Australian banks take China punt

Although the bursting of China's credit boom would have serious consequences for investors in resource stocks, shareholders in Australia's biggest banks have plenty to be concerned about, too.

Conventional wisdom holds that local banks mainly have an indirect exposure to China. The rupturing of the Chinese credit bubble would devastate the Australian mining sector, causing unemployment to rise and likely leading to an increase in home loan defaults while also potentially leading to falling house prices.

But Australian banks are now increasing their direct exposure to the country at a very rapid rate - the fastest in the world in fact - according to new research from the Bank of International Settlements (BIS), the bank of central banks.

According to the BIS, foreign banks are on the hook for about US$800bn in China. And if you include stuff like derivatives and credit guarantees, the total figure exceeds a trillion dollars. That's quite a lot of money, even by big bank standards.

But in comparison to the prelude to the Global Financial Crisis, when the world's biggest banks led the way to the party, in China they're latecomers, banging on the door just as everyone is searching for their keys.

The BIS estimates that in 2011 the direct global bank exposure was about US$400bn, a figure that excludes all the funny stuff like derivatives. But within three years that figure had doubled.

Not only that, this rush into China has occurred after many commentators, including renowned short seller Jim Chanos, began calling China a bubble in search of a pin-prick. It's not going to look good if the place blows up now.

The most worrying aspect for investors in the big four Australian banks is not the banks' overall level of exposure. At only 1.2% of the total, it's pitifully small and nothing against the UK banks' share approaching a huge 40%.

The real concern is the rate of growth. Over the last five years Australian bank lending to China has grown at 70% a year, almost twice the rate of growth of UK bank lending to the country, which itself is pretty impressive.

IBS figures don't break down sector lending by country but with non-bank lending - known as shadow banking - growing at a faster rate than more conventional lending, there's a good chance that a fair proportion of this growth is going to institutions most likely to go under in a crisis.

What does all this mean? That a few more years of growth at these kinds of rates and the Australian banking sector could have tens of billions of dollars stuck under the pillows of China's shadow banks.

Fitch Ratings reckons the risk of a China crash is a low probability but high-risk event, especially to countries in the Asia-Pacific region.

But still, maybe something to think about next time ANZ's (ASX: ANZ) Mike Smith raves about the growth potential in the Asian banking system.

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