Factoring in India is considered an important source of short-term and working capital financing for micro, small and medium enterprises, as it enables them to obtain upfront amounts for invoices raised without over-leveraging balance sheets. Factoring is also favourably looked at by financial institutions, as it enables them to provide financing to lower rated entities while taking on the credit risk of a better-rated entity.
The Factoring Regulation Act 2011 was recently amended by the Factoring (Amendment) Regulation Act 2021, with the intent of encouraging depth and greater participation in factoring by financial institutions, as well as non-financial institutions that require short-term financing for invoices raised in the course of their business.
This amendment introduces changes to the definitions of certain terms, such as "assignment" and "receivables" to align these with international standards. Importantly, the amendment also removes the explanation that non-banking financial companies (NBFCs) would be considered as engaging in factoring business as their principal business, and the requirement to ensure that 50% of their assets and income should be from factoring business.
Following on from the amendments to the Factoring Regulation Act, on 14 January 2022, the Reserve Bank of India (RBI) issued the Registration of Factors (Reserve Bank) Regulations 2022 and the Registration of Assignment of Receivables (Reserve Bank) Regulations 2022.
The RBI's press release notes that following the amendments and the RBI's factors registration regulations, NBFCs eligible to engage in factoring business will increase "significantly from 7 to 182". The factors registration regulations also contemplate that NBFCs that are classified as investment and credit companies (NBFC-ICCs) with an asset size of 10 billion Indian rupees (approximately $130.27 million) would be eligible to engage in the factoring business. Notably, reports in the public domain suggest that the central government anticipated that 9,500 NBFCs would be able to engage in factoring business.
The factors registration regulations require any company desirous to engage in factoring business to apply to the RBI for registration as an "NBFC-Factor". An NBFC-Factor must have a minimum net owned fund of 50 million rupees (approximately $655,435). The factors registration regulations also introduce a new definition of 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 can apply to the RBI for registration as an NBFC-Factor if:
- it does not hold or accept public deposits;
- it has an asset size of 10 billion rupees (as per its last audited financial statements); and
- it meets the net owned fund requirements prescribed by the RBI.
All NBFC-Factors are required to comply with the "principal business criteria" that at least 50% of their total assets and total income must be derived from factoring business.
The return of the principal business criteria in the factors registration regulations is a somewhat curious restoration, as the amendment to the Factoring Regulation Act removes the principal business criteria that existed in the 2011 version. This removal has received much publicity and has piqued the interest of many NBFCs, which believed that they could engage in factoring business without affecting other lines of business, as they would not need to comply with the principal business criteria.
From a jurisprudential perspective, it is unusual to see statutory legislation removing a provision only for it to be restored in delegated legislation. In this case, the presumption must be in favour of the RBI, as they would be best placed to assess the eligibility of financial institutions to participate in factoring business. It might also be the case that the RBI believes that the focus on factoring business is a must for NBFCs to participate in this sector, so as to remove any systemic risk associated with mispriced credit and inaccurate risk assessments.
This development has the effect of substantially winnowing the field of NBFCs that can participate in factoring business. Whether the amendment act and the RBI's factoring registration regulations result in the deepening of the factoring sector remains to be seen.
For further information on this topic please contact Aditya Bhargava or Sristi Yadav at Phoenix Legal by telephone (+91 22 4340 8500) or email ([email protected] or [email protected]). The Phoenix Legal website can be accessed at www.phoenixlegal.in