IMF warns on build-up of vulnerabilities in Chinese banks

The International Monetary Fund (IMF) has warned China about a “steady build-up” of vulnerabilities in its financial sector.

In its first formal evaluation of the country’s financial sector, the Washington-based lender calls for further reforms to support financial stability and promote balanced growth.

Stressing that the sector is essentially healthy, the IMF adds that its current structure encourages high savings rates and high levels of liquidity. However, it also increases the risk of vulnerabilities such as capital misallocation and the formation of asset bubbles, especially in property.

“The system is becoming more complex and interlinkages between markets, institutions and across international borders are growing,” the report says. “In addition, informal credit markets, conglomerate structures and off-balance sheet activities are on the rise.”

Furthermore, the IMF highlights China’s “relatively inflexible” macroeconomic policy framework, its current growth model and the government’s role in credit allocation at central and provincial levels as other sources of risk for the financial sector.

Stress tests of China’s 17 largest commercial banks carried out by the IMF and the World Bank pitted the institutions against a range of external shocks such as a correction in the real estate markets, sharp deterioration in asset quality, changes in the exchange rate and yield curve shifts.

“Most of the banks appear to be resilient to isolated shocks,” the report states. “If several of these risks were to occur at the same time, however, the banking system could be severely impacted.”

The fund’s review recommends China boosts efforts to broaden its financial market and foster healthy competition between its banks. In addition, financial and legal frameworks should be enhanced to strengthen the payments and settlement systems, consumer protection and financial literacy.

It also calls for the government to stop using the banking system to carry out broad policy goals and allow commercial goals to determine lending decisions, while interest rates rather than administrative measures should be the main instrument to govern credit expansion.

The review was carried out under the IMF and World Bank’s Financial Sector Assessment Program, which reports on 25 systemically important countries at least once every five years.

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