China's financial system harbours "large risks", says International Monetary Fund

China's financial system harbours

"The system's increasing complexity has sown financial stability risks", the International Monetary Fund said, advising China to take measures such as strengthening of systemic risk oversight, further improving regulation and moving toward functional supervision.

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.

The IMF report said authorities at the highest level had made financial stability a top priority this year and were "taking steps to address vulnerabilities" but added that some of the underlying causes of risk were yet to be fully addressed.

The IMF's health check of China's financial system found that credit was high by worldwide levels, that personal debt had increased in the past five years, and that the pressure to maintain the country's rapid growth had bred an unwillingness to let struggling firms fail.

"International experience suggests that China's credit growth is on a unsafe trajectory, with increasing risks of a disruptive adjustment or a marked growth slowdown", a report said.

Further, IMF said the credit to GDP ratio is very high by global comparison, and above levels consistent with a high probability of financial distress.

"The apparent primary goals of preventing large falls in local jobs and reaching regional growth targets have conflicted with other policy objectives such as financial stability", the report said. It pointed to the problem of moral hazard that runs through the financial system based on the widely held perception of implicit guarantees to compensate losses of investors and lenders.

China's "big four" banks had adequate capital but "large, medium, and city-commercial banks appear vulnerable", the International Monetary Fund said.

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This has led to a situation in which failing companies are kept afloat, thanks to incentives for local governments to do so.

The IMF said the impact of the shocks is highly uneven across banks.

"Banks often compensate retail investors for losses, while lenders assume that loss-making SOEs or financial intermediaries will be bailed out", the International Monetary Fund said, calling for the government to allow bankruptcies and failures, and to let the market decide the cost of capital and bear the risks.

Increasing capital would enhance the resilience and credibility of the financial system, as well as reassure markets.

China should "incite local governments to strengthen supervision on risks", she added.

China's central bank, the People's Bank of China, said overall a series of reports published by worldwide bodies including the IMF were "professional and valuable assessments".

The fund said that Chinese financial institutions are seemingly unwilling to allow investors to lose money and that this has created an environment where investors are simply taking more and more risk, lacking the fear that they'll ever actually see a downside.

But it said it did not go along with all of the findings and that the stress tests "do not fully reflect the whole picture". 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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