Financial Sector Reform Vital to Rebalance, Sustain China's Growth

IMF's first China check-up part of review of the world's 25 major financial sectors

More complex financial system in China means more risk

Reforms will upgrade ability to respond to crises, support domestic demand

The IMF said in a report that the financial sector’s failure to continue to evolve, innovate, and operate on a prudent basis will create economic imbalances, and amplify the potential for problems in China’s financial sector to affect its economy.

China’s recent progress in creating a properly functioning financial system has helped the economy weather the global economic crisis. As the world’s second largest economy continues to grow, the demand for credit is growing rapidly, exacerbated by rising asset prices, including housing. As a result, credit is increasingly being sought from outside the formal banking system as the government tries to manage the flow of bank credit.

In its first assessment of the health of China’s financial system under the Financial Sector Assessment Program, the IMF said the risks are manageable, and can be addressed by reforms that upgrade the country’s capacity to respond to crises while supporting strong domestic demand.

“China’s banks and financial sector are healthy, but there are vulnerable elements that need to be addressed by the government, and experience in other countries has demonstrated the sooner these are addressed, the better,” said Jonathan Fiechter, deputy director of the IMF’s Monetary and Capital Markets Department and the head of the IMF team that conducted the assessment. “

China is one of the major 25 financial sectors that must undergo a review of its financial health as part of the IMF’s surveillance. The global economic crisis laid bare the devastating economic consequences a financial crisis in one country can have on the global economy. Countries with financial sectors that have the greatest impact on global financial stability are now required to undergo in-depth reviews of their financial health by the IMF every five years.

Risks are manageable with reforms to financial system

China’s financial system is growing more complex, with linkages between financial markets and institutions both within China and around the world, the IMF said.

The main risks to the financial system within the next three years are:

• The impact of the recent sharp credit expansion on banks’ asset quality

• The rise of off-balance sheet exposures and of lending outside of the formal...