China’s banks posted their fastest profit growth in at least four years for 2011 as income from loans and fee-based financial services outpaced an increase in defaults triggered by a slowing economy.

Financial institutions in China including policy banks, commercial lenders, rural credit cooperatives and foreign banks, earned a combined net income of 1.25 trillion yuan ($198 billion) last year, a gain of 39 percent from a year earlier, the China Banking Regulatory Commission said in its annual report today.

Shares of China’s eight largest commercial banks have rallied an average 54 percent since a 2 1/2-year low in October as concern that Europe’s debt crisis would deepen the economic slowdown eased. The Asian nation’s efforts to bolster banks’ risk buffers and curb inflation have pushed up funding costs, weakened the property market and spurred defaults.

China’s economy expanded 9.2 percent last year after growing 10.4 percent in 2010.

Chinese lenders advanced 7.47 trillion yuan of new loans last year, 6 percent less than the amount offered in 2010. Banks need to keep appropriate credit growth in 2012 and boost lending to smaller enterprises and key infrastructure projects, the regulator said today.

The nation’s financial institutions had 1.05 trillion yuan of non-performing loans by the end of 2011, accounting for 1.8 percent of their total advances, according to the regulator. Banks must step up efforts to fend off risks associated with local government financing vehicles and the real estate sector this year, it said.

Lending risks to China’s property developers are rising as many have high leverage ratios and face a liquidity squeeze amid falling home prices, Liu Mingkang, former chairman of the banking regulator, said last week.