Europe was looking for China to help fund its emergency financial bail out, but that doesn't look like it's going to happen now as China is headed towards bankruptcy too.

A lending spree by China's banks in 2009 and 2010, with 8.22 trillion yuan ($1.3 trillion) loaned to local governments, has left the banks exposed to the risk of default. Big banks, however, look better able to weather any brewing storm. Research by Gao Hua, part of Goldman Sachs's China operations, shows that big state-owned banks, such as Bank of China, Industrial and Commercial Bank of China, and Agricultural Bank of China, have a low exposure relative to the size of their loan books, just 7% of their total loans were to local-government financing vehicles. In contrast, smaller commercial banks have a much higher level of exposure. Bank of Nanjing and China Everbright Bank, which in June, 2011, delayed its Hong Kong initial public offering, both have 20% of their loan books with local-government financing vehicles. So what, you say. Well, keep reading!

In an interlinked banking system such as China's, if small banks, such as the China Everbright Bank, run into trouble, the bigger banks, such as the Bank of China, will not escape unharmed. But if China's banks do run into trouble, it is the giants, like Industrial and Commercial Bank of China, that would be first in line for government support, even if smaller banks are in bigger trouble. All of China's banks have had a rough 2011, with valuations across the sector sharply down. But with the local-government debt drama beginning, it is the little banks that will be in the biggest trouble.

From Zerohedge, we learn that as the global insolvency wave has finally come to China. But a bankruptcy is now called "deferred loan payments." And from The China Daily we learn, "China's biggest provincial borrowers are deferring payment [we don't know for how long] on their loans just two months after the country's bank regulator said some local government companies would be allowed to do so….Hunan Provincial Expressway Construction Group is delaying payment on 3.11 billion yuan in interest, documents governing the securities show this month. Guangdong Provincial Communications Group Co, the second-largest debtor, is following suit. So are two others among the biggest 11 debtors, for a total of 30.16 billion yuan, according to bond prospectuses from 55 local authorities that have raised money in capital markets since the beginning of November."

Here are some more troubling facts about China and its banks:

• As local governments defer payments for projects commissioned as part of China's stimulus to ward off recession in 2009, less money is available for bank lending, even as China is taking steps to inject more into the economy. Said Patrick Chovanec, a professor at Tsinghua University, "When companies start to roll over debt they're not retiring debt, and banks aren't retrieving their capital, so you're crowding out new lending. This is a problem that's going to start to bite next year." [in 2012]

   

• Local governments had 10.7 trillion yuan in debt at the end of last year, 79% of that debt due to banks.

Europe was looking for China to help fund its emergency financial bail out, but that doesn't look like it's going to happen now. China is already in the midst of a bursting housing bubble, and is facing its own energy crisis. Now it's China's turn to "kick the can down the road," hoping against hope that a solution will present itself in the future. But that's just my opinion.