How Credit Guarantee Fund for factoring may solve liquidity crunch for MSMEs

MSME sector plays a vital role from the standpoint of spurring economic growth and providing stability to any country. The sector in India, however, has to confront the lack of adequate credit flow through formal lending infrastructures due to which most ideas do not often fructify and the promoter experiences challenge of increasing borrowing costs from informal channels by paying usurious interest. For this, factoring is a possible solution for problems of cash-starved MSME Sector. “In several economies across the globe, especially in the UK, EU Zone and lately in China factoring help address liquidity issues. Factoring helps transfer payment risk from a smaller and relatively weaker enterprise to a larger (and presumably having access to better financial resources) corporate buyer,” said Sundeep Mohindru, Founder Director, Mynd Solutions told Financial Express Online.

While the factor derives comfort from the deed of assignment of receivables made in his favour by the supplier, the capability to enforce the legal rights so obtained depends on trade practices, business ethics and availability of a mature legal system and enactments of supporting legislation. As a product, factoring in India did not take off but today Trade Receivables Discounting System (TReDS) has boosted factoring.

The three TReDS platforms approved by the RBI has done business worth Rs 9,000 crores and about 5,000 MSME vendors have digitally availed collateral-free, without recourse factoring based on competitive bidding by almost the entire banking sector and two factoring companies, said Mohindru.

While this seems an impressive first step, viewed against the total credit gap for the MSME sector, the volumes have to scale up sharply. “The Indian banks at present seem to be still testing waters and possibly limit exposure levels on TReDS. Another important factor is the lack of credit insurance or suitable credit guarantee scheme for TReDS portfolio which restricts the exposure of banks on TReDS,” added Mohindru. As per IRDAI regulation, financiers cannot avail of any credit insurance.

Successful roll-out of the Credit Guarantee Fund Scheme for Factoring (CGFSF) may be the catalyst to improve available liquidity on TReDS and thereby to the MSME sector, according to Mohindru. CGFSF has been approved to cover domestic receivables of MSMEs in India factored on ‘with recourse or without recourse’ basis around three years ago.

We consider this as an opportune time for National Credit Guarantee Trustee Company (NCGTC) to roll out the CGFSF with some modifications to suit current market trends and needs. TReDS platforms operate digitally and are in the position to support seamless data transfer to NCGTC for administering the Scheme, he added. CGFSF is the only product available to the financiers without whose participation the TReDs platform created to support MSMEs may not be able to fully meet its objective.