After a series of tightening measures by China's central bank choked off bank loans to small- and medium-sized companies (SMEs), many resorted to importing copper and other commodities as a way to get cheap loans.

Following are questions and answers on the cash for commodity business in China:

HOW ARE COMPANIES USING COMMODITIES FOR CASH?

The most common way of doing this is to import a commodity with a letter of credit (LC), whereby a bank pays the overseas seller and gives the buyer a period of three months to a year to pay the money back. During this window companies can sell the cargo and use the proceeds for higher-yielding investments.

Alternatively, firms can submit a warehouse receipt or a warrant to use the commodity as collateral for a discounted loan.

In the case of copper, bank fees and commissions can amount to 3.5 to 10 percent of the cargo's value for an LC and about 10 to 30 percent for warrant financing, depending on the company's credit standing with the bank.

WHY COPPER AND STEEL?

The most popular assets used for commodity financing purposes in China are copper and steel, due to their high per-tonne value and liquidity in the spot market.

Iron ore and coal are less attractive due to non-standardized specifications, which limit their appeal to only selected segments of potential customers, and higher storage costs because of lower per-tonne value.

Aluminum imports to China are low, and zinc, lead and nickel suffer from big price swings which can make financing costs more difficult to control.

In agricultural commodities, soybean imports and stockpiles have been used by a handful of crushing companies for financing, as a surprise release of state reserves moved the market into surplus. Despite their high value, the use of other commodities such as corn and cotton is limited as Beijing has stringent import quotas on them.

WHAT IS THE GOVERNMENT DOING ABOUT THIS?

Beijing has introduced various measures to close off loopholes in the banking system. In March, it restricted re-exports to prevent China's foreign reserves from further expanding. to leave the entire sale proceeds in a suspended account until they can prove to the authorities that it was a legitimate trade.

In late August, trade financing costs spiked after the government ordered banks to include margin deposits on LCs and other trade-related loans.

ARE THERE OTHER INNOVATIONS THAT HAVE SURFACED?

After Beijing closed the loopholes, banks are now more wary of inventory financing. The further squeeze on cash means banks have also shortened payment terms for LCs and bills of acceptance. But the competition among banks for yuan deposits means they have pushed for new financial instruments.

One type of trade financing that has become popular is the issuance of cross-border LCs, in which a company deposits yuan into a bank's Chinese branch and in return the bank issues a LC, usually in U.S. dollars, by one of its offshore branches. Bankers call this a win-win type loan, as the yuan deposits beef up their deposit base for other business, while giving companies easy access to cheap loans in the currency most commodities are priced in.

Third is a cash pledge, which is similar to collateral loans. Companies open a separate bank account and pledge those assets as part of a guarantee for the LCs. Banks are pushing hard for this type of facility as the pledged money falls out of the central bank's scope for required reserve ratios.

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