By Colin Barr
August 5, 2010

No one can accuse the Chinese of taking financial half-measures.

China responded to the financial meltdown of 2008 with the world’s biggest stimulus program. Now that the lending excesses that grew out of that plan are becoming apparent, China is undertaking the world’s toughest bank stress tests.

Lenders in China will have to check how they would fare were property prices to plunge by more than half, Bloomberg reports. The provision comes as surging house prices in big Chinese cities raise worries that the country is in the midst of a giant asset bubble.

A house in Beijing costs 20 times the average household’s annual income, according to data presented last week by the International Monetary Fund, while banks’ exposure to property loans has soared to 22% from 16% over the past year.

Officials fear a collapse of property prices would overwhelm the overextended banks and derail the nation’s rapid economic growth. That wouldn’t be good news for a recovery that already seems to be petering out.

“The scale of the expansion in credit has been unprecedented,” the IMF noted last month in its annual report on China. “The main risks facing the Chinese economy include a renewed weakening in the global recovery, a worsening of credit quality (notably from an expansion of lending to local governments), or a misstep in the government’s response to rising property prices.”

Of course, saying China is planning the toughest stress tests borders on damning with faint praise. Tests in the United States and Europe were roundly criticized as insufficiently stressful.

But the tough Chinese test, coupled with what Chinese credit rater Dagong this year termed as “resolute support from the government,” should help the banks weather the worst of the property losses.

“At this point, the banking system looks well-placed to withstand a significant deterioration in credit quality,” the IMF said.

One difference between China’s situation now and the one in the United States a few years ago is that policymakers in China aren’t trying to ignore the problem.

“The Chinese authorities are acutely aware of the underlying risks of asset price inflation,” the IMF said, noting local efforts to crack down on loose lending standards and raise interest rates on some purchases.

Even successful stress tests won’t confront the underlying problems that are feeding the property bubble, including a lack of alternatives for Chinese savers. But at the moment, everyone’s focus is on buying time to muddle through.

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