The establishment of a deposit insurance system will speed up China's bank reform through raising banks' competitiveness and promoting a fair financial environment, analysts said.

The People's Bank of China (PBoC), the central bank, published draft rules for a deposit insurance system on Sunday and started soliciting public opinion after 21 years of deliberation.

Under the draft rules, accounts with deposits of up to 500,000 yuan (81,500 U.S. dollars) will be insured per depositor if a bank suffers insolvency or bankruptcy.

Deposits exceeding 500,000 yuan will be protected under a fund to help well-managed banks acquire other banks that have serious problems, thus protecting clients by having their deposits transferred to well-managed banks.

Financial institutions will be required to pay insurance premiums into a fund and an agency be set up to manage the money. Domestic banks' overseas branches and foreign banks' China branches are exempt.

"The purpose of the insurance system is to protect depositors, step up supervision of banks and prevent risk in the financial sector", said Zong Liang, deputy head of the international finance institute of the Bank of China.

Thee scheme should stabilize the market expectations of depositors and increase public confidence in the banking system, especially improve the competitiveness of small and medium-sized banks.

"The system will raise the credit and competitiveness of small and medium-sized banks, and level the playing field for China's fragmented financial system where megabanks traditionally enjoy greater credibility with depositors," said Guo Tianyong of the Central University of Finance and Economics.

The Chinese banking sector is dominated by big state-owned lenders and their needs are not perfectly in line with small and private firms, who bear the brunt of high financing costs.

"Thus the deposit insurance system will help promote a fair environment for all financial institutions," Guo said.

China is one of several G20 countries that have yet to adopt deposit insurance scheme, which protects depositors, in full or in part, from losses caused by a bank's inability to pay its debts when due.

The insurance adds a layer to the financial system safety net and promotes stability, as its absence usually implies a compulsory role for the state in dealing with bank runs.

Therefore, the deposit insurance scheme could help to foster a proper relationship between government and market,and help China's banks to operate more in line with market principles, a report from the Bank of Communications concluded.

"With the scheme in place, the government will retreat and leave banks to bear their own risks and depositors will probably choose to put their money in banks with greater safety for deposits," the report said.

The report suggested that the coordination among the PBoC, China Securities Regulatory Commission and the deposit insurance agency should be clear to avoid supervision overlap or a twilight zone.

The report also advised that the deposit insurance agency should step up the supervision on problem financial institutions to prevent financial risks. Endi