Chinese banks cutting loans to rein in growth.

CHINA is collecting accolades for efforts to slow down the nation's allegedly excessive growth. The jury is still out, though, especially with respect to the government's instructions to the banks.

While most countries of the world despair about a lack of growth, China says its economy is expanding too last. And the government of China believes this so much that it has embarked on policies to slow the economy.

The official goal of the government is to slow growth to 7 percent this year. China's economy grew 9.6 percent in the second quarter and 9.8 percent in the first three months of this year.

To slow growth the government has concentrated on certain rapidly expanding industries that it decided needed to be suppressed. The suspect growth industries include steel, cement, property and automobile manufacturing.

Accordingly, Premier Wen Jiabao in April and May ordered domestic banks to restrict lending to the targeted industries. In effect, the banks have become a policy arm of the government as it attempts to centrally plan the reduction in the country's economic growth.

And the banks were more than happy to comply, though it may turn out they went too far. The China Daily reported that new bank loans in the first six months fell 350 billion yuan from a year earlier.

According to a report on the People's Bank of China's Web site, the decline in new loan creation in June alone was 239.5 billion yuan. The central bank reports these numbers under the header: "The faster-than-desired expansion of credit was reined in effectively."

The banks are in a peculiar situation. They are supposed to be commercial enterprises on one hand but instruments of the government's policy-makers on the other.

Where does this lead? At this rate, what China isn't going to produce is a legion of battle-tested, market-savvy commercial bankers. Instead, the successful Chinese banker will have one eye on his customers and the other on what will be the next round of central planning policy to come down from the top of the government.

If the banks overreacted by cutting loans faster than the government wanted, as China Daily reported, then is there a scenario wherein the government's directives could set off a collapse of credit?

When a government commands that certain basic industries must be cut out of the credit chain, it invites a possible chain-reaction style financial panic. Sensible banks would respond by pulling back exposure everywhere because a credit crunch in an industry like steel or automobiles could have vast implications for debtors in all industries.

And this is what must be happening right now. The only reason why it hasn't happened on a large scale is that the bankers must have some unshakable faith the government is ultimately in control of the economy. So they might be figuring: How wrong can things go?

What in turn does the government think about the banks?

We learn something of how competent the government thinks its bankers are by reading the recent remarks of Liu Mingkang, chairman of the China Bank Supervisory Commission.

According to the commission's Web site, the chairman has told banks to improve their ability to differentiate between profitable clients and those who might turn into bad credit risks. Presumably this advice is suspended if a profitable client is from among the shunned growth industries.

In other words, act like a capitalist bank until you fred out your loans have gone sour--then put on a red suit and play like Santa Claus.

David DeRosa, adjunct finance professor at Yale School of Management and author of "In Defense of Free Capital Markets," is a columnist with Bloomberg News.