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

Unregulated lending adding to massive debt levels and murky investment products sold by insurance sector also a threat, says US-based organisation

China has been urged by the International Monetary Fund to increase oversight of shadow banking from unregulated lenders and exercise tighter control of the fast growing insurance sector to address threats to its financial system.The IMF said unregulated lending risked adding to massive debt levels in China and that risky investment products are sold by the insurance sector which 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. 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 financial sector. China’s top leadership has prioritised financial risk prevention over the next three years. Efforts to reduce massive levels of debt have plunged 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. 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 fairy 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 raises 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.