Chinese banks' deteriorating asset quality and slowing profit growth are credit negative, said Moody's Investors Service in a report released on Thursday.

Over the past week, most listed Chinese banks, including two of the Big Four banks, announced interim 2012 results that generally showed non-performing loan (NPL) ratios are still low and profitability remains strong.

"However, the announcements also showed deteriorating asset quality and slowing profit growth, which are credit negative because they mean the end of a multi-year streak of improving financial performance since a massive bank restructuring nearly 10 years ago," said Hu Bin, vice president and senior analyst at the international ratings agency. Hu was the writer of the report.

The banks' results reflect the challenges of China's moderating economy and accelerating market-oriented reforms, said the report.

Although NPLs for Bank of China Ltd and China Construction Bank Corp were stable, most other banks, particularly smaller ones, reported some degree of asset deterioration. Ping An Bank Co Ltd even reported a 51 percent jump in NPLs.

"There is also evidence of higher NPLs in the pipeline. Special-mention loans, in which a borrower currently able to make interest and principal payments faces a negative development in his payment capability, are generally on the rise. Delinquent loans, defined as any loan with principal repayment or interest payment overdue at least one day, are also rising," Hu said.

"We note that joint stock banks such as PAB, Shanghai Pudong Development Bank, China Everbright Bank and China Minsheng Banking Corp Ltd, which have more exposure to small and medium-size enterprises (SMEs), reported the sharpest increases in special-mention and delinquent loans."

The weakening asset quality and profit growth reflect China's softening economy, but do not take into account several other challenges banks face, said the report.

"Banks have generally attributed worsening asset quality to slowing domestic and overseas demand that has affected the manufacturing sector, SMEs and eastern coastal areas. However, we also see persistent credit tightening in the real estate sector and a slowdown of land-sale revenue for local governments as factors that will further erode banks' asset quality, and believe the deterioration trend is just beginning."

Moreover, these results do not reflect the recent acceleration in interest rate liberalization and disintermediation, which would adversely affect banks' interest income in coming quarters, it said.