James A. Dorn reports:  The International Monetary Fund (IMF) has recommended that China institute deposit insurance before embarking on interest rate liberalization and opening its capital markets. Higher rates on deposits may encourage more risk taking by banks and some of the lending/investments may go sour. The IMF sees deposit insurance as a way to prevent bank runs.

That logic may be true, but deposit insurance also encourages banks to take more risk, because ultimately taxpayers will have to make depositors whole if a bank fails. Most banks in China are already state owned and have an implicit guarantee that the government will not let them go bankrupt. Deposit insurance may help smaller private banks compete against the giant state banks. But the real problem is not the lack of deposit insurance; it is the lack of private ownership and responsibility that permeates China’s financial sector.

Introducing deposit insurance is a double-edged sword: it may help protect depositors but it also increases risk taking and could be costly to taxpayers. China’s move toward liberalizing interest rates does not require government deposit insurance; it requires a genuine rule of law that safeguards personal and economic freedom, and holds those who make unwise investment/lending decisions responsible.

W-T-W.org notes: In the US, insuring depositors (among other protections)  has led bankers to take unreasonable risks and caused the expenditure of a great deal of taxpayer money.  Bankers go scot free.