This year, for the first time, China's state sector registered a net loss since the economic reform began some 20 years ago. Facing with such a mess in its fiancial system, Beijing is scrambling to stem the rise in bad loans. It revoked the power of central bank branches to fund local banks, a system that is just like relationship-based lending in commercial banking system, plagued by cronysm. Beijing also began pressing banks to clean up their loan portfolios by writing off bad loans against their earnings, something that was never done before. However few banks have done this so far.
More serious reform is underway.
The government recently proposed plans to give the banks a new start, including transferring all existing bad loans to a special state bank. Some predict that China will probably settle on a mixture of capital infusions to help state firms to repay defaulted loans, converting bad loans to equity in the borrowers and the securitization of problems loans so they can be sold to public investors. Nevertheless, that would only clear up the stock, not stop the creation of new bad loans. And that can only happen through a banking crisis that clenas out old cronies, according to Wall Street Journal. An Academy of Social Sceinces economist predicts that there will be a banking crisis in 5 or 10 year, triggered by massive deposit withdrawls amid political instability and hight inflation.