Gripped between the jaws of financial and economic calamity — and knowing that the banks hold the answer to everything — there are two choices a government can take with the sector: caulk and coddle or maim and martyr.

It is still early days, but with new bank lending soaring 1,000 per cent year-on-year in December, it looks very much as though China is taking the Joan of Arc (maim and matyr) option.

China’s banks may appear to be more like market-traded, market-led institutions than they did ten years ago, but that view is wishful at best. As Beijing flusters over slowing growth, decade-low exports and the threat of social instability, the reality of its banks has emerged: part crude pipes of financial salvation and part sacrificial lambs.

The biggest exposé of the banks’ true nature comes in the form of a recently produced graph of new bank lending in China, dating back four years. Between April 2004 and October 2008, the line bounces around in much the way you would expect it to in a booming economy with lots of simultaneous investment cycles and bubbles. Between November 2008 and now, it suddenly goes up. Vertically.

The 1,000 per cent surge — a slew of 772 billion yuan in new loans to companies and projects — dates almost exactly from the moment lending quotas were scrapped and regional banks were told that their loan to deposit ratio could legally drop below 75 per cent. M2 — the sum of all cash and deposits — soared 18 per cent in the same month.

For the China bulls, and the breed is not yet extinct, this chart is the belated Christmas present they dreamed of receiving. That roaring loan growth line “proves” the bull’s central theory that the banks are beautifully liquid and that Beijing is in full and perfect control of its economy. Or, as CLSA’s China strategist Andy Rothman puts it: “in China, there is only a credit crunch when the political leadership wants one.”

Rampant new lending growth, runs the logic, came on the direct orders of Beijing and with the implicit argument that the grand old growth rates can only be recovered if the banks suppress their natural caution in a downturn and open the money taps wide. For those who truly believe that restarting the lending cycle again is a guarantee of sustainable Chinese growth above 8 per cent, the unfettering of the country’s banks could even be more significant than the government’s $580 billion spending package.

And yet even the bulls acknowledge that a secret Faustian pact must have been struck between the banks and Beijing. Looked at charitably, the banks are nobly responding to the call. They are being asked to take greater risks and to sacrifice profitability for the greater good of the macro economy and those growth rates on which social stability depends. A nervous observer or credit-rating agency might see that December loan chart as the birthplace of some future, monumental non-performing loan crisis — and one that would come in addition to any latent bad loans that may be about to pop as the economy sours.

Officially, of course, Beijing is doing everything it can to allay those concerns. The China Banking Regulatory Commission, just after it endorsed a massive increase in lending to small firms and the rural sector, said at its annual conference yesterday that banks must enhance their management of non-performing assets. It may be window-dressing, but at least it gives the watchdog an alibi if the banks’ loan books do eventually turn rotten.

Nobody knows how grim the banks’ asset portfolios could get, but if strong, state-commanded lending continues through a synchronised global downturn, some significant damage must be assumed. A rise in bad loans seems inevitable, it could conceivably be enormous, and credit ratings agencies have begun rethinking the Chinese banking sector in that light.

All of which leaves the question of what lies on the other side of that Faustian bargain. What sort of post-dated cheques has Beijing written out as guarantees to the banks that are now loyally doing the government’s bidding? Lurking behind the scenes, there must be informal absolutions offered for the banks that lend themselves to death. Good for them, good for Beijing and, probably, good for longer-term stability in China: but how investable, really, is a martyr with orders from on high?

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