The Role of “Reverse Factoring” in Supplier Financing of Small and Medium Sized Enterprises

Abstract

Around the world, factoring is a growing source of external financing for corporations and small and medium-size enterprises (SMEs). What is unique about factoring is that the credit provided by a lender is explicitly linked on a formula basis to the value of a supplier’s accounts receivable – the sale payments due from customers – and not the supplier’s overall creditworthiness. Therefore, factoring allows high-risk suppliers to transfer their credit risk to their high-quality buyers. Factoring may be particularly useful in countries with weak secured lending laws, inefficient bankruptcy systems, and imperfect records of upholding seniority claims, because receivables factored without recourse are not part of the estate of a bankrupt SME. Factoring can also mitigate the problem of borrowers’ informational opacity in business environments with weak information infrastructures if only receivables from high-quality buyers are factored, as is the case in “reverse factoring” arrangements. This paper discusses the Nafin reverse factoring program and highlights how the use of electronic channels can cut costs and provide greater SME services in emerging markets. By creating “chains” of small suppliers and big buyers, Nafin can offer low-cost factoring without recourse, which is an important source of financing and improves the balance sheet of small firms. The success of the Nafin program depends on the legal and regulatory support offered in Electronic Signature and Security laws that should be a model for other developing countries.