The current rising interest rate environment has resulted in changes to reference rates related to borrowing with all financial institutions. This includes supply chain finance (SCF), as the rise in rates has impacted the discount costs on SCF programs. Even with the increase in these reference rates, Bank of America has seen a record number of suppliers enrolling in SCF programs as the suppliers’ rising cost of borrowing and tightening of liquidity has made buyer-offered SCF programs financially beneficial to suppliers.
Supply chain finance in a rising rate environment
Let’s take a look at the two components of SCF discounting:
The spread:
The spread on the program is a stable rate and is based on a combination of the buyer’s credit rating and other market conditions. The rate quoted for the spread stays consistent unless there is a change in the buyer’s credit quality, which may increase or decrease the spread charged on SCF programs. Market conditions may also impact the spread. For example, during the COVID pandemic, most banks increased rates in response to the crisis, but this type of situation is highly unusual. It is also worth noting that when the market stabilized, spreads returned to pre-pandemic levels.
The reference rate:
The reference rate is driven by the currency of the receivable that is being discounted. For US dollars, many banks used LIBOR (London Interbank Offer Rate) as a reference rate. At this time, LIBOR is being replaced by alternative reference rates such as BSBY (Bloomberg Short-Term Bank Yield Index), SOFR (Secured Overnight Financing Rate) or other reference rates such as Euribor (Euro Interbank Offered Rate), CDOR (Canadian Dollar Offered Rate), etc. These rates are publicly published rates and have only fractional changes daily. As interest rates rise or fall, reference rates tend to move in a similar fashion.
Flexibility of Bank of America’s Supply Chain Finance Program
Bank of America has designed its supply chain finance program to be flexible and offer options for suppliers who enroll. Suppliers can choose from: Auto Discounting or Selective Discounting.
Auto Discounting
This method requires no action for an enrolled supplier to receive a discounted payment. As
soon as approved invoices are received from the buyer, they are automatically discounted and
funds are sent to the supplier’s financial institution.
Selective Discounting
This method allows the supplier to pick which invoices they wish to accelerate and when it should take place. For example: Five invoices are received on day 10, each with 90-day terms and worth $10K. Once the supplier receives notification that these five invoices have been approved, they can access the Bank of America system and chose which, if any, invoices they want to discount and at what maturity (i.e., 45 days). If they don’t discount at all, the supplier will be paid in full at invoice maturity.
What happens if market conditions change or supplier’s financial strategy/needs change?
If conditions change and discounting is not advantageous, suppliers can easily change their discount elections (auto, selective). There are no fees to change, and changes can be made in fewer than 5 business days. Although there has been an increase in the reference rates, Bank of America has not experienced suppliers changing their discounting election from Auto to Manual or seen suppliers exiting the program. On the contrary, we have seen an increase in supplier activity as suppliers’ cost of borrowing has increased at the same or an accelerated rate. The flexibility and design of the supply chain finance program that Bank of America offers have been able to meet suppliers’ financial strategies and needs despite changing market conditions.
Author
Len Dunleavy, Director, Global Trade & Supply Chain Finance, Bank of America
