Can FinTech help Banks Develop Mid Market Supply Chain Finance Solutions

I’ve had a number of reactions from bankers to my piece Moving Downstream – Supply Chain Finance Opportunities with the Middle Market. The middle market in the USA is very large. A recent study by HSBC found that in the U.S., middle market companies (defined as having annual sales between $50 million to $500 million) number 55,700representing the largest number of any country in the world including China

According to the report, in terms of industry, more than one-third of the American middle market segment are in the wholesale and retail sectors, followed by business services (legal, accounting, engineering and design) with 14,100, and manufacturing with 7,500.

What the Bankers Say

When banks look at enabling supply chain finance in this segment (or say even bigger, companies $1bn or $2bn in size), they typically fall back on the unsecured credit model of the large corporate programs. And they mention a number of major barriers to enabling programs here.

First, the absolute revenue relative to fixed costs to roll out a program does not merit investment. One banker told me it costs as much to setup a program for a Fortune 50 name as it does a middle market name (sales process, implementation efforts, legal negotiation of docs, etc.) even excluding the supplier onboarding.

Another banker told me the biggest hurdle that all banks continue to face in these types of financing arrangements is KYC.  Banks would love to further finance the mid-market suppliers of their customers and their further downstream suppliers, but need to perform the KYC/Due Diligence in all affected parties. He went on to say what is needed is a common enforceable KYC framework that can exist globally (ie MasterCard, Visa, ACH) with transferable KYC standards across banks/FIs.

The third issue is integration, which relates to fixed cost. Banks spend a considerable time integrating into their large customers and their customized install of very complex ERP systems (by far mostly SAP and Oracle). Doing this for mid market companies would be uneconomic (even though their ERP systems are generally not as customized).

Why this thinking needs to change for the Mid Market

I believe each silo within the bank will have their perspective on why this won’t work. Trade finance folks will certainly point to KYC and costs, and commercial lenders will look at cannibalization of their existing business (why do that if KPIs and incentives don’t change).

So we are left with the specialty finance players to attempt to put innovative structures in place, combining their underwriting and access to balance sheet with partners who can provide the data science, algorithms, servicing, marketing, etc. to create economically viable solutions.

Think about that middle market furniture retailer that is dealing with 20 suppliers who must factor their receivables.  There are opportunities here to help these suppliers reduce their factoring costs.  Or think about that vitamin manufacturer that must buy key ingredients from much larger suppliers like Chevron and Cargill and pay them quickly and may need term extension in order to make their pills and capsules to sell globally. There are opportunities here not only with deferred payment, but potentially early pay of suppliers to capture discounts and perhaps even help with customer receivables. Or the OEM middle market technology company that has resellers and a customer network where resellers need to be financed because large customers don’t pay resellers quickly. Again opportunities.

But these are not opportunities for banks and their trade finance departments, or banks and their Treasury solutions group or ABL lenders. There is too much effort, cannibalization, risk, etc. to leverage their customer relationships. In fact, one regional banker flat out told me there is no customer demand. Sure, middle market companies don’t need working capital, no that’s not the problem, the problem is you don’t have a solution that ties in the incentives and right partners to make it work.  Your conclusion is no demand.

The other hurdle banks need to get over is this control of collateral issue. Look, I get the credit policy – No Collateral, No Lending.  That’s an easy way out for Credit Risk departments – just say NO!. Times have changed.  Just saying No never worked for Nancy Reagan, and it doesn’t fit the new age.  Banks can be curators of marketplaces for apps that combined with the right partners can create these solutions.

The banks have the relationships, but will they act?

Global Business Intelligence is conducting market intelligence here to discover how are financial service providers and specialty lenders creating middle market supply chain finance.  What’s working?  What’s not?

For those interested in the current research, contact me at dgustin@tradefinancingmatters.com

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