Concerns a bubble was forming in China's hot property market was one of the reasons why policymakers have repeatedly drained excess cash from the financial system and tried to cool off borrowing, and on Tuesday raised the amount banks must keep in reserve by a half percentage point.

Shanghai's composite index fell 3 percent and led Asian equities lower, with investors caught off guard by how quickly the central bank acted. Banks and property developers were especially hard hit by fears borrowing costs in China's booming economy would rise.

China's banking regulator warned of the risks of excessive borrowing among land developers, and a housing official said property prices in the rich coastal cities were too high, indicating the government remained concerned about asset price inflation.

"We must recognize that housing prices in some major Chinese cities, especially in coastal big cities, are excessively high," Vice Minister of Housing and Urban-Rural Development Qi Ji said.

HIGHER LENDING RATES COMING?

This week, official statistics are expected to show a marked drop in year-on-year growth of money supply and credit in December. However, bank lending surged in the first week of January, sources told Reuters on Monday, suggesting uneven loan demand.

The market is also expecting figures for 2009 foreign exchange reserves, forecast to have grown to $2.4 trillion from $1.95 trillion at the end of 2008. Economists say further growth in reserves this year and associated with it rise in money supply will force the central bank to further tighten its policy.

Meanwhile, housing demand could simmer down after the central bank's increase in the reserve requirement ratio to 16 percent, the first rise since June 2008 when it peaked at 17.5 percent, though lending rates will play a decisive role for the market.

"It will be an interest rate hike, especially on mortgage rates, that will be the most determinant factor on whether the property market will be driven down as a result," said Eric Wong, head of Asia real estate research at UBS in Hong Kong.

"In the meantime, I think demand will likely take the back seat while people wait for a stream of policies to stabilize."

Loan quality among China's biggest banks so far continued to improve, especially compared with U.S. and European peers, where bad debts triggered the financial crisis.

Wang Zhaoxing, vice chairman of the China Banking Regulatory Commission, said the amount of non-performing loans in Chinese institutions was stable though he said there are risks if property-related lending continues to grow quickly.

"Until now, loans to developers and to mortgage borrowers combined account for about 20 percent of China's new lending as well as the outstanding loans," he said.

The State Council, China's cabinet, on Sunday warned of the negative impact of letting hot money flow into domestic real estate markets and inflating prices further. The housing ministry has also called for stricter rules on mortgage lending to second-home buyers and is discussing eliminating discount financing for buyers who already own a home.

BATTLING BUBBLES

However, doubts persist whether the authorities will manage to prevent an asset bubble after last year's borrowing spree when Chinese banks probably doubled lending to some 10 trillion yuan ($1.5 trillion), complementing Beijing's 4 trillion yuan fiscal stimulus.

"The Chinese government is trying to use administrative measures to contain it," Credit Suisse Equity Strategists Vincent Chan and Peggy Chan said in a research note. "But our experience in the last few years tells us that while such measures can contain the issue for a while, they have never been able to fundamentally resolve it."