Trade finance has been an unfortunate casualty of the banking contagion that came with the global financial crisis. Companies placing large export orders in China often rely on letters of credit to keep the wheels turning. When a bank issues a letter, it stands as a guarantor of the company’s ability to pay for the goods so suppliers can make the shipment confident in the knowledge they will be paid. But these letters are becoming increasingly unappealing to many in the business.
"Letters are available, but the cost is so high that no one will do it," said Steve Dickinson, a partner at Harris & Moure, which has numerous clients in the sourcing business. "The bank takes some risk on the letter and they are not comfortable with this right now."
According to Ross McGregor, managing director of manufacturing and sourcing company Rapid Offshore Group, there may be good reason for this discomfort. There have been cases in which buyers take out loans so they have enough money in the bank to get a letter of credit only to disappear when they can’t pay off their debts. The bank that issued the letter is obliged to settle the payment with the supplier’s bank.
This has led to accusations of fraud hurled between the two banks as they try to pin the blame – and the financial responsibility – on each other.
Although the situation is expected to right itself – possibly under government direction – this won’t solve all exporters’ problems. Wary of letters of credit, many Chinese companies prefer to receive 30% of the payment up front and 70% just before delivery. This means the supplier at least has some working capital with which to purchase raw materials.
However, Richard Brubaker, managing director of China Strategic Development Partners, has experienced situations in which the buyer has still backed out, even though it cost 30% to do so. "The supplier was left with some raw materials and just had to scrap them," Brubaker said.
In some cases, not even 30% of the order is recovered. Many suppliers have been working with particular customers for years, and so they agree to receive full payment at a certain date rather than take money up front. In the current climate, this has some worried.
"Since September our customers have been asking to extend the payment period by an extra month," said Norman Wong, general manager of Fook Lung, which provides corrosion resistant finishings for door lock sets, mostly for export to the US. "We have good relations with these customers, but now it is November and we still haven’t received payment."