(Bloomberg) China’s worst cash squeeze in at least a decade may weigh on smaller banks’ financial strength as their reliance on interbank funding leads to an erosion of loan margins, according to Moody’s Investors Service.

Mid-sized banks got 23 percent of their funding and capital from the interbank market at the end of last year, compared with 9 percent for the largest state-owned banks, Moody’s said in an e-mailed statement today (Monday). Those banks will probably compete “more aggressively” for deposits amid the credit crunch, which would increase cost of funds, it said.

China’s money-market rates, which climbed to a record high last week before retreating for a second day today, have triggered a drop in shares of China Minsheng Banking Corp. and China Merchants Bank Co. on investor concern that funding may tighten and curtail credit growth. Slowing economic growth and efforts to rein in shadow banking have contributed to higher borrowing costs and rising bad loans.

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