The ongoing COVID-19 pandemic has highlighted the critical nature of global interlinking and reliance on supply chains. Breakdowns in supply chains have exposed the dependency of some countries on others, leading to higher domestic price levels and a rise in inflation.
The role of banks is to ensure a smooth mechanism of supply chain financing, but with a renewed emphasis on sustainable supply finance. The emphasis on sustainability is due to the very visible fragility of some supply chains over the past two years, which was the focus of corporate decision-makers in making their businesses more resilient.
This means having a better understanding of what is going on in supply chains, their roles and being able to mitigate abuses such as labor rights issues, as well as potential problems, including those that are the result of climate change.
Sustainable supply chain financing is also something that regulators are demanding, such as a reduction in emissions to reduce carbon footprints. Reliable and sustainable procurement emphasis has led international companies to seek assistance from banks in incorporating sustainability into their supply chains for extending financing.
Some governments have also taken action. The German Parliament adopted the Supply Chain Due Diligence Act, requiring large and medium-sized companies to conduct due diligence along their supply chains to combat labor exploitation, especially in emerging market supply chains.
However, it is very difficult for every player in an extended supply chain network to link their ESG data, raising the question of how banks will obtain the necessary supply chain data on whether ESG standards are being met or not.
Some argue that, over time, especially as trade finance goes digital, fintech is expected to make inroads into solving more data problems. Again, this raises some other questions in that obtaining more intrusive supply chain data might become more expensive and leave companies open to regulatory and reputational risk, thus forcing some to cut their losses and re-shore production to their domestic market.
However, given the large amount of investment made by global supply chain companies, the option to re-shore their production would not be an easy one to take. Would ESG-focused supply chain companies then be willing to provide such confirmation data on their activities in order to obtain cheaper bank financing? Would this become more prominent in developed countries to the detriment of developing country supply chain producers?
It is generally the supplier who pays for an ESG rating. The cost of rating is usually manageable for mid-sized firms, but becomes relatively costlier for SMEs, since most of their data is qualitative and harder to use in quantitative form.
This begs the question on whether sustainable supply chain finance will be enough to drive real change, and whether the final consumer could become, in the long term, the arbiter of who survives in the global supply chain network.
This, however, assumes that consumers are fully aware of complex ESG elements and their application in different tiers of the supply chain network, with the most complex being classified in Tier 1, and least complex in lower tiers, up to Tier 7. This is indeed already a tall order for banks, let alone for the ordinary consumer. The current banking ESG solutions to supply chain financing will be with us for some time to come.
• Dr. Mohamed Ramady is a former senior banker and professor of finance and economics at King Fahd University of Petroleum and Minerals, Dhahran.
