International Monetary Fund warns over 'large risks' for China's financial system

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The IMF report comes a day after regulators in Beijing drafted new rules to strengthen bank funding, and follows a number of alerts about a ballooning debt problem in the world's number-two economy.

The report said China should put less emphasis on targets for growth, which led to excessive credit expansion and higher levels of debt at local level; that it should beef up financial supervision and put increased emphasis on spotting risks ahead; and that it should gradually increase the amount of capital targeted banks should hold.

These issues combined with the country's emphasis on sustaining a high level of economic growth and a reluctance to let unprofitable firms go under led the International Monetary Fund to recommend the government re-evaluate its emphasis on maintaining growth, instead increase financial regulation and better banks' finances.

Ratna Sahay, deputy director of the IMF's Monetary and Capital Markets Department said in a statement that central government officials were aware of these risks and were proactively working to contain them.

The IMF's experts carried out stress tests on dozens of banks. China's "big four" banks had adequate capital, but "large, medium and city-commercial banks appear vulnerable", it said. These 33 banks account for 74 percent of banking system assets.

The report recommended the country steps up its monitoring of financial risk, increase liquidity buffers and reduce its emphasis on maintaining its GDP growth.

Such firms with weak fundamentals have become a key concern in China as they contribute to debt vulnerability and low productivity, and this issue is seen as one of the main reasons for the rise in corporate debts.

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That came weeks after the Bank for International Settlements - dubbed the bank of central banks - said the banking sector could be facing an imminent blowout, raising worries about its effect on the world economy.

The IMF said the impact of the shocks is highly uneven across banks.

At times there had been pressure to keep struggling firms open rather than allowing them to fail - a policy that could conflict with financial stability, it added.

But it said it did not go along with all of the findings and that the stress tests "do not fully reflect the whole picture".

China's economy beat expectations by growing 6.9 percent in the first three quarters of the year, though several global credit agencies have sounded the alarm about rising debt.

The IMF's latest assessment said financial engineering helped banks obscure the potential losses.

"It would be wise to have a high-level committee to monitor the risks across all sectors".