||The pervasive extent of bad loans in the PRC’s banking system has received much attention in the aftermath of the Asian financial crisis. But is the concept of bad loans applicable to a socialist economy? This paper argues that the extent of “bad loans” in China is a measure of little meaning. An alternative perspective focusing on the net claims of households against the state sector shows that there is no compelling economic reason to locate the state sector’s “financial hole” in the balance sheets of the state banks. Accepting the restrictions a socialist economy places on financial and real sector reforms, a number of suggestions are made on how to manage the existing financial hole and how to prevent it from expanding in the future.