Supply Chain Financing Versus Factoring: More Than a Dispute Over Words

Despite having given supply chain finance (SCF) the status of a fully-fledged product category in their global transaction banking units, major financial institutions still have a long way to go to establish a coherent industry jargon and clarify the fuzzy boundaries with some adjacent product types.

One of the most recurrent sources of confusion revolves around the usage of the term ‘reverse factoring’ in the context of SCF. For banks that run both factoring operations and modern transaction banking divisions, the dispute around terminology is not trivial at all.

At a very high level, the most common form of SCF – that is the financing of receivables after an acknowledgement of debt given by the buyer – shares with reverse factoring a few defining characteristics. The transaction is disclosed and the buyer is asked to confirm the validity of the invoices issued by a supplier. At a more detailed level, though, some important differences emerge between the two products.

Cash and Trade Come Together

In the case of SCF, the financing aspects are often seamlessly combined with the cash management requirements of the buyer. Corporate treasurers look for banks that are able to receive electronically big volumes of payables data, turning them into discounted payments for the suppliers or, in case financing offers are not possible or not accepted, disbursing the funds punctually at maturity.

The bank needs to be able to set up an efficient process, debiting the buyer’s account according to his instructions and executing all the financing and payment operations according to a straight-through automatic mechanism. The immediate consequence of such an approach is that the financial institution, playing the role of paying agent to the suppliers on behalf of the buyer, gets involved in the payment and settlement cycle. This basically eliminates any collection risk associated with the re-payment of a financed receivable. Overdues, dilutions, wrong transfers or other typical ‘noise’ factors that may interfere with the successful conclusion of a receivable finance transaction are excluded.

This fundamental feature, coupled with the various forms of automatic debt acknowledgement that characterise the agreements between buyers and banks, give SCF the undisputable advantage of making any credit assessment on the suppliers basically redundant. The only relevant risk is the one of a buyer’s default, which also explains why all large programmes are mainly built around an investment-grade corporate client. Programmes with one single buyer and hundreds of suppliers can therefore be realised efficiently, without running into administrative bottlenecks in the credit departments.

Flexibility Matters

Reverse factoring is, in general, unable to completely eliminate the need for a risk analysis on the supplier side. In the most common structures, the suppliers send out invoice lists that the buyer is expected to validate. The process relies normally on various manual steps and the buying organisation has to initiate the re-payment autonomously at maturity. This often leaves the financing institution with a remaining ‘servicer’s risk’, mostly related to the quality of the collection activities in the hands of the supplier.

Since the original concept of factoring is based on a portfolio, or one (supplier)-to-many (buyer) approach, the single debtor risk capacity of factoring companies is by default limited. However, typical buyer-centric SCF-programmes that follow the many (suppliers)-to-one (buyer) concept exceed by far these single debtor limits. Banks, on the other hand, are familiar and well equipped to also manage large amounts of debtor risk.

End-to-end Financing

Banks that have invested in SCF are also making a real effort to extend the boundaries of the product. Both the technological platforms and the credit models are being stretched to accommodate other forms of transaction-based financing, using the information that can be captured along the supply chain.

Starting from a confirmed purchase order, the most advanced SCF solutions can trigger a pre-shipment finance loan, convert it into post-shipment finance as soon as transport data is available, and eventually prompt the purchase of the resulting receivables when the invoices are issued and accepted. This allows financial institutions to inject liquidity into the corporates’ value chains at various stages of their business cycle, adjusting the risk assessment and the corresponding pricing based on the maturity level of each transaction. This approach relies on the fact that nowadays most enterprises are already able to exchange electronic data, documenting the events in their physical supply chains. SCF platforms can use this data to track the progress of every delivery and calculate dynamically the risk profile of the related transaction-based financing.

The more data available, the higher the chance that the risk can be mitigated and the financing rates can go down. This projects forward-looking banks into a completely new dimension, one that provides them with a much deeper insight into the corporates’ daily operations and makes them a strategic contributor to their business model.

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