World financial markets have calmed after the turmoil earlier this year, but more needs to be done to ensure global financial stability amid slowing growth, weak commodity prices and worries about China’s economy, the International Monetary Fund warned on Wednesday.

The IMF said in its latest Global Financial Stability report that financial system risks have risen since the last report in October and market turmoil could easily recur and intensify if no action is taken to clean up bank balance-sheets, particularly in China and Europe.

“If the growth and inflation outlooks degrade further, the risk of a loss of confidence would rise. In such circumstances, recurrent bouts of financial volatility could interact with balance-sheet vulnerabilities,” the IMF said in the report.

“Risk premiums could rise and financial conditions could tighten, creating a pernicious feedback loop of weak growth, low inflation and rising debt burdens,” it added.

Worries about China's growth slowdown and transition to a more consumer-driven economy helped spark the most recent financial turmoil, and the IMF said China’s struggling state enterprise sector is straining bank balance-sheets. The report estimates that bank loans to companies potentially at risk in China could translate into potential bank losses of around 7 per cent of the country’s gross domestic product.

“This may seem like a large number, but it is manageable given China’s bank and policy buffers and continued strong growth in the economy,” said Jose Vinals, head of the IMF’s Monetary and Capital Markets Department.

Negative rates crucial

The IMF report said negative interest rate policies, along with bond purchases, were “crucial” to boosting economic growth.

Although they have reduced banks’ profit margins, the report said banks would ultimately benefit from stronger growth.

However, should the IMF’s worst-case scenario occur, potential global output growth could be reduced by 3.7 percentage points over five years..

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