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

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At the same time, banks are offering increasingly complex wealth management products to savers looking for higher-yielding assets.

Meanwhile, the worldwide financial institution warned that China's rapid credit growth, complex financial products and government's implicit guarantee posed threats to financial stability.

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.

It found that Chinese banks, while meeting worldwide "Basel" targets, should gradually increase their levels of capital to provide buffers against potential losses that can be expected as credit is tightened and the assumed guarantees for investors are removed.

"The system's increasing complexity has sown financial stability risks", the IMF's assessment said. Banks continue to be positioned at the core of this highly interconnected system of indirect lending, with uncertain linkages among numerous institutions constituting a challenge for supervision.

"The authorities have recognized these risks and are proactively taking important measures to address them".

The Chinese authorities should create a body to focus exclusively on financial stability and to improve oversight of systemic risk.

According to the IMF assessment, China's regulation and supervision of its banking, insurance, and securities sectors show a high degree of compliance with worldwide standards. They encouraged the authorities to implement the recommendations of the FSSA to further strengthen systemic risk analysis and oversight, data quality and collection, and information sharing.

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The result is "moral hazard and excessive risk-taking", the IMF's Financial Sector Assessment Program (FSAP) team said. President Xi in April cited financial stability as a key goal for China.

China's leaders have made financial stability one of their top priorities.

She added that "implicit guarantees to SOEs [state-owned enterprises] need to be removed carefully and gradually".

"Regulators should reinforce the primacy of financial stability over development objectives", the fund said. Further reforms are needed to reduce the reliance on public funds in managing weak financial institutions, while ensuring they can fail safely, for example by expanding administrative resolution powers in line with global standards.

The IMF also noted developments in the Chinese financial system similar to those in the U.S. in the years before the financial crisis of a decade ago.

[1] The Financial Sector Assessment Program (FSAP), established in 1999, is a comprehensive and in-depth assessment of a country's financial sector.

The newly established Cabinet-level Financial Stability and Development Committee is expected to play a significant role in monitoring systemic risks and preventing financial disruptions, Ratna Sahay and James Walsh, economists and leaders of the assessment program with the International Monetary Fund, said.

The Financial Sector Assessment Program, jointly launched by the International Monetary Fund and the World Bank in 1999, aims to gauge the stability and soundness of the financial sector and the quality of the regulatory framework of member economies and to assess the financial sector's potential contribution to growth and development. In cases where the FSSA is discussed separately from the Article IV consultation, at the conclusion of the discussion, the Chairperson of the Board summarizes the views of Executive Directors and this summary is transmitted to the country's authorities.

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