Saturday, 06 June 2020 Sydney

China’s robust financial system still face challenges::

China’s financial system is robust overall, however, it faces a steady build-up in vulnerabilities, according to the International Monetary Fund (IMF). 

China has made remarkable progress in its  transition toward a more commercially-oriented and financially sound system, with ongoing improvements being made to the structure, performance, transparency and oversight of financial institutions and markets. As a result, the financial sector entered the global financial crisis from a position of relative strength. 

China is on the eve of a demographic shift that will have profound consequences on its economic and social landscape. Within a few years the working-age population will reach a historical peak, and then begin a precipitous decline. This fact has raised questions about whether China is poised to cross the Lewis Turning Point, a point at which it would move from a vast supply of low-cost workers to a labour shortage economy. 

Crossing this threshold will have far-reaching implications for both China and the rest of the world. The IMF’s central result is that on current trends, the Lewis Turning Point will emerge between 2020 and 2025. Alternative scenarios — higher fertility, greater labour participation rates, financial reform or higher productivity— may peripherally delay or accelerate the onset of the turning point, but demographics will be the dominant force driving the depletion of surplus labour. 

"China’s banks and financial sector are healthy, but there are vulnerabilities that should be addressed by the authorities,” says Jonathan Fiechter, deputy director of the IMF’s Monetary and Capital Markets department and the head of the IMF team that conducted the review. 

While the existing structure fosters high savings and high levels of liquidity, it also creates the risk of capital misallocation and the formation of bubbles, especially in real estate. The cost of such distortions will only rise over time, so the sooner these distortions are addressed the better."

Near-term risks  

According to the Financial Sector Assessment Program report, China’s financial sector is confronting several near-term risks: 
• deterioration in loan quality due to rapid credit expansion; 
• growing disintermediation by shadow banks and off-balance sheet exposures; 
• downturn in real estate prices; 
• uncertainties of the global economic scenario. 

Medium-term vulnerabilities are also building and could impair the needed reorientation of the financial system to support the country’s future growth. Moving along this path will pose additional risks, so priority must be given to establishing the institutional and operational preconditions that are crucial for a wide-ranging financial reform agenda. 

Main areas of reform

The IMF says the main areas of reform should include: 
• steps to broaden financial markets and services, and developing diversified modalities of financial intermediation that would foster healthy competition among banks
• a reorientation of the role of government away from using the banking system to carry out broad government policy goals and to allow lending decisions to be based on commercial goals
• expansion of the use of market-based monetary policy instruments, using interest rates as the main instrument to govern credit expansion, rather than administrative measures
• an upgrading of the financial infrastructure and legal frameworks, including strengthening the payments and settlement systems, as well as consumer protection and expansion of financial literacy

Stress tests 

Stress tests conducted jointly by the IMF and Chinese authorities of the country’s largest 17 commercial banks indicate that most of banks appear to be resilient to isolated shocks. These shocks include a sharp deterioration in asset quality (including 
a correction in the real estate markets), shifts in the yield curve, and changes in the exchange rate. If several of these risks were to occur at the same time, however, the banking system could be severely impacted, the report warns.