The Role of Factoring for Financing Small and Medium 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 to the value of a supplier's accounts receivable 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 judicial enforcement and imperfect records of upholding seniority claims, because receivables are sold, rather than collateralized, and factored receivables are not part of the estate of a bankrupt SME. Empirical tests find that factoring is larger in countries with greater economic development and growth and developed credit information bureaus. In addition, we find that creditor rights are not related to factoring. This paper also discusses "reverse factoring", which is a technology that can mitigate the problem of borrowers' informational opacity in business environments with weak information infrastructures if only receivables from highquality buyers are factored. We illustrate the case of the Nafin reverse factoring program in Mexico and highlight how the use of electronic channels and a supportive legal and regulatory environment can cut costs and provide greater SME services in emerging markets.