8 Risks to China’s Financial Markets

China faces eight major risk areas in the financial sector: bad loans, liquidity strains, bond defaults, shadow banking, external market shocks, property bubbles, government debt and online financing, according to Yang Weimin, a senior official with China’s top economic policy-making office.

“Pressure for financial risk control is growing, with a possible U.S. Fed rate hike and other external uncertainties,” said Li Wei, director with the Development Research Center of the State Council. “Meanwhile, the ongoing de-leveraging of the economy and reform of ‘zombie enterprises’ might expose some financial risks.”

At the annual Central Economic Work Conference in December, the central leadership pledged to make preventing financial risks a priority, saying that curbing asset bubbles would be more important in 2017.

Nevertheless, China has proven its mettle in dealing with past financial shocks. In the aftermath of global financial crises in 1998 and 2008, China held fast as an anchor of economic stability, even as many market stalwarts faltered.

China can avoid the worst yet again, according to a recent research note from Morgan Stanley citing three major factors.

Firstly, China’s own savings have funded its debt build-up, which has gone into investment rather than consumption.

Secondly, the government enjoys strong net asset positions both domestically and externally, offering adequate buffers against shocks.

Thirdly, strong external macro positions, including a current account surplus, high levels of foreign currency reserves, and lack of significant inflationary pressures, leave China with plenty of leeway to manage domestic liquidity.

While China’s financial market regulators are stepping up supervision, there is growing call for more reform of the current regulatory framework.

A recent survey of 1,794 Chinese bankers showed that over 40 percent believed that financial market supervision should take a macro-prudential view and focus more on functional regulation that would address supervision of cross-sector financial business.

Regulation capability and cross-sector coordination should be improved to prevent financial risks making bigger waves, analysts say.

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