Financial industry in the spotlight

A2 In the short run, the liquidity squeeze exposes problems in the financial sector, especially at those banks that have relied more heavily on interbank assets and off-balance-sheet credit to grow.

In the coming months, banks will likely have to unwind some off-balance-sheet assets and may suffer some losses, their non-performing loans are likely to rise and they may need to shore up capital in a difficult market environment.

Nevertheless, we don't expect bank failures or a systemic meltdown: the central bank can provide liquidity when necessary; China has high savings with a largely closed capital account, which means the banking system does not rely much on wholesale funding; and the government is the majority owner of both creditors and most problematic debtors.

A3 We think the central bank is right in trying to rein in credit growth and warn banks to properly consider liquidity and counter-party risks.

We also think regulators would be right in cracking down on reckless interbank and other types of regulatory arbitrage, through which banks increase leverage, hide loans, bad assets and risks. This will be helpful to regulate local debt and wealth management products.

To control financial risks, over the coming months, we expect credit growth to slow and financing costs in the economy to rise.

As some shadow banking activities unwind or shrink, sectors that rely more on shadow lending, such as local government finance vehicles and construction-related sectors, will likely suffer more.

This could lead to slower economic growth later in the year and higher non-performing loans in the banking sector.

Hu Shaowei senior economist with the State Information Center