A number of newspapers yesterday reported a warning by the International Monetary Fund about the health of China's banking sector. I'm surprised it hasn't been more widely discussed in the context of the generally dismal outlook for the global economy.

The IMF's analysis has some quite frightening implications. The general message is that the Chinese financial sector is full of hidden liabilities and is vulnerable to shocks from the bursting of a property bubble. It is written, as IMF reports always are, in arid technical prose, but the picture that emerges is one of a system that has become bloated and irresponsible thanks to a lack of regulatory and commercial rigour. Anyone know any other financial systems that meet that description?

The system is becoming more complex and inter-linkages between markets, institutions, and across international borders are growing. In addition, informal credit markets, conglomerate structures, and off-balance sheet activities are on the rise.

The scale of the risk was hard to assess because of a shortage of good data, which hardly encourages a generous interpretation of the situation.

Perhaps most alarming is the suggestion that Chinese banks have made heaps of loans based on political rather than commercial imperatives.

Banks' large exposures to state-owned enterprises, guaranteed margins provided by interest rate regulations, still limited ability and willingness to differentiate loan rates, coupled with the implicit guidance on the pace and direction of new lending, undermine development of effective credit risk management in the banks. It is important that banks have the tools and incentives to make lending decisions based upon purely commercial goals.

Given China's well-documented problems with corruption, that would imply that Chinese bankers have been doling out cash to their patrons and friends in state-owned companies. That situation can run along unchecked for a while, but at some point in its transition to a functional market economy Beijing will have to enforce some discipline in terms of which enterprises are bona fide and which are unprofitable make-work schemes - or worse, empty shells funneling cash to corrupt officials - supported by loose credit. It sounds as if any serious rigour along those lines would risk bank failures and even a systemic financial crisis. That can't be good.