Following the 2008 financial crisis, as banks started tightening finance facilities for corporate entities of all sizes, partner finance started gaining strength. Banks began partnering more often, both with other banks as well as non-banking financial institutions, in supply chain finance (SCF). Prior to the crisis, the lending directives in banks did apply ceilings in terms of the quantum of finance that could be provided to an entity, with country caps, currency caps and a limit on industry exposures all enforced. Post-crisis these credit controls were tightened, pushing banks into closer partnerships with other financial intermediaries to retain client relationships and also open up non-interest income streams.
Dynamics of Partner Finance
Banks on-board partner banks and other financial institutions (FIs) based on multi-factor due diligence processes, with the lead banks needing to be aware of their partners’ risk appetite. These processes also mirror credit limits that the credit partners have set up in their organisation in terms of the risk factors, credit caps for each risk entity and utilisation of the credit caps.
The risk factors typically include the borrowing client’s ID, the industry sector in which the company operates, the counterparties on which invoices are drawn and the currencies involved. When the lead bank receives a finance request against approved invoices under reverse factoring programmes, it evaluates the amount with respect to own maximum credit limit head rooms. As and when necessary the lead bank will then refer the finance request to its panel of partners based on its knowledge of the availability of their respective credit lines. In a situation where a single partner cannot fund the client entirely, they distribute the finance amount among multiple partners.
More often than not, the lead bank does not let its partner directly interact with the client. It remains the lender for its clients but has back-to-back sale agreements with the credit partners; an arrangement that enables them to have recourse to the lead bank. All repayments are routed through the lead bank and are then distributed to the credit partner(s) based on the size of their contribution. In cases that involve a complete outsourcing of finance, the lead bank may end up moving the finance out of its books on to the credit partner – albeit at the same time booking contingent entries to reflect any recourse. All credit servicing and collection efforts put in by the lead bank generate fee income for it.
The following are some of the common features typical of partner finance:
- Registering invoice portfolios: This feature is typical of self-assisted channels, as well as back office. Bulk capture, as well as singular capture of approved invoices, is required.
- Recording credit partner profiles: This can be done after the credit partners have been on-boarded. The SCF application may not necessarily handle the on-boarding process.
- Setting up and tracking of credit partner limits and own bank limits: This requires the ability to set up credit limits for the lead bank as well as the limit details shared by the partner banks. Partner bank limits are an extension of the credit partner profile.
- Generating an optimal mix of partners: For a given finance request, the SCF solution is required to determine the minimum number of financing entities to be involved. The aim is to avoid the complex orchestration required in moving repayments to the credit sharing finance institutions.
- Repayment servicing: This requires the ability to receive repayments through various modes, such as cheques, electronic payments (e-payments) and account-to account-transfers. After repayments are received from the borrower, servicing involves routing the credit partner shares to the destination banks and also recording the release of used-up credit limits for the credit partner.
This is challenging as it requires the splitting of the repayment to first recover the fees for services provided by the lead bank and then breaking down the net repayment amount into shares for the credit partners. Splitting the credit partner share further in terms of repayment into principal repayment, interest repayment is hugely complex and usually not a system expectation.
As the industry evolves to design new ways to adapt to the crippling credit norms self-imposed by banks to control risks sustain marketable portfolios, system support takes centre stage.
The ability of supply chain finance (SCF) providers to devise new products matching new credit arrangements with strong reporting and data presentation and enabling closer and real-time monitoring of credit limits becomes crucial. This is the new reality for system vendors who pitch for technology mandates from banks that aggressively strive to remain relevant to their clients and the financial ecosystem as a whole.