Illustration: Peter C. Espina/GT

Two categories of risks within China's financial system have begun to emerge in 2015, and the trend will continue in 2016.

The first category is the growing non-performing loan (NPL) ratio among commercial banks. The problem was noted in 2014, but it was still not fully reflected in banks' balance sheets in 2015. These risks will increase in 2016, and perhaps further.

The second category of risks lies in Internet finance. The rapid growth of the sector in recent years has resulted partly from technological advancement, but the relative absence of proper laws and regulations has also allowed activity in the industry to increase. Internet finance is still growing at a rapid pace, with numerous investors being drawn by the potentially huge profits, but the sector is also filled with an excessive number of companies. Also, the quality of industry practitioners remains highly variable, with some lacking in financial knowledge and others engaged in outright fraud.

Some government officials and media outlets have been involved in the fraudulent activities of some companies without thoroughly understanding their business model, and have helped them in attracting investment and acquiring cash flow, which also helped these enterprises to gain trust from the public. But hard lessons about abuses in Internet finance should be learned from cases such as Ezubo, a peer-to-peer lending platform that is being investigated for alleged illegal operations and getting into a 70 billion yuan ($11 billion) debt. Greater scrutiny is needed over the behavior of government officials and the media as well.

Considering the current loose industry regulations, the next risk for Internet finance is that the regulatory grip of the relevant authorities might turn to the other extreme and become too tight. If that is the case, it would severely endanger the sector's development and could freeze the momentum of progress in China's financial system. The benefits offered by Internet finance should also be borne in mind. For instance, loan sharks have sometimes charged extortionate interest rates as high as 30 percent. Internet finance has offered a vital alternative funding channel, which has genuinely lowered financing costs for many small and micro-sized enterprises.

Looking ahead, China's financial system in 2016 is also likely to encounter risks from the global financial system.

The US Federal Reserve started a new round of interest rate rises at the end of 2015. Even though markets in developed countries had been anticipating this for two years in advance, China's financial institutions and companies are often not as good at thinking ahead and predicting global trends, and at taking action accordingly. Such institutions and companies are likely to be impacted by the further US interest rate increases that are expected in 2016. And some of these companies may struggle to withstand the effects.

Since the beginning of the year, China's foreign exchange management system and yuan exchange rate have been affected by the US rate rise. The latest statistics from the People's Bank of China (PBC), the central bank, show that China's foreign exchange reserves declined in December 2015 by more than $100 billion from the previous month. An even greater decline of foreign exchange reserves is anticipated in January 2016. Meanwhile, the PBC has been tightening controls on foreign exchange, and also cracking down on speculative activities in Hong Kong's offshore yuan market. But these temporary measures can't fundamentally solve the problems for China's foreign exchange management system and yuan exchange rate.

There are expected to be four further interest rate increases by the Fed this year, with a 0.25 percent rise each time. But how the market will respond is unknown. Even though the Fed is mainly concerned with US interests, volatility in global markets also affects the economic benefits of American companies. So swings in the global markets this year, particularly in China's financial market, could slow the pace of the Fed rate increases.