- By R Narayan
Credit and Finance for MSMEs: The Reserve Bank of India (RBI) in 2017 instituted an online bill-discounting platform called The Trade Receivable Discounting System (TReDS) to give routinely cash-strapped MSMEs a way of raising funds by selling trade receivables from corporates. Three TReDS exchanges are licensed currently: Receivables Exchange of India (RXIL), a joint venture of the National Stock Exchange and SIDBI; Mynd Solution’s M1xchange; and A.TREDS, a joint venture of Axis Bank and mjunction services.
The Case before TReDS
Prior to the setup of the TReDS platforms, MSMEs often suffered greatly from delayed payments from customers. Since small businesses require regular cash flow to stay operational, deferred payments, usually from large corporate customers, seriously threaten their operations. Moreover, the difficulty in obtaining credit also translates to a scarcity of working capital loans, adding to the MSMEs’ difficulty in continuing business.
The TReDS platform not only ensures that MSMEs have access to a regular flow of funds at attractive interest rates but also preserves the working capital limits of a company as those are not included in the balance sheet. Most importantly, it ensures that the buyer pays the MSME supplier within 45 days, in compliance with the MSME Act.
The industry has responded well to the TReDS scheme. Since April 2018, PSUs, large corporates, as well as banks such as SBI and Bank of Baroda, have recognised the platform’s criticality and have registered. M1xchange, for instance, has enrolled over 1000 MSMEs/sellers, 100 corporates, and 24 banks since its launch.
How It Works
A seller (MSME) uploads an invoice on the platform. From there, it goes to the buyer for acceptance, and once accepted, it becomes a factoring unit which goes to auction. The financiers enter their discounting (finance) rate, and the party bearing the interest (financing) cost is the one to accept the final bid. The discounting rate cannot fall below the marginal cost of funds-based lending (MCLR) rate stipulated by the RBI.
TReDS then debits the financier and pays the seller. The amount gets credited the next working day into the seller’s bank account. The second part of the transaction is when the amount is repaid to the financier.
MSMEs, corporate buyers and financial institutions are thus linked on a common platform. After both sellers and buyers approve, the financier may bid on the invoices and make the payment to the seller.
MSMEs do not need to give any collateral when they sell their receivables and will have no recourse upon them in case of defaults, meaning that they would not be responsible for non-payment of the trade receivables amount on the part of buyers.
MSMEs thus stand to gain immensely by selling their receivables on the TReDS platform. The rate of interest for a seller can fall to 8-9% on the platform, as against 12-18% from traditional routes. Also, customers’ payment deferrals, a major pain-point for MSMEs, are now between the bank and the corporate, as the latter has taken the risk from the MSME seller.
In the initial days after the introduction of TReDS, companies were unwilling to upload invoices online, as they feared to reveal their MSME suppliers to competitors. However, this issue was soon settled, as corporates experienced greater ease in conducting business at more reasonable costs.
In 2017, the government mandated that PSUs register on the platform as well, but this move has faced some opposition, as PSUs take inordinately long over the invoice approval process. Banks, therefore, do not come forward to fund the invoices, thus negating the intent of the scheme.
In November 2018, the government announced that companies with turnover exceeding Rs 500 crore must compulsorily register on the TReDS platform. This move saw a large number of MSME vendors, corporate buyers, banks and NBFCs registering on one of the three licensed TReDS platforms.
Since the stoppage of Aadhaar-based KYC, however, the onboarding cost for TReDS platforms has increased. Now, KYC must be physically completed for vendors across multiple locations in India, an expensive and time-consuming process.
The Case after TReDS
In FY2017-18, all three platforms together did a business of about Rs 800 crore, which further increased to approximately Rs 7,000 crore in FY19. This number is expected to touch a phenomenal Rs 25,000 to Rs 30,000 crore in FY19-20.
While this system intends to ensure a smooth flow of liquid funds to MSMEs, which have long struggled due to delayed payments from corporate customers and lack of adequate credit from the financial sector, there remain loopholes which act as impediments to enabling efficient MSMEs business.
A major issue is that large corporates do not register on TReDS leaving their transactions to be made offline, which again aggravates the delayed payments problem of MSMEs and leaves it unchecked. The solution lies in automation. To amplify the purpose for which it was instituted in the first place, TReDS needs to be automated completely so that transaction costs can reduce and even the smallest MSMEs can leverage the benefits. Not only will this reduce transactions costs, but also, MSMEs would be able to clear their bad debt and recover their outstanding payments.
Another initiative which had been devised for the upliftment of the bottom-most rung of commercial entities is MUDRA, which has proved to be a game-changer when it comes to enabling last-mile credit delivery – making it a win-win for the MSMEs and lenders looking for a growth opportunity alike. To plug the leak, completely, financial institutions serving the SME sector must be mandated to register on TreDS. GSTN needs to be linked to TReDS and the two need to work in sync. This will serve two purposes: it will link everyone with GSTN to TReDS by default and maintain the automated invoicing records across networks. Any payments due after the legally defined time frame of 45 days, must be then directed to be paid to respective banks of MSMEs. This is a highly recommended move as in our country default payments towards banks adversely impacts a firm’s credit rating.
(R Narayan is the Senior Vice President at FICCI-CMSME and Founder & CEO at Power2SME. Views expressed are the author’s own.)