Chinese banks' reserves for soured loans fell to its lowest level in three years, which could slow down profits as they are forced to set aside higher levels as protection for rising bad debts, Bloomberg reported.

As of June 30, Chinese banks' capital for bad loans stood at 262.9%, lower than the first quarter's level of 273.7, the China Banking Regulatory Commission (CBRC) said in a statement today.

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Bloomberg reported that nonperforming loans have been on the rise for almost three years and have reached 694.4 billion yuan (US$113 billion) but only account for a percent of total loans.

It added that China's top banks will likely see an end to its double-digit profit growth as competition for deposits tighten with the interest rate deregulation and the economy weakens.

Analysts also see bad loans rising due to the softening property market that have also hit other businesses and the government's efforts to rein in shadow banking.

"China needs another two to three years to clean up weak loan portfolios," Jim Antos, a Hong Kong-based analyst at Mizuho Securities Asia, told Bloomberg. He added that China is already in a period of "severe credit shock" despite the low levels of non-performing loans.

Last month, CBRC Chairman Shang Fulin called on China's banks to raise capital for bad debts and increase write-offs. Chinese banks are mandated to set aside at least 150% of the value of soured debt or 2.5 percent of total credit, whichever is higher.

Bad debts inched up to 1.08% of total loans in June from 1.04% in March, CBRC data showed. However, special-mention loans, those already overdue but have yet to be classified as non-performing, spiked up to 5.4% from 1.6% three months earlier.

Bloomberg pointed out that in the eastern province of Shandong, where there is an ongoing state investigation into a suspected loan fraud at Qingdao port, nonperforming loans surged 26%, according to CBRC figures released July 21. The province's five biggest banks recorded a 6% slide in profit, according to the regulator.

Bloomberg added that Chinese firms had the most debt globally, with total loans reaching US$14.2 trillion as of Dec. 31, larger than that of the U.S. which stood at US$13.1 trillion, according to debt watcher Standard & Poor's June 15 report. 

TagsChina Banks, Bad loan buffers, China Banking Regulatory Commission