China's banking sector will face a "more difficult environment" this year after a "stellar" 2007, due to a global economic slowdown and tighter monetary policy at home, said Charlene Chu, senior director with Fitch Ratings.

Speaking at a teleconference, Chu said that tougher state credit quotas, the stock market correction and a weaker property market will create difficulties for China's banks over 2008.

"The very strong growth last year was an outlier and we don't expect it to reoccur on the same magnitude this year, but we nevertheless expect to see a fair amount of earnings growth," Chu said.

"This year is the first time we have seen the authorities come out with publicly-announced quarterly quotas and also quotas for individual banks. We interpret this to mean that they are much more serious this year about monitoring loan growth and will step in to tighten the reins sooner than later if they need to," she said.

"As the stock market fizzles out, we also expect to see moderation in the growth in bank fee income," she added.

Furthermore, while only a "handful" of Chinese banks are exposed to subprime risk, particularly the Bank of China, there remain problems with disclosure in the sector.

"We do want to emphasize that disclosure in China about subprime exposure is quite weak and information risk is high, and we will certainly be watching for what banks are disclosing in the coming months," she said.

She also noted that property financing in China has tightened significantly, and while some developers have turned to the international market, that channel has now also "dried up" as a result of recent global financial turmoil.

"This will be a negative for Chinese banks asset quality," she said. "The exposure (of banks) to property lending... amounts to about one quarter on average, half split between mortgages and construction and development. There is also a fair amount of indirect exposure being recorded as something else."

While asset quality has improved markedly among China's banks in recent years, Fitch remains cautious, Chu said.

"There has certainly been a noteworthy improvement in asset quality in recent years but we tend to remain very cautious. We believe that these are the best of times, and during the best of times a lot of things don't show up as being as risky as they really are. In addition, there are still issues with data and with loss assumptions in reserve calculations.

"As always we remain focused on the portfolio of special mention loans which for banks under our coverage remains upward of twice the size of non-performing loans. Were a substantial share of those loans to go bad, Chinese banks would certainly find themselves under-reserved."