Striking parallels between China today and Japan in the late 1980s, suggest that China faces similar risk as Japan did then. The risk of a sharp correction in Chinas asset markets when the economy slows down should not be overlooked, though it would not necessarily lead to a prolonged and deep economic recession as it did in Japan in the 1980s. Bank loans are growing faster than nominal GDP growth in both the countries. In addition, lending decisions are not always based on creditworthiness. Although in the past there have been efforts in China to reduce State-directed bank lending, events in 2009 showed that State moral suasion remains influential in banks lending decision. As in China today, strong loan growth to the real estate and construction sectors was observed in Japan in the late 1980s. Nevertheless, there are differences between Japan of the late 1980s and todays China. China is a much larger country in terms of territory and population, and more importantly, it has higher long-term GDP growth potential. The Chinese economy remains largely protected from sharp swings in portfolio investments, which reduces the risk of volatility from global financial markets. Although the Japanese collapse in demand was largely a domestic problem, triggered by a domestic factor, the relatively sheltered nature of the Chinese economy makes it easier for Beijing to influence domestic market psychology. Moreover, Beijing has capital controls while Tokyo did not. Greater disparity in Chinas urban-rural divide gives room for reallocation of resources. This gives the Chinese government more scope to make GDP growth smooth, i.e. steer resources away from the overheated sectors to deficit sectors, thus potentially reducing the risk of a hard landing. Thus, a valuable lesson learned from Japan is that imbalances cannot be corrected through macroeconomic measures alone. They have to be accompanied by microeconomic reforms. The fact that microeco-nomic reforms are being implemented in China for some time now gives the country a chance to avoid a Japan-style downturn. Success depends on reallocation of resources to revitalise Chinas heartland. The game plan to rebalance the economy away from investment toward private consumption is important. As part of the urbanisation policy, the vision is to develop key cities to function as regional growth engines. Plus, more funds will be allocated to education, health-care and public housing, especially to help bridge the rural-urban divide and achieve the specific goal of quadrupling per capita income by the year 2020. But China has to beware of the pitfalls. Chinas vulnerability could be heightened by a combination of unfavourable factors. Hypothetically speaking, they include lower global demand, policy mistakes on the speed and sequence of reform, and failure to see through reform implementation at the micro-level. Slower global growth could prompt Chinese firms to invest less and consumers to cut their spending. An economic slowd-own, because of low global demand and continued tightening policies, may be relatively mild at first but could increase non-performing loans as firms revenue drop and financing costs rise. There is a risk of a pull-back in lending activities if the banks are under pressure to meet the capital adequacy requirement of eight percent. If credit lines are pulled, it could potentially aggravate the correction in the asset and real estate markets. The asset market, especially the stock market, will not be immune to correction as investors grow more sophisticated and pay more attention to valuation. The correction in the asset market could be triggered by an outflow of domestic savings for overseas investment. This is why the Chinese authorities have proceeded very cautiously in liberalising the capital account. But they still need the large domestic savings pool to fund domestic investments, recapitalise banks and plug the unfunded pension liabilities gap. A sharp correction in the asset market will not necessarily lead to a prolonged and deep economic recession as it did in Japan. The Chinese have been more proactive than their Japanese counterparts in implementing corporate and banking sector reform, although the process is far from over. Their cautious and gradual reform approach seems appropriate because, on average, risk management capacities are not yet fast enough. Overall, Chinas attractive long-term potential and its large market size still make a compelling case for investors. China Daily