THE problem of bad loans at Chinese banks may worsen this year as heavy lending to local governments in 2008 comes due, Deloitte Touche Tohmatsu CPA Ltd said.

In a wide-ranging report on the China banking industry issued yesterday, Deloitte said the non-performing loan ratio may increase but they pose no great risk to the system. It also said foreign banks, though still small players, are helping provide the framework for a modern banking system.

On bad loans, Deloitte noted data from a National Audit Office report last June which showed that 80 percent of local government debt is in the form of bank loans.

Loans to local governments have been particularly worrying amid reports that some of them may have borrowed too much and may have trouble repaying debt.

About half of the 10.7 trillion yuan (US$1.69 trillion yuan) of loans issued to local governments in 2008 come due between 2011 and 2013, Deloitte said. Moody's Investors Service last year estimated that between 8 percent and 12 percent of loans to local governments may become non-performing.

In their fourth quarter earnings report, China's big five banks - the Industrial and Commercial Bank of China, the China Construction Bank, Agricultural Bank of China, the Bank of China and Bank of Communications - reported aggregate NPL balance of 316.6 billion yuan, or an average 1.09 percent NPL of all lending. The outstanding balance rose 9.29 billion yuan from the third quarter.

The Deloitte report also said foreign banks in China have become an integral part of the sector. At the start of the fourth quarter, there were 39 incorporated foreign banks with 247 branches and subsidiaries, 93 foreign bank branches and 207 representative offices in China.

The assets of foreign banks in China last September grew 18.3 percent from a year earlier to 2.06 trillion yuan, accounting for 2 percent of the banking system. The net profit of foreign banks comprised 1 percent of the industry total.