Here's How To Reduce Financial Risk In China

• China’s economic troubles have rattled global markets in 2015.
• The economy’s leverage and the financial sector’s high exposure to property are particularly concerning.
• UBS has a five-pronged plan for reducing financial risk in China.

It’s no secret that China’s economy has hit some bumps in the road this year. In a new report, UBS analyst Tao Wang discusses exactly what is going on in China and how the nation can reduce its financial risk.

The problems
According to Wang, property-related adjustment remains the biggest drag on growth in China. For now, he sees policy initiatives in China focused on fiscal and infrastructure targets.

He believes the major financial risk that China faces must be addressed by reducing the debt servicing burden, stabilizing nominal growth and the restructuring debt and excess capacity.

Financial risk
Wang sees the containment of financial risk as “the big macro challenge” in China in 2016. Leverage has increased sharply in China in recent years to troubling levels. In addition, the debt servicing burden has climbed along with deflationary pressure. Perhaps most troubling, China’s banking sector currently has 40-50 percent exposure to property, leaving it extremely vulnerable to swings in the market.

How to control financial risk
Wang outlines a five-part plan to scale back financial risk levels in China:
1. Stabilize growth via new policies aimed at infrastructure investments, tax cuts, social safety net enhancement and other initiatives.
2. Ensure sufficient domestic liquidity and reasonable and stable interbank rates.
3. Lower financing costs via benchmark rate cuts and interbank rate cuts.
4. Undertake local government debt restructuring, including expanded asset securitization, closed excess capacity and bad debt write-offs.
5. Undergo a cycle of capital raising that will facilitate debt write-offs among financial institutions.

It remains to be seen whether or not the Chinese government will adopt aspects of Wang’s plan, but he believes that taking these five steps would ensure that the occurrence of a financial crisis in China that could threaten global market stability would remain “highly unlikely.”

The iShares FTSE/Xinhua China 25 Index (ETF) NYSE: FXI) is down 27.1 percent in the past six months.

Disclosure: the author holds no position in the stocks mentioned.