The annual reports by local authorities last week, which expect slower revenue growth and a possible rise in debt to finance China's urbanization initiatives, are credit negative, Moody's Investors Service said in a report on Monday.

"Taking on more debt would add to their already high indebtedness through the activities of their financing conduits, local government financing vehicles," the ratings agency said.

"The reports are also credit negative for Chinese banks because more debt at already debt-laden financing vehicles would deteriorate the asset quality of banks' loan portfolios," the agency said.

The growing pace of local governments' fiscal revenues remains solid, with budgetary revenues growing 16.2 percent nationwide in 2012. However, the figure is down sharply from the 29.1 percent growth recorded in 2011, and is likely to drop further this year.

However, local authorities report rising expenditures related to the growing demand for services and infrastructure in rapidly growing urban centers.

The Chinese National Audit Office reported that RLG-related debt reached 10.7 trillion yuan ($1.72 trillion) in 2010 fueled by borrowing for economic stimulus during the global financial crisis. This debt grew by 300 million yuan, or 2.8 percent, in 2011.

Chinese banks' asset quality will also be negatively affected by increasing local debt, Moody's said, adding that weaker local government revenue implies less ability to support financing vehicles, and undermines the asset quality of banks' current loan portfolio.