The Local Option for Working Capital Efficiency

Supply chain efficiency has long been an important issue for banks and corporates, and the current combination of the liquidity drought and increasing restrictions on bank lending – which is leaving some credit-worthy corporates cut-off from funding – has brought the matter to a head. In order to overcome the present challenges, the corporate call for fully integrated working capital services is becoming increasingly loud: but are local banks listening and will they ultimately lose out if they don’t? I believe that for the most part they are, but they will need to persuade their local corporates of the same, if they are to stay relevant.

Treasury Services – a Revolution

In essence, the key requirements of a corporate treasury function include the provision of adequate and timely liquidity, the minimising of credit and operational risk, and the optimisation of cash and working capital management. Interestingly, attitudes towards each of these areas have shifted dramatically in recent years.

Traditionally, trade finance and cash management – the two key treasury solutions areas – have been offered to corporates via two separate banking disciplines, typically by their house (and usually local) bank. This practice continues despite the fact that both areas are increasingly mutually dependent and both have a major bearing on supply chain efficiencies. Indeed, such a division worked well when cash management was largely focused on liquidity and optimisation of cash, while trade focused mainly on risk. Yet the general decline in trade risk and heightened need for cash optimisation in the past 20 years should have pushed the two together.

In some cases – especially among larger corporations – the separate cash and trade disciplines became united. But further down the supply chain, they typically did not. This was partly as a result of conservative attitudes to change, although such attitudes were supported by a period of easy access to cheap liquidity enjoyed by most corporates, thereby suppressing the need for innovation. Now, however, the tide has turned and the decreasing availability of credit lines is exposing the flaws in this disjointed methodology – as well as fuelling the argument for the complete unification of the two treasury solutions strands, for optimum supply chain efficiency.

The Path Towards Integrated Treasury Solutions

So how best to plot the path towards fully integrated treasury solutions? While there is no direct path towards such a combined solution, a trajectory of sorts may be traced through developments to date, in treasury services. The integration of the physical and financial supply chains – although a clear step forward – has been just the tip of the iceberg. Just as important has been the changing patterns of international trade.

The changes in trade patterns have indeed been fundamental. Data from the 2008 United Nations Conference on Trade and Development shows that countries from outside the Organisation for Economic Co-Operation and Development (OECD) – i.e. emerging markets – are playing an increasingly important role in global trade. For example, in 2007, trade originating from non-OECD countries increased to 37% of world trade, from 12% in 1995. By 2030 it is estimated that this trade will account for 45% of international trade volume. This shift, coupled with cheap liquidity and diminished credit concerns, sparked the rise of open account trade, which can be seen as a reflection of the power of OECD-based buyers to squeeze preferential trading terms from their emerging markets suppliers.

The rise in open account trade gave rise to the concept of supply chain finance – the function of aligning the execution of trade finance instruments with the movement of goods and payments along the supply chain. The key motive in trade finance, it seems, moved from one of risk mitigation to efficiency maximisation – making trade a branch of the treasurer’s classic cash optimisation objective.

In addition, the rise of open account trade was also partly due to the misguided belief that letters of credit (LCs) and documentary collections were simply too time consuming (and expensive). This belief stemmed from the way in which LCs were traditionally processed, and shifted the focus of trade further towards technology, particularly in the OECD economies. If LCs could be processed or even issued via electronic platforms, they would become more efficient instruments and, ultimately, retain their relevance.

Technology Development Feeds Increased Treasury Role

Indeed, sophisticated technological developments – particularly those involving internet-based solutions – have served to highlight documentary process inefficiencies and the need for accurate financial information across organisations. Whereas treasurers were once responsible solely for practical functions, the increased responsibilities and expectations of today’s treasury departments mean that they are now assuming a more strategic role in organisations – and for many this includes responsibility for the entire working capital chain.

This is the power of IT automation – in a stroke turning the practical treasury function into a vital profit centre. Yet corporates need the practical help and support of their banks in order to fully achieve this and, frankly, many local banks – the traditional house support for many corporates – are not up to the job.

Proprietary development of the necessary infrastructure to support these activities comes at a prohibitive cost for the majority of local banks, which has led to an overall lack of local banking provision in this arena. This in turn means that local banks are at risk of being displaced from their role in the supply chain.

The Role of Local Banks

Prior to the age of centralisation, local banks were a key component in the supply chain, playing a pivotal role in assessing the risks of local borrowers – a crucial function that has latterly been replaced by a centralised risk management model. Local banks have, consequently, lost touch with the needs and concerns of local corporates, leading to a loss of knowledge about these entities as a credit risk and meaning that they are gradually becoming pushed out of the process.

I view this as a step in the wrong direction, as most corporates value both the relationships they hold with local banks and the dedication they have to local trade.

So what should be the response of local banks to this situation? In my opinion local banks should look to deepen their existing relationships by finding a way to elevate their local knowledge and experience to a global level. They need to offer their corporate clients an integrated treasury solution that couples the best of local market practice with global reach and technology. This will allow them to reassert their presence in the supply chain in numerous ways – such as helping with the facilitation of risk-mitigation programmes, reviewing business models and offering new revenue-increasing opportunities. Indeed, if they fail to do this, they may find that they lose even more ground to the global players.

Working Capital Collaboration

The real question, therefore, is not if local banks should find a solution to this challenge, but how. Working capital collaboration may be the answer. Assuming that the integration of treasury solutions can be seen as having its roots in the shift in global trade patterns, combined with the benefits of the automation of cash management and trade functions; then working capital collaboration can be seen as the evolution of the traditional outsourcing model, which sees smaller banks outsourcing technology-based functions to larger banks, sometimes on a white label basis.

This brings its own dangers, however, not least the fact that local banks usually outsource key client-facing functions to their larger banking rivals. Some specialist global providers reject the standard outsourcing model in order to allow local banks to avoid the inherent competitor risk. True working capital partnerships involve a specialist provider that is non-competitive in its very essence – meaning that local banks can directly offer bespoke supply chain services to their corporate clients with no fear of loss of business to the global provider. Services are also tailored to the needs of a local bank and its local corporates rather than being modelled on a proprietary system that involves adapting local market practices to the standards and systems of a rival wholesale banking provider.

Supply chain collaboration with a non-competitive partner brings together the core intermediaries between a supplier and a buyer, to generate a common communications platform for both the physical and financial supply chain. This can allow local banks to offer pre- and-post shipment financing and liquidity services against open account trading – an area originally responsible for their displacement from the supply chain.

Collaboration could, therefore, be the key to helping local banks offer effective treasury solutions while retaining core competencies and generating cost efficiencies and could pave the way for fully integrated treasury services for corporates globally.

The views expressed herein are those of the author only and may not reflect the views of BNY Mellon. This does not constitute treasury services advice, or any other business or legal advice, and it should not be relied upon as such.


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