Low interest rates cause difficulties for supply chain finance

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In this article CloudTrade CEO David Cocks, who helped establish one of the first global supply chain finance companies, expresses some concern regarding the current situation in supply chain finance with low interest rates challenging the business model of some supply chain finance service providers.

CloudTrade is a natural part of the supply chain finance world, but we see supply chain finance companies struggling to make their business work.

CloudTrade provides document data with 100% accuracy, quickly and automatically, so that if invoices are going to be discounted and paid early, then they can be paid early at the first possible moment. There is no delay between the invoices being issued by the supplier and them being delivered to the buyer thanks to the automation provided by CloudTrade’s data-capture system.


Payment terms not as they should be

Suppliers have for a long period of time looked at ways of getting their money earlier than the buyers were prepared to release it, be that by means of factoring, invoice discounting, or supply chain finance.

Modern businesses seem to have forgotten the purpose of commercial payment terms. Commercial payment terms were originally there for the receiving party to verify that goods had been delivered successfully before they were paid for.

Commercial payment terms were never meant to be an arrangement enabling buyers to hang on to cash for extended periods, so starving their supply chain. Nonetheless, that is where we are today and unfortunately that has become embedded into standard business practices.

Extending payment terms currently, in the present era of very low interest rates, is an odd thing to do, in that buyers are hanging on to cash, not earning any interest on it, and meanwhile their suppliers are left waiting for payment.


Current problems associated with supply chain finance

Today there are many computer-aided supply chain finance tools. There are however various problems associated with supply chain finance. These problems are the reason why supply chain finance services continue to underwhelm.

Three of the big problems are as follows:

  1. Firstly, interest rates are very, very low and so supply chain finance as a way of funding your invoices can often look very expensive for a supplier. Cost of funds are typically only 1- 2% APR, but supply chain finance companies are adding high overheads often resulting in supply chain finance costing more than 10% APR. That’s very expensive in this day and age.

  2. The second problem is that there is an awful lot of money around at the moment, and banks are very keen to lend to businesses. A business that has a reasonable track record can usually borrow money, so supply chain finance is tending to be used more and more by businesses that have serious financial issues. And that high risk is therefore making the supply chain finance riskier for the lenders. This results in the lenders having to increase interest rates even further, creating a vicious circle where the high risk is driving up interest rates on an already expensive service. So it comes as no surprise that our ex-PM, David Cameron, was trying under the guise of recovery from Covid to get the UK government to give credit guarantees to Greensill so that Greensill could offer competitive supply chain finance to SMEs. Never mind that Greensill was already on the rocks.

  3. The third problem is that a service provider of supply chain finance has a relatively low-margin business. The pressure on the interest rates, outlined above, plus the fact that the sort of suppliers who are short of cash tend to be the smaller suppliers, means you need an awful lot of people opting for supply chain finance to make a supply chain finance business viable. And each of these suppliers needs a complex service contract, increasing cost of service adoption.

In this way, you end up with this worst of all worlds:

  • Supply chain finance businesses have to charge an interest rate that is too high.
  • Supply chain finance businesses only attract high-risk companies to use their service, and the cost of bringing them on to the service is high.
  • These high-risk companies tend to be quite small, so the supply chain finance business needs a very large number of them to be viable.

These three factors are slowing down supply chain finance business and causing a big headache. This may change if borrowing for suppliers becomes more difficult or when base interest rates rise, making supply chain finance more competitive against alternative funding methods.


David Cocks in supply chain finance

In 2001 David Cocks, as CTO, helped establish Orbian, a joint venture between Citibank and SAP. This was one of the very first global supply chain finance companies.