Visibility, Risk, and the Recent China Metals Fraud

I did a recent post talking about how Commodity trade is financed given many of hte traditional European banks losing access to USD deposits, and hence, the ability to finance commodity trades which happen to be mostly in USD. See - Commodity Trade Finance – Still the Banks’ Domain

And then the WSJ posted the article on how Chinese commodity traders are using collateral to double (triple, etc.) dip on loans.  Stuart Burns from our sister site MetalMiner, in his piece What China's Shadow Metal Financing Means for Markets, indicated “The nub of the problem is that funds secured from long-dated letters of credit issued for the import of certain commodities and collateralized on the value of those commodities has been used to make loans at higher interest rates to organizations that could not normally borrow at commercial rates from the banks.”

It got me thinking that you can change the asset (invoice, copper, Prime mortgages) but that discipline of knowing what you are buying, ensuring proper risk mitigation, and having controls in place is relevant no matter what you buy.

Strange how we live with so much tracking technology these days, I mean we are literally a data stream with our cell phones, we have RFID that has been around for well over a decade and we have Google Earth and yet we cannot adequately control for inventory fraud.

One of the key conclusions in the WSJ article is the Western banks will stop funding these types of deals. I think the bigger story here is that fraud continues at these banks (Citi’s unit in Banamex has a $400 million fraud on its hands) and you have to wonder what controls lenders have in place.

It reminded me of the Seinfeld episode where Jerry reserves a car at the airport and they dont have a car and he goes, you know how to take the reservation, you just dont know how to hold the reservation, and that’s really the most important part of the reservation, the hold. So it is true with loans. What matters is not making the loan, but getting paid back.

In this day and age of P2P lending, auction markets for receivables, transactional lending off of networks, etc. there are many risks to monitor, and none more important than fraud. With regulations tightening on how to move money globally – FACTA as an example, smart crooks find ways of overinvoicing, underinvoicing, double invoicing, or various other schemes. Certainly transactional networks can control for this if the data is there and scrubbed appropriately, but for many, trust and control needs to be the mantra of the day.
If we don’t, this will have a major impact on pricing loan deals. The more visibility, the more you control cash dominion, the more you have quality data, the better underwriting decision and the better price for the deal, and everyone wins. There is a reason factors only advance partial sums to suppliers at double digit rates. They lack the visibility into the invoice beyond it being issued. Therefore, part of their risk controls is to hold back cash and the supplier pays dearly for the additional costs to underwrite.

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