A deposit insurance system to dilute banking risks - discussed for years and widely regarded as vital for China's banking reform - will be covered by the three banking laws that are now under review by the highest legislative body, the Standing Committee of the National People's Congress (NPC), insiders say.

China is amending the Law on the People's Bank of China and the Commercial Banking Law, and is also drafting a law on banking supervision, all of which were scrutinized by the NPC on Saturday, with increased emphasis on risk management.

An important part of risk management is the deposit insurance system, which is in place in more than 120 countries and regions.

The People's Bank of China (PBOC) launched a special project to study the feasibility of the system as early as six years ago, which concluded that establishing a well-designed deposit insurance system in a stable economy and banking system would better protect the interests of small and medium-sized depositors, enhance public confidence in banks and offer great help in dealing with bankruptcy or closure of banks.

The report was submitted to the NPC in April; and experts have suggested the establishment of special banking deposit insurance companies to provide the service.

Ma Weihua, president of China Merchants Bank, a shareholding commercial bank based in Shenzhen, also proposed to the NPC in the March national conference that the deposit insurance system should be clarified in the amended Commercial Banking Law - that each commercial bank is obliged to insure the balances of its depositors against potential payment risks.

The reform would be essential to promote the development of the small and medium-sized banks, which often find it harder to absorb risks than the big State-owned banks because of less public trust in their creditability.

And as the "Big Four" State banks are also moving towards the shareholding structure, government credit should also be replaced by a sound commercial insurance system to protect depositors.

"Without that, the banking industry's next step of reform will have a security problem," said Wei Jianing, a researcher with the Development and Research Centre of the State Council.

But insiders said it is a complicated issue, especially after the PBOC was split into two entities in April, with the launch of the China Banking Regulatory Commission (CBRC) to specialize in banking regulation and the PBOC performing the traditional central bank's function of framing monetary policy designing and monitoring.

It will need a lot of co-ordination for the two to work out the deposit insurance system together because it involves both risk monitoring and lenders' management, especially in cases of emergency.

Presently, one of the major issues is exactly which body should be liable for the risks of small- and medium-sized financial institutions, said Wei.

As a transitional measure, it is suggested that the deposit insurance system be first established within each commercial bank, or to launch regional deposit insurance funds.

Then China can gradually catch up with international standards and form a nationwide deposit insurance scheme.

Chinese banks and credit cooperatives have witnessed several panic bank withdrawals over the past few years, including one in the Xunda City credit cooperative in East China's Zhejiang Province two years ago, when the cooperative chairman Lin Gan was found to have embezzled 60 million yuan (US$7.2 million) funds.

Depositors rushed to draw out money upon the news, which finally led to the bankruptcy of the cooperative, in spite of rescue efforts by the central bank and the local government to inject new funds.

(China Daily HK Edition August 26, 2003)