China will allow the creation of up to five privately financed banks this year gradually opening the state-run industry in a bid to boost growth, the country's banking regulator says.

Analysts including the World Bank say Chinese banks lend little to entrepreneurs and an overhaul of the system is urgently needed to achieve the ruling Communist Party's goals of making the economy more productive.

The China Banking Regulatory Commission said in a statement Monday it would enlarge the role of private capital in banking. It said that would include a closely supervised "pilot project" to allow creation of three to five privately financed banks.

The moves are aimed at promoting "modernization of governance," the agency said. It gave no details of who would be allowed to set up a bank or in what lines of business they can compete.

Reform needed to boost growth

Communist leaders are trying to inject more competition into China's economy while retaining control of key industries. They also are trying to reduce reliance on trade and boost investment that will encourage more domestic consumption.

China's economic growth tumbled to a two-decade low of 7.5 per cent in the second quarter of last year, adding to the urgency of pushing through reforms. Growth rebounded to 7.8 per cent in the third quarter but the Cabinet has said it expects growth for the full year of 7.6 per cent, which would be the economy's weakest performance since 1999.

A reform plan issued in November promised to give the market a decisive role in allocating resources and to open more industries to private and foreign competitors. But it affirmed that state ownership will remain the core of the economy.

Any change to China's banks will be politically fraught because they are the ruling party's most powerful tool in controlling the economy and supporting politically favoured companies with low-cost credit.

Commercial thinking needed in banking

Change will be slow but privately financed lenders might inject more commercial thinking into a heavily politicized industry, said economist Lu Zhengwei at Industrial Bank in Shanghai.

"Privately financed banks would be more focused, with more realistic risk controls," said Lu.

The government of President Xi Jinping already has begun gradual steps to make the banking industry more responsive to the market.

In its first major reform, Xi's government announced an end in July to controls on interest rates banks charge on loans. That might spur growth by allowing borrowers to shop around for lower rates.

The banking regulator also said it would "explore the gradual relaxation of barriers to foreign entry into the industry" and to allowing foreign institutions to handle China's tightly controlled yuan. It gave no details or a timetable.

China trying to control government borrowing

The announcement comes as Beijing tries to rein in a surge in commercial credit and borrowing by local governments and to tighten control over informal lending on which entrepreneurs rely for financing.

Private sector analysts estimate total credit grew by more than 18 per cent last year, well above the central bank's 13 per cent target.

Debts owed by local governments soared 70 per cent over the past three years to 17.7 trillion yuan ($2.9 trillion), according to an audit released last month. It said debt still was "rising relatively fast" and called on local leaders to tighten control over borrowing.

Economists say the size of the debt is manageable but have warned the rapid increase is dangerous for the financial system.