Chinese currency regulators are planning to start a country-wide inspection of bank loans to curb illegal inflows that have inflated the stock and property markets. Chinese Banks should check that their books comply with laws on short-term foreign debt, as per a notice on State Administration of Foreign Exchange's website. It's already punished some local and foreign banks for breaking currency rules in a probe that started last year. The inspection highlights concern that hot money is pushing up asset prices, driving growth in China's $1.2 trillion of foreign-exchange reserves and undermining efforts to cool the economy. A crackdown on investments with borrowed money and a tripling of the tax on share trades failed to halt a 92% advance in the benchmark stock index this year.

Chinese government is suspicious that speculative funds have been a reason for the rapid increase in the country's forex reserves and such inspections can help stem hot money inflows and may serve as a warning to market speculators. The CSI 300 Index rose 1.3% and it has almost tripled in the past year and trades at 44 times earnings, the most expensive in the Asia-Pacific region. The Chinese currency regulator are closely watching the stock market and are concerned about a possible bubble.

Chinese currency is only partly convertible on the capital and financial account, which covers investment in the stock and property markets. It was made fully convertible in 1996 on the current account, which covers trade in goods and services. The government restricts investment in the equity markets to a maximum $10 billion by 52 approved investors. Overseas investment in property is also restricted. Moreover, Chinese forex reserves has increased by 37% from a year earlier and has flooded the Chinese financial system with cash, making it harder for the central bank to slow lending and investment. Some banks broke regulations on their foreign currency positions and foreign debt borrowing, which eroded the effect of government policies and complicated the central bank's monetary policy operations, as per central bank statements. The quality of some data reported to regulators failed to meet requirements, it said.

The central bank has taken several measures like reducing the amount of foreign debt banks are allowed to take on, and the medium and short-term foreign debt increased 16% in 2006. Bank quotas for short-term foreign debt will be reduced to 45% of the 2006 level by June, for foreign banks, the reduction is to 85% and then 60%. Qualified individual traders will also be subject to forex payment reporting requirements, similar to demands on corporate traders - a key element in China's forex management regime. China still maintains capital controls as its local currency, the Reminbi, is only partly convertible under the capital account.

This may be the cost of moving to a market economy. Giving foreign trade rights to individuals marked the final move in turning China’s foreign trade sector from a planned-economy into a market-oriented one. For example, in first few days after the new Foreign Trade Law took effect in July 1966 individuals completed registration procedures in Beijing alone, which analysts say reflected the huge demand from individual Chinese for foreign trade rights. But the foreign trade law only legalizes entry of individuals, while related regulations in such areas as customs, forex controls, product quality inspection and taxation need to be updated to facilitate transactions, as per market analysts.

This recent new regulation was to clarify key forex procedure for the China's growing ranks of individual traders, according to some reports. The rule has been seen as a step forward by the authorities to enforce a legal framework which is needed to implement a new Foreign Trade Law. The law, which came into affect last month, will allow individuals to conduct foreign trade.