The age-old disparity between the ‘haves’ and the ‘have-nots’ is nothing new on the world economic stage. When crises of a financial nature occur, the gap between these groups widens to reveal two sides of the same coin: large, cash rich enterprises (the haves) grow risk-averse and hoard mass amounts of capital to no benefit; while small, cash-poor businesses (the have-nots) struggle to attract the necessary capital to fund their operations.
Traditionally, banks have served as the go-between for these two groups, helping to provide much needed cash in the form of bank loans and credit to small and mid-size enterprises (SMEs), while allowing large enterprises the opportunity to earn a modest return on their excess liquidity. But in the environment created by the European sovereign debt crisis, this delicate balance is quickly thrown off by banks which are unable or unwilling to engage at the lending level, and which can no longer provide significant interest rate returns on stored cash.
Dynamic discounting is a modern twist on this perpetual problem. While the concept of providing discounts for early payment on approved invoices is nothing new, inefficient paper-based and manual processing made it an unreliable and mostly minor benefit. With the advent of purchase-to-pay (P2P) technologies, electronic invoicing (e-invoicing), and advances in procurement software, dynamic discounting capabilities are now robust enough to ensure double-digit returns for buyers, while providing suppliers with accelerated payments and access to much-needed cash.
Why Banks Won’t Solve the Problem
To understand the connection between the two, you must first understand why banks have stopped lending. In southern European countries, such as Spain, Portugal, Greece and Italy, banks have dramatically decreased crucial funding to SMEs, either through refusing to issue new loans or significantly reducing existing lines of credit. One reason is that many banks maintained very little equity and held huge loan portfolios for their clients, creating an unstable situation that was exposed when the real estate bubble burst. This forced these banks to de-leverage and to demand loan repayment in order to survive or, as is the case with many banks in Spain for example, depend on a government bailout to stay afloat.
To further complicate the problem, banks in countries where the sovereign debt crisis has been most significant have been faced with rising refinancing costs, are burdened with large amounts of government debt, or both. It has become a vicious and perpetual circle of under-capitalised banks expected to hold up under-financed governments, and under-financed governments expected to back the under-capitalised banks. This double-edged sword prevents banks from lending to SMEs, as they are hard pressed to maintain their own solvency.
All of this uncertainty has created another issue on the buyer-side. The risk-return curve has shifted to the point where investors are willing to accept negative real interest rates for the most secure asset classes, such as US treasuries or German bunds. In other words, they are willing to see safe investments decline in purchasing power. This low-yield environment, coupled with most treasurers’ desire for security over money, makes it extremely difficult to achieve target returns on excess liquidity and short-term investments.
Large enterprises have responded to the debt crisis and related uncertainties, often by enhancing their cash flow and position, and by extending days payable outstanding (DPO) terms with suppliers. This puts an additional strain on suppliers who face a widening gap between the time when goods and services are delivered, and the time when they receive payment.
Given these very significant issues many SMEs, particularly but not only in the European periphery, face difficulties in making it through the current business cycle, with very little hope of an infusion of capital from banks and an increased demand on already taxed resources. Conversely, this burden on the SME market results in potentially significant risk to large companies, which rely on a robust supply chain across Europe to maintain the necessary output of goods and services. Dynamic discounting can help offset these issues.
Dynamic Discounting: A Fresh Approach
It is important to recognise the benefits that a proper dynamic discounting approach can have both on the buyer side and the supplier side.
First, and probably most obvious, it gives immediate and vital access to cash for suppliers. Even in the EU countries hardest hit by the debt crisis, dynamic discounting offers suppliers a non-bureaucratic way to leverage one of the few valid assets they have, namely the accounts receivables (A/Rs) resulting from their goods and services. It also disintermediates the banks, which serve as middle men and which may be facing their own liquidity issues, by allowing suppliers to accelerate payment from more solvent buyers within or outside the EU. Dynamic discounting serves as the mechanism to accelerate the flow of liquidity to where it is needed most and thus strengthens the overall European supply chain.
Next, dynamic discounting serves as a risk-free investment for buyers. Not only does it provide immediate, double-digit returns on money that would otherwise sit nearly stagnant in a low-yield account, it is a strategic way to strengthen relationships with key suppliers, thus enhancing the buyer’s supply chain. It allows the buyer to have more confidence in the market and its position.
Finally, dynamic discounting is a tool that provides the buyer with crucial visibility into the financial health of its supply chain, as the cash need of suppliers becomes transparent based on the agreed-upon, dynamic payment terms. It serves as a safe and reliable way for the buyer to strengthen their financial supply chain (FSC) by injecting capital in a secure way. The right dynamic discounting programme gives a buyer more knowledge and flexibility to react swiftly and intelligently to changes or crises in the market.
It is clear that the issues surrounding the European sovereign debt crisis aren’t going to be resolved any time soon. The ability for banks to play their traditional role of providing liquidity to businesses has been severely compromised, and any significant turnaround in the market is, at best, still a long way off. Today’s small businesses need cash flow to remain solvent, and large enterprises need the backbone that a strong SME supply chain provides.
Dynamic discounting is a new and effective way of doing business that skirts negative economic conditions, while creating a compelling, win-win proposition for large enterprises and their smaller European suppliers alike. In today’s negative economic climate, it is rare that you hear that kind of promising news.
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