The nasty cash squeeze that roiled China's banking system in recent weeks could be just a preview of greater instability to come if China's leaders push ahead with liberalizing interest rates and capital controls.
A spike in the interest rates that banks charge for lending to one another sent stocks plunging last month and raised the specter of bank runs as reports circulated online about ATMs with no cash and electronic payments that failed to clear.
But further progress towards de-regulation of China's interest and exchange rates will only increase the challenge for Chinese banks in managing risk, analysts say.
"The recent instability reflects some of the risks with interest rate liberalization that proceeds too rapidly, or more precisely relying excessively on interest rates to achieve objectives," Yukon Huang, former World Bank country director for China and senior associate at the Carnegie Endowment for International Peace, told Reuters.
China's State Council, or cabinet, has said it wants to push interest rate liberalization, and the central bank made a move towards that goal in June last year when it granted commercial banks limited flexibility to vary deposit rates.
One reason that freeing up interest rates could lead to instability is that such a move would unleash fierce competition between banks for customer deposits.
(Read More: China Cash Crunch Already being Felt on the Ground)
"One has to be very careful and think about 'What do we do with banks if they become overly aggressive? What do we do with banks that compete themselves into losses?" Markus Rodlauer, deputy director of the Asia and Pacific Department at the International Monetary Fund, said at a panel discussion in Shanghai on Saturday.
Last month's crunch, which saw China's interbank lending rates soar to record levels on June 20, was engineered by the central bank, which declined to inject liquidity into the market in a blunt signal to lenders to rein in risky credit growth.
The resulting turmoil, which rippled out across financial markets, sending emerging market equities and currencies reeling, was reminiscent of the onset of the global financial crisis in 2008, when money markets froze as banks stopped lending to each other amid fears that many were overextended.