The mainland's state banks will adopt risk-based international standards of classifying loans this year as part of the overhaul of the technically-insolvent banking system intended to avoid a financial crisis. Analysts said the move to grade loans as normal, special mention, sub-standard, doubtful and loss would more accurately reflect the banks' portfolio quality and thus their balance sheets. It dovetails with Beijing's decision to allow the state banks to lend according to asset-liability ratios instead of the credit quota plan which came into effect last month. A few days ago, Beijing also announced a special treasury bond issue plan to recapitalise the big four - Bank of China, China Construction Bank, Industrial and Commercial Bank of China and Agricultural Bank of China. The bond issue is awaiting parliamentary approval. The official media said People's Bank of China (PBOC) governor Dai Xianglong met state and commercial bank chiefs about two weeks ago to discuss implementation of the new classification system. 'This is a system which requires a lot judgment on what constitutes risk and is a more helpful way of tracking the trend and quality of a bank's portfolio,' said Thomas Macy, Price Waterhouse's Beijing-based chairman of Financial Services Practice in China. Mr Macy helped lead a World Bank-funded programme, which ended 18 months ago, to strengthen supervisory controls at the PBOC, the central bank. 'This new classification requires a lot of management attention on, and supervision of, the loan portfolio and the level of attention changes the higher the risk rating.' said Stephen Harner, Deutsche Bank's Shanghai chief representative. At present, mainland banks classify loans based on a formula and time elapsed into two broad categories: normal and non-performing. Non-performing loans are further grouped into overdue loans, which are unpaid for under two years; idle loans, unpaid for two years or more; and bad loans, which are irrecoverable. The lax classification means state-owned banks tend to underestimate the magnitude of non-performing loans and provisions for bad debts. 'The current system is rule-based and leaves no room for judgment of risk,' said Mr Harner. The Ministry of Finance allows banks to set up a reserve for uncollectable loans equal to 0.6 per cent of the total commercial loan balance at the start of the year. In subsequent years, the allowance could go up by 0.1 points until it reaches 1 per cent of qualifying loans.