MNI: IMF Urges China Tighten Financial Regs Amid Complex Risks

--Warns Of Contradiction Between Financial System Security, Development Policies

--Central Gov't Policies Not Being Fully Implemented by Local Governments

     BEIJING (MNI) - The International Monetary Fund recommended Thursday that

China tighten regulation of its financial sector as risks continue to rise amid

rapid growth of the sector.

     Expansion of monetary and fiscal policies, regulatory arbitrage by

financial institutions mixed with a rise of their offerings of increasingly

complex investment vehicles, and the proliferation of implicit guarantees for

financial products pose risks to China's financial system, the IMF said in its

latest Financial System Stability Assessment (FSSA) of China. 

     The FSSA, released every five years, aims to identify major financial risks

and offer recommendations for better policy making to enhance its economic

resilience.

     Government initiatives to buoy job creation and domestic growth, especially

by local governments, have hindered the closure of "non-viable firms" and

allowed substantial credit growth that has fueled a sharp rise in corporate and

household indebtedness, the Fund said.

     FINANCIAL RISKS HAVE PROLIFERATED

     Under tight regulation of the banking sector, regulatory arbitrage -- the

practice of moving riskier business practices to units supervised by less-strict

regulators -- along with the creation of increasingly complex investment

vehicles skyrocketed, resulting in the transfer of financial risks to non-bank

financial institutions (NBFIs) from banks, the Fund said. Some NBFIs, such as

insurance companies and asset managers, report faster growth of their investment

products under less stringent supervision, but banks are still interconnected

with these players, thus creating uncertain financial risks.

     Unreasonable guarantees by governments and financial institutions on

financial assets also pose moral hazard risks, though the Chinese government has

recently sped up new policies to tackle the problem, according to the FSSA

report. Financial institutions' reluctance to let retail investors suffer

investment losses, using implicit payment guarantees remain problematic even

though the People's Bank of China is clamping down on the practice. Continuing

expectations that the government would bail out and take accountability for debt

of local government financing vehicles (LGFVs) and state-owned companies (SOEs)

is another key contributor for overall systemic risks, the Fund said.

     CONTRADICTION BETWEEN FINANCIAL SECURITY AND PRO-GROWTH POLICIES

     The IMF praised the Chinese government's recent policy initiatives to

tighten controls on financial risk, but pointed out the contradiction between

the central government's goal to defend the safety of the financial system and

local governments' intentions to grow the economy and secure jobs could hold

back China's progress in restructuring and rebalancing its economy.

Implementation at the local level of policies issued by the central government

is lacking and so oversight needs to be strengthened, the Fund said.

     The nation's large credit overhang and the proliferation of shadow banking,

which international ratings agencies and international organizations have warned

about repeatedly when assessing China's economic health, must be resolved, the

report said.

     A clear government emphasis on prioritizing financial stability over

economic growth would help rein in risks, the Fund stressed.

     Regulators and oversight officials should be given sufficient legal

protection, independence and resources to effectively supervise the financial

sector, the Fund said. The newly established Financial Stability and Development

Committee (FSDC) has been mandated to ensure financial stability and to enhance

development, the Fund noted, arguing that this dual mandate may affect its

decision-making in setting policies to secure financial stability. The IMF

suggested China create a separate agency with the sole task of defending the

stability of the financial sector, even if it reports to the FSDC.

     Because Chinese banks remain the core of the nation's financial system,

bank capital should be gradually increased under a specific target to ensure

banks hold sufficient capital in line with their risk profiles and management

capacities, IMF said. This does not necessarily mean a an increase in the

regulatory capital ratio, the Fund noted, adding an increase in banks' profit

and a temporary reduction in their excess capital would help achieve the same

effect as a regulatory ratio cut. 

--MNI Beijing Bureau; +86 (10) 8532-5998; email: iris.ouyang@marketnews.com

--MNI BEIJING Bureau; +1 202-371-2121; email: john.carter@mni-news.com

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