BEIJING (BLOOMBERG) - China's smaller banks have never been more reliant on each other for funding, prompting rating companies to warn of contagion risks in any crisis.

Wholesale funds, including those raised in the interbank market, accounted for a record 34 per cent of small- and medium- sized bank financing as of June 30, compared with 29 per cent on Jan. 31 last year, Moody's Investors Service estimated in an Aug 29 note that analyzed central bank data.

Shanghai Pudong Development Bank Co.'s first-half earnings showed its short-term borrowings and repurchase agreements surged by 75 per cent in the past three years, while its consumer deposits rose just 24 per cent.

Policy makers have sought to sustain an economic recovery by keeping the seven-day repurchase rate at around 2.4 per cent for the past year, a level that has encouraged borrowing for investment in property, corporate bonds or risky loans, often packaged as shadow banking products. CLSA Ltd estimates China's total debt may reach 321 per cent of gross domestic product in 2020 from 261 per cent in the first half, while the Bank for International Settlements also warned lenders are at risk from surging leverage.

"Contagion risks are definitely rising," said Liao Qiang, Beijing-based senior director for financial institution ratings at S&P Global Ratings. "The pace of the development is concerning. If this isn't stopped in time, the central bank will lose some control and flexibility of its monetary policy."

Shanghai Pudong Development Bank said in an e-mailed response on Sept 24 it has been using appropriate financing and its regular deposits and interbank borrowing have been developing properly and in synchronization. Total liabilities will be kept under control in the long run and all liquidity gauges meet regulatory requirements, it said. Rising short-term borrowing doesn't mean its risks have climbed as well, the bank said.

The People's Bank of China resumed longer-term reverse repos to boost borrowing costs in August and deputy governor Yi Gang said in a television interview earlier this month that the nation's short-term goal is to curb leverage.

Interbank market stability only makes it more appealing for traders to borrow money and invest in illiquid assets of longer tenors, S&P and Moody's warned.

China's financial system is cushioned by the nation's 148.5 trillion yuan (S$30.33 trillion) of savings, even though regulators removed a rule that limited loans to 75 per cent of deposits in 2015. Industrywide, the ratio was 67 per cent on June 30, up from 64 per cent five years ago, China Banking Regulatory Commission data show. Including shadow banking, it is closer to 100 per cent for some lenders, such as Shanghai Pudong, Moody's wrote. The rating company said the big four state banks still have "strong deposit franchises and a more prudent growth strategy.

Short-term borrowings and repos accounted for 37 per cent of Industrial Bank Co.'s total liabilities as of June 30, up from 34 per cent three years ago, according to its filings. The lender's loan-to-deposit ratio rose to 73.8 per cent, from 67.8 per cent at the end of 2015.

The higher the reliance on wholesale funds, the greater the risk of a liquidity crunch, said Christine Kuo, a Hong Kong- based senior vice president at Moody's.

"When banks face fund withdrawals by other financial institutions, this will in turn prompt them to call back their own funds," she said.

Banks are also buying each others' wealth-management products and accounting for the transactions as investment receivables. A record 26.3 trillion yuan of WMPs were outstanding as of June 30, doubling over two years, China Banking Wealth Management Registration System data showed. Investment receivables at 25 listed Chinese banks grew 13.4 per cent in the first half to 11 trillion yuan, earnings reports show.

China Minsheng Banking Corp's receivables surged 77 per cent in the first half, while its short-term borrowings and repos more than doubled in the past two years, company filings show.

"Banks' use of wholesale funds to buy WMPs only makes the contagion risks higher," said He Xuanlai, a Singapore-based analyst at Commerzbank AG.