Industrial and Commercial Bank of China is set to become the first public-sector Chinese bank to securitise its bad loans.

The initiative is the most serious indication yet that the banks plan to clean up their strained balance sheets.

ICBC, China's biggest bank, is to pioneer a new way of reducing the bad loans weighing down China's state banks by issuing domestic bonds backed by Rmb3bn ($360m) of non-performing assets. This loan securitisation could herald radical changes in the way the big four state-owned institutions - China Construction Bank, Bank of China, Agricultural Bank and ICBC - dispose of non-performing loans estimated at $350bn-$750bn.

Chinese regulators must approve the action. The problem of NPLs threatens to undermine the banking system.

A clean-up of the banks' balance sheets is a precondition of their privatisation. Up to $6bn of NPLs are expected to be auctioned off in the next few months.

So far, banks and their associated asset management companies have disposed of NPLs by selling them at a fraction of their face value to foreign investors.

Under the ICBC plan, the bank would issue bonds backed by a portfolio of NPLs from its branch in Ningbo in south-east China.

The interest on the bond would be paid with the income from the recovery of the loans, which have a face value of up to Rmb3bn.

In past NPL auctions loans have been sold at between 9 and 20 per cent of face value.

The bonds would be offered only to Chinese companies and investors. Banks and insurance companies would not be allowed to buy them.

The ICBC deal was concluded last week, during a trip to China by John Mack, CSFB's chief executive. He said the securitisation would "break new ground" in the NPL sector.

"We know that the non-performing loan issue is a key one for China's banks. China's companies and its government are seeking innovative solutions to tackle this issue," he said.

According to CSFB, securitisation is preferable to an outright sale because it would enable Chinese banks to retain some of the income from the recovery of loans. Under the ICBC plan, the would will keep any income it recovered over and above what was needed to pay the bond's interest and principal.

According to Paul Calello, CSFB's Asia-Pacific chief executive, this should spur the banks to redouble their efforts to recover their bad loans.

"This deal could be the beginning of a new wave for these types of transaction," he said. The Ningbo branch portfolio is only a small part of ICBC's bad loans. NPLs in the nine months to September accounted for 21 per cent of its total loans, down 4.3 percentage points from the same period last year.

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