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Thought Leadership
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August 18, 2020
Pushing the boundaries of Supply Chain Finance
Mengtao Li - VP & Global Head of Trade Finance

The world is dealing with an unprecedented pandemic that has caused huge disruption for companies at all levels. Factory outages and spend reduction across the board severely impacted the sustainability of supply chains. As such, many companies are currently refocusing their strategy to build resilience in their supply chains and maintaining a larger than usual liquidity headroom that will help them face tougher times ahead.


As expected, the impact has been greatest for small businesses

Throughout the pandemic, many banks have been very active in capturing financing opportunities, extending existing credit lines, and issuing additional loans to their most valuable clients to help them navigate the economic turmoil. However, the first companies to receive support from their banks are often those with the best credit profile and strongest liquidity. Furthermore, as banks put in place stricter financing criteria and demand higher returns on capital, only a handful of SMEs have been able to raise much needed funding. The decline in financeable assets and collaterals have exacerbated this situation further, causing struggling SMEs to collapse.

High-street lenders and companies who rely heavily on SME suppliers have been looking at ways to help. Trade Finance, and in particular Supply Chain Finance (SCF), have become increasingly relevant. SCF is a solution whereby banks leverage the credit worthiness of their large corporate clients to offer competitive financing to their suppliers, allowing banks to inject liquidity into the supply chain without having to underwrite the suppliers’ credit risk. While this solution was designed to reach the entirety of the supplier base, in reality even the most advanced SCF programs today are constrained by cumbersome manual processes and high operational costs. This makes it expensive for banks to extend financing beyond a handful of large suppliers who, generally, are the most financially robust. Whilst this certainly is not the intention of companies who embark on the journey to implement SCF, these programs often end up leaving many SMEs without access to competitive financing.

As the global economy begins its recovery phase, building supply chain resilience will be a key area of focus for most CFOs. Large supply chain companies will look at their banking partners to help ensure that every member in their supply chain receives adequate financial support. For banks, this will highlight the need to rapidly upscale their programs, capabilities, and overall financing reach.


What are banks doing about it?

Banks have taken several steps to accelerate scale over the past several years. Many have chosen to build collaboration models with fintech start-ups who offer innovative tools, platforms and capabilities. However, taking the joint value propositions beyond proof of concept has highlighted important structural barriers – such as a lack of streamlined processes for banks to quickly approve FinTechs, legacy technology, operational restrictions and, on the flipside, unrealistic expectations from start-ups about bank adoption rates. Great effort has been put in by both parties to improve the collaboration model. For example, most banks have now established dedicated innovation teams focusing on identifying and building strategic partnerships with FinTechs to help banks capitalize on the pace and breadth of innovation that they can bring. These teams are also increasingly working together to create innovative cross-banking consortia. FinTechs, on the other hand, have been heavily upscaling their industry knowledge by hiring executive talent with banking background and a deep understanding of the complexities of banking. As banks continue to invest in technology, and as innovative FinTechs keep emerging and maturing, this partnership model will evolve into a popular industry practice and rapidly add scalability to banks’ existing offerings.

Another focus area has been to couple bank financing with third party platforms such as e-commerce networks, procure to pay software providers and ERP platforms. Through more open APIs and strategic partnerships, banks can increase their coverage and efficiently deploy finance across a wider set of transactions and suppliers. However, as this collaboration model develops, software providers have started to recognize their strategic place in the value chain and are increasingly demanding hefty margins to allow banks to access the highly coveted data and transactions that are running through their platforms. As transaction and distribution economics change, banks will increasingly need to make careful trade-offs between margin and scale.

Some banks have also taken the approach of building their own marketplace, creating a digital ecosystem for buyers and sellers to trade and transact with trusted counterparties. Supported by a fully integrated workflow, banks can capture each trading event – such as a purchase order or shipment confirmation, and use this data to deliver contextual financing to buyers and suppliers. Since the suppliers become known participants in the network, KYC processes become more scalable and banks are able to deploy payment and financing solutions to a larger number of parties. Benefits grow exponentially by allowing buyers and suppliers to become part of a shared directory. This is a promising model which is still in its infancy and should be followed closely.


The true enabler

Whether buying, renting, partnering or building new and disruptive capabilities, it is imperative for banks to have a truly digital core around which they can assemble and integrate these innovations.

However, despite aggressive investments in digital over the past few years, many trade finance banks have only started to scratch the surface (digital frontends, digitization of paper processes, etc.) and most of them still operate with outdated back-end banking, payments and trade finance systems. This causes a great reliance on manual operations, weighs down product P&Ls and hinders the ability to capitalize on bank innovation investments.

That said, if there is one silver lining of the Covid-19 pandemic, it is that banks have recognized the urgency and strategic importance of finally shrinking their legacy platforms and gaining true escape velocity in digital transformation. Roadmaps that were planned for the next 2-3 years have become imminent and no CIO or COO is sitting still off the heels of the pandemic. Successfully accelerating these initiatives, particularly in the context of increasingly tight margins and reduced investments, is no simple task. It requires flawless execution of the transformation agenda and the creation of efficient funding and partnership constructs that minimize risk and unlock funding flexibility.


The blog was shared on Mengtao Li’s LinkedIn Pulse. Click here to read more article on his LinkedIn Pulse.