China’s Deposit Insurance Seen as Risk for Small Banks

China’s plan to introduce a deposit insurance program may exacerbate a liquidity shortage at smaller banks and increase their chance of failure as savings shift to the biggest state-controlled lenders.

While the move could limit systemic risks, it may fuel competition for deposits and drive up lenders’ borrowing costs as savers divert money to stronger banks or those that offer higher interest rates, according to Jim Antos, a Hong Kong-based analyst at Mizuho Securities Asia Ltd.

China may offer customers deposit protection as soon as the start of 2015, the official Xinhua News Agency reported, citing unidentified sources. The insurance would help to prepare China’s financial system for bank failures as the economy slows and authorities allow banks to pay higher interest on deposits.

“Competition for large deposits will clearly increase, with pricing and the perceived financial strength of the banks being the key factors for consumers,” Antos wrote in an e-mail. “We expect to see a shift of large deposits to the megabanks which, being government-owned, are viewed as stronger institutions.”

The government may cap coverage at 500,000 yuan ($81,000) and set different premium levels based on a bank’s regulatory rating under the plan, Economic Information Daily reported today, citing a person close to regulators.

Multiple government departments, including the People’s Bank of China and the China Banking Regulatory Commission, are preparing the program, Xinhua said.

Implicit Guarantee

The nation’s savers had amassed 112 trillion yuan of deposits by the end of October, PBOC data show. Industrial & Commercial Bank of China Ltd. and its three largest state-owned peers held 43 percent of that total.

Chinese banking shares rallied in Hong Kong and Shanghai today. ICBC surged 5.5 percent to close at 4.04 yuan, the highest since September 2013, while its Hong Kong-listed shares rose 1.5 percent to HK$5.26. Bank of China Ltd. gained 8.1 percent in Shanghai and 3.6 percent in Hong Kong.

“We haven’t seen anything like this for A-share banks in quite some years,” said Antos. “A few years ago you could not give the shares away for free. Now they are being snapped up enthusiastically. The economy is not as robust and the banks really have not changed their business practices much in the intervening period.”

Exit Strategy

The central bank last week moved further toward freeing up interest rates by raising the cap banks can pay on deposits to 1.2 times the benchmark rate from 1.1 times. That may make it more costly to attract and retain deposits, putting a strain on finances of smaller lenders.

Deposit insurance is “a clearly defined exit strategy for troubled banks,” Judy Zhang, a Hong Kong-based analyst at BNP Paribas SA, wrote in a note today. “It protects the public interest and shows the government is accelerating financial reform to gradually break its implicit guarantee of the financial system. However, it may lead to a deposit shift from small banks to large and medium-sized banks in the short term.”

Smaller banks face the risk of withdrawals by corporate depositors to counterparts with strong capital bases and extensive distribution networks, Zhang said. Beside liquidity risk, smaller lenders may have to bear higher funding costs to keep customers, putting pressure on their earnings, she said.

— With assistance by Jun Luo

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