International Monetary Fund says China's banks need more capital after credit boom

Mae Love
December 7, 2017

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.

"Overall, the reports have presented professional and valuable assessments of China's financial system and its recommendations are highly relevant in the context of deepening financial reform in China", the PBOC said.

"Risks are large", Sahay told reporters during an online briefing.

Although the government is trying to use credit and fiscal policies to support employment and the economy as the shift away from a high-growth focus continues, these policies often conflict with financial stability, the International Monetary Fund said.

China's credit-to-GDP ratio is very high by global standards and consistent with a high probability of financial distress, the IMF said, citing an estimate from the Bank for International Settlements.

"Credit growth has outpaced GDP growth, leading to a large credit overhang".

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

It added that risk-taking was encouraged by a reluctance among financial institutions to allow individual investors to take losses, an expectation that Beijing would bail out state-owned enterprises and local government financing vehicles, and efforts to stabilise financial markets in volatile times. The government should also put more focus on restructuring the operations of distressed companies that could survive rather than resolving their debt problems.

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The PBOC said under the severely adverse scenario during the stress testing, the common equity tier 1 ratios of the banks whose combined assets account for over 65 percent of the total commercial bank assets in China have remained 7 percent and above, attesting to the strong resilience of the financial system.

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

Near the top of the list in the International Monetary Fund 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.

The update, issued after two years of research, said tensions have emerged as China is undergoing a necessary but prolonged economic and financial transformation, the International Monetary Fund said in a statement on its website.

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. The IMF recommended China form a financial stability sub-committee comprising the central bank and regulatory agencies and provide more staff for the banking regulator.

"It is essential that the regulators expand their range and depth of skills before industry developments leave them unable to maintain meaningful oversight and authority", the report said.

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".

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