* Draft of law dealing with bank failures now expected
within three months
* Resolution and deposit protection framework likely to
follow US model
* Jiangsu bank run shows state support no longer seen as
By Lianting Tu
SINGAPORE, March 28 (IFR) - This week's run on a small rural
lender in Jiangsu province has underlined the urgent need for
Chinese authorities to unveil a framework that will protect
retail depositors and wind down insolvent banks.
On Monday, depositors queued up to withdraw their money from
Jiangsu Sheyang Rural Commercial Bank in Yancheng after rumors
that the bank had turned down a request to withdraw Rmb200,000
(US$32,680). The panic soon spread to other branches in the
area, which by Wednesday were exhibiting stacks of cash to try
and calm depositors.
"It is logical that the Chinese government wants to insure
bank deposits now with the noise of recent bank runs and
corporate defaults," said Mike Murphy, managing director and
restructuring specialist at Alix Partners.
Onshore market players now expect that the government will
finish drafting legislation on a deposit insurance scheme within
the next three months, and that the scheme will be accompanied
by rules on bankruptcy of financial institutions.
Yiwen Lu, a Shanghai-based banking analyst at Shenyin Wanguo
Securities, said she expected the two laws to be unveiled later
this year. In fact, the bank bankruptcy law has already been
drafted, according to Simon Gleave, regional head of financial
services at KPMG.
Chinese depositors have long assumed that the government
would step in to prevent a bank from failing. But the nervous
savers in Jiangsu show that those assumptions are being
challenged after an unprecedented bond default and a build-up of
risks in the financial system. A recent government approval for
the establishment of smaller privately-owned banks also
increases the need for depositor protection.
As a result, market participants expect the government to
speed up the rollout of the legal infrastructure to ensure
stability and pave the way for further reforms.
"China's financial sector risks have moved into our forecast
horizon as the authorities appear to be laying the groundwork
for addressing widespread moral hazard problems in the credit
market," said Standard & Poor's economist Paul Gruenwald in a
recent report on China's financial risks.
Murphy noted that deposit insurance would have to be put in
place before interest rate deregulation.
"Deposit insurance is the next stage for banking in China in
order to increase visibility," Murphy said.
So far, China does not have a law that deals with bank
failures nor does it offer an explicit guarantee on deposits.
The current bank regulation states the People's Bank of
China could step in to oversee banks that are in danger of being
insolvent, but there are no details about liquidation
procedures. Also there are no measures that allow the regulator
to step in before a bank faces liquidity issues.
"It is important for the regulator to intervene before banks
actually run into liquidity troubles. It is a way to curb losses
and therefore limit the hit on the deposit insurance fund," Lu
of Shenyin Wanguo Securities noted.
Such an approach would mirror what happens in the United
States. There, the Federal Deposit Insurance Corporation,
established in 1933 to regulate deposit insurance, also has the
authority to wind down failed banks.
The agency can close a bank as soon as its capital adequacy
ratio drops below 2%. This is in addition to the traditional
book value or liquidity definition of insolvency.
Once the FDIC declares receivership, it takes over and winds
down the bank in order to prevent further losses. Specific
liquidation procedures include calculating the value of the
bank's assets and inviting bids for them.
The regulator may either sell the bank as a whole or sell it
in pieces. In the meantime, the FDIC makes sure depositors'
activities are uninterrupted in an "orderly liquidation." For
depositors, the portion that is not covered by deposit insurance
tends to be paid out proportionally after the liquidation.
The US bank bankruptcy and deposit insurance arrangements
may provide an appropriate model for China to consider,
partially because China also has a number of very big banks as
well as medium and smaller banks at a provincial level, Gleave
of KPMG pointed out.
"The US model is a good one for China to benchmark itself
to. China will also need an outside independent regulatory body,
like the FDIC in the US, to provide security to retail
depositors," Murphy echoed.
"The US model is intended to protect depositors and wind
down failed banks in a quick and efficient manner," Murphy said.
A CHINESE FDIC
China has been working on its bank deposit insurance rules
since 1998. Current drafts call for the Chinese government to
establish an entity called the Financial Stability Commission
under the People's Bank of China to oversee deposit insurance,
according to people familiar with the plans.
The scheme would cover up to Rmb500,000 (US$80,500) of
retail deposits, but this would not include investments in
wealth management products, according to a recent research
report from Shenyin Wanguo Securities. The FDIC insures the
first US$250,000 in deposits.
In the beginning, big banks in China are expected to put in
more money toward the deposit insurance fund. On average, banks
are expected to pay an insurance fee of 8bp to 30bp of their
deposits, according to Shenyin Wanguo's report. The insurance
scheme could guarantee a 40%-50% payout of the deposit covered
by the insurance, the report said.
Meanwhile, China is also likely to adopt the approach least
costly to the deposit insurance fund when winding down failed
While many market participants believe the upcoming rules
will instil some discipline into the Chinese banking system,
some analysts are less optimistic.
"What the Chinese government cares about is social
stability. Hence, it is likely to still look at bank bankruptcy
on a case-by-case basis even after the release of the new
rules," said Ritesh Maheshwari, lead analytical manager of
financial services ratings at Standard & Poor's.
(Reporting By Lianting Tu; editing by Christopher Langner and