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China’s shadow banks need ‘close monitoring’: IMF

China's booming unregulated banking sector needs to be scrutinized, the International Monetary Fund (IMF) said on Wednesday, shortly after an official from the Chinese central bank defended its role in the economy.

Growth of shadow banking is outpacing that of the traditional banking system in emerging markets, where the unofficial sector is now worth around $7 trillion, according to the IMF. Its economists noted that the escalation was particularly marked in China.

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Shadow banks are financial intermediaries that provide services similar to traditional commercial banks, but are largely unregulated. Shadow banking can include financial activities by hedge funds, money market funds, structured investment vehicles and private equity funds.

"Among emerging market economies, the large size (between 35 and 50 percent of GDP (gross domestic product)), and fast growth (over 20 percent per year), of shadow banking in China stands out and warrants close monitoring," said the IMF on Wednesday in an update to its Global Financial Stability Report.

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According to the IMF, shadow bank financing is expanding at twice the rate of bank credit in China. Entrusted loans—where a bank organizes a loan between borrowers and lenders but does not bear any of the risk—originating outside of the highly-regulated banking system accounted for a large share of the sector.

Shadow banks first caught the attention of experts because of their growing role in turning home mortgages into securities in the U.S., with some economists arguing that the lack of regulatory oversight of the sector precipitated the global financial meltdown of 2008-09.

Recently, Chinese authorities have taken steps to combat what the IMF termed the "excessive growth" of shadow banking, including pushing for tighter risk controls in financial trusts.

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However, the vice-governor of the People's Bank of China defended the economic benefits of the unregulated sector last week.

"We can't just say 'no' to shadow banks, because to some extent, they satisfy some financing demands of a diversified economy," Hu Xiaolian told Xinhua, the Chinese state news agency, on Friday.

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The IMF's report comes at a time of burgeoning concern that major emerging markets like China can pose systemic risks to the world economy.

This Monday, economists warned in the annual "Geneva Report" that a "poisonous combination" of low economic growth and high debt could catapult the world into its next crisis—with China at the forefront, given its high debt-to-GDP ratio of 217 percent.

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Shadow banking in China has boomed since 2010, when the government placed significant restrictions on the traditional banking system in response to concerns about the rapid growth of bank lending and inflation. The intervention slowed conventional lending, but not off-balance-sheet loans.