2019 promises to be an exciting year from many prospective, of course, the most exciting would be watching how the political scenario plays out in the first half of the year and it is already building up to be a nail biting thriller!

We as a nation are also looking forward to become the 5th largest economy in the world in terms of nominal GDP, getting past United Kingdom. In terms of smart phone users we will cross the 350 million user milestone this year. Out of the top ten large economies of the world, though slightly down, our growth rate is still the highest at over7%.

It is also great to see that we as a nation are now looking at the MSMEs more closely and recognising the potential and importance of this segment in terms of achieving inclusive growth. Going by statistics, more than 95% of the business enterprises in India fall under this category. In terms of contribution to GDP, exports and manufacturing, MSMEs’ contribution is overwhelming. In terms of employment generation this sector provides employment to more than 110 million people, that is good, but what is better, is that it has the potential to employ much more. To improve our world raking in terms per capita income and progress on the inclusive growth agenda we need to ensure that we resolve the bottlenecks restricting the growth of MSMEs.

The present Govt. has come out with a number of schemes for the MSMEs, which will help this segment in the days to come. One of the major recognised problem which is restricting the growth of this segment in India as well as the world across is availability of finance at the right time, right amount and on reasonable terms and conditions.

Problem statements

It is a known fact that out of the 63 million plus MSMEs in the country only about 10% have access to formal credit from Banks and NBFCs. Some of the estimates show a credit demand and supply gap of Rs. 19 lac crores for the MSME segment. We all are aware of the financing gap in the segment and it is encouraging that the system is recognising the problem and trying various ways and means to address it.

Considering the fact that 90% of the formal MSME funding today is from Banks and NBFCs we need to identify and address the pain points this two segments are facing in proving finance to the MSMEs. We also encourage the Micro Finance companies, the new Fintech companies to enter this space to increase the coverage and improve on the credit delivery processes.

Worldwide, factoring is an excellent way of financing working capital needs of the MSMEs. In India unfortunately factoring of receivables as a business model could not make much progress mainly due to lack of regulatory frame work. But the things have now changed with introduction of Factoring Relations Act, Payment Settlement and Systems Act, IT Act, GST, Etc. The Factoring companies have earlier suffered due to non-standardised processes and insufficient regulations. Factor Chain International (FCI) reported a volume of EUR 2598 Billion in 2017 registering a growth of 9% over the 2016 numbers. While China tops the list by registering factoring volume of EUR 405 billion, UK occupies second place at EUR 324 billion. The Factoring business for 2017 in India stands only at EUR 4.2 billion, while some of the other Asian economies such as Taiwan, Korea and Singapore do 10 times more factoring volume than us. Considering that the GDP of these countries are much smaller than ours, the scope in increasing this business is humongous.

Given that the existing lending models and credit appraisal processes will take some time to align with the unmet demand, resolving the existing bottlenecks, these institutions can look at factoring as an alternate channel of funding the MSMEs and thus supporting them in better cash flow management.

Trade Receivable Discounting System (TReDS)

TReDS was introduced by RBI based on the report of the Raghuram Rajan Committee on Financial Sector Reforms in 2008. The final guidelines were preceded by a report prepared by RBI appointed working group in November 2009. The final Guidelines on TReDS was issued by RBI on 3rd December 2014.

TReDS is a payment system and operates under the Payment & Settlement Systems Act, 2007. The three participants on the TReDS exchanges are Large Corporate Buyers/PSUs/Govt. Depts., MSME Sellers and Banks and NBFC Factors. TReDS exchange offers factoring and reverse factoring options through a transparent and electronic bidding mechanism for discounting of receivables by the MSME sellers. The MSMEs sellers on the platform have a unique opportunity of getting a host of Financiers on platter who are willing to provide discounting rate for factoring the receivables of the MSMEs through a bidding process. The sellers need not enter into bilateral agreements with the Financiers, they only have to execute a onetime documentation with the TReDS platform, the discounting is without recourse to the MSME sellers and topping it, the same requires no collateral to be provided to the Financier. TReDS thus provides the best possible rate to the MSMEs as financiers provide rates depending on the credit risk of the large corporate buyer and not that of the MSMEs.

This ability to choose the discounting rate provided by a host of Banks and NBFC Factors registered with the platform makes the platform attractive not only to the MSMEs but also to their corporate buyers. The platform allows the MSMEs to receive their payments on time while allowing corporate buyers to extend the credit period up to 180 days thus aligning it to their cash flow and enjoy a better discounting rate in the case of reverse factoring. This enables buyers and their MSME suppliers to manage their working capital cycles more efficiently thus saving costs substantially.

For the banks, I believe this is a superior model of booking PSL (Priority Sector Lending) as exposure on TReDS qualify as PSL. Booking exposure on TReDS is much more cost effective, as TReDS platform does the KYC of the sellers and the financiers need not do any further KYC, which is a huge cost saving. Similarly the financiers are taking a risk on the large corporate buyer and hence credit risk comes down substantially, moreover they need not have large team for credit appraisal, documentation, KYC and security creation. For the MSMEs it is a huge cost saving not only in terms of better discounting rate, but they save cost as they are not required to pursue late payments with corporates and jeopardising business relations with the buyer.

In the past one and a half years of operations, Invoicemart (the leading TReDS platforms) discounted invoices worth more than INR 1,800 crores. The figure of INR 1800 crores may be small keeping in mind the huge unmet demand for credit by the MSME sector, which is estimated to be around INR 19 lakh crores, but it is a revolutionary step which allows MSMEs to secure credit at significantly favourable terms as compared to the traditional channel to access working capital finance.

Road Ahead

Thus TReDS is one channel which I believe must be explored by all financiers as a new channel for MSME financing. The Govt of India has now made it mandatory for all CPSEs (Central Public Sector Enterprises) and all companies having turnover of Rs. 500 crores and more to compulsorily register with TReDS platforms. Thus we foresee TReDS as a game changer in the near future for increasing factoring as a way of working capital financing option in India. TReDS is an end to end digitized platform for receivable factoring and must be adopted by all business units and financiers as a preferred mode of working capital finance. It is highly efficient in terms cost savings for all stake holders, the sellers, buyers and the financiers.

At present TReDS Model is buyer led, meaning the process of acceptance of invoices on the TReDS Platform by the buyer is mandatory, of course, this makes the model more credible and trust worthy, but at the same time it makes it exclusive for sellers which have relationship with buyers, which are registered with the platform. I would like to highlight that across the world factoring is supported by credit insurance which at present is not available in in India to the financiers. My appeal to the policy makers and Insurance Regulator would be to have a relook at the present position and whether we can at least allow credit insurance in favour of the financiers for MSME participants on the TReDS Platforms. TReDS will then become a real enabler for the MSMEs as a source of working capital finance and can be accessed by the MSMEs independently without dependence on the Buyer making a meaningful impact in reducing the credit funding gap and make inclusive growth possible.