(Adds byline and adds prices in paras 10, 11)
By Melanie Burton
SYDNEY, June 11 (Reuters) - Worries over Chinese copper financing are prompting some banks to wind up deals or stop doing them altogether - and not just in the Qingdao port at the center of a probe into possible fraud, traders said on Wednesday.
The focus, mostly from Western banks, is on so-called repo deals, which give companies ready access to short-term credit in exchange for goods, three trading sources and two banking sources said. Repos is a shortening of repurchasing agreements.
Shanghai alone has an estimated 500,000-600,000 tonnes of copper stored in bonded warehouses, around 2.5 percent of global supply, so a partial unwind of these deals could have significant impact on global liquidity and prices.
"The story driving the copper market is people using repo, thinking they have no counterparty risk. Now all of them have to think again. That changes the fundamentals of the whole market," said a trading source at a Western bank in Shanghai.
Three traders said that their repo financing business had slowed down this week due to banks taking a more cautious approach to granting credit, which was likely to drag on copper prices and premiums.
"Right now, liquidity is very bad. Everyone wants to sell (copper), but no one wants to buy," said a physical trader in Singapore who sells metal in China.
"(Premiums) have already been dragged very low but they could still fall further," he added.
In Shanghai, premiums to obtain physical metal dropped another $10 to $70-$90 a tonne on Wednesday, according to China price provider Shmet, down from $105-125 a week ago. (www.shmet.com)
London Metal Exchange (LME) copper traded up by 0.1 percent at $6,680 a tonne, after hitting one-month lows the session before, while in Shanghai copper closed up by 0.7 percent, fuelled in part by technical buying.
The cash-to-three-month backwardation, with nearby prices at a premium to forward levels, widened on Wednesday to $58 per tonne from $35 a day earlier.
Last week, concerns about the potential unleashing of metal from financing deals had almost wiped out the backwardation, with the spread narrowing to as low as $3 on Friday.
In a repurchase agreement, a commodity owner sells a warehouse receipt and takes a short position on the underlying commodity with a bank, while at the same time agreeing to buy the deal back in anything from two weeks to three months.
A repo is different to an import financing deal, where a Chinese firm typically opens a letter of credit with a bank for imports and pays a deposit which varies depending on the credit of the firm. The term is generally 3-6 months.
Both deals use warehouse receipts as proof of ownership and banks have been scrambling to check their exposure since the fraud investigation at Qingdao raised the uncomfortable prospect that their metals holdings may not exist.
The probe at the Chinese port, where a third-party firm is suspected of duplicating receipts for metal multiple times to obtain financing, has shaken markets amid fears the problems could extend to other ports and force a crackdown on using metal as collateral for finance.
So far there are no signs that the practice has been more widespread, but banks are still jumpy and checking their warehouse exposure, said one head of commodity finance at a South East Asian bank.
Banks are likely to raise the bar for Chinese commodity financing deals in general, in order to broadly lower the exposure to this sector, Goldman Sachs said in a note. That could be done through raising funding costs, which would cut the profitability of copper financing deals and release more metal on to the market.
In March, the bank estimated commodity finance deals in China were worth as much as $160 billion, or about 31 percent of the country's total short-term foreign exchange loans.
"If there are further similar cases to be found, the whole exposure could be reduced sharply, which would lead to a disorderly unwind of repo and CCFD (Chinese Commodity Financing Deals) business in general," it said.
Still, some market players expect financing appetite to remain fairly steady, although it may incur higher costs, given that a full scale retreat by banks would ultimately lose not just their customers' business but also eat into their own.
"I don't buy the idea it's the end of copper financing or that demand is going to collapse," the first trader said. "It won't really change supply and demand, but it will change the mechanism of the market." (Reporting by Melanie Burton; Editing by Alex Richardson; and Peter Galloway)