"While the transformation of bank financials is undoubtedly positive, deeper, more difficult reforms of overall credit culture, risk management, and corporate governance remain in the very early stages," said Charlene Chu, a Fitch analyst, in a report. "The risk of a subsequent deterioration remains quite high."

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China has been prompting its largest lenders to transform into joint-stock ventures, attract strategic investors and list shares publicly as part of bids to counter looming rivalry from overseas players.

The central government has poured billions of yuan into state-owned lenders before their initial public offerings to clear up bad debts as well as urging institutional buying of banking issues.

The country started this month to deregulate its retail banking sector to foreign lenders, allowing them to take yuan-denominated deposits from local citizens and issue credit cards.

"The impetus for most reforms has been externally - rather than internally - driven," said the report. "A number of recent trends also prove to be increasingly challenging next year, including intensifying competition from foreign banks, ever-increasing liquidity, and emergent disintermediation."

China's central bank is striving to mop up funds from its monetary system, strained by a mounting trade surplus, in an effort to reduce liquidity available for investments.

Analysts expect the tightening move, along with a recovering stock market that could siphon out bank deposits, may hurt banks' ability to expand and dampen earning.

Despite highlighting the problems, Fitch said it has witnessed progress over the years in Chinese banks' risk-management systems which have seen a greater centralization of loan-approval authority.

"We consider the effort to centralize credit decisions to be one of the most encouraging developments," said Chu in his report.

"It takes direct aim at breaking the political influence over lending at the branch level and permits more comprehensive monitoring and management of institutions' risks."

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