With liquidity in the Gulf Cooperation Council (GCC) region falling and economic growth cooling, companies want to maximise the efficiency of their cashflow and working capital finance. They are starting to look for more complex instruments, driving change in the banking sector.
Traditionally, firms sourcing supplies from abroad simply used letters of credit (LCs). The LC then allowed the supplier to rely on the credit risk of the bank, which is better than that of the importer.
“Opening an LC is a cost for the importer that they would like to avoid,” said Kwabena Ayirebi, head of global trade and receivables finance in the Middle East and North Africa (MENA) region at UK lender HSBC. “If cost is a priority then they want to shift as quickly as they can,” he added.
As suppliers and buyers build a relationship, they begin to look for other, more efficient options. That shift is driven by the terms of trade between corporate clients rather than by the banks. “As people get to know each other, they stop demanding guarantees of payment like LCs, and start operating on open account terms,” stated Ayirebi.
But open account terms bring their own issues. Small and medium-sized enterprises (SMEs), which often form an important part of larger companies’ supply chains, struggle to access finance under any conditions.
“Once you shift away from LCs, it becomes more difficult for part of the supply chain to access financing,” said Ayirebi.
As liquidity falls and the wider economy slows, this lack of financing becomes even more pronounced. The wave of SME defaults in the UAE in late 2015 highlights the precariousness of smaller firms’ cashflows.
Large corporates are beginning to look at ways to support SMEs in their supply chain to reduce the risk of them going under.
“You need to go beyond the norm to supply chain solutions and financing,” pointed out Ayirebi. “Trading on open account terms calls for different solutions to make sure the whole supply chain has the necessary credit risk protection and working capital.”
This is especially true in the current credit cycle. Even large corporates are struggling to manage cashflow.
“What happens to your suppliers who have to push out their payment terms to you?” questioned Ayirebi. “There is a recognition by some corporates that there is something in it for them if they protect their supplier base by working with their banking partners on alternative sources of financing for affected suppliers.”
So far, only a small proportion of corporates have begun to consider how their own better credit risk could help the SMEs they rely on.
This is no less true in the construction and real estate sectors, which have been hit hard by falling government spending and soft real estate markets in the GCC. Government project owners are being less generous with advances and cost overruns.
“There is an acknowledgement by governments that they can no longer provide liquidity to support the infrastructure build,” said Ayirebi. “With governments the issue is not the credit risk of the paymaster but delays. There is definitely increased demand for working capital support to bridge the gap in payments.”
Major companies such as Dubai’s Drake & Scull International and Saudi Binladin Group have already hit cashflow problems. Size of the contractor will be less important to get through this more difficult, less liquid period, than its ability to manage working capital. A greater reliance on working capital solutions would be a significant change in the way corporate finance works in the region. As the crisis in commodity prices drags down the value of global trade, banks are also looking for other ways to generate trade finance revenue.
“It is still in the early stages, but the momentum of take-up of supply chain and working capital solutions is there,” says Ayirebi. “The fundamentals have to drive the process. Like any change, initially it’s slow, but the first thing is establishing in people’s minds that there’s a real need.”