Financing Small for Big Growth

Supply Chain in India is seeing a slow but sure transformation and has a cascading impact on almost all aspects of trade and retail. One of the powerful growth drivers to have emerged from this is Supply Chain Finance (SCF). What exactly does SCF mean and how does it help steer the wheels of growth? This cover story aims to unlock the true value of SCF in the post-GST era with valuable insights from the industry veterans…

SUPPLY chain management has historically been focused to ensure right goods are delivered in the right quantity and the right place and time. New age supply chains need to deliver all the value chain drivers at the ‘right cost’ – that’s the distinguishing factor between competing supply chains. Effective working capital management (payable/receivable/inventory) – unlike before, is now a key deliverable for effective supply chains. Also, global supply chains have more links than ever, and not all those links may completely be in sync when it comes to payments, cash flow and financing – hence the need for Supply Chain Financing (SCF), highlights Vickram Srivastava, Delivery Head – Supply Chain, GDSO, Zydus Group.

Technically speaking, SCF is a Short-Term Working Capital finance provided to dealers/suppliers (“Spoke”) having business relationships with large corporate (“Anchor”) to optimize working capital requirements of both Spoke & Anchor. “Supply Chain Finance is a fine blend of Bill Discounting & Overdraft product with the essence to optimize finance & flexibility for the customer. All transactions are linked to a base document (Invoice) between the Anchor and the Spoke. It accelerates the cash flows and the finance is available at a relatively competitive pricing. It is like an efficient fuel at lower cost for corporates. This allows companies to churn money faster and rotate your business in many more cycles, which will ultimately augment your sales and profitability,” shares Litesh Majethia, Senior Vice President & Head Supply Chain Finance, Bank of Baroda.

On similar lines, Saurabh Batra, Director – Financial Services Risk Management, Ernst & Young, states, “SCF provides short-term credit that optimizes working capital for both the buyer and the seller. It generally involves the use of a technology platform in order to automate transactions and track the invoice approval and settlement process from credit disbursal to the payment on due date. Supply chain finance programs typically aim to build stronger supplier buyer relationships by offering and participating in a mutually beneficial working capital optimization, which results in early cash realization for suppliers and optimized payment terms for the buyers. The result is better working capital, improved relationships between parties, and a stronger supply chain.”

The best way that buyers can build quality relationships with their suppliers is by offering them tools to manage their working capital. At present, Banks, NBFCs and FinTechs have started to play a valuable role in facilitating this collaboration. Technology-led solutions, enabling last mile transaction information between trading partners; has made SCF programs to become more focused towards the untapped mid-size and small corporate segment. In line with this, we are seeing the emergence of multiple fintech solutions, which are truly expanding the sources of funding alternatives available to mid and small companies today.

Relevant across multiple industries, this offering has evolved into a much needed component that drives value to sectors like commodities, electrical & electronics, consumer durables, FMCG & Agro based industries to finance their supply chain.

Market size

Based on the latest estimates, the SCF market is approximately USD 10 billion, as highlighted by Sandeep Chatterjee, Senior Manager – Technology Consulting, Deloitte Touche Tohmatsu India LLP. Key Players in this space include State Bank of India, HDFC Bank, Standard Chartered Bank, Axis Bank, IndusInd Bank and Tata Capital. The market is mostly fragmented between PSU Banks (SBI, PNB, etc.), private Sector Banks (HDFC, Axis and others), MNC Banks (Standard Chartered, HSBC, etc.) and NBFCs (Captive Finance companies of corporate such as Tata Capital, Aditya Birla Finance, etc.). The SCF Market share is further broken down as SBI holding 18%, HDFC 21%, ICICI Bank 12%, Standard Chartered 13%, Axis Bank 11%, IndusInd 5%, others 20% for Channel Finance (Rs400 Billion). In terms of Vendor Finance, which is close to $4 Billion market, SBI holds 16%, HDFC has 24% share while Kotak commands 10%, MNC Banks have 15% and others have 35% market share.

According to Saurabh Batra, the size of any SCF market depends on extent of unmet funding needs of the SME segment. As per a CRISIL study in 2011, the untapped market for SME funding in India is more than Rs50,000 crores. There is another research from McKinsey that points out to a global USD 3.1 trillion gap in the funding of SMEs out of which non-developed nations require around USD 1.7 trillion. The current market for supply chain finance in India is estimated to be more USD 10 billion and increasing due to new, innovative products entering this space.

Funding partners want to lend to SMEs as research shows that the ROI on credit to SMEs is far better than retail or corporate credit. SMEs want access to formal sources of finance simply because it is cheaper than any other form of finance.

Creating value

Supplier payment terms are extending to historic lengths—an average of 66 days globally—wreaking havoc on supply chains as even well established businesses close shop due to cash flow problems. Tighter credit since the Great Recession and the increasing globalization of supply chains are driving demand for better supply chain finance solutions. Consulting firm Bain estimates that the market for supply chain finance is expanding by 15-25% a year in the Americas and by 30-50% in Asia. But yesterday’s solutions won’t work in today’s market. Supply chain finance programs have been offered historically by big banks and financial institutions, but only to top-tier suppliers, not to the small and mid sized businesses that need them the most.

During their initial research, Bank of Baroda team found that Small and Medium Enterprises (SMEs) contribute about 28% to the GDP but were inadequately served by the pre-existing banking system, largely relying on money lenders and private investors, with a funding gap of around USD 418 billion. SMEs have demonstrated high demand for finance, particularly debt, but of their total financial requirement, over three fourth is either self-financed or comes from informal sources. The demand for finance has also seen an increase due to the implementation of the Goods & Services Tax since July 2017. This scenario led Bank of Baroda to launch Supply Chain Finance services for corporates and SMEs.

“Building on the Jan-Dhan-Aadhaar Mobile, known colloquially as JAM capability, we saw an opportunity to enter the market for supply chain finance solutions, calculating that the combination of India’s digital modernization, its own capabilities as a bank, and a dedicated platform would allow us to offer better services to the under-served SME market. Historically, this sector has had little access to bank finance, relying instead on private borrowing and non-bank lenders,” shares Litesh Majethia.

In providing SMEs with access to cheaper bank funding and related business banking services, banks see an opportunity to enter the value chain ecosystem. SCF services allow the bank to reach a large market quickly by leveraging the networks of large corporate customers while simultaneously improving the services offered to those large corporates. These corporate ‘anchor’ clients have networks of SME suppliers and distributors often running into hundreds and thousands. SCF covers a range of financing processes that bring the needs of these different participants together to meet their working capital needs in a holistic manner.

Banks are aggressively pushing this offering due to its lower delinquency rates and easy disbursals. As JP Singh, President and Head SME, Axis Bank, aptly states, “SCF is a win-win opportunity for all stakeholders in the supply chain ecosystem — the corporates, their suppliers and dealers.” It links small vendors to the large corporates. This enables SMEs to access credit at a lower cost with minimal documentation and lesser collateral. Negligible Non Performing Asset (NPA) in the segment is a driving factor for banks, which they attribute to the inherent structure of the SCF. Bank of Baroda claims to have zero NPAs in this segment.

Critical need

Global expert Robyn Barrett, Managing Member & Founder at FSW Funding, in one of her posts, elaborated that lowering financing costs and improving business efficiency would be attractive to any business – but lenders and their clients are realizing so many more benefits and advantages with SCF. Banks and lenders are generating new fee income by offering a product their clients find reduces cost of capital and extends the accounts payable (A/P) cycle. With SCF, companies are transforming their A/P department – saving time and money. Supply chain financing helps mitigate supply chain risks and empowers suppliers to optimize their working capital when needed, which improves relationships. Buyers can improve working capital by extending pay terms, improve working capital through accounts payable and supply chain financing, and realize long term benefits to their supply chain.

Highlighting the ever-growing need of SCF, JP Singh says, “Supply Chain Finance is primarily a partner linked program and as such partner’s involvement and its sales & credit control processes play an important role. Dependency and vintage of supplier/buyers on the anchors play a crucial role in the success of any program in addition to the pre-requisite of strong consumer demand for the funded product line. Availability of adequate funds at the right time and affordability are the major drivers of financial value creation.” Adds Lalit Malik, Chief Financial Officer, Dabur India Ltd, “Positive GDP growth and consumer sentiments are leading to an increase in demand. In the short run, working capital cost has increased post-GST, through better supply chain networking and direct supplies, these can be minimized and can be converted into opportunities. Effective collaboration between the supplier and the partner in the value chain can result in a smooth supply chain and help in accelerating growth without increasing risk. Supply Chain Finance has the potential to bridge the void and emerge as the biggest value enhancer in the whole business.”

According to experts, the corporate linkages serve as an assurance. “Any default in repayment results in the stoppage of supply invocation by the large corporates, which can jeopardize the business’ existence. This acts as a deterrent for borrowers,” avers JP Singh. Naveen Goel, Sr Vice President & Country Head – Supply Chain Finance, Auto- IndusInd Bank Ltd., highlights the drivers of financial value creation as:

• Selection of right corporate
• Selection of right technology platform and financing partners
• Cross-functional approach
• Integration into a comprehensive procurement to pay initiative
• Education to maximum corporates and their suppliers/dealers particularly SMEs about the products
• Digitization.

Alluring advantages

As per United Nations Trade Facilitation Implementation Guide, while buyers and suppliers can fund their own supply chains, SCF services reduce both the cost of capital and the risk of these operations, allowing clients to decrease their working capital requirements and improve their ability to raise capital. The advantage for clients is accompanied by considerable benefits for banks, as they can increase revenues by financing the supply chain working capital for their clients, specialize by expanding into their entire supply chain, cross-sell other products and services (such as foreign exchange services) to other operators in the supply chain, and thus increase their client base.

In a recent report, Anil Walia, EMEA Head Supply Chain Finance at Deutsche Bank AG, stated, “The success of a buyer-led supply chain finance program is often measured by the efficiency and speed of the on-boarding process. A well-executed program will clearly demonstrate to the supplier base the working capital benefits; enroll them quickly and in number; and put little burden on suppliers in order that the output is positive for all.”

Seconds Litesh Majethia, “For the Supplier/Vendor, early payment reduces financial dependence on the buyer. It reduces the cost of capital by leveraging buyer’s credit rating as well as increases certainty of cash flows. SCF provides post-shipment; WIP financing and financial discipline. For Anchor, the product minimizes investment in working capital, reduces cost of goods sold (COGS) and total cost of borrowing. The entire automated process reduces administration cost and increases cash flow as well as enhances stability of supply chain. The SCF platform ensures availability of goods for end users, thereby increasing sales.

When it comes to dealers, it provides much-needed working capital for purchase of inventory at lower cost of funds than other working capital products. This also increases sense of financial discipline due to short duration & monitored end-use of funds. The Digitization of the process with real-time alerts and reports reduces administration cost & augments sales for the dealers.

Vickram Srivastava enlists some of the advantages that augur well for supply chain financing:

FOR BUYERS

• Being able to increase their working capital
• Buyers get an additional negotiating lever to use with their suppliers
• Buyers can also earn suppliers’ loyalty and goodwill

FOR SUPPLIERS

• Giving preferred suppliers new ways to access funds at discounted rates
• Suppliers benefit from SCF not only by gaining liquidity but by having more options for when they can receive payment
• Supplier’s financing transaction costs are lowered too
• Any risk of a buyer’s insolvency is covered because the funder bears that burden

Banking on each other’s competencies

In this complex maze, enhancing supply chain efficiency must be a daunting task. Vickram Srivastava remarks, “The finance people are incentivized to improve working capital while supply management wants to cement relationships with suppliers to gain the best possible quality, pricing, availability, delivery terms, responsiveness and new ideas—and those sets of objectives can collide when it comes to paying suppliers. In short, SCF cannot be viewed as a temporary fix or a quick patch for a one-off problem; it has to be applied strategically.”

Such financing programs cannot be effective unless they are applied as part of a coherent business strategy that balances the legitimate concerns of the buyer’s finance department with those of the company’s supply chain management experts. That calls for consistent, open collaboration between cross-functional teams. The answer lies in less focus on payables as a negotiating point and a more open, visible buyer-supplier relationship that’s enabled by IT. “We should negotiate around adding value between sellers and buyers – understanding the cost impact relative to the financial benefit is critical to ultimately determine whether financing makes economic sense or not. SCF will work if it meets two key goals, one of reducing cost of procurement (easing of working capital pressure) and second, if it works reduce supplier/dealer risk to supply chain continuity and disruption,” elaborates Vickram Srivastava.

SCF not only aligns itself well with the growth of open account trading, but also maximizes the efficiency gains made possible by the introduction of improved information technology (IT)-driven supply chain management monitoring. For instance, managing the supply chain more efficiently – through online data management platforms – has reduced corporate inventories and brought industries closer to justin- time production. This has meant smaller, more frequent, shipments replacing single large orders.

Talking about developing a close to perfect model to harness greater collaboration, which is ably backed by technology, Litesh Majethia shares, “When we were brainstorming about the nuances of the product, we realized that a modern digital delivery platform would allow us to take share from the non-bank lenders and narrow the gap between us and the other banks already in the space.” A central tenet of its thinking was that the platform had to be able to give the bank a good understanding of the clients’ financial needs and status, allowing it to offer advice and services at strategic moments. A seamless, intelligent and digitized platform would help transactions & money flow faster to its clients.

“At the same time, the bank benefits from data on the clients’ creditworthiness and can monitor its own risk exposure closely. Though the main criterion of success will be how much it can ‘grow the book’ – that is, how many new clients we can attract to the service – with a view to maintain rather have a good book than a big book,” emphasizes Majethia. “In cognizance to this, we implemented a new comprehensive supply chain finance platform, which focuses on centralizing, simplifying and accelerating transaction processes,” he adds.

This solution augments the strengths of companies that are driving the country’s growth, thereby opening new financing opportunities for companies of all sizes via a cutting edge digital products. Bank of Baroda has received positive and encouraging response from many of its customers and they are happy that SCF product is not only delivering value in terms of speed of transactions and information but is very swiftly acquiring dealers and vendors. This product has empowered the Bank and has given it a competitive positioning in the market by working on the key pillars of growth – digitization, centralization, and faster & seamless Transaction processing.

By increasing automation and straight-through processing, while enhancing reporting capabilities, the SCF platform reduces risks while uplifting satisfaction of our clients. The SCF technology & processes have been designed to ensure faster approvals, seamless transaction processing and availability of finance to the SME customers. “We have kept the design & framework of the technology & processes for the Supply Chain Finance product such that it augments the growth drivers for both Large Corporates and MSME clients. The strategy augurs well with our endeavor to support our clients’ ecosystem partners and leveraging their trade relationship to augment their business,” he adds. 

Turning advantages into objective outcomes, Naveen Goel avows, “An effective Collaboration can be established through collaborative communication and information sharing”. Once it is achieved, it can result into:

• Reduced risk for financers due to diversification & defined end use of the funds
• Shorter lead times
• Improved customer service metrics
• Visibility into customer demand and supplier performance
• Earlier and quicker decision-making
• Lowers cost of funds for SMEs due to leveraging on the Credit strength of the large Corporate
• Better and Faster MIS to all stakeholders in the value chain.

Backed by technology

Digital availability of information has led banks and other institutions to provide funding to vendors more efficiently. Digitalization has enabled these interactions to become smoother and easier to implement. The integration of all relevant data on a single platform also helps the firms to manage the key performance indicators.

“The transactions happening through these platforms also creates a transaction history that can act as a pseudo credit rating for any business. Further, information like whether a corporate buyer pays its suppliers on time, their order performance, any history of late shipments or cancelled orders will be used to assess risk rather than credit ratings in a new, performance-based financing when end-to-end automation for this practice is achieved. These histories are becoming better standard for determining discounting rates than credit scores and enable small but reliable suppliers gain access to low cost capital,” adds Saurabh Batra.

According to Naveen Goel, the future of supply chain financing will be based on key developments such as Artificial Intelligence; Cognitive opportunities; Blockchain & Distributed Ledger Technology; FINTech; P2P Lending; Robotic Process Automation; Cyber Security; and Digitization.

By now, it is quite evident that emerging technologies such as artificial intelligence, natural-language processing, and robotic process automation will play a definitive role in bringing about efficiencies in the SCF space. However, to achieve commercial success and revenue growth, banks must try to replace their conventional risk assessment techniques and compliance models (that are balance sheet and P&L statements oriented) with more dynamic models that can make use of both quantitative and qualitative tools.

Saurabh Batra elaborates, “In times to come, we see technology driven SCF solutions to dominate the market with online platforms and cloud-based solutions enabling greater integration and flow of information between the stakeholders. The move towards automated processes and their increasing acceptability of technology has opened opportunities for end-to-end automation of supply chain, greater efficiency, increased transparency, greater data collection capabilities and better underwriting capabilities. This will provide the financing partners to fund both forward and backward participants across the value chain. Some of the most interesting solutions have emerged in the buyer led financing space in form of dynamic discounting, reverse factoring, approved invoice financing. We are also seeing innovative ways of monetizing AR through digitization of invoice discounting and factoring solutions emerging as working capital optimization for supplier. We believe that we are in the phase where greater digitization, transaction data, analytics and real-time capabilities of cloud based systems will define the new age SCF solutions.”

Blockchain technology will soon be put to use. 11 of the largest Indian banks are joining hands together to initiate the very first blockchain-linked loan providing system. A live network is being set up through which more systematic and secure supply-chain financing will be achieved.

RBI has also recently taken steps to allow three players to launch Trade Receivables Discounting System (TReDS), which is a digital platform where small businesses (MSMEs) can get access to capital by auctioning their trade receivables. The market is awaiting more players being allowed on such platforms including HNIs and asset management companies, which will expand the SCF market and add the much-needed depth around funding partners.

Talking about the interesting times ahead, JP Singh concludes, “India is poised to become a USD 10 trillion economy by 2030. The growth will be felt across sectors. The growth will result in strengthening of the supply chain ecosystem and increase awareness and demand for supply chain financing products. GoI’s various initiatives like Make in India, GeM, TReDS, etc., will give a further impetus to MSMEs to enter the supply chain ecosystem. Leveraging the capabilities of technological advancement, we will soon see a revolution in the way we keep the entire supply chain funded as well as reduction in payment cycle for MSMEs. Cash payments have already seen a decline owing to the push towards digital transactions. Features like instant discounting of invoices, transfer of funds, GST invoices funding, etc., already exists and will only improve the experience going forward.”