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

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. It urged Beijing to halt credit-fueled growth and bulk up on banks' capital reserves.

Banks participated in the test were classified into five, namely the big-four banks, large banks, medium, city commercial banks and rural banks.

The International Monetary Fund warned of brewing risks in China's banking system as it found dozens of crucial lenders needed to beef up their protection against possible financial crises.

Stress test results revealed widespread under-capitalization of banks other than the Big Four banks under a severely adverse scenario.

China has seen robust growth over recent years, driven by debt-financed investment and exports.

The IMF has acknowledged that President Xi Jinping is taking steps to contain the risks and is committed to improving financial security.

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".

"Implicit guarantees to SOEs [state-owned enterprises] need to be removed carefully and gradually", she said.

At times there had been pressure to keep struggling firms open rather than allowing them to fail - a policy that could conflict with financial stability, it added.

The introduction of increasingly complex and opaque financial products and banks encouraging excessive risk-taking by compensating investors for losses posed additional risks, the report added.

The report said reining in excessive growth would require China to reduce emphasis on high GDP projections in national plans, which have spurred local authorities to set high growth targets. "We recommend the authorities to de-emphasize GDP growth", Sahay added, under efforts to "encourage local governments to strengthen supervision of risk".

In order to guard against potential risks from illicit guarantee, the International Monetary Fund also recommended that China increase capital and liquidity requirements on banks although they have met Basel requirements.

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