Towards a Deposit Guarantee Insurance in China? A Law and Economics Perspective

Deposit guarantee insurance has been a very debated topic both in the USA and in Europe. Deposit guarantee insurance is considered to be a highly important mechanism to prevent bank runs and to restore depositor confidence, which is why both in the USA and in Europe during the financial crisis measures were taken to increase the coverage amounts. Interestingly, China is also considering the introduction of a deposit guarantee system. China has indeed known many cases of bank failures recently. Until approximately 20 years ago, this may not have been a big problem in China for the simple reason that all banks were state owned and an implicit guarantee system was provided via the state. However, with privatization of financial markets also occurring in China, bank runs and resulting bank failures have also begun to occur in this country. Attempts have been taken to introduce a deposit guarantee scheme, but they were put on hold because of the financial crisis. This article looks at the particular situation of China, not only addressing some of the instances of bank failures but also studying the particular design problems that may arise in the Chinese context, in the light of experiences in the USA and Europe. Indeed, from the US and European experience, it is well known that, on the one hand, deposit insurance may have many beneficial aspects (preventing bank runs), but, on the other hand, it may also create problems of its own (in particular, creating a moral hazard on the side of financial institutions and neglect on the side of depositors). The article examines how these problems may play out in China and also argues that given the fact that the big five Chinese banks are still state owned introducing risk dependent contributions (which is now advocated in the USA and Europe) may not be appropriate in China.