* New rules signal fresh push for deleveraging
* Chinese cabinet says shadow banking is positive
* But new rules needed to plug regulatory loopholes
* Trust companies shouldn't engage in "credit-like" business
By Heng Xie and Gabriel Wildau
BEIJING/SHANGHAI, Jan 6 (Reuters) - China's cabinet has published guidelines strengthening regulation of risky off-balance-sheet lending in a new effort to address growing financial risks from an explosion in debt.
The State Council's guidelines call for tighter regulation of banks' off-balance-sheet lending and say that trust companies - the biggest non-bank players in what's called "shadow banking" - should return to their original pupose as asset managers and not engage in "credit-type" business.
A copy of the council's Document 107, dated Dec. 11, was obtained by Reuters. There's been no official confirmation of the document, which was addressed to government agencies at the central and local level.
An index of the biggest mainland stocks closed at its lowest level in five months on Monday, as concerns about the new regulations weighed down the market.
China's policymakers are concerned that the country's economy has become overly reliant on borrowing to fuel growth and that debt-fueled investment has created massive overcapacity in many industries.
If strictly implemented, the deleveraging push could put China's economy on a more sustainable long-term path by reducing the risk of a bad-debt crisis. But short-term growth would likely fall as a reduction in credit growth spurs a fall in spending.
"One can predict that growth of total social financing will slow and fixed-asset investment will also slow," said Liu Yuhui, director of the financial focal point laboratory at the Chinese Academy of Social Sciences, a government think tank, referring to the central bank's measure of total credit from all sources.
"If this isn't accompanied by various forms of debt restructuring, some sectors may see their funding chains broken and there could be defaults," he said.
An official audit released last week showed that China's local government debt reached 17.9 trillion yuan at end-June 2013, or up from 10.7 trillion at end-2010. Local governments are among the largest recipients of shadow bank loans.
China's ratio of total debt-to-GDP, including government, corporate and household debt, was set to reach 218 percent of GDP by the end of 2013, up 87 percentage points since 2008, rating agency Fitch estimates.
Though this level remains lower than many developed countries including the U.S. and Japan, economists warn that such rapid debt run-ups have been associated with financial crises in other nations. That's because most economies aren't able to efficiently deploy such a large amount of investment within a short period.
The State Council's guidelines also come amid two major cash crunches in the past six months. The interest rates that banks charge each other for short-term loans spiked to record highs in June and again last month, as banks scrambled to raise cash to pay maturing debts.
Many bankers attributed the interest-rate spikes in part to the growth of shadow banking.
Banks raise funds for shadow bank loans largely by selling so-called wealth management products (WMPs), which they market to savers as a higher-yielding alternative to traditional bank deposits.
Regulators are concerned that banks are using short-term interbank borrowing to fund payouts on maturing WMPs, even when the underlying assets - including loans, bonds, and bank acceptance bills - haven't yet matured.
"In the last year, banks have been hit hard by liquidity problems. Quite a few banks wish the central bank would relax liquidity, but based on Document 107, it appears the relevant authorities don't agree," said Liu.
While the guidelines signal high-level concern about the risk from shadow banking, they contain no specific rules.
In China's policymaking process, the State Council typically issues broad guidelines, which regulatory agencies then follow up with specific rules.
Indeed, rumours have circulated for several months that the banking regulator is preparing new rules to crack down on the use of complex interbank transactions designed to disguise risky corporate loans as loans to other banks.
The State Council document says shadow banking is a "beneficial" and "inevitable" consequence of financial development and provides an official definition of the term.
But the guidelines also call for closer monitoring and tighter regulation of banks' off-balance-sheet lending, which is often conducted through intermediaries such as trust companies and securities brokerages.
Shadow banking has grown rapidly in China since 2010, when banks began running up against limits on expanding loans through traditional channels.
With credit demand still strong but banks increasingly constrained by regulations such as capital adequacy and loan-to-deposit ratios, institutions devised complex structures designed to keep lending to customers.
Like bank WMPs, trust companies raise funds by selling high-yielding investment products, using the proceeds to make loans or buy other assets.
Chinese savers have flocked to these products as an alternative to low-yielding bank deposits, a weak stock market and a frothy property market. Trusts surpassed insurance companies this year to become the non-bank financial institutions with the most assets under management.
If fully implemented, cutting off trusts' credit business could restrict lending to weak borrowers such as local governments and property developers, who are largely shut out from traditional bank loans but can still obtain high-interest trust loans.
A Reuters investigation last year found that local governments, property developers and industries suffering from surplus capacity accounted for about 70 percent of trust loans given in 2012.
Trust loans outstanding reached 4.62 trillion yuan at the end of September, according to the China Trustee Association. Such loans accounted for 11 percent of net new corporate fundraising in the first 11 months of last year, central bank data shows.
The latest guidelines follow a set of regulations issued in March, which limited the amount of shadow bank loans that banks could package into WMPs.
With the new policies, authorities seek to address the problem of banks exploiting loopholes by clarifying the responsibilities of various regulators, including the People's Bank of China, the China Banking Regulatory Commission and the China Securities Regulatory Commission.
The State Council also said that investors must bear the risk of losses associated with WMPs and that banks are forbidden from providing guarantees on the underlying credits.
Analysts are concerned WMP investors widely perceive the products as carrying an implicit guarantee from state-owned banks, even when the fine print says otherwise. That leaves banks exposed to the risk from many loans not on their balance sheets, as they could face heavy pressure to compensate investors to protect their reputations.
The fresh guidelines also call on the PBOC to develop new statistics to measure shadow banking and to make regular reports to the State Council.