Ever since supply chain finance was incorporated into national policy, as early as 2017, there has been ample discussion of various topics among market players. However, with the emergence of the coronavirus pandemic, the role of supply chain finance in the real economy has come under the public spotlight.
Commercial banks, being an important component of China’s financial system, are the major promoters of supply chain finance and supporters of developing the real economy. This article looks at the role played by banks and their business models, along with some suggestions on how to prevent and avert certain risks.
What is supply chain finance?
Supply chain finance refers to “the general use of financial and technological means to integrate logistics, capital flow and information flow, in order to establish a financial supply and risk assessment system encompassing both the core enterprises dominating the supply chain and their upstream and downstream neighbours, to provide systematic financial solutions in authentic transactions and cater in a timely fashion to the various industry-chain needs in terms of settlement, financing and financial management, and to reduce costs and enhance the value of all parties along the industry chain”, according to the Opinions on Standardising the Development of Supply Chain Finance to Support the Stable Circulation, Optimisation and Upgrading of Supply Chain and Industry Chain. Based on this definition, we shall focus on three aspects:
(1) Supply chain finance serves the entire supply and industry chain, rather than individual or isolated enterprises. Hence, unlike the traditional financial services and their “personalised” and “high-end customised” services built around large and medium-sized enterprises, supply chain finance is a boon for many small and medium-sized enterprises (SMEs).
(2) Supply chain finance is based on authentic transactions, without which supply chain finance serves little more than idling or even arbitrage of funds.
(3) Supply chain finance provides systematic financial solutions, which further test the comprehensive service capacity of commercial banks. In this regard, it differs noticeably from traditional finance, which usually provides only financial support.
Banks play the following three roles in supply chain finance:
Fund provider. In China, where indirect financing is the leading financing mode, banks have become the most important source of funding, and the role of banks in supply chain finance is mainly reflected as a fund provider.
Information centre. Core enterprise is only one link in the supply chain. SMEs without direct business relations with the core enterprises but which are also part of the supply chain need banks to act as information centres, hubs of logistics, capital flow and information flow on the chain, to provide true and genuine credit assessments of other enterprises, which in turn assists other financial institutions with their own financing services.
Service platform. In supply chain finance, banks also provide services in the form of service platforms.
Financing business models
Supply chain finance is a financing method providing systematic financial solutions for upstream and downstream enterprises throughout the supply chain. Depending on the different stages of production and marketing, the financing business model of supply chain finance can be divided into three categories: accounts receivable financing for sales, prepayment financing for procurement, and inventory financing for production and operation, from payment of goods to sales of finished products.
For suppliers with insufficient financing capacity, each of the three financing categories targets their respective cash flow difficulties in bulk purchase, effective sales and recovery of accounts receivable. In addition, accounts receivable, inventory and orders capable of generating stable cash flow on the supply chain may be securitised through the design and risk pricing of financial products.
For SMEs with limited financing channels, supply chain finance brightens their prospects for funding but also brings risks. For instance, as fund providers in supply chain finance, banks are exposed to two common legal risks:
Authenticity of the underlying transaction. Supply chain finance is shouldered by core enterprises, but it is a pathway paved with authentic transactions. If the business or title documents (e.g. dispatch bills) provided by the financing enterprises are false or invalid, expenditures cannot be recovered, and fund providers (i.e. banks) will face capital risks.
Legal risks of guarantee. In supply chain finance, repayment comes from sales proceeds of the borrowing enterprises and their upstream and downstream neighbours. Banks usually require the enterprises being financed to supplement collateral in the forms of movable property (e.g. inventory) or pledge of rights (e.g. warehouse receipts and accounts receivable). If the collateral is invalid, banks may have a hard time recovering funds. Thus, guarantee is another minefield of material legal risks in supply chain financing.
Based on this analysis, banks should be attentive to the following risk prevention measures when providing supply chain finance services:
(1) strengthening their reviews of trade authenticity while taking into consideration the internet of things, blockchain and other new technologies used along the supply chain;
(2) improving banks’ own credit investigation systems, especially in terms of risk management and control with core enterprises;
(3) highlighting the control of capital flow and logistics and the compatibility and connection between them, so as to ensure account accuracy and consistency, and preventing any misappropriation of financing funds.
Yao Xiaomin is a partner and Cai Min is an associate at Lantai Partners
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