IMF warns on brew­ing risks in China’s fi­nan­cial sys­tem

Enterprise - - International news -

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 de­fences against pos­si­ble fi­nan­cial crises.

The IMF re­port comes a day af­ter reg­u­la­tors in Beijing drafted new rules to strengthen bank fund­ing and fol­lows a num­ber of alerts about a bal­loon­ing debt prob­lem in the world´s num­ber-two econ­omy.

Near the top of the list in the IMF study on the sta­bil­ity of China´s fi­nan­cial sys­tem is the need for banks to in­crease their cap­i­tal to ward off risks from mount­ing debt. China has largely re­lied on debt-fu­elled in­vest­ment and ex­ports to drive its tremen­dous eco­nomic growth, but the Fund said this model has reached its lim­its.

Part of the prob­lem lies in high growth tar­gets, the IMF said, which in­cen­tivise lo­cal gov­ern­ments to ex­tend credit and pro­tect fail­ing com­pa­nies. “We rec­om­mend the au­thor­i­ties to de-em­pha­sise the GDP (growth),” Ratna Sa­hay, deputy di­rec­tor of the IMF´s Mon­e­tary and Cap­i­tal Mar­kets Depart­ment, said dur­ing a news conference.

China should “in­cite lo­cal gov­ern­ments to strengthen su­per­vi­sion on risks”, she added. Abun­dant credit al­lows lo­cal gov­ern­ments to hit high growth fig­ures but now each ex­tra dol­lar of debt is pro­duc­ing di­min­ish­ing re­turns.

The bal­loon­ing debt - es­ti­mated at 234 per­cent of gross do­mes­tic prod­uct by the IMF - adds fi­nan­cial risk and may weigh on China´s fu­ture eco­nomic growth. “Credit growth is an im­por­tant in­di­ca­tor of fu­ture fi­nan­cial dis­tress, be­cause lend­ing stan­dards of­ten fall in the rush to make more loans,” IMF ex­perts warned in a blog post. The Fund´s ex­perts car­ried out stress tests on dozens of banks. China´s big four banks had ad­e­quate cap­i­tal but “large, medium, and city­commer­cial banks ap­pear vul­ner­a­ble”, the IMF said.

It added that 27 out of the 33 banks tested - ac­count­ing for three-quar­ters of China´s bank­ing sys­tem as­sets - were “un­der­cap­i­talised rel­a­tive to at least one of the min­i­mum re­quire­ments”.

While the coun­try´s bank­ing sys­tem meets the re­quire­ments of global bank­ing rules known as Basel III, “cur­rent cir­cum­stances war­rant a tar­geted in­crease in cap­i­tal”, the re­port said. “This would cre­ate a buf­fer to ab­sorb po­ten­tial losses that can be ex­pected dur­ing the eco­nomic tran­si­tion as credit is tight­ened and im­plicit guar­an­tees are re­moved.”

China´s cen­tral bank said it dis­agreed with “a few de­scrip­tions and views” in the re­port. “The de­scrip­tions of the stress test­ing did not fully re­flect the out­comes of the test,” the Peo­ple´s Bank of China said on its web­site.

The China Bank­ing Reg­u­la­tory Com­mis­sion re­leased a draft of fresh rules to tackle re­lated is­sues. The lat­est reg­u­la­tions call for new in­di­ca­tors to mon­i­tor com­mer­cial banks´ liq­uid­ity and set re­lated re­quire­ments.

They will “strengthen man­age­ment of liq­uid­ity risk for banks and pro­tect the safety and sta­bil­ity of the bank­ing sys­tem”, the com­mis­sion said. In some cases lo­cal banks face pressure to lend to po­lit­i­cally im­por­tant com­pa­nies, as lo­cal gov­ern­ments aim to maintain high em­ploy­ment even if that means cash-bleed­ing en­ter­prises con­tinue to op­er­ate.

Th­ese loss-mak­ing firms, of­ten state-owned, have come to be known as zom­bie com­pa­nies, and banks and in­vestors fund many of them as if they will not be al­lowed to fail. Im­plicit guar­an­tees and the gov­ern­ment´s de­sire to sup­port growth en­cour­age th­ese firms to in­vest ex­ces­sively, rais­ing al­ready­high lever­age while weak­en­ing per­for­mance on prof­itabil­ity and debt ser­vice ca­pac­ity.

In Oc­to­ber, it warned China´s de­pen­dence on debt was grow­ing at a “dan­ger­ous pace” and needed to act to avert a cri­sis. That came weeks af­ter the Bank for In­ter­na­tional Set­tle­ments - dubbed the bank of cen­tral banks - said the bank­ing sec­tor could be fac­ing an im­mi­nent blowout, rais­ing wor­ries about its ef­fect on the world econ­omy.

The IMF´s lat­est as­sess­ment said fi­nan­cial engi­neer­ing helped banks ob­scure the po­ten­tial losses. “Im­plicit guar­an­tees to SOEs (state-owned en­ter­prises) need to be re­moved care­fully and grad­u­ally,” Sa­hay said. “It would be wise to have a high-level com­mit­tee to mon­i­tor the risks across all sec­tors.”

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