It's been eight years since my dear wife had to physically drag me away from the TV set at the hotel we were staying at for a short vacation in Paris. I'm glad she was there because the TV acted as too strong a magnet with all the gory news about the Lehman bankruptcy.

Things aren't as bad today. But the news of the past couple of weeks have not been encouraging. I'm thinking, in part, of the events brewing at Deutsche Bank. That institution does not seem to have learnt the hard lessons of the financial crisis, namely, that risks are real, that leverage is risky, and that it may take less to disturb of a balance sheet than you may think. Equally worrisome is the apparent fact that European banking regulators haven't seen this either, but keep complaining that uniform global regulations would put European banks at a competitive disadvantage vis-à-vis their U.S. competitors. What about the stability of the European financial system? Does that come second to the competitive position? In the middle of all of this I am happy to see that the German government at least hesitates to bail out Deutsche. They may still have to do that to stabilize the system; but if so, I sincerely hope they will do all they can to limit the side effects in terms of moral hazard.

However, Europe is not the only region I'm concern about. I'm also worried about China. The history of the Chinese banking system is well known. The government did a good job of unloading legacy NPLs in the late 1990s, and risk management has improved. However, the situation deteriorated again in the aftermath of the Global Financial Crisis and is now raising new, serious concerns. A number of factors are at play:

As banks have kept ailing manufacturing plants alive, NPL portfolios have risen, even the official numbers.
To solve this problem, the government has asked the banks to swap debt for equity. This process has now started, but risks doing little more for the banks than a swap of bad equity for bad debt.
The housing markets in the big cities seem out of control even as housing inventories remain piled up in the Tier 3 and 4 cities. Although household leveraging may not be a big problem, developer leveraging is.
Finally, borrowing by Local Government Financial Vehicles (LGFV) is again accelerating. This debt, which was the main financing source for the 2009 - 10 RMB 4 tr. investment program, was supposed to be cleaned up after the central government ordered about half of this debt to be converted into state-guaranteed bonds and further borrowing curtailed. A new Brookings Paper by my friends BAI Chong-En of Tsinghua University in Beijing and SONG Zheng (Michael) of the Chinese University of Hong Kong, along with HSIEH Chang-Tai of the University of Chicago, documents how these conduits increasingly are being exploited by essentially private companies. In a financial system dominated by state-owned institutions, access to financing continues to depend on political connections. These connections don't have to go to Beijing; quite often the trick is to have the right connection with local and regional officials, who in turn control the LGFVs. This way, the LGFVs formally obey the prohibition against borrowing for local governments, but serve instead as a quasi-government funding source for politically connected businesses.

This does not mean that a Chinese financial crisis is clear and present danger. But it does make me uneasy, especially as it happens at the same time as some of the European financial giants seem to risk losing their footing. The good news is that the mutual exposure between Asian and European banks seems more limited now than eight years ago. Yet, I feel the crisis risk has risen above the trivial level.