Future of Fintech-Led Supply Chain Finance in India for Corporates & Investors

India’s Micro Small & Medium Enterprises (MSME) sector forms the country’s backbone by contributing nearly 30% to India’s GDP. Despite being a bellwether, the MSME sector continues to remain highly vulnerable to a cash flow crunch. Cash-reliant MSMEs were just beginning to get back on their feet after the disruption caused by the demonetisation and GST reforms when the pandemic hit and almost pushed them to the brink of bankruptcy. The Government’s Emergency Credit Line Guarantee Scheme launched to help distressed MSMEs take collateral-free loans from banks prevented Rs. 1.8 lakh crore of outstanding credit slipping into NPAs. And while the MSME industry representatives continue to push the Government for better reforms in the Credit Guarantee Scheme, these schemes, while helpful, aren’t a sustainable solution to the country’s Rs 6.3 crore and growing MSMEs cash flow woes.

Hence, corporates and small businesses have an urgent need to consider alternate sources of securing funds to ensure they have sufficient cash flow and working capital to continue day-to-day operations. 

Why do MSMEs need supply chain finance?

Let’s dive into the world of a small business to understand the core need of supply chain finance. Imagine that you are a textile manufacturer that provides textiles to a leading apparel chain that styles the cloth and sells it through its branded stores to end consumers.

You receive a large order from the apparel chain that will take up 60-70% of your manufacturing capacity. The apparel company agrees to make a payment only 60 days after delivery and invoice goods. So assuming that your manufacturing takes 60 days, there is a gap of 120 days or nearly four months between execution and payment. This creates the classic problem of receiving a large one-time payment. On the other hand, having to pay recurring costs of raw material, manufacturing overheads, staff and logistics costs on a monthly or fortnightly basis. The gap of 4 months here is the best-case scenario in this situation, not accounting for the poor payment culture widespread in India. It is quite likely that the apparel company may default on their payment or request to extend the payment period. They may also increase the order and request clearing all dues at the end of the project- the possibilities are endless. 

This story is not unique or unheard of. Small businesses face this cash flow crunch day in and day out and often have limited access to the formal credit sector and seek refuge with high-cost third-party lenders. 

Banks and financial institutions may not readily give credit to such businesses. A significant percentage of cash transactions, unaudited financial data and small volumes lead banks to ask for hefty collateral; however, a limited asset base leaves a large percentage of MSMEs outside the ambit of traditional bank loans. Further, the rising NPA numbers have left banks wary of undertaking risky transactions in the last few years. Alas, banks and financial institutions are practically shut doors when it comes to such businesses seeking short-term credit. 

And that is precisely the gap that supply chain finance (SCF) aims to fill.

What is supply chain finance?

Supply chain finance is an umbrella term for numerous working capital financing options. A Mckinsey report classifies domestic supply chain finance into two categories – seller-side and buyer-side finance.

• Seller Side Finance

In simple terms, in seller-side finance, the seller provides all information linked to outstanding accounts receivable and borrows cash against it. As against traditional term loans, seller side finance treats invoices not as collateral, but essentially as a commodity sold by MSMEs to financiers at a discount. Also known as invoice finance, this addresses the issue of liquidity arising from long payment cycles.

• Buyer Side Finance

Buyer-side finance covers the financing needs of suppliers originated by large buyers, such as a large automobile OEM helping its auto-parts suppliers access to finance, for example. This could be structured as reverse factoring, where suppliers can access third-party financing for buyer-approved invoices, as well as dynamic discounting, where buyers (typically large corporates) pay suppliers early in exchange for discounts on the invoice. 

Reading the above explanation of supply chain finance makes it abundantly clear that supply chain financing isn’t a new form of working capital management. Yet why haven’t banks or the RBI pushed this form of financing?

Banks have their own supply chain finance programs; however, they typically cater to only the first leg of the distribution supply chain: manufacturers and large distributors. The smaller distributors and retailers are geographically scattered and have smaller volumes in the lower part of the chain. They are often out of the ambit of these programs due to the bank’s limited risk appetite. 

Tech-enabled platforms like CredAvenue fill this gap by aggregating enough volume to make it profitable to lend to them.

But, how have tech-enabled platforms contributed to building depth in supply chain finance?

This has a two-part answer. 

Many of the drivers of supply chain finance growth are longstanding; while the ongoing changes signal a structural shift in the ecosystem. Platforms like CredAvenue have jumped at the opportunity and capitalised on these changes to act as an enabler for businesses. 

Typically the challenge of access to formal credit for micro, small and medium enterprises (MSMEs) arises due to a lack of reliable financial information being one of the main reasons. However, the Government’s mandate for small businesses to issue e-invoices under the GST laws has become a significant enabler for the digitisation of supply chain financing. Significant indicators about these enterprises’ financial health can now be obtained through monthly returns, electronic invoices, and e-way bills. 

e-Invoices provide financiers and investors with an additional layer of trust and authenticity for identifying and funding genuine trade transactions. At the same time, GST data indicates upcoming defaults by monitoring the borrower’s business on a near-real-time basis.

Further, enablers like the increased adoption of digitisation led by cheap access to the internet and innovations such as VideoKYC and TReDS (Trade Receivables Discounting System), an electronic platform for facilitating financing/discounting of trade receivables, has increased the adoption of these technology-led solutions for businesses.

CredAvenue’s marketplace seamlessly brings together the largest network of lenders covering the requirements of corporates of all sizes and across sectors and the rating spectrum. Using validated invoices historical business transactions of borrowers with corporate anchor partners, CredAvenue matches lenders’ supply chain finance solutions with businesses’ specific needs. These proprietary risk scoring and matching algorithms help companies spend less time in finding the appropriate solutions and instantly unlocking capital for growth. Digitisation resolves issues arising from fragmentation, and supply chain finance is accessible to vendors in Tier 1 and Tier 2 cities.

Further, the NPA issue that negatively affects the financial sector’s credit appetite is mitigated largely by supply chain finance, because it is tied to invoices payable within a definite period of time.

The fact that supply chain finance is typically an anchor led model with specific end-use of funds against a transactional document mitigates the risk to a large extent.

McKinsey estimates that buyer-led supply chain finance is now the fastest-growing segment of the US$7 trillion trade finance market and is expected to post 20-24% growth in the five years to 2024.

What does growth in SCF mean for buyers and sellers?

Ease of access to supply chain finance ensures that MSMEs (typical suppliers to large corporates) get immediate access to a fair amount of cash but a recurring monthly payment commitment which is easier to manage. MSMEs can consistently fulfil their orders and consequently start the virtuous cycle of more orders from corporates as their trust in their ability to deliver without disruption increases. Supply chain finance also helps small and medium enterprises provide easier access to the formal credit sector as they can now access a higher volume of bank credit and perhaps lower rates on the back of their large volume transactions.

An uninterrupted supply chain, especially when the world is still reeling from the after-effects of the pandemic, can become a competitive advantage for corporations. Large companies can avoid disruption in their workflow by ensuring vendors are well-financed and their working capital requirements are addressed promptly. Early payment terms may also help them improve their margins through purchase discounts.

According to an internal analysis performed by the International Finance Corporation (IFC) in 2020, the cumulative volumes for the TReDS platforms were upward of Rs 2000 crores per annum. Seeing a massive upsurge, the monthly run rate crossed Rs 1000 crore in August 2021. These numbers prove the increased depth and adoption of supply chain finance.

Supply chain finance is an emerging frontier for investors (lenders) and anchor corporations. It can guarantee survival for small businesses in these ever-changing markets and accelerate their growth by outpacing their peers. Access to real-time risk analysis and reports on stress tests, default analysis, dynamic delinquency through digital platforms significantly mitigates the traditional risks associated with SCF.