China’s Bank Stress Tests Assume Property Bubble Burst

China’s latest stress tests for its banks include a simulation in which property prices fall by almost two-thirds in the most overblown markets, according to a Bloomberg report. Previous stress tests had no more than a one-third drop in property prices as a worst case.

The latest tests, apparently ordered last month, suggest regulators are increasingly concerned about the property bubble bursting, leaving banks with huge bad loans on their books in the wake of last year’s record $1.4 trillion of new loans. Authorities have been reining in new property lending since April. This has halted the growth in property prices but in the 70 cities monitored prices were still up 11.4% in June over the same month of 2009.

The fear is that a 60% stress test implies the banking regulators expect that sort of fall in some cities. That would not be an unreasonable assumption given that prices in cities like Beijing and Shanghai have doubled in this bubble. (Our abacus reminds us that a 60% fall in a price means it had to rise 150% in the first place to end up where it started). In which case, a second bail-out of the big banks’ balance sheets can’t be far behind, though heaven knows what can be done about the shadow banking system. Not much that is too big to fail there, though in the aggregate it will be a mess.

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