Beijing – the mirror that China’s central bank is holding up in front of the country’s banks is providing uncomfortable viewing. Too many banks are reliant on short-term funding markets to survive, and a shake up in the sector is needed, experts say.The central bank has engineered the current cash crunch as a warning to over-extended banks but a growing concern, analysts say, is of a miscalculation that sets off a full-blown crisis.The central bank’s determination to rein in rapid credit growth has sent interbank lending rates soaring to record highs, sparking panic and swirling speculation that banks are defaulting on deals as they scramble to secure short-term funds.Analysts suspect a particular target of the central bank is non-bank lending, or shadow banking, which has boomed in recent years."A more structural factor behind this squeeze is that banks are using liquidity tools to support their long-term business. That should be a strong warning sign for the industry,” said Hu Bin, a senior China banking analyst at Moody’s Investor Service in Hong Kong.In particular, Hu says, some banks are relying on short-term interbank borrowing to come up with the cash necessary to meet repayment obligations on high-yielding investment products, a similar reliance that caused problems for some Western banks during the global financial crisis."Everyone in the system is impacted by this, even all the way at the top in terms of the largest banks in the country,” said Charlene Chu, a senior director at Fitch Ratings."It’s certainly swift and more effective in reining in the growth of shadow credit. But it does create a lot of repayment risk within the system between financial institutions and there is potential for unintended consequences.”Overall financing in the Chinese economy increased by 52 per cent in the first five months of 2013 compared to the same period last year, which analysts say was led by a surge in shadow banking activity and wealth management products that promised investors high returns.Fitch estimated that total sales of wealth management products reached 13 trillion yuan by the end of the 2012, more than 16 per cent of total bank deposits.More immediately, it estimated that more than 1.5 trillion yuan in wealth management products will mature in the last 10 days of June. That may explain the scramble by some banks to secure short-term funds, which are often used to meet the repayment obligations.Wealth product boomBanks have created wealth products by packaging various assets like money market deposits, corporate bonds and informally securitised loans.Many of these products are held off-balance-sheet, which allows banks to meet state-mandated loan-to-deposit ratios and still create new loans.Many are also based on long-dated assets, so when payouts are due to investors, banks often raise cash by issuing new products, or by borrowing in the interbank market.Authorities have tried to regulate the shadow banking sector and in particular these wealth management products but with little impact on the sector’s growth. Now the central bank is playing hard ball with the banks by refusing to provide liquidity to the money markets, which this week drove the interest rate for some banks to borrow short-term funds to 25 per cent or higher.