China's banking regulator, concerned record lending could lead to a spike in bad loans, may tighten banks' capital rules by excluding subordinated bonds they sell to other banks from their capital base, sources said Monday.

The China Banking Regulatory Commission (CBRC) has issued a document to lenders seeking feedback on the move, banking sources close to the regulator said.

The CBRC wants to restrict banks' mutual holdings of one another's subordinated bonds as these sorts of holdings do not reinforce banks' capital capabilities, said one source.

The sources said there was no immediate timetable for implementing the proposed rules.

The measure comes amid other signs the government is strengthening supervision of bank lending, though officials have said China would stick to its appropriately loose monetary policy adopted in the second half of last year, when the global crisis slowed China's economic growth significantly.

Some financial regulators estimate that as much as one fifth of banks' new loans have flowed to the surging stock and property markets this year, creating asset price bubbles. China's stock market .SSEC has jumped 90 percent so far this year.

Late last week, the CBRC said it would strengthen its controls over loans made by banks for corporate working capital to ensure the money was put to proper use.

Earlier in the week, CBRC chairman Liu Mingkang said banks must ensure that loans they issue for investment projects were actually being put to use in the real economy.

The (latest) move means that supervision on lending by banks as well as other loan-offering financial institutions is being tightened in the second half of this year, said Lian Ping, chief economist at Bank of Communications.

The goal is to push new loans into the real economy.

Chinese banks' new lending in the first half reached 7.37 trillion yuan ($1.1 trillion), far above the government's 5 trillion yuan minimum target for the year, sparking worries that rampant lending may lead to a steep rise in banks' non-performing loans.

Subordinated bonds are typically included as part of banks' Tier 2 capital, not Tier 1 core capital, and part of the broad capital adequacy ratio requirements, which China sets at a minimum 8 percent for its banks in line with global standards.

Chinese banks have issued about 200 billion yuan in subordinated bonds so far this year, more than double their issuance last year, as they try to maintain higher capital adequacy ratio requirements due to massive lending.

Many banks have issued subordinated bonds to one another to help meet their capital adequacy ratio requirements. Some bankers estimate banks' subordinated bonds mutually held by other banks have reached more than 50 percent of total issuance in China.

The clampdown on capital will have a bigger impact on those banks who have lower adequacy ratios, said analyst Gao Qing also at Bank of Communications, China's fifth-largest bank.

While analysts declined to name any individual banks, they said the move would surely push banks to diversify to other fund-raising channels such as stock offers.

Minsheng Bank, China's first private bank, has announced a plan to raise money via a Hong Kong stock offering and Shenzhen Development Bank is considering selling private placement shares to Ping An insurance, China's second-biggest life insurer.

STICK WITH THE PLAN

The tightening in lending comes amid the emergence of diverse views among executives in various sectors of the economy on whether China should stick to its now relatively easy monetary policy, though Chinese premier Wen Jiabao and other senior officials have stressed the government would stick to its policy.

State media have said the government had carried out spot checks on how the economy was performing, and its teams concluded that the base of economic recovery was not solid, adding it would take time for the country's exports to return to positive growth.

($1=6.83 yuan)

(Reporting by Shanghai Newsroom, Editing by Jacqueline Wong, Ken Wills and Valerie Lee)

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