International Monetary Fund sounds China warning amid debt build-up

The PBOC disagreed with some points in the report, but said the fund's recommendations are "highly relevant in the context of deepening financial reforms" in the country.

The IMF's health check of China's financial system found that credit was high by worldwide levels, that personal debt had increased in the past five years, and that the pressure to maintain the country's rapid growth had bred an unwillingness to let struggling firms fail. The credit-to-GDP ratio is now about 25% above the long-term trend, very high by worldwide standards and consistent with a high probability of financial distress.

Speculation has grown that the government may lower the annual GDP growth target or abandon it altogether after President Xi Jinping stopped short of following his predecessors in setting a long-term economic expansion target at the twice-a-decade National Party Congress in October.

This has led to a situation in which failing companies are kept afloat, thanks to incentives for local governments to do so. The government should also put more focus on restructuring the operations of distressed companies that could survive rather than resolving their debt problems.

While the country's banking system meets the requirements of global banking rules known as Basel III, "current circumstances warrant a targeted increase in capital", the report said.

The IMF said China's growth has been supported by a financial system that is increasingly complex and lacks rigour.

China should "incite local governments to strengthen supervision on risks", she added.

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But the International Monetary Fund said a more-effective macroprudential policymaking structure was needed, and to ensure the FSDC made well-informed decisions, a Financial Stability Sub-Committee should be set up, composed of the People's Bank of China (PBOC) and the banking, securities and insurance watchdogs, to take on the sole mandate of ensuring financial stability.

Beijing should put less emphasis on growth, beef up regulation, and improve banks' finances, the International Monetary Fund said.

The fund said that Chinese financial institutions are seemingly unwilling to allow investors to lose money and that this has created an environment where investors are simply taking more and more risk, lacking the fear that they'll ever actually see a downside.

"In terms of resources, the CBRC as with the other supervisory agencies under the [People's Bank of China] have been working with a headcount that hasn't changed in 10 years, a period in which the Chinese financial sector has more than doubled in size", Piris told reporters.

"It is essential that the regulators expand their range and depth of skills before industry developments leave them unable to maintain meaningful oversight and authority", the report said.

"The descriptions of the stress testing did not fully reflect the outcomes of the test", it said on its website.

"We are also concerned that in a very innovative financial system such as China's, new products can emerge very quickly and very rapidly become large and popular, and potentially a systemic risk", said James Walsh, deputy division chief of the Monetary and Capital Markets Department.

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