Plans for a stricter test of the country's banking system look good on the surface, but they could really be a sign that more capital is needed to face troubles ahead.
Now that's a stress test.
Bank regulators in China said on August 5 that the country's stress test of its banks will include a worst-case drop in real estate prices of 50% to 60% in the country's most speculative markets.
Take that, euro zone, and even the United States, where stress tests of the banking system—which showed just seven and ten banks, respectively, needed to raise additional capital—have been widely criticized as too lenient.
But before you start cheering on news that a country is finally getting tough on testing its banks, consider this possibility: China is publicizing how tough its test will be not because it thinks its banks are in good shape (and will pass an honest test), but because is becoming increasingly worried that investors are losing confidence in the country's banks just when those banks need to raise billions in new capital to fix portfolios swamped with bad loans.
In other words, consider the possibility that what looks like a sign of strength is actually a loud signal of growing weakness in China's banking sector.
Is the Game Rigged?
Hey, it wouldn't be the first time a country cynically designed a stress test with the purpose of reassuring investors that its banks were safe, would it? The euro and US stress tests were exactly that kind of exercise, after all.
Think I'm being too cynical? Can you be too cynical about bank accounting in any of the world's markets?Well, look what happened after regulators announced the new test. (The last stress test of China's banks assumed a 30% worst-case drop in real estate prices. Sure doesn't look like things are getting better for bank balance sheets, does it?)
On August 5, shares of property developers plunged on the Shanghai stock exchange on news of the new test, and shares of the country's big banks followed. It was the worst drop for the sectors in three weeks. The market seemed to think that the new worst-case scenario in the test was a sign that the government was getting more worried about real estate loans.
On August 6, bank regulators rushed to reassure investors that the stress test didn't mean that at all. The worst-case scenario isn't a sign that regulators are predicting a 50% to 60% drop in real estate prices, the China Banking Regulatory Commission said, or that regulators are looking to impose even tougher controls on bank lending and mortgages.
Regulators are simply being prudent, and regulators will simply continue to instruct banks to "resolutely" curb speculation.
The Shanghai Composite Index climbed 1.4% on the reassurance. Bank regulators, I'd say, have at least one eye on stock prices.
NEXT: Stress Test, Version 2.0