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- The International Monetary Fund released an assessment on China's financial system stability on Thursday

- The study identified three tensions in China's financial system that emerged as the country transitions into a more consumer-driven economy

- The IMF also listed recommendations to improve financial stability in the world's second-largest economy

An almost two-year long study of the Chinese financial system by the International Monetary Fund found three major tensions that could derail the world's second-largest economy.

The first tension in China's financial system, according to the IMF, is the rapid build-up in risky credit that was partly due to the strong political pressures banks face to keep non-viable companies open, rather than letting them fail. Such struggling firms have, in recent years, taken on more debt to achieve growth targets set by the authorities.

The overall debt-to-GDP ratio in the Asian economic giant grew from around 180 percent in 2011 to 255.9 percent by the second quarter of 2017, data by the Bank for International Settlements showed. The rise coincided with a slowdown in productivity growth and pressures on asset quality in the banking system — increasing the risks faced by the Chinese economy.

The second tension identified by the IMF is that risky lending has moved away from banks to the less-regulated parts of the financial system, commonly known as the "shadow banking" sector. That adds to the complexity of the financial sector and makes it more difficult for authorities to supervise activities in the system, the IMF said

And the third issue identified by the international organization is that there's been a rash of "moral hazard and excessive risk-taking" because of the mindset that the government will bail out troubled state-owned enterprises and local government financing vehicles. An example is the "implicit guarantees" that financial institutions offer when selling products to retail investors. That is a situation where the financial product sold are not guaranteed, but banks almost always compensate investors for principal losses by dipping into their own capital.

The IMF said it acknowledged what China has done and welcomed President Xi Jinping's commitment to ensuring financial stability in the country. However, some gaps remained and the fund has five main recommendations for further improvement:

· The Chinese authorities should create a body to focus solely on financial stability and to improve oversight of systemic risk.

· Financial supervisors should be allowed greater independence to do their jobs without the fear of being overruled. They also need more resources and better coordination across all levels to adequately supervise China's large and complex financial system.

· Banks should increase their capital to cushion against a sudden cyclical economic downturn. That is especially important at larger banks as any shocks they face can spread to the other parts of the financial system.

· Banks are recommended to hold more liquid assets and lending rules should be amended to encourage "safer, and longer-term, lending."

· China should reduce the reliance on public funds to help weak financial institutions while ensuring they can fail safely.