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The Sam M. Walton College of Business

Does Banking Turbulence Threaten Supply Chains?

Battered piggy bank with bandages
May 11, 2023  |  By Andrew Balthrop, Jason Miller

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Banks play a role in just about every aspect of a business, so it’s no surprise that the recent troubles in the banking sector are creating red flags for supply chain managers.

High finance can seem complicated, but the basic business model for banks is rather simple: They profit from borrowing money and loaning it at higher interest rates than they paid to get it. The fictional George Banks and his colleagues at the Fidelity Fiduciary Bank explained in “Mary Poppins” that such loans—done well—can fund “railways through Africa” and “dams across the Nile.” But they aren’t always done well, and that can bring trouble throughout supply chains.

Rising interest rates can change the spread between a bank’s cost of capital and its return on that capital, thus pressuring the bank. Silicon Valley Bank provides a poignant example. Falling bond prices (the result of increasing interest rates) resulted in unexpected losses, triggering a bank run and the institution’s collapse. Other banks are now under scrutiny, and a full-fledged contagion is possible.

What does this mean for supply chains?  

The biggest and perhaps most obvious worry is in forecasting product demand. Banking panics can trigger macroeconomic recessions like the 2008-09 global financial crisis. This can cause demand for goods, especially long-lived products, to plummet. For example, production of machinery fell almost 35% during the global financial crisis.

Unanticipated declining demand can result in excess inventories, which subsequently need to be drawn down, further worsening business conditions.

One industry to keep a keen eye on is single-family housing, where starts have plunged almost 30% since early 2022, returning to the average level of 2017-19. Further declines in housing activity would have wide-ranging impacts on construction-dependent industries, including sawmills and makers of windows, shingles, appliances, and concrete, as well as furniture wholesalers and building-material retailers.

A second and less-frequently discussed concern is how banking paranoia can disrupt financing throughout a supply chain.

When suppliers deliver product, they invoice the buyer for payment. It takes time for the buyer to settle up, but the supplier might really like to have that cash sooner (to pay workers, produce more product, etc.). A variety of supply chain financing arrangements exist where a bank steps in, pays the supplier, and is later repaid by the buyer. These arrangements are important, as they reduce supply chain costs while creating flexibility for suppliers and buyers.

Banking instability threatens finances in supply chains on a number of interrelated fronts.

1.       Increasing costs of capital for banks are passed on to the supply chain, making it more expensive for buyers to finance purchases. With less financing available, buyers and suppliers will need to revert to older and more expensive ways of doing business—i.e., keeping more cash (working capital) on hand.

2.       Banking panic can spread faster than companies can respond. In 2008 and 2020, crisis-related paranoia resulted in a near halt of the commercial paper market (short-term, unsecured loans to large, credit-worthy companies), and the Federal Reserve had to step in to provide short-term loans. While the commercial paper market is “too big to fail,” the supply chain finance market is much smaller. Companies need contingencies in case these sources of financing suddenly disappear.

3.       Banking panics are associated with general economic upheaval that can threaten the solvency of both buyers and suppliers. On one side, this may make banks reluctant to grant supply chain loans in the first place. Loans can also be called in suddenly, leaving the buyer on the hook for large short-term payments.

4.       Finally, while the intent of supply chain financing is to maintain working capital, it also provides a creative means for hiding debt. There are unresolved regulatory and transparency issues in the supply chain financing market. A placid economy promotes more relaxed oversight, although companies will not want to be on the wrong side of increasingly rigid regulators and investors.

Supply chain leaders are accustomed to managing for product demand, so it’s natural they would pay closer attention to the changing dynamics of forecasting associated with macroeconomic recession. But the financial implications that come with failing banks are less obvious, making them all the more disruptive. Poorly managed supply chains can slow to a trickle, like water in a dammed-up Nile.

Andrew BalthropAndrew Balthrop is a research associate within the Supply Chain Management Research Center at the University of Arkansas. His present research focus is on the interaction between the efficiency of freight transportation and government policy.  He has also done research in energy and environmental policy. He has published in the Journal of Operations Management, Journal of Business Logistics, Empirical Economics, and Energy Economics. Andrew received his Ph.D. in Economics from Georgia State University in 2012. 




Jason MillerJason Miller is an associate professor of supply chain management at Michigan State University's Eli Broad College of Business. He utilizes economic data from various government sources to develop insights for supply chain management practitioners.

 







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