The China Banking Regulatory Commission (CBRC) said on Tuesday that nearly one-fifth of the bank loans disbursed to local governments are questionable, but will not cause any systemic risks to the banking sector.

Lenders have disbursed over 7.7 trillion yuan ($1.14 billion) till June this year to finance local government projects. Loans amounting to nearly 1.54 trillion yuan face default risks due to lack of qualified borrowers or warrantors, according to CBRC data. The regulator had recently conducted a nationwide assessment of the lending portfolio of commercial lenders.

"These questionable loans won't necessarily turn sour, as most of them have eligible collateral or a secondary source of repayment," a CBRC spokeswoman told China Daily on Tuesday.

The regulator said in a statement that it would conduct on-site inspections over the next three months and urge banks to make adequate provisions to prevent possible increases in bad loans.

As part of the country's effort to bolster economic growth amid the global financial crisis, Chinese lenders gave out record 9.6 trillion yuan of new loans last year with a big chunk of them for funding infrastructure construction.

The lending spree also raised the specter of surging bad loans and could hamper efforts to overhaul the banking sector.

According to the Chinese Academy of Social Sciences, local government loans accounted for 11.6 percent of the total outstanding loans for major State-owned lenders last year, while the exposure of mid-sized lenders was around 12.9 percent.

Qiu Zhicheng, a banking analyst at Guosen Securities, feels that the economic growth over the next few years will determine the fate of the bad loans.

"In boom times, it is unlikely that these loans will turn bad, as local governments would have adequate funds to repay the loans due to ample gains from land sales. But it is hard to imagine the quality of these banking assets if economic growth slows down," he said.

Qiu said the regulator might require banks to set aside additional funds to counter rising default risks. That in turn, may hurt lenders' profitability over the next few years.

The non-performing loan ratio of Chinese banks stood at 1.3 percent as of the end of June, while their average bad loan provision ratio was 186 percent, according to CBRC data.

"Right now, China's commercial banks have adequate provisions and they are capable of controlling risks," the regulator said in the statement.