China's plan to prop up the price of bank shares by buying in the market is a Band-Aid at best. While it delivers a strong message the state will stand behind its four largest lenders, whose shares are languishing below their financial crisis low of 1.5 times prior-year book value, it won't spare them from the trouble that looms.
Two risks weigh on the Bank of China and its peers. One is that the property market, to which they are all highly exposed, may be about to pop. Developers are highly leveraged and could be running out of cash, especially after last week's slump in holiday-season home buying in big cities. Many have borrowed from short-term "trusts," which depend on a steady stream of new investors. Were a developer to go bust, the chain reaction would link back to the banks.
The other risk is in the hyperactive "shadow bank" sector. Tight lending restrictions have pushed smaller borrowers to informal channels, where those who can borrow cheaply lend expensively to those who can't. This peer-to-peer market may account for 8 per cent of total local-currency loans, Credit Suisse Group estimates. Wenzhou, a city known for its entrepreneurs, has been particularly enthusiastic, leading Premier Wen Jiabao to visit in person and call for restraint.
The risks to Chinese banks are hard to quantify. Bad loans are reported at just 1 per cent of the total loan book. That number is largely meaningless, however, given how fast the denominator has grown. Structured financial products that banks technically have no responsibility to backstop may end up on their balance sheets anyway, if excessive defaults threaten the social order.
Buying bank shares doesn't meaningfully address these problems. It may make depositors feel safer and coax investors back to the market in the short term. And Beijing is right to worry that a big shock could drive trillions of yuan in savings back inside mattresses. But if the worst comes to pass, there may be more urgent uses for state capital than propping up the share prices of banks, like plugging the holes in their balance sheets.