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Micro, small and medium enterprises (MSMEs) persistently face payment delays from large clients, a hurdle somewhat smoothed by factoring businesses. On Monday, the Lok Sabha cleared the Factoring Regulation (Amendment) Bill that aims to support this sector. Mint takes a look:

What is factoring business?

When MSME suppliers have to wait long for payments, they sell the purchase invoices to factoring businesses. These businesses buy the invoices at a discount, so that MSMEs get their money quickly. Non-banking financial companies (NBFCs) and firms need a licence to be in the factoring business, but not banks and statutory corporations. Factoring is done manually as well as over the electronic exchange called Trade Receivables Discounting System (TReDS). RXIL, Invoicemart, and M1xchange are three such platforms for online factoring. Factoring helps small firms to manage their working capital cycle.

What does the new Act seek to achieve?

When the government introduced the Factoring Regulation Act in 2011, the statute said the Reserve Bank of India (RBI) authorization would be available to NBFCs to remain in factoring business only if it was their principal business; that is, more than half of assets were deployed and income earned from the factoring business. The bill removes this threshold and opens up the sector to other NBFCs for participation in factoring business as well as in the online platform. It also mandates TReDS platforms to report details of the factoring transaction with a central registry set up under the SARFAESI Act.

Factoring market
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Factoring market

Which are the existing NBFC-factors?

The seven existing NBFC-factors are Canbank Factors Ltd, India Factoring and Finance Solutions Pvt. Ltd, SBI Global Factors Ltd, Siemens Factoring Pvt. Ltd, Bibby Financial Services (India) Pvt. Ltd, IFCI Factors Ltd, and Pinnacle Capital Solutions Pvt. Ltd. The number of players as well as the factoring transactions is exp-ected to go up once the changes take effect.

How will the changes help small businesses?

One of the impacts of the second wave of the pandemic is the stretched payment cycle, lengthening the payment wait for MSMEs and a vibrant factoring industry will make financing smooth for them. If small firms are financially healthy, it will improve their ability to purchase from large producers, which, in turn, will help in repairing the supply chain disrupted by the pandemic and mobility restrictions. More players in the factoring business are expected to improve competition and efficiency.

Why are the changes significant?

Small businesses are the backbone of the economy in manufacturing, services and exports. They account for about 45% of manufacturing output, over 40% of exports and around 30% of gross domestic product. They are also major job creators in rural as well as urban areas and, hence, a politically important segment of the industry. One difficulty MSMEs have in access to credit is the absence of physical assets against which lenders could give credit. A robust ecosystem of factoring in this context assumes significance.

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