SHANGHAI, April 24 (Reuters) - Chinese banks are slashing loans to steel traders further in the face of rising bad debts, a move set to put more pressure on a steel sector suffering from tepid demand.
A crackdown on lending by Chinese authorities launched last year shuttered thousands of trading firms who failed to repay loans as a slower economy hit steel consumption, a situation set to be repeated this year unless steel demand picks up.
A fresh wave of traders defaulting on loans could force more out of business and lead to a further swelling of steel inventories at mills, hitting their cashflow and dragging down steel prices already at multi-month lows.
Steel traders act as vital intermediaries greasing the wheels of China's steel industry - the world's biggest - with about 90 percent of mills relying on traders to sell their products.
"We will not ease credit to steel traders and are still tightening lending to some existing customers," said a Shanghai-based official at Minsheng Bank , China's seventh-largest lender by market value.
"Bad loans (from steel traders) in Shanghai and Hangzhou are still serious, and they have risen in the first quarter from a year ago," the official said, declining to be named due to the sensitivity of the issue.
Some of the banks, many of which are state-controlled, have sued traders in a bid to get back loans.
Loans to steel traders in Shanghai, China's main steel trading centre, reached about 180 billion yuan ($29 billion) last year, with roughly 20-30 percent used for purposes other than steel and highly unlikely to be recovered, Citi Research said in a research note early this year.
Citi forecast that banks would cut loans to steel traders by at least 20-30 percent this year.
A separate estimate from Shanghai Steel Service Trade Association, a lobby group for traders, showed loans to steel trading firms in the city dropped to 150 billion yuan in 2012 from 210 billion yuan in 2011.
"Non-performing loans from traders have risen since late last year. The issue turns out to be more complicated than we expected, and might not improve substantially until September." said an official at one of China's top four lenders who declined to be named.
Some traders have repeatedly pledged the same collateral for loans from several different banks, multiplying the risk.
"The total financing has been far higher than the actual value of the collateral, so the potential systemic risk for banks remains big and we are still cutting loans to steel traders," the bank official said.
Banks have taken tougher measures to fend off potential risks from lending to traders, closely scrutinising financial statements and collateral.
"If I borrowed 1 million yuan, banks would ask for steel products worth double the value coupled with a property as collateral too," said an owner of a trading company in Shanghai.
More than 60 lawsuits were filed by Shanghai banks against steel traders between April 22-May 31, data from Shanghai Court's website showed.
But the battle to get back the money is proving to be tough.
"It's a slow process recouping repayments from steel traders as the court has to deal with a large number of similar cases and gives banks a daily quota, so we can't do anything but wait," the Minsheng Bank official said.
Courts at different districts in Shanghai could also face lawsuits from several banks against traders who have pledged the same collateral, further complicating the process.
Fears of souring loans are being fanned by a cooling Chinese economy, which grew by a less than forecast 7.7 percent annual rate in the first quarter. Many had been expecting the world's No. 2 economy to help kick off a global rebound this year.
Inventories of steel products held by traders in China hit a record high of 22.5 million tonnes last month and remain above 20 million tonnes, according to industry website Mysteel.
Stocks held by large mills also hit a record of 14.5 million tonnes last month and now stand at around 13.7 million tonnes, according to data from the China Iron & Steel Association.
The value of stocks has fallen as prices have dropped. The price of rebar, which comprises the bulk of these stocks, touched a 7-1/2-month low of 3,578 yuan a tonne on Wednesday.
The brake on lending and falling steel prices have forced thousands of trading firms in Shanghai to leave the supply chain, many of them from the southeast coastal Fujian province.
"Trading firms owned by Fujian bosses have had bank loans totally blocked, with the exception of a few big ones," said a steel trader in Wuxi, another major steel trading hub.
Many traders are currently making losses of 80-200 yuan a tonne and more are expected to go bust, with steel demand unlikely to pick up significantly.
"We don't want to borrow too much from the banks either. Deposits at banks make even more money than selling steel as the lending costs are surging quickly while steel demand is weak. So bank loans are also a big risk for traders as well," said a senior executive with a big Shanghai trading firm. ($1 = 6.1791 Chinese yuan)