IMF warns shadow banking poses high risk to China’s financial stability

China has been urged by the International Monetary Fund to address threats to its financial system by increasing oversight of shadow banking from unregulated lenders and exercising tighter control of the fast growing insurance sector.

The IMF said unregulated lending risked adding to massive debt levels in China and that risky investment products sold by the insurance sector need far greater oversight from the authorities. 

“The large-scale and opaque interconnections of the Chinese financial system continue to pose stability risks,” the Washington-based organisation said in a half-year report on global financial stability released on Wednesday.

The IMF has long warned of China’s murky shadow banking activities and its threat to the financial system of the world’s second largest economy.

China’s asset-management growth plummets after sweeping regulations rain down on shadow banking sector

The fresh warning came on the heels of Beijing’s reshuffle of its financial regulatory regime.

This included the establishment of a Financial Stability and Development Commission and the merging of the banking and insurance regulators.

A fresh team of government leaders has also been unveiled to oversee the finance sector. Vice-Premier Liu He, banking and insurance regulator Guo Shuqing and central bank governor Yi Gang have taken office to help clean-up the sector.

China’s top leadership has prioritised financial risk prevention over the next three years. Efforts to reduce massive debt have hit the level of transactions between banks and brought on the first slowing in their balance sheets in years.

“Despite these [derisking] efforts, vulnerabilities remain elevated. The use of leverage and liquidity transformation in risky investment products remains widespread, with risks residing in opaque corners of the financial system,” the report said.

Beijing announced regulations in November to oversee the 100 trillion yuan (US$15.9 trillion) asset management sector, which was previously full of leveraged investments.

China’s off balance-sheet investment vehicles are largely funded through investment products, many sponsored by banks. 

“A key challenge for the reform agenda will be phasing out implicit guarantees for investment vehicles,” the IMF said.

It recommended Beijing further limit borrowing for lower-risk products and eventually require that implicitly guaranteed off balance-sheet business carry the same capital and liquidity buffers as on balance-sheet business.

Xi Jinping’s war on shadow banking spills over, rocking China’s wider financial world

Government policy measures, such as lowering economic growth targets, could also be used to reduce incentives to borrow excessively, the IMF said.

China’s insurance companies’ assets are fairly small in the nation’s financial sector, but they have more than tripled in scale over the past seven years.

The firms have invested aggressively at home and abroad through the sale of “universal life insurance” products to raise funds.

Medium-sized and smaller insurers have invested more heavily and have a weaker capability to manage risks, while the size, complexity and interconnectedness of the big life insurers requires greater supervision and a framework to aid their recovery should one fail, the IMF said.