China is in the middle of the last and most difficult restructuring of its large lenders: that of Agricultural Bank of China (ABC), a behemoth with nearly half a million employees, 27,000 branches and a stack of bad loans on its books.

China has restructured four of its five state banks, cutting tens of thousands of staff, at the same time as selling stakes in each institution to foreign investors before listing them offshore.

However, the ABC presents the greatest challenge because of the size of its bad debts, the opacity of its books and its relatively high reliance on the countryside – the least creditworthy part of the Chinese economy.

Just how difficult a task can be gleaned from the response of local bank officials to a crisis in branches in Jining, a small city near the imperial-era grand canal in Shandong province, in late 2004 and early 2005.

The crisis, detailed in a series of internal circulars sent to sub-branches by the Jining HQ, and seen by the Financial Times, underlines the challenges faced not just in restructuring the bank, but in discovering what is happening in its vast network in the first place.

The circulars outline how the officials at the Jinxiang sub-branch, on the eve of an inspection by the People's Bank of China (PBoC), the central bank, fixed the level of non-performing loans to be reported to their visitors.

The Jining officials also instructed their subordinates at the sub-branches how to manage the PBoC representatives, and retrieve any damaging documents that might fall into their hands. The circular said that after a study by the Jining branch, the sub-branches, such as the one at Jinxiang, should adjust their NPLs to “the following amounts”, listed in the documents. “This is compulsory. Your branch must complete this task. The category of various types of loans cannot by shifted,” the circular said.

ABC's headquarters in Beijing in a statement blamed the allegations on a disgruntled former employee, adding “most of the problems” reported by this person were “non-existent, baseless or incorrect”.

“We have corrected a small number of problems that were later discovered. As a result, there is absolutely no falsification of NPLs at Jining Branch at the moment,” the statement said.

In the period the documents cover, the Jining branch had serious difficulties with a number of key clients, something which would have left them with an embarrassingly high level of bad debts. In the first eight months of 2004, the ABC's Jining branches accumulated NPLs totalling Rmb332m ($42.3m), mainly as a result of the problems of two companies, the documents show.

The clients were the Jiujiu Group, an ethanol producer whose founder was later arrested for embezzlement, and Phoenix Textile, acquired by a private buyer.

ABC's accumulated bad loans in 2006 were Rmb729bn, or 23.4 per cent of all loans. To reduce them to 5 per cent, the unofficial benchmark used in the makeover of other large state lenders, would cost about $76bn.

In addition, a further $40bn would be needed to get ABC's capital adequacy ratio to 8 per cent, in line with international standards which China has signed on to, according to Victor Shih, an expert on Chinese finance at Northwestern University.

Even with China's bulging foreign exchange reserves, the potential bill of over $100bn to fund the restructuring has already sparked alarm in sections of the bureaucracy. Wu Xiaoling, the deputy-governor of the PBoC, said in March that any capital injection depended on the progress ABC made in its restructuring. The auditors, Deloitte Touche Tohmatsus, are not expected to finish their work before the fourth quarter of this year at the earliest.

The auditor's job has been made more difficult by the multiple financial reporting platforms used inside the bank, which must all be reconciled to provide a complete and consistent picture of the state of ABC's books.

Mr Shih said even more than the other large state banks, ABC is caught “between the pressure for commercialisation and the persistent demands from politicians to meet political goals.”

“In the lead-up to the IPO,” he said, “there is little indication that this contradiction is diminishing in a significant way.”