While the fragility of the Chinese banking system is increasingly acknowledged by people as the system experiences more strain (read here), it is not completely clear what the 'trigger point' of a collapse is. Even though bad loans continue to build up, my contention is it is unlikely to be on the asset side of the balance sheet. The simple reason is banks will simply manipulate the accounting principles and keep the bad loans at face value (never write it down). If it really becomes unsustainable, the central government will ultimately buy the bad debt from the banks to bail them out, like they have in the last Chinese banking crisis of 2002/3 to keep the system stable.
The trigger point ought to be something outside the bank and central government's control. My guess is it will be on the funding side of the bank balance sheet, ie. deposits. Deposits have never been a problem for Chinese banks as deposits have grown rapidly in the last few years due to the gradual appreciation ('expected' appreciation) of the RMB (among other reasons) as people convert their USD (or another currency) and deposit it in RMB with a Chinese bank. But the continued revaluation of the RMB is no longer clear (and few viable RMB investment alternatives other than real estate), and deposits are escaping the system as people convert RMB back to USD (or another currency). This could create a painful unwinding process if it triggers a classic bank run.
The central government has to keep 'slowly' appreciating the RMB to ensure the bank's deposit base is stable (or growing). Yet, due to the lack of investment alternatives, banks end up lending money to real estate developers, local governments and SOEs, which the central government is trying to clamp down on! And the juggling act continues...
