Vinu:  Manu, a borrower we are assessing purchases nearly 70% of its raw materials from a single supplier. The business is profitable, but should this concentration concern us?

Manu: Definitely. Heavy dependence on one supplier creates supplier dependency risk. If that supplier delays delivery, increases prices, reduces credit terms or stops supplying altogether, the borrower’s operations may be disrupted.

Vinu: So even a financially strong borrower can face repayment problems because of its supplier?

Manu: Exactly. A borrower may have good sales and adequate orders, but without timely raw-material supply, production can stop. That can affect sales, cash flow and ultimately loan repayment.

Vinu: How do we identify whether the dependency is significant?

Manu: Start by examining the percentage of total purchases made from the top suppliers. For example, suppose the borrower’s annual purchases are ₹10 crore:

Vinu: Is a high percentage always risky?

Manu: Not necessarily. We must understand why the dependency exists. The supplier may offer superior quality, competitive pricing, reliable delivery or longer credit terms. In some industries, only a few approved suppliers may be available.

Vinu: What questions should we ask the borrower?

Manu: We should ask:

Vinu: Why is the supplier’s location important?

Manu: Location brings additional risks. An overseas supplier may expose the borrower to import restrictions, foreign exchange fluctuations, shipping delays and geopolitical events. A supplier located in a disaster-prone or politically sensitive region may also create continuity risk.

Vinu: What if the borrower depends on a supplier for a specialised component?

Manu: That requires deeper scrutiny. If the component is technically unique or protected by a patent, changing the supplier may take months. The borrower may need fresh product testing, customer approval or regulatory clearance before using an alternative.

Vinu: Which documents can help us verify the dependency?

Manu: Review purchase registers, GST returns, bank statements, creditors’ ledgers, invoices, purchase orders and supplier agreements. We should compare at least two or three years of purchases to see whether the concentration is increasing.

Vinu: Should we also examine the supplier’s credit terms?

Manu: Yes. Suppose the supplier currently provides 60 days’ credit. If it suddenly demands advance payment, the borrower’s working-capital requirement will rise sharply.

For example, monthly purchases may be ₹80 lakh. Losing 60 days’ credit could create an additional funding requirement of approximately ₹1.60 crore. That can put immediate pressure on the cash-credit account.

Vinu: Can supplier dependency affect the borrower’s profitability too?

Manu: Certainly. A dominant supplier may have strong bargaining power. A 10% increase in raw-material prices may not be fully passed on to customers. The borrower’s gross margin and cash accrual can then decline.

Vinu: How do we assess the borrower’s ability to handle such a situation?

Manu: Conduct a sensitivity analysis. Check the impact of:

Vinu: What are the major warning signs?

Manu: Some important warning signs are:

Vinu: How can the borrower reduce this risk?

Manu: The borrower can develop multiple suppliers, maintain safety stock, enter into long-term supply contracts, identify substitute materials and secure alternative transport arrangements. For imported materials, appropriate foreign exchange risk management may also be necessary.

Vinu: Can the bank include safeguards in the sanction terms?

Manu: Yes. Depending on the level of risk, the bank may require the borrower to:

Vinu: Should we reject a proposal merely because supplier concentration is high?

Manu: No. Concentration alone should not decide the proposal. We must examine the supplier’s reliability, length of relationship, availability of alternatives, contractual protection and the borrower’s contingency plan.

Vinu: So what should our final appraisal note capture?

Manu: It should clearly state the supplier-wise purchase concentration, reasons for dependency, possible operational and financial impact, alternative sourcing arrangements and proposed risk mitigants.

Vinu: Then the real question is not simply, “Who supplies the borrower?”

Manu: Correct. The stronger credit question is: “Can the borrower continue operating and servicing the loan if its key supplier fails?” That is the essence of assessing supplier dependency risk.

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