Rising Fed Interest Rates and the Resilience of Supply Chain Finance
By 5 minute read• Published July 26, 2023 •
It looks like the Fed’s temporary pause in interest rate increases is over. Officials have announced a quarter point increase in one of two hikes expected to be issued by fourth quarter of this year. This pushes rates to a range of 5.25% to 5.5%, the highest level in 22 years.
June’s decision to pump the brakes on rate increases garnered attention for a couple of reasons. First, it ended a long run of consecutive rate hikes dating back to March 2022. Second, the decision to pause interest rate increases was clearly just that – a pause. A spate of historic rate hikes has dampened economic growth as intended, which is a strange flavor of good news for those businesses and consumers seeking relief from high inflation. Inflation has been cut in half (4%) from this time last year (9%). But that’s still twice as high as the ideal annual rate of 2%.
So, what does this mean for supply chain finance? There are some concerns that rising interest rates could negatively impact supply chain finance programs. While it’s true fluctuations in base rates will obviously have an effect on all sources of financing, supply chain finance is still a smarter, cheaper and more attractive liquidity option for most businesses.
Supply chain finance remains a proven, affordable way to improve cash flow
To understand supply chain finance’s resiliency in the face of rising interest rates, let’s start with a quick review of how supply chain finance works. Supply chain finance is an early payment program that helps businesses manage their working capital. It enables companies to improve their cash flow by extending payment terms to their suppliers while offering their suppliers the option to get paid earlier through third-party financing at a nominal fee.
Buyers offer supply chain finance to their customers because they want to optimize and unlock working capital trapped in the supply chain – and because they want to do so without adding debt to their balance sheets. Suppliers participate in supply chain finance because they want to improve cash flow for a variety of reasons. For some, it may be a countermeasure to rising costs (inflation, disruption). For others, it may be a way to fund supply chain resiliency. Whatever the reason, supply chain finance represents a dependable way for suppliers to access liquidity at a cost that is materially lower compared to traditional financing mechanisms like commercial lending.
As mentioned earlier, any fluctuation in interest rates affects all financing options. With that in mind, supply chain finance remains a more attractive liquidity option compared to other forms of financing – particularly in the current business climate. The rate that suppliers pay to participate in supply chain finance is based on the buyer organization’s credit rating, which is typically more favorable than what the supplier would pay in a lending scenario based on their own credit rating.
Improved cash flow also goes a long way in neutralizing any negative impact of higher interest rates. Businesses can use these funds to pay down debt, invest in growth (which can lead to higher profits), fund resiliency initiatives, etc.
What the data tells us
As we reported earlier this year, our data shows suppliers continue to have a strong appetite for early payment. Historically, global trade ratios average around 76% and that has been true throughout 2021 and 2022. This year, we’ve seen minor fluctuations with volumes decreasing by 7%, but we saw ratios start to level out in late June. Our supplier trading behavior observations indicate this will continue to be the norm even as the market absorbs the idiosyncrasies of the Fed’s decisions (and sometimes indecisions) as it tries to tackle inflation.
While we anticipate there will be at least one more interest rate increase on deck in 2023, supply chain finance has always been – and will continue to be – an effective tool for navigating cash flow pressures. Any impact of rising supply chain finance costs is immaterial compared to the positive impact that better cash flow has on the business. By improving cash flow, buyers and suppliers can combat the financial impact of inflation, invest in critical business initiatives, and fund stability and growth.