The unusually sharp warning by Liu Mingkang, head of the China Banking Regulatory Commission, highlighted deep official unease about the threat that rampant credit growth poses to the Chinese financial sector and the broader economy.

He made his comments in mid-January at a first-quarter planning session with the country's top bankers, when a surge in loans was complicating official efforts to dampen inflation and fuelling bad debt risks at the same time.

But Liu made clear that he was talking not just about a single month's problem but one that had been building for far longer.

"Over the past two years, to confront the financial crisis loan growth has been abnormally explosive," he said, according to the source, who attended the meeting.

"It has exceeded the extreme upper managed limits," he added, apparently referring to the lending caps that China imposes on its banks.

Chinese banks issued a combined 17.5 trillion yuan ($2.7 trillion) of new local currency loans in 2009 and 2010, almost a quarter of the economy's total output during that time.

The government kick-started the lending binge at the height of the global financial turmoil, when it called on banks to unleash a blast of credit to power the Chinese economy to recovery. But with growth once again soaring, it has struggled to pull credit issuance back to a more normal pace.

Liu's words captured that sense of exasperation.

"The scale of new loans has increased incredibly fast, even doubling, in just a short period, but the expertise and efficiency of loan officers can't have doubled at the same time," he said.

SLOWER LENDING?

The severity of his warning appears to hit the mark. Banks were reported to have made 1.2 trillion yuan in new loans in the first half of January, but their final total for the month was just over 1 trillion yuan, suggesting that they sharply reined in credit after the meeting with Liu by allowing old loans to expire.

Whether that restraint has continued will be seen next week when China publishes loan data for February.

Despite Liu's note of alarm, analysts downplayed worries about the country's banks, saying it was the regulator's style to cast a spotlight on blemishes to nip problems in the bud.

"The regulator aims to prevent risks in a forward-looking approach, so this does not mean that credit risks are serious in the banking system," said Jin Lin, a banking analyst at the Orient Securities in Shanghai.

"Instead, I think credit risks are manageable, as the banking regulator has been consistently taking powerful measures and has achieved good results," Jin added.

Liu warned that "irrational factors" in the Chinese real estate market had increased and that credit risks were accumulating.

"Banks must pay close attention to the potential impact of a sharp decline in property demand," he said. "Banks should explore ways of conducting comprehensive stress tests on real estate loans."

RISK MITIGATION

A massive capital infusion from the government and better business practices have led to a sharp decline in Chinese banks' bad debt levels over the past five years, an accomplishment that Liu is eager to preserve.

He reminded banks of a ban announced last year on extending or rolling over loans to local government financing vehicles when they expire, the source said.

China has been trying to clean up local governments' books after they incurred piles of debt in the course of stimulating the economy to recover from the global financial crisis.

The Chinese banking regulator has also drawn up a new set of capital requirements that, if implemented, will be tougher than the global benchmarks of Basel III guidelines.

Under those rules China's big banks, or systemically important financial institutions, will be subject to a minimum capital adequacy ratio (CAR) of 11.5 percent and must meet it by the end of 2013, according to a document seen by Reuters last week.

Under Basel III, banks will need CARs of 10.5 percent and will have until 2015 to reach that level.