Written by Vinod EP, Client Director at #dltledgers
Enron, WorldCom in the USA, Satyam in India, recent frauds in the oil sector in Singapore and many more in between are examples of manipulation of the system which have left the banks running for cover. In recent times, we have seen the banking industry becoming wary of lending to the commodity sector, and some banks are also moving entirely away from the Industry. This probably can be seen as a knee-jerk reaction to the current happenings or possibly it can also be seen as a realisation in hindsight of the insufficient risk mitigation steps that are currently in place in banks while lending to commodity players.
Banks have traditionally looked at funding from the perspective of financing the working capital gap. In the era of slimming margins on actual trade, corporates were looking to squeeze additional margins on transactions by obtaining funding and using the funds for generating additional margins on the same transaction. Liquidity is the lifeline of a company. The explosion of banks and their willingness to finance trade provided avenues to corporates for generating liquidity. But unfortunately, the controls that have to be in place for monitoring were slowly diluted over a period as Corporates, and in many cases, Banks were looking at reducing the hassle associated with the close monitoring.
I am happy to see that The Association of Banks in Singapore (ABS), together with the support of the Monetary Authority of Singapore (MAS), Enterprise Singapore (ESG), and the Accounting and Corporate Regulatory Authority (ACRA), launched today the ABS Code of Best Practices for Commodity Financing. Interestingly, Singapore, through their guidance paper on AML CFT controls in Trade finance and Best practices for countering Trade-based Money Laundering has always been a pioneer in such initiatives. ABS Code of Best Practices provides a benchmark for bank’s lending standards in the commodity sector. It has spelled out the key themes of understanding the corporate and understanding the transaction.
The document covers Corporate governance, Risk Management, Business Due Diligence, Transparency and control, and Industry Collaboration along with examples covering the above.
Understanding the corporate governance and policies is tricky as big statements may not reflect the ground reality and practice followed by the corporate. However, an eye on these details and understanding of how governance is handled by the corporate can help decision making if the banks don’t just treat the same as only another piece of paper, but analyse it and get back to the corporates for irregularities, if any, regularly. Risk management policies and practices may vary, and a banker can flesh out the relevant information using the right questions. Scrutinising the information on the balance sheet for Turnover and inventory has been mentioned. However, analysing and cross-checking the size of payables, receivables, and Cash in the balance sheet has not been specified, especially when we have seen auditors not covering themselves with glory in the cases of past corporate failures. However, Warranties declaration and information can be used to bring in transparency and control but will prove ineffective in case of fraud where false declarations are provided. Inspection and verification of goods financed, ensuring title documents are consigned or endorsed to the order of bank. Confirmation of receivables, obtaining acknowledgment of notice of assignment, Sending of original invoices through the lender to the debtor are all steps that can provide additional comfort to the lender. However, these are easier said than done.
Considering this is the first version, the document is impressive for showcasing the intent. It also lays the theme for future initiatives that could include leveraging technology to authenticate underlying trade transactions financed by lenders and to enhance the lender’s assessment of the creditworthiness of corporate entities.
One recurring issue that we have seen in corporate failures is the manipulation of the balance sheet, notwithstanding the presence of the Big four to vouch for the document. I sincerely feel that if Banks are relying on the balance sheet, they should ensure that it is not just a piece of fiction. Banks should cross-check data regarding Inventory, Cash, Payables, and Receivables. A blockchain-based central repository like ACRA, where the corporate uploads the balance sheet and annexures into a structured template can help in data analysis and matching of payables, receivables, Cash with corresponding data of other corporates / Banks whose name is mentioned. Lenders can trigger enhanced check on the balance sheet in case of substantial mismatches. Once this is implemented in Singapore, It is only a matter of time before such best practices percolate to other regions. Over time, I am sure upload of financials into a common reporting platform would become a global norm. To allay the fears of corporates, ACRA can store the data in a private permissioned network with granular access authorised by the corporate only to financing banks on a confidential basis.
It is the technology that can help meet the complex demands forced on banks by the failure of the system. A repository of transactions that can be made available to lenders for transaction-level due diligence will allay the fears of Bankers. A system that can be accessed by the corporate, lenders, and other stakeholders in a transaction on a permissioned basis can help satisfy the lender and provide the necessary comfort to the Corporate. Blockchain can help create immutable, consented records that provide confidence to all stakeholders, especially banks. It is in the interest of Industry and genuine stakeholders that technology adoption is speeded up.
Singapore has been a leading light in this area by providing support to help companies digitise. We have seen corporates and banks work in Silos for long. Covid19 has helped in highlighting the urgency of digitising trade. Failures in the commodity sector have again underlined the need for transparency in trade transactions, and it is technology and digitisation that can bridge the gap. A blockchain solution which connects all stakeholders and provides permission-based / access based view to financial Institutions can help increase transparency and give assurance to financial institutions to come back to this sector with confidence. The time is now.
Tailpiece: In July this year, I had written an article titled “Listen more to what they don’t say than what they do”. Extract from the article is as follows:
“It is time red flags in lending are circulated so that all banks can understand the significance of exceptions and deviations. A compendium of best practices in lending should also be available, which over time can become the master reference book… Singapore can lead the way in such an effort…….. Banks on their own may not share these with a competitor. But a nodal agency or regulator can help compile the best practices and reduce the knowledge and experience gap faced by the toddlers. Sharing of information about corporates among bankers in a structured format should also be implemented.”
This code of conduct is the first version of the compendium of best practices, and over time, I am sure this will help all the players raise the bar and standards in the lending game.