BEIJING - Xiao Jiashou once inspired thousands of aspiring entrepreneurs from his hometown in Fujian Province to come to Shanghai to try their hand at trading steel. Now many of the steel traders from Zhouning are following him into financial ruin.

Xiao, who came to be known as the "king of the steel trade," is facing dozens of lawsuits by bank creditors who in late January won court orders freezing millions of dollars worth of assets, including a stake of about 30% in Ningxia Xinri Hengli Steel Wire.

A two-year slump in Chinese steel prices has driven many steel traders to the wall, touching off a brutal credit crunch as loose collateral pledges and loan guarantees messily unwind. State news agency Xinhua predicted on Feb. 7 that at least a third of the country's 200,000 steel trading companies will fail. Their travails are already having an impact on China's banks.

Zhu Xiaohuang, president of China Citic Bank, said earlier this year that the 7.7 billion yuan ($1.23 billion) increase in the bank's non-performing loans last year primarily related to credit extended to steel traders since 2011. "We started to notice the bad loans of steel trading and manufacturing companies in this area in the second half of 2013," Song Xianping, director of risk management of Agricultural Bank of China, recently told reporters.

More than 20 banks in southeast China have ceased lending to steel traders since last August, according to Moneyweek, a Shanghai-based financial magazine. "Almost all banks in the city of Hangzhou have stopped approving loans to them," said Xu Saizhu, a manager at industry information site Mysteel.

"Every day, I hear of debtors running off," said one Shanghai steel trader from Shunde, Guangdong Province. Local media have reported steel traders fleeing overseas or committing suicide. "It's the worst time I've seen," said the trader.

The troubles are set to get worse as China's economic growth loses steam. Tim Murray, managing partner of J Capital Research in Beijing, wrote in a recent report that steel traders have been telling his researchers that they have received few if any orders since the Chinese New Year holiday ended in early February. "Fewer new starts in construction are the main driver of that downturn in demand," he said.

Credit is especially critical to the traders as they customarily pay steelmakers in full for supplies then get paid in turn for the steel by construction companies and developers weeks or months later.

Steel traders profited handsomely after China's property market was liberalized in 1998. In the boom building years between 2001 and 2007, trading profits of 300-500 yuan per ton were common, according to Mysteel.

Banks were more than happy to lend to the traders then. Some reports have said that banks were so eager that they would give 5 million yuan loans to anyone in Shanghai with a Zhouning ID card. At least half of the 67,000 Zhouning traders received credit cards with limits of at least 500,000 yuan. "Borrowing tens of millions of yuan used to be as easy as blinking," said Zhang Yirong, owner of a steel logistics company in Zhejiang Province.

The banks also became blase about securing their loans. "They would allow steel traders to use the same collateral multiple times simultaneously to get loans, raising the mortgaging rate from 50% to eventually 150% or 200%," said one industry official.

Sometimes the traders pledged their holdings repeatedly by quietly shifting the same steel between warehouses. The Zhouning traders, who came to control 70% of Shanghai's steel market, formed mutual guarantee groups where three to five companies guaranteed each other's loans to expand their ability to borrow. Borrowings by steel traders eventually reached 200 billion yuan.

The flood of credit in turn led many steel traders to invest in other things. Xiao Jiashou, for example, bought commercial buildings in secondary cities in the provinces of Jiangsu, Zhejiang and Inner Mongolia and provided credit guarantee services. Said Sheng Zhicheng, deputy secretary general of the steel committee at the China Federation of Logistics & Purchasing, "Many companies invested in property and the stock market and some in areas they had no experience in."

With a credit crunch on, the financing web is falling apart. "When the price drops and the market goes bad, it's dangerous," Sheng said. "The risk is multiplied [by the mutual guarantee groups] and no one can help each other, which is what's happening now in the Shanghai steel market." Analysts worry the troubles could spread as traders have borrowed against iron and copper holdings as well.

The Shanghai steel trader from Shunde meanwhile is readying to leave town. "I'm going home this year to open a mobile phone shop or something," he said. "It's too hard here."