How lenders can unlock the opportunity of receivables-based finance

Too many banks and investment managers are missing out on the opportunity presented by working capital and receivables-based finance in the new economy. With many asset classes depressed, and low interest rates shrinking credit margins, diversification is more important than ever for big lenders keen to reverse or limit plunges in profits. And given the criticism that banks faced following the last financial crisis, a failure to be seen supporting the economy this time around – and small businesses in particular – poses a major reputational risk that some may not recover from. Those funders involved in supply chain finance have already enjoyed a big uptick in revenues from the business in recent months, and bank enrolment to digital working capital platforms is on the rise. But why are some still dragging their feet?

Part of the solution, not the problem

The Covid-19 crisis offers banks a rare opportunity to rebuild public trust and prove they are a true friend to business, while failure to support industry with sufficient credit will be remembered long after public health and financial markets have recovered.

Banks have not yet been absolved in popular consciousness for the role they played in the 2008/09 financial crisis or the decade of austerity it ushered in. In the UK, many banks also bear fresher scars from payment protection insurance (PPI) mis-selling and other scandals.

The UK’s Financial Conduct Authority (FCA) issued banks a warning in April, reminding them that they must support small and mid-sized enterprises (SMEs) through the pandemic and avoid repeating their alleged maltreatment of such firms following the financial crisis.

After a slow start, UK banks have largely lived up to that challenge, HMRC figures suggest. By early July, they had lent more than £43 billion to British firms through the 80% government-guaranteed Coronavirus Business Interruption Loan Scheme (CBILS) and the Bounce Back Loan Scheme (BBLS), which is 100% government guaranteed.

While non-performing loan rates from the schemes are indeed expected to be high, for banks with strong balance sheets but poor public trust, the reputational harm of not shouldering that risk could last longer than any damage to their bottom line.

Participating in emergency loan schemes is however only one of the ways that banks can demonstrate their support for business through the pandemic. For many firms – including those whose business remains fundamentally sound – ongoing working capital injections, including in the form of supply chain finance or invoice discounting programmes, may offer more long-term benefit than one-off loans.

The current crisis offers banks a chance to demonstrate their value with innovative products and services, as well as a speed to market that has been lacking in the past. Teaming up with a fintech or challenger brand has become established as one of the fastest, most cost-effective ways for banks to expand their product offering or reach new customers quickly, for example through working capital programmes, but can be achieved in-house with the right tech and marketing expertise.

However banks decide to support corporates, it is vital that they do. In an era when revenue-hit corporates are slashing staff and shrinking their footprints – and suffering corporates and retail customers had already started a migration towards non-bank lenders – the sector cannot afford to take another reputational hit.

Profit boost

The economic downturn ushered in by Covid-19, combined with the lower interest rates now on offer, has also put banks under more pressure than ever to diversify their lending, including venturing into markets they may have shied away from in the past.

Bank of England data show that UK households paid off much more than they borrowed from banks in April, despite falling interest rates making borrowing cheaper and large-scale take-up of payment holidays on mortgages and credit cards. During the month, they repaid £7.4 billion of consumer credit – the highest level since records began and up 100% from March. And although the recent introduction of stamp duty exemptions for the purchase of homes valued at up to £500,000 has helped revive the country’s housing market, mortgage lending looks set to suffer amid rising unemployment.

Within commercial lending, many of the sectors bearing the brunt of the Covid fall-out are also those that banks had targeted aggressively in recent years, such as real estate. Non-performing loans in such industries have surged while new lending opportunities dry up. Almost a quarter of loans backed by US hotels in commercial mortgage-backed securities, for example, were at least 30 days behind on repayments in June, while more than 6% were 60-plus days past due, according to data firm Trepp LLC. So-called delinquency rates for all property types in the month also hit an all-time high.

The woes of HSBC – which on August 3 reported a 65% plunge in pre-tax profits for the first half of the year – in some ways epitomise the wider banking sector’s challenges and its opportunities. The bank blamed a number of factors for its worse-than-expected performance, including lower interest rates and the need to set aside between $8 billion and $13 billion for bad loans, and revealed it had granted more than 700,000 payment holidays – worth more than $27 billion – on mortgages, credit cards and loans.

But while HSBC is now looking to shrink its operations in the Europe and the US, including potentially selling its US retail banking operations, it continues to invest in supply chain finance. It announced at the end of July, for example, a partnership with the Asian Development Bank to provide trade finance loans to Asian firms selling Covid-19 related items such as medical supplies. It also announced last month its first receivables finance transaction in Bangladesh, as well as its first fully digitalised SCF programme in Malaysia.

Working capital finance

Working capital finance certainly presents an opportunity in the current environment for banks to plug gaps in their credit income with relatively low-risk, high-volume and – for the moment at least – higher-margin business.

Supply chain finance has generated consistent revenue growth for funders like banks and investment managers since the 2008 global financial crisis, with worldwide revenues reaching between $50 billion and $75 billion in 2019, according to International Chamber of Commerce estimates.

And in the first quarter of this year, even while Covid-19 and other trade disruptions contributed to a 1% year-on-year contraction in global revenues from trade finance, those from supply chain finance specifically expanded 3% to 4%, with Europe and the US outpacing other regions, according to Coalition. The research firm partly attributes this growth to the lower funding costs and higher margins available from SCF than many other forms of lending.

Receivables-backed financing is of course not without risk, with credit rating agencies cautioning in recent months that because of the way SCF is treated from an accounting perspective – with programmes not counted as regular debt on company balance sheets – it can represent a hidden risk for funders if additional measures are not taken to improve corporate disclosure and transparency.

Still, platforms offering receivables finance point to a huge uptick in demand for working capital as liquidity remains a top priority for company treasurers amid market disruptions and economic uncertainty, while the number of banks and fund managers signing up to offer SCF programmes also continues to grow.

Some funders are also forming bilateral partnerships with industry titans, with Goldman Sachs, for example, announcing in June the formation of a new lending programme with Amazon to support the e-commerce giant’s third-party sellers.

The value of supply chain finance is also demonstrated by the trend for a wide variety of business types now looking to provide it to customers as a part of an integrated offering. UK-based digital freight forwarder Beacon, for example, announced in June plans to offer SCF alongside freight forwarding to help its customers manage their cash flow.

Banks keen to profit from the growth opportunities offered by receivables finance are under pressure however to act fast. Just as they did with banks’ traditional lending business, fintechs, asset managers and other non-banks are rapidly gaining market share in receivables finance and are proving particularly competitive in the SME space.

Window of opportunity

In a world where liquidity is king – but demand for traditional credit is low and the risks associated with it high – banks have a unique window of opportunity to gain a lead in working capital finance. They also have a social responsibility – and a chance to prove they are stepping up to it. How banks support companies through Covid-19 will define their relationship in the years to come. This crisis round, the sector must demonstrate it can be part of the solution, not the problem.