Goldman Sachs said last week that the Qingdao probe was expected to lead to a rapid unwinding of commodity financing deals and depress copper prices. That would drain money from a shadow-banking system that supplies credit to industries cut off from regular lending channels. Moody's Investors Service said in a report last month that it expected more defaults in sectors such as steel, mining and property, primarily among unrated companies.

"For some steel and metals firms, or even real estate companies short of cash, it has been these financing deals that helped maintain their cash flow in the past couple years," said Ren Gang, general manager of metals trading firm Qingdao Youbangyuan Trading's unit in Shanghai. "Some of them may not be able to survive this time as such financing deals will shrink following the crackdown."

Overcapacity of steel and nonferrous metals in the world's largest producer has led to shrinking profit margins. He Wenbo, chairman of Baoshan Iron & Steel, said the industry was in the "harshest" operating environment he had ever known.

Home sales slumped 10 per cent in the first four months of this year, prompting Moody's to revise its credit outlook for mainland developers to negative from stable. Construction accounted for 73 per cent of the mainland's steel demand last year, while 71 per cent of the copper was used in power and construction.

The Qingdao branch of the customs administration had issued rules to help prevent goods being pledged multiple times as collateral for loans, two sources said. The authorities would expand the probe nationwide, the reported last Wednesday, citing Cheng Xiaoyong, an executive at Baocheng Futures.

Early this month, Citic Securities, the mainland's largest brokerage, listed steel, nonferrous metals and coal as the industries with the highest risk of failures and recommended investors avoid bonds issued by such companies.

"Funding shortages have become a paramount issue for steel and steel-trading companies, as was reflected in the large proportion of non-performing loans in banks' 2013 reports," Citic Securities bond analyst Deng Haiqing wrote. "Like steel, the copper and aluminium industries also face serious overcapacity and shrinking downstream demand due to a sluggish real estate market."

The extra yield investors demand to hold five-year AA-rated debt over comparable AAA bonds widened to 149 basis points on June 4, the most since March 2012, before falling to 141 basis points on June 12 ChinaBond data shows. The yield on 10-year sovereign debt fell to an eight-month low of 4.01 per cent on June 4, before rising to 4.06 per cent.

The People's Bank of China has singled out industries with excess capacity and real estate developers as sectors most vulnerable to defaults.

Bonds issued by Nanjing Iron & Steel halted trading on the Shanghai Stock Exchange from May 12 after the company reported losses for two consecutive years. Haixin Iron & Steel, a privately owned producer in Shanxi province that suspended production in March and failed to repay overdue bank loans, is unlikely to resume production, magazine reported last month.

The yield on Hunan Valin Iron & Steel's 2019 bond climbed more than 200 basis points from a year ago to 8.81 per cent on Friday.