China's state banks make money "far too easily", state media quoted Premier Wen Jiabao as saying on Tuesday, in comments that reignited debate over the role of banking in cushioning the descent of the high-flying economy, the world's second largest.

"Frankly, our banks make profits far too easily. Why? Because a small number of major banks occupy a monopoly position, meaning one can only go to them for loans and capital," China National Radio quoted Wen as telling local businesses at a roundtable discussion.

"That's why right now, as we're dealing with the issue of getting private capital into the finance sector, essentially, that means we have to break up their monopoly," the radio news service reported Wen as saying on its website.

Wen's comments came as a senior economic official, citing a "related research agency", revealed the economy might have grown 8.4 percent in the first quarter from a year earlier, the slowest growth since the second quarter of 2009, when China began to accelerate out of the global financial crisis. The official GDP figures are due to be released next week.

Such a result would be in line with private economists' forecasts - and with efforts by Chinese policymakers to engineer a gradual slowdown in the economy, which had been speeding along at an unsustainable rate of more than 10 percent two years ago.

As the economy has slowed, the role of state banks in rationing credit has come more into focus. They prefer to lend to other state firms, starving smaller entrepreneurial companies that must then borrow from informal lenders at high rates.

Only last week, Beijing approved financial reforms for Wenzhou - known as the country's cradle of private enterprise - to encourage private investment in local banks.

Experts said the need for further steps was apparent, though it remained to be seen whether the views of Wen, due to step down next year in China's biggest leadership change in a decade, would translate into action under the new leadership.

"The basic need for drastic financial reforms is clear," said William Overholt, senior research fellow at the Kennedy School of Government at Harvard University and author of "Asia, America, and the Transformation of Geopolitics."

"This is a time in China's economic history where future growth, and future jobs, depend heavily on small and medium enterprises and the private sector."

The Big Four banks, including Industrial and Commercial Bank of China, Bank of China, Agricultural Bank of China and China Construction Bank, have long maintained a stranglehold on virtually every aspect of the financial services industry.

OPENING DOOR WIDER

In another move to usher more capital into the economy, China also announced it would widen a major channel for inward foreign investment in Chinese markets, expanding a quota for foreign institutional investment by $50 billion to $80 billion.

In addition to boosting the qualified foreign institutional investor scheme (QFII), which is currently nearing its limit, China said it would allow foreign investors to plough more of their offshore yuan holdings into mainland securities.

The Renminbi Qualified Foreign Institutional Investor scheme (RQFII), is being boosted by 50 billion yuan ($7.9 billion), the China Securities Regulatory Commission said.

In past years, Beijing has carried out a range of reforms in cities such as coastal Wenzhou. Last month, the Cabinet approved a pilot project it hopes will one day form a cornerstone of nationwide financial sector reforms.

China has cut its annual growth target to 7.5 percent this year, an eight-year low and a pace Beijing hopes will give it room to push through structural reforms, though many economists expect the pace of growth to pick up from the second quarter.

Economists also expect the central bank to continue to cut the amount of cash that commercial lenders must hold as reserves to crank up credit expansion, but the chances of a near-term cut in benchmark interest rates look slim.

Under the banking reform being tested in Wenzhou, private investors will be encouraged to buy into local banks and to set up financial institutions such as loan companies and rural community banks, the State Council has said.

Beijing hopes it will enable hungry small businesses - vital to employment - to access finance more easily and cheaply.

"The central government is unified on this, and you've seen the Wenzhou experiment ensue," Wen was quoted as saying.

"I think Wenzhou has had some successes, that should be replicated nationally. In fact, some can immediately be kicked off countrywide."

'WORSE THAN THE MAFIA'

Allowing private investors to lend via legal entities will help Beijing tame an underground lending market, where annualized interest rates can hit 100 percent. This market was worth 2.4 trillion yuan ($381 billion) at end-March 2010, or 5.6 percent of total lending, according to People's Bank of China.

Many private businesses turn to grey-market lending because they lack connections to access loans at official rates, which primarily flow from state-owned banks to state-owned enterprise.

The idea of a financial reform zone emerged late last year after media reports surfaced about Wenzhou entrepreneurs who had gone into hiding or committed suicide after they were unable to repay high interest on under-the-counter loans.

The local central bank branch estimates underground lending in Wenzhou at 110 billion yuan. About a third of that is used for real economic activities, with the rest going to speculative investments, according to media reports.

"It's worse than the mafia," Harvard's Overholt said, referring to punitive borrowing costs. "When you control inflation by high reserve ratios, what the banks do is cut off everybody but their biggest clients."

"The financial system is strangling them." ($1 = 6.2980 Chinese yuan)

(Reporting by Edwin Chan in SAN FRANCISCO, Aileen Wang and Kevin Yao in BOAO and Michael Martina and Jim Bai in BEIJING; Writing by Mark Bendeich; Editing by Emily Kaiser)

• A Permanent Economic Emergency