China to allow commercial banks to swap bad debt for equity stakes

China's central bank is preparing regulations that would allow commercial lenders to swap non-performing loans of companies for stakes in those firms, two people with direct knowledge of the new policy told media.

The sources, who spoke on condition of anonymity, said the release of a new document explaining the regulatory change was imminent. The People's Bank of China (PBOC) did not immediately respond to requests for comment.

Non-performing loans (NPLs) surged last year as China's economy grew at its slowest pace in a quarter of a century.

Official data from the China Banking Regulatory Commission showed banks held NPLs and "special mention" loans, or debts that could potentially turn sour, in excess of 4 trillion yuan ($614 billion) at the end of last year.

The new regulations would reduce NPL ratios at commercial banks, requiring them to set aside less cash to cover losses incurred by bad loans. Funds could then be freed up for fresh lending for investment in a new wave of infrastructure products and factory upgrades that the government hopes will rejuvenate the economy.

"Such a rule change shows banks' bad loans have risen to such a level that this issue has to be tackled now before it's too late," said Wu Kan, Shanghai-based head of equity trading at investment firm Shanshan Finance.

State banks have extended a lot of loans to government financing vehicles and to state-owned coal and steel producers, so this policy can help give lenders time to deal with their non-performing assets as China pushes supply-side reforms, Wu added.

The quality of assets held by banks is worse than it looks, analysts have said. To avoid stumping up capital and to protect their balance sheets, some Chinese banks have underreported bad loans and underrecognised overdue debt, they say.

The top banking regulator has warned commercial lenders to pay special attention to risks. China's bank shares fell more than 2 per cent on Thursday, with Industrial and Commercial Bank of China down 2 per cent and Bank of Communications losing 2.7 per cent.