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DOMESTIC FACTORING :Bangladesh Perspective
PRASHANTA K. BANERJEEProfessor and Director (RD&C)
Bangladesh Institute of Bank Management
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CONCEPT AND MECHNICSOF DOMESTIC FACTORING
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Is a contract between the Supplier the Factorand wherein:
the Supplier assigns receivables to the Factor
the Factor performs atleast two of the following services:
Financingby way of prepayments against invoicesSales Ledger Maintenance
Collection of Receivables
Credit Protection against Bad Debts
Notice of Assignment of receivables is given in writing to the debtors.
Factoring- What It Means?
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Factoring When Best Suited ?
Situation OfOpen Account Sales
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Involving ContinuingRelationships
Factoring When Best Suited ?
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Assignment OfWhole Turnover
Factoring When Best Suited ?
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Bill Discounting vs. Factoring
Financing of Receivables ofClients (Borrower) against BOEsand LC.
Lending Against Strength ofBalance Sheet .
Credit Risk on Client ( Borrower)and Client repays Credit .
Serviced by Consolidated Cash
Flow of the Client .
Security / Collateral Driven .
Only Finance
Limits Linked Security/ Collateral.
Financing against Clients(Sellers) invoices in Open AccountTrade.
Lending Against Strength ofTransactions.
Performance Risk on Clients (Borrower) and Credit/ PaymentRisk on Debtor. RepaymentComes from Debtors not Clients.
Serviced by Invoiced BackedDedicated Cash Flow from
Debtors.
Cash Flow and portfolio Driven
Finance and Value AddedServices (Sales Ledger
Management and Collection ) Limits Linked To Growth .
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Types Of Factoring
Domestic Factoring Export Factoring
For Inland sales on a With Recourse basis
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Seller Buyer
GTF
4.Transports goods
1. Places Order
Domestic Factoring Process
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Can sell on Open Account Terms
Immediate and Flexible Finance Supports growth
Not Collateral Linked
Collection and Follow ups
MIS
Credit Management
Credit Protection
Sellers Advantage
Sells More
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Can buy on open accountsubstitute LCs
Automatic revolving line
Sellers credentials established
See the goods before payment
Commercial IssuesDebit Notes/ Credit Notes/
Replacements accepted
Buyers Advantage
Buys More
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THANK YOU
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Domestic Factoring : PolicyIssues
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Industry and Business Segment
Focus
Trade/ Industry/ Services
Exposure Caps
Diversification of Risk
Preference for Sectors
Discourage Business Types
Single Clients / Group Limits
Single / Group Sales Ledger Limit forDebtors.
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Factoring Facility Parameters -1
Maximum outstanding amount ( Fund-in-Use)in respect of a single client
Individual debtor sales ledger limit
Debtor wise prepayment percentage
Debtor wise invoice tenor. It is suggestedthat tenor is decided on a realistic basis of
actual trade credit period
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Factoring Facility Parameters -2
Debtor wise facility pricing discountrate of prepayment, factoring chargeon invoice value
Upfront one time set up fee for client
Penal interest for delayed payment.
Covenants
Security
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Credit Assessment
Assessment of Performance Riskof Client (Seller)
Assessment of Financial Healthand Payment Record of Debtor
Assessment of Trade Reputationand Financial health of Client ( ForEventual Recourse , if Required ).
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Organization Structure
Chief Executive
Relationship/Marketing Mgt.
Credit & RiskManagement
Credit
Administration
Mgt.
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The Responsibilities of
Relationship/Marketing Management -1
Market factoring as a product.
Maintain relationship with clientson an ongoing basis.
Keep abreast with industry / trade
knowledge and currentinformation of business trends ofclient (seller) and debtor (buyer).
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The Responsibilities of
Relationship/Marketing Management -2
Submit factoring proposals timely
and accurately to credit
department for scrutiny and
independent evaluation.
Give market feedback to Chief
Executive and other departments
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The Responsibilities of
Credit & Risk Management -1
Independently scrutinize and vet thefactoring proposals prepared by theRelationship management
Recommend to the approval authorityto approve or disapprove a proposal
Oversight of factoring policies ,procedures and controls relating tocredit risk
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The Responsibilities of
Credit & Risk Management -2
Oversight of quality of factoring
portfolio
Periodical review of factoring
portfolio
Advise the Chief Executive on
need to review existing
guidelines on credit & risk
management
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The Responsibilities of
Credit Administration Management -1
Ensure that facility documentationincluding specific covenants andsecurity are executed in compliancewith terms & conditions of approval
and same is enforceable
Scrutinize each invoices in details toensure validity of invoices
Authorize release of prepayment andensure that aggregate prepayment atany point of time is within the salesledger limit of each debtor and withinthe overall limit of the facility.
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The Responsibilities of
Credit Administration Management -2
Monitor repayment i.e., receipt of paymentfrom debtors against invoice on due date
Follow up with client/debtor in case of delayin receipt of payment from debtors
Recommend recourse to client / enforcementof security for recovery of bad debts
Custodial duties
Compliances
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Segregation of Duties
Approval AuthorityInternal Audit
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THANK YOU
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Domestic Factoring :Procedural Guidelines
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TYPES OF RISK IN FACTORING
Performance risk of client / sellerCredit risk of debtor / buyerCredit Risk of Client ( Seller) in the
Eventuality of Recourse
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Performance Risk
Years of Relationship BetweenBuyer and Seller.
All Instance of Delayed Payments
Must be Examined. The Extent and Reasons for
Dilution Should be Highlighted.
Defaults of Any Nature are to beHighlighted With Complete Detail.
Two Way Trade Must be Checked .
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Debt Collectibility Rating 1
Criteria Weight
age
Parameter Rat
ing
Weighted
Score
Period of
Relationship
(Between Clients/
Sellers &Buyers /
Debtors)
25% Above 3 years
2- 3 years
18 -24 months
12-18 months
6- 12 months
1
2
3
4
5
Dilution Level
(If the payment
received from the
factor against aninvoice is less
than the value of
the invoice)
30% Less than 5%5-10%
10- 15 %
15 -20%
Above 20%
1
2
3
4
5
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Debt Collectibility Rating 2
Criteria Weight
age
Parameter Rating Weighted
Score (Rating
Weight age)
Aging of
Debt( % of
debt
outstandin
g for morethan 30
days past
due date )
30% Less than
5%
5-10%
10- 15 %
15 -25%
Above 25 %
1
2
3
4
5
Account
Criticality (sales to a
specific
debtor as
% of total
sales of
client )
15Above 80 %
60-80 %
40 to 60%
20 -40%
Less than
20%
1
2
3
4
5
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Overall Debt Collectibility
Rating- 3Superior Satisfactory Acceptable Not
Acceptable
1 - 2 2 - 3 3 - 4 4 - 5
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Credit / Payment Risk of
Debtors
Management and Experience Competitive Position and Market Types of Industry Trade References Financial Assessment Cash Flow Assessment Debtor Payment Practice
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Debtor Rating Model-1Sl. No. Particulars Weightage
1. Industry Competency Management and Experience
Competitive Position in Market
Types of Industry (Growing ,
Matured
and Stagnating )
15%
2. Transparency and References 5%
3. Financial Assessment 404. Cash Flow Assessment 255. Debtor Payment Practice 15%
Total 100%
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Debtor Rating Model-2
Score 90%
and
Above
75-90% 60-75% 45-60% Below
45%
Rating A+ A B C D
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Documentation in Factoring
Factoring Agreement
BOE/Undertaking /Debtor Introductory Letter
Personal / Corporate Guarantee
Demand Promissory Note
Post Dated Cheques
Accepted Bill of Exchange, Where Feasible
Limits Set on Individual Debtor- TotalExposure Within the Set Limits
Set Off Clause Between Debtors andBetween Group Companies
Whole Turnover Clause
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Domestic Factoring is aFully Recourse Facility.
However, Recourse isexercised as a Tool of
Last Resort.
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Thank you
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MANAGING RISK
Performance risk of client / seller
Export / domestic- Client Audit Trail
Client Financial Analysis and Rating
Credit risk of debtor / buyer
Export Risk covered by cover from Import Factor
DomesticDebtor Financial Analysis and Rating
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Surveyor reviews the books of the client for
1. Verifying the statutory payments for any O/s dues
2. Fund based and non fund based limits of the client - for any overdueinterests and defaults on account of LCs
3. Checking for any dilution due to two way trade
4. Term loans availed by the client are checked with relevant document
like repayment schedules and term loan account in the books ofaccounts.
GTF appoints qualified field surveyors to visit the site of client
CLIENT AUDIT - PAST TRAIL
MANAGING CLIENT / SELLER RISK
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5. Trade Creditors & Trade References
6. Conducting sales ledger analysis - separate tests are done for
analysing the Invoice to Cash Trail conducted with the
historical data available for the proposed factorable customers
7. Atleast 5-10invoices checked for large factorable customer
8. All instances of delayed payments are highlighted and
corroborated with supporting documents (Invoice, BL and
Remittance Advise).
9. All Defaults of any nature are to be highlighted with complete
details
CLIENT AUDIT - PAST TRAIL
MANAGING CLIENT / SELLER RISK
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Two Scale Alphanumeric Grading
Client Quality Rating on Alpha Scale (A-D)
Financial -40%
Cash Flow -30%
Management -15%Product -15%
-Debt Collectibility Rating on Numeric Scale (1-4)
-Years of relationship
-Invoice / Cash Trail
-Dilution Levels/ Two way trade
-Ageing of debt
-Account Criticality
CLIENT SCORE CARD
MANAGING CLIENT / SELLER RISK
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DOMESTIC DEBTOR RATINGBASIC MODEL STRUCTURE
Industry Competency 18%
Management & Experience
Competitive Position & Markets
Type of Industry
Transparency & References 8%
Financial Assessment 43%
Cash Flow Assessment 20%Debtors Payment Practice 11%
MANAGING DEBTOR / BUYER RISK
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Factoring Agreement
Post Dated Cheques
Debtor Introductory Letter
Personal Guarantee / Corporate Guarantee
Demand Promisory Note
Accepted Bill Of Exchange
Set off clauses between group companies
Limits set on individual debtorsexposure within the set limits
DOMESTIC FACTORING - FULLY A RECOURSE FACILITY
RISK MANAGEMENT IN FACTORING
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Factoring Agreement
Signed before the start of the facility
Includes Inter alia the following clauses-
1. A) Export (with credit protection)In case of non receipt of payment,automatic payment,automatic payment done 90 days past due date
B) Domestic (With Recourse facility)In case of non receipt of
payment , we have full recourse to the seller
2. Whole Turnover clause
3. Arbitration
Any future amendments are made a part of the original agreement
RISK MANAGEMENT IN FACTORING
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RISK MANAGEMENT IN FACTORING
Post Dated Cheques -
Domestic Clients - One time or transaction based.
Export Clients - One time PDC for only for with recourse facility.
Deposited by GTF on due date if payment is not received
Undertaking from the client that the signatures on the PDC s will not
stand null and void as on the due date of the PDC.
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RISK MANAGEMENT IN FACTORING
Sno Domestic Exports
1 Signed and accepted by the
buyer to remit funds to GTF on
due date.
Sent to the buyer on Clients letter head,
intimating to remit funds to the Import
Factor.
2 Funding done only on receipt of
signed and accepted debtor
introductory letter from the
buyer.
Funding done on receipt of the debtor
introductory letter on the clients
letterhead.
3 Buyer contact done by GTF
before funding the first set of
documents
Buyer contact done by the import factor
Debtor Introductory Letter -
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RISK MANAGEMENT IN FACTORING
Personal Guarantee / Corporate Guarantee
Taken as an additional security document where the financials of the
company/firm is not strong.
The guarantors would be liable to pay to GTF any outstanding, inthe event the company/firm goes bankrupt.
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RISK MANAGEMENT IN FACTORING
Demand Promisory Note-
Another security document given by the seller promising to pay on
demand the value as mentioned in the DPN.
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RISK MANAGEMENT IN FACTORING
Bill of Exchange -
Drawn by the seller and accepted by the buyer, to pay to the
account of GTF on due date specified on the BOE.
Used as a security where accepted Debtor Introductory letter is notprocured.
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RISK MANAGEMENT IN DOMESTIC FACTORING
Set off clause between group companies
Where we have factoring agreement signed with two companies
under the same group-
A set off clause is signed with both the companies whereby theyagree to make good the dues of the other.
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RISK MANAGEMENT IN FACTORING
Control on exposure on individual domestic debtor limits
Debtor limits are set after review of the financials and the rating
generated for the particular debtor.
This is entered in the system as the maximum exposure limit on theparticular debtor.
If the exposure on the debtor has to be increased the same is
presented to the board for approval.
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The Market
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1003 FACTORING COMPANIES
Euro 713 BILLION (DOMESTIC)
Euro 48 BILLION (INTERNATIONAL)
World Factoring Volumes 2003
Source : Factors Chain International
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Domestic factoring INR 8700 cr (USD 1.9 Bn Equiv)
< 1% of the overall domestic receivable financing
Export factoring INR 662 cr (USD 144 Mn Equiv)< 1% of the overall export receivable financing
Estimated GrowthDomestic Trade Finance > 12% p.a
International Trade Finance > 15% p.a
The Indian Factoring Marketing 2003
Source : Factors Chain International
Understanding The Market
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Significant SME sector
Move from LC to open account
Buyer seeking credit upto 180 days
Seller and Buyer have a continuing trading relationship
Significant exports to developing and developed markets
Understanding The MarketINDICATORS OF POTENTIAL
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Absence of law relating to factoring and/ or specifically
assignment over receivables
Confusion over title of receivables
High and varying incidence of stamp duty across different
states on assignment of receivables
Environmental Inhibitions
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SO FAR.
ON A ROAD LESS TRAVELLED
MILES TO GO
THANK YOU