China's efforts to clean up the balance sheets of its big four banks have been slow and have failed to eliminate financial risks for the state-owned lenders, Moody's warned on Wednesday.

The credit rating agency said China's four "asset management companies" (AMCs) have found it difficult to dispose of the RMB1,400b (US$169b) of bad loans they took over from the banks in 1999.

A sell-off of the estimated US$350bn-750bn of non-perfoming loans (NPLs) made by the big four banks - China Construction Bank, Industrial and Commercial Bank, Agricultural Bank and Bank of China - is crucial to the country's financial stability.

"The performance of the AMCs has been uneven, while an illiquid market and a slow bureaucracy have further hampered the resolution process," Moody's said in a report.

The agency estimates the AMCs have resolved some RMB300bn of bad loans. With a further RMB400bn having been converted into equity, the AMCs still have to dispose of half of their NPLs allocation after four years of activity.

Moody's comments come as the Chinese authorities are split over whether to have a direct bail-out of the banks or transfer more of their bad loans to the AMCs.

The agency said further transfers of non-performing assets "need to be conducted with care" as they could stoke up future risks for the banks.

According to the report, the interest received by the banks on the bonds issued by the AMCs - Cinda, Huarong, Great Wall and Orient - in return for the NPLs will not bolster their balance sheet. This is because the banks have to keep the interest as a provision against the possibility the AMCs would be unable to repay the bonds when they mature in 2009.

Moody's said it was likely the AMCs would be unable to repay the bond's principal in full, leaving the state-owned banks to foot the bill.

"Consequently ... the credit risks - which were first thought to have been isolated from the originating banks - are now creeping back to their starting points," Moody's said.

The disposal of NPLs has been made difficult by the fact that foreign investors have so far been interested in only a small portion of them. In the two most recent transactions, Morgan Stanley bought NPLs worth RMB10.8bn and a Goldman Sachs-led consortium bought assets with a face value of RMB1.97b.

In order to speed up the clearance of the NPLs, Industrial and Commercial Bank of China, advised by Credit Suisse First Boston, is considering issuing a bond backed by RMB3b of non-performing assets.

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