SHANGHAI -- Private Chinese firms are braced for another wave of funding difficulties as banks hoard cash to meet regulatory requirements at the end of the year.

At least 40 textile companies in east China's Jiangsu and Zhejiang provinces have disappeared in the past six months, most likely the result of failure to secure funding for their debts, an official with the China National Textile and Apparel Council told Xinhua in a recent interview.

The official added that another large textile firm went under earlier this month, leaving behind 600 million yuan in outstanding debt.

"Most of these textile firms ask each other to guarantee loan repayments. If one of them goes under, it will take everybody else down as well," ?said a textile business owner in Zhejiang.

With gross margin for most small and medium firms between three and five percent, funds in the banking system tend to chase higher returns, said Zhou Dewen, Chairman of the Wenzhou SME Development Association. This leaves small firms with no choice but to seek credit from informal lenders at higher interest rates. The rates charged by these lenders, some of which are exorbitant, make it almost impossible for firms to repay the loans.

The latest cash squeeze comes as the People's Bank of China (PBoC), the central bank, said the banking system has excess cash reserves of 1.5 trillion yuan.

Small and medium banks are the major lenders to private business, but they are not as competent in attracting household deposits as the large state lenders. Much of their funds come from interbank market, where banks lend to each other in the short term.

The sudden rise in the cost of interbank funds over the past week underscores the difficulties for banks at the end of the year.

It is small firms who suffer the collateral damage of the cash crunch.

"It is even hard to rollover existing loans in the second half this year, let alone getting new loans!" ?said Jiang Mingguang, who runs an engineering firm in east China's Zhejiang Province, with an annual turnover of 20 million yuan.

Research by global credit rating agency Moody's, found that total borrowing in the Chinese mainland's non-financial private sector in the fiscal year that ended in October, is likely to equal 180 percent of the whole national economic output in the same period. The scramble for cash by highly leveraged firms to repay loans will become more frequent in the near future.

The rising amounts banks charge each other to meet short-term obligations is reminiscent of a similar cash squeeze in June. The overnight rate back then topped 30 percent at one point as the central bank suddenly decided to turn a stern face toward banks' pleas for liquidity.

The turbulence eventually scared the PBoC into action in June, much like the spike, if it is a spike, which has forced the central bank to intervene this time around. PBoC pumped 29 billion yuan into the system through Tuesday's seven-day repo auction. Money rates have since started to decline, with one benchmark rate settling at 5.08 percent on Friday.

"Regulatory requirements, increased corporate spending and the maturity of debt instruments have all added pressure to the interbank market" , said Hu Bin, a senior analyst with Moody's.

Interbank lending traders say it is normal for funding costs to rise at the end of a year as banks usually need more cash to meet regulatory requirements and roll over debts.

This demand could drive the rate up to 5 percent for seven-day repo, a key gauge of interbank liquidity, and a further rise would indicate other factors at play. The rate hit nearly 9 percent at the beginning of the week and the central bank said late last week that it had pumped 300 billion of cash into the system

Analysts say much of the spike is fueled by the shadow banking system, an important device for banks to work around regulatory mandates and extend credit they do not want to show up on their balance sheet.

PBoC has a long love-hate relationship with shadow banking. Banks have worked with trust companies to raise money through wealth management products (WMP) by promising a better return than that which accrues on bank deposits. This amounts to a bottom-up interest rate liberalization and is a boon for households with few options for investing savings.

Most of the money raised in the interbank market, analysts say, has gone to repay customers who purchased WMPs.

Average return on such products has gone beyond five percent, with some already edging toward 10 percent, as cash strapped banks go all out for funds.

The PBoC is equally displeased that much of the money raised through WMP goes to sectors struggling with overcapacity, property developers and local government financing.

Lending to such entities is either tightly controlled or restricted in the formal banking sector and since banks mask such loans as lending to each other in the interbank market, it does not appear on the balance sheet and thus creating unfathomable risks of defaults.

Lin Cai, senior economist with Guotai Junan Securities, said the frequent cash crunches have spooked investors and this speaks to banks' ?lousy record of managing liquidity.

"A liberalized interest rate, and an optimized credit structure are what it takes to address the liquidity squeeze at its core." ?Lin said.