How to Start a Factoring Business in India: A Comprehensive Guide

Factoring, as a financial service, has been gaining traction globally and in India due to its potential to provide liquidity and working capital to businesses. In the Indian context, Non-Banking Financial Companies (NBFCs) play a pivotal role in offering factoring services. The regulatory framework, primarily governed by the Reserve Bank of India (RBI) and the Factoring Regulation Act, 2011, has recently undergone significant amendments to promote factoring services, particularly for micro, small, and medium enterprises (MSMEs). This article provides a comprehensive guide on how to start a factoring business in India, covering regulatory requirements, operational guidelines, and strategies for success.

Understanding Factoring and Its Importance

What is Factoring?

Factoring involves the acquisition of receivables by a factor (NBFC-Factor or bank) through assignment or by providing financing against receivables. The Factoring Regulation Act, 2011, defines factoring as:

“The business of acquisition of receivables of an assignor by accepting assignment of such receivables or financing, whether by way of making advances, loans, or in any other manner against the security interest over any receivables.”

Factoring helps businesses convert outstanding invoices into immediate working capital, enabling smoother operations and liquidity management. However, the Act explicitly excludes credit facilities offered by banks, transactions related to agricultural product sales, and certain other financial activities.

Importance of Factoring in India

India’s MSME sector forms the backbone of its economy but often faces liquidity challenges. Factoring addresses this gap by offering quicker access to funds against trade receivables. Despite its benefits, factoring comprises only 2.6% of the total MSME credit in India, leaving significant room for growth. Recent regulatory reforms aim to expand the scope and accessibility of factoring services, especially for smaller businesses.

NBFC-Factor: The Key Player in Factoring Business

Who is an NBFC-Factor?

An NBFC-Factor is a non-banking financial company primarily engaged in factoring. To qualify, it must:

1. Derive at least 75% of its total assets and gross income from factoring.
2. Maintain a minimum Net Owned Fund (NOF) of ?5 crore.
3. Obtain a Certificate of Registration (CoR) from the RBI under Section 3 of the Factoring Regulation Act, 2011.

NBFC-Factors bridge the gap between businesses seeking liquidity and financial institutions, facilitating economic growth by addressing working capital needs.

Steps to Start a Factoring Business in India

1. Incorporate a Company

The first step is to incorporate a company under the Companies Act, 2013. The company’s objectives should include factoring and financial services.

2. Meet Entry Point Requirements

To register as an NBFC-Factor, the company must:

• Maintain a minimum NOF of ?5 crore.
• Satisfy the Principal Business Criteria (PBC): At least 75% of financial assets must relate to factoring. At least 75% of gross income must come from factoring activities.

Existing companies that do not meet the NOF criteria can request additional time from the RBI to comply.

3. Register with the RBI

An NBFC-Factor must obtain a CoR from the RBI. The registration process involves:

• Submitting an application under Section 3 of the Factoring Regulation Act, 2011.
• Providing documentation, including: Incorporation certificate Audited financial statements Business plan detailing factoring activities Compliance with PBC requirements

If the applicant is an existing NBFC-ICC (Investment and Credit Company) transitioning to an NBFC-Factor, the original CoR must be surrendered during the application process.

4. Develop Operational Infrastructure

A robust operational setup is essential for a successful factoring business. This includes:

• Establishing credit analysis mechanisms for assessing debtor’s creditworthiness.
• Implementing risk management systems to handle exposure limits, particularly in “without recourse” factoring.
• Setting up technology platforms for seamless invoicing and payment tracking.

5. Comply with Regulatory Framework

NBFC-Factors must adhere to the Factoring Regulation Act, 2011, and other RBI directives. Key compliance areas include:

• Classification of assets: Receivables unpaid for more than six months are classified as Non-Performing Assets (NPAs).
• Prudential norms: Maintain minimum capital adequacy ratios and provisioning for NPAs.
• Reporting requirements: Submit periodic reports on financial performance and factoring portfolio to the RBI.

Regulatory Framework for Factoring in India

Recent Amendments: Expanding Opportunities

The Factor Registration Regulations, 2022, and the Assignment Registration Regulations, 2022, have significantly reformed the factoring ecosystem. Key changes include:

1. Broader Scope of Eligibility: Increased the number of NBFCs eligible for factoring from 7 to 182. Introduced dual classifications: NBFC-Factor: Primarily engaged in factoring. NBFC-ICC: Investment and credit companies that can undertake factoring activities.
2. Streamlined Assignment of Receivables: Mandated registration of trade receivables with the Central Registry within 10 days of assignment. Enhanced transparency and reduced double financing risks.

Export/Import Factoring

For NBFC-Factors engaging in export/import factoring, compliance with the Foreign Exchange Management Act (FEMA), 1999, is mandatory. This includes obtaining authorization from the RBI’s Foreign Exchange Department and adhering to FEMA guidelines.

Challenges in Starting a Factoring Business

1. Stringent Entry Barriers: High asset thresholds for NBFC-Factors (?10,000 crore for total assets). Regulatory compliance requirements that may deter smaller NBFCs.
2. Credit Risk Management: Factoring often involves assuming credit risk, particularly in “without recourse” transactions. Effective risk mitigation strategies are critical.
3. Market Awareness: Limited awareness of factoring services among MSMEs restricts market penetration. Educating potential clients about the benefits of factoring is essential.
4. Competition from Conventional Financing: Factoring must compete with traditional credit products like overdrafts and cash credit facilities, which dominate the receivables financing market.

Strategies for Success in Factoring Business

1. Focus on MSMEs: Tailor factoring solutions to address the unique challenges of MSMEs. Partner with government initiatives promoting MSME financing.
2. Leverage Technology: Use digital platforms to streamline factoring processes, from invoice submission to payment collection. Adopt AI and data analytics for credit assessment and fraud detection.
3. Risk Diversification: Spread exposure across various industries and geographies to mitigate sector-specific risks. Set clear underwriting limits for high-risk clients.
4. Build Strong Partnerships: Collaborate with banks, trade platforms, and fintech companies to expand service offerings. Participate in government initiatives like the Trade Receivables Discounting System (TReDS).
5. Enhance Customer Awareness: Conduct workshops and seminars to educate businesses about factoring benefits. Develop targeted marketing campaigns highlighting liquidity solutions for startups and MSMEs.

Conclusion

Starting a factoring business in India is a promising venture with immense potential to support MSMEs and drive economic growth. However, it requires navigating a stringent regulatory environment and addressing operational challenges. By aligning with the guidelines of the Factoring Regulation Act, 2011, and leveraging recent amendments, entrepreneurs can build a successful factoring business that contributes to financial inclusion and economic development.

As the regulatory framework evolves and more NBFCs enter the factoring space, the ecosystem is expected to grow exponentially. With the right strategies and a focus on innovation, factoring businesses can unlock significant opportunities in India’s financial landscape.

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