Patrick Chovanec is an associate professor at Tsinghua University's School of Economics and Management, a regular financial commentator on Chinese television, and author of the blog An American Perspective From China. He has more than two decades of experience traveling, investing, and doing business in China.

Chinese bank stocks took a tumble early last week, with nearly a dozen hitting 13-month lows on the domestic A-share market. They rallied back later in the week, on news of strong Chinese exports, but not before calling into serious question the viability of the planned listing of Agricultural Bank of China, still scheduled for mid-July. The size and importance of the AgBank offering -- billed at $23 billion, which would set a new record as the world's largest IPO -- not to mention the long lineup of other Chinese banks hoping to raise additional capital in its wake, make it worth getting to the bottom of what's really going on here.

Chinese jitters
To some extent, last week's plunge in bank stocks is part of a broader case of jitters that have driven the Shanghai market down more than 20% this year, as investors worry the eurozone crisis and government measures to rein in lending and property speculation will dampen China's fast-paced economic growth. But it's also just beginning to dawn on investors just how many Chinese banks are going to be coming to market looking for capital this summer. 

Chinese banks have already announced plans to raise at least 300 billion yuan ($44 billion) over the next few months by selling both stocks and bonds. In addition to ABC, the last of China's "big four" state banks to list, the other three -- Bank of China (BOC), Industrial and Commercial Bank of China (ICBC), and Construction Bank of China (CCB) -- are set to raise tens of millions in secondary share offerings. The Bank of Communications (BoCom), China's fifth largest bank, hopes to raise 33 billion yuan ($4.8 billion) in a rights issue later this month, after paring back its initial plans this week by 20%. At least a half dozen other midsize banks are also actively planning to raise capital following the ABC listing. Even if you're bullish on China's banking sector, you have to wonder whether the market has the appetite to buy all these stocks in one go.

Less-than-bullish appetite
Some investors aren't feeling very bullish. They wonder why Chinese banks seem so eager to raise funds in such a lackluster market, and they suspect that the banks are desperate to shore up their balance sheets against a mountain of bad debt that has yet to be disclosed. Last year, at the government's encouragement, state-owned Chinese banks engaged in an unprecedented lending boom to help stimulate the economy. By year's end, they lent 10 trillion yuan ($1.5 trillion) -- more than double the previous year -- expanding the country's entire loan portfolio by a third. Some analysts warned that, with so much money being lent out so quickly, many of the loans could eventually go bad. During previous bouts of state-directed lending by Chinese banks, non-performing loan (NPL) ratios topped 20%.

Ironically, at the same time Chinese banks were making all these new -- and potentially risky -- loans, they were reporting record low NPL ratios. This happened in part because the denominator, total loans outstanding, had exploded, and in part because of more lenient loss recognition guidelines from encouraging regulators. In any event, these figures gave a seriously flawed impression of banks' future risks. Chinese banks bragged that their loan loss reserves totaled 150% or more of NPLs. But with recognized NPLs so low, those allowances covered only a paltry portion of new loans being made that year. ICBC, for instance, increased its bad debt reserve by 9.5 billion yuan, while its loan portfolio grew by 1.2 trillion yuan -- a provision rate of just 0.8%, barely half the bank's existing NPL ratio of 1.54%.

Troubled loans
This time last year, Chinese regulators actively pooh-poohed concerns that banks were not making adequate provisions for bad debt, arguing that since most of the loans were going to government-sponsored projects, they were virtually certain to be paid back. Now the very loans they once touted as "safe" have become regulators' worst headache. Worried that provincial and local governments lack the wherewithal to stand behind the guarantees they issued, China's Ministry of Finance has revoked those guarantees, leaving the loans they backed in limbo. Preliminary studies estimate that such troubled loans account for 40% of total lending by Chinese banks both last year and this year.

Faced with the prospect of big holes in their balance sheets, Chinese banks are now being encouraged by regulators to raise more capital -- but to do it with smiles on their faces. Given China's 10%-plus rate of GDP growth this year, officials are painting the moves as purely a "precautionary" measure.

Some bullish investors argue that China's state-owned banks are a good buy, regardless of their true financial condition, because the government would bail them out if they ran into trouble. That reasoning ignores two critical points.

First, Chinese banks were originally sold to global investors not only on their limited downside, but an upside story as well: that they were being reformed into commercially viable, profit-driven enterprises. Their reversion, last year, into mere conduits for government stimulus spending calls that upside story into question. Today, Chinese banks earn hefty profits on the guaranteed spread in regulated interest rates. But as China moves toward a more convertible currency, those protections can't last forever.

Second, when Chinese banks were last bailed out, the government was the only shareholder. A similar recapitalization in the future would almost certainly mean stock market investors would face dilution. China's big state banks may be too big to fail, but their private shareholders may not be so invulnerable.

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Fool contributor Patrick Chovanec owns none of the companies mentioned. Check out The Motley Fool's disclosure policy.