The fat years may be ending for Chinese banks as bad loans increase and monetary policy tightens.

After government bail-outs and reforms ended a debt crisis early this decade, bad loans could rebound because of exposure to the country's red-hot property market. But a debacle on the scale of the U.S. subprime credit crisis remains very unlikely, officials and analysts say.

The good days for China's banks are about to end, said Qiu Zhicheng, analyst at Haitong Securities in Shanghai.

China's economy is near the peak of its cycle and growth is slowing down. Banks, the biggest beneficiary of this round of the economic boom, will start to suffer.

While strong profit growth could be crimped by tighter economic policy, Chinese banks and their share prices will probably continue to outperform lenders in most developed economies which are much more vulnerable to the global credit squeeze.

But regulators are pressing banks to cut loan growth, and the central government announced on Wednesday it was shifting to tight monetary policy after a decade of prudent policy.

Some banks have already begun to suffer from bad loans in the second half of this year, official data shows.

Outstanding non-performing property loans at Guangdong Development Bank, in which Citigroup Inc. has a major stake, rose by 1.05 billion yuan ($142 million) between the start of 2007 and October, according to the transcript of a speech by Liu Mingkang, chairman of the China Banking Regulatory Commission

(CBRC), China's top banking watchdog.

As a result, Liu said he had put Guangdong Development Bank on an internal list of about 10 Chinese banks which were ordered not to extend new loans before the end of 2007. These banks may receive further guidelines to restrict loan expansion in 2008.

Property prices are continually reaching new highs because more people who earn money from the stock market are investing in the property market, Liu said in the closed-door speech made to senior Chinese bankers and local regulators in late October.

A rapid increase of asset prices will add overall risk to the national financial system, and create considerable credit risk in the banking sector, he said.


A slight slowdown in the overall economy next year may also sour some loans in overheated sectors such as steel and cement.

China's economy might slow considerably in the next year, in which case the banking industry would bear the brunt and bad loans would rise sharply, says Lin Yan, a Fitch Ratings analyst in Beijing.

The non-performing loan ratio of major Chinese banks now averages 5 to 6 percent, compared to over 20 percent before 2003, when Beijing began to use its foreign exchange reserves to bail out institutions such as Bank of China and China Construction Bank.

Some analysts estimate the ratio may rise by 1 or 2 percentage points next year, especially if the government's efforts to curb the property market misfire. Authorities are using taxes and administrative steps to try to cool the market gradually, but there is the risk of a sudden pull-back of prices.

Higher provisions for bad loans could squeeze bank profits even as slower expansion of lending hits growth.

However, Lian Ping, chief economist at Bank of Communications, predicts major Chinese banks will still enjoy net profit growth of about 50 percent next year, after an estimated 70 percent this year.

Other analysts, such as Li Shanshan at Merchants Securities, forecast 30-40 percent profit growth next year as the economy continues to grow rapidly, though perhaps more slowly than this year's 11 percent pace.

That should prevent any collapse of the banks' share prices, which have already pulled back in the past two months. The biggest bank, Industrial & Commercial Bank of China, was at 8.36 yuan on Thursday morning, up 35 percent from the start of 2007 but down 7 percent from its peak.

At 35 times this year's projected earnings, ICBC is more than twice as expensive as many big foreign banks, but its long-term potential to profit from the China's boom may help it sustain a big premium.

Banks were told by CBRC this year to limit their lending growth to 13 percent, commercial bankers say. While most banks far exceeded that target, the regulator has in the past few months become more serious about enforcing it, and it may set an even lower quota next year.

Authorities may drive home that point by further limiting banks' access to fresh money. HSBC and Lehman Brothers predicted in separate research reports on Thursday that the reserve ratio for big banks would be raised to 17 percent by the end of 2008 from the current record level of 13.5 percent.

We expect loan growth to slow down next year, so we have to find alternative ways to keep our profit growth up, says Qian Wenhui, vice president at Bank of Communications, partly owned by HSBC Holdings Plc.

We will focus on fee income-based services such as credit card, fund distribution and wealth management next year, as such businesses do not need to rely on a credit quota.