“I don’t look at the numbers from a finance perspective. Instead, I look at what the customer is trying to tell us”, says Peter who is retail and finance executive. Customer and supplier satisfaction has always been the key to groom the business and reduce the risks in any organization. In financial services, if you want to lead in the industry, you first have to be the best in risk management and credit quality. It is the foundation for every other measure of success. There is almost no room for error. The challenge for banks is not becoming digital, its providing value that is perceived to be in line with the cost or better yet, providing value that consumers are comfortable paying for. Financing the supply chain has dependably been a tricky business, with such a significant number of uncertain elements to consider. The supply chain can envelop various suppliers, distributors and buyers, and an issue with only one connection in the chain can result in non- installment somewhere else. There are different types of risk associated with supply chain finance including operational non-performance risk, transfer risk, sovereign risk, currency risk and interest rate risk, but one of the major risks is corporate credit risk. The increasing sophistication and electrification of supply chain data are key enablers in enhancing corporate credit risk assessment and performance monitoring, which are dependent on the advanced risk models of banks. Basel II has now provided a framework to better incorporate
the various risks measured by banks into the calculation of their capital, which is necessary in supporting the business. There are various current trends in the supply chain processes that are leaving corporate and the banks that fund their trade flows open to risks. Moving from trade finance is one of the major trends within financial supply chain which can be done through documentary credits, such as letter of credit to trade done on open account. This move to open account settlement creates several problems for corporate to contend with. A particular problem resulting from the move to open account settlement is the change in counterpart credit risk where instead of relying on the buyer’s bank, suppliers must deal with the credit risk of their buyer. Another challenge is that electronic payments made on an open account basis are much quicker than the LC method: payments are now done electronically within one day as compared to a week with the still largely paper based LC process. As a result, there is no time to do verification of documents, which could expose corporate to the risk of fraudulent authorizations or inaccurate data. “For most corporate, however, it still makes sense to use LCs when large transactions are involved and secured
payment is vital. Supply chain finance based on open account data is a much needed for the daily flow of smaller transactions because of the lower process cost.”
Corporate engaged in cross-border trade need to manage numerous risks at the same time, such as “country risk, bank risk, currency risk and interest rate risk. Hedging currency risk is mainly important with the current volatility between the euro and the US dollar, which also affects exchange rates with Asian currencies. In addition, interest rate risk has an adverse effect on funding risk. The popular argument to deal in the home currency does not mitigate risk; it just transfers it to the trading partner and at the cost of transparency. In such scenario, offering optional currency pricing and finance periods could be a potential solution. Without data, you are just ordinary person with an opinion. The way to risk management is the accessibility and availability of financial data, having the right risk calibration models and being able to continuously monitor the established profiles. In trade finance, banks generally
estimated political and counterpart risk, more often that of other banks and the risk of the bank’s clients whom they finance. The latter involves analysis of the counterpart’s balance sheets, profit and loss accounts, and budgets. “The result of this evaluation determines the credit appetite and hence the credit availability, which was often not available at the required amount and to the right partner in the overall supply chain. It is important for buyers, suppliers and banks to consider the financial supply chain in its gross across the various layers of suppliers, manufacturers and clients, also how each party links its performance with the next segment of the financial supply chain, in terms of cost and credit, process and availability.
Previously, each buyer and seller in the chain looked for financing from its own bank, which meant that each bank based its credit assessment on the pertinent business of its client alone. Now the entire supply chain is displayed to the bank, usually by the final product owner who typically negotiates a supply chain financing program, which would include funding for its suppliers. Each supplier then has the choice of either participating in the funding program, or using other existing means of financing. This procedure streamlines the process, reduces operational risk and aligns partners equally with the support of web based transaction platforms. In order to efficiently build a supply chain financing program, obtain all the important information and make a collaborative platform to interact seamlessly with all suppliers as well as the buyers. Such kind of platform allows the exchange of trade related data which includes purchase orders and invoices electronically. The most conventional platforms are easily accessible through the internet and accept data directly via the user’s ERP system. There are several ways in which such a platform reduces risk i.e. it eradicates an amount of operational risk because all parties already collaborate
on the same platform, which is usually hosted by the bank and uses the same sets of data. It intends to imitate the lower product risk, which is translated into an attractive funding cost. Cost in the financial supply chain can be standardized if there is transparency and cooperation between the larger importing companies and their smaller suppliers. As long as the suppliers deliver the contracted goods, the buyer will pay for them. The divergence between the lower funding rate of the financially stronger importer and the higher rate of the small cap supplier provides the potential to create attractively engineered packages. The advantage for the importer is that, on
the back of such financing programs, it becomes possible to extend payment terms and re- shape the balance sheet and liquidity position. Basel II and electronic data management have presented a model for banks to improve their risk assessments and capital allocation in the financial supply chain as well as for the better measurement of particular product risks. As a result, they are able to offer more effective
products and create cost advantages for their clients and partners in the supply chain. When considering the current liquidity crisis in the financial markets, it is vital for corporate to think about diversification of funding sources including supply chain finance alternatives; as such programs are more likely to be sustained by banks during difficult times, compared with typical commercial lending propositions such as short-term loans and overdrafts. “While achieving lower cost, financing will always be at the top of every corporate agenda, there are three basic key factors that they must be recognized if they want to significantly enhance risk management and efficiency in the financial supply chain.” Firstly, they must ensure that they consider the supply chain end-to-end. Secondly, working within the financial supply chain means sharing advantages; no partner will give up a benefit without something in return.
Thirdly, transparency is paramount and that is only achieved by making the relevant
transaction finance data available to banks.
(The writer is MS (SCM), in Bahria University Islamabad)