Chinese Shadow Banking

Shadow banking or curbside lending is the way many merchants and manufacturers in China go about securing business loans. These small businesses could not otherwise secure a bank loan because they do not have the collateral required for security. So instead, they turn to individuals in their network for micro loans, often at annual interest rates of 30% - 40%. Loans are typically small (less than $50,000), and are paid back quickly in 3-6 months.

Sometimes this short-term borrowing is for the purchase of raw materials to support a manufacturing opportunity. Perhaps these borrowers have been asked by a friend or relative to be a subcontractor on a project that requires immediate working capital. Instead of a traditional bank loan, they turn to the unregulated shadow market. If you know anything about the concept of Chinese Guanxi, (http://en.wikipedia.org/wiki/Guanxi), you can understand how China is the idea setting for this casual system of loaning money.

According to Bloomberg News, this shadow financial market is worth an estimated $5 trillion. No small potatoes.

So how do these loans affect your supply chain and why should you be concerned? First, these small manufacturers may be supplying parts, subassemblies or complete products to your primary suppliers. With very high interest rates and a fast turn-around time to make a profit, it is inevitable that these manufacturers or subcontractors will be cutting corners any way that that they can to save time and reduce costs. And with cutting corners, comes quality issues. Remember the lead paint on Mattel toys a few years back?  That was a case of subcontractors cutting corners to fill orders for the Christmas holidays. While we don’t know if the Mattel case involved shadow banking, it certainly involved lack of control over subcontractors.

The lesson is clear: You must know all the links in your supply chain. If your Chinese manufacturers are dealing with subcontractors (and they most likely are), find out who these subcontractors are and audit them. Prepare your questions in advance and know what you want to see before you go to their manufacturing site. Include questions about how long they have been in business and ask for references. Visit while your products are in production. Test parts and subassemblies for required quality, just as you do on finished products. It is worth the investment to get reliable test results from a recognized lab such as Bureau Veritas or SGS.

When dealing with Chinese suppliers and subcontractors, “trust but verify” is the best advice.

SC
MR