Google ‘value chain finance' and you will find a cornucopia of articles, case studies, and trainings. Much of the material is funded by and targeted to international development agencies with a supply-side perspective. The development-driven approach aims to set up and push goods through the value chain. The practice has merit and it contributes to economic development. Go read those materials for more of that perspective. This article focusses on value chain finance (VCF) from the financial institution (FI), demand-side, angle.
FOLLOW THE MONEY is a basic principle of sustainable VCF. The value chain is monetized from the end. Each customer validates the value chain by purchasing good from the previous link and the end is the final payout. If nobody is willing to buy the goods at the end, the chain is not producing much value. VCF is not alchemy. FIs play the role of providing sustainable finance to economically viable clients within value chains.
The following steps are a proven path for FIs to establish a VCF program:
-
Create a list of 5-7 business sectors that are growing and projected to grow faster than the overall economy. The inverse is to create a blacklist of lagging sectors to avoid. Public information on business sectors is available in most markets.
-
Create risk parameters and targets for the VCF portfolio, including sector concentration limits. Be aware that risks for borrowers within a value chain are correlated with the overall value chain (i.e. they usually rise together in good times and they usually fail together in hard times).
-
Identify your active Corporate Clients in targeted sectors. Use the FOLLOW THE MONEY principle. Suitable Corp Clients must have healthy finances because they provide liquidity for their value chain. If your Corp Client is in a growth sector, but doing poorly, the competition is eating their lunch. Pick other Corp Clients for your VCF program.
-
Target businesses within the identified value chain. This can be done in two ways: (1) your Corp Clients communicate your VCF program to their suppliers and (2) you build your own value chain businesses list. Cast the net as wide as you can including as many links in the value chain as reasonable. Be aware Corp Clients may pitch you illiquid suppliers in hopes of collecting on past obligations. Perform adequate due diligence on all credit cases.
-
Match financial products and services to target value chain businesses. Use common sense and established banking practices. VCF can grow your portfolio, but it is no reason to change your company culture or your client risk parameters.
-
Sell financial products and services to value chain businesses. Pay attention to the supplier quality standards required by the businesses further up the value chain. Supplier borrowers are less likely to repay their loans if they are unable to sell sub-quality goods to the Corp Clients.
- Monitor and make needed adjustments.
The above is a recipe. The details of financial products and services you can offer will depend on (1) your company registration and (2) local laws and regulations. Banks are in a better position than credit-only FIs because banks can offer a wider product range, especially current accounts. Current accounts are key to execute three important VCF practices:
- Control use of loan funds
- Capture business revenues for loan repayments
- Finance success and grow with the value chain
VCF is a powerful development tool that allows FIs to leverage existing Corp Clients and grow the loan portfolio. FIs have a duty to their shareholders and employees to practice responsible finance. DO NOT LEND MONEY TO BORROWERS THAT CANNOT PAY IT BACK. The demand-driven approach (FOLLOW THE MONEY) allows FIs to serve value chains within acceptable risk levels. Leave the value chain building and management to the development organizations. The demand-driven approach allows FIs to finance success and grow with value chains sustainably.
A blog by John Yancura, RSBP PKE meetings moderator
https://www.linkedin.com/pulse/follow-money-john-yancura-cfa/