The Covid-19 pandemic has had devastating impact on the global economy, especially the retail industry. Lockdowns and closed borders forced many retailers to change their operating model from brick-and-mortar stores to online platforms. Supply chains came under severe pressure, adding to the sector’s woes. SME’s already stressed working capital was squeezed further by suppliers requesting earlier payment, and buyers requesting longer terms.
While central banks and governments were quick to respond with monetary and fiscal stimuli, liquidity did not return evenly across sectors. Within consumer non-durables, for example, food related companies have had significantly more access to credit than retail. Risk is clearly higher in the latter; however, given the oceans of liquidity in the economy, how can we make financing more available to out-of-favor industries?
A key variable to consider is how to properly assess the inherent risk in industries that are going through an economic downcycle. Traditional lenders overly emphasize financial statement analysis. While important insights can be gained from it, and projections can certainly be made, financial statements are by definition backward looking. Security in the form of collateral and guarantees can limit downside risk, though doing so reduces potential loss. Government guarantees reduce Loss Given Default (LGD) can be helpful, but basically work in the same way. That is, the probability of loss remains unchanged. Given the choice, lenders understandably prefer to allocate credit elsewhere. The fundamental changes that some sectors, such as retail, are undergoing only serves to compound the perceived risk, and therefore exacerbate the unavailability of credit.
We are not arguing for making credit available to uncreditworthy obligors. Rather, an ‘enhanced’ risk mitigation framework can make capital more available where and when it is most needed than otherwise. Combining elements of traditional financial statement analysis with a dynamic, real-time risk mitigation approach gives a clearer picture of risk. By leveraging data and technology, we can obtain real-time visibility to an obligor’s financial performance and take any necessary risk mitigation measures. Understanding the flow of funds in the supply chain can also be utilized to further understand risk, and to implement mitigation mechanisms.
On the opposite end, improvements in a borrower’s performance can also be identified earlier than otherwise. While each lender needs to consider its own decision to make additional credit available, doing so can further support a borrower’s turnaround.
Some industries may be more conducive to an ‘enhanced’ risk mitigation framework than others. Ecommerce can be an ideal environment for this ‘enhanced’ framework to work, though a similar approach can work for non-ecommerce as well, especially given the vast availability of technology tools that allow for direct communication.
Traditional lenders will continue to play a key role in the economy, though depending on various factors some may be better positioned than others to look at risk in such a dynamic way. Could FinTechs lead the way? Get in touch with us to find out!