Finance: Research, Policy and Anecdotes

The Greensill Failure – looking beyond the headlines

This Monday, Greensill Capital filed for administration in London, while Greensill Bank in Germany was intervened by regulators last week. A lot has been written, but here I’d like to touch upon some less mentioned dimensions – supply chain finance as product, non-bank financial intermediaries/shadow banks and the role of short sellers.

 

The failure of Greensill has many different aspects and dimensions to it. At the core there seems to be the overexpansion of a financing company providing what has been traditionally known as (reverse) factoring, i.e., the discounting of invoices: Firm A sends invoice to Firm B with payment target of 30 days, and receives (discounted) funding from the factoring company immediately, with the factoring company collecting money from Firm B after 30 days. The additional twist in the case of Greensill seems to have been that it attracted funding from investment funds linked to Credit Suisse (but with credit insurance as condition), benefiting from investors being desperate for any yield in the time of low interest rates. Together with the rapid (over-) expansion there was a concentration risk and some rather non- or less transparent (to stay with diplomatic language) deals with Sanjeev Gupta. The trigger for Greensill’s failure was that its main insurer – Tokio Marine- refused to renew an important credit insurance contract and that, as consequence, Credit Suisse froze its funding to the firm.

 

At the core of it, supply-chain financing or factoring is a sound financing technique. It is especially attractive for smaller companies in many developing countries that do not have easy access to bank credit. Being suppliers for large firms, they can use invoices to these large firms to gain access to short-term funding, effectively using the reputation and credit rating of their large firm clients to gain access to credit. My former World Bank colleague Leora Klapper has an interesting case study on the introduction of an electronic platform in Mexico in the late 2000s to connect small and unbanked suppliers with factoring companies. So, effectively, a useful technique/innovation that can expand the universe of companies with access to external funding; in the ideal case allowing these firms to get a step on the external financing ladder, allowing them to eventually gain access to bank credit.

 

However, it is not only in developing markets where this is an interesting financing tool, but also in advanced economies where small companies face financing constraints and/or long payment targets from their clients and delays in payment. This is where Greensill seemed to have come in in the UK. And it went beyond financing for small firms to what amounts effectively to salary loans for NHS staff (again, something that was initially hailed as a positive financial innovation in some African countries, but has the potential to push many households into overindebtedness). And supply chain financing can also be used by risky corporates to hide debt from its balance sheet.

 

While factoring can be offered by banks, it is often offered by non-bank financial intermediaries. In some developing countries with small financial systems, one can look at this with sympathetic eyes, as expanding financial service provision beyond a concentrated banking system can help increase competition and the range of available products. At the same time and especially in more developed financial systems (including in emerging markets), this can have regulatory implications if these non-bank financial intermediaries (or shadow banks as we used to call them) are linked to the regulated banking system. The case of Greensill is a certainly a posterchild case for this, with its connection to Greensill Bank in Germany, insurance companies and Credit Suisse.  While of no systemic importance, it clearly poses regulatory challenges.

 

Another dimension of the case is the involvement with politics. The research programme on the value of political connections in finance is still growing – their role in boom and bust episodes can use Greensill as interesting case study; maybe it is even time to include political connections as warning signal in the supervisory dash board.

 

Finally, Greensill is the second time in a short period that short-sellers have gained in reputation, with an Australian short-selling hedge fund pointing Australian regulators to a potentially dangerously high exposure of an Australian insurance group to Greensill capital back in November 2020. This comes after the Wirecard scandal, where short-sellers were first vilified by German bank regulators (Bafin, not Bundesbank) when taking positions against Wirecard, before being proven right. It is telling that it was the (originally left-wing) Green party that invited a New York based short-seller against Wirecard to testify in front of a Bundestag Committee about her experience with Wirecard (report only in German).  As the short-seller in question acknowledged herself, there are black sheep in the profession, but short-sellers can constitute an important market intelligence, monitoring and disciplining tool.  As the case of Wirecard has shown, exclusive reliance on supervisory discipline is not sufficient, other players are important and short-sellers can be an important player in this context. Greensill is another case to show this.

 

In summary, supply chain finance is a useful financial product, be it offered by banks or non-banks. As most financial products it can be abused. Greensill has clearly shown this, as well as that market discipline can be very useful!