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BEIJING/SHANGHAI (Reuters) - China is developing a new trading platform to enable banks to sell off loans to a wider range of investors, in a move that could pave the way for a government bailout of lenders or distressed asset sales to private investors.
The trading platform, now in the testing phase, is designed to introduce banks to a new class of investors, including non-bank financial institutions and large companies.
Currently, the lack of well-established precedents for asset disposals effectively leaves banks only two options: sell non-performing loans in private deals, mostly with big state-backed asset management firms, or keep rolling them over indefinitely to avoid booking a loss.
Most analysts believe Beijing will eventually be forced to use some public funds to help peel off bad loans from state banks, but the ability to draw in at least some private capital could reduce the cost of that bailout.
The new platform could aid the effort to draw in private investors by allowing for price discovery for loan transfers, creating benchmarks that could guide future deals. Greater transparency in pricing could thus lure even more investors.
The China Banking Regulatory Commission (CBRC) will introduce a so-called "credit transfer system" in the country's interbank market, which includes banks as well as non-bank financial institutions and large companies, three sources with knowledge of the situation told Reuters.
The system would allow for the transfer of asset-backed securities (ABS) as well as non-securitized loan packages.
China's banks are struggling with an overhang of potentially bad debt from a state-backed lending binge unleashed from 2008 to 2010 in response to the global financial crisis.
Market participants widely suspect that the true scale of the bad loan problem is far larger than the official, system-wide non-performing loan ratio of under 1 percent. Loans to local governments have emerged as a particular source of risk.
Allowing banks to unload assets could help prevent a debt crisis that could lead to a sharp recession if asset prices tumble and credit flows to the real economy decline.
It could also free up space on bank balance sheets, enabling them to support the economy with fresh credit. China is on pace for its slowest full-year growth since 1990.
In response to questions, the CBRC appeared to confirm the program, saying that in line with the leadership's call for "revitalizing the monetary credit stock," the agency was "in the midst of researching related institutional structures and methods."
The State Council, China's cabinet, first introduced the "revitalize the stock" formulation in a policy statement in June.
The establishment of a system allowing troubled assets to circulate and trade - rather than sit like deadweight on banks' balance sheets - sheds new light on what the cryptic but oft-repeated phrase means.
The new platform will be administered by the China Central Depository & Clearing Co., Ltd., the state-backed clearing house that clears trades in the interbank bond market, Reuters sources said.
"China Central Depository's system is working on supporting both ABS as well as (non-securitized) loan transfers," said a source with knowledge of the system.
Several simulated trades occurred on the system last week, and it will be formally launched following further internal discussion and a public comment period, said another source, who is close to regulators.
But questions remain about who would be willing to buy risky bank assets and at what price.
China set up four state-backed asset management companies (AMCs) in 1999 to buy 1.4 trillion yuan ($230 billion) in bad from the nation's Big Four banks. They bought the bad loans at or near face value in an explicit bailout of commercial banks.
This time around, the AMCs may again step in to purchase the lowest-quality assets.
In addition to the original four, the CBRC last year authorized provincial governments to set up their own AMCs to buy bad debt from smaller banks. So far only Jiangsu, a wealthy province in southeast China, has formally established one.
But private investors, including brokerages, commercially-oriented AMCs, distressed debt investors, insurance companies, and pension funds, would likely require discounts to face value for all but the highest quality loans.
Even with such discounts, however, the difficulty of performing due diligence on loans originated by other institutions could limit these investors' appetite for these assets, market participants say.
"The non-standardization of assets has always been the main factor restricting credit asset transfers. How can you assess the risk? Bonds can have credit ratings, but loans don't. This has created difficulties for price setting," said a senior interbank market participant at a mid-sized Chinese bank.
Securitized assets, which are standardized, carry credit ratings, and are typically more liquid than bank loans, could be more enticing.
Reuters reported last month that the CBRC was working with China's securities regulator to formulate new, less restrictive guidelines for the creation of ABS.
China cautiously re-launched a securitization pilot program last year, following a halt during the financial crisis.
But only 25.6 billion yuan in credit-based ABS are currently outstanding in China's interbank market, a tiny fraction of the 27.25 trillion yuan in total bonds outstanding, according to data from China's two main bond clearinghouses.
Additional reporting by Zhang Shengnan in BEIJING and Zhao Hongmei in HONG KONG; Editing by Kim Coghill