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The headquarters of the People's Bank of China in Beijing.Jason Lee/Reuters

China needs to resolve outstanding financial risks, and must counter risks from “abnormal” market fluctuations that stem from external shocks, said the central bank on Monday, as Beijing prioritises financial stability amid increasing challenges.

Financial markets are highly sensitive to global trade situations and rising uncertainties in global liquidity, said the People’s Bank of China (PBOC) in its annual financial stability report, adding that it will step up real-time supervision on stock, bond, foreign exchange markets to prevent cross-sector risk contamination.

Bond defaults may continue, so authorities must prevent the risks of such defaults from triggering systemic risks, it said, while penalties on regulatory violations in the securities market would be increased.

Beijing has stepped up daily supervisions and assessment on potential “black swan” and “grey rhino” events that may occur in the future and has prepared contingency plans, as downward pressure on the economy rises, said the PBOC.

China’s household leverage ratio rose to 60.4 per cent relative to gross domestic product (GDP) by the end of 2018, reaching the international average level and posing debt risks in some regions and low income families, according to the annual report.

The central bank reiterated that it would maintain a proactive fiscal policy and a prudent monetary policy, as well as implement greater tax cuts and increase the issuance quota for local governments’ special bonds used to fund infrastructure projects by a large margin.

Looking ahead, the PBOC will tailor its credit supply to better boost the economy and strike a fine balance in achieving growth and fending off risks.

“Overall speaking, China’s financial risks have been slowly resolved but the risks are still abundant, after accumulating rapidly in the past few years,” said the PBOC. It added that potential risks and problems will be difficult to eliminate in the short term.

At the end of last year, 13.5 per cent of China’s 4,379 financial institutions, mostly rural and smaller institutions, were rated as “high-risk” by the PBOC in the annual review of the industry. That compared with an about 10.58 per cent of institutions that failed the PBOC’s 2018 test.

It is also exploring development of an exit mechanism for unqualified shareholders of rural financial institutions, as well as market-based and diversified approaches for financial institutions to exit the market.

Earlier this year, a rare government seizure of then little-known Baoshang Bank and the state rescue of Jinzhou Bank and Hengfeng Bank revived concerns about the true health of hundreds of small lenders in the country as China’s economic growth slowed to nearly a 30-year low.

China’s big four banks - Bank of China, Agricultural Bank of China, Industrial and Commercial Bank of China and China Construction Bank - face relatively large pressures to meet standards for their total loss-absorbing capacity (TLAC), said the PBOC.

It will coordinate with other departments to roll out regulations to help those banks meet TLAC requirements on time, it added.