IMF alert on banks adds to fears about dangers in China

The International Monetary Fund warned yesterday that China's banks are increasingly vulnerable to asset bubbles and called for an overhaul of risk management and regulation, adding to concerns about risks in the world's second-biggest economy.

In its first appraisal of China's financial sector, the IMF warned that banks faced systemic risk from a potential combination of credit, property and currency shocks.

The fund praised China's efforts to liberalise its financial system but warned that the sector needed further reform to guard against risks from surging property prices and opaque off-balance sheet lending.

China needs to rein in state direction to let its banks act in a commercial manner, the IMF said. The fund said the banks could cope with individual events but that they were open to crises caused by a combination of risks.

The IMF's judgement added to fears about dangers lurking in Asia's economic powerhouse. Investors are attracted by the country's booming markets but potential risks and rewards remain difficult to calculate.

Anthony Bolton, Britain's most successful fund manager, admitted on Monday that he had underestimated the difficulty of investing in China. As well as bad bank debts and falling house prices, Mr Bolton was caught out by losses at two companies that were later accused of fraud.

China's forestry company yesterday sought to rebut accusations of fraud. Sino-Forest released an interim report that it said refuted allegations made by Muddy Waters, a research firm specialising in Chinese companies and headed by a US short-seller.

The report, produced by two Sino-Forest directors aided by auditors from PwC and external lawyers, confirmed the company's cash balances, timber assets and income, which had been questioned by Muddy Waters.

The chief executive of Sino-Forest, Judson Martin, said: "Far from being a 'near total fraud' and 'Ponzi scheme' as alleged by Muddy Waters, Sino-Forest is a real company, with real assets and real revenue." However, he admitted that the company's communication, management team and internal processes had been found lacking by the investigation.

Carson Block, Muddy Waters' boss, said the report had no credibility because the directors who headed the investigation were defendants in shareholder lawsuits and a third director had quit just before publication.

Sino-Forest, listed in Toronto, is one of many Chinese companies traded on international exchanges that have faced accusations of making misleading claims.

The IMF said its report was hindered by gaps in its data, reporting weaknesses and its team's lack of access to confidential information.