Financial supply chain in the Covid-19 pandemic: fuel or wildfire?
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 headlines about the Covid-19 epidemic, PPE shortages, non-essential business closures and millions of job losses around the world, there is a spark in the “chain of “complicated financial supply that fuels global trade, which if left unchecked it could turn into a wildfire. We recommend three strategies to mitigate this risk.
Impact of the Covid-19 pandemic
Around the world, Covid-19 has created unprecedented demand volatility. With prolonged store closings around the world throughout April and unprecedented job losses, consumers have cut spending and some could default on debt.
As of this writing, Deutsche Bank has downgraded brands like GM, which only has 15 weeks of cash flow before reaching the minimum cash flow required to operate. In addition to massive layoffs by airlines and hotels such as British Airway and Marriott, and holidays by automakers such as Honda, Jaguar and Volkswagen, retailers such as Neiman Marcus Group Inc. and Debenhams are on the verge of file for bankruptcy, and likely to suspend or postpone payment to their suppliers.
This abrupt disruption dramatically increases risk in the financial supply chain. As buyers rush to cancel orders with suppliers to cut costs, they will also delay or default on existing invoices. This will wreak 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 can withdraw lines of credit from buyers, on which debt financing is based. Withdrawing buyers’ lines of credit can leave many suppliers with longer credit terms and no possibility of prepayment of their invoices. Likewise, as credit insurance contracts, suppliers will be even less willing to extend credit to their business partners.
At the same time, Covid-19 has also caused an increase in demand in many sectors, such as PPE and medical equipment. As the global supply chain provides a greater opportunity for companies to work together to design and produce new products such as ventilators and masks, suppliers may not have the funds to ramp up production, such as purchase of raw materials or the purchase of new equipment, and being forced to give up opportunities that generate value and, in this case, save them.
Going forward, as countries plan their strategies to ease or exit the current lockdown, many sectors will enter a recovery or rebound phase. Without financial support, cash-strapped suppliers may not be able to scale up production quickly, thus delaying the recovery of the economy after the crisis.
How to Mitigate Risks in the Financial Supply Chain
Unless the entire supply chain is owned and managed by a single company, the financial supply chain is essential to facilitate global trade. Different supply chain finance schemes should serve as catalysts to facilitate smooth physical flows between supply chain partners, instead of an accounting game. To this end, accounting rules and regulations must require increased transparency of these regimes. More importantly, the financial supply chain needs to be better integrated with the supply chain information flow and emerging technologies.
1) Better visibility of the supply chain
Our research, in collaboration with Jing Wu of the Chinese University of Hong Kong, suggests that supply chain lenders need to better understand information flows in supply chains, not just a member’s financial health isolated from the supply chain. This information includes supply chain visibility and real-time monitoring of physical transactions.
Obviously, acquiring this information can be difficult, but the lender may partner with one of the major players in the supply chain to access the information to assess the financial health of the borrower.
For example, HSBC linked with Cainiao (Alibaba’s logistics arm) in March 2020 to enable Hong Kong merchants who sell their products on Small (Alibaba’s electronic marketplace) to apply for funding up to $ 500,000 without the need for collateral or financial documents. With superior visibility into merchant history and end-to-end transaction information, Alibaba provides detailed and timely information for HSBC to perform credit reviews. Through this type of partnership, banks can better manage risk exposure in the financial supply chain, and Alibaba can help creditworthy merchants access loans to support their operations, which also helps Alibaba support its business. growth. It is a win-win solution.
2) Go further in the supply chain
It is vital that lenders gain visibility not only on a buyer’s direct supplier, but also on their indirect suppliers. The advancement of technology allows this.
For example, the Chinese fintech start-up JDH leveraged mobile and blockchain technology to enable lenders to finance tiered vendors in various complex electronics manufacturing supply chains based on buyer’s creditworthiness. This approach mitigates potential supply disruptions caused by hidden suppliers further up the global supply chain.
3) Frequent loans with smaller amounts
Increased loan frequency with smaller amounts and shorter time frames can allow supply chain lenders to reduce risk while better serving supply chain partners with just-in-time loans.
Leveraging artificial intelligence, fintech lenders such as Financial ant (formerly Alipay, affiliated with Alibaba) and cabbage (a US-based online financial technology company) can overcome this challenge by approving business loans in minutes.
Additionally, technologies such as IoT and smart contracts can help better link loan amount and timing to physical supply chain transactions. For example, the release of funds in purchase order financing can be directly related to the amount of raw materials purchased.
Fuel or forest fire?
The financial supply chain powers supply chain operations and global commerce. As we overcome the current disruptions caused by Covid-19, we can better manage risks in the financial supply chain by leveraging information technology to make data-driven lending decisions driven by insight in real-time and reliable data on physical transactions within the supply chain.
In doing so, supply chain finance can continue to fuel global trade without risking turning into a devastating wildfire.