The dual role of turning a profit and contributing to economic stability is bringing high risks to banks.

China’s banking industry was thrown into a dilemma when the central bank cut interest rates five times over the last three months of 2008. This unusual move was likely a signal that banks should help stimulate domestic consumption and GDP growth.

The China Banking Regulatory Commission (CBRC) warned of increased pressure on banks’ earnings in 2009, arising from narrowing interest rate spreads, shrinking income from intermediary businesses and higher risks in overseas investment.

Policymakers have set the tone for 2009. The State Council announced on Dec 15, 2008 a target of 16 percent growth in bank loans to 4.8 trillion yuan in 2009. Expanding credit at such a rate is expected to help stabilize the economy through recovery of investment and production.

The banking regulator announced on Jan 10, 2009 that it would encourage domestic commercial banks to grant more loans to small- and medium-sized enterprises (SME) and businesses related to individual consumption to promote domestic economic growth. It also allowed more room for commercial banks to restructure their overdue bad loans in balance sheets.

The country’s leading banks are answering the government’s call for action. China Construction Bank, the country’s second-largest commercial lender by assets, said it will extend 400 billion to 500 billion yuan in new loans in 2009, an increase of 13 percent to 15 percent on last year’s levels and about half of the loans will go to infrastructure projects.

Bank of China, the country’s fourth-largest bank, will support the government’s fiscal stimulus plan by extending at least 300 billion yuan in loans for major infrastructure projects.

As an additional safeguard against a possible increase in risks stemming from an unexpectedly steep economic decline, CBRC has further raised the 2009 target for risk control on commercial banks. The average provision coverage ratio is now no less than 130 percent and the capital adequacy ratio is above 8 percent.

But risks accumulate when bank loans grow at such a high speed. The problems might be solved by issuing special treasury bonds or divesting non-performing assets but bad loans caused by unreasonable capital allocation will remain risky for the future.