‘I’ll have my bond; speak not against my bond.’
Shylock, The Merchant of Venice
For any organisation trying to provide a small business lending facility, receivables finance makes perfect sense. In the current climate, turning an unpaid invoice into a collateralised asset in return for a fee is a far lower risk to the lender than a traditional loan. Previously known as factoring – and once considered to be the ‘loan of last resort’ – receivables finance is making something of a comeback.
The old maxim that ‘cash is king’ rings true today more so than ever. The debtor and creditor situation is a crucial operational element of any business in the current environment – especially for small firms. The banks have been told by the politicians that they must provide a stimulus to business recovery and supplying small firms with lending facilities is a vital component of that strategy.
Unfortunately, the banks themselves are in a similarly precarious position. BASEL III (which effectively triples the size of the capital reserves that the world’s banks must hold against losses) and the Voicker rule (which prohibits proprietary trading at commercial banks in the US) both increase the pressure on banks to get their own house in order at the same time as they are being asked to back small business: therein lies the conflict. In the current context, therefore, where the banks do not have the reserves to provide traditional lending facilities, receivables finance is one solution.
The shift away from overdrafts
The major banks are all looking to move away from granting overdraft facilities to small businesses. There are two reasons for this. First, asset values are all depreciating. For example, property values are falling, so securitising on a tangible business asset such as premises is becoming less attractive. Second, when a bank lends it has to provide capital to support that loan and tying up capital is not an attractive option for a bank.
With receivables finance, however, the asset against which a bank is lending is an invoice. An invoice is a hard asset: usually people pay their invoices. Therefore banks are in a position to use the invoice as an asset against which to provide working capital, rather than an overdraft.
The typical cut for the factoring company is about 15-20 percent. Yes, the small business has a percentage fee to bear, but the opportunity cost of that £20 fee – thus receiving £80 from a £100 invoice – is outweighed if the £20 is used to sustain the business. The ‘Keynesian multiplier’ effect of that firm being able to pay off its creditors or buy more stock also benefits the wider economy.
Therefore from the government, bank and small business perspectives, if a firm cannot obtain a loan from a bank to keep the business running, receivables finance should be considered.
A growing, global market
According to the latest statistics from the receivables finance industry, sales in 2010 reached a new record with a 25 percent increase globally. The worldwide figures, released in April 2011 by Factors Chain International (FCI), the leading industry body, point to significant growth in open account trade within and from China as well as in Asia generally. For example, the receivables finance industry in China, which barely existed in 2001, is now of equivalent size to that of France.
The UK market was worth EUR 226, 243 million in 2010, after a third consecutive year of growth.
The technology challenge
While the banks are grappling with the new business opportunity of turning capital intensive overdrafts into receivables finance accounts, their ability to execute has been severely constrained by IT support. Many banks built their factoring platforms twenty years ago, during the last big boom period for the growth of receivables finance. Both these legacy platforms and those of third party vendors, built around the same time, aimed at processing invoices in the back-office with no thought for customer experience, credit risk or fraud detection. Most were ‘high feel and touch’ platforms with significant manual processes to manage risk and fraud.
From a technological perspective, the challenge for the receivables finance provider is to deliver the right information at the right time. Process management and workflow play a fundamental role. It’s a retail-style environment, dealing with numerous invoices arriving from a multitude of business enterprises. Rather like on-boarding a retail banking client, extensive checks need to be built into the IT infrastructure to process credit histories when the relationship begins, in order for the bank to avoid default problems.
After that, the day-to-day issues for the provider’s back office platform to deal with are numerous. For example, the product being sold by the client may be inferior and therefore cause bad debts. Then the back office platform has to deal with the process of debt collection and the constant valuation of the exposures on the books. The task of risk management, record keeping and tracking is immense. The platform has to be able to collect static data about the organization it is collecting on behalf and, because the fees paid are ‘stepped’ according to the size of invoice, determine the transactional cost for the client.
All this has to happen at lightning speed, if it is to work at all. The client on-boarding process from application to decision has to be rapid, otherwise the client may go under. And once the client is on the provider’s books, the collateralisation of a new invoice must be almost instantaneous. It’s a high volume, high-speed industry requiring a demanding straight through processing IT capability. Scalability, speed and reliability are the watchwords.
A cultural change in British industry
Receivables finance addresses an issue at the very heart of the UK banking industry. It requires a cultural change, altering the manner with which small businesses manage cash flow in the future. Politically, the banks are being told to lend, but they won’t because overdrafts and loans carry are a higher exposure. Therefore they have to find another method of fulfilling their obligations to the Government. As a consequence, receivables finance provides an immense opportunity for all the UK’s national banks. And whilst it carries a bittersweet taste for many small business owners – hence the name change away from factoring – receivables finance can assist banks in their strategic move away from business overdrafts.
For banks to succeed in the new environment for receivables finance, platforms must provide straight through processing, integrated credit risk management and fraud management. They must also deliver easy to operate secure Internet and mobile-based receivable finance facilities that provide the same ‘ease of access’ to funds as Internet-based current accounts do today.
Then the banks really will have their pound of flesh.
Guest blogger: Ian Hallam, CEO, 3i Infotech Western Europe