[5] Four Questions About the Deposit Insurance System

Yesterday, the Deposit Insurance Regulation, drafted under the leadership of the central bank, was publicly released and will take effect on May 1. Following the adjustment of the second-home mortgage policy the day before, the central bank once again grabbed the headlines. Since the State Council first proposed a deposit insurance system in 1993, deposit insurance has come a long way over 23 years, with quite a few twists and turns. Even in the past six months, there have been some stories: on October 29 last year, the State Council executive meeting approved the Deposit Insurance Regulation; a month later, on November 30, the Legislative Affairs Office of the State Council released a draft of the regulation for public comment; on February 17 this year, Premier Li Keqiang signed a State Council decree to promulgate the regulation; on March 31, the regulation was officially released to the public, with a clear implementation timetable…. What day was February 17? It was three days after Valentine's Day and the last working day before the Chinese New Year of the Sheep…… For the sake of deposit insurance, the Premier really went the extra mile.

[3] According to the definition of the International Association of Deposit Insurers, the main objectives of the deposit insurance system are: to maintain the stability of the banking system, prevent systemic risks, and protect the interests of depositors. In fact, opinions vary across countries on whether the deposit insurance system can effectively fulfill its intended role.

China is a country with a high savings rate, with deposits in banking financial institutions exceeding 120 trillion yuan. Establishing a deposit insurance system builds a new financial safety net, lays the foundation for advancing interest rate liberalization, and provides greater protection for ordinary people’s deposits. This is a sound institutional arrangement and a common choice among 113 countries and regions worldwide.

Although deposit insurance increases banks' costs to some extent, it helps enhance the safety of the financial system and maintain public confidence and trust in banks amid the continuous advancement of interest rate liberalization. For large banks, deposit insurance helps them gradually shed their de facto “state credit” and become true market participants; for small and medium-sized banks and private banks, deposit insurance serves, in a sense, as a “credit enhancement” measure that helps them secure a more level playing field.

[6] An important function of China's deposit insurance system is investor education. The process of advancing deposit insurance is a broad and deep investor education campaign. For ordinary people, the lesson from deposit insurance is that risk and reward go hand in hand; there is no investment with only returns and no risks, not even deposits.

So here comes the question: after the implementation of deposit insurance, what changes does it mean for ordinary people–if you have 5 million in deposits, should you really split it across 10 banks?

1. Will small banks run into trouble?

Indeed, competition in the banking sector is becoming increasingly fierce, and it is not out of the question that a few banks may encounter operational difficulties in the future. Large banks are considered “too big to fail,” but what about small and medium-sized banks? Purchasing auto insurance does not mean a car accident will definitely happen. The introduction of a deposit insurance system does not mean a bank will necessarily go bankrupt or fail. As an institutional arrangement, deposit insurance only provides compensation when a bank experiences an operational crisis or faces bankruptcy. China has experienced bank failures such as the Hainan Development Bank, but in reality, the likelihood of existing banks failing is indeed very low. Commercial banks remain the safest financial institutions in China, bar none.

2. Are deposits unsafe?

Since banks can go bankrupt and the state no longer provides a “backstop,” does this mean bank deposits are less safe than before? The banking industry itself is in the business of managing risk and is inherently exposed to various risks, which exist objectively. Deposit insurance makes banking risks more transparent, fosters more fully effective competition among banks, and promotes further improvement in the overall efficiency of the banking sector, which will enhance the industry’s ability to prevent risks as a whole. After interest rate liberalization, without a safeguard system, ordinary depositors would actually face greater risks. Deposit insurance is precisely what gives depositors peace of mind.

3. Should deposits be split up?

Don’t put all your eggs in one basket—should you spread a large deposit across several banks? Theoretically, splitting 5 million yuan among 10 banks would be the safest approach. But in reality, tapping the deposit insurance fund for compensation is a low-probability event, so going to such lengths is unnecessary. Keeping 5 million yuan in a single bank lets you enjoy VIP status and various perks. Of course, you’d better not be too reckless. If a bank later tries to attract deposits with interest rates noticeably higher than the market average, you should be on your guard. “Yu’ebao” [Weibo] is not covered by deposit insurance at all. Anyone who tells you its returns are more than ten times those of a demand deposit is taking advantage of your ignorance.

Fourth, will the premiums be passed on?

The central bank has stated that deposit insurance premiums are paid by banks and have nothing to do with ordinary depositors. Every bank must contribute to the deposit insurance fund to insure its deposits. Some people worry that banks will pass this premium on to depositors. Dear, if you have deposits, you are the boss—how would a vulnerable bank dare to make demands of you? With 4,000 banks nationwide, if you're unhappy, just switch to another one! Will banks pass the premium on to loan customers? Probably not. Using the relatively low international premium rate of 0.05% as our country's average premium rate, the banking industry would need to pay approximately 60 billion yuan in deposit insurance premiums. This amount is a drop in the bucket and has little impact on banks.

We are pleased to see that “deposit insurance premium rates consist of a benchmark rate and a risk-differentiated rate,” which confirms that differentiated rates are established. If a uniform rate were applied indiscriminately to both “good banks” and “bad banks,” then “good banks” would receive no incentive, which could easily lead to “adverse selection” in the banking sector and the market, giving rise to moral hazard. It was said that a uniform rate would be implemented initially, but it now appears that this should only be a transitional arrangement. That is reassuring.

Currently, the specter of “rigid repayment” in China’s investment and wealth management sector persists, and the market risk-free interest rate remains excessively high. This is detrimental to social income distribution and financial innovation, and ultimately harms ordinary citizens. By establishing deposit insurance and thereby advancing interest rate liberalization, it is possible to gradually lower the risk-free interest rate and alleviate the long-standing problem of “too much money and too high a cost of money,” which would also be favorable for the capital market.

(Dong Ximiao)