BEIJING (Reuters) -China has instructed state-owned banks to roll over existing local government debt with longer-term loans at lower interest rates, two sources with knowledge of the matter said, as part of Beijing's efforts to reduce local debt risks in a faltering economy.

Debt-laden municipalities represent a major risk to the world's second-largest economy and possibly its financial stability, economists say, amid a deepening property crisis, years of over-investment in infrastructure and soaring COVID-19 costs.

Local government debt reached 92 trillion yuan, or 76% of economic output in 2022, up from 62.2% in 2019. Part of it is debt issued by local government financing vehicles (LGFVs), which cities use to raise money for infrastructure projects.

The People's Bank of China (PBOC) issued orders last week to major state lenders to extend terms, adjust repayment plans, and reduce interest rates of outstanding loans to LGFVs, according to the sources.

To ensure banks do not incur heavy losses from the debt restructuring, interest rates on rolled over loans should not be below China's treasury bond rates, said one source, adding that loan terms should not exceed 10 years. China's benchmark 10-year government bond is now yielding around 2.7%.

Still, China's central government has taken a cautious stance on resolving local debt issues to avoid risks of moral hazard: Investors could be encouraged to take even greater risks if they assumed Beijing would always come to the rescue of local governments or companies.

The People's Bank of China (PBOC) and the National Financial Regulatory Administration didn't immediately reply to Reuters' request for comments.

(Reporting by Beijing Newsroom; Editing by Simon Cameron-Moore and Kim Coghill)