Factoring, bill discounting,

forfeiting
An overview
• We have seen in the previous unit how venture
capitalists come to the rescue of entrepreneurs
by providing risk bearing capital known as
venture capital. It is usually a long term
investment either in the form of equity,
conventional loans, conditional loans and
convertible loans. Venture capital has potential
for significant growth and financial returns. In the
present unit we will be discussing in detail three
services used for financing short-term, trade, i.e.
factoring, Forfeiting, and bill discounting.
• Factoring services have become quite popular
all over the world now, with more than 900
companies offering these services. Factoring is
a contract like any other sale purchase
agreement regulated under the law of contract.
• Forfeiting is a source of trade finance which
enables exporters to get funds from the
institution called forfeited on transferring the right
to recover the debts from the
• importer
• Another source of short-term trade
financing known as bill discouting where
one party accepts the liabilities of trade
towards the third party.
 FACTORING SERVICES
• Factoring services started in the United
States of America in the 1920s and were
introduced to the other parts of the world
in the 1960s. Today there are more than
900 companies offering factoring services
in more than 50 countries. Factoring
services have become quiet popular all
over the world
• Factoring is a financial service covering the
financing and collection of accounts receivables
in domestic as well as in international trade.
Basically factoring is an arrangement in which
receivables on account of sale of goods or
services are sold to the factor at a certain
discount. As the factor gets title to the
receivables on account of the factoring contract,
he becomes responsible for all credit control,
sales ledger administration and debt collection
from the customers
 Functions of the Factor
• Broadly speaking the main functions of the
Factor are as under :
• 1) To provide finance against book debts, say up
to 90 per cent of the invoice value immediately.
Thus the client gets funds immediately for his
working capital.
• 2) To collect cash against receivables on due
date from the customers of the clients and
furnish reports to the client.
• 3) To undertake sales ledger administration (i.e.
accounting work) for the client in respect of
client’s transactions with its customers.
• Under the non-recourse factoring arrangement, if the
customer become financially insolvent and cannot pay
up, the Factor provides protection to the client against
bad debts on all approved invoices. Thus the Factor
provides debt insurance facility to the client against
possible losses arising from insolvency or bankruptcy of
the customer.
• 5) Factor also provides other information such as sales
analysis and overdue invoice analysis which enable the
client to run the business more effectively. Besides, the
Factor also provides relevant expertise in the areas of
marketing,finance, etc., to the client
Parties to Factoring Contract
• There are three parties involved generally in a
factoring contract, viz.,
• 1) Buyer of goods (i.e. customer) who has
purchased goods or services on credit and as
such has to pay for the same once the credit
period gets over.
• 2) Seller of goods (i.e. client) who has supplied
goods or provided services to the customers on
credit terms.
• 3) ‘Factor’ who purchase the invoices
(receivable) from seller of goods andcollect the
money from the customers of his clients.
 TYPES OF FACTORING
SERVICES
• The various types of factoring arrangements can be
classified into the following
• categories.
• 1) Full Servicing Factoring: This is also known as
without recourse factoring service. It is the most
comprehensive type of factoring arrangement offering all
types of services, namely: (a) Finance, (b) Sales ledger
administration, (c) Collection, (d) Debt protection, and (e)
Advisory services. The most important characteristic of
this type of factoring service is that it gives protection
against bad debts to the client. In other words, in case
the customer fails to pay, the factor will absorb the
lossesarising from insolvency or bankruptcy of the
client’s customers
• 2) Recourse Factoring: In such a type of factoring
arrangement, the factor provides all types of facilities
except debt protection. That means, in other words, the
client is responsible for any bad debts arising from
insolvency of the client’s customers.
• 3) Maturity Factoring: Under this type of factoring
arrangement, except for providing finance, all other
facilities are provided to the client. As far as finance is
concerned, the client is paid at the end of a pre-
determined date or maturity date whether or not the
customers have settled their dues in respect of credit
sales
• Invoice Discounting: In such type of
arrangement, only finance is provided, and,
hence, no other services are offered in respect
of receivables.
• 5) Agency Discounting: Under this
arrangement, the facilities of finance and
protection against bad debt are provided by the
factor. As against this, the sales ledger
administration and collection of book debts are
carried out by the clienthimself
 TERMS AND CONDITIONS OF
FACTORING
CONTRACT
• Factoring contract is like any other sale
purchase agreement regulated under the
law of contract. The terms and conditions
on which factor agrees to purchase the
debts from seller are mutually settled
keeping in view the business connections
and customs. Nevertheless, some of the
important aspects which are supposed to
be born in mind and incorporated in
factoring agreements are as follows
• 1) Offer to sell debts from time to time arising out of business
transactions on such terms and conditions as are stipulated in the
agreement. The offer shall specifically mention about the invoices
relating to each debt as an evidence of he delivery of goods or
rendering of services to the customer.
• 2) Acceptance of the offer shall be comprehensive, covering all
interests in the purchased debts, with all remedies for enforcing the
debts and rights of unpaid seller being vested in the factor.
• 3) Condition to have no recourse to the supplier by the factor in the
case of non- recourse factoring contract on the failure of the
customer to pay the dues.
• 4) Power of attorney from the firm to the factor so as to empower the
factor to the
• factor
• 5) Payment of purchase price of debts.
• 6) Notice of sale of assignment of debt be endorsed on invoices
sent to customer to entitle the factor to recover their dues and issue
discharge receipt of the customers.
• 7) Non-collection of dues by the firm : Firm (client) not to collect
dues from customers assigned to the factors.
• 8) Notice of credit allowed to customer to be given to the factor.
• 9) Warranties and covenants.
• 10) Factoring commission, charge, fees and mode of payment.
• 11) Durations of agreement.
• 12) Notice of termination.
• 13) Jurisdiction of court to entertain dispute between the parties
 FACTORING: ADVANTAGES
AND
DISADVANTAGES
• Benefits of Factoring to Clients
• 1) Under the factoring arrangement the client
receive prepayment upto 80-90 percent of the
invoice value immediately and the balance
amount after the maturity period. This helps the
client to improve cash flow position which
enables him to have better flexibility in managing
working capital funds in an efficient and effective
manner. Besides this, such arrangement also
improves the ability of the client to develop sales
to credit worthy customers
• If the client avails the services of the factor in
respect of sales ledge administration and
collection of receivables, he need not have any
administrative set up for this purpose. Naturally
this will result into a substantial saving in time
and cost of maintaining own sales ledger
administration and collecting receivables from
the customer. Thus, it will reduce administrative
cost and time. As a result of this, the client can
spare substantial time for improving the quality
of production and tapping new business
opportunities
• When without recourse factoring
arrangement is made, the client can
eliminate the losses on account of bad
debts. This will help him to concentrate
more on maximizing production and sales.
Thus, it will result in increase in
sales,increase in business and increase in
profit.
• The client can avail advisory services from the
factor by virtue of his expertise and experience
in the areas of finance and marketing. This will
help the client to improve efficiency and
productivity of his organization. Besides this,
with the help of data base, the factor can readily
provide information regarding product
design/mix, prices, market conditions etc., to the
client which could be useful to him for business
decisions
 Disadvantages of Factoring
• Image of the client may suffer as engaging a
factoring agency is not considered a good sign
of efficient management.
• 2) Factoring may not be of much use where
companies or agents have one time sales with
the customers.
• 3) Factoring increases cost of finance and thus
cost of running the business.
• 4) If the client has cheaper means of finance and
credit (where goods are soldagainst advance
payment), factoring may not be useful
MECHANISM OF FACTORING
• Operation of Factoring Services
• There are three parties to a domestic factoring
arrangement:
• 1) The client who is supplier or seller of goods
and services.
• 2) The customer who is a debtor or buyer of
goods and services provided by the client.
• 3) The factor who is a financial institution or
intermediary between client and customer who
provides the factoring services
• In normal business, the client sells the
goods to the customer on credit. He sends
• invoices to the customer directly and also
collects payment directly from the
customer
• Customer places an order with the client for
goods and/or services on credit.
• 2) Client Delivers the goods and invoice with a
notice to pay to the factor.
• 3) Client sends of invoice to the factor.
• 4) Factor provides finance (pre-payment) to the
client say 80-90 per cent of the invoice value on
the production of a copy of invoice.
• 5) Monthly statement of accounts are sent to the
customer and follow-up if invoice remains unpaid
by due date.
 Cost of Factoring
• Once the goods or services are delivered or
supplied to the customer by the client, he sends
invoices to the customer in the normal way.
However, all the invoices must bear the
notification that the invoices have been assigned
in favor of the factor and accordingly payment
must be made to the factor. After the client has
sent theinvoices to the customer, he offers to
sell to the factor, the book debts on standard
• form, supported by copies of invoices and
delivery orders
• The factors buys the book debts and
immediately makes the agreed upon
advance payment (Normally upto 80-90
per cent of the invoice value) to the client.
The remaining balance (i.e. 10-20 per cent
of the invoice value) will paid to the client
after the factor has been paid by the
customer on maturity date depending on
the type offactoring arrangement
• Using the invoices submitted, the factor
maintains the sales ledger for the client
and statements of accounts are sent to the
customer on a monthly basis. The factor
takes over the collection of book debts,
and reminders are sent when the invoices
are overdue. Client is kept informed of all
the factoring transactions through monthly
and weekly reports provided by the factor
 Cost of Factoring
• These are two types of costs in factoring
services
• 1. Service Fee or Charges
• 2. Discount Charges
 service Fee
• Service Fee: Service fee is levied for the work
involved in administering the sales ledger as well
as protection against bad debts. It is calculated
as a percentage of gross value of the invoices
factored and is assessed on the following
criteria:
• a) Gross annual sales volume;
• b) Number of customers;
• c) Number of invoices and credit notes; and
• d) Degree of risk represented by the customer
 Discount charge
• ) Discount Charge (interest charge):
The discount charge is levied on the
advance provided by the factor and is
computed on the basis of prime lending
rate of banks plus premiums for credit risk
basis. It is calculated on a day-to-day
basis on the advances outstanding and
ranges from 1 to 3 per cent above the
reference bank’s prime lending rate
 MAIN CHARACTERISTICS OF
FACTORING
SERVICES
• Factoring is a money market instrument.
• 2) Book debts represented by invoices ar
assigned in favour of a factor.
• 3) Since, factoring is not a negotiable
instrument, customer’s consent is required about
the factoring arrangement under which he will
make a repayment directly to the factor but not
to the client.
• 4) Dual pricing structure comprising discount
charges and services charges is followed
• Under without recourse factoring credit insurance facility
is offered to the client. In view of this cost of factoring
services is more under without recourse factoring as
against with recourse factoring.
• 6) Margin is kept in the range of 5 per cent to 20 per
cent. In other words, usually about 80 to 95% of the
invoice value is provided as pre-finance by the factor to
the supplier which is known as prepayment.
• 7) Remaining amount of the value of invoice is paid to
the client after collection of money from the customer
and after deducting his own charges
 EXPORT FACTORING
• Export factoring services are offered to the exporters
(clients) who sell their products or services to the
importers (customers) in other countries on open
account terms having a credit period ranging from 60 to
180 days. Before the goods are shipped to the customer,
export factor is expected to investigate the customer’s
creditworthiness and assume responsibility for collecting
all amounts owed as well as affording credit protection.
Export factor can offer benefits of export factoring both to
the exporters as well as to the importers. The
mechanism of export factoring is similar to that of
• domestic factoring, the exception being the exporter and
importer belong to two different countries
• Four different types of arrangements are
possible for export factoring :
• a) Two Factor System
• b) Single (Direct) Factoring System
• c) Direct Export Factoring
• d) Direct Import Factoring
 RBI Guidelines for Factoring
Services
• Banks should frame an appropriate policy
on factoring services with the approval of
their Boards
• As activities like factoring services requires skilled
personnel and adequate infrastructure facilities, it should
be undertaken only by certain select branches of banks.
This will have to be suitably published for the benefit of
banks customers.
• 3) The activities like factoring services shall be treated
on par with loans and advances and therefore should
accordingly be given the risk weight of 100% for
calculation of capital to risk asset ratio. Further the
guidelines on income recognition, asset classification
and provisioning norms would also be applicable to the
portfolio of factoring
• The facilities extended by the prepayment under
the factoring services would be covered within
the exposure selling fixed upto 25% of bank’s
capital funds to an individual borrower and 50%
of bank’s capital funds to a group of borrowers.
• 5) Banks shall maintain a balanced portfolio of
financing receivables under factoring services
vis-à-vis the aggregate credit portfolio. The
exposure towards prepayment in respect of
purchase of receivables under factoring services
should not exceed 10% of total gross advances
as on the date of previous balance sheet
FACTORING SERVICES IN INDIA
• Though factoring services have been introduced since 1991 in India still it is quite
new in the sense that factoring product is not widely known in many parts of the
country. Recognising the utility of factoring services for small and medium size
industrial and commercial enterprises in India, for the first time the Vague Committee
which submitted its report on the Money Market, recommended the development of a
system of factoring of open account sales particularly for the small scale industrial
units. This committee further observed that both banks and non-bank financial
institutions in the private sector should be encouraged to set up institutions for
providing factoring services. Later, the Kalyana sundaram Committee, which was
appointed by the Reserve Bank of India (RBI) in 1988 specifically for exploring the
possibilities of launching factoring services in India, found an abundant scope for
such services and hence strongly advocated for the introduction of factoring services
in India. This committee also observed that banks were ideally suited for providing
factoring services to the industries in the economy. However, the said Committee
expressed the view that to begin with only four or five banks either individually or
jointly should be allowed on zonal basis to undertake factoring services. The
recommendations of Kalyanasundaram Committee were accepted by the RBI.
Subsequently a suitable amendment was made in the Banking Regulation Act 1949,
so as to allow banks to set up subsidiary company for undertaking factoring services.
• To begin with, the RBI permitted both the State Bank of India and
Canara Bank to start factoring services through their own
subsidiaries. Accordingly, two factoring companies in India, i.e. SBI
Factors and Commercial Services Ltd. and Canbank Factors Ltd;
sponsored by the State Bank of India and Canara Bank
respectively, commenced operations in 1991. In the beginning they
were allowed to operate in Western and Southern Zone of India
respectively. However, later on, the RBI lifted these area restrictions
on their operations and accordingly, both these companies were
given permission to expand and operate their business in other
parts of the country. In view of this, they can operate on all-India
basis. In 1993 the RBI allowed all the scheduled commercial banks t
introduce factoring services either departmentally or through a
subsidiary set-up. Besides SBI Factors and Commercial Services
and Canbank Factors Ltd., there are a few non-banking finance
companies
• such as Formost Factors Ltd., Global Trade Finance Pvt.
Ltd. (a subsidiary of EXIM Bank) and Integrated
Financial Services Ltd., which are also in the business of
domestic factoring in India. Of these, Global Trade
Finance Pvt. Ltd. and Formost Factors Ltd. have
undertaken the business of export factoring also.
Besides these non-banking finance companies, Small
Industries Development Bank of India (SIDBI), Hongkong
and Shanghai Banking Corporation have been offering
factoring services to their clients. Almost all of them have
been providing factoring services to the SSI and non-SSI
units
 FORFEITING: AN
INTRODUCTION
• Forfeiting is the purchase of receivables along with availed
negotiable instruments like promissory note or bills of exchange
(without recourse to any previous holder of the instruments) due on
a specific date to be matured in future and arising from the exports
of goods on credit. Thus, Forfeiting is a source of trade finance
which enables exporters to get funds from the institution called
forfeiter on transferring the right to recover the debts from the
importer. The debt instrument is purchased by the forfeiter at an
appropriate discount. This facility is always provided with non-
recourse feature. Normally all exports of capital goods and other
goods made on medium to long term credit are considered for
providing finance through Forfeiting arrangement. Now-a-days, in
many developed countries, a forfeiter provides a finance even in
respect of commodity exports wherein the credit period is upto 180
to 360 days. (It is estimated that about 15 to 20 per cent of Forfeiting
market worldwide isrepresented by transactions involving
commodity exports upto 180 to 360 days
 Features of a Forfaiting
Arrangement
• It is a specific form of export trade finance.
• 2) Export receivables are discounted at a specific but fixed discount
rate.
• 3) Debt instruments most commonly used in Forfaiting arrangement
are bill of exchange and a promissory note.
• 4) Payment in respect of export receivables which is further
evidenced by bill of exchange or promissory notes, must be
guaranteed by the importers’ bank. The most usual form of
guarantee attached to a Forfaiting agreement is an aval.
• 5) It is always without recourse to the seller (viz. Exporter).
• 6) Full value of export receivables i.e. 100 per cent of the contract
value is taken into account.
• 7) Normally the export receivables carrying medium to long term
maturities are considered
 COST OF FORFEITING
• A Forfeiting service is subjected to various costs such as commitment fee, discount
rate and documentation fee. Of these, discount rate, which is fixed, forms a larger
Value of bills less discount amount (cash payment) (7) portion of cost of Forfeiting
service. The discount rate charged by the forfeiter is based on the following
elements :
• l
• A charge for the credit extended or finance provided. This is the main element and is
roughly equivalent to the forfeiter's own costs of raising the money.
• l
• A charge based on the risk of interest rate and exchange rate movements in the
• currency in which the credit is extended.
• l
• A charge based on the sovereign risk, political risk and transfer risk e.g. the
• probability of a change of government and imposition of exchange controls preventing
the discharge of the debt.
• l
• A charge based on the credit risk attached to the importer as well as valor
 BENEFITS OF FORFAITING
SERVICES
• The benefits accruing to the exporter are numerous. Few of these
benefits are stated below:
• 1) Exporter can convert export transaction under deferred payment
arrangement into a cash transaction. Thus he can improve his own
liquidity position.
• 2) Since the forfaiter takes all risks, naturally exporter is relieved of
the risks arising out of the default by the buyer (importer) as also the
political and exchange risk.
• 3) Since the Forfaiting is a fixed rate contract, the exporter is
hedged against interest rate risk and exchange rate risk.
• 4) Exporter gets finance upto 100 per cent of the contract value
(which is to be reduced to the extent of Forfaiting cost).
• 5) Exporter is freed from credit administration and collection
problems
 MECHANISM OF FORFAITING
SERVICES
• Commercial contract between exporter and importer.
• 2) Delivery of goods by exporter to importer on credit.
• 3) Contract between importer and his bank to have guarantees
which will be given in respect of payment against negotiable
instrument on due date.
• 4) Delivery of avulsed negotiable instrument either bill of exchange
or promissory note to the exporter.
• 5 & 6) Forfeiting contract between exporter and forfaiter under which
avulsed negotiable instrument will be endorsed without recourse in
favour of the forfeiter.
• 7) Cash payment of discounted avulsed negotiable instrument by
forfeiter to
• exporter (face value of bill less discount amount).
• 8) Presentation of avulsed negotiable instrument to the importer’s
 MARKET GROWTH
• During the period 1970-1980, both the primary and secondary
markets in and for non- recourse trade paper increased
considerably. Specialist banks in addition to traditional deposit and
clearing banks developed Forfeiting departments, usually within
their trade finance departments. Later, specialist Forfeit Houses
were set up and there was a perceptible geographic growth and
shift of the market from Switzerland/Northern Italy to Western
Germany and more markedly to London. In 1984 London Forfeiting
Company PLC, the only publicly owned and U.K. Stock market
quoted specialist Forfeiting Company, was set up. The primary
forfait market has developed along side state backed credit export
schemes, sometimes as a competition and sometimes as an adjunct
to the state credit export schemes. Between market professionals a
secondary market also evolved in forfeit paper, which in effect
securities these exporter receivables. During the period 1980-90 an
increasing awareness of the forfeit market was developed in many
• developed countries among business community
FORFAITING SERVICES IN INDIA
• Recognizing the utility of Forfeiting services to
Indian exporters, the RBI decided to make
available such services to the exporters. At the
beginning the RBI authorized EXIM Bank in
1992 to offer Forfeiting services. The role of the
EXIM Bank has been that of a facilitator between
the Indian exporter and the overseas Forfeiting
agency. Scheduled commercial banks have also
been permitted to offer Forfeiting services by
acting as an agent or a facilitator between Indian
exporter and the Forfeiting agency operating in
some other country
• scheduled commercial banks can undertake Forfeiting services as a part of fee based
financial services. A subsidiary of EXIM bank namely; Global Trade Financial
Services Private Ltd. has been engaged in providing Forfeiting services to the
exporters in India. As per the RBI’s A D Circular No. 3 Dated February 13, 1992,
discount fee, documentation fee and any other costs levied by a forfeiter must be
transferred to the overseas buyer. In view of this, the exporter, who intends to avail
Forfeiting facility, should finalize the export contract in a manner which ensures that
the amount received in foreign exchange by him after payment of Forfeiting discount
and other fees is equivalent to the price which he would obtain if goods were sold on
cash payment terms. If the banks are able to act as an agent to structure Forfeiting
deals keeping in view the requirements of our Indian exporters, then there will be
demand for such product. For this, commercial banks and others may have to
introduce a lot of flexibility while acting as an agent or a facilitator in this regard. For
example, the minimum value of the Forfeiting transaction may be required to be kept
at a reasonable level. Instead of acting simply as an agent, with the permission from
the RBI, banks and financial institutions in India must explore the possibility of takin
up Forfeiting activity as a fund based activity. With the dissemination of knowledge
about Forfeiting among Indian exporters, it may be possible to create awareness
about it and subsequently demand for the same
 DIFFERENCES BETWEEN
FACTORING AND
•
FORFAITING SERVICES
Factoring services is mainly meant for financing and
collecting of receivables arising from short term credit
transactions say upto 180 days. As against this,
Forfeiting is meant for financing credit transactions of
having deferred credit period of more than 1 year.
• 2) Factoring arrangement can be with recourse or
without recourse depending on the terms of factoring
contract between a client and a factor. As against this,
Forfeiting transaction is always without recourse where
forfeiter absorbs credit risk also.
• 3) Factoring services can be considered either for
domestic transaction or for export transaction. As against
this Forfeiting transaction is always considered for export
transactions only
• Factoring is done on the strength of sales invoices only. Whereas
Forfeiting involves use of avulsed negotiable instruments like bill of
exchange or promissory note.
• 5) In a factoring arrangement, a margin of 5 to 20 per cent is kept. In
other words, finance is provided immediate on the purchase of
invoice to the extent 80 to 95 per cent of invoice value. As against
this; a forfeiter discounts the entire sale value of the export
transaction without keeping any margin.
• 6) Factoring services include sales ledger, administration, collection
of receivables and other advisory services. On the other hand,
Forfeiting is a pure financial arrangement.
• 7) Factoring is done on whole turnover basis, whereas, Forfaiting
can be done on transaction basis
 BILL DISCOUNTING: AN
INTRODUCTION
• Bill financing is considered to be an appropriate
form of financing trade and business. Under this
form of financing, seller of the goods draw a bill
of exchange on the buyer(who accepts and
returns the same to the drawer). Subsequently
seller of the goods discounts the bill of
exchange with bank or finance company and
avail the finance accordingly. Only those bills
which arise out of genuine trade transactions are
considered by the banks and finance companies
for discounting purpose.
 Parties to a Bill of Exchange
• The drawer (seller of the goods) Who draws the
bill. Who ensures that the bill is accepted and
paid according to its tenor. Who promises to
compensate the holder or any endorser of the
bill if it is dishonoured.
• B) The drawee (buyer of the goods) The person
on whom the bill is drawn. Who has shown
assent by signing across the bill for payment at
maturity (thus becoming the acceptor) The
person who assumes legal obligation to pay the
bill.
• The Payee
• The person to whom or to whose order the bill is payable.
• D) The Endorser
• l
• The payee or any endorsee who signs the bill on negotiation.
• l
• If the bill is negotiated to several persons who signs it in turn
becomes an
• endorser.
• l
• The endorser is liable as a party to the bill.
• If the bill of exchange is not endorsed then drawer and payee will
be the same person
 BENEFITS OF FINANCE
THROUGH BILL
DISCOUNTING
• Cheaper form of Credit: Banks usually discount bills at a
rate lower than the rate charged for cash credit. In view
of this, drawer of the bill can reduce its cost of funds by
raising the funds through discounting of bills with
banks.
• Better Funds Management: Bills seems to have certainty
of payment on due dates and this helps to have efficient
working capital management. It also leads to greater
financial discipline as bills are discounted only against
genuine trade transactions as compared with bank
overdraft facilities which may be utilised for any other
purpose
 Following are the benefits of
providing finance against bills for
the banker
• No Risk in Lending: By providing finance against
bill, the bank can ensure safety of funds lent. As
a bill is a legal negotiable instrument with the
signatures of two concerned parties,
enforcement of a claim is easier. Further, with
recourse to two parties, it implies a lower credit
risk. In other words, if the acceptor of the bill
fails to make payment on the due date the bank
can claim the whole amount form the drawer of
the bill
• Greater Liquidity: A banker who is in need of
funds can rediscount bills with various financial
institutions as approved by the RBI. Thus bank
can raise the funds easily and quickly against
the bills which are discounted.
• No change in the value of the bill: As a security,
the value of a bill is not subject to fluctuations
which are found in case of values of tangible
goods and financial securities. The amount
payable on account of a bill is fixed and the
acceptor is liable for the whole amount
Precautions for Bill Discounting
• Before approving a bill for discounting the following should be
ensured by the banker : The signature as well as credit limit of the
bank’s borrowers have been verified. (Need to ensure that limit for
bill discounting has been sanctioned by the credit manager). The
nature of the transaction is mentioned on the bill and all invoice
details are provided. There is a need to verify and ensure that bill is
drawn against a genuine trade transaction. (i.e. bill covers only sale
of goods transactions).
• L The original tenor of the bill does not exceed 120 days if Bill
Discounting Facility is to be availed of.The payment instructions
and maturity date are clearly mentioned on the bill.
• The bill is drawn in favour of or endorsed to the discounting bank.
All material alterations have been authenticated. Notice of dishonour
and presentment have been waived
 DEVELOPMENTS IN
COMMERCIAL BILL
MARKET IN INDIA
• Even though the role of commercial bill
market as an important segment of money
market was recognised as early as in
1930s, deliberate efforts were not made to
ensure development of commercial bill
market till 1952
• In January 1952, the Reserve Bank of India (RBI) introduced a Bill
Market Scheme under section 17(4)(C) of the RBI Act, 1934. This
scheme was introduced with the objective of providing liquidity to
banks in the form of demand loans against the security of usance
promissory notes or bills drawn on and payable in India of their
constituents provided they arose out of bonafide commercial or
trade transactions. In order to avail refinance under the above
section, the scheduled banks were required to convert a portion of
the demand promissory notes obtained by them from their
constituents in respect of loans, overdrafts and cash credit granted
to them into usance promissory notes maturing within 90 days. The
accommodation which was initially restricted to licensed scheduled
commercial banks having deposits of Rs. 10 crore or more, was
later extended to all the licensed scheduled commercial banks
irrespective of size of deposits. The scheme however, did not
develop into a genuine bill market as it was primarily intended for
providing accommodation from RBI to banks
 REASONS FOR NON-
DEVELOPMENT OF BILL
•
MARKET IN INDIA
Despite various measures taken by the RBI to activate
bill market, the same is yet to be fully developed in
India. The various reasons can be identified in this
regard. Few of these reasons are given below :
• 1) Reluctance of industry as well as trade and
Government undertakings as well as departments to
move towards bill financing since it does require
observance of strict financial discipline. In other words,
industries and Government departments are not
prepared to subject themselves to the strict commitment
to honor financial obligations on the agreed date.
• 2) The procedural delay involved in the creditor getting a
prompt legal remedy in case of dishonored bills
• With the era of globalization and reforms in the
economy, the domestic market has become
highly competitive and has turned into a buyer’s
market. As a result, sellers of goods are not able
to bring around the buyers to accept bill o
exchange for sale of goods on credit. From the
buyer’s point of view, they would like to retain
the character of the transaction as a pure credit
transaction with simple debtor-creditor
relationship rather than elevate it to a negotiable
instrument
• Cost of availing credit through bill
discounting is perceived to be high
compared to cost of cash credit facility. In
addition to the discounting charges,
collection and handling charges are also
levied. In view of this, effective cost of bill
discounting turns out to be rather high
especially in case of bills of smaller
amount
 REVITALISING BILL MARKET IN
INDIA
• Since the introduction of the New Bill
market scheme, the RBI has introduced
several measures to encourage use of
commercial bills and thus widen the
commercial bill market in India. Few of
these measures are stated
• Simplification of the rediscounting
procedures by dispensing with the actual
lodgment of bills in respect of bills below
the face value of Rs. 10 lacs and replacing
it with derivative bills. The minimum
amount of bill at Rs. 5000/- prescribed
under the scheme was also done away
with
• Promotion of Drawee Bills Scheme, by making it
mandatory for banks to extend atleast 25 per cent of the
cash credit limit to borrowers in the form of bills and
requiring banks to ensure that their corporate borrowers
financed their domestic credit purchases from SSI units,
atleast to the extent of 25 per cent, by way of
acceptance bills drawn on them by their suppliers, and
advising banks to monitor the compliance of thi
requirement through a suitable monitoring syste (These
mandatory stipulations were subsequently withdrawn
with effect from 2nd November, 1999
• Remission of Stamp duty by the
Government of India on bills of exchange
drawn on or made by or in favour of a
commercial bank or a co-operative bank
and payable not more than three months
after date or sight
• The licensed scheduled commercial banks
have been allowed to rediscount bills with
a few financial institutions such as Life
Insurance Corporation of India (LIC),
General Insurance Corporation of India
(GIC) and its subsidiaries and Unit Trust of
India (UTI) and such other financial
institutions
• In 1981, in addition to all India financial
institutions, RBI allowed Mutual Funds to
participate in Bill Rediscounting market thus
augmenting the supply of funds in the secondary
market.
• lThe Discount and Finance House of India Ltd.
(DFHI) was set-up by the RBI jointly with public
sector banks and All India Financial Institutions
to develop secondary market for commercial bil
• To simplify the procedure for rediscounting of bills by banks and to
enable multiple rediscounting of bills, the RBI has introduced a
revised procedure under which derivative usance promissory notes
drawn by banks for suitable maturities upto 90 days on the strength
of underlying bills discounted by the banks’ respective branches can
be rediscounted with other banks, approved financial institutions
and primary dealers. The Government of India has exempted the
• payment of stamp duty on these usance promissory notes.
• l
• Delinking interest rates applicable on discounting of bills from the
prime lending rates of banks thus giving commercial banks the
freedom to charge market determined interest rate on bills
• In this unit we have discussed the financial services namely
Factoring, Forfaiting and bill discounting. Factoring involves
financing and collection of accounts receivables in domestic as well
as international trade. This service is rendered by the factor who
provides finance against book debts, collects cash against
receivables, undertakes sales ledger administration, provides
protection against bad debts, etc. There are three parties to a
factoring contract: buyer of goods, who has to pay for goods bought
on credit terms, seller of goods, who has to realize credit sales from
buyer. and the factor, who acts as an agent and realizes the sales
from the buyer. Forfeiting is a source of trade finance which enables
exporters to get funds from the forfaiter on transferring the right to
recover the debts from the importer. denotes the purchase of trade
bills or promissory notes by a bank or financial institution, without
recourse to seller. Bill discounting is a source of short-term trade
finance. It is known as acceptance credit, where on party accepts
liability of trade towards third party