Let’s get right to it.

Early last month – I wrote an article highlighting the U.S. dollar shortage that’s plagued corporate China (leading to record defaults on dollar-debts). And that I believed it would soon spread into the already fragile Chinese banking system.

The thesis was – since most of these Chinese banks guaranteed corporate dollar-loans. Then the record surge in corporate defaults would directly affect Chinese banks – damaging their balance sheets.

Makes sense – right?

Well – since then – we’ve seen China’s banking sector reach a ‘tipping-point’. . .

Just two weeks ago – news broke that Chinese regulators were ‘absorbing’ Baoshang Bank – an inner Mongolia-based commercial bank.

Now – keep in mind that this was China’s first bank takeover in the last two decades. . .

The regulators cited that there were “severe credit risks” – and warned that some creditors may suffer potential losses. But that they would guarantee Baoshang’s smaller depositors (trying to prevent citizens from panicking).

And yet – while the government has desperately tried to ‘window-dress’ this as nicely as possible – don’t be fooled.

That’s because – back in April – China’s own central auditing authority sounded the alarm on the surge of souring debt held by small banks around the country.

For perspective – some banks in the Henan province (central China) reported that 40% of the loans on their books were labeled ‘bad-debt’.

(Some more context: there are 42 banks in this province with non-performing loans – NPL’s – that had crossed the “warning line” of 5% – with 12 banks exceeding 20% – and a “few” exceeding 40%).

This was the first official disclosure highlighting the dangerously high rate of toxic assets in China.

And although some disclosure is nice – there’s still a serious lack of transparency.

And – even worse – very troubling indicators coming from China’s city and rural banking sector.

For instance – according to Barclays Investment Bank – there are 19 city and rural commercial banks in China (including Baoshang Bank) that sit on a combined 4.5 trillion-yuan-worth of assets ($647 billion) which haven’t yet published their 2018 financial results. . .

Now – most speculators know that if a bank fails to publish an annual financial statement – it’s usually not a good sign. And may indicate the bank’s having problems.

But if multiple (19) banks don’t – the entire banking sector is having problems.

Some banks have given brief explanations over why they haven’t published their 2018 financial reports.

But I believe it has only made things worse.

For example – according to the Financial Times – the Hong Kong-listed Bank of Jinzouh (second largest bank on the list above) announced only a few days ago that their auditor – Ernst & Young Hua Ming LLP – resigned after discovering some of the bank’s loans “were not used for their stated purpose”.

(The auditor asked the bank for evidence of the customers’ ability to service such debts – and when the bank couldn’t provide the evidence – the auditor resigned).

These delayed financial annual reports are a worrying sign that non-performing loans are much higher than many anticipate.

And it’s leaving investors and depositors blind – not fully aware of how many assets have soured into ‘bad-debt’. . .

So – in summary – the Chinese banking sector is beginning to openly crack.

First – it was corporate China that was suffering funding issues and mounting liabilities (leading to record defaults on dollar-denominated debts).

But now – it’s rural and city Chinese banks that are experiencing an explosion of ‘bad-debt’ on their balance sheets. (After concealing toxic assets for years).

And I believe that if Baoshang Bank required a bail out. Then many other banks in the country experiencing similar problems will also (especially the Bank of Jinzouh).

Much sooner than many realize.

(Note that China’s largest banks haven’t reported such troubling news – yet. But as I recently highlighted – the four largest banks in China have bled out all their dollar-assets. And now have overwhelming dollar-liabilities – putting them in a fragile position).

So – stay tuned.

PS – I’m still short China and holding my $FXI put options. . .