If 10 percent of these loans turn bad, a very conservative estimate, we are talking about total bad loans in the range of 1 to 1.4 trillion yuan. If the share of dud loans should reach 20 percent, a far more likely scenario, Chinese banks would have to write down 2 to 2.8 trillion yuan, a move sure to destroy their balance sheets.
According to Pei, China’s problems are masked by the existence of a large shadow banking system, which has emerged to evade strict government control over official banks. This is not a trivial matter: These shadow banks may account for as much as 11.5 percent of total bank deposits. These invisible high-risk loans could turn into another trillion yuan in bank losses.Finally, state banks’ official books may also be greatly misleading, since they have been using interbank loans to mask losses in real estate loans. Interbank loans have increased by 70 percent since 2009.The Chinese stimulus may give way to a painful hangover.