BEIJING, Dec 2 (Reuters) - Risks to the stability of China's financial system are rising on continued sluggishness in its property sector and an economic slowdown, making smaller banks more vulnerable, rating agency Moody's said on Friday.
China's property sector has slowed sharply this year after Beijing's efforts reined in excessive borrowing by developers. The clampdown has triggered falls in property investment, sales and prices, and a growing number of bond defaults.
"Some buffers protecting the financial system are eroding, which would pose risks if the property downturn becomes protracted," Moody's said in a report, adding that sluggish demand kept the outlook negative for the real estate sector.
"Risks to the stability of China's financial system are rising amid a contraction in the property sector and the country's economic slowdown."
Beijing has stepped up support in recent weeks to increase liquidity in the industry, which accounts for a quarter of the world's second-largest economy and has been a key driver of growth.
China's biggest commercial banks have also lined up at least $162 billion in fresh credit to property developers.
While the government's new policies could ease funding constraints, they will take time to have an effect, the report said.
"Although the authorities continue to have tools to prevent a systemic financial crisis some of these buffers are weakening, and could pose risks if the property downturn endures," says Lillian Li, Moody's vice-president and senior credit officer.
Despite the banking system's overall strength, smaller banks are most vulnerable and much more exposed to risks from the property sector, Moody's said.
While Chinese banks' direct exposure to risks from the property sector is limited, their indirect exposure, including lending to industries along the property sector supply chain and from collateral devaluation, is larger, the report added.
The property sector risks have weighed on banks' asset quality, with analysts expecting the non-performing ratio for real estate will stay high for lenders in the coming months. (Reporting by Ziyi Tang and Ryan Woo; Editing by Sumeet Chatterjee and Rashmi Aich)