For years, Indian banks granted huge unsecured loans to large companies, sweeping the mess of distressed assets under the rug and hoping it would somehow resolve itself. This mess has now reached gargantuan proportions. The gross non-performing assets (NPAs) of the entire banking sector now stands at Rs 8.41 lakh crore (~$126 billion). In that context, since January 2015, the Reserve Bank of India (RBI) reduced its lending rate to commercial banks by 200 basis points, but banks did not adequately pass this relief on to the market, citing the looming mountain of NPAs. This kept lending rates high, defeating the RBI’s attempts to stimulate the economy.
With no reduction in bad loans and the recent emergence of a series of banking frauds, the RBI has been forced to crack the whip. The central bank has tightened the Prompt Corrective Action (PCA) framework, and now, over half of the country’s public sector banks (PSBs) are under the RBI’s scanner. After the Rs 13,580 crore (~$2 billion) Nirav Modi-Punjab National Bank fiasco, the RBI has also banned letters of undertaking (LoUs).
These stringent measures have led to a serious liquidity crunch in an already credit-starved economy. However, while large corporations have reaped the benefits of the unsecured lending that led to this impasse, the most impacted by all of this is a segment of the economy that had precious little to do with the problem — micro, small and medium enterprises (MSMEs).
The MSME (loan exposure <Rs 10 crore) segment has a lower and more stable NPA rate compared to large (loan exposure >Rs 100 crore) segment, with the recognised NPAs for MSME standing at Rs 77,000 crore (~$11.5 billion), only 9% of the Rs 8.41 lakh crore (~$126 billion), as on December 2017.

The fact that PSBs account for more than half of all loans to MSMEs means that their sorry state has choked the liquidity pipeline of a sector already short on funds. So, MSMEs have had no choice but to acquire finance from non-banking financial companies (NBFCs), peer-to-peer lenders and loan sharks, where the borrowing cost is much higher than in banks. In this mess, stands the Trade Receivables Discounting System (TReDS).
Originally proposed by Raghuram Rajan in his 2008 Committee on Financial Sector Reforms report, TReDS have come as a lifeline to MSMEs. Set up with the aim to ensure that MSMEs receive timely payments at a low cost of funding, they are digital platforms where MSMEs can get finance by auctioning off their trade receivables. For the first time in India, these exchanges have created a platform where MSMEs (sellers), large corporates (buyers) and banks (financiers) can communicate with each other in real-time, settling their invoice financing in a day or two.