With such broad authority, and given China’s two standing bank overseers — the PBoC and China Banking Regulatory Commission — experts urge a clear coordination mechanism.

The scheme, commonplace around the globe as a way to boost confidence and prevent bank runs, also serves as a great leap of faith in China, which seeks to introduce more disciplined risk-taking to the banking industry long dominated by giant state players.

Benefitting smaller banks

The scheme will significantly improve the competitiveness of medium and small-sized banks as the insurance will assure depositors of the safety of their savings, according to the central bank.

As a string of private banks look to join the game, deposit insurance will also put up the necessary foundation for potential insolvency risks. Chinese banks’ favoring of state-owned enterprises and disdain for private entrepreneurs has long been seen as one core problem of the economy’s imbalance.

The DIS is also seen as a monumental step of policy rate liberalization. Without deposit protection, smaller banks would most likely need to pay significantly higher rates to retain depositors under a fully liberalized rate environment, owing to the greater stability the larger banks could offer depositors, said Fitch ratings. As such, a deposit insurance plan will be essential to creating a more level playing field between larger and smaller institutions.

“Once the DIS is put into place, deposit rate liberalization, the transition for the central bank towards a new policy rate as well as the relaxation of the loan-to-deposit ratio will all need to speed up,” according to Yao of Societe Generale.

Moreover, the DIS could impact China’s vast shadow banking system, where wealth-management products have usually been protected under the previous universal government guarantee.

Taken together, the insurance will be an important development for further financial reforms to reduce moral hazard and inappropriate risk-taking by banks — by extension contributing to a more rational pricing of capital in the economy, said Fitch. Furthermore, Fitch views insurance as an important prerequisite for full deposit rate liberalization — a necessary reform for more market-determined pricing of capital.