Stress test in China?

Beijing was eager to hear the results of the fiscal health check-up for 130 banks in Europe announced last weekend. While the majority passed, 13 banks fared so badly that they were deemed to have failed, their main weakness being lack of capital. Overall, the results were encouraging, which is just as well. The question remains as to whether anyone actually wanted to hear the European Central Bank's realistic appraisal in the first place.

In China, political considerations play an even greater role. But a straight-talking verdict on China's financial situation would be a good thing - and indeed relevant to the entire world. The country is home to over 4,000 banks, together worth more than 160 trillion RMB ($26 trillion), which exceeds the combined worth of $22 trillion of all the banks tested by the ECB.

Not only Western banks have the clout to send shockwaves through the global financial system: Based on their capital alone, Chinese banks play a role pretty much equal to that of Western ones.

But the one considerable difference is that the West wants to avoid private banks taking risks and then pocketing the profits if these risks pay off, but relying on government bailouts if they don't. Privatize profits and let the state deal with losses is the rationale.

No surprises in store

In China, in contrast, the state functions as supervisor, banker and borrower in one, which is why it has always abided by rules that prevent anything comparable to the euro crisis from arising in the first place. That's all very well, but when those in charge of controls and those subjected to controls all belong to the same Communist party, there is a danger that a blind eye might be turned.

For the time being, at least, stress tests of state banks would be unlikely to contain any surprises. They lend mainly to state companies and regardless of balance sheets, help secure social stability. If the going gets tough, the government steps in - and it has no shortage of reserves. Just a few weeks ago, to prove its vested interest in their stability, Beijing gave its banks an injection of liquidity.

Europe-style stress tests nonetheless have much to recommend them. Not only Chinese investors but the West too would no doubt be interested to know just how many non-performing loans appear on their balance sheets, however likely it is that any existing debt is dire enough to threaten the country's financial statistics.

Local municipalities are especially cash-strapped, but they also boast assets in the form of state businesses, few of which are still loss-making. First and foremost, they own valuable property.

Financial buffers

But Chinese Premier Li Keqiang would like to privatize the financial system, which means it makes sense to look West and learn from its mistakes. In case of emergency, medium-sized and fast-growing online credit banks would be particularly under pressure to prove they have sufficient capital.

Last fall, Beijing announced it would be bolstering the private banking sector, thereby encouraging competition with the state banks, which have hitherto played a dominant role.

Clearly, there first needs to be sufficient awareness of the risks with these private and therefore largely unregulated banks. Stress tests could ensure not only that all the banks have to play by the same rules but also that the banks' respective services are completely transparent.

This would become increasingly important were the economy to flounder and the room for maneuver to shrink. Any crises that would then unfold would not only rock the Chinese financial system but the entire world's.

It seems ever more unlikely that China will reach its target of 7.5 percent growth. Industrial production was as low in August as it was during the global financial crisis in 2008. But its gigantic foreign exchange reserves of some $4 trillion serve as a buffer, overseen by Zhou Xiaochuan, the head of China's Central Bank and a man highly respected by his western colleagues. Rumors of his imminent removal from his post aside, Zhou has kept a close eye on the methodology of the stress tests.

In this area, the West would be well advised not to be too guarded about sharing its expertise; assuming, of course, the ECB didn't cheat any more than even Beijing thinks it did.

DW columnist Frank Sieren is one of Germany's leading China experts. The author of the bestselling book "Geldmacht China" ("Financial powerhouse China") has been living in Beijing for the last 20 years.