China's Banking Sector

China's financial services sector is artificially supported - I doubt there's anyone out there who doesn't believe this. The open question is whether or not this can be managed (Megan McArdle via Instapundit):

Banks are controlled by the government, with interest rates for both deposits and loans set by fiat. The government also feels free to tell banks how much to lend, and to mandate that they buy government bonds at particular prices. When I went to China in 2010, one of the bankers there told us that a huge chunk of their Tier One capital consisted of special government bonds that couldn’t be sold and paid about 5 percent interest — at a time when inflation was, according to most of the experts I talked to, well above that.

In a Western banking system, you’d expect this to lead to a crisis. But what would that even mean in China? Its currency isn’t convertible, and financial links to the outside world are tenuous. Maybe the government can just keep ordering banks to keep making loans at low interest rates, and declare by fiat that the loans are performing. That seems like a crazy thing to say, but it’s also hard to describe how a crisis would happen.

Adds Glenn Reynolds: "Everybody hates the bust, but the real harm is done in the boom, with capital being diverted to things that don’t make sense, because the boom’s distortions make them seem to make sense."