Beijing is readying twin initiatives to curb opaque financing practices that threaten the stability of the country's US$864 billion investment trust industry and booming corporate paper market, sources say.
The moves, from the People's Bank of China (PBOC) and the China Banking Regulatory Commission (CBRC), form part of a campaign to clean up the country's financial system as it opens up domestic capital markets to diversify funding options for cash-strapped firms.
Two sources close to the CBRC said the big four managers of bad loans - so-called asset management companies (AMCs) - would be banned from lending directly to investment trust companies under the pretext of acquiring bad debt.
Meanwhile, continuing a clampdown on the corporate bill that began last year, the PBOC would, from next year, stop bankers acceptances and similar products from being used to camouflage off-balance-sheet lending to firms, sources said.
Neither the CBRC nor the PBOC provided comment on their plans.
The initiatives could provide reassurance that Beijing is serious about rooting out hidden risks that investors fear lurk in a financial system dominated by state-controlled banks and government-backed business.
For years, the country has shuffled bad debt run up by big state firms between state banks, other state companies and the government in labyrinthine deals that hid the cost of bad banking, and shielded unviable state enterprises from bankruptcies.
These losses lurk in the system unaccounted for, and frustrating potential investors who say Beijing quashed the bad debt market by refusing to sell dud loans openly to protect state firms from creditors.
The new rules take aim at two key areas - real estate and lending - to the biggest, mainly state-backed, firms.
"Right now, asset management companies are focusing their main acquisitions among property trusts," one of the sources said.
Property trusts absorb nearly 13 per cent of China's total trust investment and have been pressured in the past year as falling home sales strain developers' ability to repay loans.
Some developers have sold land or half-finished projects held as collateral with trusts to repay debts, with the four AMCs emerging as buyers. That raises the risk of collateral being pledged twice, or that developer simply uses land to raise fresh loans to fund another unviable project.
Mainland trusts are essentially private capital funds that get money from rich individuals and wealth management arms of Chinese banks on the hunt for lucrative investments.
They had 5.5 trillion yuan (HK$6.7 trillion) of assets as of the end of June, and had 5.3 trillion yuan of cash to invest, data from the China Trustee Association showed.
Property trusts have boomed in the past two years after Beijing banned real estate developers from borrowing from banks, or raising money in public capital markets.
Meanwhile the target of the new PBOC rules is the trade in vaguely endorsed, repeatedly discounted corporate bills, which change hands in an intermediate market of "bridge institutions" that regulators fear impair transparency in the financial system.
These bills are notes from a firm instructing a bank to pay a specific sum to a third party payee on a particular date. But if the payee needs the money earlier, it can cash the bill early for a discount - either at the same bank or a different one.
The discounted bill is recorded on the bank's balance sheet, but banks that wish to decrease the amount of loans that appear on their balance sheets may use repurchase agreements to temporarily erase the asset from their balance sheets in order to avoid breaching loan-to-deposit ratios or other lending restrictions.
The proposed regulations would address highly technical aspects of the corporate bill trade, related to how they are endorsed and resold.