A new report by PwC lays out a series of challenges confronting banks and non-bank financial institutions in the Asian giant.

Bosses of banks and non-banking financial institutions in China are bracing for a period of “intense reform” as the government moves to put the sector on a more robust footing, according to a report by PricewaterhouseCoopers.

The report, called Banking and Finance in China: The Outlook for 2015, covers domestic and foreign banks, trusts, peer-to-peer lenders and Internet finance and auto finance companies.

Many organisations are already looking beyond two or three years of difficult change and preparing for the medium to long term, the report said.

With e-commerce giant Alibaba getting into areas such as wealth management, and new private banks in China taking wing in what has been a traditionally state-dominated field, the market in the world’s second-largest economy is changing. For example, WeBank, backed by a group led by Chinese internet firm Tencent, has launched. China is also opening more to foreign investors, as seen by last year’s arrival of the Shanghai-Hong Kong equity market link and the widening of foreign investment quotas.

The government is reforming the sector – traditionally state-owned - just as the economy is slowing and non-performing loans are mounting. The value of non-performing loans in China’s banks jumped 36 per cent year-on-year to RMB767 billion at the end of the third quarter of last year – the sharpest rise in four years.

The trend of bad loans is expected to continue, but at the same time, banks expect to see net interest margins squeezed to around 2 per cent. This is a common level in most mature markets and means that banks in China will have to be less reliant on deposits and lending, PwC said.

The report also analyses the effects of new entrants and products in the finance sector, such as web-based wealth management providers, P2P lenders, third-party payment platforms and auto finance companies. While these new players often directly challenge existing market participants, many of the banks surveyed said they saw more opportunities for cooperation than competition – a view reciprocated by Internet finance respondents.

“Traditional banks not only have to cope with a rapid pace of reform, but also with e-commerce giants becoming some of China’s largest fund managers in a matter of months,” William Yung, financial services partner for PwC China, said. “This has forced many banks to accelerate their innovation strategies and to start offering web-based services.”