BEIJING, March 4 (Xinhua) -- Coming up with policy tools to channel credit to small and medium-sized firms has been one of the most persistent challenges facing Chinese regulators. Now they have brought securitized products into the mix, replacing loans with capital for banks to extend more credit.

Though the central bank entered an easing cycle with two interest rate cuts and a reduction in the amount of funds banks must hold in reserve, credit condition remains tight in an economy that slowed to a 24-year low of 7.4 percent in 2014.

Banks have grown reluctant to lend as a slowing economy increases borrowers' uncertainty about repaying loans. But a slew of policies issued by the nation's financial regulators over the past two years has encouraged banks to securitize some of their loan portfolios, sell these products to other investors and hopefully use the capital to lend more.

This led to a boom in China's securitization market last year, with issuance growing tenfold from a year earlier to more than 280 billion yuan (44.66 billion U.S. dollars).

Encouraging trading of such structured products is also in line with China's goal of developing a multi-tiered capital market.

Chinese regulators started to entertain the idea of securitization in 2005, with minuscule issuance under a pilot program. Then the program was shelved on the eve of the global financial crisis, as products such as mortgage-backed securities (MBS) originating in the United Stateswere widely blamed for causing the global turmoil.

But authorities warmed to such products again after the crisis as the ongoing interest rate liberalization in China has made it increasingly expensive for banks to secure capital through deposits and the crackdown on shadow banking activities has closed a grey area for banks to unload assets from their balance sheet.

Banks have been given more incentives through strong policy support over the past two years, including replacing a previous deal-by-deal approval issuance with a registration-based one and reducing the share of the lowest grade of securitized products banks must hold for each issuance.

"Securitization has been increasingly viewed by Chinese regulators as a feasible solution to revitalize existing resources in the market to address corporates' funding needs," said Ma Li, a senior executive with rating agency Moody's.

Ma noted that the regulators are removing restrictions concerning securitization. The pilot is now on its way to becoming a full-blown market, with products promising decent gains for both issuers and investors.

Securitization allows banks to unload risks off their balance sheet and replenish capital without increasing leverage, and in China's case, gives banks more freedom to lend under a stringent quota.

Chinese banking law requires banks to abide by a loan-to-deposit ratio, which has remained unchanged for years at 75 percent. The central bank last year expanded the caliber of what constitutes a bank's deposit in a bid to release more lending capital.

Economists at Capital Economics referred to such a ratio as a binding constraint over credit growth and they see the Chinese central bank's recent two rate cuts as less effective in boosting lending.

At less than 300 billion yuan, China's securitization market is still nascent, accounting for only 0.5 percent of GDP, a far cry from 60 percent in the United State and trailing behind countries such as Japanand Germany, at 3.6 and 2.8 percent respectively, statistics from China International Capital Corporation (CICC) show.

To what extent banks will use the capital acquired through selling securitized products also remains in question, according to analysts.

"In theory, that's what banks do with capital raised from securitization, but in practice it's a decision subject to a bank's strategic consideration," said Moody's Ma.

Other problems include inactive trading in the secondary market and an investor base consisting mostly of banks. This means banks cross-holding their securitized assets does not help diversify risks away from the sector.

"This is still a very young market, and it is not big enough to attract a diverse range of investors to participate," said Ma.

According to the CICC, the securitization market in China will expand to two trillion yuan, or 2 percent of China's GDP in five years. But whether this expansion will lead to increased credit supply remains to be seen.