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BEIJING, March 29 (Reuters) - Moody's Investors Service warned on Wednesday that the financial risks facing China from a potential property downturn have grown as record lending has made banks more risk-prone while the government is less able to combat those risks.
China extended a record 12.65 trillion Chinese yuan ($1.84 trillion) of loans in 2016 to support economic growth, half of which was household loans - mostly mortgages - sending new home prices to five-year highs in the year.
Policymakers now face the prospect of a nasty property market crash damaging the economy.
More large cities on China's wealthy east coast - Fuzhou, Xiamen, and Hangzhou - stepped up property curbs again this week, following Beijing's drastic moves that analysts say could freeze the market.
Fuzhou, Xiamen and Hangzhou home prices rose 23.7 percent, 36.5 percent and 25.4 percent year-on-year in February, according to statistics bureau data.
Recent weeks have seen the biggest wave of tightening of home purchase and lending rules since October, as China's red-hot property market picked up pace in February after price gains had slowed in the previous months.
"Previously, the banking sector's exposure to the property market was relatively modest," says Lillian Li, a Moody's Vice President and Senior Analyst.
"But the rising share of mortgages in new bank credit, the risk from property pledged as collateral on other loans, and the increasing role of shadow banks as providers of finance to the property sector have all raised the financial system's vulnerability to a property-related shock," she said.
While risks are rising, the scope of the Chinese authorities for mitigating such risks through fiscal and monetary policy has become more limited, as such moves may exacerbate other economic challenges such as capital outflows which have become increasingly pressing, Moody's said.
It noted the central government's fiscal balance had "deteriorated" and government leverage at 36.7 percent was no longer low.
The rating agency expects China to increase its deficit to 3.3-3.5 percent of GDP over the next few years.
$1 = 6.8930 Chinese yuan renminbi Reporting by Yawen Chen and Elias Glenn; Editing by Eric Meijer