China’s financial system is healthy but vulnerabilities in the system are piling up, according to the Financial Sector Assessment Program (FSAP) jointly conducted by the IMF and World Bank.
The report found that banks are resilient to shocks like a correction in real estate prices, changes in exchange rates or deterioration in asset quality but would take a huge hit if these shocks occurred together.
The biggest domestic risks to the financial system are:
(1) The impact of the recent sharp credit expansion on banks’ asset quality; (2) the rise of off-balance sheet exposures and of lending outside of the formal banking sector; (3) the relatively high level of real estate prices; (4) and the increase in imbalances due to the current economic growth pattern.
Now here’s a chart that shows that the system can withstand relatively sizeable aggregate increases in credit risk, and that more resilience in banks from 2008 to 2010 can be attributed to fewer non-performing loans.
Note: CAR stands for capital adequacy ratio. The regulatory minimum is 8%. The entire report is available here.