A couple of readers have highlighted a Forbes story stating that there could be a potential mega default at the end of January. The default is said to come on a wealth management product or WMP that looks like it will be unable to pay out on maturity. While Forbes paint a rather catastrophic picture to the Chinese banking sector, if that default happens, it may not be the “end of the world” event they think it is.

Firstly the amounts involved are tiny in the overall scheme of things. Sales of the WMP totalled 3.03bn yaun which is around $496m, which was then loaned to, what has turned out to be, a rather struggling company called Zhenfu. They say they borrowed the money at 12%, which compares to the guaranteed 10% offered to the buyers of the WMP.

The product was sold through the ICBC, one of China’s biggest banks and one of the worlds most profitable lenders and Forbes states that they will not assume the main responsibility for any default.

Now I don’t doubt the importance of these types of defaults happening nor the possible market ramifications but I think they are being overblown somewhat. The potential risks from WMP defaults have hit the market before and have been soaked up by the banks while the PBOC kept the market waters calm. Another factor is that the banks have been setting aside huge amounts to deal with bad loans and other “rainy days” events. Back in October the market got spooked by a story of a mass of debt writedowns by Chinese banks but on further analysis it wasn’t as shocking as it was made out to be given numbers involved and the provisions put aside by the banks. Here was our coverage over that event.

I do agree with Forbes in that if China keeps covering defaults then they are pushing themselves into a corner as it will be seen that they will be prepared to cough up on anything. That’s not good and investors need to have the fear that something can go wrong and that people and the market needs to take a hit now and again. The longer they leave it the worse it will be when they do need to take a hit.

It’s still a very murky world in Chinese banking and shadow banking and no doubt if the default happens we are likely to see some volatile days in Chinese markets which could spread. It will be the response from China that will be telling to see whether they will cover it or let the default happen as a warning to others. If they let the default happen then we could have some rough days. If they cover it then the market will likely not bat an eyelid, this time.

Zerohedge also has some background to this situation and cover exactly how WMP’s work.