SHANGHAI/BEIJING (Reuters) - A takeover by Chinese regulators of a troubled lender with links to a missing tycoon jolted markets on Monday, lifting interbank financing costs for some smaller banks and raising worries about broader risks to the country’s financial system.

The China Banking and Insurance Regulatory Commission (CBIRC) will take control of Inner Mongolia-based Baoshang Bank for a year from May 24, as it posed serious credit risks, the regulator and the central bank said on Friday, in a rare move to seize direct control of a bank.

The seizing of Baoshang fanned concerns about indebted small banks across the country, pushing up yields on some negotiable certificates of deposit (NCD) issued by regional banks by more than 10 basis points on Monday, traders said.

“We recommend paying close attention to the impact on liquidity that could be triggered by this event,” analysts at China Merchant Securities said in a note, referring to the Baoshang takeover.

Selling pressure on Baoshang debt would not only affect the deposit yield curve, but could also lead to pressure on instruments from “Baoshang-like” city commercial banks that have not released financial results in several years and have significant interbank borrowings, they said.

The bank’s own bonds were suspended from trading following the takeover, said an official at the China Foreign Exchange Trading System and National Interbank Funding Center, China’s interbank market trading platform.

The regulator’s Beijing branch issued a notice on Monday asking banks not to try to grab clients from Baoshang, two banking sources with acknowledge of the matter said.

In Baotou, the regulator has made similar requirements, and warned of “severe punishment” of any breaches, a Baotou banking regulator told Reuters.

FINANCIAL CRACKDOWN

Baoshang, partly owned by Chinese financial group Tomorrow Holdings, has not published any annual reports since 2016, citing a plan to seek strategic investors.

Tomorrow has been in the process of divesting some assets since its chairman Xiao Jianhua was investigated more than two years ago amid a government crackdown on systemic risks posed by financial conglomerates. The billionaire has not been seen since 2017.

Baoshang Bank has 206 outstanding bonds worth a total of 73.83 billion yuan ($10.71 billion), according to Refinitiv data.

Baoshang’s last filing on its assets and liabilities shows the bank had a total of 156.5 billion yuan ($22.7 billion) of outstanding loans by the end of 2016, a 65% jump from the end of 2014.

China’s central bank said on Sunday that it would offer “timely and sufficient funds to ensure that (Baoshang Bank’s) payment system is operating smoothly.”

The People’s Bank of China (PBOC) also said that it and the CBIRC would give more policy support to improve small- and mid-sized banks’ corporate governance.

Chinese financial magazine Caixin, citing sources, reported on Monday that at least 70% of interbank debts exceeding 50 million yuan ($7.25 million) owed by Baoshang Bank will be initially guaranteed by regulators.

The PBOC on Sunday said it would guarantee all principal and interest of corporate deposits and interbank liabilities below 50 million yuan, which analysts said helped to contain the market reaction.

“The reaction of the (interbank) capital market is relatively calm due to the guarantee offered to NCDs,” said Dai Zhifeng, a banking analyst at Zhongtai Securities.

Traders said weakness in China’s interbank market on Monday reflected broader concerns about the economy in the absence of clear signs for more policy stimulus.

Benchmark Chinese 10-year Treasury futures for September delivery, the most-traded contract, fell as much as 0.71 percent to a low of 96.12.

HEAVY BORROWER

NCDs are short-term debt instruments traded in China’s interbank market, which are used by smaller banks to borrow from larger lenders, and which have in the past attracted regulatory scrutiny as they were used to fund speculative investments.

Reuters reported last year that interbank borrowings at Baoshang Bank, including NCD issuance, accounted for 48 percent of its total liabilities at the end of the third quarter of 2017 - far exceeding a 33-percent cap stipulated by the authorities.

While rare, regulatory takeovers aimed at cracking down on systemic financial risks are not unprecedented. The CBIRC took over Anbang Insurance Group in February 2018.

The takeover of Baoshang is not unexpected due to the risks it poses, Xing Wei, secretary of the Communist Party Committee at the Insurance Association of China, said at a forum on Saturday.

Xing cited a spot check five years ago in which he found that a Hangzhou-based small insurer had “colluded with” Baoshang. He did not elaborate.

At a Baoshang Bank branch in Beijing, customers had mixed reactions to the takeover.

Li Yan, whose parents had purchased a dozen short-term wealth management products at Baoshang, said bank staff had used the regulatory move as a selling point.

“They even comforted me with the possibility of Baoshang becoming a state-owned bank...they’re daydreaming,” she said, adding she would not let her parents invest in more Baoshang products.

An elderly client, who did not give his name, was more sanguine.

“Under the leadership of the Party, there will be no problem. The PBOC and CBIRC all promised that the takeover won’t hurt the interests of normal people. I believe in the bank and will continue to put my money there,” he said.