Editor's note: Wang Jianhui is the general manager of the Research and Development department at Capital Securities. The article reflects the author's opinions, and not necessarily the views of CGTN.

Mirror is every household's necessity. With a mirror, people can check their appearances and see if they are in shape. The Global Financial Stability Report (GFSR), one of the major publications issued by the International Monetary Fund (IMF), has been serving the same purpose for economists, politicians and central bankers; it helps them monitor the soundness of different countries' financial systems, the potential hazards to the systems as well as the possible solutions. Looking in this "mirror", one should pay sufficient attention to what one sees.

In the previously issued reports, IMF analysts expressed concerns on China's corporate debt level, the elevated leverage of its financial sector (except for insurers), balance sheets of its small and medium banks, and the mismatch of short-term funding and mid- or even long-term investments in the country. Similar concerns as well as those on the excessive credit growth and shadow banking products were expressed in the 2016-2018 reports.

According to IMF, Chinese non-financial sector, households, banks and broker dealers have been more vulnerable than their peers in other economies since 2018. The two regional banks, Baoshang Bank and Jinzhou Bank of northeastern China, with total assets of 551 and 720 billion yuan (78 and 102 billion U.S. dollars) respectively, were taken over by the supervising authority in May and July. One broker-dealer with assets of 21.5 billion yuan (3 billion U.S. dollars) from the same northeastern region has also reportedly terminated its operations. In August, another bank with total assets of 1.05 trillion yuan (0.15 trillion U.S. dollars) (in relatively better developed Shandong Province) was restructured. All these seem to underscore the vulnerability of China's small- and mid-sized banks and securities firms.

Despite potential threats stemming from financial vulnerability to growth in later periods, IMF has been relatively bullish on the Chinese economy. It downgraded all the major economies but revised projection for China upwards in the April's World Economic Outlook report, and lowered expectation this time by only 0.2 percentage points compared to the cut of 0.3 percentage points for global and 0.5 percentage points for emerging economies in 2019.

In this scenario, how should we interpret the concerns about our financial stability? The IMF team, I think, kept bringing these subjects up these years because there are "chronic" threats to the soundness of our system, which must be monitored constantly and tackled gradually.

So far, IMF has been basically sharing the view with People's Bank of China (POBC), which is cautious about the overall rate cuts but proactive on precisely targeted liquidity supply. Thanks to the powerful tools and policy environment, the situation may not be out of control in the near future, and these structural imbalances are not yet posing imminent threats to the overall growth.

However, the situation has become more worrying lately. In the latest report published on October 16, researchers pointed out that the overall financial vulnerability has continued to increase.

The most pressing dangers threatening global financial stability may come from non-bank financial sector (insurers not included so far). Since the normalization of interest rate has been actually replaced by a new round of rate cuts and quantitative ease, investors searching for higher yield of return have increasingly turned to risky and even illiquid assets.

Their major suppliers are the non-bank institutions, such as broker-dealers, trust companies and asset managers, which have been funded by bank loans and short-term financing tools like money market funds or commercial papers. Cheaper capital released by the easy monetary policy has pushed the overall asset valuation to an elevated level, increasing market vulnerability.

According to the IMF staff, the number of major economies with the highest degree of vulnerability (top 20 percent of the sample) in the non-bank financial sector surged from four in April to 18, accounting for 80 percent of the sample and reaching the level of 2008 global financial crisis. 

The assessment of the vulnerability of the non-bank financial sector in the U.S. has gone from "high" to "highest" in the past six months. For the EU, this has gone from "medium" to "high" level. China remains highly vulnerable, including its banking sector which provides large portion of funding to the other financial sectors, while the insurers have gone from "less vulnerable" to "medium".

This could be one of the main negative factors causing IMF researchers to downgrade China's 2020 growth by 0.3 percentage points in April, as compared to a cut of 0.2 percentage points for other emerging economies.

Although we are not seeing another financial tsunami coming soon, given the disappointing experiences during 2008-2009, both industry regulators and market participants ought to be aware of the approaching dangers and take actions right away before it's too late. 

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