Thanks to new technologies:
Counter-cyclical SOCIAL TRADE CREDITS for SMEs
Demand and credit for businesses thanks a new way of collecting guarantees for high risk credits and innovations in times of recession
0. Summary
During a recession banks are more careful to provide credit. Risks grow and the premium for these risks too, annihilating the effect of the lower interest rates. Any lack of credit reinforces the downward trend of the economic cycle. In contradiction to this trend, the need for credit during a recession actually increases. Even more: the need for the demand, the purchasing power the credit would introduce is stronger than ever. Also a crisis is a period of restructuring, a moment of transition to tomorrow’s economy. And to achieve that credit and investment in riskier, innovative businesses is needed. When businesses and consumers are not able to obtain credit this reduces their demand from suppliers. This text raises the question: What could these suppliers do to enable their clients to obtain a credit that without their support would be considered too risky?
This text introduces the concept of Social Trade Credit, a new approach towards credit that benefits of the opportunities modern technology offers to collect guarantees in the supply chain where the credit is going to be spend. These guarantees allow higher risk credits and might even deliver capital to invest during the transition of the economy. The Social Trade Credit innovation transfers (part of) the costs of the credit the bank provides from the debtor towards the (group of) supplier(s) that stand to gain from the access to new the credit. This starts with the direct supplier who would gain marginal sales if this credit is spend with him, but also includes other actors in the economy where the additional demand introduced by this credit leads to additional purchases. Together they finance a guarantee facility that facilitates banks to deliver access to credit which would otherwise have not been possible.
The government also stands to win from such an initiative, through the additional tax income from higher sales turnover. Therefore, they also have an incentive to contribute part of these additional taxes to the guarantee fund and thus enable higher credit risks and more credits.
The technology necessary to collect the contributions to the guarantee fund is crucial. STRO Cyclos software is tailor-made to deliver the appropriate technology. After all for the system to have added value for the participating businesses this contribution should not be more than the marginal profit made by the supplier thanks to the additional sales revenue generated as a result of the additional credit.
Thus, Social Trade Credit allows banks to raise their risk limits on credit, The introduction of more credit acts as a counter-cyclical tool, introducing fresh money in times of austerity. If banks are still reluctant to provide more credits , insurance companies or other financial institutions will seize the opportunity that new technologies offer to create a new and profitable market. Feasibility of Social Trade Credit related to economic circumstances spare capacity in the supply chain to be mobilized to contribute to the guarantee fund
Recession zero-growth stable Growth-rate
During a recession spare capacity increases and businesses are more likely to offer higher contributions to the guarantee fund as long as this leads to additional clients. More money in the guarantee fund allows to raise the level of risks for credits. Growth-rate
On the other hand, when the economy grows and spare capacity lowers, the supply chain is less willing to contribute to a fund that enables credits for their clients and the level of risks will be back to what banks found acceptable before the recession.
2. Credit can be made easier using the characteristics of a recession
During a recession suppliers and government can improve their finances pro-actively by facilitating higher risk credit. Let us consider the following example:
Producer A sells product P, for 100€. Before the recession he needs 40€ to pay the fixed costs, 35€ for the marginal costs, and is left with a profit of 25€ per product sold.
Graph 1 Due to the recession producer A sells less products, because lack of demand. As a result the fixed costs per product go up. This takes all the profitability out of the business. A’s fixed costs per product sold rise to 63€. The marginal costs are still 35€. So he only make a profit of 2€ per product sold.
Graph 2 Now suppose a new client walks into the door and offers to buy the product for 85€. Would producer A accept the offer or not? The 85€ would be more than enough to cover the marginal costs of 35€. So this additional sale would - even at this reduced price - actually deliver him a profit of (85€ - 35€) = 50€. Still he would not be able to accept the offer, because the risk that his regular customers may find out about this discount is far too big. And if they would start to demand the same price he would go bankrupt. So he refuses the new client and loses the 50€ profit.
pro Graph 3
Due to the recession producer A hardly has any profit left from the sales to remaining clients. Almost all his sales turnover is needed to cover his fixed and marginal costs (as illustrated in graph 2). In this situation, however, new clients would lead to additional profit, only and as long as it would not affect the acceptance of the full price charged to the existing clients. (graph 3) .
Producer A would be anxious to hear of a way that would bring him additional clients without ruining his market, because every price offered above the marginal costs of 35€ leads to additional profit. Social Trade Credit offers precisely this opportunity to businesses. Producer A only has to communicate the following to potential clients who are not clients because they do not have the money to buy: they should apply to the special Social Trade Credit-line the bank is offereig, where they can tell that Producer A is willing to support the guarantee fund with a contribution. And also that he will accept payment in the digital payment environment that facilitates the credits and the collection of the guarantees. Let’s see how such a sale and contribution to the guarantee fund will affect the supplier. One thing is important: Producer A sells additional products without disrupting the price on the existing market.
In this example producer A contributes a 15€ commission to the guarantee fund and the marginal costs are still 35€. If the guarantee leads to a new client who pays 100€, producer A will still have 50€ profit on that sale.
Because businesses specifically have spare capacity when markets go into a recession Social Trade Credit is an innovation that provides banks to offer a counter-cyclical type of high risk credit. Feeding the guarantee with part of the marginal profit of the supply chain and possibly a contribution from the government, may thus lead to marginal credit that is presently considered too risky. Clearly this credit line is only possible, because of the contributions of suppliers to the Guarantee Fund. Suppliers are willing to contribute as long as their contribution allows them to sell their spare capacity profitably, as shown in the example and graphs above. For the debtor’s supplier, contributions to the Guarantee fund feel like a sales commission that they pay to the Bank for bringing them clients and profits.
Back to the example: Contributing to a guarantee that allows additional credit to be given does not disrupt existing markets, it only adds new customers. Producer A from the example, cannot give a 15% discount because that would ruin the market, while contributing 15% to the Guarantee Fund does not have that effect and still leaves him a profit of 50€. Still this contribution and other contributions of the suppliers (and potentially the government) to the guarantee fund facilitates access to credit that would otherwise not have been possible. This approach breaks with conventional economic thinking that economic actors always compete in one big survival-of-the-fittest contest. According to that ideology, the (cost of) credit is the individual problem of the debtor. This is fine, as long as sufficient demand is available. When consumer sentiment and business trust in the economy becomes negative and hoarding seems wiser than spending, credit becomes the concern of both buyers as well as suppliers with spare capacity that they can sell if the buyer receives credit.
In order to collect the contributions to the Guarantee Fund the bank(s) liberates the credit on a special type of current account. In many ways this account is just the same as any current account and ready to make payments to everyone else who also opened this type of account. Cash-out however or payments to a current account of a non member, is only possible once a certain period of time has passed and the contributions to the Guarantee Fund have been paid. 3. Additional high risk credits potentially benefit 4 groups of economic actors
Counter-cyclical credit can provide marginal trade and marginal income to various traders in the supply chain provided they cooperate, behave competitively and socially. This sounds contradictory, but it is made possible by and hence named Social Trade Credit. The social trade environment supports the interests of 4 groups that - during a recession - profit from the availability of high risk credits. Specific incentives and rules for each of these groups allow a rational distribution of contributions to a Guarantee Fund related to the profit these groups make, as a result of the credit:
3.1. Debtors (customers) Debtors are first and foremost responsible to repay the credit and its costs. Still even this ‘logic’ needs to be evaluated in times of recession.
As stated above, organizing the economy only along the lines of individual gain, might not lead to the best outcome in economic terms. We need to re-evaluate the contribution the debtor is supposed to make to ‘his’ credit and the conditions he needs to meet. It makes sense that the bank that evaluates credit request distinguishes between different types of debtors. In this text we look specifically to debtors that are a business and leave the consumers for another discussion: a. Companies that can presently fulfill all the financial obligations requested by banks (i.e. interest on loans). Clearly these do not need to the Social Trade Credit program. b. Businesses for which the price of the loan almost fully determines the profitability or viability of the company. Especially those companies with a promising future. For example, a capital-intensive company that presently competes with automated production against very cheap labor. Where labor prices can be expected to rise, technology might become cheaper. So if a cheaper loan would improve the future options of such a company and reduce the risk of default, it might be an option not to charge too much. Since the Guarantee fund has more sources of income it might even be better to allow these debtors not to contribute at all to the costs of the credit insurance, if that would reduce the risk of default strongly. c. Thirdly, innovative, high risk – high profit companies. They are successful and they can either afford the higher cost of the loan or they fail. There is not much in between. Clearly these companies introduce an extra risk and – if they want to be successful - should contribute strongly to the Guarantee Fund. Many of these companies however would never be able to grow successfully if they would have to pay the costs of the high risk from day one onwards. In such cases the Bank would target an average credit risk that is considerably less than what the Guarantee Fund would be able to handle and use the opportunity to provide venture capital instead that has a 100% backing in the Fund to these companies. In this wat the cost of the credit does not affect the options of these companies to become successful and if that is the case the Fund will profit a lot.
If these are innovative businesses contributing to the process of transition to a sustainable economy the spin-off of their innovation may even be another type of benefits. Like any commercial venture capital, the participation in many of these companies will be lost, but other companies will be successful and thus compensate for all the lost investments in those innovative enterprises that did not make it. Another reason to invest in these companies is that successful innovators produce significant positive externalities and spill- overs to the rest of the economy, which are extremely important in the long run.
3.2. The debtor’s supplier During a recession many suppliers have spare or excess production capacity, just like producer A in our example. In this text we refer to any supplier paid with money that comes directly from the Social Trade Credit as the first supplier. Clearly only part of those first suppliers with spare capacity will contribute to a guarantee fund that makes credit available. Only those suppliers have a clear interest that his potential customer receives credit that the customer would otherwise not receive in the regular financial market. And because the marginal income from such an additional sale depends entirely on the availability of credit, it makes sense for this supplier to contribute part of his marginal profit to enable the credit. Others will not have marginal capacity or the marginal costs may be too high. These firms will not be interested to help their potential customers. In general only those debtors will take a credit that know their supplier is willing to make this contribution.
By design, the Social Trade payment circuits attract and select those providers that have marginal profits higher than the commission they are requested to pay to the Guarantee Fund. Other suppliers that will get less marginal profit from a marginal sale will clearly not have an incentive to contribute. Producer A from the previous example is the kind of supplier who would gladly join a Social Trade Credit Circuit against a commission to support the Guarantee Fund of for example 15%, when the marginal sale leaves enough profit for him after deduction of that contribution.
Social Trade Credit not only introduces new purchasing power in the market, it also enables higher credit risk that otherwise would not have been possible. The effect can be impressive: Many banks do not accept to insure defaults higher than 3%, and few programs go beyond that. Making risk up to 15% acceptable would extend the credit market considerably. SMEs and cooperatives that are considered to be more risky debtors, would also get improved access to credit.
As the economy recovers, suppliers have less and less excess production capacity available. And at some point they are no longer interested in contributing to the guarantee fund in order to get new customers. Gradually, their contribution to the guarantee fund will drop, reducing the level of risk the Social Trade credit can deal with. Eventually, suppliers are not willing to contribute at all, the Social Trade credit service would go into hibernation, waiting for the next recession to counter. During positive economic cycles, the cost to insure the credit risk would be financed as usual: by the client in need of a loan.
3.3. Governments The additional sales to the debtor and probably further in the supply chain will deliver the tax office additional income. Clearly the government has to decide what is best: using the tax income or part of it to contribute to the guarantee fund and thus increasing the potential of the guarantee fund to counter the recession, or act as a freerider. Governments that choose to reinforce the guarantee fund need not worry that they will get caught up in a permanent obligation to subsidize credits. They can easily follow the market: As the recession comes to an end, the first supplier will hardly have any spare capacity left and will thus no longer accept to pay a commission to contribute to the guarantee fund. Subsequently the Social Trade Credit comes to a halt and with that so does the contribution of the government. Throughout the economic cycle, Social Trade credits thus provides the government with a possibility to simultaneously increase total tax revenue and mitigate the worst effects of a recession. The government still has a nice marginal tax income if ut contributes 10% to the guarantee fundof the amount of new purchasing power that the credit introduces.
3.4 The rest of the supply chain The last group that benefits from the creation of Social Trade Credits are businesses along the supply chain of the first supplier. Their sales are affected by the additional purchasing power introduced by the credit. However, these suppliers are usually not aware of this connection: there is no direct relation to the debtor that received the credit. Therefore, the contribution to the Guarantee Fund cannot be based on the level of their marginal profits and should be limited. The contributions of this wider range of businesses are best linked to their economic behavior: if they actively use purchasing power they pay very few, but those businesses that do not spend, in other words hoard the purchasing power that was intended to stimulate the economy should pay. In times of recession it makes sense to prevent this kind of hoarding. In a closed payment circuit such as is used in this approach a negative interest rate on current accounts is a very convenient tool to prevent hoarding while at the same time it brings a lot of tiny bits of contributions to the guarantee fund, that in the end can be considerable. Between 4% and 15% of the amount of money in circulation could be captured and transferred to the guarantee fund.
Demurrage causes positive externalities, in particular a multiplier effect on economic activity and employment. An historical example of the implementation of such a tool can be found in the city Wörgl in Austria in the crisis of the 1930s:
During the 1930 crisis the mayor of Wörgl decided that the unemployment figures in the city were unacceptably high. He knew from the writings of economist Sylvio Gesell of a potential cure: a tax on money would prevent hoarding and would boost spending. However, this approach was not used by the Central Bank of Austria. So the mayor looked for an opportunity to introduce it in Wörgl. He developed the idea to create a special payment circuit in Wörgl that would not use money, but claims on money. These claims were setup in a way such that non-use would be fined.
The first step was to create claims on money instead of money. This was done by transferring part of the money the city normally spent into a blocked current account at a local bank each month. The agreement was that the bank would keep that money on that blocked account and would present the city with the counter value in paper vouchers that represented a claim on the money in the bank. The use of that claim was conditioned in two ways:
a. If somebody wanted to cash the voucher for normal Austrian shillings the bank would allow that but would charge a 5% penalty in favor of the city. b. Owners of vouchers were taxed for hoarding. To maintain the value of the vouchers the owner would have to buy a stamp each month, at a cost of 1% of the nominal value of the voucher and fix that to the back of the voucher.
The municipality started to pay their expenses with these vouchers instead of shillings. Because of the hoarding tax and the marketing around the project, individuals and companies deferred from hoarding these vouchers. The circulation of vouchers was much faster than the circulation of money. They went from hand to hand rapidly, facilitating trade. This behavior resulted in increased economic activity. Those activities would not have occurred if the government had paid with shillings instead of these claims on the shillings.
The effect of the faster circulation and higher velocity multiplier was soon to be seen in the city: unemployment fell in the city of Wörgl while neighboring cities saw the unemployment figures rise. The government earned from the sale of the stamps and the increased economic activity and immediately spent that money on additional infrastructural programs.
No wonder neighboring cities started to prepare to introduce similar schemes. At that moment however the Central Bank outlawed this option to create vouchers representing claims on money stored in the bank. This seems unexpected. Central Bank authorities that could not solve the problems themselves were blocking these positive initiatives? To judge this question, one should know that the political situation was close to civil war and the Anschluss to Hitler’s Germany happened only a few months later.
5. The organization of a Social Trade Creditby a bank:
To collect the contribution to the guarantee fund from first suppliers as well as from other suppliers in the supply chain one has to know who they are. In other words, the bank needs to keep track on the money that is liberated through the credit. This is feasible if the credit is liberated inside a special, semi- closed payment circuit or transactions network. Just like in Wörgl where the money was temporally spent as vouchers that could only circulate locally. Like in Wörgl where users contributed through buying the stamps, the digital payment environment would need to collect the money for the guarantee fund while the purchasing power is restricted to that environment. Of course, these days this can and should be a digital environment.
The creation of a payment circuit that is separate from the normal money circuit is quite feasible. Consider the situation of saving deposits where banks reward their clients with a higher interest. This money is located on a special type of bank account that no longer gives clients right to cash at an ATM cash machine. The money is isolated from the normal current accounts in the bank, and the administration of that money is also different from that on current accounts.
Basically, the value in the saving account has become a claim on money that can be cashed at some moment in the future. In the bank’s administration, it becomes an obligation, rather than cash. From the point of view of the client it is a future payment promise of the bank. The promise is secure as long as the bank is secure or the government guarantees the claim on that future money. Banks do not offer the opportunity to do so (yet?), but there is no reason why they would not facilitate clients to use their future cashing right as means of payment to settle debts with other clients of the bank. Imagine a bank starting to facilitate that payment service. Current IT developments make it perfectly possible that businesses transfer the rights on future cash as means of payment. The software can calculate the costs of the fact that this is actually not money, but a claim on future money.
This example of long term saving accounts show that banks can operate a special type of virtual account. Without any doubt software can be installed to allow exchanges in between the accounts from that same type. Transfers of claims on future money can settle debts among buyers voluntarily accepting these claims as means of payment in their transactions.
Social Trade Credits can be liberated in such an account. The software can first charge suppliers a commission and everybody that holds a positive amount a small Demurrage fee. And indeed, the side effect of collecting that contribution is that it makes people spend their purchasing power.
Liberating EU money by Co-funding
Supplier using their margins on additional sales to support the provision of credit can be compared to suppliers making donor funding accessible. Donors like the EU often request 50% own contribution to support a project. This demand is pro-cyclical: own contributions are no problem when things go fine, but may no longer be available after austerity measures have been taken. A Social Trade Payment Circuit allows suppliers of the beneficiaries of EU funding and the supply chain behind these first suppliers to contribute directly instead of contributing to the Guarantee Fund. The government could also support the program with additional tax-income they will get when the donor money starts to circulate; income they would never receive if the money stays in Brussels.
Conclusion:
New technologies allow tagging and tracking money flows. When these flows during a certain period of time are confined to a specific type of account within the bank all beneficiaries of a marginal credit can contribute to the costs of that credit. They are willing to make these contributions as long as they have enough spare capacity to reduce the marginal cost of these sales. Using these opportunities the Social Trade Credit approach provides a counter- cyclical credit mechanism that can finance SMEs in times of recession according to their needs and capacity. A guarantee fund would be able to deal with defaults between 10 and 40 percent . If credits are provided that have considerably less risk the fund can provide venture capital for participation in innovative companies that can move the economy towards growth and sustainability or can invest in liberating individuals and small companies from the debt trap..
EU supported introduction in Europe The first users of this new technology will be the regions in Spain, England and Italy, that joined a European wide project initiated by STRO and co-financed by the EU to start in 2014. STRO is also talking with various Dutch parties to see if such an initiative can be established in the Netherlands.
As any innovation it needs the support of everybody that likes the idea in order to bring it to and through its first implementation stage. If you are interested in supporting us, please contact us at [email protected]. . Follow (and like) us on Facebook
Practical example of the flows filing the guarantee fund
Suppose 2000 credits of 25000 euros = a total at risk of 50.000.000 In the guarantee fund almost 12.500.000 euro Suppose not repayment within the agreed period is 10% and real default is 7%. In that case at the moment of repayment 45.000.000 is available for those who want to transfer their money from the special account to an account that can be used anywhere on the world. The total value still in circulation on the special account is 75,1% of 50.000.000. So quite some cash is available as investment money for the provisoion of high risk capital for innovative businesses. the guarantee = 5.000.000, there is a surplus in the guarantee fund