Can TReDs pull some threads to capture its Rs 8 lakh crore opportunity?
Can TReDs pull some threads to capture its Rs 8 lakh crore opportunity?
Trade credit is the fuel that keeps the wheels of the economy turning.
The different legs of production activity, viz raw material procurement, production, distribution, wholesale, and retail, depend on working capital; a shortage could halt business operations. Receivable finance, also known as factoring, is a widely used tool to address this gap in operating capital.
Invoice factoring is a concept that has been introduced previously. The need for a business to be able to raise funds has existed as long as trade and commerce have. The oldest known history of business financing, and invoice factoring, go back 5,000 years to Mesopotamia (now modern-day Iraq, Kuwait, and Syria). From mediaeval businessmen and English colonists to the current services we see today, invoice factoring has an extensive history.
Last week, I wrote about how mere access to financial services or digitisation does not warrant financial inclusion. In keeping with the theme of inclusion, I want to write about one of the first children from the Indian digital financial services stable - TReDs platform - but with an inclusion lens of 633.9 lakh MSMEs.
A brief history of invoice financing in India
India's bill discounting system, historically known as Hundies, has been a traditional way of dealing with commercial bills in vernacular languages. The Reserve Bank of India (RBI) has tried to modernise this system to provide better receivable finance access to SMEs. Despite these initiatives, as the chart below shows, the share of discounted bills and cash credits, overdrafts and loans in the bank's total advances has declined between 2005 and 2021.
SBI Factors was established in 1991 as the first factoring company in India, followed by other players. However, only 10% of MSMEs' account receivables were served by the formal factoring industry, as most still needed cash credit or overdraft arrangements with banks. In December 2009, SIDBI and NSE launched Trade Receivable E-discounting Engine (NTREES) for electronic receivable discounting, but it needed more competition among lenders for efficient price discovery. That’s when the RBI proposed and issued operational guidelines for Trade Receivables electronic Discounting System (TReDS) exchanges to address this issue.
TReDS - a step towards inclusion
TReDS is a digital platform for MSME suppliers to upload invoices, allowing banks and NBFCs to compete for efficient price discovery. The platform serves as an interface among MSME sellers, corporate/PSU buyers, and banks/NBFCs, enabling MSMEs to access trade credit at attractive rates through a transparent electronic auction process. With TReDS, payment risks are transferred to the discounting bank, allowing financing on a "sans recourse" basis.
In ‘sans recourse’ financing, the strength of the buyers is given precedence over the credit rating of the MSME. More recently, to protect against defaults, the RBI recently proposed providing an insurance facility for invoice financing, permitting all institutions and entities undertaking factoring business to participate as financiers in TReDS and enabling rediscounting invoices.
Currently, three digital platforms offer without-recourse receivable financing under the TReDS framework. Receivables Exchange of India, M1xchange, and Invoicemart. Data from the RBI indicates that the number of financed invoices uploaded on these platforms grew by 62% in 2020-21, with a success rate of 91%. This success rate is determined as the ratio of financed invoices to the total invoices uploaded on the platforms and has improved from 88% to 91% since the TReDS platform's inception, as shown in the graph.
Not through a glass, darkly - the arduous task of formalising MSME invoice discounting
Despite being in existence for several years, the platform is yet to meet its intended objectives. Notwithstanding the small successes illustrated above, the opportunity in invoice financing remains largely untapped – the overall lifetime transaction value on the platform is a meagre Rs 69,277.93 crore, compared to the estimated market opportunity of Rs 8 lakh crore.
The government has attempted to address the issue through various means, including establishing the MSME Samadhaan portal to manage delayed payments. However, the number of pending applications related to unpaid dues remains significant, with many MSMEs not approaching the government for fear of harming their business relationship with creditors. Some need to be made aware of the portal's existence.
On January 28, 2021, about 43,245 applications were pending related to unpaid dues, amounting to Rs13,797.76 crore.
The system is fraught with challenges -
1. Adoption
As of 2020, only about 10,000 MSMEs were registered on TreDS. That’s less than 1% - a negligible fraction of the 633.9 lakh unincorporated MSMEs. In 2018, the government made it mandatory for all companies with a turnover greater than Rs 500 cr to be registered on the TReDs platform. However, as of 2021, out of the 4,714 companies identified by the Ministry of Corporate Affairs, only 1,643 companies have registered on the portal. A report from October 2022 reveals that the finance ministry asked 92 operating central public sector enterprises (CPSEs) to sign up for TReDS.
Adoption delays negate the success rate of the TReDS platform seen in the chart above. The entire exercise is futile if there are no buyers for the sellers or sellers for the buyers.
The way I look at it, there are four parts to this issue -
A NITI Ayog report posits that large buyers, especially corporate buyers, lack the motivation to sign up on the platform due to restrictive procedural guidelines - they’re required to waive their rights to dispute goods or services upon accepting an invoice. While it assures the financiers, it deters buyers because they’re understandably unwilling to relinquish their ability to dispute the goods or services by accepting the factoring unit.
In addition, since these platforms are exclusively for MSME suppliers, they discourage corporate buyers with complex supply chains that involve non-MSME suppliers. Such buyers may be unwilling to divide their operations and manage two separate invoice discounting systems.
Many corporate buyers currently have in-house corporate treasury departments that manage their own reverse factoring initiatives for their supplier network. This factor has contributed to the limited adoption of external platforms. The report further noted that several other banks, such as SBI, provide comparable programs for financing their clients, vendors, and dealers.
TReDS is exclusively open to entities that the Reserve Bank of India regulates. Until the recent Factoring (Amendment) Act 2021, only a restricted group of Non-Banking Financial Companies (NBFC-Factors) were authorised to provide financing through these platforms, apart from banks.
2. Integrations
There are two parts to this -
The need for a unified payments platform for all MSME vendor payments by a PSU. Currently, PSUs go through the administrative trouble of bifurcating payments / tracking for discounting/making changes in Enterprise Resource Planning (ERP). As a result, they can’t upload all the vendor payments through TReDS, which results in a delay in payments that can be difficult to track. If the PSU releases direct payment to the MSME through the TReDS settlement mechanism, the exact payment date will be recorded, and delays can be tracked.
Integration of the TReDS platform with GSTN e-invoicing is a significant roadblock. Integration with GST will ensure the automatic uploading of all GST invoices approved by buyers onto TReDS. Subject to consent from MSMEs, this could create an environment of greater transparency. Based on MSME cash flow and GSTN data, it could also mean greater liquidity for MSMEs. Additionally, with the integration of GSTN e-invoicing, MSMEs don’t need to wait for buyer acceptance - the financier could take exposure on financing based on GSTN data.
3. Factoring
When we think about MSMEs and their large corporate buyers in one equation, the power scales are naturally tipped towards the corporates. Currently, TReDS allows for factoring (where the MSME or the seller takes the lead in discounting) as well as reverse factoring (where the corporate or the buyer takes the lead in discounting). Many MSMEs shy away from participating in TReDS because a) factoring needs to be done digitally, and b) they might need more faith in their buyers to approve the invoices on time. Encouraging reverse factoring means a couple of things -
For large companies, it might act as an incentive as only MSMEs approved by them will be on the platform, incentivising them to continue participating.
It would also help them develop better ties with their sellers, leading to greater trust between the two parties.
4. Regulatory hurdles
Currently, there’s no secondary market where financers can offload their TReDS portfolio to other financiers. A secondary market, especially one where a financier's PSL TReDS portfolio can be traded, would - a) Bring more liquidity, b) release the limits of the financier, c) Increase participation and volumes on TReDS. While it is envisaged in the TReDS guidelines, it hasn’t been implemented.
Also, the TReDS portfolio of new-to-bank customers is treated differently from financing against receivables for banks’ existing customers in terms of unsecured exposure limits. A review of the capital adequacy norms could potentially help new-to-bank MSMEs.
What I’m trying to say is…
TReDS is a long-term transformation project, so easy results are unlikely.
At the same time, the government must listen to the industry more, make easy integrations such as GSTIN and involve more entities to make the platform more valuable.
Marketing is the biggest issue even after all the changes, and it can only be fixed with a blitz campaign + incentives and rewards - the kind used for UPI to educate people and enable them to come on board.
It’s a four-way platform - MSMEs (suppliers), Corporates (buyers), financiers (banks and NBFCs), and now insurers - all eCommerce stories tell us that marketplaces have this chicken and egg problem, but the most challenging part is bringing MSMEs on board - once that’s done - banks and financial institutions will come running to capture business.
China - the fintech lab of the world, as I always say - has some lessons to offer on double factoring. Alibaba, JD.com, and Suning have set up in-house factoring subsidiaries. The idea is to permit e-commerce companies in India to set up NBFCs that can get funded by larger banks for invoice financing. MSMEs get their money; the in-house NBFC has better asset liquidity, and the larger bank now has access to a broader pool of borrowers.
If trade credit is the fuel for the economy, it’s high time we fix the engine that is TReDS.