* Pilot scheme planned this year - official, bankers
* Current law bars commercial banks from direct investment in non-banks
* Move to allow smaller lenders to tap into tech boom
* More domestic competition for private equity players eyed
By Shu Zhang and Matthew Miller
BEIJING, Feb 1 (Reuters) - China is planning a pilot programme to allow selected commercial banks to set up equity investment arms to take direct stakes in technology firms, people familiar with the matter said, a move aimed at giving lenders a chance to buy into a high-growth industry while stoking competition with private equity players.
Under China’s commercial banking law, banks are forbidden from directly investing in equities of non-bank institutions, unless otherwise stated by the government.
The pilot programme, dubbed an “investment and loan linkage mechanism”, is set to start sometime this year via special approval by the State Council, China’s cabinet, a government official with direct knowledge of the plans said. The official was not authorised to talk to the media and requested anonymity.
Details of which banks will qualify to take part in the pilot scheme, and under what conditions, have yet to be hammered out, the official and three senior bankers said, but China’s banking regulator has identified the effort as a major task for 2016.
The bankers declined to be identified because they were not authorised to talk to the media.
The China Banking Regulatory Commission (CBRC) did not respond to a faxed request for comment.
The move is intended to channel more financial support to China’s high-flying tech sector, a traditional hunting ground of private equity, venture capital and foreign investment banks.
“If these rule changes bring more capital to the market, its going to create more competition and put more pressure on returns for all investors,” said Bain & Co partner Vinit Bhatia.
While China’s broader growth prospects have cooled, its tech sector remains in demand. Investments in telecommunications, media and technology totalled $14.1 billion in China in the first half of 2015, surpassing the $13.3 billion invested during the whole of 2014, according to Bain & Co.
With an eye on the Silicon Valley model, Chinese commercial bankers told Reuters that while sometimes risky, tech start-ups can make for lucrative business if lenders are allowed to not only lend, but also take ownership in those firms.
With more resources to set up offshore vehicles, some of the country’s bigger lenders have already made indirect investments in rising tech firms.
Last week, China Merchants Bank Co agreed to invest $200 million in fast-growing ride-hailing firm Didi Kuaidi, which competes with ambitious U.S. start-up Uber.
In order to make the investment, part of a $3 billion fund-raising round that brought in money from investors including Singapore state fund Temasek, China Merchants Bank used an offshore investment affiliate, a person familiar with the matter told Reuters.
China Merchants Bank declined to comment.
Elsewhere, Hankou Bank, a small city bank based in central China, has teamed up with Legend Capital and Hony Capital, both owned by Legend Holdings, the biggest investor in PC and smartphone maker Lenovo Group Ltd. The bank provides loans, while its partners buy stakes in tech firms. Legend Holdings has a 15.3 percent stake in the bank.
But the model isn’t ideal, Hankou Bank Chairman Chen Xinmin told Reuters in December. Although each of the parties shoulders high risks, equity investors benefit as valuations increase, while the bank makes money only from loan interest.
“Traditional banks mainly have debt relations with clients, but to develop tech finance, we need to build shareholding relations with them,” Chen said.
Some banks already are testing the boundaries of current law restricting equity investment in tech companies, using debt-to-equity terms in loan agreements and by appointing friendly private equity houses and venture capital firms as proxy shareholders, bankers said. (Additional reporting by Paul Carsten; Editing by Lisa Jucca and Kenneth Maxwell)