BUYER-LED SUPPLY CHAIN FINANCE: UNLOCKING VALUE THROUGH FINANCIAL INNOVATION

In a buyer-led financing program, the lender will establish a supply chain financing program for the suppliers of a buyer, based on the credit appraisal of such a buyer. This financial innovation takes advantage of the higher credit ratings of the buyers, who are generally large corporations. As a result, the suppliers, which are usually MSMEs, have access to cheaper credit while also taking advantage of the benefits associated with an SCF Platform.

The disruptions caused in the global supply chain networks in the aftermath of the Covid-19 pandemic have brought to the fore the importance of maintaining strong and resilient supply chain networks. While the world continues to reel and recover in the aftermath of the COVID-19 pandemic, it remains important to allow the supply chain networks easy access to capital. This will play a key role in building stronger supply chain networks that can not only recover from the current disruptions but also build resilient infrastructure that can withstand further disruptions going forward.

While globally, supply chain financing systems have gained prominence, in India, these systems are yet to gain widespread traction, especially among the micro, medium and small enterprises (MSMEs). While traditional banking solutions are available to MSMEs, access to capital through such means has remained cost prohibitive. In June 2019, a report by the Reserve Bank of India's Expert Committee on MSMEs (RBI MSME Report), established that the credit gap in the MSME sector is about INR 25 trillion¹.

This article aims to explore how innovations in supply chain financing can enhance the flow of capital and reduce the credit gap in the MSME sector, which holds the key to India's growth story.

Traditional Supply Chain Finance

Supply chain financing is a cash flow-based lending program which is a shift from the traditional balance-sheet-based financing. The RBI MSME Report highlighted the importance of cash flow-based lending in easing the credit gap that afflicts the MSME Sector². In a typical supply chain, once the supplier fulfils an order and raises an invoice, the buyer has a period ranging from 30 - 90 days to clear the invoice. This leads to locking of capital for the supplier for such a duration. Supply chain financing aims to free up capital available to the suppliers.

In a traditional supply chain financing, as illustrated below, the supplier reaches out to the financial institution and establishes a financing program for itself. However, given the difficulty MSMEs generally face in accessing credit, such access to financial institutions is often difficult and cost prohibitive for MSMEs.

Technology Driven Supply Chain Financial Solutions

Innovations in the fintech sector have enabled buyers, suppliers, and financial institutions to onboard a single platform which provides multiple benefits such as easy access to credit, improved document submission for creditworthiness evaluation, reduction in timelines, improved efficiency, and overall reduction in costs. A typical tech-driven supply chain financing solution is illustrated below.

Step 1: Buyer issues purchase order to seller

Step 2: Supplier fulfils order and issues invoice to buyer

Step 3: Supplier uploads invoice on the supply chain finance platform

Step 4: Lender picks the invoice to be financed

Step 5: Buyer confirms the invoice on the supply chain finance platform

Step 6: Lender disburses funds to supplier

Step 7: Buyer pays invoice amount to lender on the due date

On boarding multiple suppliers, buyers, and lenders on the technology-based supply chain finance platform (SCF Platform) allows cheaper access to credit due to competitive pricing. Furthermore, such SCF Platforms can be set up either in (i) a supplier led model or (ii) a buyer-led model.

Supplier-Led Financing Program

In a supplier-led financing program, the lender will undertake a credit appraisal of the supplier and establish a supply chain financing program which is priced in accordance with the creditworthiness of the supplier. However, despite the benefits associated with an SCF Platform, the suppliers, which are usually MSMEs, will continue to face entry barriers due to higher cost of credit in a supplier-led model.

Buyer-Led Financing Program

In a buyer-led financing program, the lender will establish a supply chain financing program for the suppliers of a buyer, based on the credit appraisal of such a buyer. This financial innovation takes advantage of the higher credit ratings of the buyers, who are generally large corporations. As a result, the suppliers, which are usually MSMEs, have access to cheaper credit while also taking advantage of the benefits associated with an SCF Platform.

Setting Up a Buyer-led Supply Chain Financing Program

To set up a buyer-led supply chain financing program, the following steps and documentation are to be noted:

• The lender, supplier and the buyer are on boarded on an SCF Platform.

• The broader terms of the facility are agreed under a term sheet issued to the buyer and a sanction letter issued to the supplier separately.

• The lender and the buyer enter into a facility agreement (Buyers Facility Agreement) setting out the terms and conditions of the supply chain financing facility such as, inter alia, interest rates, processing charges, commission rates, tenor, and type of security.

• If the lender wishes to have a recourse to the buyer in the facility, a guarantee may be taken from the buyer under the Buyers Facility Agreement.

• Simultaneously, the lender enters into a facility agreement for a supply chain financing facility with the supplier (Suppliers Facility Agreement), which sets out in detail the various terms and conditions of such a facility and the obligations of the parties.

• Based on the credit appraisal, security may be sought from the supplier to further lower the cost of funding.

• The entire facility is administered and managed on the SCF Platform and the Buyers Facility Agreement, the Suppliers Facility Agreement and other documents may be executed digitally.

The RBI has also encouraged fintech innovations such as the Trade Receivables Discounting System (TReDS) to provide MSMEs with ane-platform for supply chain financing³. Further, fintech innovations such as buyer-led supply chain financing solutions offered through SCF Platforms allow the supply chain networks faster and cheaper access to credit. At the same time, given the key role that MSMEs play in the Indian supply chain infrastructure, these fintech innovations can help accelerate the growth trajectory of MSMEs.

Disclaimer – The views expressed in this article are the personal views of the authors and are purely informative in nature.