China's banks raked in a combined after-tax net profit of 899.1 billion yuan ($137 billion) last year, soaring 34.5 percent from a year earlier, the fastest pace in three years, said the China Banking Regulatory Commission (CBRC).

The net interest margin contributed 66 percent to the profit while the rest came from investment gains and fees and commissions.

Asset quality continued to improve, as the ratio of non-performing loans stood at 2.4 percent at the end of 2010, compared with 3.29 percent in 2009.

The CBRC struck a note of caution, citing risks that may arise from financing vehicles of local governments and bubbling property markets.

Meanwhile, liquidity strains are hassling some banks as the central bank tightens its monetary stance to keep serious inflation at bay, said the CBRC.

In a recent report, the international credit rating agency Moody's Investors Service said the outlook for China's banking system is stable for the next 12 to 18 months, as the domestic economy remains strong and provides banks with ongoing opportunities to generate strong earnings.

The key issue facing the banking system is the extent to which credit expansion can slow to a sustainable level that checks inflationary pressures, while simultaneously accommodating the government's 7-percent real GDP growth target from 2011 to 2015, it said.

"We expect a rise in banks' non-performing loans, which typically follow in the wake of very strong loan growth," said Yvonne Zhang, a senior analyst of Moody's. "Robust earnings, significant loan loss reserves and additional capital raised from the capital markets will help the banks tackle challenges in asset quality and continue improving their balance sheets."