The stability of the yuan may come under great pressure and China needs to improve the currency regime further, central bank governor Zhou Xiaochuan was quoted as saying.

Zhou's remarks, carried in the China Securities Journal, elaborated on the central bank's first report about China's financial stability, published Monday. "Currently, there is an imbalance between direct and indirect financing," he said, referring respectively to equity and bonds, on one hand, and bank loans on the other.

"The ratio of bank loans to gross domestic product is excessive and so financial risks are concentrated in the banking system," the newspaper quoted Zhou as saying.

"The stability of the currency's value faces very great potential pressures and the exchange rate formation mechanism still needs further improvement," he was quoted as saying.

When it refers to stability in the value of the yuan, the central bank, the People's Bank of China, has in mind not just its exchange rate but also its domestic purchasing power, Chinese officials have said.

Zhou said China's ongoing efforts to reform the banking sector had helped maintain financial stability, but domestic banks still needed sound corporate governance to curb risk. They also had to avoid moral hazard in the reform process.

He did not elaborate, but one obvious source of moral hazard has been the willingness of the government to step in and recapitalize insolvent financial institutions.

"As China's financial system becomes increasingly open, it will definitely face external shocks and pressures," Zhou added.

(Shenzhen Daily November 10, 2005)