Financial Supply Chain

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Economic Clouds Bring Out the Sun for Supply Chain Finance in Latin America While SCF has been widely adopted in Mexico and, to a lesser extent, in Brazil, it has struggled to gain momentum in other major countries in the region. Changing economic conditions across Latin America could be poised to give SCF a boost.

Economic Clouds Bring Out the Sun for Supply Chain Finance in Latin America

by Ana Kube, Managing Director, Regional Trade and Product Management Executive, Global Treasury Solutions - Latin America and the Caribbean, Bank of America Merrill Lynch

Supply chain finance (SCF) in Latin America could be about to experience a new dawn. While SCF has been widely adopted in Mexico, largely because of the close integration of its economy with the US, and, to a lesser extent, in Brazil, it has struggled to gain momentum in other major countries in the region, such as Chile, Colombia and Peru [1]. Now, changing economic conditions across Latin America could be poised to give SCF a boost.

According to the World Bank, growth in Latin America and the Caribbean slowed markedly to 0.8% in 2014 – a third of the level enjoyed in 2013 and the slowest in over 13 years, with the exception of 2009 [2]. While there are significant differences in the prospects of individual countries, domestic problems, reinforced by falling global commodity prices and the slowing Chinese economy (which is a major buyer of Latin American exports), are hampering the prospects of some of the largest economies in the region.

Weaker conditions in major Latin American economies could create challenges for domestic banks in the region, with consequent effects on the price and availability of finance. In some instances, it could also lower the credit quality of suppliers across Latin America, further exacerbating the challenges they face in securing cost effective finance. All of these developments should spur enthusiasm among suppliers in the region to take part in targeted SCF programmes whereas previously they might have balked at a programme they didn’t always perceive as being to their advantage.

Roadblocks to SCF

Within Latin America, it is important to differentiate cross-border SCF from other supply chain focused financing solutions, such as factoring and invoice discounting. While the latter have been enormously successful, true cross-border SCF has struggled in many countries in the region since international banks began to introduce it in the 2000s. The slow adoption of SCF in many Latin American countries in the past can be attributed to a number of factors.

Firstly, outside Mexico and Brazil, the vast majority of Latin American companies are modest in size, and in SCF size does matter. Of interest is the fact that some of the largest companies in the world are the ones who have most aggressively adopted SCF due to the significant cash flow improvements their sheer size can generate, reportedly up to $1bn in some cases.[3] The more modest the company size the smaller the cash flow improvements and many either don’t have the scale necessary to initiate SCF programmes or the knowledge, experience and ambition that encourages Mexican and Brazilian corporates to emulate US and Europe multinationals. From a supply chain perspective, Mexico also clearly benefits from both its proximity and integration into much of US manufacturing and its consequent integration into US supply chains as SCF necessarily mirrors existing relationships. Other regional economies do not have similar levels of integration with more developed markets.

Secondly, the diversity of Latin America in terms of regulations and markets has discouraged many international banks, which most often implement cross-border SCF solutions, from marketing the solution widely outside Mexico and Brazil. Different legal environments and financial systems mean that banks have to tailor the mechanics of SCF to each country. Given potentially more limited business prospects in many Latin America markets, the region as a whole is less of a priority for international banks than Europe, the US, or parts of Asia.

Thirdly, and perhaps most importantly, the disparity in credit quality – with buyers having superior credit quality (and, therefore, the ability to borrow more cheaply than suppliers) – that ordinarily drives the adoption of buyer-driven SCF seldom exists in Latin America. Traditionally, SCF uses the superior credit quality of buyers to enable suppliers to get paid sooner than usual by financing their receivables below their usual borrowing cost via arrangements with the buyers’ bank. In return, buyers increase their payment terms allowing them to extend their days payable outstanding. In Latin America, the disparity in credit ratings between buyer and supplier is rarely marked and, therefore, the potential savings in terms of financing costs is more limited.

Lastly, the macro-economic outlook of the region can hamper growth of SCF as banks tighten up on lending, especially to smaller firms. And without bank lending to step into the gap created by longer terms, the programmes struggle to be as successful as anticipated.

Notes

[1] All products and services may not be available in all jurisdictions and are subject to change without notice.
[2] ‘Global Economic Prospects’, World Bank, January 2015
[3] New York Times, April 6, 2015

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