Supply Chain Finance for SMEs – The Hidden Opportunity
Supply Chain Finance – as a financing option for SMEs – is ripe for digital disruption.
Small and medium-sized enterprises (SMEs) – companies with fewer than 250 employees and annual turnover of less than £25m – are becoming ever more prevalent within global supply chains. Owing in part to increases in globalisation, digitalisation and consumer demand for bespoke products and services, SMEs are at the forefront of the global trade landscape.
As such, financial service providers should consider the increased prominence of SMEs in global supply chains and the effect this has on demand for trade finance products. According to Worldbank research, over 50% of SMEs globally lack access to credit, with the total credit gap for SMEs as high as US $2.6 trillion. With SMEs often struggling to obtain finance through traditional means, such as loans due to weak credit ratings, Supply Chain Finance (SCF) is a viable financing alternative.
In practice, SCF involves a supplier selling its invoices to a financial services provider (usually a bank) at a discount, with the bank assured of payment from the buyer on a later date. For SME suppliers, therefore, it enables them to leverage the better credit rating of their corporate buyers to free up working capital.
One may think that the largest global banks are best placed to profit most from the surge in demand for Supply Chain Finance. However, they appear to be struggling to fully capitalise on this demand, due to two key factors:
- Increased regulation is making it costlier for the larger banks to do business with SMEs with the result that SMEs are often deprioritised
- A lack of digital agility amongst the bigger banks is enabling third-party challengers to erode market share and offer better SCF products and services
There can be no doubt that increased regulation and the ensuing operational cost is making it ever harder for the larger banks to onboard new SME clients. Yet it would be a mistake to deprioritise focus on this customer segment. According to Accenture research, globally, SMEs could open up £8.5 billion in new transaction banking revenue by 2020. SCF could not only represent a key constituent of this revenue, but the starting block of closer relationships between a bank and SMEs. After all, traditional trade finance products may not be available to SMEs with weaker credit ratings and SCF may be the only viable initial trade finance product. Given the traditionally “sticky” nature of transaction banking, focusing on SMEs and SCF may reap huge rewards later for a bank, with the potential for cross-selling and divergence into the realms of cash management and payment services.
The risk is that the larger banks, by failing to appreciate the significance and opportunities presented by SMEs, leave the door open to third party service providers. New FinTechs, such as Invoice Bazaar based in the United Arab Emirates, have already begun to offer alternative, easy-to-use SCF digital solutions to connect SMEs, larger corporations and intermediary finance providers. The result is a growing disintermediation, with SMEs now re-evaluating their need to go to the larger banks for SCF options. This begs the question: how should the incumbent banks respond?
Firstly, they should not panic. Brand and reputation is well valued by SMEs, 63% of whom are ready for deeper engagement with their existing banks rather than necessarily considering FinTech alternatives. Moreover, whilst certain regulation complicates engagement with SMEs, for example Know Your Customer requirements, other regulation, such as PSD2 and Open Banking, could help the larger banks become more digitally agile. This in turn could allow them to better meet SME demand for enhanced digital experiences and bespoke product offerings.
Historically, the incumbent banks have often been limited to offering vanilla SCF products to SMEs, limited by legacy technological infrastructure and an inability to scale effectively. Yet Open Banking will change this, with banks able to define their partnership models with FinTech companies and make use of the latter’s bespoke e-platforms and infrastructure.
To meet the growing SCF demands of SMEs who value the brand of an established bank but crave enhanced digital solutions, the incumbent banks should look towards strategic third-party partnership models as the solution. Santander UK’s partnership with Funding Circle in 2014, a peer-to-peer lending company, has already proved highly popular with SMEs looking to enhance their working capital. As testimony to its success, RBS formed a similar partnership with the company two years later.
Supply Chain Finance, as a finance alternative to peer-to-peer lending for SMEs, is similarly ripe for disruption. The incumbent banks that recognise this, partnering with the likes of Invoice Bazaar, will be those who dominate the trade finance landscape in the years to come. Given that SMEs now account for over 95% of firms in the world it’s clear that this should be a strategic priority for the largest global banks.