BOFIT Viikkokatsaus / BOFIT Weekly 2017/17

The IMF's latest Global Financial Stability Report suggests that the risks to China's financial system are still rising. Indebtedness continues to soar as meeting official growth targets requires on-going debt-fuelled stimulus. Vulnerabilities of the financial system are highlighted by the fact that financial institutions rely on extremely short-term market financing to cover their long-term liabilities. Thus, financial institutions are quite susceptible to changes in money market rates. In addition, the structure of the financial sector has become more complex as the shadow banking sector provides means to increase leverage through various financial chains. The IMF would like to see China make special efforts to supervise smaller banks and the shadow banking sector, as well as focus its attention on possible contagion problems in the interbank markets. The policy contradiction between the need for deleveraging and high growth targets must be resolved. The IMF said that it is as urgent as ever to solve the debt problem as the likelihood of a major financial crisis increases the longer action is postponed and the larger is the size of the debt.

The Chinese have become far more serious about rising financial market risk in recent weeks. In a speech to the politburo this week, president Xi Jinping stated that government should attach great importance to ward off any financial risks and make sure there are no systemic risks. Since Guo Shuqing took over as chairman of the China Banking Regulatory Commission (CBRC) at the end of February, banking rules have been tightened and oversight increased. For example, the CBRC has tried to crack down on shadow banking operation designed to evade banking regulation and banned certain types of complex financial arrangements. Issuance of certificates of deposit on the interbank market has been restricted and banks are required to provide more information than earlier to officials. Officials last week announced that they would begin to reassess collateral and loan guarantors. A number of cases have emerged in recent months in which companies have cross-guaranteed each other's loans.

The growth of Chinese debt remained brisk in the first quarter of this year. The stock of total social financing, China's broader concept of credit, grew by 12.5 % y-o-y. The strong growth in bank lending remained steady overall, even if lending by the shadow banking sector accelerated to its highest growth level in two years. Some observers expect the new measures to restrain the growth of indebtedness. However, hitting growth targets requires rapid debt growth. In any case, disturbances like those seen before are likely to continue on China's financial markets.