Just as concerns over a hard landing in the world's second largest economy look to have faded, economists at Nomura sounded a warning that the Chinese economy is exhibiting the same worrying symptoms that triggered the 2008 financial crisis.
The country's rapid buildup of leverage, decline in potential growth and elevated property prices, are three red flags that should not be downplayed, according to economists at the bank, Zhiwei Zhang and Wendy Chen.
"China faces rising risks of a systemic financial crisis and the government needs to take action quickly to contain such risks. We believe the true extent of financial risks in China is not fully appreciated by investors," Zhang and Chen wrote in a report released over the weekend.
According to the analysts, if China maintains a loose policy stance this year it would heighten the risk of a financial crisis in 2014. Easy monetary policy risks pushing up inflation and leverage in the economy, making the eventual de-leveraging process more disruptive.
"This is clearly a dangerous choice, but we cannot rule it out given political pressures to maintain strong growth," Nomura said in the report.
Leverage, a leading indicator of financial strain and measured as a ratio of domestic credit to gross domestic product (GDP), has reached its highest level since records began in 1978. This ratio was 121 percent before the financial crisis of 2008 and has risen to 155 percent in 2012, as a result of the government's fiscal and monetary policies to support growth.
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"China's leverage rose by 34 percent of GDP in five years — a worrying sign given its history," they said, noting leverage in the U.S. rose by around 30 percent of GDP in the five years before entering a crisis.
The Chinese government has in the recent months sent a number of "unusually strong" signals that it is concerned about financial risks in the economy, they said.
During the People's Bank of China's (PBOC) fourth-quarter monetary policy committee meeting, the central bank said "controlling risks" was a top policy objective.
Last week, PBOC governor Zhou Xiaochuan said the risk banks face on loans to local governments should not be underestimated. He noted that around 20 percent of loans to the financing arms of local governments were risky, several media reported.
In addition to worrying levels of leverage, China is facing a decline in potential growth, according to the economists, driven by a decline in the labor force and productivity growth. The country's working age population began to decline in 2012, according to Nomura.
Last year, China's economy expanded 7.8 percent, its slowest pace in 13 years. In 2013, the government has set an annual growth target of 7.5 percent.
Rapid property price inflation is the final warning sign in the economy, they said, noting that unusually strong increases in asset prices have typically preceded banking crises.
According to official data, housing prices have risen 113 percent from 2004 to 2012 in major Chinese cities. However, they deem the data highly "questionable" and "contradictory" to observations on the ground.
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Citing a report by three professors in Tsinghua University and National University of Singapore, Nomura said property prices rose by 250 percent from 2004 to 2009, far outstripping the level of growth in the official index. This compares to a rise of 84 percent for the Case-Shiller U.S. housing price index from 2001 to its peak in 2006.
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The government has acknowledged risks in the property sector through imposing a slew of measures to stabilize prices earlier this month including the stricter enforcement of a 20 percent capital gains tax on home sale profits.
However, Zhang and Chen, expect they will be ineffective in keeping a lid on prices in the long run.
"The pattern has been for house prices to initially dip after tightening policies are introduced, then to rebound, which suggests that the risks have not been mitigated," they said.