(Adds analyst comments, details)
By Ruby Lian and Fayen Wong
SHANGHAI, April 28 China's banking regulator has
urged local authorities and banks to step up an investigation
into iron ore financing deals in a bid to minimize default
risks, prompting a sell-off in iron ore futures that saw prices
fall nearly five percent.
The probe, confirmed to Reuters by sources with direct
knowledge of the matter, raised fears that the crackdown on
commodities-backed financing could unleash a flood of iron ore
sales from 100 million tonnes-plus of stocks sitting at Chinese
ports, raising the prospect of a price slump.
A China Banking Regulatory Commission (CBRC) spokesman
declined to comment.
In a document issued on April 18, the commission told local
regulators and banks to start investigating iron ore financing
and to submit detailed reports by April 30.
"Local offices must step up measures to manage risks arising
from commodities trade financing and to assess the risks
presented by iron ore financing," the CBRC said, adding that
regulators should also check if firms were logging fake trades
to secure financing.
Trade sources said Chinese banks have started to tighten
loan requirements for steel mills and trading firms seeking
credit for iron ore imports.
"The thing we've been hearing from traders is the margin on
the letters of credit has gone up quite sharply over the last
week - it used to be 10-20 percent and now is 40-50 percent, and
that seems seems to be forcing a bit of liquidation (to cover
the margin call)," said Graeme Train, an analyst at Macquarie
Commodities Research in Shanghai.
Although Chinese banks have been gradually cutting back on
loans to the steel sector since late last year, many private
mills saw their lines of credit either suddenly cut off or
slashed at the start of the year.
While the credit crunch has caused some floundering mills to
shut, others stepped up iron ore imports as a way to get trade
financing, which was more easily available and offered at a
lower interest rate. They would then sell the raw material in
the domestic spot market to raise cash.
The scramble for credit, via the use of iron ore imports,
has caused imports in the first quarter of 2014 to surge about
20 percent from a year ago, even though demand has been anaemic,
and inflated stockpiles at Chinese ports to an all-time high.
Iron ore port stocks stood at above 108 million tonnes in
early April, enough to build almost 1,200 New York Empire State
News of the probe caused the benchmark iron ore contract for
September delivery on the Dalian Commodity Exchange to
close down 4.5 percent, its biggest daily fall since the
contract was launched in October 2013.
Spot prices also fell, with a cargo of Australian iron ore
fines sold at $107 a tonne on Monday, down $3 from last
Thursday, traders said.
RISKS TO ECONOMY
Commodities such as copper, rubber and soybeans have been
commonly used for financing, where traders or investors borrow
against the commodity with the aim of investing the money in
high-return areas in real estate or shadow banking.
As the financial noose on private mills and traders
tightens, some state-owned firms that enjoy easy bank credit and
are eager to keep profits ticking over in a cooling economy,
have stepped in to fill the lending void.
To avoid unwanted attraction from regulators, many of them
have offered credit facilities under the guise of trading.
"Some banks are cutting new credit to us this year, but some
have given us more. So we finance companies by helping them to
purchase raw materials and then charging them an interest," said
a senior official with a state-owned trading firm, who spoke on
the condition of annonymity due to the sensitivity of the topic.
Some private companies are also cashing in.
A senior executive from a major environmental rehabilitation
company said his firm was also extending loans to smaller
companies through the sale of coal and iron ore shipments.
"The coal or iron ore may not be sold in the end but we use
the trades on paper to justify the loan and interest rates
charged," said the executive, who declined to be named.
Interest rates charged could range from 9 percent to 15
percent, compared with an official rate of 6 percent that many
state firms enjoy, industry sources said.
Apart from adding systematic risks to the broader economy,
the participation of SOEs in shadow banking is complicating
China's efforts to curb overcapacity in a slew of sectors.
($1 = 6.2536 Chinese Yuan)
(Additional reporting by David Stanway, Xie Heng, Zhao Hongmei
and Li Ran in BEIJING; Editing by Richard Pullin)