How can a firm convert its (illiquid) Accounts Receivable into Short-Term Financing?

2. Trade Credit – the extension of Accounts Receivable – is an important source of financing in emerging markets • Demirguc-Kunt & Maksimovic (2001), Fisman & Love (2002) • Van Horen (2004), Fisman & Raturi (2003), McMillan & Woodruff (1999) • Trade Credit is Often Extended by Small and Medium Sized Firms (SMEs) • For instance, 81.1% of small Mexican firms offer supplier credit:

3. How can a firm convert its (illiquid) Accounts Receivable into Short-Term Financing? "I don’t lend against Assets, I lend against Collateral“ -- CEO of Heller Financial • Receivable Loans • The collateralization of receivables • Requires good collateral law allowing “floating liens”, electronic credit bureaus and registries, strong bankruptcy laws, and efficient judicial implementation • Factoring (“Receivables Management”) • The sale of receivables

4. WHAT IS FACTORING?? Step 1: “Tiny Textiles (TT)”, an SME, sells 1 million in raw material to its customer “Massive Manufacturer (MM)”, a large multinational exporter. TT (in a competitive gesture) offers MM 30-days trade credit; TT records the sale as 1 million in accounts receivable. Step 2:TT needs working capital to produce more inventory. TT’s only available assets to use for collateral are its accounts receivable from MM. The factor purchases TT’s accounts receivable (TT “assigns” its accounts receivable from MM to the factor.) TT receives today 80% of the face value of the accounts receivable (800,000.) Step 3: In 30 days, the factor receives the full payment from MM, and TT receives the remaining 20% less interest (on the 80%) and service fees.

5. “Ordinary” Factoring • TT sells all its receivables -- from various customers (MM, AA, ZZ, etc.) -- to a factor. • Requires the factor to collect timely and comprehensive credit information and calculate the credit risk for MM, AA, ZZ, etc.

6. “Reverse” Factoring • The lender pools and purchases accounts receivables payable by onlyMM from many suppliers (including TT) • The lender only needs to collect credit information and calculate the credit risk for MM (a large, very transparent, internationally accredited firm) • Since the credit risk is reduced, lenders in developing countries can absorb the credit risk and offer factoring “without recourse”

8. Challenges in Emerging Markets • Taxes (stamp tax, VAT, etc.) • Burdensome and costly regulation of NBFIs • Weak legal environment • Factoring Act • Electronic securities and signature Laws • Inadequate technology infrastructure

9. Example: The Nafin Product in Mexico • Uses an electronic platform to provide on-line factoring services, which allows cheaper, quicker and safer transactions • Nafin has extended over US$ 9 billion in financing (~US$600,000 monthly); over 1.2 million transactions – 98% to SMEs. • Depends on strong technological infrastructure and good electronic security and signature laws • Provides factoring, contract financing, training and technical assistance to suppliers

10. Nafin Factoring Product

11. Nafin Purchase Order Financing

12. Lessons Learned • Most suppliers have no other source of financing. • The success of the Nafin program shows how the use of electronic channels can reduce costs and increase access to SME financing. • Banks can lend at lower margins • Penetrate rural areas • Requires supporting laws and regulations • Reverse Factoring can be an important source of financing in countries with weak secured lending laws, inefficient bankruptcy systems, and imperfect records of upholding seniority claims.