China is ready and willing to use private banks to reform a financial sector dominated by state-owned lenders to better serve cash-strapped small firms neglected by the banks.

The China Banking Regulatory Commission (CBRC) on Friday issued a directive on boosting the development of private banks, officially giving green light to the registration and operation of private banks.

About 40 applications, all from domestic private enterprises, are on a waiting list and the approval results will be released within four months and the banks established within six months of being licensed.

Private banks, both domestic and foreign, will aid in financial reform, invigorate the financial market and improve other financial institutions, said the directive.

"Domestic capital, state capital and overseas capital shall be treated fairly and equally. Qualified private enterprises are encouraged to launch private banks," it said, but the 20 percent share-holding ceiling for one overseas investor, or 25 percent for all overseas investors, in one Chinese lender must be followed.

The directive said that private capital is welcome to buy stakes in the existing financial institutions as part of reform of financial institutions' ownership.

Guo Tianyong, a professor at Central University of Finance and Economics, said more private funds will shore up the financial sector, expand investment channels for private funds and digest existing financial risks.

China has been encouraging private investment in its reform of the financial sector, which is mainly state-owned. Private investors have opened rural community banks and of 1,263 new rural community banks, 93 percent used private capital at a ratio 73.4 percent.

Such banks were jointly set up by private investors and state banks. The "residual risks" that are not covered by the deposit insurance system, which provides coverage of up to 500,000 yuan (82,000 U.S. dollars) for individual bank accounts, are borne by the state.

Since 2003, private investors have been encouraged to buy stakes in existing financial institutions. Private investors have helped 758 rural commercial banks and the ratio of private capital hit 85 percent in these lenders. Private investors took shares of 134 urban commercial banks at a ratio of 56 percent.

"All channels for private capital to enter the banking sector are now open," said CBRC chairman Shang Fulin.

Before the directive, a pilot scheme opened a limited number of such institutions. In 2014, the CBRC approved five private banks, including Shenzhen-based Webank and Hangzhou-based MYbank. Previously, China had only one private bank, China Minsheng Bank, founded in 1996 in Beijing.

China is accelerating reform of state banks ownership. The latest move was made by the Bank of Communications, China's fifth-largest lender by assets. It announced that it would have private shareholders in mid June.