Chinese Shadow Banking and the Rise of the Bank of Foxconn

China has only been open for business for 25 years or so, and prior to that had no particular standards for accounting or banking.

It’s common to evaluate potential supplier and supply chain partner’s financial position before placing an order or signing a contract.  In fact, most purchasing departments these days, require obtaining supplier key financial data as a standard part of the procurement process.

This financial data is then evaluated by the company finance or accounting department and the risk associated with the supplier or supply chain partner is determined.  If the supplier is a publically traded U.S. company, that’s easy to do as these companies must comply with SEC rules on financial reporting. But you should be leery of accepting information provided by Chinese suppliers at face value.

Chinese accounting, and all Chinese business operations for that matter, are different and somewhat immature as compared with practices in the Western world.

After all, China has only been open for business for 25 years or so, and prior to that had no particular standards for accounting or banking. In addition, requirements such as VAT are just now being deployed. The application of overhead may be different, and cost accounting may follow different rules. While China is making headway in applying global accounting standards, it will be a while before buyers can depend on the information provided by Chinese suppliers.

In addition, China’s largest banks typically only lend to the largest corporations, leaving small and medium sized suppliers to obtain loans from friends and relatives or from a “shadow bank.”  Shadow banks are private lending companies that are not regulated by the Chinese government.

These shadow banks lend money at a much higher rate of interest, squeezing the small suppliers’ already-thin profit margins.  So if you are buying from a Chinese supplier, you should ask and verify where their working capital comes from. You just might find that some suppliers cannot make their loan payments and will simply shut their doors and disappear, leaving you scrambling to find another manufacturer. Finding working capital in China is risky business.

Enter: The Bank of Foxconn.  Foxconn, the world’s largest contract manufacturer and maker of iPhones, iPads and many brands of laptops, has ventured into the lending world. To protect its suppliers from the pitfalls of shadow banking in China, Foxconn is now making business loans.  That makes Foxconn the banker for the world’s electronics supply chain.  And Foxconn isn’t the only company to provide banking services in China. Baidu (the “Google” of China), Alibaba (the “Amazon” of China) and Tencent ( WeChat and mobile games) all have lending banks, too.  Lending to small and medium businesses provides higher returns to Foxconn than they can make on their contract manufacturing business. It also provides an opportunity for suppliers to borrow at a lower rate than from shadow banks. Foxconn reportedly has obtained licenses from Chinese local governments to provide loans, factoring, financial guarantees and equipment leasing.

When evaluating suppliers, be sure to ask where their funding comes from, and don’t be surprised if the answer is the Bank of Foxconn.