Beijing is tightening scrutiny of government debt and the shadow banking system to contain risk, Premier Li Keqiang said yesterday.
He said Beijing had been "highly attentive" to financial and debt risks, and set a timetable for implementing rules to stop banks overexpanding.
"We decided to audit government debt last year, which showed our firm conviction to face the problem," Li said.
In the lending spree in the wake of the 2008-09 global financial meltdown, funds poured into local governments and state-owned enterprises, leading to redundant projects and overcapacity in steel, cement, shipbuilding and other industries.
Local government debt had swollen to 17.9 trillion yuan (HK$22.7 trillion) by the middle of last year, the National Audit Office said at the end of last year. This was nearly 70 per cent more than at the end of 2010, and accounted for 31 per cent of gross domestic product last year.
Li said the debt level was "generally controllable", but the rising trend should not be overlooked. Local debt would be included in budget management and local government financing vehicles would be regulated, he said.
The lending binge from both banks and the shadow banking system has increased China's leverage. Fitch Ratings predicted its credit-to-GDP ratio at the end of 2017 would be close to 250 per cent, compared with 130 per cent in 2008.
Chinese authorities have set a timetable for implementing the Bank for International Settlements' Basel III requirements to rein in overexpansion of banks, according to Li.
He was asked by bankers recently whether China's requirements for capital adequacy are set too high, but Li said high standards were necessary. Capital adequacy, expressed as a ratio of capital to assets, measures the financial strength of a bank.
"We are a developing country, but this is what we have to do, and we cannot let today's stepping stone become tomorrow's stumbling stone," he said.
Banks must have a minimum capital adequacy ratio of at least 10.5 per cent, compared to 8 per cent previously, while larger banks must meet an 11.5 per cent requirement. They must meet their targets by 2016 under a regulatory road map released last year.
Mainland banks, which make most of their earnings from lending, face pressure to meet the higher ratios, analysts say.
The inability of projects to generate sufficient cash flow to repay debts has also led to defaults involving financial products, from wealth management products and trust products to bonds, since 2012, and many analysts forecast more defaults this year.
"It is indeed difficult to avoid a few default cases," Li said. "We must tighten monitoring to prevent regional and systemic financial risks."