China is considering setting up a deposit insurance company to improve financial stability, central bank governor Zhou Xiaochuan said Thursday.

Establishing an insurance system for deposits is an urgent need of the Chinese government, Zhou told visiting US Federal Deposit Insurance Corp (FDIC) chairman Sheila Bair, according to Xinhua News Agency.

Such a mechanism will help make the financial market more active, and encourage small and medium financial institutions to offer services to farmers, Zhou was cited as saying.

"The time has come to put the arrangement into place as the macro-economy and bank reforms are going smoothly; the financial sector is opening wider to the outside world, and supervision of the financial sector is improving," Zhou told Bair.

China could learn from FDIC in strengthening supervision, promoting financial services, and enhance financial stability, according to Zhou.

The two sides have signed a memorandum of understanding on improving financial services, deposit insurance, personnel and information exchanges, the report said.

A deposit insurance system will give borrowers confidence to deposit money with smaller banks, especially in rural areas, Dow Jones newswire cited Bair as saying.

Bair said China could reference the American deposit insurance system because the two countries are comparable in having a large geographical area with many small towns and rural areas, the report said.

Deposit insurance is a measure introduced by policy makers to protect deposits, in full or in part, in the event of banks being unable to pay deposits. The insurance can maintain public confidence in the financial system and prevent bank runs, thus helping promote financial stability.

The United States was the first country to establish an official deposit insurance scheme, during the Great Depression in 1934. Currently, nearly 100 countries have such an arrangement in place.