[BEIJING] China's Big Four state-run banks this week are set to report annual earnings growth that likely flat-lined after around a decade of terrific profitability, as a surge in soured loans continued unabated while economic expansion weakened.

Profit growth has slowed in recent years while the sector tackles its greatest challenge since the global financial crisis, with bad loans at a 10 year high while funds set aside to cover the losses fall close to regulatory limits.

While banks ramped up lending during a government stimulus drive during the meltdown, much of that lending went to industries where rapid expansion developed into over-supply as economic growth tapered, raising the risk of default and dragging on profits.

For 2015, analysts estimate net profit at the Big Four to range from 1 per cent growth to 1 per cent decline, showed Reuters calculations based on data from Starmine SmartEstimate.

Bank of Communications Co Ltd , China's fifth-biggest lender, reports earnings on Tuesday, followed on Wednesday by Industrial and Commercial Bank of China Ltd (ICBC) and Bank of China Ltd (BOC) .

China Construction Bank Corp and Agricultural Bank of China Ltd report on Thursday.

Fitch Ratings, in a research note on March 22, said banks are likely to announce "continued subdued earnings growth amid margin compression and asset deterioration." Six cuts in the central bank's benchmark interest rate over 17 months has narrowed lenders' net interest margins - or the difference between interest earned on loans and funds extended. Analysts expect slow economic growth and reforms to prompt more cuts.

Non-performing loans (NPLs) reached a 10 year high of 1.27 trillion yuan (US$195 billion) last year, or 1.67 per cent of all loans outstanding as of December, showed data from the China Banking Regulatory Commission.

However, analysts said some banks appear to be delaying recognising some loans as soured. The potential real bad loan ratio may be 8 per cent to 9 per cent, banking analyst Li Nan at Beijing Gao Hua Securities wrote in a recent report.

Hinting at the extent of the problem, the regulator has issued a series of notices in recent weeks highlighting the risk of debt extended to industries suffering over-capacity, and advising banks to quickly dispense of bad loans.

The central bank is also preparing to let banks accept debt-for-equity swaps to lower leverage in the corporate sector.

Last week, shareholders of shipbuilder-turned-oil explorer China Huarong Energy Co Ltd voted overwhelmingly in favour to swap US$2.7 billion in debt for equity, in what would be a test case for the new policy. "This is a way to avoid an explosion of non-performing loans," said a senior Big Four banker, who was not authorised to speak publicly on the matter and so declined to be identified. "When a loan is converted to equity, it increases efficiency, (by) taking it off the balance sheet."

Chinese banks are required to set aside funds equivalent to at least 150 per cent of bad loans to cover losses. That loan loss provision for the sector as a whole was 181 per cent at the end of last year. But, at September-end, it was as low as 153.7 per cent at BOC and 157.6 per cent at ICBC.

Banks have been lobbying for a lower minimum provision ratio to free up funds. "Everyone knows banks are having a tough time. But there is also an easy way to boost profits immediately - lowering provisioning requirements," said a Big Four banker.

Seven lenders may have received permission to lower loan loss provision ratios, financial magazine Caixin reported last week citing unidentified sources.

REUTERS