“Should the Chinese banking system lose 10% of its assets because of nonperforming loans, the nation’s banks will see about $3.5trn in equity vanish,” wrote hedge fund manager Kyle Bass in a letter to investors, as reported by Bloomberg.
Bass, the founder of US-based Hayman Capital Management, successfully bet against mortgages during the US subprime crisis.
According to Bass, China may have to print more than $10trn in RMB in order to recapitalise banks, "pressuring the currency to devalue in excess of 30% against the US dollar.
“Credit in China has reached its near-term limit, and the Chinese banking system will experience a loss cycle that will have profound implications for the rest of the world.”
A steep slide in China's currency could lead to company defaults, particularly real estate developers and leasing companies, which have in recent years increasingly tapped foreign-currency debt to fund their business expansion, according to a recent report from Moody's on China's banking sector.
China’s banks are moving to a higher level of risk as volatility increases in interest rates, the markets, exchange rates and fund flows, the report warned.
The ratings firm expects an increase in loan delinquencies, defaults on corporate debt and some losses in wealth-management products, as "more borrowers struggle to meet payments against the backdrop of high financial leverage and a downturn in their respective sectors", said Christine Kuo, a senior vice president.
"While the Chinese authorities will implement measures to mitigate financial market volatility and corporate default, the effectiveness of such measures will vary, because of the challenges of managing China's large and complicated market."