument with the signatures of two

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concerned parties, enforcement of a claim is easier. Further, with recourse to twoparties, it implies a lower credit risk. In other words, if the acceptor of the bill fails tomake payment on the due date the bank can claim the whole amount form the drawerof the bill.80Fund Based Services Greater Liquidity: A banker who is in need of funds can rediscount bills with variousfinancial institutions as approved by the RBI. Thus bank can raise the funds easilyand quickly against the bills which are discounted.No change in the value of the bill: As a security, the value of a bill is not subject tofluctuations which are found in case of values of tangible goods and financialsecurities. The amount payable on account of a bill is fixed and the acceptor is liablefor the whole amount.Precautions for Bill DiscountingBefore approving a bill for discounting the following should be ensured by the banker :l The signature as well as credit limit of the bank’s borrowers have been verified.(Need to ensure that limit for bill discounting has been sanctioned by the creditmanager).l The nature of the transaction is mentioned on the bill and all invoice details areprovided. There is a need to verify and ensure that bill is drawn against agenuine trade transaction. (i.e. bill covers only sale of goods transactions).

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l The original tenor of the bill does not exceed 120 days if Bill Discounting Facilityis to be availed of.l The payment instructions and maturity date are clearly mentioned on the bill.The bill is drawn in favour of or endorsed to the discounting bank.l All material alterations have been authenticated.l Notice of dishonour and presentment have been waived.19.18 SCHEME OF REDISCOUNTING OF BILLSIn order to make commercial bill an active instrument in the secondary moneymarket, the RBI introduced bill rediscounting scheme in November 1970 and thesame was revised from time to time. The features of revised rediscounting schemeare as under :1) The bank, which originally discounts the usance bill, will have to issue aninstrument known as “Derivative Usance Promissory Note” in favour of thebank or other approved financial institution with which it is rediscounting thebills. Such usance promissory note should be payable not more than 90 daysfrom the date of rediscounting. (Government has exempted stamp duty onderivative usance promissory note).2) The usance promissory note should be backed by unencumbered usance bills ofexchange arising out of genuine commercial transactions evidencing sale ofgoods.3) The negotiation of the usance promissory note shall be restricted to theparticipants in the Bills Rediscounting scheme as approved by the RBI.4) Rediscounting of bills must be for a minimum period of 15 days.19.19 DEVELOPMENTS IN COMMERCIAL BILLMARKET IN INDIA

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Even though the role of commercial bill market as an important segment of moneymarket was recognised as early as in 1930s, deliberate efforts were not made toensure development of commercial bill market till 1952.81Factoring, Forfaiting andBill DiscountingBill Market Scheme of 1952In January 1952, the Reserve Bank of India (RBI) introduced a Bill Market Schemeunder section 17(4)(C) of the RBI Act, 1934. This scheme was introduced with theobjective of providing liquidity to banks in the form of demand loans against thesecurity of usance promissory notes or bills drawn on and payable in India of theirconstituents provided they arose out of bonafide commercial or trade transactions. Inorder to avail refinance under the above section, the scheduled banks were requiredto convert a portion of the demand promissory notes obtained by them from theirconstituents in respect of loans, overdrafts and cash credit granted to them intousance promissory notes maturing within 90 days. The accommodation which wasinitially restricted to licensed scheduled commercial banks having deposits of Rs. 10crore or more, was later extended to all the licensed scheduled commercial banks

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irrespective of size of deposits. The scheme however, did not develop into a genuinebill market as it was primarily intended for providing accommodation from RBI tobanks.Bill Market Scheme for ExportersIn 1958, the RBI extended the Bill Market Scheme to export bills also to encouragebanks to extend credit facilities to exporters on a more liberal basis. The banks,however, could not avail of these facilities as exporters were reluctant to drawusance promissory notes as required by the RBI, after having tendered to banks forpurposes of negotiation, documentary usance export bills which the banks sent abroadfor acceptance and collection.In 1963, the RBI introduced a new Export Bills credit scheme whereby advancescould be made by the RBI to scheduled banks against their promissory notes only andupon their declaration of holdings of eligible usance export bills drawn in foreigncurrencies or Indian rupees and discounted or negotiated by them.New Bill Market SchemeThe next significant measure taken by the RBI for promotion of a bill market wasin November 1970 when on the recommendation of a Study Group chaired byM. Narasimham, it introduced the New Bill Market Scheme (NBMs). This schemes

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was an improvement over the earlier scheme in that only genuine trade bills, maturingwithin 90 days, arising out of bonafide commercial or trade transactions involving saleor despatch of goods were made eligible for rediscounting with the RBI by alllicensed scheduled commercial banks.19.20 REASONS FOR NON-DEVELOPMENT OF BILLMARKET IN INDIADespite various measures taken by the RBI to activate bill market, the same is yet tobe fully developed in India. The various reasons can be identified in this regard. Fewof these reasons are given below :1) Reluctance of industry as well as trade and Government undertakings as well asdepartments to move towards bill financing since it does require observance ofstrict financial discipline. In other words, industries and Governmentdepartments are not prepared to subject themselves to the strict commitment tohonour financial obligations on the agreed date.2) The procedural delay involved in the creditor getting a prompt legal remedy incase of dishonoured bills.82Fund Based Services 3) With the era of globalisation and reforms in the economy, the domestic markethas become highly competitive and has turned into a buyer’s market. As aresult, sellers of goods are not able to bring around the buyers to accept bill ofexchange for sale of goods on credit. From the buyer’s point of view, they

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would like to retain the character of the transaction as a pure credit transactionwith simple debtor-creditor relationship rather than elevate it to a negotiableinstrument.4) Operational and procedural constraints in the discounting and rediscounting ofbills.l Lack of uniformity in the documents to be submitted for availing billdiscounting facility.l Wide geographical spread of the buyersl Delay on the part of drawers bank in sending the bills for presentation/acceptancel Delay on the part of drawee in accepting the bills within a reasonable timeframe.l Delay in remittance of proceeds by the bank at the drawee’s end.l Delay in the approval of new customers (drawees) in the absence ofreliable credit information especially in respect of small and medium sizeenterprises as well as unlisted and unincorporated entities.5) Cost of availing credit through bill discounting is perceived to be high comparedto cost of cash credit facility. In addition to the discounting charges, collectionand handling charges are also levied. In view of this, effective cost of billdiscounting turns out to be rather high especially in case of bills of smalleramount.19.21 REVITALISING BILL MARKET IN INDIASince the introduction of the New Bill market scheme, the RBI has introducedseveral measures to encourage use of commercial bills and thus widen thecommercial bill market in India. Few of these measures are stated below :l Simplification of the rediscounting procedures by dispensing with the actuallodgement of bills in respect of bills below the face value of Rs. 10 lacs and

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replacing it with derivative bills. The minimum amount of bill at Rs. 5000/-prescribed under the scheme was also done away with.l Promotion of Drawee Bills Scheme, by making it mandatory for banks to extendatleast 25 per cent of the cash credit limit to borrowers in the form of bills andrequiring banks to ensure that their corporate borrowers financed their domesticcredit purchases from SSI units, atleast to the extent of 25 per cent, by way ofacceptance bills drawn on them by their suppliers, and advising banks to monitorthe compliance of this requirement through a suitable monitoring system (Thesemandatory stipulations were subsequently withdrawn with effect from2nd November, 1999).l Remission of Stamp duty by the Government of India on bills of exchange drawnon or made by or in favour of a commercial bank or a co-operative bank andpayable not more than three months after date or sight.l The licensed scheduled commercial banks have been allowed to rediscount billswith a few financial institutions such as Life Insurance Corporation of India(LIC), General Insurance Corporation of India (GIC) and its subsidiaries andUnit Trust of India (UTI) and such other financial institutions, incorporated in83Factoring, Forfaiting andBill DiscountingIndia, as may be approved by the RBI on a reference made to it. (In fact theRBI has enlarged the list of approved institutions for rediscounting bills).

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l In 1981, in addition to all India financial institutions, RBI allowed Mutual Fundsto participate in Bill Rediscounting market thus augmenting the supply of funds inthe secondary market.l The Discount and Finance House of India Ltd. (DFHI) was set-up by the RBIjointly with public sector banks and All India Financial Institutions to developsecondary market for commercial bill.l To simplify the procedure for rediscounting of bills by banks and to enablemultiple rediscounting of bills, the RBI has introduced a revised procedure underwhich derivative usance promissory notes drawn by banks for suitable maturitiesupto 90 days on the strength of underlying bills discounted by the banks’respective branches can be rediscounted with other banks, approved financialinstitutions and primary dealers. The Government of India has exempted thepayment of stamp duty on these usance promissory notes.l Delinking interest rates applicable on discounting of bills from the prime lendingrates of banks thus giving commercial banks the freedom to charge marketdetermined interest rate on bills.19.22 SUMMARYIn this unit we have discussed the financial services namely Factoring, Forfaiting andbill discounting. Factoring involves financing and collection of accounts receivables indomestic as well as international trade. This service is rendered by the factor whoprovides finance against book debts, collects cash against receivables, undertakes

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sales ledger administration, provides protection against bad debts, etc. There are threeparties to a factoring contract: buyer of goods, who has to pay for goods bought oncredit terms, seller of goods, who has to realize credit sales from buyer. and thefactor, who acts as an agent and realizes the sales from the buyuer.Forfaiting is a source of trade finance which enables exporters to get funds from theforfaiter on transferring the right to recover the debts from the importer. It denotesthe purchase of trade bills or promissory notes by a bank or financial institution,without recourse to seller. Bill discouting is a source of short-term trade finance. It isknown as acceptance credit, where on party accepts liability of trade towards thirdparty.19.23 KEY WORDSFactoring: is a financial service covering the financing and collection of accountsreceivables in domestic as well as international trade.Factor: acts as agent in realising credit sales from buyer and passes on the realisedsum to seller after deducting his commission.Forfaiting: denotes the purchase of trade bills or promissory notes by a bank or afinancial institution without recourse to seller.19.24 SELF ASSESSMENT QUESTIONS1) What do you mean by factor and factoring services?2) What do you mean by without recourse and maturity factoring?

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3) Explain the benefits and disadvantages of factoring services.84Fund Based Services 4) Explain the mechanism of factoring services.5) Explain the various types of export factoring arrangement.6) Define Forfaiting services?7) What are the differences between factoring and Forfaiting services?8) Comment on factoring and Forfaiting services in India.9) Explain the benefits of finance through bill discounting.10) (i) What do you mean by rediscounting of bills?(ii) Explain in brief RBI’s scheme of rediscounting of bills11) Write short notes on :(1) Bill Market Scheme of 1952(2) New Bill Market Scheme of 1970.12) “Despite various measures taken by the RBI, the commercial bill market is notdeveloped in India”. Comment on this and give the reasons for the same.19.25 FURTHER READINGS“A Guide to Factoring and Invoice Discounting” – The New Bankers, by TimLea and Wendy Trollope, Chapman and Hall, London, 1996.The Business of Factoring – “A Guide to Factoring and Invoice Discounting”,David Hawkins, McGraw Hill, Book Company, London, UK, 1993.“Forfaiting for Exporters” : Practical Solutions for Global Trade Finance, RipileyAndy, London International Tompson, 1996.Sengupta A K and Kuvalekar S V, “Factoring Services”, Skylark Publications, NewDelhi, 1992.Sengupta A K, “Introduction of International Factoring in India” : Issues,Problems and Prospects, Unpublished Thesis submitted to the University of Poona forthe award of Ph.D. degree, Pune, 1995.

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Report of the “Working Group on the Money Market”, Reserve Bank of India,Mumbai, 1997.“Report of the Study Group for Examining Introduction of Factoring Services inIndia”, Reserve Bank of India, Mumbai, 1998.“Annual Reports of Canbank Factors Ltd. and SBI Factors and CommercialServices Ltd.” 2003-04 and 2004-05.“Financing of Trade Through Bill Discounting” – An Overview, by DFHI andCitibank N.A., January 1990, Mumbai.“Report of the Working Group on Discounting of bills by Banks”, Reserve Bankof India, Mumbai, September 2000.

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