A senior Chinese banking executive has warned against the growing use of off-book wealth management products, arguing they create dangers for the Chinese banking system.

China must "tackle" shadow banking, particularly the short term investment vehicles known as wealth management products, Xiao Gang, the chairman of the board of Bank of China, wrote in an op-ed in the English-language China Daily today.

Xiao explained: "Shadow banking can broadly be described as the system of credit intermediation involving entities and activities outside the regular banking system. In developed countries, the biggest shadow banking players are usually hedge funds, venture capital and private equity funds. However, in China, shadow banking has mainly taken the form of a large amount of wealth management products, or WMPs as they are known, underground finance and off-balance-sheet lending."

"Given that the number [of such products] is so big and hard to manage, China's shadow banking sector has become a potential source of systemic financial risk over the next few years. Particularly worrisome is the quality and transparency of WMPs. Many assets underlying the products are dependent on some empty real estate property or long-term infrastructure, and are sometimes even linked to high-risk projects, which may find it impossible to generate sufficient cash flow to meet repayment obligations," he wrote.

His warnings are not new. In June last year, China's banking watchdog ordered lenders to stop trying to attract deposits by offering high-yielding wealth management products.A draft of regulations made available for public opinion is aimed at cracking down on abuses in the marketing of wealth management products which bankers admit are being used to lure deposits amid tight liquidity conditions.

Xiao said: "Unsurprisingly, although Chinese banks' non-performing loans are at a low level of 0.9 per cent, the potential risks are worse than the official data suggest." He went on to say that a problem could come as indebted borrowers face cash flow problems or enter default, straining the banking system.

"The music may stop when investors lose confidence and reduce their buying or withdraw from WMPs."

Reuters reported that wealth management projects, which are technically off-book, have grown to account for about a fifth of all new financing in China. They fund projects, such as property development or infrastructure that have trouble tapping normal loan channels.

Their growth has been spurred by credit curbs meant to rein in speculative property investment and by investors' desire for higher yields than traditional bank deposits, which often offer negative real interest rates. More than 20,000 of such products are in circulation, up from just a few hundred five years ago, the BoC chairman said.

"China's general banking stability is increasingly intertwined with the shadow banking system. In the past, Chinese depositors earned the same interest no matter which bank they placed their money with. Today they can shift their deposits to whatever entity offers the best WMP yields. As a result, money has flown out of banks' saving deposits, further eroding the capabilities for lending to the real economy, and could even lead to future cash pressures on banks," he added.