Decoding the deposit insurance system

Since the global financial crisis, financial regulation departments of major economies have explored and analyzed macroeconomic regulatory and systematic risk management. And macro-prudential regulation is one of the measures they have zoomed in on. Supervision over the years has made its framework more mature, and it has played a positive role in maintaining a stable financial system because of its cross-economic cyclical and retro-regulatory characteristics.

Establishing a deposit insurance system now would be good for China, for it would help build a macro-prudential regulatory framework linking commercial banks' insurance rate with their risk levels. Furthermore, it can help establish stricter restrictions for commercial banks and give deposit insurance institutions the choice to refuse some unqualified banks' insurance requirements. This way, commercial banks can clearly perceive the risks and supervise their prudent operation.

China should include a related legal system that clearly defines the property rights and the contract spirit. Very few cases of bankruptcy have been reported from China since the closing down of Hainan Development Bank in 2007, but there has been administrative intervention in every one of them. The system in an ideal scenario, however, should depend more on equity rights and contract spirit than administrative intervention.

In 2006, the Enterprise Bankruptcy Law made principled provisions for financial institutions' bankruptcy and authorized the State Council to enforce the specific regulation, leaving room for bankruptcy legislation.

Internationally, there are two models for legislation on deposit insurance system and bankruptcy. The first combines the two, and the second treats financial institutions' bankruptcy as other standard bankruptcy cases with some special provisions for deposit insurance. But no matter which model is used, a market-oriented risk compensation mechanism can be established with minimum government interference only by protecting property rights and honoring the contract spirit. This will also allow the market to play a fundamental role in the allocation of resources.

Finally, for a suitable environment to be created, other reform measures should match the deposit insurance system. The financial market is a system of interrelated components where earnings can be shared and exchanged. So related reform measures would include those for the social credit system, interest rates and consumer protection. This calls for the creation of a diversified and multi-layer reform environment consistent with the plenum document.

The author is a researcher with China Foreign Exchange Trade System.