China's banking regulator warned Tuesday the nation's banking system faces major risks, the prominent being loans made to local governments and the real estate sector turning bad.

The China Banking Regulatory Commission (CBRC) urged banks to use scientific analysis in their lending in its 2009 annual report, published Tuesday on its website.

The report said some banks were lending large amounts to local government units with inadequate risk management, and that lending to local governmental vehicles entails significant potential risk.

The average non-performing loan (NPL) ratio at the country's commercial banks fell to 1.58 percent at the end of 2009, declining 0.84 percentage points from the level at the beginning of the year, according to the report.

Despite the NPL ratio remaining low, CBRC Chairman Liu Mingkang, said in the report some credit assets could turn into losses this year.

"Domestically, the soundness of the banking sector is being tested by increased pressure for an NPL rebound. There are risks associated with lending to local government financing platforms, the real estate sector and industries with excess capacity," Liu was quoted as saying in the report.

"Internationally, fundamental flaws underlined by the recent global financial crisis have not been resolved," Liu said.

Trade protectionism and disputes, sovereign debt crises and high unemployment rates pose possible new challenges to the world economy, he added.

In 2009, China's banking industry net profit hit 668.4 billion yuan (98 billion U.S. dollars) with a return on equity of 16.2 percent, the report said.

The banking industry's total assets totaled 78.8 trillion yuan at the end of 2009, up 26.2 percent compared to the start of the year, according to the report.