Veteran investor Jack Rodman has had enough. After waiting 11 years for China to sell its rising pile of bad bank loans, he is quitting and going to Spain instead.

His pull-out exposes a pressing failing in China’s booming financial sector: it does not properly dispose of a growing store of bad loans from banks’ profligate lending, keeping risks pent up within the world’s second-biggest economy.

And the problem only scratches the surface of deeper troubles plaguing China’s banking industry, where heavy government intervention has produced a dysfunctional system that is at times better at destroying capital than creating it.

The frozen market for bad loans shows just that.

For years, China has shuffled bad debt that was run up by big state firms between state banks, other state companies and Beijing in labyrinthine deals that hid the cost of bad banking, and shielded unviable state enterprises from bankruptcies.

These…