China’s financial system has entered a new era in the last two months, as risks have emerged that strike at the heart of economic and financial stability. For the first time since 1998, a financial institution in China has failed, and markets must price that failure into dealings with other institutions. This counterparty solvency risk has been a key component of credit risk in other economies, but has not existed until recently in China, where financial stability was buoyed by the belief that government-backed financial institutions are effectively guaranteed.
