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China’s central bank said on Sunday it will raise the amount banks must hold in reserve for a third time this year, the latest move by Beijing to cool its booming economy.

The increase came after regulators ordered China’s largest banks to re-examine their loan books and provide estimates of their exposure to un-collateralised loans, especially to provincial governments, according to Chinese bankers and analysts.

If banks are unable to find assets to collateralise these loans within a few months they might be required to downgrade the loans, potentially leading to a spike in non-performing assets on their books, analysts said. After reporting record profits in the first quarter, Chinese banks are under pressure to rein in lending and restrict loans to certain sectors and industries as Beijing tries to calm the economy without causing growth to stall.

The biggest concerns for regulators are huge loans to shell companies set up by local governments to supplement their fiscal income, as well as loans to real estate developers and speculators that have helped inflate a bubble in the property market.

The central government has ordered banks to curb lending, especially to these sectors, after an unprecedented expansion in credit last year that saw new loans nearly double from 2008 to Rmb9,600bn ($1,406bn).

As part of its efforts to reduce lending, the People’s Bank of China will raise the reserve requirement ratio for deposit-taking financial institutions 0.5 percentage points, with effect from May 10, bringing the rate to 17 per cent for large Chinese banks and 15 per cent for smaller lenders. The ratio for rural credit co-operatives and village banks will not be raised.

Although credit growth has slowed, Chinese banks still managed to extend Rmb2,600bn in new loans in the first quarter, helping banks such as Industrial & Commercial Bank of China, Bank of China and Bank of Communications post their best-ever quarterly profits.

But analysts expect the profit growth to slow this year as Beijing introduces more measures to cool an economy that grew 11.9 per cent in the first quarter.

Consumer price inflation hit 2.4 per cent in March, down slightly from February’s 2.7 per cent but still high enough to push real interest rates for Chinese savers into negative territory thanks to low deposit rates.

The central bank has not adjusted benchmark interest rates since December 2008, preferring to rely on adjustments to the reserve requirement and direct intervention with banks to curb excessive lending.

The government has already prohibited banks from accepting local government guarantees for loans instead of collateral, according to Dorris Chen, analyst at BNP Paribas.

Loans to local government entities or projects must now be collateralised with government land, cash flow from the project taking the loan or a guarantee from an independent entity with a “strong financial background”, according to Ms Chen.

“Out of a total of Rmb6,000bn to infrastructure projects in 2009 about half went to local government financing vehicles,” she said. “There is no data on how much of the Rmb3,000bn in loans is collateralised but I am sure the majority of it is not.”

Some analysts said the government might not immediately require banks to classify such loans as non-performing because of the sheer scale of the problem and the damage to bank finances and market sentiment that would result in an abrupt deterioration in asset quality.

Copyright The Financial Times Limited 2017. All rights reserved.

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