China's banking regulator urged commercial banks on Friday to increase lending to small businesses and the rural sector, a move that may bolster the cooling economy but also risks saddling banks with more troubled loans.

"Commercial banks must utilize the government's current policy support to further improve their financial services to micro and small businesses," Zhou Mubing, vice chairman of China Banking Regulatory Commission (CBRC), told reporters at a briefing.

Currently, China's commercial bank non-performing loan (NPL) ratio for small business lending stands at around 3 percent to 4 percent, about twice the overall average, Zhou said.

"That's natural, because it (small business lending) has higher risks," he added.

Commercial banks' NPL ratio stood at 1.39 percent at the end of March.

China's banking regulator has been issuing notices to encourage lending to smaller businesses for the last two years. In June 2014, CBRC freed up liquidity by adjusting the loan-to-deposit calculations for lending to the sector.

Zhou said that CBRC has "a higher tolerance" for bad loans to small businesses. Banks wouldn't be held responsible for higher NPL levels to the sector, as long as they follow necessary procedures.

Last month, the country's five biggest listed state-owned lenders, including Industrial and Commercial Bank of China Ltd, China Construction Bank Corp, Agricultural Bank of China Ltd and Bank of China Ltd, all reported higher first-quarter NPL ratios, while profit growth dropped to below 2 percent.

Loans to micro and small businesses climbed to 21.41 trillion yuan (2 trillion pounds) in the first quarter, up 17 percent from a year earlier, faster than the average loan growth rate, according to the CBRC.

"Although its (small business lending's) NPL ratio is higher," Zhou said, "I don't think it will have a huge impact on banks' asset quality."

The banking regulator also urged lenders to provide more loans to agriculture-related businesses to ease their financial burden as the world's second-largest economy is set to grow in its slowest pace for a quarter of a century.

Agriculture-related bank lending rose about 13 percent to 24.6 trillion yuan for the first three months of 2015 from a year earlier, the CBRC said.

Separately, Zhou said that a proposed debt swap scheme, allowing local governments to convert some high-interest debt into cheaper municipal bonds, would lower risks for commercial banks by extending debt maturity, while improving transparency.

Zhou said banks, themselves, would make their own determination as to whether to buy the debt.