China's central government will loan money to financial institutions to help them pay off their debts to individual investors.

The debts are the result of such things as institutions being closed down, going bankrupt or being taken over.

The new rules were announced yesterday by the People's Bank of China, the Ministry of Finance and China Securities Regulatory Commission.

The central government's compensation will cover the following items: Individual bank deposits, the money individuals entrust to financial institutions and securities issued by financial institutions.

It also covers securities lodged at financial institutions that have been misappropriated, and individual investors guarantee funds at the securities companies.

The financial institutions covered by this new scheme do not include futures companies and insurers, the government's circular said.

The central government will pay the entire debt for individual bank deposits and guarantee funds when banks or brokers have problems.

But for other compensation items, the central government will shoulder 90 percent of the debt, with local governments paying the remaining 10 percent.

The compensation paid by the central government are loans to these financial institutions and must be paid back, according to the circular.

The assets of bankrupt firms will belong to the central government under the plan.

A protection fund for securities investors will be established, funded by financial institutions and the government, to pay any unsettled loans back to the central government.

The move is to protect the interests of small public investors and maintain the stability of China's financial market, said the circular.

China still lacks a sound legal system to prevent market irregularities. At the moment there is no bank deposit insurance and securities investor protection mechanism, said Dong Chen, a senior analyst at China Securities.

Most people do not have a deep understanding of market risks and brokers often take advantage of legal loopholes to engage in irregular activities, he said.

To protect small investors is a must to keep financial stability. Financial institutions are very special bodies because when they fail or go bankrupt they cause great losses to small investors and market panic. The panic often spreads to other sectors of society and can create social problems, the analyst explained.

When the former market leader Southern Securities fell into financial difficulties and was taken over by the government early last year, the central bank had to loan it an extra 8 billion yuan (US$986 million) to prevent investors rushing to withdraw their funds.

And when Xinhua Securities was closed down in December 2003 the central bank loaned it 1.5 billion yuan (US$185 million).

But the government cannot always bail out these firms, said Yi Xianrong, a Beijing-based economist.

This would lead to serious moral problems and does not encourage financial institutions to act properly, he said.

The securities investors' protection fund, which the government is trying to establish, would replace the government in future by offering compensation to small investors, according to the economist.

Investors should be responsible for their own investments. They have to learn to choose credible brokers, he said.

China has about 130 securities companies, but most of them are performing badly.

According to the Securities Association of China, last year 114 brokers lost a total of about 15 billion yuan (US$1.85 billion). That is the fourth consecutive bad year for China's securities companies.

The market regulators are now reshuffling the brokerage sector and experts say more than half of brokers will be forced out of the arena.

(China Daily July 28, 2005)