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China to bring in bank deposit insurance, step towards liberalisation

BEIJING (Reuters) - China will introduce a scheme to insure bank deposits from May 1, the government said on Tuesday, ushering in a reform seen as vital for freeing up a highly-protected banking sector.

The scheme, which has been talked about in China for around 20 years but gained urgency last year, comes at a time of increased financial stress, as a slowing economy fuels bad debt problems.

Deposits of up to 500,000 yuan (54,561 pounds) will be insured under the scheme, which is expected to help reduce financial risks and protect the rights and interests of savers, the State Council, or cabinet, said on the government's website.

The move will bring China a step closer to dispelling investors' belief that its government will always bail out Chinese banks, no matter how reckless their dealings, just to protect depositors' savings.

Crucially, it will also let authorities abolish controls on deposit rates, which are still managed by Beijing to shield banks from competition and safeguard profits.

Banks must now "take responsibility for their own losses and profits", the State Council said in an online statement that was later inaccessible on Tuesday.

After staging one of the world's biggest bank bailouts from 1998, China has spent many of the ensuing years battling an implicit moral dilemma, in which banks and investors assumed the state would always pick up the tab for irresponsible lending.

Critics say the mindset could hurt the world's second-largest economy, as it encourages inefficient use of capital.

As China's economic growth grinds to an expected 25-year low of about 7 percent this year, the cost of indiscriminate lending is growing. Bad debt levels are already at multi-year highs.

But for Jiahe Chen, chief strategist at Cinda Securities, old habits are likely to die hard.

"Domestic depositors fundamentally don't believe that Chinese banks could go bankrupt and their money could disappear," Chen said.

"Even if you have the deposit insurance programme, if the bank really fails, depositors will still go to the government as a last resort."

FREEING UP DEPOSIT RATES

The cabinet said the scheme would cover both yuan and foreign currency deposits, and the government retained the right to adjust the maximum limit for compensation of 500,000 yuan, depending on the economy and financial risks.

To pay for the scheme, which will cover 99.6 percent of all savers, banks will pay into a deposit insurance fund to be managed by the central bank. How much each bank will have to pay in will be decided on a case-by-case basis.

The rules say premiums will be determined, among other things, by economic and financial developments, deposit structures and the risk management status of each institution.

The cabinet said the fund can invest in government bonds, central bank bills and other high-grade bonds.

Average deposit rates could rise by one percentage point if authorities do free up deposit rates, as expected, analysts at Capital Economics predicted.

"This would shift income to households equivalent to 0.8 percent of gross domestic product, helping to support consumption," they said.

(Reporting by Koh Gui Qing and Kevin Yao; Editing by Alan Raybould)