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China bank deposit insurance could tilt competitive landscape

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China's newly announced deposit insurance scheme could pressure margins at struggling state-owned banking giants, but the country's small lenders still have their work cut out to take market share from the big players.

China's cabinet announced on Tuesday that a long-awaited deposit insurance scheme - covering 99.6 percent of depositors for up to 500,000 yuan ($80,700) each - would be launched on May 1.

China's largest banks have long enjoyed an advantage in attracting deposits because customers view them as having an implicit state guarantee. By extending a guarantee to deposits at all banks, the government theoretically erodes that edge.

Comments from some savers suggest that a credible deposit insurance scheme might indeed benefit small banks.

"I split my saving deposits at different banks before this deposit insurance came out, as it can lower the risk. Who knows what may happen to these banks?" said a security guard at a small bank in Shanghai who asked to remain anonymous.

"I invest in some wealth management products here. But I don't keep my savings here. Big banks are more trustworthy."

While Chinese banks are largely state-owned and almost never go bankrupt, recent years have still seen rare runs on smaller financial institutions, including rural cooperative banks, that have mismanaged their cash.

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For example, in March 2014 a rumor sparked a three-day bank run in the small city of Yancheng that led banks to pile stacks of cash behind teller windows to reassure depositors they were liquid.

Freeing deposit rates

The reform also sets the stage for full liberalization of deposit rates, which would allow smaller banks to compete on the basis of deposit yields, seen as a key step toward letting the market, not the state, set the price of capital and risk.

Deposit rates in China have already been partially liberalized - banks can set their actual deposit rate at up to 1.3 times the official rate.

But big banks have been loath to try to use higher rates to attract savers, given that the central bank is determined to push lending rates down - so raising deposit rates would only compress profit margins - and bankers who spoke to Reuters said they expected this to persist even after liberalization.

An online survey of 14 large national banks on Wednesday showed no meaningful adjustments in deposit rates following Tuesday's reform announcement. In fact, large banks have for the most part been content to let deposit yields stay steady or fall since the People's Bank of China granted greater flexibility in November.

Small banks have more latitude to raise deposit rates, since they often lend to riskier borrowers and so their lending rates are also much higher. Indeed, some have already begun doing so since the first in a series of central bank rate cuts in November.

"To an extent this segmentation has already happened," said Julia Wang, a China economist at HSBC bank in Hong Kong.

"The large state-owned clients are already very well served by the big SOE banks. The smaller banks have carved out a niche lending to riskier and/or more productive enterprises at higher rates. As a result every time there is an incremental move on interest rate liberalization, you usually see a bigger reaction from the small banks."

For other savers, higher returns outweighed safety, suggesting true rate liberalization remains the key step.

"I don't have much savings, but I purchase wealth management products at banks," said Ye Hao, a recent college graduate. "Whoever offers a higher rate, that bank is the go-to place for me."