In my opinion, the move by Citic is a reaction to what that company worries is the beginning of a wave of defaults that could overwhelm the trust (and security company) sector's ability to make good investor losses out of the pockets of trust companies.

This will open up a legal can of worms that China's courts and financial regulators are unprepared to deal with. The courts will have to decide if trusts were sold with any implicit guarantee. And whether trust companies can be sued in the event of a default by a borrower. And how much legal responsibility flows back to the bank through affiliated trust companies and through investments that the bank sold to the trust company. (Complicating all this will be the clout of the politically connected wealthy who have bought wealth-management products.)

The big question is what regulators will do with all these off-balance-sheet assets. If banks were required to put them back on consolidated balance sheets, a rise in defaults could damage bank capital ratios just when China's banks are trying to meet new international capital requirements and to make further inroads into global financial markets. Anything that required Chinese banks to buttress their capital requirements would reduce the money supply just when China was trying to increase the money supply to stimulate the economy.

The potential cost

On the precedent of past financial crises, and especially the Asian currency crisis of 1997, I think the odds are very low that Beijing will do anything that raises the bad-loan ratio at China's banks or that might force them to raise significant capital at this point in China's economic recovery. In the aftermath of the Asian currency crisis, Beijing's financial regulators buried massive bad loans by creating new financial companies that bought the bad debt of China's banks and took it off the banks' balance sheets. Then, through complex transactions, these new financial entities buried that bad debt.

That effort wasn't cost-free. China's growth rate for gross domestic product dropped from 9.3% in 1997, before the crisis hit the country's financial system, to 7.8% in 1998 to 7.6% in 1999 before rebounding to 8.4% in 2000.

This time, China is starting from a weaker economic position -- China's growth rate bottomed at an annual 7.4% rate in the third quarter of 2012 -- in a world where developed economies are still digging out from a severe financial crisis and the subsequent Great Recession. And currently, China has much bigger ambitions for its banks on the global financial stage and for the global role of its currency. Those ambitions would be damaged by an Asian currency style crisis -- and fix.

I don't see a Chinese banking crisis crashing China's economy in 2013 any more than it did in 1997. But it certainly wouldn't be good for the share price of China's bank stocks or for the important real estate and financial sectors in China's stock markets. And even if it knocked a percentage point or two off China's economic growth, that's growth that the global economy sorely needs.

I'd watch carefully to see how China's banking crisis develops and how serious it might become.

In doing that observing, I'd pay attention to bad-loan ratios at China's banks -- the official reported rate of 2% or less is clearly understated, so I'd pay more attention to whether it starts to rise than to its absolute number. I'd pay even more attention to companies in China's non-bank financial sector such as Citic Securities and Haitong Securities -- and their related trust companies -- to see how much of the problem they recognize and how they cope with it.

And finally I'd look at moves by the People's Bank to see if China's central bank is getting nervous about bank reserve requirements. If the People's Bank should start to raise reserve requirements even while China's efforts to increase economic growth are unfurling, then I think we've got signs that the banking crisis is bad enough to worry Beijing.

Updates to Jubak's Picks

These recent blog posts contain updates to the stocks in Jubak's market-beating portfolios:

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At the time of publication, Jim Jubak did not own or control shares of any company mentioned in this column in his personal portfolio. When in 2010 he started the mutual fund he manages, Jubak Global Equity Fund(JUBAX), he liquidated all his individual stock holdings and put the money into the fund. The fund may or may not now own positions in any stock mentioned in this column. The fund did not own shares of any company mentioned in this column as of the end of September. Find a full list of the stocks in the fund as of the end of September on the Jubak Global Equity Fund website.

Jim Jubak's column has run on MSN Money since 1997. He is the author of the book "The Jubak Picks," based on his market-beating Jubak's Picks portfolio; the writer of the Jubak's Picks blog; and the senior markets editor at MoneyShow.com. Get a free 60-day trial subscription to JAM, his premium investment letter, by using this code: MSN60 when you register at the Jubak Asset Management website.

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