August 15, 2017

IMF published its staff report and selected issues report in the context of the 2017 Article IV consultation with China. Directors commended the authorities’ increased focus on reducing financial stability risks and urged them to continue to strengthen regulatory and supervisory efforts. To this end, they look forward to the findings and recommendations of the ongoing Financial Sector Assessment Program (FSAP), which is expected to conclude in November 2017.

The staff report highlights that China now has one of the largest banking sectors (310% of GDP) in the world. The sharp growth in recent years reflects both a rise in credit to the real economy and intra-financial sector claims. The large stock of intra-financial sector credit continues to raise important risks for financial stability. Intra-financial sector credit is a way for institutions to boost leverage and profits while avoiding regulatory hurdles such as capital and provisioning requirements on bank loans. Recent regulatory and supervisory tightening is thus critically important and should continue, even if it means some financial tension and slower growth. Given the size of accumulated imbalances, this tightening is bound to create difficulties in the form of defaults of overexposed firms and to dampen activity in related sectors. To prevent such tension from derailing the supervisory tightening and leading to another “stop-go” cycle, regulators should coordinate effectively to ensure that financial conditions do not tighten excessively; ensure that all solvent banks have equal access to The People’s Bank of China’s (PBC) standing lending facilities, provided they have the required collateral; and allow insolvent financial institutions to exit.

  

Also, in early 2017, the PBC extended the coverage of its Macro-Prudential Assessment to off-balance sheet activity for the first time by including wealth management products. The China Banking Regulatory Commission, or CBRC, published several new documents aimed at stricter enforcement of existing regulations and reducing regulatory arbitrage across financial products. The authorities recognized that the growth in the size and complexity of the financial sector raised risks but argued the problem was manageable. The ongoing FSAP will provide staff’s comprehensive assessment of the financial sector framework, risks, and recommendations.

 

The selected issues report, among other issues, discusses the implications of credit boom in China, the rise in corporate debt (focusing on the Central role of state-owned enterprises), and assesses the residential real estate market in China. In the second half of 2016, the authorities started tightening macro-prudential measures for the real estate sector, reversing much of the previous easing. The also report emphasizes that financial reforms are necessary to bolster the regulatory and supervisory framework, including closing loopholes for regulatory arbitrage, reining in leverage, and increasing transparency of nonbank financial institutions and wealth management products.

 

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Keywords: Asia Pacific, China, Banking, Article IV, FSAP, Financial Stability, IMF

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