An explicit Deposit Insurance System (DIS) has been under extensive consideration by the government for more than 20 years. The factors that have delayed it appear to have subsided, and it looks like China is ready to start a DIS. But the real question is—Does DIS helps in the event of a systemic banking crisis?
A Deposit Insurance System (DIS) is a practice widely adopted by countries around the world, and appears consistent with the Chinese authorities’ goal to build a better-functioning financial market with fair competition for both large and small institutions as reforms increase competition.
Major features expected for a Deposit Insurance System in China
- A government-administered “risk minimizer” actively involved in supervisory monitoring and failure resolution of troubled banks.
- Compulsory membership for deposit-taking institutions of all sizes.
- A coverage limit of cRMB 200,000-500,000, which would protect more than 99 percent of deposits.
- A target size for deposit insurance funds at 0.5 percent of covered deposits, ex-ante, funded by fees charged on banks, likely to initially be based on a simple fee by size of bank and eventually benchmarked to banks’ risk profile, as assessed by bank regulators.
Regulators’ goals in introducing Deposit Insurance in China
Deposit insurance has been widely adopted around the globe
Since the 1960s, more and more countries worldwide have adopted an explicit Deposit Insurance System (DIS) with the total reaching 111 as of 2011. This demonstrates that a DIS is widely accepted by financial regulators globally as a key element in building a modern financial safety net. As financial development and reform in China reaches a crucial stage of liberalization, a Deposit Insurance System (DIS) comes naturally into the regulator’s sight as a major building block to creating a more market-oriented financial environment.
Enhance market discipline
An explicit DIS provides a clearly defined exit strategy for troubled financial institutions. Compared with an implicit DIS, the depositors share the responsibility with regulators to monitor bank risks if they have large deposits exceeding the insurance limit. If banks take excessive risks, a depositor could withdraw their deposits if they perceive the bank is taking high risks and their deposits are unsafe.
Improve confidence for smaller institutions
As market competition intensifies, savers may be reluctant to deposit in small financial institutions that may be less safe than large banks. The existence of an explicit DIS helps improve savers’ confidence in small banks by ensuring the safety of their deposits, even in the case of bank failures, therefore enhancing the credibility of small banks. This improves the funding position for small banks in a competitive market environment.
Protect public interests
Social stability is a core concern for the Chinese government. A well-executed Deposit Insurance System (DIS) protects depositors, especially the mass-market depositors. As China’s financial market becomes more market-driven, failures of financial institutions are possible by historical experience. This makes protecting the wealth of the public a top priority if the regulators want to push reforms.
Deposit Insurance Moderate impact likely on net profits and ROE's of banks
Barclays said that, “We estimate the immediate negative impact of a Deposit Insurance System (DIS) on our net profit estimates for 2014 for the China banks in our coverage universe at -0.86 percent to -1.91 percent and the impact on ROE's at -19bps to -36bps. We estimate it would take the fund 13 years to reach our assumption for target size of 0.5 percent of insured deposits. Although the market may interpret a DIS as the beginning of accelerated financial reform, creating a negative impact on bank shares, we estimate that any negative impacts on banks’ financials would be manageable and we believe the benefits of a DIS in the China banking system would outweigh the negatives in the long run.”
Deposit Insurance helps in a normal banking environment, not in the event of a systemic banking crisis
The DIS first came into existence in the US as a response to thousands of bank failures that took place during the Great Depression – depositors lost US $1.4 billion in total during the period. However, an explicit DIS may not be able to curb a systemic banking crisis as occurred recently in the US and Europe during the global financial crisis:
Governments still need to intervene with an implicit guarantee in a financial crisis
During widespread financial crises, governments may still need to offer a broader explicit guarantee as not doing so would further precipitate the situation. This is evidenced by the recent global financial crisis in which many countries launched extraordinary measures, including raising coverage limits, providing emergency liquidity to banks and offering full blanket guarantees for deposits.
Flight to quality
Deposits could fleet to big names in a crisis: When panic sentiment prevails in a market, historical experience suggests that bank runs usually occur on problem banks and extend to smaller/weaker banks. Depositors may move their money to larger/safer banks, further weakening the liquidity at the troubled financial institutions.
High concentration of deposits in China
The ability of an insurance scheme to share risks only applies when there are a large number of insured parties and they are highly independent. However, Chinese banks are dominated by the big 4 state-owned banks – ICBC, CCB, ABC and BOC – which together share almost half of the banking system. As of April 2013, RMB deposits at the four state-owned commercial banks stood at RMB47tn while the total deposit balance at all financial institutions was RMB97.8tn.
Barclays believe that a Deposit Insurance System (DIS) in China would not likely lower systemic risk, but rather create a fair competition environment supporting medium- and small-size financial institutions in an increasingly competitive market. A proper and comprehensive exit mechanism for banking failure could also reduce moral hazard and enhance market discipline.