In the latest Global Financial Stability Report released this month, IMF finds that China’s tightened financial sector supervision and regulation has partly slowed the growth in bank balance sheets and risks, but further notes that the financial sector still has major vulnerabilities.
Distortions in how funds get distributed constitute a problem for the entire financial sector. As the government is expected to support real estate prices in troubled times and as financing is raised commonly by an entity assumed to have full government backing, banks continue to provide cheaper financing for real estate and infrastructure projects than for other branches. In recent years, such favourable lending has increased faster than other lending, increasing the already high land and real estate prices. Infrastructure projects may also lack sufficient cash flow to pay back loans, with the result that such loans end up on the public ledger.
The IMF noted specific problems facing China’s small and mid-sized banks. Many of these banks have weak balance sheets, low profitability and are barely able to meet capital requirements. The IMF recommended that these banks cut back on lending to bolster their balance sheets.
The IMF sees that easing of monetary and credit policies to stimulate the economy could only exacerbate the financial sector vulnerabilities and at the end it might risk the financial stability.