Forward and backward linkages in a business organization play a significant role in the success or failure of the business entity. For example a manufacturing or trading firm, while the suppliers of raw material are important as they provide input for production, equally important is the role of its distributors which sell products manufactured by the firm through retailers to the ultimate consumer. Channel financing relates to ensuring that integrated financial and commercial solution is available to the entire chain of supply and distribution that could ensure the good health of the firm, financed by the bank.

Channel financing is different from the conventional lending since, in conventional lending, the financing banks are generally not concerned as to how the suppliers of the firm and dealers of the products of firm, are financing their activity. The weak financials of the supplier (leading to delay in supply and non-availability of market credit) or the dealers of the products (delay in receipt in payment leading to higher book debts) could adversely impact the top-line(sales) as well as bottom-line(profits) of the financed firm. In the channel financing the financing bank may have to find ways and means as to how the suppliers and buyers can be financed through various instruments/facilities. Hence, the channel financing adds value to the transaction for all the parties concerned, be it the manufacturer/trader, the supplier of the inputs or the dealer/buyer or the financing bank.

Through channel financing, the business firms can out-source a major part of their working capital needs thereby reducing their dependence on bank finance. For instance, it need not avail of credit from its bank to pay off the supplier if the supplier gets the finance in his own name from the bank for the raw materials supplied on credit in the form of say, drawee bills financing. The bank can also allow loan to the dealer for the credit term that has been fixed between the firm and the dealer in the form of receivable finance or finance against book debts or factoring of the receivables. This enables the manufacturing firm to get cash immediately for the finished goods supplied. This firm functions as the principal customer which suggests the names of its suppliers and dealers to the bank. Thereafter, the bank makes a due diligence assessment of the suppliers’/dealers’ standing and credit worthiness and decides to provide finance on merit.

The pre and post sale working capital requirement of the manufacturing concern would be scaled down. Such firms can concentrate more on their core competence area of production and marketing their products besides saving time and costs involved in arranging creditors and monitoring recovery. As regards the suppliers and dealers, the major benefit is that they get payments promptly, which improve their liquidity position and cost. This also helps them as well as the bank to cut level of counter party risks.

The banks also gain substantially from the process of channel financing which include increased customer base, effective due diligence and smoothness of lending activity and loan origination process. Besides, the banks will be able to ensure better credit discipline. Since the risk is diversified through finance to supplier, manufacturer and the dealers, the credit exposure norms are better observed. Hence channel financing is a very convenient tool in managing their assets portfolio.

Channel financing, due to its distinct advantages to the business firms as well as banks, has been suggested for implementation in various forms, by various committees in India such as receivable financing by Tandon Committee, drawee bills financing by Chore Committee and through factoring by Kalyansundram Committee. Channel financing opens up manifold opportunities due to which the banks can make conscious efforts at popularizing this credit delivery mechanism.