Greater transparency and stronger management controls, supported by digital technologies to enable closer monitoring of company transactions, are key to the long-term success of supply chain finance says Alex Yang, Associate Professor at London Business School.
The recent collapse of Greensill, the supply chain financier, sounds a piercing alarm bell – but not the death knell - for its sector.
Abundant academic research shows that trade credit plays many positive roles in facilitating
business transactions and helps to control and share supply chain risks.
If these opportunities and the inherent risks surrounding the underlying asset, trade credit, can be carefully balanced, supply chain finance has the potential to improve supply chain efficiency and reliability and deliver real value to the economy, says Alex. However, he stresses the need for urgent controls:
“Current accounting rules and flawed risk modelling create the temptation for big companies to use supply chain finance as a tool to create higher leverage, but it is not properly priced into capital markets. For these products and companies to be properly regulated, a mix of greater transparency and improved risk management controls are necessary.
“This means, for example, that businesses should explain supply chain finance arrangements and disclose the size of such programmes in their financial statements. This would remove the arbitrage opportunity and restore supply chain finance to its true purpose.
“Every link in the supply chain finance ecosystem needs to be properly managed. A risk
management system is only as strong as its weakest link. Strict risk assessment and monitoring must be carried out not only on credit risk, but also on operational risk, such as business misconduct.
“Traditionally, bank-led supply chain finance programmes focus on very large and reputable
companies. When such finance is extended to smaller and riskier companies, it is important to pay attention to risk concentration. Ideally working with a roster of companies to ensure diversification.
“Credit insurance acts as a final gatekeeper. Our research reveals that such contracts are often complex, and it is important to choose reputable insurers and set up proper contracts to ensure that the investors are indeed protected from the risks concerned.
“Technology also has a major role to play. Transactions are increasingly digitised and the growing use of the Internet of Things and blockchain, for example, means financial and information flows between parties become more visible, enabling better monitoring and risk control. In addition, this would make supply chain finance available to smaller suppliers and those deep in the supply chain, affording greater financial inclusion.”