Foreign banks operating in China now see their Chinese competitors as their biggest challenge, said PricewaterhouseCoopers (PwC) in a report based on a poll of 42 foreign banks.

The foreign banks now see their domestic counterparts as formidable competitors. With their extensive branch networks and rising service expertise, Chinese lenders are much better placed to fend off competition from foreign banks, said Raymond Yung, Financial Services Leader for PwC China.

In areas such as wealth management, bank cards and Internet banking, domestic banks are continually "lifting their games," forcing foreign banks to compete based on a superior level of service, he said.

Despite the challenge, foreign banks continue to stake their futures in China. "They have been working hard in the last year to expand their reach across China. Many are now opting for local incorporation, and those who have are opening new branches," said William Yung, Financial Services Advisory Partner of PwC China.

Inorganic growth is also an area of focus, with the banks looking to make investments in areas such as asset management, private equity firms and trust and securities companies, he said.

The survey also revealed foreign banks expected a 10-20 percent increase of annual revenue in 2010.