China facing possible debt crisis

China's banking sector could be facing an imminent debt crisis, a global central bank watchdog has warned, fuelling fresh fears about a blowout in the world's number two economy that could hit the world economy.

The Bank for International Settlements (BIS) -- dubbed the central bank of central banks -- said a gauge of Chinese debt had hit a record high in the first quarter of the year.

China's credit-to-GDP gap reached 30.1 percent in the first quarter of 2016, its highest level ever and far above the 10 percent level associated with banking risks, the Switzerland-based bank said in a quarterly report released late Sunday. 

The gauge measures the difference between the credit-to-GDP ratio and its long-term trend.

The BIS gave China a red signal, a level it said was intended to indicate the possibility of a financial crisis in the three years ahead.

China's total debt hit 168.48 trillion yuan ($25 trillion) at the end of last year, equivalent to 249 percent of national GDP, the China Academy of Social Sciences, a top government think tank, has estimated.

The warning comes as Beijing tries to avoid a so-called hard landing for the economy while transforming it from one based on state investment and exports to consumer-led growth.

Analysts have warned that the ballooning borrowing risks sparking a financial crisis as bad loans and bond defaults increase.

Because China is a key driver of world growth, a crisis in the country's banking sector could have catastrophic implications around the world, with the global economy still struggling to recover from the 2008 financial crisis.

China's credit-to-GDP gap for the period was well above all other countries in the survey, which covered 43 economies including the United States, Greece, and the United Kingdom. 

The BIS early-warning indicators are intended to capture "financial overheating and potential financial distress" in the medium term and to highlight that rapid credit growth could "sow the seeds" for future crises, it said. 

China's "Big Four" state-owned banks reported mounting bad loans in the first half of the year, and earlier in the summer an official with the banking regulator said lenders had written off more than $300 billion of bad loans in the past three years. 

Chinese authorities have unveiled a set of policies intended to tackle the problem of souring loans, including debt-for-equity swaps, and analysts say the country's vast foreign-exchange reserves and control over the banking system could help cushion the economy from financial crises.

"The debt problem (in China) is serious, but the risk of a hard landing or banking crisis is, in my view, low," Andy Rothman, China specialist at Matthews Asia, said in a note.

He added tha most potential bad debt is held by state-controlled companies and banks, giving Beijing control over the pace of recognising and dealing with bad loans.  

"Cleaning up China’s debt problem will be expensive, but this process is likely to result in gradually slower economic growth rates, greater volatility, and a higher fiscal deficit/GDP ratio, not the dramatic hard landing or banking crisis" that many fear, he said.