As authorities crack down on risks, "this creates powerful incentives for financial innovation and finding imaginative ways to finance firms despite their lack of economic viability", the report said.
It added that the system's increasing complexity "has sown financial stability risks".
China's central bank, the People's Bank of China, said overall a series of reports published by global bodies including the IMF were "professional and valuable assessments". "Having said that, the authorities are really aware of risks and they are working proactively to contain these risks".
At times there had been pressure to keep struggling firms open rather than allowing them to fail - a policy that could conflict with financial stability, it added.
"Credit growth is an important indicator of future financial distress, because lending standards often fall in the rush to make more loans", International Monetary Fund experts warned in a blog post.
In order to reduce the pace of credit growth, the government needs to overhaul state-owned enterprises (SOEs) and allow those that aren't viable to fail, and also to strengthen the social safety net so that the impact on the population when companies close down is minimized, the International Monetary Fund said.
The IMF specifically warned that the rapid development of financial products for investors could pose grave risks.
China announced the establishment of a Financial Stability and Development Committee (FSDC) in July, reporting directly to the State Council and chaired by Vice Premier Ma Kai, to strengthen supervision of the financial system, prevent system risks and formulate new laws and regulations to provide one unified regulatory framework.
"Regulators should reinforce the primacy of financial stability over development objectives", the fund said.
"Better coordination among supervisors is therefore essential to make sure that these risks are contained, and that everyone understands what the risks to these products are", he said.
There had also been growth in increasingly complex investment vehicles while risky lending had been moving away from banks to less well-supervised parts of the financial sector.
It found that Chinese banks, while meeting worldwide "Basel" targets, should gradually increase their levels of capital to provide buffers against potential losses that can be expected as credit is tightened and the assumed guarantees for investors are removed.
China has relatively strong ability to fend off any financial risk, the central bank said in a statement on its website.