Why UK Investors Will Suffer If The Chinese Debt Crisis Explodes

Over the past six months, while events have been unfolding in both the Middle East and Eastern Europe, the market has kept one eye firmly fixed on China’s debt mountain.

Towering debt

It’s no secret that China has a debt addiction but this addiction has got out of hand recently.  

Indeed, according to recent figures supplied by Standard Chartered (LSE: STAN), China’s total debt load is now more than two-and-a-half times the size of its economy. But it’s not the size of this debt pile, it’s the speed of how quickly debt is rising which is worrying.

For example, during the last six months alone China’s debt-to-GDP level has jumped by 17 percentage points. Last year it took 12 months for growth of 20 percentage points.

With debt exploding, City analysts have started to become concerned about the health of China’s economy. Moreover, analysts are worried that the debt bubble will suddenly pop, causing a regional credit crisis.

Will feel the effectsStandard Chartered

There’s no doubt that the FTSE 100 (FTSEINDICES:^FTSE) will feel the spill over effects from a Chinese credit crunch. Unfortunately, the two companies that are most likely to be affected are HSBC (LSE: HSBA) (NYSE: HSBC.US) and Standard Chartered. 

As a predominantly Asian bank, Standard will feel the most paid if the Chinese debt crisis blows up. It’s likely that fallout will reverberate around Asia and Standard will be drawn in.

Still, Standard has been de-risking its loan portfolio over the past few months, which has hit results. However, if things really do start to get messy within China, the bank will be better positioned than most.

What’s more, the bank revealed within the past few days that, to preserve capital, management has scaled back expansion plans. The bank is also pulling back from deals.

Some investors have interpreted this move as a sign that management has lost its way, but pulling back from credit markets could be a shrewd move by the bank, as it seeks to protect itself in uncertain markets.

HSBCPlaying down risk

Meanwhile, HSBC’s management has played down risks of a Chinese credit crunch. Indeed, the bank has acknowledged that some defaults are unavoidable, although the bank’s exposure to bad debt is minimal.

Additionally, management believes that a number of credit defaults across Asia are likely to encourage future fiscal prudence, which is long-term positive for the region. HSBC had an industry leading tier one capital ratio of 13.6% at the end of the first quarter and the bank continues to de-lever its portfolio. 

Tough to analyse 

To some, the banking sector may appear daunting. Indeed, the complex numbers and formulas used to value banks can be daunting for even the most experienced analyst.

However, with dividend yields over 4% banks like HSBC and Standard Chartered could help you to boost your portfolio returns and make 2014 an even stronger year for your portfolio.

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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool owns shares of Standard Chartered.