There is no question that the principles of supply chain finance (SCF) are strong and that the correspondent benefits are considerable. The perspective to get financed on the basis of the client’s creditworthiness should line up multitudes of roaring companies demanding for such an attractive—and apparently low cost—facility. Yet, reality shows that SCF programs are evolving very slowly and are far from widespread adoption. Financial institutions have invested significant resources in money, time, and staff to develop and market SCF programs but have so far obtained relatively small returns compared to the initial expectations. Non-finance companies represent a growing SCF alternative to banks but their firepower is a small fraction of what financial institutions may put in place.

An initial overview of the market and of its players suggests likely valid reasons for such a slow uptake:

• The level of information among companies about SCF is still low
• Banks are reluctant to change “old-fashioned” credit-checking, risk and collateral management processes and adapt them to the new offerings
• Companies have already financing lines in place and do not want to change
• Some large multinationals are already running self-made SCF programs
• Companies do not line up finance specialists in SCF program teams
• Accounting and auditing issues may advise against the introduction of SCF programs
• Company internal disconnects between treasury and procurement functions represent a serious concern

These facts are however too general to detect what justifies the lack of SCF growth. I thought there was a need for deeper investigation and analysis. To simplify the work—and yet achieve significantly still valid results—I decided to focus my observations on reverse factoring (a.k.a., approved payables finance). This instrument represents one of the most significant SCF solutions offered today. It would not be too distant from reality to consider reverse factoring the preeminent SCF instrument. The fact that some banks call “supply chain finance” their reverse factoring product shows how much this financial instrument has grabbed the attention of the market and represents indeed the epitome of supply chain finance.

I have come to the conclusion that there is a sequence of facts that may explain why reverse factoring (hence, supply chain finance) programs grow so slow:

• A large buyer approaches its bank asking to set up a reverse factoring program for a number of suppliers. The foundation of reverse factoring is that suppliers get financed by the bank on the basis of the creditworthiness of the buyer
• The bank receives a mandate to approach the suppliers
• Normally these suppliers are based in fast-growing or emerging foreign countries (see later the comment regarding domestic suppliers)
• The bank is supposed to finance these companies, so has the need to properly review them under the lens of a full KYC procedure
• Current regulatory pressures demand very strict KYC controls and thorough assessments of each company profile
• Since the companies to control are based abroad, the bank must have a physical presence in each of the suppliers’ countries to execute the KYC mandate. Even with a physical presence onsite it will not always be feasible to conduct a compliant KYC control due to lack of primary information from the company. Not all countries have the same levels of control and not all companies are provided with the proper systems to collect and store KYC required data
• The bank may have a correspondent bank partner in the country, in which case the profiling of the supplier company can be somehow facilitated
• It is however highly unlikely that the KYC norms allow for a “on-behalf-of” KYC check
• The bank of the buyer company, at this stage, may decide to opt out from the reverse factoring program because the lack of KYC information risks to compromise its compliance to regulatory requirements
• The practical impossibility to perform supplier on-boarding compliant with stringent KYC regulations prevents banks from running SCF programs
• The cause of slow SCF programs resides in the lack of adequate information that allows a financial institution to comply with regulatory mandates
• In case of domestic supplier companies the KYC issue is resolved. However, in such case there are already established SCF offerings that go under the name of “factoring”. Factoring is offered by specialized companies and by banks; both are enjoying very profitable results from these business lines
• Banks are therefore unwilling to touch their factoring business units
• Domestic companies are also normally familiar with factoring as a source of receivables finance. In fact factoring business is growing at incredible high pace globally. Although companies lament the high costs of the factoring service they are hardly aware of alternative solutions. On their side, banks have no real interest to distract the companies’ attention away from traditional factoring in favor of nascent reverse factoring. Why merge the bank’s lucrative factoring business—and loose revenue—into a (almost still unknown) SCF line of business?

Conclusion

Slow adoption of SCF programs does not depend on lack of demand from companies. The steering wheel is squarely in the hands of banks (could it be otherwise?) that are either unable to comply with KYC controls or unwilling to cannibalize the very profitable income of their factoring business units.

If banks are (really) interested to solve at least the KYC conundrum, they should work to a solution similar to the European Economic Area (EEA) “Passporting”(*). With Passporting, a document, having been approved by one EEA competent authority (Home Authority), can be used as a “passport” for offers or listings in all other EEA countries, without further review or the imposition of further disclosure requirements by the relevant authority of that EEA country (Host Authority). Similarly, banks could work on a “KYC Passporting” model.

As per the factoring business, nothing prevents banks from putting their factoring business under the wider Supply Chain Finance “umbrella”. If they choose not to, then banks will remain in the eyes of their corporate clients as product-centric dinosaurs despite all the efforts and attempts from banks marketing to declare their dedication to a client- and solution-centric “cause”.

(*) Read http://www.nortonrose.com/knowledge/publications/30873/european-passporting)