China's yuan. Picture: REUTERS/KIM KYNG-HOON
China's yuan. Picture: REUTERS/KIM KYNG-HOON

BEIJING — China’s banking sector could be facing an imminent debt crisis, a global central bank watchdog has warned, fuelling fresh fears of a blowout in the world’s second-largest economy which could hit the global financial system.

The Bank for International Settlements (BIS) — dubbed the central bank of central banks — said a gauge of Chinese debt had hit a record high in the first quarter of the year.

China’s credit-to-GDP gap reached 30.1% in the first quarter of 2016, its highest level ever and far above the 10% level thought to present a risk to a country’s banking system, the Switzerland-based bank said in a quarterly report released late Sunday. The gauge measures the difference between a country’s current credit-to-GDP ratio and its long-term trend.

The BIS gave China a red signal: a warning that it could face a financial crisis in the next three years.

China’s total debt hit 168.48-trillion yuan ($25-trillion) at the end of last year, equivalent to 249% of national GDP, the China Academy of Social Sciences, a top government think tank, has estimated.

The warning comes as Beijing tries to avoid a "hard landing" for the economy while transforming it from one based on state investment and exports to consumer-led growth.

Analysts have warned that the ballooning borrowing risks sparking a financial crisis as bad loans and bond defaults increase.

Because China is a key driver of world growth, a crisis in its banking sector could have catastrophic implications around the world, with the global economy still struggling to recover from the 2008 financial crisis.

China’s credit-to-GDP gap for the period was well above all other countries in the survey, which covered 43 economies, including the US, Greece and the UK.

The BIS early-warning indicators are intended to capture "financial overheating and potential financial distress" in the medium term and to highlight the fact that rapid credit growth could "sow the seeds" for future crises, it said.

China’s "Big Four" state-owned banks reported mounting bad loans in the first half of the year. Earlier in the summer an official with the banking regulator said lenders had written off more than $300bn of bad loans in the past three years. Authorities have unveiled a set of policies intended to tackle the problem of souring loans, including debt-for-equity swaps.

Analysts say the country’s vast foreign-exchange reserves and control over the banking system could help cushion the economy from financial crises.

"Cleaning up China’s debt problem will be expensive, but this process is likely to result in gradually slower economic growth rates, greater volatility, and a higher fiscal deficit/GDP ratio, not the dramatic hard landing or banking crisis" that many fear, said Andy Rothman of Matthews Asia in a note. And because most potential bad Chinese debt is held by state-controlled companies and banks, Beijing has control over the pace of recognising and dealing with bad loans, he said.

But the impact of a debt crisis could be widespread, the International Monetary Fund has warned. Its number two official David Lipton said this summer it was "crucially important" for the world economy that China tackle its debt problem, since "we have learned over and over in the past 20 years how disruptions in one country’s economy and markets can reverberate worldwide".

The risk of a debt crisis in China remains manageable "though it’s undoubtedly growing," Qiang Liao, senior director at S&P Global Ratings, said, adding that the global impact of such a crisis through disrupted trade flows, investment, and changes in risk appetite "could be huge, given the size of the Chinese economy".

AFP