On Sunday, the Chinese cabinet ordered local governments to improve the management of their investment agencies as a result of concerns that their loans -- estimated at hundreds of billions of US Dollars -- could become a problem for Chinese banks.
The State Council also ordered banks to monitor lending to these agencies by targeting loans at specific projects and controlling how the credit is utilized.
Chinese banks have escaped the mortgage-related disaster that hit the Western financial world and triggered the global economic recession, but analysts predict that a lending boom driven by government stimulus spending will leave lenders in a mountain of bad loans.
In May, the State Council ordered a review of the investment agencies after the World Bank and central bank warned about debt levels and said banks could face losses if the agencies would not be able repay their debts. Such agencies invested heavily in real estate and infrastructure as part of Beijing's stimulus spending.
"There are some problems that have occurred that require a high degree of attention," said a statement dated Thursday but only posted on the State Council's website Sunday.
"Mainly, the size of debt-financing of the financing platform companies has swelled rapidly, while their operations are not standardized," it said. Finance platform companies refers to the investment agencies.
Chinese media say local government investment agencies owe 6 trillion yuan ($880 billion) to state banks. An American researcher, Victor Shih of NorthwesternUniversity, estimates total local government borrowing in 2004-09 at 12 trillion yuan ($1.6 trillion).
The State Council statement stated that some banks and financial organizations had poor risk awareness while investment agencies lacked adequate credit management.
Local governments, it said, have also broken rules. They are not allowed to use state-owned assets or government revenues to offer guarantees, directly or indirectly, for the investment agencies.
State banks were long expected to prop up government companies, lending to them regardless of their ability to pay the loans back. The government has written off some $400 billion in non-performing loans at state banks in the past ten years.
The central government paid for only one-quarter of its 4 trillion yuan ($586 billion) stimulus plan. The rest came from state companies and borrowing by lower-level governments from state banks.