Chinese shares drop as investors wonder about the soundness of China’s banking system

China’s main banks are publicly owned. In July they continued to lend to stimulate economic recovery. But increasingly observers are convinced that most of the money is going into speculative ventures and will be hard to collect. The mainland’s financial institutions can thus be certain of huge losses. 

The market may even lose a further 10 per cent over the next few days as lending tightens, said Andy Xie, a former chief Asia-Pacific economist for Morgan Stanley, now an independent economist.

An estimated 1.16 trillion yuan of loans were invested in stocks in the first five months of this year, China Business News reported on 29 June, citing Wei Jianing, a deputy director at the Development and Research Center under the State Council, China’s Cabinet. This could lead to a speculation bubble.

A constant feature of developing economies is easy lending, which entails greater risks of default, the more so if the economy is state-run rather market regulated. One example is Nigeria, where the central bank recently published a list of more than 200 customers, including companies and state governments, that might default on loans worth US$ 2.6 billion, with great risk on the liquidity of the lending institutions (for more on the subject, see Maurizio D’Orlando, “Signs of a new financial storm for September coming from Dubai and Saudi Arabia,” in AsiaNews, 1 June 2009).

For analysts a certain cautious optimism can be envisaged because the expected adjustment will be small even if it has not yet worked its way through. However, investors are still not convinced by China’s economic recovery. They are concerned that good results in the second quarter of the year (7.9 per cent expansion) are mainly due to Beijing’s stimulus package (4 trillion yuan or US$ 550 billion), the more so since exports, which are the driving force of China’s economy, are not picking up.

At present, everyone is waiting for the Chinese government to step in to protect investors as it did several times in the past whenever markets were hard pressed.

After a quiet start of the day, Shanghai’s tumble dragged down other Asian bourses. In Hong Kong shares lost 1.7 per cent. In South Korea the Kospi Index finished down 0.28 per cent. In Japan the benchmark Nikkei shed 0.8 per cent. Indian shares dropped 1 per cent in early trade.

In Hong Kong the mainland’s big banks were the main losers. The Bank of Communications, the fifth lender in the country, was down 1.2 percent. The world's second-largest lender, China Construction Bank, fell 1.9 per cent, whilst the Bank of China dropped 2.1 per cent.