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Moody's upgrades China's banking system outlook, first since 2015

SHANGHAI, July 27 (Reuters) - Moody's Investors Service changed its outlook for China's banking system to stable from negative on Thursday, the first revision in two years.

As non-performing loans (NPLs) rose at China's lenders amid slowing growth and a rise in struggling borrowers, Beijing has adopted measures, from debt-to-equity swaps to encouraging NPL transfers, to help its flailing banks.

The improved outlook reflects the stabilization of soured debt after successive quarters of fast rising NPLs and the latest crackdown on shadow banking, said Moody's in a statement.

"While China is facing a structural downtrend in its growth path, the importance Chinese policymakers attach to growth suggests that any fall in their official growth targets is likely to be gradual," said Moody's.

The move comes after the credit rating agency downgraded in May China's long-term local and foreign currency issuer ratings to A1 from Aa3 on debt concerns and slowing growth.

For banks though, efforts to counter high corporate leverage and check the growth of shadow banking have started to work, said Moody's.

Under the leadership of Chairman Guo Shuqing, the China Banking Regulatory Commission (CBRC) has launched at least eight sets of rules since March in a widespread crackdown on shadow banking among other ills.

But banks still face "relatively elevated asset risks" from high corporate leverage and more defaults among highly leveraged borrowers as funding costs rise and regulations tighten, it said.

Liquidity conditions will stay tight for small and medium-sized banks while profit growth will be hampered by higher funding costs on margins and slowing fee income, it added.

"Worsening margins will be a bigger challenge for small and medium-sized banks, which tend to rely more on market funds," said Moody's. (Reporting by Engen Tham; Editing by Eric Meijer)