The People's Bank of China (PBOC), the mainland's central bank, is spearheading inter-governmental efforts to draft guidelines for the scheme.

The system, which is expected initially to take the form of a centrally and independently managed fund, would replace decades of tacit government guarantee of the safety of deposits in an industry previously dominated by state-owned players.

PBOC first explored the possibility of deposit insurance after the Asian financial crisis in 1997 precipitated the failure of a raft of small financial institutions. Compensating their depositors cost the government at least 100 billion yuan.

But regulatory efforts have gained momentum since last year, when another wave of smaller financial institutions went under, including trust companies controlled by now-disgraced private conglomerate D'Long.

The gradual privatisation of financial institutions has further called into question the propriety of using public finance to rescue failing private firms, which experts say also encourages moral hazards.

The State Council, the mainland cabinet, recently approved in principle the establishment of the deposit insurance scheme.

Although PBOC may produce a first draft of the regulation soon, it will take time to build consensus with other government agencies and obtain the State Council's final approval.

The plan being drafted is said to envisage the fund playing a role in helping liquidate failed banks on top of compensating depositors.

It would be financed primarily by mandatory contributions from all deposit-taking financial institutions in the mainland, although uncertainties remain over whether it would cover foreign banks' mainland branches and less risky postal savings bureaus, which have yet to gain independent corporate status.

Concern has also arisen over whether the much higher-risk rural credit co-operatives should be protected by the same fund.

Banks have already baulked at the China Banking Regulatory Commission's (CBRC) new regulation charges, estimated at a combined five billion yuan last year, meaning the new insurance system is unlikely to extract more than that amount from them annually.

Proposals have been tabled to levy different premium rates on banks, with lower-risk lenders paying less, to discourage depositors from seeking high yields on offer from risky banks.

But since the CBRC began a pilot only to calculate regulatory risk weightings, premiums might instead be determined by banks' capital adequacy ratios initially.

Until recently, individual depositors of bankrupt financial institutions received full compensation from the government while institutional claims were ignored. The new scheme would put both parties on an equal footing.

Depositors might be fully insured up to 100,000 yuan each, with the possible exclusion of deposits by shareholders and senior managers of the failed banks as well as inter-bank deposits.

Still uncertain is the coverage of foreign-currency deposits, although regulators are worried the exclusion of massive foreign-currency savings of mainlanders may encourage them to swap them into yuan, disrupting monetary policies.

Payout would be made only when financial institutions become defunct.

'The idea is there will be money only for a coffin, but not for medicine,' a source said.

A foreign credit analyst said efforts to establish such a system on the mainland might be premature and further tilt the scale towards large banks that were already receiving government help in financial restructurings.

'Smaller banks without government aid and in a worse financial state may end up paying higher premiums, creating unfair competition. It would also increase banks' financial burdens when they are trying to improve profitability [to write off bad debts],' he said.