China's banking watchdog has ordered rural financial firms to strictly control lending to local government financing vehicles (LGFVs) and cut exposure to shadow banking assets, in the latest move to strengthen risk controls in the sector.

The China Banking Regulatory Commission (CBRC) told small-to-medium financial institutions in rural areas to cut back on loans to LGFVs at county level or below, according to an official circular dated March 8 and obtained by Reuters.

The document, distributed to different localities across China, also said rural financial institutions must not extend new loans to LGFVs or buy corporate bonds, medium-term notes and other debt instruments issued by them.

But rural financial institutions are permitted to provide funding for key projects and urbanization programs that are supported by the central government.

The directive also requires rural financial firms to cap new loans to property developers at a level no higher than the average lending growth rate to other business sectors.

Rural banks must make it a priority to provide lending to support agricultural production and smaller enterprises.

The smaller financial institutions targeted by the new directive include rural commercial banks, rural cooperative banks, rural credit cooperatives, micro-credit firms and village banks, according to the CBRC.