In an effort to help China’s commercial lenders get rid of non-performing loans (NPL), the People’s Bank of China is preparing regulations that would allow the lenders to swap the loans for equity stakes in the same companies, people with direct knowledge of the new policy told Reuters.

PBOC HQ in Beijing
PBOC HQ in Beijing

By reducing the commercial banks’ NPL ratios, the new rules will make available more cash for much needed investment in new infrastructure projects and factory upgrades that should help slow the declining growth rate of the world’s second-largest economy.

As the Chinese economy grew at its slowest pace in a quarter of a century, NPLs surged to a decade-high last year. Official data showed banks held more than 4 trillion yuan ($614 billion) in NPLs and “special mention” loans, or debts that could sour, at the year-end.

Analysts say the quality of assets held by banks is worse than it looks. Some banks have under-reported bad loans and under-recognized overdue debt as a way to protect their balance sheets.

The top banking regulator has warned commercial lenders to pay special attention to risks.

The sources, who spoke to Reuters on condition of anonymity, said the release of a new document explaining the regulatory change was imminent.

“Such a rule change shows banks’ bad loans have risen to such a level that this issue has to be tackled now before it’s too late,” Wu Kan, Shanghai-based head of equity trading at investment firm Shanshan Finance told Reuters.

State banks have extended loans to government financing vehicles and state-owned coal and steel producers, so this policy can help give lenders time to deal with non-performing assets as China pushes supply-side reforms, Wu added.

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