The MSME TReDS problem is something I have from up close in the past, both as to how it has helped firms and how it has been abused.
What I came here to say is about we could enhance its utility. Why not consider linking it to the GST network whereby the buyer gets opted in by default the moment they take the GST credit into their kitty? You cant have it both ways, can you? What do you think we can do to pass on this to the right ears?
> Multiple banks and NBFCs can see the invoice and bid on it to finance the unit. The MSME picks the best bid (lowest interest rate), gets paid within a day or two, and the transaction is done for them. On the actual due date, the buyer repays the financier
who pays the interest that builds up on this credit, the seller (MSME) or the buyer (PSU or some giant private firm)?
As per my understanding, it should be the BUYER, since in the original transaction, they are the ones who are not (able to?) paying on time when the goods were exchanged. But if so, why is MSME (seller) picking up the best bid (lowest interest rate). The one who ends up paying interest has better incentives to choose the best bid.
However if seller is the one who ends up paying the interest, I don't understand the equation, given it's the buyer who is not (able to?) paying on time, so the buyer is in need NOT the seller.
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Also thanks for the Daily Brief, I started reading (or the podcast sometimes) almost everyday since ~ a month, and it's definitely one of the most interesting thing of my day.
We should have clarified this a little better: in this case, the interest rate refers to the discount rate. So, if the invoice is for 10 lakhs, and the lowest bid by a financier comes to, say, 3%, then the MSME gets 9.7 lakh cash straight up from the financier. 60-90 days later (or whatever the invoice terms are), the buyer pays the full amount to the financier.
So far, your understanding of the situation is indeed correct. The gap you're looking to fill is that while the MSME gets cash early, it pays a small interest rate to ensure early payment. That interest rate is the spread the financier earns.
Yet, in essence, this does work as a cheaper loan for the MSME. Otherwise, they'd have been stuck with borrowing at much higher rates and posting lots of collateral, that too just to meet day-to-day needs. That's the upside that invoice discounting / TReDS hopes to offer.
This still feels like a bad situation for the sellers though,
if I understood the underlying problem correctly, i.e "Buyers are not (able to?) paying on TIME to the MSME, and MSMEs can't really demand faster payment without risking the relationship".
This essentially forces the seller to settle for less than what was promised in the underlying deal.
In essence, yes. That's why we said that small firms in India often face lopsided terms from both banks and large firms.
The only major upside is that MSMEs will get the cash they need immediately, instead of 60-90 days, which helps reduce uncertainty for them. The expectation is that, in the long run, the cost of removing that uncertainty doesn't matter much if it improves their liquidity *now*.
What's also worth checking is how countries like Germany and China, where MSMEs have played a huge role in economic development, figured this out. Perhaps, we may do this for another episode :)
Thanks for this post.
The MSME TReDS problem is something I have from up close in the past, both as to how it has helped firms and how it has been abused.
What I came here to say is about we could enhance its utility. Why not consider linking it to the GST network whereby the buyer gets opted in by default the moment they take the GST credit into their kitty? You cant have it both ways, can you? What do you think we can do to pass on this to the right ears?
Interesting! But I assume that GST invoicing and getting input tax credit must have its own set of problems
Hello, just want to clarify one this, regarding:
> Multiple banks and NBFCs can see the invoice and bid on it to finance the unit. The MSME picks the best bid (lowest interest rate), gets paid within a day or two, and the transaction is done for them. On the actual due date, the buyer repays the financier
who pays the interest that builds up on this credit, the seller (MSME) or the buyer (PSU or some giant private firm)?
As per my understanding, it should be the BUYER, since in the original transaction, they are the ones who are not (able to?) paying on time when the goods were exchanged. But if so, why is MSME (seller) picking up the best bid (lowest interest rate). The one who ends up paying interest has better incentives to choose the best bid.
However if seller is the one who ends up paying the interest, I don't understand the equation, given it's the buyer who is not (able to?) paying on time, so the buyer is in need NOT the seller.
-----
Also thanks for the Daily Brief, I started reading (or the podcast sometimes) almost everyday since ~ a month, and it's definitely one of the most interesting thing of my day.
Cheers to the team
Hey Akhil, thanks for the comment.
We should have clarified this a little better: in this case, the interest rate refers to the discount rate. So, if the invoice is for 10 lakhs, and the lowest bid by a financier comes to, say, 3%, then the MSME gets 9.7 lakh cash straight up from the financier. 60-90 days later (or whatever the invoice terms are), the buyer pays the full amount to the financier.
So far, your understanding of the situation is indeed correct. The gap you're looking to fill is that while the MSME gets cash early, it pays a small interest rate to ensure early payment. That interest rate is the spread the financier earns.
Yet, in essence, this does work as a cheaper loan for the MSME. Otherwise, they'd have been stuck with borrowing at much higher rates and posting lots of collateral, that too just to meet day-to-day needs. That's the upside that invoice discounting / TReDS hopes to offer.
Hey Pranav, thanks for the quick reply!
This still feels like a bad situation for the sellers though,
if I understood the underlying problem correctly, i.e "Buyers are not (able to?) paying on TIME to the MSME, and MSMEs can't really demand faster payment without risking the relationship".
This essentially forces the seller to settle for less than what was promised in the underlying deal.
In essence, yes. That's why we said that small firms in India often face lopsided terms from both banks and large firms.
The only major upside is that MSMEs will get the cash they need immediately, instead of 60-90 days, which helps reduce uncertainty for them. The expectation is that, in the long run, the cost of removing that uncertainty doesn't matter much if it improves their liquidity *now*.
What's also worth checking is how countries like Germany and China, where MSMEs have played a huge role in economic development, figured this out. Perhaps, we may do this for another episode :)