An explicit and limited-coverage deposit insurance system is ready to replace the historical implicit and blanket governmental guarantee for failed financial institutions.

On November 30, 2014, the Legislative Affairs Office of the State Council released the draft of Regulations on the Deposit Insurance (Draft) prepared by the People’s Bank of China (PBOC) and invited comments from the public. This is the first officially publicized draft regarding establishment of a deposit insurance scheme, although discussion of the topic has persisted for more than two decades.^[1]

Implementation of the Draft (subject to further revisions based on public comments and official approval by the State Council (SC), which normally takes at least half a year) is expected to be a milestone for the Chinese government as it replaces the historical implicit and blanket government guarantee for failed financial institutions by an explicit and limited-coverage deposit insurance system. Establishment of the deposit insurance scheme is a linchpin of the movement to reduce the cycle of instability and moral hazard that is the result of implicit and explicit governmental ownership of the banking and payments system in China, along with (i) gradual liberalization of interest rates in the banking sector and (ii) approval of the establishment of wholly privately owned banks.

This alert highlights the key features of the Draft.

Deposit Insurer

A company newly established solely for the purpose of managing the deposit insurance fund or an existing entity designated by the SC will act as the deposit insurer (Deposit Insurer), having the functions and responsibilities of both a typical insurer (e.g., determining the premium rate for each policyholder, collecting and managing the insurance fund(s), and making reimbursement on occurrence of the insured events) and a quasi-financial regulator, including but not limited to

• issuing rules related to the operation of deposit insurance business;

• adopting early warning systems and taking corrective and risk-mitigation measures against troubled Insured Depositary Institutions (as defined below), such as requiring these institutions to inject supplementary capital, tightening control over lending, and decreasing leverage; and

• sharing information and coordinating with other financial regulators.

However, the Draft is silent on the role, if any, of the Deposit Insurer in the areas of bank ownership, capital adequacy requirements, and corporate governance, which traditionally have been the jurisdiction of the China Banking Regulatory Commission (CBRC).

Membership

Financial institutions duly established and licensed to engage in deposit-taking business in China, such as banks and credit cooperatives, whether wholly domestically owned or with foreign shareholding (Insured Depositary Institutions), are required to participate in the deposit insurance scheme, except (i) offshore branches of the Insured Depositary Institutions (Offshore Branches) and (ii) onshore branches and representative offices of foreign banks^[2] (Foreign Bank Branches), unless otherwise stipulated by mutual agreement between China and the host countries of the Offshore Branches or the home countries of such Foreign Bank Branches.

Whether Offshore Branches or Foreign Bank Branches can attain membership of or be included in the deposit insurance scheme on a voluntary basis (and the entry requirements, process, and time frame) is unaddressed in the Draft.

Coverage

According to the Draft, the deposit insurance scheme shall cover all deposits that natural persons and entities place in the Insured Depositary Institutions, whether denominated in RMB or foreign currencies, except (i) inter financial institution deposits^[3] and (ii) deposits in the Insured Depositary Institutions that belong to their senior management personnel.

For the purpose of the above, “deposit” is narrowly defined to include only the monies placed in the Insured Depositary Institutions for safekeeping, with return amount calculated according to an ex anteinterest rate and does not include other deposit-like or fixed-income financial instruments provided by the Insured Depositary Institutions, such as collective investment schemes.

Reimbursement Limit

The Draft sets the reimbursement cap (Reimbursement Limit) on a “per depositor, per institution” basis, according to which, on occurrence of any of the trigger events defined below:

• The reimbursement such depositor can receive for his or her deposits in such Insured Depositary Institution is no higher than RMB 500,000^[4] (as such amount may be adjusted by the SC from time to time).

• For the remaining outstanding principal and unpaid interest of his or her deposits, the depositor can claim only from the available assets of the failed Insured Depositary Institution.

Funding and Eligible Reinvestments

The proposed deposit insurance scheme will be funded on an ex antebasis, from the following principal sources:

• Premiums collected from the Insured Depositary Institutions, the premium rate applicable to each specific Insured Depositary Institution being (i) the base premium rate applying to all Insured Depositary Institutions plus (ii) the risk-differential premium rate determined according to the assessment of risk profile of each individual Insured Depositary Institution

• Assets recovered from the assets of failed Insured Depositary Institutions after required reimbursement

• Proceeds obtained by reinvestment of the above

Eligible reinvestments are limited to low-risk, highly liquid assets, such as (i) deposits in PBOC and (ii) Chinese central government bonds, central-bank notes, and highly rated bonds of Chinese financial institutions.

Reimbursement and Other Uses

The trigger events for intervention by the Deposit Insurer include receivership, closure, or bankruptcy of the Insured Depositary Institution, on the occurrence of any of which, the Deposit Insurer may, following the principle of minimum cost, choose to

• support other eligible Insured Depositary Institutions (by way of providing security or funding, or guaranteeing/sharing in the liabilities/losses incurred) in acquiring all or a portion of the business of the failed Insured Depositary Institutions; or failing which,

• subject to the Reimbursement Limit, make payment to the depositors or finance other eligible Insured Depositary Institutions in making the payment on its behalf provided that, once the Deposit Insurer has become the receiver or liquidator of the failed Insured Financial Institution, or the competent court has accepted the bankruptcy application against the failed Insured Financial Institution, depositors thereof are entitled to require the Deposit Insurer to make direct and timely payment.

This post was written with contributions from Yan Li.

_{[1]. In 1993, the State Council issued Decision on Reform of the Financial System, which posited the bankruptcy of failed financial institutions and the establishment of a deposit insurance scheme.}

_{[2]. Unlike Insured Depositary Institutions with foreign shareholding that are incorporated in China as independent legal entities, Foreign Bank Branches are only direct extensions of, and not legally or financially separated from, their foreign parent banks. Under People’s Republic of China laws, the capability of Foreign Bank Branches to take deposits from Chinese citizens is restricted (minimum fixed-deposit size of RMB 1 million).}

_{[3]. Inter financial institution deposits are the deposits that belong to financial institutions (including but not limited to banks, trust companies, securities companies, fund-management companies, and insurance companies) held by the Insured Depositary Institutions. Unlike ordinary deposits, the interest rate of which is determined by a depositary institution and highly regulated, and the interest rate of the inter financial institution deposits can be freely negotiated.}  

_{[4]. According to the investigation and research by the PBOC, the Reimbursement Limit is sufficient to cover the deposits of 99.5% of all depositors.}