The system lacks a basic appreciation of the role of receivables financing and the way it is practised
Last month, the Reserve Bank of India (RBI) released its Draft Guidelines http://rbi.org.in/scripts/BS_PressReleaseDisplay.aspx?prid=31682) for setting up of and operating a “Trade Receivables Discounting System (TReDS)” and sought feedback on it. The aim of TReDS is to set up and operate an institutional mechanism to facilitate financing of trade receivables of micro, small and medium enterprises (MSMEs) from corporate buyers through multiple financers. The need for setting up such a system arises from the fact that MSMEs, despite playing a very important role in the country's economy, continue to face constraints in obtaining adequate finance, particularly in terms of their ability to convert their trade receivables into liquid funds.
The idea of setting up the TReDS is conceptually sound and its successful implementation would enable, (a) faster monetisation of receivables, meaning easier availability of credit; (b) lowering of costs (both operational as well as risk premium); (c) building of a database which would make credit risk (arising from payment of receivables) to be treated as a stochastic process (on the lines of credit cards), further reducing the costs, effort and time required for making detailed appraisal / monitoring / recovery.
However, the way the scheme is presently formulated and presented, it gives the impression that it lacks a basic appreciation of the role of receivables financing and the way it is practised. Any system would be more useful, if it takes into account the ground realities of receivables financing in India. Moreover, for a robust system to be built and operated successfully, costs would be high and would be justified only if large volumes can be built. Restricting its use for financing sales by MSMEs to large corporates might not result in generating required volumes. Moreover, this segment is a very small segment of the overall market and is already well serviced by existing banks. Therefore, it would fail in achieving its basic objective of helping those MSMEs, for whom availability of credit is a major problem.
Similarly, no reason has been given for excluding sales by one large corporate to another. It has also not done for financing receivables arising from sales to a buyer, who is a non-corporate (say another MSME) from being hosted on the same system. Excluding such players from operating on the platform would be counter-productive, as it would reduce generation of volume of transactions.
Another area where the system needs strengthening, is by making it explicit that receivables eligible for financing would cover sales of both goods and services. With more than 65% of the Indian economy comprising services, making this clarification is critical for allowing this large component of the economy to access institutional finance. Services could mean processing, jobs, supply of contract labour, advertising agency fees etc. This would open the door for “accommodation” receivables being financed – suitable mitigants can and should be designed. Similarly there is no reason to restrict it to receivables which are “without recourse” to seller? For a more vibrant market and price discovery to develop, both “with recourse” and “without recourse” should be eligible for financing and should be hosted on the proposed platform.
The draft guidelines seek, inter alia, to build safeguards against the risk of double financing, diversion of working capital funds and dilution of control over security. The proposed solution is a Master agreement between the MSME sellers and the TReDS, and an assignment agreement to be executed between the MSME seller and the financer. A simpler method would be to insist that proceeds of receivables financed should in all cases be payable only to the working capital bank account of the seller. Even in a case where the seller is not availing of any working capital credit limits from any bank, proceeds should be credited to the account identified in the one-time agreement between TReDs and the seller.
Since the law and practice of discounting “Bills of Exchange” is well established and accepted (including stamping), it would be simpler if the receivables being financed be evidenced by the equivalent of an electronic, dematerialised, version of the Bill of Exchange and all financing be done on this basis. There should be no confusion between “invoice” financing and “Bill of exchange” financing. Suitable changes in the Negotiable Instruments Act (NI Act) 1881 should be made, if required. This will also not require any assignments/ assignment agreements.
It is also important to explicitly acknowledge the ground reality, that whenever sellers are able to access finer rates due to implicit or explicit support of the buyer (as envisaged by the proposed system), the buyer invariably negotiates for finer pricing from the seller. As such, some of the benefits of lower costs/availability of liquidity will be passed on, to the buyer as well.
This initiative of RBI deserves the support of all concerned parties like banks, NBFCs, industry associations and the government, for its speedy resolution and implementation.
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