China’s banking regulator has told commercial lenders to restrict new credit they provide to local governments’ financing vehicles, to ward off potential risks of default, state media reports.

The move is part of broader efforts to check explosive lending growth that has set off concerns about asset price bubbles and the potential creation of a fresh crop of bad loans.

The China Banking Regulatory Commission (CBRC) ordered banks to inspect their existing loans to commercial units used by local governments to raise funds, and to stop lending to those projects that are backed only by expected fiscal revenues, the state-run Shanghai Securities News newspaper said, citing unnamed sources.

That follows the top economic planning agency’s tightening control over bond issuance by such investment vehicles in January, as worries mount over a build-up of local government debt.

About 40 percent of China’s 9.6 trillion yuan ($1.4trn) in new loans last year, or 3.8 trillion yuan, went to local governments, state media reported in January.

“The new restriction will have a huge impact,” said Shi Lei, an analyst at Bank of China in Beijing.

Shi estimated that the move had the potential to trim lending to local governments by a third this year, or by more than one trillion yuan, leaving about two to three trillion yuan in credit to allow them to complete projects already under way.

“So banks may divert their cash into loans to other types of companies and borrowers, or into bond investments, as they allocate funds to meet their lending targets,” he said.

Chinese provinces and municipalities are not allowed to issue bonds directly, apart from through a limited pilot programme launched last year, but they have set up more than 3,000 commercial units and borrowed heavily through them.

Bonds in favour
Banks lent a record 9.6 trillion yuan ($1.4trn) in 2009 as they rushed to support the government’s economic recovery programme. This year Beijing has set a loan target of 7.5 trillion yuan.

The CBRC has already ordered banks to check that their loans are not flowing into property or stock market speculation, while the central bank has twice raised banks’ required reserves and ordered some lenders to put up additional punitive reserves.

The latest step could reduce some of the cash flowing into the stock market, as some of that credit is thought to have been used for speculative purposes, analysts said.

“The stock market is really feeling a crunch of funds after a slew of official liquidity clampdown steps effectively cut money supply, particularly funds improperly flowing into the market,” said Chen Huiqin, stock analyst at Huatai Securities in Nanjing.

“The latest lending clampdown may not be a major move but it really points to the direction once again. Once the government starts such a campaign, it won’t stop until it reaches its goals.”

The bond market could see greater interest as banks look for other places to park their money, analysts and traders said.

The Shanghai Securities News also reported that the CBRC had ordered trust companies to ensure that they were not supplying credit to developers to build up reserves of land.

With property prices soaring in many major cities, the government has sought to rein in speculation and limit practices such as land hoarding that drive up prices.

The two detailed orders follow a more sweeping warning by the CBRC that banks must not lend too aggressively and must verify that their loans are being used for the intended purpose.