Here are 5 threats to Chinese banks' growth outlook in next 12-18 months

Asset quality, profitability could be hit.

According to Moody's, the outlook for China’s banking system is stable, as it has been since March 2011, reflecting its assessment that the overall performance of Chinese banks will remain in line with their rating levels in the next 12-18 months.

While the stable outlook is underpinned by Moody's view that China will stay on a path of steady expansion and pursue an agenda of orderly reform, the banks will face several pressure points that will mostly likely be reflected in their asset quality and profitability.

Here's more from Moody's:

These challenges will come from: (1) economic rebalancing, (2) rising financial leverage, (3) increasing interest rate liberalization, (4) a greater shift towards higher-risk loan segments, and (5) continued large fluctuations in deposit flows.

Our ratings of Chinese banks take into consideration their modest standalone credit strengths – ranging from ba1 to ba3 – and our assumption of significant systemic support, especially for the larger banks.

We have taken a conservative approach in assessing the banks’ standalone credit profiles relative to their financial metrics, reflecting our long-held concerns over their untested risk governance and credit portfolios, given the rapid growth in credit in recent years.

Nonetheless, despite a likely worsening in the banks’ asset quality and profitability in 2014, we do not expect their credit metrics to deteriorate to a level that will negatively affect their current ratings.

The ratings should be supported by: (1) economic growth stabilizing at an annualized rate of 7%-8% in 2014-15, based on our central scenario, and (2) likely actions by national and local governments to mitigate the effects of new non-performing loan (NPL) formation, despite evidence of the weak standalone debt-servicing ability of many local government financing vehicles (LGFVs), and some state-owned enterprises (SOEs).

While we expect system-wide NPLs to rise above 1% of total loans, a level at which they have stabilized in recent quarters, the ratio is unlikely to exceed 2% during the horizon of our outlook.

On interest rate liberalization, we expect the authorities to continue to adopt a gradual approach to reform. Consequently, overall net interest margins (NIM) should be around 2.4% over the next 12-18 months, a deterioration of no more than 20 basis points.

Further supporting the stable outlook is the Chinese government’s (Aa3 stable) reforms, outlined after the conclusion in mid-November of the Third Plenum of the 18th Congress of the Communist Party of China.

The policy statements stressed the need to deepen financial sector reforms through market-based mechanisms and supervisory oversight.