Business lending: the case for "transaction funding"

In today's rapidly changing global, economic, and political landscapes, banks are proactively providing lines of funding to their corporate customers. Banks are willingly sanctioning lines for transaction-based funding such as bill discounting, vendor finance, and factoring. At the same time, banks are also reluctant to sanction traditional lines like overdraft and line of credit to their corporate banking customers. In this paper, we will try to understand why and also learn about the role of IT in enabling banks for transaction funding.

What is the traditional funding method?
For the working capital needs of corporate customers, banks typically first assess the financials of the company. This helps them arrive at the maximum limit they can offer. Customers are then offered a line in the form of overdraft, or a short-term line of credit based on their requirement and collateral provided by them. Banks adjust the drawdown limit available to customers periodically based on certain parameters like stock levels and security value. Banks have realized that there are problems in monitoring customers in this type of funding as they have limited visibility of customer suppliers or buyers.

Problems with traditional funding method
In traditional funding, banks have limited or delayed visibility of the customer's business with their buyers and suppliers. This has some drawbacks:

• Chances of fraud: The bank decides on the available limit for drawdown, periodically based on stock statements submitted by its customers. This increases the chances of customers manipulating the numbers. Verifying these numbers is difficult for the bank, as it doesn't interact with the customer's buyers and suppliers

• Limited control on the account behavior: Even if the customer submits correct data to the bank, it's highly unlikely that they can recognize any problem between them and their buyers and suppliers. This means delays in taking timely and  proactive control measures on the account based on informed decision.

• Limited due-diligence on customer counterparty: Generally, banks are not aware about their customer's buyers and suppliers. This is because of the unavailability of relevant data on the customer's counterparty. Due to this, they are unable to do complete due-diligence on them.

Banks can address all these drawbacks of traditional funding through transaction funding.

What is transaction funding?
Lately, banks have started funding clients based on the comfort of transactional lines of business. In this, they involve the customer's buyers and suppliers and analyze them before sanctioning credit lines to the customer. Credit lines sanctioned to the customer are dependent on their business with buyers and suppliers. Examples of transaction-based funding are factoring, invoice discounting, vendor finance, among others.

Salient features of transaction funding
Banks exercise additional controls while sanctioning transaction funding line to client. This is possible because of the features of transaction funding. Banks perform additional due-diligence through KYCC (Know your customer’s customer) and KYCS (Know your customer’s supplier).

Banks directly contact customer’s buyers and suppliers which helps them in establishing the genuineness of the trade relationship along with providing enhanced due-diligence. Additionally, funding to customers is based on invoices that are submitted to the bank. Banks exercise the following for invoices submitted:

• Invoices to be accepted by buyer for payment on due date, to eliminate risk of non-payment.

• In case of large value invoices, banks check with the issuer to authenticate it.

• In case ageing is more for invoices, banks do not fund it.

• Payment against invoices from buyer is routed through bank, which in turn is refunded to customer.

• Banks do not fund invoices in case of commercial dispute.

Benefits of transaction funding (banks /customers)
Transaction funding helps banks bring more visibility to their customers’ businesses. It also helps overcome traditional funding problems in these ways:

• Eliminates chances of fraud: Banks are in direct touch with the customer's buyers and suppliers and funding is linked to individual invoices. This minimizes the chances of fraud. Banks also have more visibility on the customer's trade partners because of KYCC and KYCS.

• Better account control: Banks have timely information on their customers’ businesses. This enables them to foresee problems and analyze subsequent impacts. Accordingly, the bank can take proactive action to safeguard its interests based on early warning indicators.

Transaction funding also provides benefit to customers:

• Improved receivable management for customer: Banks, because of their reach, also offer to manage the small customer’s receivables. This helps the customer focus on their core business.

• Improved trade terms for customer: Customers are able to negotiate better trade terms with their suppliers and buyers.

• Better pricing: Since these funds are generally short term in nature, customers are able to negotiate better pricing for borrowing from their banks.

Role of IT in transaction funding
IT can play a very important role in transaction funding, right from the origination of a business to loan servicing and monitoring.

• Origination of business: Banks prefer to analyze the past performance of the customer with their buyers and suppliers. This analysis is done based on invoices for a specific period of time. It covers parameters like receivable ageing, short payment of invoices, dilution, and commercial disputes. Since data involved for the above analysis is huge, IT can play a crucial role in consolidating and analyzing the data while sanctioning loans to the customer. Also, data once entered in the system can be reused later for different purposes rather than re-entering it.

• Loan servicing: IT can help in streamlining the processing of customer requests. Customer can upload the invoices on customer portals for processing by the bank. This not only helps in paperless transactions but also helps in reducing the turnaround time for the transaction. Customers can also access account and facility information through the portal that saves time and cost both for customer and bank. Banks need to look at various parameters, while allowing funding against invoices submitted by the customer. They include factors such as ageing, amount, counterparty on which invoices are drawn, and limits available for them. IT enables banks by setting various rules and analyzing the information based on data captured through invoices. This eliminates any chances of fraud or wrong funding.  

• Loan monitoring: The bank seeks better reconciliation mechanisms and timely follow-up on due invoices. Data available on payments received helps banks and its customers keep track of the buyer's payment performance. Thus, IT plays an important role in making relevant information available and generating alerts based on various rules and sending notification to the monitoring team for taking corrective actions.

IT can also enable banks for transaction funding through self-servicing (customer portal) where customers can view their available limit (customer/counterparty), upload invoices on the portal, and print debit/credit advices along with statements. IT can aid banks in capturing various data from invoices, which can help in generating reports like invoice ageing and debtor dues. The disbursement of customer requests can be completed based on data captured through invoices. Banks can also automatically allocate the payment receipts from debtors against due invoices. IT can also help banks in generating alerts based on various rules which can be used to effectively monitor customer and counterparty.

Conclusion
While it is evident that banks are more comfortable in providing transaction funding to their customers rather than traditional funding methods, customers are also asking banks for transaction funding because of better pricing and other benefits associated with it. IT has the potential to enable banks for transaction funding right from loan origination through to loan monitoring. Since banks need to capture voluminous amounts of data on various parameters during transaction funding, IT plays a crucial role in capturing, analyzing and processing of transaction based on these data.

About the author
Vikash Kumar is principal consultant, Banking and Financial Services at Mindtree Limited with 11-plus years of experience in the banking domain. He has worked with various banks in corporate banking divisions performing various roles. Corporate banking and corporate lending are his area of expertise.