Financing Supplier Through Retailer's Credit

This paper studies retailer-sponsored financing (RSF), an emerging practice of retailers in developing economies to help capital-constrained suppliers obtain external financing for production. Under RSF, the retailer agrees to share the loan-repayment responsibility with the supplier – the retailer is responsible for paying the loan principal, and the supplier is responsible for the loan interest. Without RSF, the supplier, when in need of capital, has to finance her production with bank-direct financing (BDF), under which she is responsible to repay both the loan principal and interest. We show that in an environment where both the supplier and the retailer face exogenous bankruptcy risks, the supplier always prefers RSF to BDF. The retailer, on the other hand, benefits from offering RSF in two cases: (a) when the supplier's bankruptcy-loss factor is low, or (b) when the supplier's bankruptcy-loss factor is relatively high but her need for capital is light. In both cases, RSF causes the supplier to lower her wholesale price and encourages the retailer to increase quantity commitment. Issuing RSF loans benefits the bank by increasing its clientele among suppliers and by increasing the lending business volume. Interestingly, the bankruptcy risks of the supplier and the retailer tend to have the opposite impact on the value of RSF.