So far the dim sum market has run remarkably smoothly. Much of the issuance though has come from Chinese banks whose ratings almost touch that of the sovereign. But how safe are these bonds? China's finances are not as robust as the headlines suggest. There is vast debt held at the municipal level that is increasingly coming under scrutiny by economists and analysts. Defaults in this sphere could seriously harm China's banks and, therefore, the value of the yuan bonds they issue in Hong Kong. Dong Tao, chief Asia economist at Credit Suisse, says that local government debt is the biggest problem the facing the country he has seen in all his years watching China. 'It is a time bomb waiting to explode,' says Tao. ' We believe that the central government will need to separate the local government's bank debt from banks' balance sheets and recapitalise the banks.' No one expects a big state bank to default on its debt anytime soon. Nevertheless, the institutions might be far more exposed to bad debt than their quasi-sovereign credit ratings suggest. A consideration, perhaps, when an investor is presented with yet another bond from a mainland financial at a razor-thin yield. The central government remains closely involved in the affairs of the mainland banking industry, a fact that cuts both ways for bond investors. When they are speaking honestly and off the record, many stock analysts express concern about how the government directs the lending of mainland banks to suit state policies, and not necessarily according to the suitability of the borrower. Pressure from the state on banks to lend to preferred entities, regardless of these entities' ability to repay their debts, has contributed to a growing problem of non-performing loans. Just as much, however, banks' relationship with the state suggests the strong possibility of a government bailout should the banking sector turn get in trouble (as, indeed, was seen in the early 2000s when the state massively recapitalised the big banks' fractured balance sheets in preparation for their international listings). That is just as well, as the Chinese banking sector has been a main target for bears on the Chinese economy. Much of the concern dwells on the money banks have lent to municipal governments. Vast amounts of capital were injected into the local economy as stimulus lending in 2009 at the request of the central government, to ensure the global recession did not consume China. The numbers quickly become too large to be meaningful, but they bear reviewing. Stephen Green, Standard Chartered's head of Greater China research, reckons the value of debts Chinese lenders have given to local governments that will turn bad could be four trillion to six trillion yuan (HK$4.88 trillion to HK$7.32 trillion). Moody's analyst Yi Zhang says up to 18 per cent of the loans in the mainland banking system could be non-performing. In June, China's National Audit Office estimated that local governments had run up over 10.7 trillion yuan of debt by the end of last year, and warned that some Chinese provinces would struggle to repay it. 'Banks' exposure to local government borrowers is greater than we anticipated,' says Zhang of Moody's. Chinese local government debt could be under-estimated by 3.5 trillion yuan, she says. So can investors largely ignore the warnings of analysts on the health of the Chinese banking sector? Who pays for the likely hole in the books of several local governments? The local government, banks or central government? Such complexities may ultimately be of much more relevance for those invested in mainland bank shares than in their bonds. But for Hongkongers who are about to be offered billions in bank bonds, the abstract issues of who directs the lending of mainland banks and who ultimately picks up the bill for any default, may become a very concrete matter.