China’s central bank steps in to calm fears over banking crisis

Two system failures at China's banks this week point to what could turn out to be major banking crisis with global implications. An ATM network failure at the world's largest bank by market value, the Industrial and Commercial Bank of China, collapsed last Sunday, leaving millions without access to cash while a failed transfer system at the Bank of China, the next day saw similar chaos.

Though official circles have chosen to downplay the incidents, commentators say there could be much more to these outages than mere technical snags.

Commentators point to a looming banking crisis on a scale hard to imagine, thanks to the country's unregulated shadow-banking system.

This opaque secondary lending market involves vast webs of trust companies, insurance firms and other finance houses, that fall outside the often strict rules that apply to the official banking sector.

The size of the secondary market, with huge sums tied up in speculative loans as also sub-economic infrastructure investment, has been estimated by ratings agency Fitch's at around 60 per cent of China's GDP, or $5 trillion.

In a sign that the crunch may be coming, short-term rates have skyrocketed, indicating that banks are getting very nervous about the health of the counter-parties they are dealing with.

There have been unconfirmed rumours that at least one sizeable Chinese bank had missed a payment, and until a recent intervention by the country's central bank to inject liquidity, there was market talk of a credit freeze.

Meanwhile with its indication this week of a willingness to inject liquidity into the markets, the People's Bank of China brought the financial system much needed relief with the possibility of avoiding a ''Lehman moment''.

The current credit crunch, which a saw marked reluctance of the part of the central bank to act as the lender of last resort, was different from two previous episodes, of the late 1980s and early 1990s.

It also showed that the country's approach to macroeconomic governance had evolved, with its leadership no longer going solely on political and administrative controls, but letting the market forces play a greater role.

According to commentators through the 1980s, the central bank had to relied much on enforcement of credit quotas to keep the  economy from overheating, with reserve requirements by the central bank to regulate credit to the banking system.

The first crunch, in the late 1980s, stemmed from a failed price-reform effort led by premier Deng Xiaoping. It was essentially supposed to unify the dual-track pricing system into a single regime based on market prices, but it lacked complementary wage reform, which finally led to inflation.