Many small and medium enterprises (SMEs) across Bangladesh find it difficult to access credit and finance, and as a result, they often operate at a disadvantage. Digital factoring is an alternative financial service that can provide small enterprises with the funds they need for their operations without tying up capital or assets. This article discusses how this system works, its benefits, and the success of one such company in Bangladesh.
Digital Bangladesh has successfully adopted so many initiatives in versatile sectors. The business sector is not an exception. Bangladesh Bank has issued the Guidelines for Local Factoring/Receivable Financing through Digital Platform – Pilot Phase on January 18, 2022, to harvest the fruits of the digital factoring platform in Bangladesh. It will help businesses get finance quickly and digitally. A new company, ThinkBig Solutions Ltd., has been licensed to pilot a receivable digital financing platform for MSMEs in Bangladesh.
Digital Factoring Platform in Bangladesh
1. MSMEs are critical drivers of economic growth and poverty alleviation in Bangladesh. With a 25% contribution to the GDP, they play a crucial role in employment.
The Economic Census, 2013, by the World Bank and Enterprise Survey, 2013 by the Bangladesh Bureau of Statistics (BBS), about 99 percent of all non-farm firms are micro and small enterprises. They employ 20.3 million Bangladeshi workers.
2. The lack of access of the majority of the MSMEs from the formal lending channels poses risks to their growth. Most of them suffer from access to credit and liquidity required for working capital needs.
Traditional funding intermediaries are hesitant to lend to MSMEs due to high risks and costs and opportunity costs for monitoring. In addition, the loan size is tiny and demands close monitoring and supervision.
Also, they fail to comply with the collateral requirements for lack of immovable properties. Also, lack the necessary documentation for legal and formal agreements. Moreover, terms and conditions for microfinance institutions are unfavorable, along with higher interest rates. Thus, MSMEs mainly depend on sources of informal funds, resulting in higher borrowing costs. In this way, MSMEs have to struggle to get funds from traditional channels, resulting in a massive credit gap.
Scope of Local Factoring/Receivable Financing
3. Local factoring/Receivable Financing can fill the credit gap for MSMEs cost-effectively and efficiently. It can provide a new option to finance MSMEs by using accepted invoices and receivables as intermittent collaterals. Receivables financing describes several ways a business can get funds against dues from the customers. In short, as a process:
a) A corporate firm purchases products from MSME;
b) MSME receives an accepted invoice (which has a maturity date) from the large firm after delivery of products;
c) MSME sells the accepted invoice to a Financier [Bank/NBFI(Non-Banking Financial Institution)] at a discount and receives cash immediately;
d) Financier receives the total amount from the corporate firm at invoice maturity.
4. Bangladesh Bank (BB) to develop the MSMEs in Bangladesh has taken noteworthy initiatives, including improving the existing environment in the formal sector through regulatory and policy interventions and different refinance schemes. Following these initiatives, banks and NBFIs have emphasized financing to MSMEs. However, even after the formal sector’s emphasis, there is still scope to improve the scenario.
Hence, a guideline by BB on local factoring/receivable financing through the digital platform can encourage the financial institutions to invest in MSMEs, which will open an avenue of short-term financing opportunities for these entrepreneurs. Besides, a technology-based platform will improve efficiency, ensure transparency and reduce cost. Therefore, at the pilot phase, along with other interventions, Bangladesh Bank has decided to set up a digital/electronic platform on a pilot basis to automate local factoring/receivable financing.
5. Current scenario consists of some stand-alone systems provided by some banks and NBFIs. These platforms are only available to the A/C holders of the specific banks and NBFIs. Besides, these platforms still require a manual process to complete the entire cycle of factoring.
6. A technology-based online platform will facilitate trading among MSMEs, corporate and banks/NBFIs. MSMEs, corporate and banks/NBFIs will be the platform’s users and will be able to participate in the trading of various invoices. Invoices will be uploaded and verified for trading between respective parties. Bank/NBFI as a financier will compare invoices and their issuers and endorsers based on information available in the platform.
Eligibility Criteria for the participants during the Pilot Phase
7. MSMEs, Corporate and Banks/NBFIs with the following criteria will be eligible to participate in the platforms:
a) MSMEs: Any MSME entity (direct supplier of the participant corporate), holding accepted invoices;
b) Corporate: Any corporate incorporated or operating in Bangladesh;
c) Banks/NBFIs: Any bank or NBFI licensed by BB.
8. MSME and Corporate with the following criteria will not be eligible to participate in the platforms:
a) MSME and corporate having pending bankruptcy litigation against them;
b) MSME and corporate who are loan defaulters of any Bank/NBFI as per the law of the land;
c) Banks/NBFIs will not discount any invoices where any of their director and director’s family members (as defined in Bank Company Act’ 1991 & Non-Bank Financial Institution Act’ 1993) have majority shareholdings (as defined in Bank Company Act’ 1991 & Non-Bank Financial Institution Act’ 1993) or is a director of either the concern corporate or the concerned MSME.
Documentation & Confidentiality
9. Proper KYC (Know Your Customer) document, audited balance sheet, company profile of the participants (MSMEs and corporate firms) will be collected and maintained (if applicable)by the platform operator. Each participant will have a system-generated unique identifier.
10. Approved invoices will only be eligible for financing from one single source and hence to be uploaded and traded in a single platform. Once approved invoices are uploaded to a platform, the relevant MSME must ensure that no other financing facility is being opted against the same invoice elsewhere
11. Platform will have sole custody of the documents (agreement/KYC/invoice) during business operation.
12. All the data in the platform, like bidding and transaction data, KYC documents, and any other document required during the operation, have to be preserved for up to 12 (twelve) years. In case of liquidation, cessation of business, or end of NOC period without further approval of business continuity of the platform, documents will be handed over to respective participants or entities as directed by BB.
Other Operating Conditions
13. MSME sellers, corporate buyers, and financiers (Banks and NBFIs) will participate in the platform. A Memorandum of Understanding (MoU) and necessary participating agreements must be between each participant and the platform. The MoU and the participating agreement will sufficiently detail the roles and responsibilities of each party of the platform.
14. Steps or procedures to be followed:
a) MSME will submit an accepted invoice in the platform;
b) Platform administrator will check the eligibility of the invoice and then upload the same in the platform;
c) Notification will be sent to the approving corporate for necessary approval of the submitted invoice;
d) Corporate will approve the invoice within a specified time frame, and the approved invoice will become available for bidding by the financiers;
e) Financiers will bid for available invoices;
f) After a successful bid, the particular invoice will be locked and will not be available for further trading;
g) The winning bidder will do a verification of loan default for both the issuer and the approver and will initiate payment and settlement process;
h) On settlement confirmation, the ownership of the invoice will transfer to the financier;
i) Information about all the discounted invoices will be made public (through the website) by the platform;
j) At the maturity of the invoice, corporate will settle the fund against the invoice through its nominated bank and inform the platform accordingly.
The platform will send a prior notice to the corporate about the upcoming maturity of the invoice; k) The platform will record all the information of such settlement and update the status of each outstanding invoice.
15. In case of a failure or default in maturity payment, the platform will provide reminders to the corporate for immediate payment. Otherwise, it will provide the necessary support to the financier to recover the investment.
16. The pilot phase will be for one year. Platform owners will be given four months before the pilot phase to prepare for the infrastructure and complete all initial agreements with the participants. In case of failure or postponement of the pilot phase, six months will settle all the outstanding invoices. During these six months, no new invoice shall be uploaded or approved in the system.
17. During the pilot phase, BB will have the right to stop such an operation by providing a 7-day notice to the platform provider. After that, the platform provider shall get 120 days more to settle all the existing outstanding dues with all the parties. No new transactions are allowed during this period.
18. The piloting of the proposed system will be conducted with at least Ten(10) banks, Five (5) corporate firms, and at least two (2) MSME suppliers of each corporate. There will be no restrictions regarding the number of corporate and MSMEs during the pilot phase.
19. Platform should have the capability of interoperable transactions. Furthermore, all such future platforms should have interconnected features.
20. Secondary trade of 10% of a financier’s portfolio must be encouraged during the pilot phase.
21. In default, the recourse will be on the approving corporate. Limit of Investment and Transaction
Transaction limits during the piloting phase:
Bank Guarantee and Capital Requirement
23. The platform provider will provide a bank guarantee of BDT 1,00,00,000 (One Crore) in favor of the General Manager, Payment Systems Department, Bangladesh Bank for the whole duration of the piloting phase. It will cover any unforeseen losses to the participants. The format of the bank guarantee has to be approved by BB before issuance of the same.
24. BB will determine the paid-up capital of the platform at the licensing phase depending on the risk specification of such operation.
25. Platform will have the policy to ensure timely funds settlement in accepted bids and matured invoices. Funds need to be transferred between respective banks (financier bank to MSMEs bank in case of accepted bids and buyer’s bank to financier bank in case of invoice maturity) at a T+1 basis. To ensure transparency and integrity, the financier bank (in case of accepted invoice) and corporate (in case of invoice maturity) will have to confirm the initiation of the agreed payment amount in the system.
The mentioned procedure must be incorporated in the platform, financier, and corporate buyer agreement. In addition, the platform will have to put a separate recourse mechanism in case of settlement failure.
26. Invoices that any financier did not discount may be settled by the respective corporate and MSME at the maturity date. This action will be outside the scope of the platform. The platform will remove these invoices from further bidding after the maturity date.
27. In case of any transaction-related problem, the platform should have a dispute resolution process where each participant can raise issues.
Audits, credentials, and continuity of the platforms
28. Platform will provide username and password to all the direct participants and ensure multifactor authentication procedure and maker checker concept at the transaction level.
29. Platform owners will perform regular and random audits regarding the authenticity of the uploaded document (KYC and invoice).
30. Technology infrastructure of the platform should comply with the latest version of “Guideline on ICT Security For Banks and Non-Bank Financial Institutions” by Bangladesh Bank.
31. Platform should have a proper business continuity plan (BCP)/backup IT infrastructure in place.
Evaluation and Monitoring of Pilot Results
32. The performance of the platform will be evaluated and monitored in respect of the following Key Performance Indicators (KPI) for 12 (Twelve) months of the pilot operation:
33. Based on the KPI report and overall assessment of the desired goals, there will be a final report for the management of BB with recommendations about the future course of action in this regard. A comprehensive guideline for such operation will be formulated and issued if the management of BB decides to introduce such a platform-based business modality for MSME financing.
34. Bangladesh Bank will perform regular and ad-hoc onsite and offsite oversight on the platform. Based on oversight, there will be up-gradation/alteration of the system/business procedure during the pilot phase
35. There should be a proper policy for all participants to exit the platform. In case of completion of the provisional period, failure to achieve key performance indicators, cessation of business, or any other reason deemed satisfactory to the regulator. The NOC of the pilot may suffer an early end. The platform will have to inform the participants at least two months ahead.
The exit policy for all related parties may be as follows:
- MSMEs: MSMEs can leave the system at any time. As soon as the resignation is accepted, their account in the system will have to be suspended. All of their uploaded invoices which are yet to be financed, should be removed from the platform.
- Corporate: Before leaving, a corporate must inform the platform, MSME, and the financier. All the due payments to the financier must be cleared before the resignation. All the approved invoices of the corporate to be financed will have to be removed from the platform immediately after receiving the release request.
- Financiers: A financier can leave at any time. However, if any due payment is received from any corporate after the resignation date, it can settle the matter outside the platform afterward.
- Platform Providers: A platform provider may leave at any time, giving a notice period of 3 months or the most significant maturity date of invoices of that particular moment, whichever is higher. Upload no new invoices in the system from the notice period.
What is receivables financing?
Receivable financing, also known as accounts receivable financing, is an arrangement where a company sells its outstanding invoices to another party for a price lower than the face value of the invoice. There are various forms of this type of financing, including factoring and invoice discounting.
Many companies today are looking for ways to work smarter and more efficiently. One way to do this is by borrowing money from a lender instead of using cash reserves. A receivables financing provides the company with short-term funds in return for a future payment based on the expected revenues of the company’s clients. This type of financing enables growth by investing in its operations or buying new equipment.
What are the common forms of receivable financing?
Types of receivable financing include factoring, invoice financing, and Asset-Backed Securities.
What are accounts receivables factoring?
Factoring is a form of financing that is used for accounts receivables. The process involves the company selling its invoices to a third party, usually at an agreed percentage discount, in exchange for money upfront. This allows the company to pay its short-term obligations and focus on building up cash reserves or finding other forms of financing. Accounts receivables factoring is a form of financing used for accounts receivables.
Why do companies factor accounts receivable?
Many businesses factor accounts receivable to improve their cash flow. This means that the business sells its account receivable to a third party who then collects the money for them, usually at an agreed-upon interest rate. As a result, not only does this generate cash right away, but it also allows the company to delay paying its obligations until later when it is more financially able to do so. In addition, such finance allows for a company to expand its access to cash flow by providing them with what they need when they need it most.
What are the two types of accounts receivable factoring?
Factoring may be of two types based on the risk transfer, recourse factoring, and non-recourse factoring.
Digital factoring in Bangladesh is a fast and friendly way for enterprises to acquire instant working capital for MSMEs. Moreover, it provides significant benefits for both buyers and providers.
Many MSMEs may not access affordable financing due to lack of collateral, high-interest rates, and strict repayment schedules. Therefore, digital factoring services with easy finance could provide an infinite number of benefits for these companies.
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