China has urged banks to increase real estate financing in the first quarter and has eased a major debt restriction for developers, indicating that officials are growing concerned about the industry's liquidity issue.

According to persons familiar with the matter, regulators told banks to increase lending to developers after at least two quarters of continuous reductions in previously undisclosed window guidance published last month. At the same time, borrowing by major real estate companies to finance mergers and acquisitions will no longer be counted toward the "three red lines" debt-limitation parameters, according to the sources.

As they aim to arrange a smooth landing after years of debt-fueled expansion, regulators are easing up on a multi-year crackdown on the nation's real estate sector. Developers such as China Evergrande Group and Kaisa Group Holdings have been defaulting on bond payments and other types of financing such as trust products, posing a serious threat to China's economic growth and social stability.

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The plan to ease funding for M&A comes as developers struggle to sell assets in order to relieve liquidity pressure. While banks are willing to issue loans for deals, developers are having difficulty reaching agreements, according to one of the sources.

"The most effective market-oriented strategy for the real estate sector to handle risks is project M&A," said Lan Zou, a People's Bank of China official. "Many stronger developers expressed a willingness to purchase distressed assets from cash-strapped peers."

Analysts estimate that the industry will need to find at least $197 billion this month to cover maturing bonds, coupons, trust products, and deferred wages to millions of migrant workers. Beijing has urged developers such as China Evergrande to meet payrolls by the end of the month to avoid social unrest.