"Establishment of a deposit insurance system will help to better protect the interests of depositors and maintain public confidence in the financial markets and the banking system," the State Council said.
Foreign bank branches operating in China, along with the overseas branches of Chinese banks, will not be covered by the scheme, the draft document said.
All banks under the system will be required to set aside capital, to be collected by China's central bank and administered by a deposit insurance fund, to pay for the scheme.
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China's cabinet will approve standard rates for the insurance program, along with additional risk rates, the draft regulations said. No details were provided. The deposit fund will be permitted to invest in government bonds, central bank notes, and highly-rated financial bonds.
"From a long-term perspective, the impact on smaller banks will be bigger," said Chen Xingyu, banks analyst at Phillip Securities (Hong Kong) Ltd, before the announcement.
"Depositors may prefer to put their deposits in the larger banks, so the risk of capital outflows from smaller banks will increase."
Control of deposit rates is a legacy of China's state planning and its financial troubles in the early 2000s, when its biggest banks were technically insolvent and bailed out by the government.
Authorities have since kept a close eye on financial institutions, and have in the past dictated a minimum level for lending rates that banks had to comply with. The floor was scrapped in July 2013.
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The restrictions have been criticized by economists, who say they distort credit costs by artificially depressing deposit rates and fueling wasteful investment. China, they say, should instead allow markets to set the costs of lending and borrowing.
In a landmark measure, China removed controls on bank lending rates last July, but left a ceiling on deposit rates intact.
China's central bank further eased deposit rate restrictions earlier in November when it allowed domestic banks to pay savers as much as 1.2 times the official benchmark level. The ceiling was previously set at 1.1 times.
The move on Nov. 21 was accompanied by China's first interest rate cut in more than two years as authorities tried to lift flagging growth in the world's second-largest economy.