Some super bears are now expecting an imminent collapse of China’s banking system and currency’

Jim Edwards | 16/02/2016 | Business Insider

China’s banking sector is now so big that if it lost only of 10% of its outstanding loans to defaults, that would be the equivalent of wiping out about 30% of China’s annual gross domestic product, according to UBS economist Tao Wang.

That scenario would require an immediate bailout of China’s banking system, which is now the largest in the world, Wang says, so “some super bears are now expecting an imminent collapse of China’s banking system and currency.”

But don’t freak out, Wang says. The China “super bears” are wrong, and everything will be just fine.

Wang’s discussion of the state of the Chinese financial sector comes in a note titled “Do the Facts Support the Super Bears?” The note is crucial reading for China watchers because it states in simple, stark terms just how big Chinese banking credit actually is, in the context of the flight of capital from China.

It then adds a nuanced understanding of how Chinese banking works — i.e., not the same way as it does in London and New York. Wang concludes that fears that the low-quality credit market in China is so large it could create a new global financial crisis are overblown. We’ll explain why in a moment.

But first, here is the problem with China’s banks, as stated by Wang:

China’s banking sector is 340%* of GDP, 10% loss would be over 30% of GDP or more than $3.5 trillion, which would require an immediate and large bail out.

… some super bears are now expecting an imminent collapse of China’s banking system and currency. The latest super bearish view goes like this:

• The RMB has appreciated by over 40% and become significantly overvalued on a real effective basis, requiring a huge depreciation to correct China’s imbalances;
• The rapid credit expansion of the Chinese banking system will result in unprecedented losses which requires an immediate large bail out;
• China would need to use FX reserves or embark on major QE to recapitalize its banks;
• China’s official FX reserves include CIC [China Investment Corporation] holdings and policy bank recap funds, and are already inadequate.

But none of that will happen, Wang says, because China will “muddle through.” The government has the ability to restructure, renegotiate, and generally stave off nonperforming loans that would be poison inside a more private system that had to answer to shareholders.

*Wang’s note describes bank assets as both 290% and 340% of GDP. In an email Wang clarified that 340% is what the “super bears” claim; 290% is UBS’ estimate based on official data.