[BEIJING] China's financial watchdogs are pushing for harsher rules and stepping up action against miscreants, spurred on by official pressure on them to curb risk in the financial system, according to multiple sources with direct knowledge of the situation.

Officials at the central bank, as well as at the banking, insurance and securities regulators, have been stepping up their enforcement activities, which have been under increased scrutiny since late last year, the sources told Reuters.

Regulatory officials worry they may get into trouble for not acting fast enough or being tough enough on financial institutions, the sources said.

But senior industry sources say some of the new regulations, such as the central bank's new rules restricting asset management, are unnecessarily harsh and can may hurt the development of the financial system and the economy.

President Xi Jinping has made it clear that the Communist Party must strengthen its leadership of the financial industry, which he says is key to national security.

The party is preparing a major overhaul of the country's financial regulatory structure as it makes prevention of financial risk a top priority for the next three years. On Tuesday, China said it would merge the banking and insurance regulators and transfer some of their current roles to the central bank.

Much of the political pressure is coming from officials from the Central Commission for Discipline Inspection (CCDI) who were installed at the regulators late last year, according to the sources with knowledge of the situation.

Originally tasked with rooting out officials engaged in corrupt practices, the inspectors are now expanding the scope of their activities, the sources said.

The inspectors are now also participating in internal discussions on drafting rules and implementing policy, they said.

Financial regulatory officials are being told to submit work materials unrelated to corruption to graft busters for review, sources with three different regulators said. Some officials have been criticized for lacking "teeth", one of the sources said.

"They're looking at almost everything, from regulation to the dining hall," the source said. "It's not just corruption-related. It's everything. Where is the boundary?" The CCDI, central bank, and the banking, insurance and securities regulators didn't immediately respond to requests seeking comment.

Xu Jia'ai, who in September was named head of the central bank's disciplinary inspection unit, wrote in a report in February that collusion between "cats and rats" - referring to regulators and the financial institutions they oversee - had become a major risk in financial regulation.

The sources also said that many of the appointees had little experience in the financial sector.

"These people have no exposure or existing relations with the financial industry," said Chen Long, China economist at Gavekal Dragonomics, speaking generally on the appointments.

"That means they are more free to implement the anti-corruption mandates." In the past senior officials were typically drawn from relevant sectors or government bodies.

Mr Xu established his credentials as a Zhejiang official, most recently serving as the head of the province's Politics and Law Committee.

At the China Banking Regulatory Commission, Zhou Liang, a former official with the discipline commission without finance experience according to his official resume, was appointed vice chairman in November.

At the regulators, there is now a sharper focus on issuing greater volumes of tough financial regulations, the sources with knowledge of the situation said.

"The anti-corruption campaign is binding the hands and feet" of regulators, said one source at a financial regulatory agency.

At the China Securities Regulatory Commission, which said in November that it was stepping up supervision of officials responsible for initial public offering (IPO) approvals, the approval rate of IPO applications had markedly declined, two people working closely with the regulator said, citing applications of similar quality.

"They are trying not to approve IPO applications in order to avoid responsibility," said one of the people, referring to the officials at the regulator. "But China will lose many good companies to Hong Kong and New York capital markets if they continue to work this way."

The anti-corruption drive has been particularly intense at the China Insurance Regulatory Commission, whose former chairman, Xiang Junbo, last April became the highest-ranking finance industry official to be investigated for corruption.

Since then, the commission has launched an internal movement calling for "cleaning up Xiang Junbo's residual poisonous influence".

Internally, Mr Xiang was accused of loosening supervision for "financial crocodiles" with whom he was involved and held up as a cautionary tale for officials, two sources with knowledge of the situation said.

Staff were cautioned to avoid any personal interactions with the institutions they supervise, the sources said.

For all the agencies, the paramount task is now regulation, rather than development of their industries, said Chen Xingdong, chief China economist at BNP Paribas.

That assessment was echoed by a senior official at one of the financial regulatory bodies. "My job now is to regulate, not to develop," the official said.

In the past, a primary focus of regulators was attracting businesses in order to seek rapid expansion of the industries they oversaw, according to sources within the agencies.

The new focus on tough regulation has led to some rare pushbacks by the financial industry. Last year, 10 banks objected to the People's Bank of China's move to tighten rules for the asset management sector, saying it could cause a rush of redemptions among other risks.

Analysts say they expect the tough regulatory stance to continue this year.

"2018 is the clean-up year," said Chen at BNP Paribas. "The real challenge is to balance the clean-up and moving forward."

REUTERS