The man-made rates gap became the major source of profits for state-backed banks. The reform has bridged the gap, but not as much as people anticipated, said Zhao Qingming, a researcher with CCB.

"Credit remains a rare resource, and banks have strong bargaining power, so the rates gap remains wide." he noted.

Zhao played down the bad loan risks, believing that bank assets are still expanding.

Bad loans mainly rose in eastern China's Jiangsu and Zhejiang provinces. Those in Shandong and Fujian provinces can not be taken lightly.

In terms of industry, manufacturing, wholesale and retail sectors saw the most increase of bad loans. Small business are also included.

In the second half of the year, insiders estimate profits will continue to slow, with profits of listed-banks easing to about eight percent.

The macro-economy has shown stabilizing signs, and third quarter data is not expected to be worse than the second. The annual profits of listed banks are likely to increase between 10-15 percent, Zhao Qingming said.

Zhao Xijun, professor of finance at China Renmin University, said as the government will step up efforts to eliminate outdated industries in the second half of this year, sectors on the reshuffling list will suffer more bad loans.

Analysts said China's banks may be about to enter a rocky period, and must improve to cope with the changes.

Last Monday, the central bank governor Zhou Xiaochuan said the bank is ready to liberalize deposit rates and the reform is underway as planned. He is personally optimistic.

Scrapping the floor of the deposit rates is regarded as the most critical yet most risky move in interest rate liberalization. If realized, banks will no longer sit on the rates gap to pocket handsome returns.