China’s current banking system reminds me a lot of the US banking system in the 1920s:  opaque and therefore primed for funding “runs”.

My prediction for the future of China’s banking system is it adopts transparency and deposit insurance with a Chinese twist.

Specifically, I expect Chinese leadership will recognize deposit insurance eliminates runs by retail depositors.  There is no benefit to the Chinese leadership from the image of people standing in line to get their money back from the banks.

At the same time, I expect Chinese leadership to want to minimize the state’s exposure to the banking system.  Doing this requires investors including other banks, individuals, institutions, etc. being responsible for losses on their exposure to the Chinese banks.

The only way Chinese leadership can ensure holding investors responsible for losses is not disruptive is by having the banks disclose to the investors the information the investors need in order to know what they own (ie, transparency).  Investors understand the tradeoff from having the information they need is they will be held responsible for losses.  So they adjust their exposure to each bank to what they can afford to lose given the risk of the bank.  As a result, investors willingly, if begrudgingly, accept losses.

Please note, providing financial transparency does not require a change in China’s form of government.  On the other hand, it tends to expose misbehavior by bankers.