There is a "very high" chance one or two small mainland banks could collapse next year as risks due to mismatches between assets and liabilities are rising, a Communist Party economic official has warned. Fang Xinghai, a bureau director at the Central Leading Group for Financial and Economic Affairs, said liquidity and interest-rate risks were building up in the banking system as lenders increasingly relied on short-term borrowing to finance long-term investments. "Some time next year, we may see one or two medium to small banks collapse, and the possibility is very high," Fang told a forum yesterday. Small banks got about 80 per cent of their funding from the interbank market or wealth management products (WMPs), he said. The funding was usually short-term and with high interest rates, which posed a mismatch with their investments in long-term property projects and the infrastructure construction programmes of local government financing vehicles. The mismatch exposed the banking system to liquidity risks as banks, especially smaller lenders more reliant on interbank borrowing, could easily default on the short-term loans, he said. Lenders struggling to cover the cost of WMPs, which offer higher rates than deposits, also faced mounting interest-rate risks. The financial system has seen liquidity problems for lenders more often this year. The seven-day repurchase rate reached a monthly high of 5.4 per cent on Monday, following a cash crunch in June when the overnight rate hit a record 12.85 per cent. Risks also stemmed from the deteriorating quality of lenders' assets and rampant, under-regulated shadow banking, Fang said. Banks usually packaged trust companies' projects into WMPs, he said, and any failure of the trust firms could see the risks of the shadow financing system spread to banks. The economic slowdown and industrial overcapacity have hit lenders' asset quality. Outstanding non-performing loans rose for an eighth consecutive quarter to 563.6 billion yuan (HK$716.8 billion) in the third quarter, with the non-performing loan ratio rising from 0.96 per cent in the second quarter to 0.97 per cent, the China Banking Regulatory Commission said. People's Bank of China deputy governor Hu Xiaolian said local governments accessing loans through their financing vehicles usually covered the real risks in the projects, while corrupt "rent-seeking" officials were usually involved in fund distribution when governments intervened in bank lending. Premier Li Keqiang has vowed to stem a US$6.6 trillion credit binge over the past five years and give the market forces of supply and demand a bigger role in allocating resources in the world's second-largest economy. The lending spree since the 2008-09 global financial crisis saw the central government channel most lending to local infrastructure projects and industries dominated by state-owned enterprises, exacerbating industrial overcapacity and leading to many white-elephant projects. Real estate developers and other private companies, with limited access to bank loans, thus resorted to shadow banking, getting the money out of banks through trust products.