Bank shares fell more than 2 percent on Thursday, with Industrial and Commercial Bank of China down 2 percent and Bank of Communications losing 2.7 percent.
"This was mainly due to a technical correction, but there's also investor uncertainty over how those non-performing assets would be valued, and disposed of eventually," said Wu at Shanshan Finance.
The sources said the new regulations would get special approval from the State Council, China's cabinet-equivalent body, thus skirting the need to revise commercial bank law, which bars banks from investing in non-financial institutions.
Previously, Chinese commercial banks usually dealt with NPLs by selling them at a discount to state-designated asset management companies which, in turn, would try to recover the debt or re-sell at a profit to distressed debt investors.
The sources had no further detail on how banks would value the new equity stakes, which would represent assets on their balance sheets, or what ratio or amount of NPLs they would be able to convert this way.
On paper, the move would also represent a way for indebted companies to reduce their leverage, cutting the cost of servicing debt and making them more worthy of fresh credit.
Beijing has prioritized the closure of so-called "zombie" firms responsible for much of China's corporate debt overhang, and has taken aim at overcapacity in industries such as steel and coal.
Lai Xiaomin, chairman of China Huarong Asset Management, the country's biggest bad debt manager, said he had no direct knowledge of the move, but would welcome such debt-to-equity swaps.