China's top banking regulator is drafting rules on bankruptcy risk handling for commercial banks, aiming to provide sufficient guarantees for rapidly and thoroughly dealing with banks in crisis.

In reply to a proposal by the fifth session of the 12th National People's Congress, the top legislative body of China, the China Banking Regulatory Commission said it will strengthen communications with legislators to push forward with legal protection for close-out netting, the primary means of mitigating credit risks associated with over-the-counter derivatives. The CBRC will also communicate with the International Swaps and Derivatives Association on establishing a close-out netting arrangement for Chinese commercial banks.

"The upcoming regulation on bankruptcy risk handling for commercial banks will set a sound legal foundation for a bank to withdraw from the financial market at a low costs, low risks and high efficiency," said Zeng Gang, director of banking research at the Institute of Finance and Banking under the Chinese Academy of Social Sciences. "The launching of the withdrawal mechanism, which is in accordance with China's interest rate liberalization and financial marketization, will help prevent spillover risk among banking institutions. It doesn't mean a large number of Chinese banks will collapse."

Added Wu Qing, director of the comprehensive research office of the Research Institute of Finance at the Development Research Center of the State Council: "It is absolutely necessary to establish the legal procedures to deal with bankruptcy of commercial banks, as the regulator will make laws to empower banks to handle crises proactively and in advance."

China launched a deposit insurance system in 2015, announcing that accounts with deposits of up to 500,000 yuan ($74,863) per depositor will be insured if a bank suffers insolvency or bankruptcy.

Compared with the introduction of a deposit insurance scheme, it is more important to establish the legal and risk disposal procedures, Wu said, noting it is increasingly possible that bankruptcy will occur in China's banking system as time goes by.

"The risk will be higher at small -and medium-sized banks, especially some newly founded village and township banks, if they fail to reach net profit on a profit and loss account in the next few years."

Foreseeing an uneven distribution of risks, he said city commercial banks and rural commercial banks, faced with increasingly intensified competition, are in danger of losing business, and technological advancement is likely to reshuffle the banking industry, thus leaving some banks in a crisis of survival.