Covid-19 has resulted in unprecedented job losses, consumers have curtailed their spending, and some ... [+]
By Christopher S. Tang, Edward W. Carter Chair in Business Administration, UCLA Anderson School and S. Alex Yang, Associate Professor, Management Science and Operations, London Business School
Behind the shocking news headlines about the Covid-19 outbreak, shortages of PPE, shutdowns of non-essential businesses, and millions of job losses around the world, there is a spark in the complicated “financial supply chain” that fuels global trade, which if not controlled could turn into a wildfire. We advocate three strategies to mitigate this risk.
Impact of Covid-19 Pandemic
Around the world, Covid-19 has created unprecedented demand volatility. Due to prolonged closures of stores globally throughout April and unprecedented job losses, consumers have curtailed their spending, and some may go into default on their debt.
At the time of writing, Deutsche Bank has downgraded brands like GM which has only 15 weeks of liquidity before it hits the minimum requisite of cash to operate. In addition to massive layoffs by airlines and hotels such as British Airway and Marriott, and furloughs by auto manufacturers such as Honda, Jaguar, and Volkswagen, retailers such as Neiman Marcus Group Inc. and Debenhams are the verge of filing for bankruptcy, and will be likely to suspend or postpone paying their suppliers.
This abrupt disruption significantly increases risk in the financial supply chain. As buyers rush to cancel their orders with suppliers to cut costs, they will also delay or default on existing invoices. This will play havoc with their upstream suppliers who are stuck with materials or components that are no longer needed. These upstream suppliers have no funds to pay their suppliers, creating a dangerous cascade.
As buyers’ creditworthiness deteriorates, banks may withdraw buyers’ lines of credit, upon which receivables financing relies. The withdrawal of buyers’ lines of credit can leave many suppliers suffering from longer credit terms and no option for early payments of their invoices. Similarly, as credit insurance contracts, suppliers will be even less willing to extend credit to their trade partners.
At the same time, Covid-19 has also caused demand surge in many sectors, such as PPE and medical equipment. While the global supply chain offers greater possibility for companies to work together to design and produce new products such as ventilators and masks, suppliers may fall short of funds needed to ramp up production, such as purchasing raw materials or procuring new equipment, and be forced to forego value-generating, and in this case life-saving opportunities.
Looking forward, as countries are planning their strategies to loosen or exit the current lockdown, many sectors will be entering a recovery or rebound stage. Without financial support, liquidity-drained suppliers may be unable to quickly ramp up production, delaying the economy’s recovery from the crisis.
How to Mitigate Risk in the Financial Supply Chain
Unless the entire supply chain is owned and managed by a single firm, the financial supply chain is essential for facilitating global trade. Different supply chain financing schemes should serve as enablers for facilitating smooth physical flows among supply chain partners, instead of an accounting game. For this purpose, accounting rules and regulation need to require improved transparency of such schemes. More importantly, the financial supply chain needs to be better integrated with the supply chain information flow and emerging technologies.
1) Better Supply Chain Visibility
Our research, together with Jing Wu of Chinese University of Hong Kong, suggests that supply chain lenders need to better understand the information flows in supply chains, not just the financial health of an isolated member in the supply chain. Such information includes visibility into the supply chain and real-time monitoring of physical transactions.
Clearly, acquiring this information can be challenging, but the lender can form a partnership with one of the key supply chain players to gain information access in order to evaluate the financial health of the borrower.
For example, HSBC linked up with Cainiao (Alibaba’s logistics arm) in March 2020 to enable merchants in Hong Kong who sell their products on Tmall (Alibaba’s e-marketplace) to apply for financing of up to US$500,000 without the need for collateral or financial documents. With superior visibility of merchants’ background and end-to-end transaction information, Alibaba provides HSBC with detailed and timely information to carry out credit assessments. Through this kind of partnership, banks can better manage risk exposure in the financial supply chain, and Alibaba can help creditworthiness merchants to access loans to sustain their operations, which helps Alibaba to sustain its growth also. It is a win-win-win solution.
2) Go Deeper in the Supply Chain
It is vital that lenders gain visibility not only of a buyer’s direct supplier, but also its indirect suppliers. Technology advancement enables this.
For example, Chinese fintech startup JDH leveraged mobile technology and blockchain to allow lenders to finance suppliers several tiers deep into various complicated electronics manufacturing supply chains based on the buyer’s creditworthiness. This approach alleviates potential supply disruption caused by suppliers hidden further upstream in the global supply chain.
3) Frequent Lending with Smaller Amounts
Increased lending frequency with smaller amounts and shorter delays can enable supply chain lenders to reduce risk while better serving supply chain partners with just-in-time lending.
Leveraging artificial intelligence, fintech lenders such as Ant Financial (formerly known as Alipay, affiliated with Alibaba) and Kabbage (a US-based online financial technology company) can overcome this challenge by approving business loans within minutes.
Further, technologies such as IoT and smart contracts can help better link loan amount and timing to physical supply chain transactions. For example, releasing funds in purchase order finance can be directly linked to the amount of raw material procured.
Fuel or wildfire?
The financial supply chain fuels supply chain operations and global trade. As we weather the current disruption caused by Covid-19, we can better manage risk in the financial supply chain by leveraging information technologies to make data-driven lending decisions based on real-time and trusted information about physical transactions within the supply chain.
In doing so, supply chain finance can continue fuelling global trade without the risk of it turning into a devastating wildfire.
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