China's push for bank resolution and deposit insurance is credit negative for small banks, said Moody's Investors Service in a report released on Monday.

"For small Chinese banks, these new elements are credit negative because they weaken the government's incentive to provide support to them," said Katie Chen, associate analyst at Moody's and writer of the report.

China's State Council recently announced that it had approved a plan that outlines the country's financial industry development during the 12th Five-Year Plan (2011-15), which serves as a guide for future legislation and policy.

Insisting on market-oriented principles, the plan called for the establishment of a deposit insurance system and bankruptcy mechanism as part of a framework to facilitate the orderly winding down of failing financial institutions.

While these measures would protect the stability of the banking system, they would weaken the government's incentive to provide support, especially to small banks, putting them at risk of net interest margin compression while market reforms accelerated and resulting in small banks paying higher deposit premiums for perceived deposit risks, said Chen.

Small banks are deposit-taking credit institutions that have limited geographic exposure and networks in China, which include city commercial banks, rural credit cooperatives, rural commercial banks, and rural cooperative banks.

At the end of 2011, China had 2,811 small banks, accounting for 20 percent of overall banking system assets, while the five large commercial banks and 12 joint-stock commercial banks together held 64 percent of total bank assets, according to the report.

The new plan contains significant operational detail compared with the 11th Five-Year Plan, which means its aims are more likely to come to fruition during the planning period, the report said.

"Specifically, the plan highlights the need to accelerate legislation to create a deposit insurance system and to implement it at the proper time. It also mentions establishing a bankruptcy mechanism, which was not specified in the previous plan."

The deposit insurance system is expected to be in place within the next two years.

wangxiaotian@chinadaily.com.cn