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* China regulator orders banks to "self-inspect" arbitrage
* Lenders told to probe any cover-up of non-performing loans
* Banks need to check actions that manipulate regulatory targets (Adds details, background)
SHANGHAI, April 11 (Reuters) - China's banking regulator has told lenders to conduct "self-inspections" in areas such as using loopholes to circumvent rules, in order to boost supervision of the vast shadow banking sector, according to documents seen by Reuters.
The move is the latest by Chinese regulators to contain risk in the banking system, as more borrowers struggle to avoid defaults and levels of non-performing loans (NPLs) rise.
The China Banking Regulatory Commision (CBRC) wants to better understand the amount of leverage in the banking system and prevent lenders from hiding the true extent of soured debt, three sources told Reuters late on Monday.
The CBRC could not be immediately reached for comment.
An attachment to a document dated March 28 that was circulated to lenders specifies subjects for self-inspections.
It says they should check whether asset management plans have been used to avoiding reporting the extent of NPLs in order to meet targets, and whether bridge financing and short-term loans have been made to hide defaults and artificially adjust other indicators.
Also to be scrutinized, according to the documents, are wealth management products (WMP) that can be used as a way to evade lending controls and buy-back transactions which can be used to artificially adjust targets.
False transfer arbitrage should also be checked, the documents said, including the use of bills, credit, WMPs and interbank lending to falsely raise deposit levels and revenues.
Related-transaction arbitrage, such as the use of domestic or foreign subsidiaries to avoid rules restricting lending to local government platforms, should also be checked, according to the documents.
Last year, bad loans written off and transferred out by China's top five banks rose by 16 percent to 309.6 billion yuan ($44.95 billion).
Moody's Investors Service said in December that Chinese banks are facing increasing risks as a result of financial sector interconnectedness between the formal banking system and the shadow banking system, which has doubled in size the past five 5 years with its assets equal to 82 percent of GDP at the end of June 2016.
Separately, the CBRC on Monday issued guidelines on risk control for lenders, as authorities ramp up efforts to deal with a rapid build-up in debt. (Reporting by Li Zheng and Brenda Goh; Additional reporting by Ma Rong and Zhang Shu in Beijing; Writing by Engen Tham; Editing by Richard Borsuk)