China predicted to launch deposit insurance system this year

Find out what the 4 major features could be.

According to Barclays, financial sector reform is the stated top priority for China's new central government.

The analyst expects competition to be further intensified within the financial system as a result of accelerated financial sector reforms, including interest-rate deregulation, the opening-up of the capital account and disintermediation.

Here's more from Barclays:

We believe this will require China to build a comprehensive financial safety net to protect public interests and to enable failed financial institutions to exit the market without causing system turmoil.

Therefore, we expect the government to soon introduce an explicit deposit insurance system (DIS) in China. In this report, we: 1) review the historical development of a DIS in China;

2) analyse the Chinese regulator's goals and concerns in introducing a DIS; 3) review the likely key features of a DIS if one were introduced in China; and 4) estimate the impact of a DIS on China's banks.

A long journey to an explicit deposit insurance system: An explicit DIS has been under extensive consideration by the government for more than 20 years. The factors that have delayed it appear to have subsided, and it looks to us like China is ready to start a DIS.

Regulators to soon launch the DIS: We would expect a DIS could be introduced this year at the earliest. A DIS is a practice widely adopted by countries around the world, and appears consistent with the Chinese authorities' goal to build a better-functioning financial market with fair competition for both large and small institutions as reforms increase competition.

We also believe some common concerns of introducing an explicit DIS, such as moral hazard and deposit migration, are legitimate but unlikely to have any major negative impact.

Major features we would expect for a DIS in China: 1) A government-administered "risk minimizer" actively involved in supervisory monitoring and failure resolution of troubled banks; 2) compulsory membership for deposit-taking institutions of all sizes;

3) a coverage limit of cRMB200,000-500,000, which would protect more than 99% of deposits; 4) a target size for deposit insurance funds at 0.5% of covered deposits, ex-ante, funded by fees charged on banks, likely to initially be based on a simple fee by size of bank and eventually benchmarked to banks' risk profile, as assessed by bank regulators.

Only moderate impact likely on net profits and ROEs of banks: We estimate the immediate negative impact of a DIS on our net profit estimates for 2014 for the China banks in our coverage universe at -0.86% to -1.91% and the impact on ROEs at -19bps to -36bps.

We estimate it would take the fund 13 years to reach our assumption for target size of 0.5% of insured deposits. Although the market may interpret a DIS as the beginning of accelerated financial reform, creating a negative impact on bank shares, we estimate that any negative impacts on banks' financials would be manageable and we believe the benefits of a DIS in the China banking system would outweigh the negatives in the long run.