Economies are currently suffering from a paradoxical situation of having too much liquidity in certain areas while having too little in others. Banks, awash with cash, are reluctant to accept deposits; larger corporations are stockpiling cash but running out of options of where to place it; while small to medium-sized businesses (SMBs) are often unable to access funding. Many SMBs are facing a liquidity crisis as a result, which is a direct risk to corporations’ supply chains. Effectively mitigating this risk is critical for corporations to secure their existing operations and enable their growth ambitions.
Bank Lending to SMBs Decreased
The credit crisis led to regulators and politicians putting regulations in place (primarily Basel III) to ensure banks would de-risk their balance sheets.
The unintended consequence of these regulations is that banks shed the business loans of their riskier clients—the SMBs who represent up to 1/3 of their total balance sheet adjustment (1) while at the same time halving their lending activity to the SMB base ($1T to $500B) (2). This is a huge drop-off that starved an already ravaged slice of the business community. Banks that continue to lend to SMBs raised lending margins, making borrowing expensive.
Corporates Squeezed their Supply Chain
Corporates learned a lesson from the 2008 crisis, when banks pulled back credit lines leaving them exposed to bankruptcy due to lack of liquidity. One of the legacies of the crisis was a culture of fear surrounding liquidity risk.(3)
In the past, corporates relied on banks to fund them, but these banks were now the source of their fear. Corporates needed an alternate liquidity source. The natural conclusion was to leverage their supply chain and improve working capital to generate cash.
This sparked a wildfire of payment terms extensions that further squeezed suppliers.
Risk Was Shifted into Corporates’ Supply Chains
This practice compounded the shortage of liquidity for SMBs, who are forced to search for funding to bridge the liquidity gap only to find that banks are now unwilling to lend to them. SMBs that would otherwise have thrived are suddenly facing a liquidity crisis. Rather than reducing their risk by lessening their exposure to banks, corporates instead shifted it into their supply chain. Even if suppliers stay solvent and do not impact current operations, they may be unable to afford to grow, potentially derailing corporate growth plans.
The Solution: Acceleration of Payments
Although lending was the answer in the past, it is not the answer for the future.
Banks recognized this and moved away from lending toward accelerating pre-existing payment obligations from buyers to suppliers in return for a discount (supply chain financing). However, this is focused on the largest suppliers, typically 5 to 10 percent of the total base; ironically, the ones who already have access to funding.
Acceleration is the answer, but to be successful, an acceleration program must be consistently used by the suppliers who need it. The methodology used by legacy acceleration models (dynamic discounting) is restrictive, buyer push in which corporates set the discount rate at which suppliers participate. This places the onus on buyers to have complete understanding of their suppliers’ cash needs in terms of their alternative cost to borrow and the timing of their needs. This can only ever be hit and miss. Ultimately, the end result is lower adoption and little impact on supply chain risk. In reality, risk may be increased as the rates pushed onto the supplier are often penal and increase their cost base.
A natural conclusion is that a successful model must give suppliers control over what price they offer for early payment. By introducing a real-time working capital marketplace, all parties can benefit.
The win for corporates is that they can significantly de-risk their supply chain while also generating a risk-free yield on their cash of c.5 to 7 percent APR.
The win for SMBs is they access the liquidity they need, when they need it and at a lower cost than alternative options. These businesses can immediately improve profitability and secure their operations. Moving forward, they can expand, advancing the economic recovery and allowing their buyers to achieve their own growth ambitions.
This solution provides a win for banks and governments, too. Banks can focus lending to less risky counterparties without having political pressure to solve the SMB liquidity crisis. Politicians are happy because SMBs have sustainable access to liquidity sourcing to kickstart investment, growth and employment without increasing levels of public debt.
Sometimes the obvious solutions are the best. The above requires no complex paperwork, uses existing accounts payable/accounts receivable (AP/AR) processes and has no losers.
1. Bending, Tim et al. “Unlocking Lending in Europe.” European Investment Bank Economic Report: Oct 23, 2014
2. Ott, John and Jeffrey Anderson. “Restoring Financing and Growth To Europe’s SMEs.” Bain & Company and Institute of International Finance: Oct 10, 2013
3. J.P. Morgan Global Liquidity Investment PeerView 2014