It is an incontrovertible fact that all banks in China are facing surging credit demand, which has made the People's Bank of China and the State Council give repeated orders to banks to strictly control their new loan issuance.

International credit rating agency Standard & Poor's (SP) released a research report that warns of the speedy growth of credit increasingly weakening China's banking sector.

SP Greater China financial service rating director Ryan Tsang stated that although Chinese banks largely use commercial principles in their banking operations, their unsound credit and risk management systems and practices will plunge the banks into severe shocks in case of sharp changes in the economic environment since industrial and commercial enterprises are too heavily indebted to the banking sector. Should economic growth slow down and corporate profit margins shrink, it would be a huge challenge to collect these loans.

SP observed that if China witnesses a rapid rise in its interest rates or accelerating appreciation of its currency, the banking system that relies on credit revenue will undergo tremendous pressure. SP's pressure test shows that in the case of the RMB appreciating by 25% and interest rate rises 2 percentage points, the net profits of Chinese firms are likely to drop 34% and the banking sector will see a 9-percentage-point increase in its bad loan ratio, namely more than 1.7 trillion Yuan (US$212.5 billion) of bad debt, if no countermeasures are taken.

SP admits on the other hand this situation is not likely to happen. Nonetheless China's banking sector should indeed improve its capability rapidly and develop relevant products to handle such risks.