The Narendra Modi government has decided to allow all non-banking financial companies to provide discount loans to Micro, Small and Medium Enterprises against their dues, using the Trade Receivables and Discounting System or TReDS platform.
As one of the many recent measures introduced to boost liquidity for a salient sector, this offers respite to MSMEs that do not wish to avail credit and working capital loans to bridge a short-term financing gap. The gap that emanates in the duration between the raising of a bill/invoice and its due date is exacerbated in the case of delayed payments. The Cabinet briefing notes delayed payments by government departments, which take 90 days to clear MSME dues.
What is the TReDS?
TReDS is an electronic platform for financing/discounting trade receivables of MSMEs through multiple financiers. On such a platform, MSMEs participate as sellers; corporates, government departments and PSUs participate as buyers, and financial institutions permitted by the Reserve bank of India (RBI) participate as financiers. All these participants enter into an agreement with the TReDS platform. There are presently three TReDS platforms that provide such discounting services.
The key benefit of using such a platform is that the seller does not have to wait for the buyer to make the payment; this is where the role of financiers comes in. Once the invoice is uploaded onto the platform by the seller, it is termed a ‘factoring unit’. After this is accepted by the buyer, an e-auction is conducted where multiple financiers bid for the factoring unit. The TReDS also allows reverse factoring – where the factoring unit is created by the buyer.
After the seller finds a suitable bid, the financiers, who are financial intermediaries such as banks and NBFCs, provide the seller with the agreed rate of financing/discounting. This financing is done without any collateral provided by the seller. The financier is repaid by the buyer on the due date of the invoice. All these payments are auto-debited from the accounts of the participants, thus ensuring that transactions are completed in a fair, transparent and efficient manner. In case the buyer defaults on the repayment to the financier, the MSME seller is not obligated to pay the financier. All transactions processed under TReDS are ‘without recourse to MSMEs’ and hence remain beneficial for them.
The need for more financiers
Until the Modi government’s decision to widen the scope of eligible financiers on the TReDS, banks and only a particular set of NBFCs — called NBFC-Factors — operated as financiers on this platform. Under the Factoring Regulation Act, 2011, NBFCs that wish to carry out the factoring business are required to a) obtain a separate registration certificate from the RBI, and b) be given registration only as per the ‘principal business’ criteria.
The ‘principal business’ criteria entails those NBFCs whose financial assets in the factoring business exceed 50 per cent of total assets and whose income from factoring business exceeds 50 per cent of gross income. A new category of NBFCs adhering to both these criteria was thus introduced — the NBFC Factors. Post this, only those NBFCs that met the criteria would continue factoring and those that did not were required to wind down their factoring business. As of 16 July 2020, only seven NBFC Factors remained.
In a bid to enhance more financiers on the TReDS, the RBI Expert Committee on MSMEs, 2019 and Union Budget 2019-2020 had proposed making necessary amendments to the Factoring Regulation Act, 2011 — to permit all NBFCs (other than NBFC Factors) directly participate on TReDS platforms. Since MSMEs supply corporates having lower ratings, a wider pool of financiers would help them discount invoices drawn on smaller and lower rated corporates. A concrete decision in this regard is a welcome step in providing a fillip to MSME financing.
Space for further changes
Since the objective of the TReDS platforms is to boost cash flow financing for MSMEs, the participation of multiple financiers is important. Entities other than banks and NBFCs also may be allowed to participate as financiers. High Net worth Individuals (HNIs) may be included as an eligible category. Additionally, Urban Cooperative Banks (UCBs) and Regional Rural Banks (RRBs) could also be allowed to participate with adequate safeguards in order to further facilitate prompt settlement of invoices at competitive rates for MSME suppliers.
Another crucial challenge regarding usage of TReDS is the low level of participation noted on these platforms. Only around 10,000 MSMEs and 1,300 buyers (with more than Rs 500 crore turnover) are registered on TReDS platforms. This is a negligible fraction of the 6.3 crore unincorporated MSMEs that are known to exist (recorded as of 2015-2016).
More awareness needs to be created about the existence of such an institutional mechanism and the benefits associated with participating in it. Clear advantages for MSMEs include multiple financiers participating in bids to produce better average interest rates, considerable reduction in time taken for MSME sellers to receive payments, and a transparent cash flow financing/discounting process. These merits must be communicated extensively to MSMEs.
Higher usage of such platforms will afford MSMEs another potential avenue to service short-term financing gaps that often arise in the course of doing business. Unless the buyers such as corporates and government agencies take an initiative to migrate onto TReDS, MSMEs may also not want to disassociate from an established credit relationship with their banks. MSME industry associations at state and district levels should be utilised to spread further awareness on TReDS usage.
Lastly, while the Budget speech of 2018 proposed linking of the TreDS platform with the GST database, it has not been operationalised yet. Once completed, the maintenance of automated invoicing records across networks will generate better credit discipline by reducing financiers’ fears of fraudulent invoices. Vendors will then have to be GST-compliant in order to be eligible for bill discounting via TReDs.
The TReDS is a key institutional mechanism to facilitate access to working capital finance. It is meant to address one of the most pressing issues that small enterprises face in conducting business — erratic and delayed payments.
Radhika Pandey is a fellow and Amrita Pillai is a research fellow at National Institute of Public Finance and Policy (NIPFP). Views are personal.
Why news media is in crisis & How you can fix it
India needs free, fair, non-hyphenated and questioning journalism even more as it faces multiple crises.
But the news media is in a crisis of its own. There have been brutal layoffs and pay-cuts. The best of journalism is shrinking, yielding to crude prime-time spectacle.
ThePrint has the finest young reporters, columnists and editors working for it. Sustaining journalism of this quality needs smart and thinking people like you to pay for it. Whether you live in India or overseas, you can do it here.