China considers DIS to mitigate coming bank failures

The souring economy is forcing China to hedge against bank bankruptcies.

The People's Bank of China, China’s central bank, has drafted policies to establish a Deposit Insurance System (DIS) to ensure the stability of the country's banking sector and protect depositors.

The government first proposed the DIS in 1995 to provide a safety net for banks filing for bankruptcy or suffering from severe financial problems.

This system, however, failed to materialize because the government’s strict control over the banking sector meant the chances of banks going bankrupt or failing to pay back depositors were low.

"So far, instances of bankruptcy in China's banking industry have been few and far between," said Zhou Yu, director of the Research Center of International Finance at the Shanghai Academy of Social Sciences.

This is no longer the case, however. The recent liberalization of interest rates and lowering the market entry threshold for banking institutions means the risk of banks defaulting on their depositors is growing.

As a result, the government is now taking the creation of a nationwide DIS seriously, Zhou said.

The intensifying competition between small banks and the large state-owned banks is also making bankruptcies more thinkable.

Since early June, small banks have been offering higher rates to draw depositors away from major banks to compensate for their lack of credibility. This trend is intensifying the financial difficulties of less well-funded banks and has hindered their repayment abilities.

Because of these circumstances, a DIS will help banks exposed to financial distress offer some guarantee to depositors, Zhou said.