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Australian investors, aware of the importance of China for continued bullishness at home, have been keenly watching the state of play in China – so news late last week that China’s flagship lender, Bank of China, as well as Industrial and Commercial Bank could face significant losses as a result of the US sub-prime crisis wasn’t good news. On the final day of trading last week, Hong Kong investors fled the state controlled Chinese banks, sending share prices lower.

Shares in Bank of China fell more than five per cent on the Hong Kong bourse after the report was released. Industrial and Commercial Bank shares fell over two per cent before closing slightly up for the day.

The important point for Australian investors is the resilience of a booming Chinese economy to the dramas unfolding from the US sub-prime mess. The Bank of China’s exposure to US sub-prime mortgages is estimated at $9 billion. To put this into perspective, the bank raised $11 billion in its IPO last June.

While Hong Kong investors punished the stocks (both banks are jointly listed in Hong Kong and China), the fallout on the Shanghai stock exchange late last week was minimal. Chinese investors turned their attention instead to healthy first-half net profits booked by the Bank of China (up 52 per cent). Few were willing to let fears of worldwide financial contagion spoil the party. The Chinese market ended the week at another record high.

Chinese bank officials hosed down fears by stressing that no losses had yet been reported on the crumbling US securities held by the bank.

Chinese banks have enjoyed a phenomenal run to date. Fuelled by a fast growing economy and exuberant punters set on throwing their savings – plus borrowings – into the market, there is much to celebrate. And who can really blame Chinese investors for their optimism. The Chinese stock market has risen by 90 per cent this year alone.

Nevertheless, the Bank of China’s exposure to the crisis is the biggest so far in Asia, bringing to light the breadth and scope of the crisis. China’s total exposure to sinking sub-prime mortgages is still unknown. Other major Chinese lenders are yet to own up.

The news comes at a time when fears of an overheating Chinese economy are rising. Already, rates have been ratcheted up four times since April last year in an attempt to curb inflationary pressures. Some Chinese stocks are trading on a lofty price/earnings ratio of 50 times or more, which – even given the buoyant corporate environment that prevails – is high.

However in a review released earlier this month of Asia-Pacific banking and insurance entities’ exposure to US sub-prime mortgage-related instruments, international ratings agency Standard & Poor noted that the “exposure to these instruments is either minimal or manageable at this time.” The agency noted that the Bank of China’s holdings of US securities were of a high quality. “Should the quality prove otherwise, the bank’s equity base might be significantly impacted,” it said.

The US sub-prime crisis has so far caused $5.5 trillion in losses on markets globally. What this means is that banks such as the Bank of China are probably less likely to place their trust in US securities in the future, and understandably so.

Australian investors should keep a close eye on stgelopments on the US sub-prime front arising out of Asia; wobbles on the Chinese bourse will no doubt shake markets at home.