FNA Papers Series: No. 5 | 2023

 

Written by: 

Anthony Butler (Saudi Central Bank – SAMA)

José Fernando Moreno Gutiérrez (FNA)

|  Dr Carlos León (FNA & Tilburg University)

Dr Kimmo Soramäki (FNA) 

 

Butler, A., León C., Gutiérrez J., Soramäki K., (2023). Liquidity-Saving Mechanisms in Trade Credit Networks: Optimizing Corporate Liquidity. FNA Papers, No. 5 – 2023, DOI Number: 10.69701/RTHH6385 [Available at: fna.fi/insights/papers-5-liquidity-saving-mechanisms-in-trade-credit-networks-optimising-corporate-liquidity/]

 

Could a new Financial Market Infrastructure (FMI) that runs liquidity-saving mechanisms reduce outstanding exposures, payment terms and risk?

Anthony Butler from the Saudi Central Bank – SAMA and FNA’ers Carlos LeónJosé Fernando Moreno Gutiérrez and Kimmo Soramäki suggest an approach to mitigate liquidity and counterparty risks in trade credit networks in this recently published article exploring:

Trade credit, or the delayed payment for intermediate goods[2], has been reported as an important source of short-term external finance for many non-financial firms. The value of trade payables is comparable with that of outstanding corporate bonds and is about one-third of non-financial firms’ outstanding bank loans (Boissay, et al., 2020). In the United States, trade receivables represented approximately 8% of the assets of corporate balance sheets in 2022 (Federal Reserve System, 2023).

Abstract: 

Trade credit, or the delayed payment for intermediate goods, has been reported as an important source of short-term external finance for many non-financial firms. The value of trade payables is comparable with that of outstanding corporate bonds and is about one-third of non-financial firms’ outstanding bank loans (Boissay, et al., 2020). In the United States, trade receivables represented approximately 8% of the assets of corporate balance sheets in 2022 (Federal Reserve System, 2023). 

 

During financial crises, as bank credit weakens, trade credit becomes a substitute source of liquidity (see Baños-Caballero, et al., 2023). According to the literature, firms able to access trade credit are better positioned to withstand financial crises. For instance, a study of over 200,000 European firms found that an increase in the availability of trade credit to a firm led to a significant decrease in the likelihood of distress (McGuinness, et al., 2018). Therefore, there is a potential benefit in supporting trade credit throughout the entire economic cycle, particularly during financial downturns.

By extending a short-term loan to buyers, sellers of goods and services provide liquidity, facilitate the purchase of supplies by other firms, encourage long-term customer relationships, and increase demand. As firms recursively borrow from their suppliers and lend to their customers through the supply chain, trade credit networks foster economic activity. Accordingly, trade credit has been reported to be a key element in enabling economic activity and ensuring financial stability.

However, this positive feedback loop created by trade credit networks also works in the opposite direction, with the potential to create instability in the economy. For instance, if some firms do not pay on time, others may find it difficult to pay on time, and a cascading effect of higher payment terms may ensue; furthermore, when firms cannot pay, the cascading effect may be worse. That is, in adverse scenarios, the trade credit channel that runs parallel to input-output linkages could negatively affect the liquidity and the solvency of firms, and, in turn, economic activity and stability (see Costello, 2020).

 

This type of network and feedback effect is well-known in interbank markets. When banks provide liquidity to each other in the money market, the inability of a single bank to pay on time may threaten the safe and efficient functioning of the payment system and, eventually, the solvency of the financial system. Large-value payment systems have long acknowledged that interbank liquidity is a network problem that is better tackled by implementing intraday Liquidity-Saving Mechanisms (LSMs), i.e., a suite of algorithms designed to compress liquidity requirements to facilitate smoother flows of liquidity. By introducing LSMs into real-time gross settlement systems, large-value payment systems have mitigated liquidity and counterparty risk.

 

We suggest a similar approach to mitigate liquidity and counterparty risks in trade credit networks. By introducing a new Financial Market Infrastructure (FMI) that runs LSMs in trade credit networks, we can reduce the outstanding exposures among firms, reduce the payment terms, and mitigate potential risks arising from undesirable network and feedback loop effects. This way, by implementing LSMs, risks and potential amplification effects from trade credit exposures are mitigated while their potential contribution to firms’ growth, supply chain resilience, and economic activity is preserved. Besides, as this implementation of LSMs requires observing the trade credit network, new data for monitoring and policy-making is available for central banks and financial authorities.

 

https://doi.org/10.69701/RTHH6385

Download the Paper > 

 

About the Authors:

 

Anthony Butler

Saudi Central Bank (SAMA)

Anthony Butler is a Senior Advisor at the Saudi Central Bank (SAMA) responsible for applied research and experiences with emerging technologies in the financial sector. Previously, Anthony was the Chief Technology Officer for IBM in the Middle East and Africa and was appointed as an IMB Distinguished Engineer, mostly for work in blockchain and cloud technologies. 

LinkedIn >

 

 

Jose Fernando Moreno Gutiérrez

FNA | Jose.m@fna.fi

José Fernando Moreno Gutiérrez has a diverse work experience in the field of data science and financial analysis. José Fernando is currently working as a Senior Data Scientist at FNA since June 2022. Prior to this, they worked at Nemuru as a Lead Data Scientist from January 2021 to June 2022, and as a Senior Data Scientist from February 2019 to January 2021. Before joining Nemuru, they worked at Bluecap Management Consulting, where they held multiple roles including Project Lead from July 2018 to January 2019, Big Data Analyst from September 2017 to July 2018, and Data

LinkedIn >

 

 

Carlos León

FNA & Tilburg University | Carlos@fna.fi

Carlos is the Director of Financial Markets Infrastructures and Digital Currencies Solutions at FNA, where he is one of the subject matter experts on network analysis for payments and financial market infrastructures. He has worked as a Senior Researcher at the Central Bank of Colombia and as a Short-term Expert for the International Monetary Fund. Carlos has published 26 articles in Scopus-indexed peer-reviewed journals that have been cited in 133 Scopus-indexed academic publications. He holds an MSc in Banking and Finance from Université de Lausanne (Switzerland) and a PhD in Finance related to network analysis from Tilburg University (The Netherlands). 

LinkedIn > 

 

 

Kimmo Soramäki

FNA | kimmo@fna.fi

Kimmo Soramäki is the Founder and CEO of FNA and the author of “Network Theory and Financial Risk”. He has over 25 years of experience working with Central Banks and Financial Market Infrastructures. In 1997, Kimmo developed the world’s first simulation model for interbank payment systems – and since then, has been regularly invited to lead and contribute to simulation and payment system innovation projects with organisations like Bank of England, CLS, Payments Canada or SWIFT. He is a frequent speaker at industry events and has written over 50 articles that have been cited in more than 2000 academic publications. Kimmo has an MSc in Finance and a DSc in Operations Research, both from Aalto University (Finland).

 

 

 

 

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