International Monetary Fund warns on brewing risks in China's financial system

International Monetary Fund IMF

A security personnel stands next to International Monetary Fund logo at IMF headquarters in Washington US

People's Bank of China, the country's central bank, said the International Monetary Fund report was objective and relevant but that it did not paint a full picture and the financial system was able to fend off risks.

"Overall, the reports have presented professional and valuable assessments of China's financial system and its recommendations are highly relevant in the context of deepening financial reform in China", the PBOC said.

The IMF's report is part of its Financial Sector Assessment Program, which was set up in 1999 in the wake of the Asian financial crisis of mid-1997. As authorities crack down on risks, "this creates powerful incentives for financial innovation and finding imaginative ways to finance firms despite their lack of economic viability", the report said.

Noting a lack of coordination and inadequate systemic risk analysis in a report released on Wednesday, the International Monetary Fund also recommended the formation of a financial stability sub-committee comprising the central bank and three financial regulatory agencies, and an increase in staff for the banking watchdog.

The IMF said the growth in credit held by companies and households had outpaced that of the wider economy and the ratio of credit to GDP was now "very high by global standards and consistent with a high probability of financial distress".

The IMF also warned against the rapid development of new financial products, which it said could "very rapidly become large and popular and potentially a systemic risk".

The IMF said: "Given the centrality of banks to the financial system, the FSAP team recommended a gradual and targeted increase in bank capital".

"Regulators should reinforce the primacy of financial stability over development objectives", the fund said.

China announced the establishment of a Financial Stability and Development Committee (FSDC) in July, reporting directly to the State Council and chaired by Vice Premier Ma Kai, to strengthen supervision of the financial system, prevent system risks and formulate new laws and regulations to provide one unified regulatory framework.

The IMF acknowledged that authorities were already taking steps to contain the risks.

"The descriptions of the stress testing did not fully reflect the outcomes of the test", it said on its website.

These institutions should raise more capital, giving them a buffer to absorb potential losses that could arise as China's economy shifts away from its investment and export-dependent model to a more-sustainable consumption-driven path.

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