Supply Chain Finance: Designing Supplier Monitoring Incentives for Bank-Financed Retailer Inventory

Bank-funded supply chain finance can support retailers’ inventory purchases, but compensating core suppliers for hidden monitoring effort can reduce lending profits. This study examines how banks should design monitoring incentives for core suppliers that sell inventory to cash-constrained retailers. The contribution of the three-party principal–agent model is to link supplier trading earnings, the retailer’s order and borrowing response, and the bank’s default recovery. Least-cost supplier contracts are derived under participation, incentive and payment-floor constraints, and illustrative financing offers are compared on nested grids. The illustrative results show that baseline financing supports larger retailer orders and higher retailer profits than self-financing, while low monitoring effort is preferred because the additional recovery from high effort is outweighed by its incentive cost. Lower effort costs and more informative signals can make high effort preferable without increasing retailer orders. A common minimum supplier payment reduces bank profitability and, when sufficiently high in the tested scenarios, leads to no financing. These illustrative grid findings support assessing monitoring’s recovery gains against incentive costs and retailer responses; they do not establish a continuous-offer equilibrium.