Factoring is considered an important source of short-term and working capital financing for micro, small and medium enterprises. It enables them to obtain upfront credit for invoices raised, without over-leveraging balance sheets. Factoring is also favourably regarded by financial institutions as this enables them to provide financing to lower-rated entities while taking on the credit risk of much better-rated entities. The Factoring Regulation Act, 2011 (FRA) was amended by the Factoring (Amendment) Regulation Act, 2021 (act), with the intention of encouraging greater participation in factoring by financial institutions as well as by non-financial bodies requiring short term financing for invoices raised in the course of their business.
The act introduced changes to the definitions of terms such as assignment and receivables to bring them into line with international standards. More importantly, the act removed the explanation that a non-banking financial company (NBFC) would be considered as engaging in the factoring business as its principal business and had to ensure that 50% of their assets and their income came from the factoring business.
Further to the amendments to the FRA, the Reserve Bank of India (RBI) in January issued the Registration of Factors (Reserve Bank) Regulations, 2022 (RFR), and the Registration of Assignment of Receivables (Reserve Bank) Regulations, 2022. The RBI’s press release publicising the changes noted that, following the amendments and the RBI’s RFR, existing NBFCs classified as investment and credit companies (NBFC-ICCs) holding assets valued at INR10 billion (USD130 million) or more, will be allowed to engage in the business of factoring. The RBI thought that the number of NBFCs eligible to engage in the factoring business would increase significantly from seven to 182. It is notable that reports in the public domain suggest that the government anticipated that 9,500 NBFCs will be able to engage in the factoring business.
The RFR require any company that wishes to engage in the business of factoring to apply to the RBI for registration as an NBFC-Factor. An NBFC-Factor must have a minimum net owned fund of INR50 million. The RFR also introduce a new definition of an NBFC-ICC as a financial institution that is engaged in asset finance as its primary business and does not fall under any other category of NBFCs prescribed by the RBI. An existing NBFC-ICC may apply to the RBI for registration as an NBFC-Factor if it does not hold or accept public deposits, otherwise holds assets of at least INR10 billion (as shown in its last audited financial statements), and meets the net owned fund requirements prescribed by the RBI.
An NBFC-Factor is required to comply with the “principal business criteria” that its financial assets in the factoring business makes up at least 50% of its total assets and that its income derived from the factoring business constitutes at least 50% of its gross income. The return of these principal business criteria in the RFR is a somewhat curious restoration, as the act removed the principal business criteria from the FRA. The previous change had received much publicity and had piqued the interest of many NBFCs. Such NBFCs believed that they could engage in the factoring business without affecting their other lines of business, as they would not need to comply with the principal business criteria.
From a jurisprudential perspective, it is not often that statutory legislation removes a provision only for it to be restored in delegated legislation. In this case, the presumption must be in favour of the RBI as it is best placed to assess the eligibility of financial institutions to participate in the factoring business. It may be that the RBI believes that NBFCs must focus on the factoring business if they wish to participate in this sector, in order to remove systemic risk resulting from mispriced credit and inaccurate risk assessments. In any case, this has the effect of substantially cutting down the number of NBFCs that are permitted to participate in the factoring business. Time will show if the act and the RBI’s RFR bring about greater participation in the factoring sector.
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