Shanghai's banking regulator is ordering banks to restrict lending to financing arms of the city government as part of a nationwide scrutiny on growing concerns of loan defaults.

The Shanghai Bureau of the China Banking Regulatory Commission has asked banks to fully scrutinize their existing loans, especially those issued at the end of 2009, to financing vehicles of the local government and to stop loans to uncapitalized projects under them, the local banking watchdog said yesterday.

"Banks must check such credit case by case to confirm the capital needed for the projects, land approval, collateral and the final use of the loans to make sure that each loan is extended for solid reasons," it said.

Banks should demand the return of such loans as soon as possible if they were extended to overcapacity industries or were misused or left idle, the regulator said.

The tightening-up is part of China's nationwide monitoring of loans to financing arms of local governments.

Local governments sidestep restrictions on them to raise capital directly through these arms, which play a big role to back up local economic growth.

However, the possibility of risks rose on the rapid growth of the loans as banks may ease their strict checks when lending to the government-backed entities during heady days of growth.