BEIJING - China's commercial banks have been very profitable, despite a slowed economy in the first three quarters of 2012. However, their heavy reliance on net interest income may prove challenging in a time of gradual interest liberalization.

The five largest banks - Industrial and Commercial Bank of China, Agricultural Bank of China, Bank of China, China Construction Bank and Bank of Communications - saw combined profits of 614.75 billion yuan in the first three quarters. All of the banks saw their profits rise by 10 to 20 percent during the period.

Eight joint stock banks, all mid-sized lenders, lagged far behind their bigger rivals in absolute numbers, but outperformed them in terms of growth.

The eight banks posted combined profits of 181.7 billion yuan, registering a 29-percent jump year-on-year.

The difference in profit growth was consistent with findings by KPMG - one of the "Big Four" international professional firms - at the end of September.

"There was substantial variance in profit growth rates between different banks in China: the big five commercial banks and joint stock banks," KPMG said in a report sent to Xinhua.

However, the overall growth rate for Chinese banks has apparently been slower. An unflattering macroeconomic environment has been blamed, with China's economic growth for the first three quarters consistently edging lower.

The third quarter saw the gross domestic product expanding at an annual rate of 7.4 percent, the lowest in 14 quarters.

"The fact that the banks' overall profit growth has narrowed is in line with market expectations, given the slowing economy," said Professor Zhao Xijun, a finance professor at Renmin University.

Loan quality may also suffer as a result of the slowing economy, Prof Zhao said.

Nine out of sixteen listed banks are now witnessing greater non-performing loans, both in value and in proportion.

The most cited case has been Ping'An Bank, a Shenzhen-based lender controlled by Ping'An Insurance. Its NPLs have increased by 2.36 billion yuan, rising 71.69 percent, since the beginning of this year .

"There is increasing evidence of risks passing through the real economy to the virtual economy, although they have largely remained mild," Prof. Zhao said.

Challenges ahead

The main concern is the banks' heavy reliance on net interest income and stagnating revenues generated from other lines of business, as a gradual path toward interest liberalization has become clearer.

Net interest income, or revenues from borrowers minus interest paid to depositors, is generally four times the income made on commission charges across the four major state banks (ICBC, ABC, BOC and CCB).

ICBC brought in 311.37 billion yuan in net interest in the first three quarters, while income from fee-based services and commissions amounted to 79.69 billion yuan.

At China Everbright Bank, net interest accounted for 85.47 percent of its nine-month business revenues.

In addition, net interest income has been climbing fast, while non-interest income has increased slowly or even declined in some cases.

ICBC saw its net interest income for the first three quarters rise 16.6 percent year on year, while fees were up just 1.8 percent. At BOC, net interest growth was 13.2 percent, versus a drop of 1.8 percent in commission charges.

The People's Bank of China, the central bank, has twice widened the range against which Chinese banks can benchmark their lending rates this year, which many have taken as a sign of a liberalized interest regime.

"It was a very significant step toward the marketization of interest rates," said David Daokui Li, a prominent Chinese economist and former member of the central bank's Monetary Policy Committee.

"Allowing banks greater flexibility in setting rates will narrow their net interest margin, as they will need to offer more competitive rates on their broad deposits and loans," said Bin Hu, vice president in charge of financial institutions at Hong Kong-based rating agency Moody's.

"In addition, challenges will emerge in liquidity management, as the broad liberalization of interest rates could encourage depositors to seek greater yields and permanently introduce market-driven volatility into the entire funding structure," Hu said.

Banks have reacted by looking to new channels for revenue.

"The reason we have put so much emphasis on private banking, wealth management and other services is the emerging outlook of interest liberalization," said Ding Wei, vice president of China Merchants Bank.