Next generation supplier financing: filling the gap

The supplier financing market today is tightly focused on post-shipment post-acceptance discounting. Even with new developments such as dynamic discounting and the recent offerings of fintechs, integrated pre-shipment financing and process simplification are still the missing pieces that will create the incremental value to corporates in financing their end-to-end supply chain and supporting their small and medium-sized enterprise (SMEs) suppliers.

The gaps in supplier financing

Current supplier financing is indeed largely post-shipment, with financing happening once an invoice is accepted. Small companies find it difficult to obtain pre-shipment financing because solutions are geared towards post-shipment post-acceptance solutions and large companies buying from small ones. Many of the global banks offering these solutions often do not have a strategy to support SMEs and, as such, no appetite to offer pre-shipment finance.

The small businesses most reliant on trade finance are finding that traditional bank financing is more difficult to obtain and takes longer to approve. In addition, it is also expensive and requires more documentation when offered to SMEs with poor or no credit ratings. This is due – at least in part – to the regulatory and capital requirements that banks face as a result of Basel III and individual regulator mandates for anti- money laundering (AML) to ensure bank stability.

Dynamic discounting alternatives are offered by peer-to-peer (P2P) lenders as well as some alternative finance companies, and some large buyers provide discounts of up to 1.5% if payment is made quickly. These solutions are, however, far more expensive than bank financing because a 1.5% discount for payment within 10 or 30 days actually costs far more on an annualised basis than borrowing at a rate of 10%. So why do SMEs use these solutions? Because they are faster, have fewer documentary requirements, come with fewer conditions and immediately plug their working capital gap.

To help fill the gap, a small number of large companies with sizeable cash balances sometimes pay for goods in advance or fund the capital expenditure needs of their selected strategic suppliers. This is to help their suppliers finance their supply chain and enable small companies to use the large corporates’ cash flow to optimise their working capital and eventually help fulfill large orders. In an increasingly volatile economic environment, however, many large companies are more often looking to extend terms with suppliers rather than to pay early. In doing so they can improve their cash flow as well as their balance sheet, and obtain a higher rating to support investment.

The current options only solve a small part of companies’ needs and address the least risky part of the supply chain, rather than solving the real challenge of financing the full supply chain. What is needed, then, is pre-shipment financing bundled with post-shipment financing that would add greater value to suppliers.

Some financial institutions, including Standard Chartered, are partly solving this problem by offering post- and pre-shipment financing solutions within their own client ecosystems.

Taking supply chain financing to the next level

Financial institutions are increasingly focusing on how the banking industry can finance the entire supply chain ecosystem, taking service and value to the next level. They are thus developing programmes to offer pre-shipment, post-shipment and buyer financing with easier client onboarding, simplified documentation, and predictive technology that enables automatic flows of invoices throughout the ecosystem between companies and banks.

A further opportunity that financial institutions need to work on is greater collaboration and integration between the buyer’s bank on one side and the seller’s bank on the other. Even in an open account transaction, for example, the banks on either side only recognise the supplier or the buyer as their customer.

If the buyer’s bank can send a standardised purchase order message to the supplier’s bank that identifies the buyer, for example via a Bank Payment Obligation (BPO), then both parties can rely on the fact that the buyer’s bank knows their customer and that the seller’s bank received the information from a trusted source. This process is much like how we trust the SWIFT network today for a similar purpose. The supplier’s bank can then pass further invoice information to the buyer’s bank, with agreement for payment after receipt of acceptance from the buyer.

These arrangements could give banks greater ability to finance client ecosystems by offering financing based on information from the purchase order or invoice, and by using the transparency of the full transaction cycle to enable both the supplier’s bank and buyer’s bank to support their clients’ needs, determine the authenticity of the transaction, and significantly reduce fraud and AML risks.

The future in supplier financing could be one where banks explicitly cooperate to play a greater role within their clients’ ecosystems and deliver messages and information with each other to streamline the end-to-end supply chain. Banks can, of course, compete for the client on the ground while still leveraging a standardised process or platform for transmitting information, which allows a higher financing quantum at a lower rate than the supplier can currently obtain from the marketplace.

To enable these transactions to occur more efficiently, more countries are beginning to develop digital solutions for trade that include banks, customers, agents, logistics providers, shipping lines and tax authorities. While post-shipment post-acceptance financing is the easiest and quickest to digitise, since it relies only on an invoice, the big shift in trade will occur once companies can have an increasing number of trade document data points such as the purchase order and bill of lading digitised.

The regulatory advantage

While one school of thought is that P2P lenders and fintechs have an advantage in this evolving financial ecosystem because they are less regulated, the reality is that regulation can give banks a competitive advantage, on top of its liquidity pools and capital buffers.

In the short term, banks’ costs and requirements for AML compliance, customer due diligence and monitoring of transactions have increased tremendously. As the P2P and fintech markets grow, and as balances become larger, it can be expected that regulators will impose bank-like requirements for non-banks. Thus, banks which have already invested in automation such as monitoring for dual-use goods or setting triggers to identify money laundering will have a competitive advantage.

Moreover, the enhanced capabilities that banks already have in place build trust from clients, regulators and other financial institutions. Rather than just signing up a customer online, for example, banks go through a detailed process to know their customer. Just as letters of credit (LCs) have helped enable trust between banks and companies for the past 500 years – since counterparties know that the bank stands behind their client – so too can the current initiatives by banks enable a similar level of trust and competitive advantage, leveraging newer and significantly cheaper technologies such as distributed ledgers or cloud solutions.

The next generation of supplier financing

Amid a rapidly growing and diverse environment, much more still needs to be done to meet the full supply chain financing needs of companies from start to finish. To support the next generation of supply chain financing, it is increasingly essential for banks to continuously challenge the status quo, disrupt themselves, and focus on innovative solutions that meet real client needs.

1080 views

Related reading