Bank of China (601988.SH) , the nation's fourth-largest bank by market value, on Wednesday posted a higher-than-expected 28 percent rise in first-half net profit thanks to loan growth as well as hefty non-interest income from commissions and fees.

The results reflect attempts by Bank of China and its larger rivals to rely less on vanilla lending, which is under pressure as the government tightens availability of capital to tame inflation, and to boost revenue from businesses such as wealth management, investment banking and credit cards.

Net interest income and interest margin -- the bulk of Chinese banks' profits -- were both up.

"The net interest margin has improved, as has the potential to widen," Bank of China President Li Lihui said at a news conference.

The Chinese government has been trying for months to squeeze capital out of the financial system by increasing required capital reserves as well as raising interest rates.

The bank also said it has carried out an investigation into loans by local government financing vehicles, which are companies set up by city and provincial governments around the country to borrow money to fund infrastructure projects.

Concerns are growing that the vigorous lending under the country's stimulus plan of 2008 and 2009 could lead to a pile of bad loans to LGFVs.

Bank of China has reserves specifically for LGFV loans of 3.6 percent of the local government loans. The central government is phasing in a rule under which all banks must have total reserves to total loans of 2.5 percent.

"What these guys have done, and it's very prudent, instead of 2.5 percent reserves to local government loans, they've got 3.86 percent," said James Antos, banking analyst with Mizuho Securities. "That's pretty good. That's what all banks in China should be doing, but they're not."

In fact 90 percent of Bank of China's local government loans are covered by cash flow and provisions, Li said.

Banks' loan books remain robust, and banks are rebalancing their revenue streams to earn more from non-interest income.

Fee growth was 23 percent, as increasingly wealthy Chinese flock to their banks for an ever-competitive array of financial management goods and services such as asset management and credit cards.

RESULTS BEAT EXPECTATIONS

Bank of China, the country's biggest foreign-exchange bank, recorded a 66.51 billion yuan net profit for the January-June period, up 28 percent from 52 billion yuan a year earlier. That beat the estimated earnings of 64.4 billion yuan according to nine analysts surveyed by Reuters.

Net interest income for the half-year was 110.2 billion yuan, up 20 percent from a year earlier. Net interest margin clocked in at 2.11 percent, vs. 2.04 percent in the first half of last year.

"The Bank of China's interest margin is relatively weak, because a relatively large proportion is foreign currency," said Xiao Li, a banking industry analyst for China Merchants Bank.

The Bank of China is the country's largest foreign-exchange bank, and has a wider network of overseas branches than any other Chinese lender.

Non-performing loans stood at 1 percent, compared with 1.20 percent in the year-earlier half.

"In the future, you will see our new loans increasing slightly, but only slightly, and we are still quite confident about the future trend for non-performing loans," Li said.

"In this very excellent range, it will sometimes increase, sometimes decrease -- this is a normal situation," he said.

The steady stream of tightening of capital since last year has soured investors on Chinese bank stocks. Bank of China shares, which have fallen some 32 percent since April, closed at HK$3.01 on Wednesday, before the earnings were announced.

Shares in China Construction Bank, the world's No.2 bank by market cap, have also declined around 30 percent since April.

But the bank, which reported a 31 percent rise in first-half profit on Sunday, dismissed concerns on Monday about rising bad debts, saying its loans to local government financing vehicles amounted to only 10 percent of its overall lending, and carried a non-performing loan ratio of about 1.1 percent. (Additional reporting by Kelvin Soh, Xie Heng and Beijing newsroom; Editing by Ken Wills and David Cowell)