The pathology of the western financial crisis is all too familiar: misallocation of capital fuelled by cheap credit and lax regulation, a proliferation of investment vehicles with limited credit assessment, and systemic biases predicated on ever-rising real estate prices. We should worry, then, that Chinese banks may be facilitating a home-grown version, especially as they plan to raise $30bn-$50bn in capital over the coming year.

The particular concern is the estimated Rmb3,000bn ($450bn) of local infrastructure loans extended in 2009, representing 30 per cent of the record new bank lending last year. Many were non-recourse loans to provinces, municipalities and counties through shell companies, known as Urban Development Investment Corporations (UDICs). Some went to fund projects backed by assets, such as commercial real estate, others to projects with future cash flows such as subways and toll roads. Still others are social in nature and backed only by an implicit guarantee of the City/Provincial Investment Holding Corporation (CIHC). Most UDIC loans have sparse local equity and limited cash flow prospects for repayment. For the time being, local governments and CIHCs can plug interest payment gaps with healthy land sales, which totalled Rmb1,600bn in 2009, as well as central government transfers. The UDIC liability is estimated at close to RMB6,000bn or 14 per cent of the outstanding loan base. A 30 per cent default rate would in effect wipe out the paid-in capital of top banks such as China Construction Bank and Bank of China.

Chinese state entities have a poor record in preventing faulty provincial lending practices and low quality asset formation. During the 1990s Asian financial crisis, the Guangdong International Trust went bust, in spite of an implicit Guangdong state government guarantee. Today's robust balance sheets of the listed, state-controlled banks are the result of an $800bn carve-out of non-performing assets by four state-backed asset management companies, which are reportedly recovering about 20 cents on the dollar.