Will China have a banking crisis? Beijing's massive credit stimulus will almost certainly lead to a future surge in bad loans, but so what? As the more optimistic of China analysts have pointed out many times, the last jump in non-performing loans a decade ago was also widely cited as a sign of impending doom, and yet nothing happened. China grew its way out of the loan mess at little apparent cost.
But did it? The optimists have almost certainly failed to understand how Beijing paid for its earlier banking crises. In fact, the cost of resolving the previous surges in non-performing loans exacerbated China's domestic imbalances. The current build-up of bad debt may very well do the same.
Beijing used three main tools to manage previous increases in bad loans, all of which passed costs on to bank depositors. First, the central bank slowed the accumulation of non-performing loans by keeping lending rates low. Low borrowing costs made it easier for struggling businesses to roll over the debt as the economy grew and reduced the real value of debt payments.