Selected Issues on the Regulation and Supervision of Factoring Companies

Factoring companies are financial institutions that specialize in the business of accounts receivable financing and management. If a factoring company chooses to purchase a firm’s receivables, then it will pay the firm a prenegotiated, discounted amount of the face value of the invoices (Sopranzetti 1998). A moral hazard problem develops when the seller’s credit management efforts are unobservable to the factoring company: Once the entire

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receivable is sold (factored), the seller has no incentive to monitor that receivable, as the seller no longer bears any credit risk. Factoring is not one homogeneous product. Most factoring companies do not simply provide immediate cash services; they also offer a range of other professional services such as collecting payments, pursuing late payers, providing credit management advise, and protecting clients against bad debts. Factoring companies typically fall under three categories: banks, large industrial companies, or independent factoring companies.

One fundamental issue with factoring resides in recognizing the commercial status of the industry, which in turn determines the oversight structure. In some countries, factor­ing is recognized as a commercial activity and is, therefore, regulated by commercial law, but it is not unusual in certain countries to see factoring companies undertake the func­tions of financial intermediation without authorization (see box 6.3 for further details).

The regulatory environment has an important effect on the factoring industry. In some countries, factoring operates entirely outside the purview of any regulatory structure or authority, and in others it is regulated along with other financial services such as bank­ing and insurance. In most countries, however, the level of regulation falls somewhere in between (Bakker, Klapper, and Udell 2004). For countries where factoring is developing, a law setting out minimum standards for the management of factoring companies and speci­fying the tools to be used to manage key risks in factoring operations could be envisaged. Some countries simply restrict market entry to formally registered financial institutions such as banks or other specialized financial institutions. However, those restrictions could hinder competition by excluding the emergence of independent factors. To address the potential lack of discipline in some markets, International Finance Corporation (1998) recommends that governments consider requiring minimum capital and prudential guide­lines as a barrier to entry into the market.

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