Should China brace for a banking crisis in 2016?

There will be heightened volatility, but a crisis is unlikely.

According to Moody's Investors Service, we will likely see heightened volatility in financial prices and fund flows, but the base case is that Chinese banks are unlikely to experience a depletion in liquidity or a cessation in lending activities; two key features that characterize a banking crisis.

Here's more from Moody's:

A liquidity crisis is unlikely because Chinese banks are primarily deposit funded, and the risk of a systemwide deposit run is limited by the substantial government ownership in most banks, as well as the insufficient alternatives for the investment of the country’s large amount of domestic savings.

We note that some joint-stock banks have become more reliant on interbank funds to support their lending and illiquid investment, which increases liquidity risk and interconnectedness. However, China as a market does not rely on external funds. 

While we are likely to see a temporary shortage of funds — possibly affected bycapital outflows — we expect that the central  bank will inject liquidity to the market directly, by cutting the required deposit reserves or engaging in open market operations,or indirectly via large state-owned banks in time of stress. 

The risk of a credit implosion is limited. China’s corporate sector demonstrates high and rising financial leverage, but we expect that the banking sector will continue to extend loans to corporates, particularly as the market is dominated by governmentcontrolled banks. 

Our assessment of a continued willingness to lend is despite the wide recognition that policy-directed lending and high corporate leverage have contributed to the current economic challenges that China faces.