But if one thinks that China's high debt-to-GDP ratio is indeed a great threat to its financial stability, then it should be noted that from a high debt-to-GDP ratio to a financial crisis, there are many links that need exploring. Only when all the specific links have been identified can one draw a tentative conclusion on whether a financial crisis is likely to happen.

Government won't resort to short-term stimulus

Financial reform 'one of China's easiest'

A financial crisis, a banking crisis in particular, will only happen when the following three conditions apply simultaneously: a large fall in asset prices, a drying up of funding, and a depletion of equity capital. The government has yet to exhaust its policy capacity to work on all three fronts to prevent a financial crisis, due to its relatively strong fiscal position, large foreign exchange reserves, relative high economic growth and its effective control over the major banks.

The real estate bubble is commonly regarded as the single most important point of vulnerability in China's financial system. So let us assume the real estate bubble has burst. Will the price collapse bring down China's banks? Probably not. In China, there are no subprime mortgages or special purpose vehicles to obscure the nature of mortgages - the required downpayment for mortgages can be as high as 50 percent (or even higher). Will house prices fall by more than 50 percent? Not very likely. When house prices fall significantly, new buyers in big cities will enter the market and stabilize prices, and the country's urbanization strategy will ensure that in these cities demographics support intrinsic demand.

Even if house prices fall by more than 50 percent, commercial banks can still survive. First, the share of mortgages in commercial banks' assets is about 20 percent for the country as a whole. Second, banks can recover funds by selling collateral. And as a last resort, the government can step in like it did in the late 1990s and early 2000s to take nonperforming loans off the books.

How about the liability side of the commercial banks? The structural investment vehicles in the US played an important role in causing the subprime crisis. There are no such vehicles in China. Additionally, the severity of the mismatch is not as serious as some observers believe.