China has brought the risks of local government financing vehicles and property loans under control and will continue to strictly monitor the systems, the country's banking watchdog said in its annual report released on Tuesday.

The China Banking Regulatory Commission (CBRC) said it had built up a firewall between the official banking system, a murky shadow banking sector and a wild underground lending market.

We will strictly prevent risks from local government financing vehicles from growing, the CBRC said in its annual report sketching out its 2012 priorities.

We will improve and enhance property loan risk checks, CBRC said. The risk level in property loans is falling continuously, it added.

The agency said it will also keep close watch on risks caused by weakening external demands, adding that recession risks in the Euro zone are growing.

Investors are deeply concerned that a considerable amount China's local government debt, estimated at $1.70 trillion at the end of 2010, and property loans could turn sour, crippling the banking system in the world's No. 2 economy.

Beijing has, however, repeatedly played down fears about local government debt risks and insists systemic problems are unlikely.

According to the numbers provided by CBRC, the overall non-performing loans in China's banking system fell to 1.05 trillion yuan at the end of 2011, representing a ratio of 1.77 percent, or 0.66 percentage points less than the previous year.

The weighted average capital adequacy ratio of Chinese commercial banks has increased by 0.55 percentage points to 12.71 percent at the end of 2011, CBRC said.

CBRC said Chinese banks will be encouraged to lend more to small businesses and agricultural sectors.

(Reporting by Zhou Xin and Nick Edwards; Editing by Ramya Venugopal)