The suggestion made in a central bank report that sales of new houses should not be allowed before construction is complete shows regulators can no longer stand the potential financial risks circulating in the property market.

Under the current policy, developers can start to sell houses even if they only have design drawings, let alone the foundations of the property. Such an arrangement, which has been common since the 1990s, has encouraged the rapid development of the property industry, a driving force of the national economy.

But now that the sizzling economy needs to cool off, it is not surprising that the central bank has started to apply the brakes.

Although not an implemented policy, the suggestion has had repercussions in the market and given real estate developers the jitters. If houses had to be finished before being sold, the industry would suffer as a significant chunk of financing comes from buyers' advanced funds.

But cooling down the sector, which many experts consider to be seriously inflated, to aid the national economy's soft landing may not be what the central bank has been aiming at.

It is rather the serious risks in the sales game that have prompted regulators to act. According to the report, property developers are mainly obtaining development funds from banks.

The common rules of the game are that developers first get a plot of land and raise a mortgage from the bank. Then they use the bank loans plus advanced payment to build houses and sell them at a profit.

Last year, more than 55 per cent of national property development capital was borrowed from banks. Of developers' asset structure, bank loans account for even higher at more than 70 per cent.

Developers have played safe by leveraging other people's money to make profits for themselves.

As the economy grows steadily, everyone is pleased at the ostensibly prosperous outlook. But if the economy went downhill, the financial system would bear the brunt of a slumping property market.

By the end of the first quarter, the bad loan ratio at the "big four" State-run commercial banks' lending to developers was 10.1 per cent. It is 4.9 percentage points lower than the overall bad loan ratio of those banks. But considering the strong economic growth momentum, the ratio remains alarmingly high.

At the Bank of China and China Construction Bank, two of the "big four," the bad loan ratio for lending to developers is much higher than their overall non-performing loan ratio.

If the economic climate changes, then risks will surface and banks will be at stake, ultimately shaking the country's fragile financial system to the core.

In the face of this hazard, it is understandable that the central bank has proposed changing developers' sales strategy. But it should also reflect on why the sector has been so heavily dependant on bank loans.

The report noted some developers have managed to borrow illegally by having their employees or relatives pose as home buyers.

But the weak risk-control regime at State commercial banks is more to blame. Besides bank managers' incompetence when assessing risks, the lack of an effective accountability system is a fatal flaw in the management of those institutions.

Banks have been reforming corporate governance to improve management. Yet still the amount of bad loans suffered by the "big four" rose last year, taking into account the State strategy of paring off from bad asset accounts.

To avoid excessive financial risk, banks need to enhance their own control abilities at the same time as a resort in the face of changing house sales policy.

(China Daily August 18, 2005)