Chinese lenders may soon be able to seek bankruptcy protection legally, a top official at the banking regulator said.

A legal framework for the system will be put in place over the next five years, Shang Fulin, chairman of the China Banking Regulatory Commission, said in a recent article to the fortnightly China Finance.

Shang said China will promote normalization and standardization of the financial market exit mechanism and the upcoming legal system will be in line with China's conditions.

Wu Qing, deputy director of banking research at the Development Research Center of the State Council, said: "Restructuring, mergers and acquisitions are likely to become the major choices for unhealthy banks to exit from the financial market."

Bankruptcy is also considered as an option, but it will not be prioritized due to the huge losses that would be brought by the stoppage of financial services once the liquidation procedure starts for a bank, he said.

The banking regulator requires small commercial lenders to have substantial shareholders to apply for a banking license. If the banks fail, they will be restructured based on the strength of the substantial shareholders.

Early last year, China launched a deposit insurance system, which was officially put into effect on May 1. The cap for the system is 500,000 yuan ($76,800) per depositor per bank. Banks will pay a fee for the insurance that will be divided into two parts, a flat fee and risk-based fee, which will vary according to their state of operation and risk management capability.

Analysts said the deposit insurance system will offer a market-based solution for banks that fail in an increasingly complex business environment.

Huatai Securities Co Ltd said in a report that the banks used to benefit from an implicit State guarantee but after the launching of the deposit insurance system, a governing body for deposit insurance funds will pay out losses of deposits if the money recovered from a bank's liquidation is not enough for reimbursement. This will help banks improve the efficiency of capital allocation and optimize credit structure.

Wu said banking regulators and the governing body for deposit insurance funds will lead the efforts in handling unhealthy banks. Foreign institutions also have the opportunity to participate in the process.

Traditional banks are facing increasing pressure from accelerated interest rate liberalization, a boom in Internet finance, and the slowdown of Chinese economy.

By the end of September, outstanding nonperforming loans of lenders increased to 1.19 trillion yuan, up from 766.9 billion yuan a year earlier.