NBFC Factors: Meaning, Role & RBI Regulations in India

A NBFC-Factor is a type of Non-Banking Financial Company (NBFC) that is primarily engaged in the business of factoring.

Factoring is an important source of liquidity worldwide, especially for MSMEs. Factoring is a transaction where an entity sells its receivables (dues from a customer) to a third party (a 'factor' like a bank or NBFC) for immediate funds. All or part of the invoice can be sold to a factor to get money immediately at a competitive interest rate. The factor then collects payments from the buyer of goods and earns a commission in the form of some interest. This is different from bill discounting. In bill discounting, a bank or NBFC gives a certain percentage of the total outstanding value of invoices to the seller and in most case the seller has to take on the responsibility for payment of invoices by the buyer to the factor (Recourse Bill Discounting). However, in the case of factoring, the factor takes on the responsibility for collecting invoices.

Example of How NBFC-Factor Works

A business sells goods worth ₹10 lakh to a customer with a credit period of 60 days.

1. The business sells the invoice to an NBFC-Factor at a discount (e.g., ₹9.5 lakh).
2. The NBFC-Factor pays ₹9.5 lakh to the business immediately and collects ₹10 lakh from the customer after 60 days.

This model helps businesses improve cash flow while enabling NBFC-Factors to generate income from the discounted purchase and collection of receivables.

Types of factoring

• Recourse: Factoring where seller has to pay back the advance obtained from the factor if buyer of goods fails to pay
• Non-Recourse: Factoring where factor bears the risk of default in case of non-payment of buyer of goods.

In contrast, in non-recourse factoring, the risk of the buyer defaulting is borne by the bank or NBFC. However, this comes with higher fees or a lower percentage of invoice value advanced to the seller because the financier is taking on more risk.

History

To solve the liquidity issues of MSMEs and lay down the basic legal framework for factoring in India, the Factoring Regulation Act, 2011 ("Act") was enacted. As per the Act, RBI grants registration to only those NBFCs which do factoring as "principal business", i.e. whose financial assets in the factoring business constitute at least 50 per cent of its total assets and income derived from factoring business is not less than 50 per cent of its gross income. This "principal business' restriction on NBFCs in the Act had limited the scope of factoring.

New amendments in 2022

In January 2022, the RBI issued regulations for the amended Factoring Regulation Act, 2011 after the Parliament had passed the Factoring Regulation (Amendment) Bill in July 2021. This regulatory shift aimed to expand access to the factoring market, particularly for small and medium enterprises (SMEs), startups, and other businesses reliant on working capital. The amendment had removed earlier guidelines that allowed NBFCs to remain in the factoring business only if their financial assets in the factoring arm and income earned from it was over 50 per cent of the company's gross assets and net income.

The Central Government by way of the Registration of Factors (Reserve Bank) Regulations, 2022 ("Factor Registration Regulations") and the Registration of Assignment of Receivables (Reserve Bank) Regulations, 2022 ("Assignment Registration Regulations") (collectively referred to as the "Amending Regulations") has provided necessary impetus to small enterprises for lining up credit.

The key changes brought about are:

• Removal of principal business criteria has significantly increased the number of eligible NBFCs that can undertake factoring business.
• The time period for registration of invoice and satisfaction of charge upon it may be specified by the Government by rules to streamline the process and prevent fraud through dual financing.
• Previously, factoring was done either manually or on the Trade Receivable Discounting System (TReDS). With the amended Act and new Rules and Regulations allow the concerned TReDS platform to register charge directly with Central Registry of Securitization Asset Reconstruction and Security Interest (CERSAI) on behalf of the factors using the platform, so as to make the process operationally efficient, promote the use of TReDS and reduce the procedural burden on factors.
• Definitions of "assignment", "factoring business" and "receivables" have been amended to bring them in consonance with international definitions.
• Regulation making power was given to RBI for the manner of granting certificate of registration under Section 3 of the Act, and the manner of filing of particulars of transaction with the Central Registry by TReDS entities on behalf of factors under Section 19 of the Act.

Factor Registration requirements as per Factor Registration Regulations

1. Every company intending to undertake factoring business shall make an application to the Reserve Bank for grant of certificate of registration (CoR) as NBFC-Factor under the Act and shall ensure compliance with PBC as stipulated in regulation 4 of these regulations.
2. Any existing NBFC-ICC, intending to undertake factoring business, shall make an application to the Reserve Bank for grant of CoR under the Act if it satisfies the following eligibility criteria:
   • (a) not accepting or holding public deposits;
   • (b) total assets of ₹1,000 crore and above, as per the last audited balance sheet;
   • (c) meeting the NOF requirement as prescribed in regulation 3 of these regulations;
   • (d) regulatory compliance.
3. Any existing NBFC-ICC, which does not satisfy the above conditions but intends to undertake factoring business, shall approach the Reserve Bank for conversion from NBFC-ICC to NBFC-Factor. Such NBFC-ICCs shall comply with the PBC as specified in regulation 4 of these regulations.
4. Application for such conversion shall be submitted with all supporting documents meant for new registration as NBFC-Factor, together with surrender of original CoR issued by the Reserve Bank to the NBFC-ICC under Section 45IA of the Reserve Bank of India Act, 1934.
5. An entity not registered with the Reserve Bank under the Act, may conduct the business of factoring, if it is an entity mentioned in Section 5 of the Factoring Regulation Act, 2011 i.e. a bank or a body corporate established under an Act of Parliament or State Legislature, or a Government Company.
6. NBFC-Factor or eligible NBFC-ICC which has been granted CoR by the Reserve Bank under these regulations, shall commence factoring business within six months from the date of grant of CoR.

Asset Classification

NBFCs-Factors with asset size of less than ₹500 crore

In addition to the Asset Classification norms contained in paragraph 14 of Master Direction - Reserve Bank of India (Non-Banking Financial Company - Scale Based Regulation) Directions, 2023 (SBR Master Directions), for NBFC-Factors with asset size of less than ₹500 crore, a receivable acquired under factoring which has remained overdue for more than 180 days of due date as applicable, shall be treated as NPA irrespective of when the receivable was acquired by the NBFC-Factor or whether the factoring was carried out on "with recourse" basis or "without-recourse" basis. Further, glide path for recognition of NPA as prescribed in paragraph 14.2 of the SBR Master Directions shall also be applicable to such NBFC-Factors. The entity on which the exposure was booked shall be shown as NPA and provisioning made accordingly.

NBFC-Factors with asset size of ₹500 crore and above and NBFC-ICCs granted CoR under the Factoring Regulation Act, 2011

In addition to the Asset Classification norms contained in paragraph 87 of the SBR Master Directions, for NBFC-Factors with asset of size of ₹500 crore and above or an NBFC-ICC which have been granted CoR under the Factoring Regulation Act, 2011, a receivable acquired under factoring which has remained overdue for more than 90 days of due date as applicable, shall be treated as NPA irrespective of when the receivable was acquired by the NBFC-Factor/concerned NBFC-ICC or whether the factoring was carried out on "with recourse" basis or "without-recourse" basis. The entity on which the exposure was booked shall be shown as NPA and provisioning made accordingly.

Risk Management

1. Proper and adequate control and reporting mechanism shall be put in place before factoring business is undertaken by an NBFC-Factor or eligible NBFC-ICC which has been granted CoR under the Factoring Regulation Act, 2011.
2. NBFC-Factors shall conduct a thorough credit appraisal of the debtors before entering into any factoring arrangement or prior to establishing lines of credit with the export Factor.
3. Factoring services shall be extended in respect of invoices which represent genuine trade transactions.
4. Since under "without recourse" factoring transactions, the NBFC is underwriting the credit risk on the debtor, there shall be a clearly laid down board-approved limit for all such underwriting commitments.
5. NBFC-Factors and banks shall share information about common borrowers. For the purpose of exchange of information, the assignor will be deemed to be the borrower. NBFC-Factors shall ensure to intimate the limits sanctioned to the borrower to the concerned banks/NBFCs and details of debts factored so as to avoid double financing.

Options for a Company without Factoring Business

1. Transition Plan:
   • If the company does not currently meet the PBC but intends to shift its business model to factoring, it will need to present a transition plan to the RBI.
   • This plan should outline how the company intends to gradually scale its factoring operations to meet the 50% threshold for both assets and income.
   • The company should demonstrate a timeline for increasing the share of factoring in its business and how it plans to develop a sustainable factoring model.
2. Investment in Factoring Infrastructure:
   • The company can consider investing in the infrastructure required to start factoring operations, such as hiring experienced professionals, developing factoring contracts, and setting up systems to engage in factoring transactions.
   • These investments, if adequately documented, could help the company increase its involvement in factoring, thereby meeting the PBC over time.
3. Additional Documentation:
   • If the company has not yet started factoring but plans to, it may need to submit a detailed business plan that includes:
     • A strategy for entering the factoring market, including target clients, expected volume of transactions, and financial projections.
     • A clear road map showing how the company will achieve at least 50% of its business through factoring over a reasonable period (e.g., within 1-2 years).
4. Interim Period for Compliance:
   • The RBI might allow a company some flexibility if it can show a strong commitment to factoring and is taking steps to develop its factoring business.
   • The company could potentially apply for a temporary registration or special approval with a clear condition to comply with PBC within a set period.
5. Explore Other License Options:
   • If the company cannot immediately meet the factoring PBC, it may be more feasible to apply for an NBFC-ICC license (if eligible) and transition to an NBFC-Factor after establishing its factoring business.
   • Alternatively, the company could start with limited factoring services while focusing on other areas of its business, and then work towards meeting the PBC in the future.

Export/Import Factoring

Foreign Exchange Department (FED) of the Reserve Bank gives authorization to Factors under FEMA, 1999. NBFC-Factors or NBFC-ICCs which have been granted CoR under the Factoring Regulation Act, 2011, intending to deal in foreign exchange through export/ import factoring, shall make an application to FED for necessary authorization under FEMA,1999 to deal in foreign exchange and adhere to the terms and conditions prescribed by FED of the Reserve Bank and all the relevant provisions of the FEMA or Rules, Regulations, Notifications, Directions or Orders made thereunder from time to time.

Disclaimer: This article has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. This article cannot be relied upon to cover the specific situation, and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact Affluence Advisory Private Limited to discuss these matters in the context of your particular circumstances. Affluence Advisory Private Limited, Its Partners, Directors, Employees, and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information in this article or for any decision based on it.