Shadow Banking Still a Major Threat to China’s Financial System: IMF

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The International Monetary Fund’s semi-annual report on global financial stability says that China’s shadow banking sector continues to be a major source of systemic risk.

According to the report released on Wednesday the shadow banking sector continues to contribute to China’s exorbitant debt pile, as well as exacerbate risk levels because of its opaque and unregulated nature.

“The large-scale and opaque interconnections of the Chinese financial system continue to pose stability risks,” said the report.

While China launched a crackdown on the banking sector and a concerted deleveraging campaign more than a year ago, the IMF believes that these efforts have done little to ameliorate risk in the financial system.

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

The IMF report urged Beijing to step up its regulation of the shadow banking sector, and to focus in particular upon risk-fraught investment products sold by insurers.

The Chinese central government recently launched the biggest reform of its financial regulatory system in fifteen years with the merger the banking and insurance regulators into a single authority.

In addition to raising the efficiency and coordination of financial regulation, observers say the move is intended to better deal with the highly integrated nature of China’s finance system, and the extensive overlap between sectors.

The assets of Chinese insurance companies have more than tripled in size over the past seven years, with firms using the sale of “universal life insurance” products to fund profligate investments both at home and abroad.

According to the IMF the poor risk management capabilities of small and medium-sized insurers who are amongst the more aggressive investors means that heightened regulation of the insurance sector is urgently needed.

Another source of risk in the insurance sector is the immense size, interconnectedness and complexity of the large-scale life insurers, necessitating greater scrutiny as well as contingency plans in the case of failure.

The IMF also said that one of the keys to bolstering the health of China’s financial sector will be the removal of the “implicit guarantees” underlying the investment vehicles so frequently used by banks to fund off-balance sheet activities.

China is on the verge of implementing a new set of asset management regulations that were first unveiled in November last year, and triggered much controversy within the domestic banking sector by specifically targeting implicit guarantees for investment vehicles such as wealth management products.