June 5, 2013 / 10:23 AM / in 4 years

China ready to start deposit insurance system: cenbank report

An employee works inside a textile factory in Linhai, Zhejiang province, May 30, 2013. REUTERS/William Hong

BEIJING (Reuters) - Conditions are ripe for China to launch a long-awaited deposit insurance system after a consensus was reached within the government, according to the central bank’s 2013 financial stability report, sources with knowledge of the report’s contents said on Wednesday.

The report paves the way for liberalizing the interest rate regime and marks the latest step forward towards market-based reforms to eventually free up China’s financial sector.

“We are ready in various aspects to set up a deposit insurance system. After numerous research and debates, all sides have reached consensus and we will kick off the scheme at a proper time,” the report said.

In late May, the People’s Bank of China put on its website a press release saying it had completed the annual report and would continue with financial reforms. The release made no mention of deposit insurance.

The central bank, which is expected to issue the full report in coming months, was not immediately available on Wednesday to comment on it.

A deposit insurance program is a measure to guarantee that a certain level of deposits are guaranteed by the state even if a bank cannot pay them.

The new insurance system is also seen as laying a foundation for interest rate liberalization, as a market-oriented interest rate would force banks to lose built-in interest rate margins and could put depositors at risk.

China started to relax its cap on interest rates from last June, lifting the ceiling of deposit rates while lowering the floor on lending rates.

Currently, Chinese banks can pay up to 110 percent of the benchmark deposit rate - currently 3 percent a year - and charge loan rates as low as 70 percent of the benchmark level of 6 percent. This ensures that banks are guaranteed a margin of at least 90 basis points.

STRONGER RISK CONTROLS

In the report, the central bank also pledged to increase flexibility of the yuan’s exchange rate as well as to quicken the pace of setting up a key benchmark rate for the country’s money market.

It also said Chinese banks must strengthen risk control over off-balance sheet activities and defuse bad loan risks to improve the asset quality of the whole sector.

“Banks must strictly control bank credit to local government financing firms and property developers while also curbing funding flows into such sectors through the shadow banking system,” said the report.

China is seeing booming growth in shadow banking activities, which channel funding to cash-starved firms such as real estate firms and debt-ridden local financing vehicles. Expansion in such activity has sparked worry that a new crop of bad loans is brewing.

Economists have said China’s rigidly-controlled interest rate regime is a major factor causing a problem, as it suppresses returns on bank deposits, spurring savers to plow cash into other investments and channel more funding to banks’ off-balance-sheet products.

The report also asked local governments to make a plan to contain risk to improve management of their debts.

It said that to prevent cash flow strains in the real economy, banks must raise their vigilance against possible default risks from mutual debt holdings among enterprises.

Reporting by Darren Cao, Kevin Yao and Aileen Wang; Editing by Jonathan Standing and Richard Borsuk

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