UPDATE 1-China steps up scrutiny on interbank lending to curb risks

Fri May 16, 2014 7:32am EDT

* China tightens regulation on a section of shadow banks

* Tougher rules aimed at increasing financing for real economy (Adds details, analyst comment)

BEIJING May 16 (Reuters) - China is tightening its grip on interbank lending with more expansive rules that include capping the size and maturity of loans, a move to defuse risks in shadow banks and better support the real economy.

The new regulations would bring the country's sometimes recalcitrant interbank market into official oversight by "blocking the back route" and "opening the front door", five financial regulators said in a joint statement.

Tougher rules would help to direct more cash into the real economy and lower funding costs for firms, the central bank and the regulators for banks, securities, insurance and currency said.

Interbank loans are one part of China's ballooning shadow bank market -- a growing headache for regulators due to its murky practices and periodically lax lending standards.

"In recent years, the interbank business of commercial banks has grown quickly, and some banks are conducting their businesses in ways that do not conform to standards," the bank regulator said in a separate statement.

"Risk management is not done properly and does not fit with the country's adjustment of its macroeconomic policies," the bank regulator said, adding that all banks must create a separate division to run their interbank businesses by the end of September.

As growth in the world's second-largest economy slows, financial risks in China are rising because more companies and individuals are struggling to repay their loans.

Ratings agency Standard & Poor's said last month that about a third of China's shadow banking sector, which it estimated has about $30 trillion worth of assets at the end of 2013 -- is risky and may pose some problems.

Just last week, a deputy central bank governor took aim at China's wealth management sector, another part of the shadow banking market, by saying that the industry was unduly raising financing costs for firms with its mercenary behaviour.

"TOO MESSY"

With immediate effect, banks can no longer make interbank loans that extend over three years, and loans are not to be rolled over when they mature.

The proportion of financing that comes from the interbank business must also not exceed a third of any bank's total liabilities, the regulators said in an 18-point statement.

For banks that do not report their interbank loans on their balance sheets, the new rules would compel them to do so. Some analysts also say that this means banks now have to include interbank loans and deposits in their calculations of the loan-to-deposit ratio.

As for branches of financial institutions that are involved in the interbank business, these firms must create a company-wide system that tracks the borrowing record of any firm, including any sum borrowed via the interbank business.

And final approval for any deal in the interbank business must be signed off by the headquarters of all financial institutions.

"Under the new rules, loans disguised by some banks as interbank business to avoid supervision will now be listed as on-balance-sheet items," said Zeng Gang, a senior bank researcher at the Chinese Academy of Social Sciences, a government think tank.

"In the long run, this is a good thing," he said. "Banks are getting too messy, and a lot of risks are being hidden. It is good for banks to build a risk management system." (Reporting by Shao Xiaoyi and Koh Gui Qing; Editing by Jacqueline Wong)