Invoice factoring companies and banks that are financing clients with ties to China should read this article. For years, China’s economy was humming along at record GDP growth rates even when compared to similar developing countries like India. For years, China’s GDP rates were in the 8-9% growth rate range and India’s GDP was in the 5-6% range, but over the last couple of years, the Chinese economy has precipitously fallen.
The problems in China are wide spread but the greatest problem is a government that thinks their economic decisions are better than the efficiencies found in a free market system making the decisions. With that said, the most obvious problems facing the Chinese economy are structured over capacity, inflation, and now, negative capital outflows.
Many of these major economic issues manifest and begin at the factory level which most US banks and invoice factoring companies have exposure to. Factoring companies that finance importers and/or exporters are exposed by the virtue of the product that is made by their Chinese supplier(s). It is difficult to find a lenders’ portfolio these days that does not have exposure to China. Factoring companies and banks must realize that financing suppliers in China presents more risk than ever before. If the risk is not apparent, then ask yourself if Walmart, or any other major retailer that your client has open invoice with, if these retailers will take deductions from the current a/r if their supply chain or supply of product is interrupted. It’s a dangerous game if you do not have eyes and ears on the ground in China monitoring critical supplies for your client. Most of the suppliers in China are going out of business because there is over capacity which has been engineered into the system by the Chinese government in order to create jobs for the last several decades. Productivity is now becoming important in China as labor rises due to inflation. Therefore, inflation and job loss in China are now everywhere…and potentially out of control for even the Chinese government to manage.
The Chinese factory owners are also taking measures to send capital out of the country which has been pushing down the Chinese Yuan (also known in China as the RMB). Normally, the capital flows move to Hong Kong for safety as the Hong Kong Dollar (HKD) is pegged to the US dollar (USD); however, the capital flows are now moving quickly out of Hong Kong and Hong Kong is having a hard time maintaining its peg to the USD. Most do not realize but Hong Kong as an equal amount of USD for every HKD. For the first time in years, Hong Kong will now probably move its peg significantly by end of year.
For US lenders in Asia with RMB denominated loans, the deterioration of the currency may be greater than even the profit earned this year. Unfortunately, the outflows of currency are a self-fulfilling prophecy in regards to currency depreciation, and the depreciation’s acceleration is increased by a negative feedback loop as the devaluation worsens in both China and Hong Kong.
Having an extra level of credit to review suppliers’ strength is more necessary than ever due to the many factories shutting down. Factories are closing at record levels not seen before. How does an invoice factoring company’s trade finance department prevent losses? The following are suggested way to prevent losses:
- Visit your clients’ largest suppliers;
- Have mini audits of all of your clients’ major suppliers at least once a year (if not more);
- Use third party audit firms to check product production quality;
- Confirm in writing all orders and dates that the Chinese factory will be required to finish (make sure paperwork is chopped by factory to authenticate approval);
- Hedge RMB denominated loans if possible;
- Invest in an International Credit Insurance Plan while lending in Asia;
- Make sure to have experienced underwriters and account managers in Asia to manage daily activity (or outsource it!).
Taking a few extra precautions will make invoice factoring and related financing a lot easier.
Stephen Perl, CEO
Author: Secrets of Doing Business with China: Dancing with the Dragon (2012) (Amazon)
Stephen M. Perl, MS, MBA is the CEO of 1st PMF Bancorp, a leading US commercial bank lender, and the founder and CEO of ChinaMart® Los Angeles, a platform that assists Chinese companies in their investment in the USA.