Securitisation of MSME receivables in India
Vinod Kothari l finserv@vinodkothari.com
- Financing needs of MSMEs in India: Working capital constitutes a major part of SMEs’ funding requirements
There are considerable gaps in funding for SMEs: In India, the total addressable demand for external credit is estimated to be USD 173 billion[1] while the overall supply of finance from formal sources is estimated to be USD 441 trillion. The Expert Committee on Micro, Small and Medium Enterprises, constituted by Reserve Bank of India in December, 2018 has estimated the overall gap in India to be USD 238 – 298 billion[2].
Read more: Securitisation of MSME receivables in IndiaTraditional sources of funding are working capital facilities with banks; however, given their unorganised nature, lack of formal financial statements, etc., many SMEs find it difficult to have formal lines of credit from banks.
| The marketplace is trying alternative sources of working capital for SME. The avenues tried based on the different components of the working capital: | |
| Accounts receivables | Inventory |
| Trade Receivables Discounting System (TREDS) Factoring/ supply chain financing | Credit period for accounts payable, funded by way of reverse factoring/ supply chain financing |
- Trade Receivables Discounting System (TReDS/TREDS)
TREDS is almost India’s own innovation, though it was inspired by Mexico’s NAFIN Cadenas Productivas Program. TREDS as a mechanism for discounting and unitisation of trade receivables was launched in 2014. Currently, there are 4 of them – RXIL, M3, InvoiceMart and C2FO Factoring Solutions Private Limited. The first one is the largest.
Limited number of funding participants. However, given that there are quite a limited number of funding participants in the TREDS ecosystem currently (as informed by some of the participants in the TREDS platform(s), only 5-6 banks are currently actively bidding), there is very little competitive bidding for invoices currently. The cost of funding, we were given to understand, is about 0.25% – 0.40% higher than bank finance, if the buyer happens to be a BBB rated entity.
Figure: Trend in TREDS over 3 years[3]
- Supply chain financing
Supply chain financing is growing, as present-day trade needs to move fast; working capital availability is key to achieving turnover with low spreads, to service the ultimate consumer affordably and efficiently. Supply chain finance is a key mode of financing for upstream procurements as well as downstream supplies by an entity with a good credit standing, say Anchor. Usually, the financing is done by setting a limit based on the Anchor’s credit standing, with a bank or NBFC. Both banks and NBFCs are active in the space. Financing may be done by discounting of supply bills, either accepted by the Anchor as due for payment, or drawn by the Anchor on the dealers/ customers of the Anchor.
Most supply chain financing programs work on first loss guarantee by the Anchor. For the downstream supplies, Anchor usually has to provide a first loss guarantee support, to the extent of 5% to 10% of the pool of receivables funded by a lender under the facility.
- Factoring
Factoring law, intended to encourage factoring, has not lived to its purpose due to regulatory overtone. The Factoring Regulation Act was enacted to facilitate and encourage factoring; however, its regulatory stance has served to stifle factoring. Only a handful of NBFCs are currently registered as factors, while banks are not required to register[4]. As a result, the volume of factoring in India is trivial, as compared to global jurisdictions.
- Potential for securitisation of SME receivables
Direct securitisation by SMEs is not feasible. There are 2 ways in which securitisation of MSME receivables can take place: securitisation of trade receivables by SME itself; and secondly, receivables are funded by intermediaries (banks, NBFCs), aggregated by intermediaries, and securitised by them.
Securitisation by SMEs directly is not feasible, as volumes are not sufficient. Plus, it requires direct access to investors, which is unviable. Hence, the discussion below focuses on securitisation of receivables funded by intermediaries.
Intermediated securitisation is the way the world does it. However, regulations in India have scuttled the possibility. Acquisition of receivables by intermediaries (either on their balance sheet, or in the balance sheets of trade finance conduits) is quite common world-over[5]. However, this activity has not picked up in India, for several reasons:
- There is a bar on securitisation of revolving credit facilities in the RBI SSA Directions. Naturally, a trade receivable funding program has to be structured as a revolving facility, to allow the SME continued and assured access to working capital. Issuance of asset backed commercial paper is also barred under the same Directions.
- Regulated financial lenders cannot do a securitisation transaction outside of SSA Directions. If unregulated entities (not regulated by the RBI, say, a conduit vehicle) does a securitisation outside of SSA Directions, no regulated lender can invest in such a transaction, as any investment so made will be a full charge against regulatory capital.
As a result, securitisation of trade receivables is currently a near impossibility under the regulatory regime.
Will trade receivables securitisation help?
Table below compares securitisation with TREDS, supply chain financing and securitisation:
| TREDS | Supply Chain Financing | Securitisation | |
| Consistent availability of funding | While the funding limits are established based on the rating and credit of the buyer, the funding happens on invoice-by-invoice basis. There is no assurance as to either availability or the cost of funding | As limits are assigned for each vendor/ dealer, there is an assured availability at a pre-agreed cost of funding | As limits are assigned for each vendor/ dealer, there is an assured availability at a pre-agreed cost of funding by the intermediary, who, in turn may take receivables to capital markets |
| Disintermediation | Involves financial intermediaries | Involves financial intermediaries | Involves intermediaries at the inception, but eventually, the intermediaries offload the receivables to capital market |
| Burden on banks’ balance sheets | Receivables are on the balance sheet of the lender | Receivables are on the balance sheet of the lender | Receivables are off the balance sheet for regulatory capital purposes |
| Pricing | While pricing is primarily done on the strength of the Anchor, at times, SME gets good pricing based on the liquidity in the banking system | Pricing is done based on the FLDG support provided by the Anchor; hence, priced based on achor’s credit rating | Availability of capital market access, coupled with credit enhancements may bring down the cost of funding |
Policymakers need to enable alternative instruments, and leave the choice to the marketplace. The Table above makes a case for securitisation of trade receivables. Such securitisation does not conflict with TREDS; TREDS may continue as an option, leaving the choice to SMEs /lenders the benefit of choice.
Role of credit enhancements in trade receivables securitisation
The potential structure of securitisation of trade receivables, as it commonly works in global jurisdictions, is as follows:
Figure: Structure of Trade Receivable Securitisation
In essence, there are two levels of credit support – one, at the level of each SME (seller), which sells receivables to the Intermediary/conduit. This is typically by way of over-collateralisation or a first loss facility.
Having thus acquired credit enhanced receivables from the SMEs, the intermediary arranges a program-wide credit enhancement. This enhancement essentially becomes a mezzanine support.
The entire program works as a revolving facility, such that the SME sellers continue to sell receivables on an ongoing basis. On the other hand, the securised paper has a fixed maturity, subject to roll-over at the discretion of the paper holders. Hence, there needs to be liquidity support provided to the conduit, typically by a bank.
Providers of credit enhancement:
- SIDBI, as credit enhancer for SME funding, may provide the program credit support.
- SIDBI, in turn, may be counter-guaranteed by MDBs
Policy/regulatory changes required:
The bar on securitisation of revolving credit facilities, introduced looking at the experience during GFC, needs to be withdrawn. There is an inherent liquidity risk on the part of the intermediary that does securitisation (the risk that early amortisation triggers may cause the facility to wind down, while the committed funding still will have to be continued by the intermediary), but this may be addressed by appropriate capital charge. Note that there is no bar on revolving credit securitisation either in the EU Capital Directions, or in Basel Securitisation Framework.
Likewise, the bar on issuance of asset backed commercial paper needs to be removed. The provider of liquidity facility needs an appropriate capital charge for the maximum value of the facility.
[1]https://www.ifc.org/content/dam/ifc/doc/mgrt/financing-india-s-msmes-estimation-of-debt-requirement-of-msmes-in-india.pdf
[2]https://dcmsme.gov.in/Report%20of%20Expert%20Committee%20on%20MSMEs%20-%20The%20U%20K%20Sinha%20Committee%20constitutes%20by%20RBI.pdf
[3] Source: RBI Statistics on TREDS: https://www.rbi.org.in/Scripts/TREDSStatisticsView.aspx?TREDSid=8, and VKC Analysis
[4] See blog by Vinod Kothari: https://www.linkedin.com/pulse/factoring-india-fractured-opportunity-vinod-kothari/
[5]https://www.euromoney.com/article/2cs68xnhl90cxtg3n64n4/treasury/trade-receivables-deals-buck-broader-market-slump
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