Hong Kong () - China should speed up interest-rate reform and allow its currency to trade more freely, the International Monetary Fund said Tuesday, warning that the Chinese banking system “confronts a steady buildup of financial-sector vulnerabilities.”
Among major risks, the IMF — in its first review of China banking system — flagged concerns about domestic banks’ asset quality in the wake of the recent credit boom, as well as lending outside of the formal banking sector and the rise of off-balance-sheet activities, high real-estate prices, and imbalances produced by the nation’s economic growth model.
It warning that “the banking system could be severely impacted” if several of these risks were to cause problems at the same time.
Euro-zone peripheral government bond yields rise sharply against safe-haven German bunds, with Spanish yields rising to levels not seen since August. Photo: Reuters.
Still, the IMF said most of China’s 17 largest commercial banks appear to be resilient to isolated shocks.
Responding to the IMF study, the People’s Bank of China said Tuesday that some of the recommended reforms were not comprehensive or objective enough, and that the specific timing and pace of reforms should be more closely consider China’s particular situation.
Still, the Chinese central bank also said praised the IMF report overall and said Beijing should remain flexible in advancing reforms on interest-rate policy beyond the “substantial progress” already made.
KGI Asia Chief Operating Officer Ben Kwong said that in making financial-sector reforms, Beijing needed to walk a tightrope between addressing the IMF concerns and taking care of the broader economy.
“Nowadays, the government is well aware of its problems, but they also have other concerns, such as growth and inflation,” Kwong said. “Beijing has already tightened its control of the banking system, but if it’s too tight, then it will affect growth.”
Some praise, some push on the yuan
The IMF also praised China’s progress towards a more commercially oriented and financially sound system. It cited improvements in the structure, performance, transparency and oversight of financial institutions and markets.
Among its 29 recommendations, the IMF said first priority should be given to advancing interest-rate reform and allowing the Chinese currency to move more freely, while also ensuring robust risk-management practices are in place at banks.
Keeping interest rates too low by placing a ceiling on deposit rates in an environment of abundant liquidity — as is the current practice in China’s banking system, where real interest rates are negative — has distorted saving-investment decisions, the IMF said.
“It distorts real activity by generating incentives to overinvest and by suppressing household income through low returns on deposits,” the IMF said.
The IMF said the problem was made worse by the lack of alternative investment opportunities for household savings.
It also said that China’s small and medium-sized enterprises had limited access to capital markets, and that these market structures needed to be more advanced.