China could be on the verge of a US-style banking crisis, according to Standard Life’s Frances Hudson (pictured), who has warned UK investors off the region.

Hudson, global thematic strategist at the firm, says there could be “serious market implications” unless China becomes a consumer nation, which relies on the emerging middle classes buying property more regularly.

“In China, the credit markets are underdeveloped, especially when it comes to buying property,” she said.

“Developers have had to borrow at extortionate prices, and we could see a situation where they have no choice but to default on their loans. If this happens, China could find itself in a banking crisis similar to the one we have seen in the US.” 

Hudson explains that developers are unable to pay back their expensive loans because there’s not enough demand for new housing from middle classes. The Chinese still have a savings culture, Hudson says, which must change very quickly if China wants to avoid catastrophe.

“Already, ghost cities have been created as the middle classes are not buying these new apartment blocks,” she said.

Performance of S&P 500 in 2008

Source: FE Analytics

The inability of homeowners to reimburse the banks in the form of mortgage payments was one of the biggest causes of the US housing crisis in 2007, which in turn precipitated the Lehman crash. In 2008, equity markets fell dramatically across the globe, with the S&P 500 down 14.83 per cent over the year. 
 
Hudson believes that the new round of monetary stimulus in the region is a telling sign that her worries about China are valid.

“We have heard a lot about the transition from a manufacturing to a consumer society in China, but the evidence is questionable,” she said. “The quantitative easing that the Chinese have implemented is directed at infrastructure and not towards creating more consumerism. So my thoughts are that this trend could continue for some time.”

James Bilson, an economist at Schroders, is more positive about China, but like Hudson, is concerned about the property market – particularly if there isn’t further monetary easing.

He said: "Though recent data confirms the Chinese slowdown, it is very much consistent with a soft-landing. We expected Q3 to be the weakest period of 2012, and forecast an upturn in the Q4 ensuring China's growth remains above 7.5 per cent for the year.”

"One disappointing aspect of [recent data] was in the housing sector, which after offering encouragement in previous quarters, was weaker in Q3.”

"This disappointment from the housing sector reinforces our view that further cuts to both the interest rate and banks capital requirements would be both justified and welcome. Though scope remains for further policy easing, with inflation falling below 2 per cent in September and the inflationary outlook continuing to look benign, the chance of it occurring in the near-term may be decreasing.”

"Our lower than consensus expectations for eurozone growth suggests that a Q4 pick-up in [the Chinese property sector] would be unsustainable without further easing,” he finished.