CREDIT CRAZE: A significant lending binge three years ago has laid a solid foundation for China's thriving banking industry (ZHANG CHUNLEI)

The bankers may have reasons to defend themselves, but economists have raised worries over the windfall profits of banks. Chen Yongjie, Deputy Secretary General of the China Center for International Economic Exchanges, said banks' profits have been much heavier than industries, and even than the monopolized oil and tobacco sectors.

"Major reasons for the banking prosperity are massive credit expansion in recent years, widening interest margins and increasing banking fees," he said.

"The high yield of Chinese banks is not necessarily a good thing in the current environment where the real economy is slowing down sharply," said Zuo Xiaolei, chief advisor to the president of the Beijing-based China's Galaxy Securities Co. Ltd. "High profits usually carry high risks, and crisis will break out after risks accumulate and reach an unbearable level."

Zuo's concern is not unfounded. By the end of 2011, non-performing loans of Chinese banks had stood at 427.9 billion yuan ($68 billion), an increase of 20.1 billion yuan ($3.2 billion) from three months before, said the CBRC.

"Chinese banks could experience a slump in asset quality this year against a backdrop of a slowing economy, property-market correction and the challenge of refinancing sizable local government debt," said the international credit rating agency Standard & Poor's (S&P) in its latest report.

"Reasonable credit buffers, healthy interest-rate spreads and sound liquidity mean the banking sector is likely to ride out the downturn for the next couple of years at least," it said.

But a sharp economic slowdown and a jump in non-performing loans beyond their own projections could lead to rating downgrades, it warned.

The S&P projected a drop in China's new loan growth to 12-14 percent in 2012 from 15.7 percent in 2011, because of moderate deposit growth and a stringently regulated loan-to-deposit ratio of 75 percent for the lenders.

"Non-performing loans will not increase greatly in 2012," said Liao Qiang, a Beijing-based researcher at S&P. "Instead, they will go up at a gradual pace. Loans made to exporters, especially small ones, are the most likely to turn sour since they have been battered the most by the European debt crisis. Slowing exports and increasing labor costs will hamper borrowers' cash flow."

Interest worry

Soaring interest income, which reflects the difference in revenue from lending and the cost of deposits, is widely believed to be a major source of juicy profits of Chinese banks.

The interest margin is currently around 3 percent in the country, well above the average level of Western economies, said Chen with the China Center for International Economic Exchanges.

In 2011, the central bank raised the benchmark one-year deposit and lending rate three times in an effort to tame stubborn inflation, leaving the rate of demand deposits unchanged. This move reduced the banks' costs of funds as demand deposits account for nearly half of the total.

"Moreover, government protection has put banks in an advantageous position to negotiate with borrowers," said Chen. "That has helped shore up bank balance sheets, but also produced negative impacts on the real economy as commercial banks consider smaller firms to be bigger risks."

He Zhicheng, a senior analyst with the Agricultural Bank of China, said a strong bargaining power made the banks more able to bump up the lending rates and attach more strings to the loans.

"As they try to survive, many financially strained enterprises had to accept the stringent requirements," he said.

Guo Tianyong, Director of the Research Center of China's Banking Industry at the Central University of Finance and Economics, agreed.

The "big four" state-owned banks have controlled more than 70 percent of the market share, and a relatively high entry threshold has in fact reduced competition, he said.

Guo suggested China further reform the financial system and encourage more players to come in, as well as liberalize the interest rates to narrow the interest margins.