Chinese banks, facing mounting bad loans from the property market and local governments, were ordered by Beijing to clamp down on new lending to steel traders, further weighing on a sector that has racked up $400 billion in debt.
While the lending curb seems at odds with Beijing's pledge to speed up infrastructure building and stimulate a slowing economy, it is the government's way of righting previous excesses, analysts say.
Some steel traders, struggling to make ends meet due to anaemic demand and overcapacity, used loans meant for steel projects to speculate in property and stocks. That led the China Banking Regulatory Commission (CBRC) to issue a directive on April 26 ordering banks to curb lending, a CBRC official said.
"Many steel traders are highly-leveraged and misuse bank loans, making such lending highly risky," a loan officer at the Bank of China in Shanghai told Reuters.
No new lending was being made available to traders unless their customers were units of major state steelmakers such as Baoshan Iron & Steel, the loan officer said.
"There will be a large number of steel traders going bust in the future, and only the fittest will be able to survive," a senior steel trader with a Shanghai-based company said.
Fraudulent applications surged late last year because of the difficulties steel firms had in securing loans, according to industry sources.
"Now banks have almost choked off lending to steel traders using their stocks at warehouses as collateral, and some have stopped all lending to traders, particularly those aiming to invest in unrelated sectors," said Tang Dayong, an executive with the Shanghai-based Haimei Materials, which trades rebar and hot-rolled coil.
Beijing's stimulus of 2009-2010 triggered a property frenzy and left a 10.7 trillion yuan ($1.68 trillion) mountain of local government debt. It also saw mills borrowing heavily to build new plants, driving global iron ore prices up to record levels.
China's 77 steel mills had total liabilities of 2.55 trillion yuan as of the end of 2011, up 16.82 percent on year, according to the China Iron and Steel Association.
Lending risks to steel traders began to emerge in the second half of last year, with many using the loans to speculate in the futures market or cover losses in other businesses, a senior official at the China Construction Bank in Shanghai told Reuters.
"Many steel traders face huge liquidity risks as steel prices slump," he said.
Product prices in May plummeted to their lowest levels in six months. And with margins in the steel industry now perilously low, banks have preferred to lend to sectors with higher returns.
Steel traders worry that the lack of credit is making a bad situation much worse, and some have already begun lobbying banks to make financing available.
A letter issued on behalf of steel traders on Wednesday said financing for Shanghai steel traders has fallen 23 percent since the beginning of the year.
The letter, sent to financial institutions in Shanghai by a group of private traders from Fujian province, said the crackdown was hurting everyone, with banks deprived of 25 billion yuan of revenue from Shanghai traders alone.
"The rise in interest rates and the cost of financing have brought total financial costs up by 33 percent compared to last year, and the debt burden for the steel industry has risen very quickly," Qu Xiuli, the vice secretary general of CISA, said at a conference last week.
But the availability of credit might not be the only answer to the woes facing the sector.
Large and well-connected traders ordering from China's giant state-owned mills have not suffered any credit squeeze, but they are also struggling.
"The biggest problem for the whole steel industry is we are not making money at all," said a trader from a state-owned steel trading company in Hangzhou in coastal Zhejiang province.
Chinese crude steel output reached record levels in the last two months even as overall losses totalled 1 billion yuan in the first quarter, with mills desperate to cling on to market share.