Collapse Rumor Causes Customer Withdrawals And Panic At Small Chinese Bank

SHANGHAI (Reuters) - Hundreds of people rushed to withdraw money from a branch of a small Chinese bank after rumors spread about its solvency, reflecting growing anxiety among investors as regulators signal greater tolerance for credit defaults.

The case highlights the urgency of plans to implement a deposit insurance system to protect investors' deposits in case of bank insolvency, given that Chinese are growing increasingly nervous about the impact that slowing economic growth will have on the viability of financial institutions.

Regulators have said they will roll out deposit insurance as soon as possible, without giving a firm deadline.

Domestic media reported, and a local official confirmed, that ordinary depositors swarmed a branch of JiangsuSheyang Rural Commercial Bank in Yancheng in economically troubled Jiangsu province on Monday.

Bank Chairman Zang Zhengzhi was quoted as saying the bank would ensure payments to all the depositors. The report did not say how the rumor originated.

Why Yancheng investors suddenly lost confidence in the security of their bank deposits is not clear, given that theSheyang bank is subject to formal reserve requirements, loan-to-deposit ratios and other rules to ensure they keep sufficient cash on hand to meet demand.

Bank failures in China are virtually unknown, as Chinese banks are considered to operate under an implicit guarantee from the government.

Finally, the central bank has eased up on money rates since February, and traders say liquidity in the interbank market -- where banks like Sheyang bank can tap short-term funds to meet depositor demand -- remains relatively relaxed.

"It's true that these rumors exist, but actually (the bank going bankrupt) is impossible. It's a completely different situation from the problem with the cooperatives," said Zhang Chaoyang, an official at the propaganda department of the Communist Party committee in Tinghu district, where the bank branch is located.

Zhang was referring to an incident that rattled depositors in Yancheng in January, when some local rural cooperatives -- which are not subject to the supervision of the bank regulator -- ran out of cash and locked their doors.

Local officials say several co-op bosses fled after committing fraud.

China's central bank governor said earlier this month that deposit rates are likely to liberalized in one to two years - the most explicit timeframe to date for what would be the final step in freeing up banks to set their own interest rates.

It is widely expected to introduce a deposit insurance scheme before liberalizing deposit rates to protect savers in case a freed-up market leads to major strains on smaller banks and alarms the public. Analysts also expect the controls on deposit rates to be lifted gradually. Is China's debt nightmare a province called Jiangsu?

DEFAULT FEARS

Local and global investors in China have taken note of Beijing's recent decision to allow China's first domestic bond default by Shanghai Chaori Solar Energy Science and Technology Co Ltd in March. Officials have indicated publicly that they are not worried that more defaults will damage economic stability.

In the past, domestic bond issuers were routinely bailed out by local governments and banks, and the willingness of regulators to let Chaori miss interest payments negatively impacted rates in Chinese offshore credit markets.

More recently, media also reported a heavily indebted real estate developer in Zhejiang province was at risk of defaulting on 3.5 billion yuan ($565 million) worth of loans -- a situation that has yet to be resolved.

When contacted by Reuters by phone on Tuesday, an official at the Jiangsu Sheyang Rural Commercial Bank branch hung up, saying she was busy.

An official at the administrative office at Jiangsu Sheyang Rural Commercial Bank said the bank would publish a statement shortly. On its website, the bank says it is capitalized at 525 million yuan ($85 million) and had total deposits of 12 billion yuan as of end-February,

Officials at the Jiangsu branch offices of the China Banking Regulatory Commission (CBRC) declined to comment. The Yancheng branch of CBRC and the propaganda offices in Yancheng city and Sheyang county did not answer calls seeking comment.

($1 = 6.1888 Chinese Yuan)

(Reporting by Gabriel Wildau, Xu Yong, Pete Sweeney, Samuel Shen, John Ruwitch and Shanghai newsroom; Writing by Kazunori Takada; Editing by Kim Coghill)