China’s banks have done their national service. Now they are paying for it. Although their non-performing loan ratios look to be under control at an average 0.9 per cent, asset quality is in fact still deteriorating. Under China’s enigmatic loan classification system, delinquent loans were up 80 per cent at Shanghai Pudong Development Bankin the first half; up almost two-thirds at Minsheng Bank. Rolling over local government debt means that this problem will get worse.

There is little the banks can do to offset this trend. The economic slowdown has flattened loan demand – tough when net interest income accounts for three quarters of bank revenues. The days of guaranteed healthy interest margins are also disappearing.

Long overdue interest rate liberalisation, which started when the central bank cut interest rates in June, will squeeze lenders’ net interest margin further. It already slipped almost 20 basis points at China Merchants Bankin the second quarter of 2012.