Supply Chain Finance – Good for Banks and SMEs
The buyer-centric approach is making waves as a viable way for banks to facilitate more access to credit for SMEs in Asia and the Pacific.
Supply chain finance (SCF) is making waves as a viable way to facilitate more access to credit for small and medium-sized enterprises (SMEs) in Asia and the Pacific.
Unlocking access to credit for SMEs in the region has been an important issue for decades, yet we seem to be making little progress.
ADB’s 2016 Trade Finance Gaps Survey shows this year again a huge global financing gap of an estimated to $1.6 trillion (up 14.3% from 2015). Developing Asia continues to be the most affected region, accounting for 43% of the gap and with SMEs the most adversely affected by it. Indeed, 56% of SME trade finance proposals are rejected, meaning that when a SME submits a financing application rejection is more likely than approval. Large corporations face rejection rates of 34% while applications from multinational corporations are rejected only 10% of the time.
A survey in the report showed that 90% of banks answered that “Anti Money Laundering/Know Your Customer requirements” are a significant impediment to the expansion of trade finance. Conducting due diligence on SMEs and then monitoring the risk on an ongoing basis has a high cost and is highly labor-intensive. In fact, it costs a bank more to provide an SME with a $50,000 loan than it does to provide a $50 million loan to a large corporate.
SCF refers to a buyer-centric, typically a largely corporate approach to financing SMEs.
A key feature of SCF is that a supplier’s receivables—owing from their large corporate buyer—are discounted based on the buyer’s credit rating, not on the supplier's. This not only makes financing accessible to SMEs, it also reduces the supplier SME financing costs. This structure is also known as “reverse factoring” because the bank arranges the SCF facility with the large buyer on behalf of the SME supplier. SCF thus removes two of the primary deterrents to extending finance to SMEs: weak financials and insufficient collateral.
Unlike traditional banking, SCF focuses on the strength, longevity, performance, and “stickiness” (mutual dependence) of relationships in a supply chain and, on this basis of risk assessment, provides financing to SMEs. SCF is changing the way big companies look at their suppliers, and has significantly improved the supply chain relationship by encouraging collaboration between buyers and sellers rather than competition, and building sustainable partnerships. SMEs will therefore benefit from additional funding at a lower cost without using their existing credit lines.
In its recent May 2016 study on SCF, the WTO emphasized the power of innovative SCF solutions to help bridge the finance gap for SMEs. This endorsement builds on increasing interest in this form of financing in recent years for several reasons:
- SCF facilitates access to new territories without taking the country risk.
- SCF enables SMEs previously considered “unbankable” for traditional trade finance products to access credit.
- SCF expands existing customers’ product range that fits into banks’ strategy of “focusing on core customers.”
Global banks and even now local banks are looking at developing these programs throughout Asia. Asia is gaining momentum and is expected to become the fastest growing market in SCF in the coming years.
But while it is an increasingly popular topic for discussion in banking conferences, SCF remains underdeveloped in emerging economies. Constrained by the unintended consequences of the “new normal” world of Basel III and US banking regulations, banks have limitations to expand their product wallet.
To address these obstacles, ADB is supporting banks willing to do more business involving SMEs with a limited risk weight asset consumption and additional funding source. ADB’s relatively new Supply Chain Finance Program (SCFP) provides funded and unfunded risk participations to banks to support supply chain finance for SME suppliers in ADB’s developing member countries. In doing so, the SCFP helps SMEs in our developing member countries gain access to cheaper and additional financing to enable them to grow and sustain their business.
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