The proposal of China's State Council to remove the mandatory loan-to-deposit ratio (LDR) for banks will have limited impact on the overall lending system, but could benefit small banks and spur more borrowing, according to market analysts.

China has imposed the LDR restriction at 75% since 1995, but now the government sees it a hindrance to banks' lending capability to the sectors that are in dire need of funding, such as agriculture and small-and-micro enterprises.

The ratio will instead be seen as a liquidity indicator in the future, the State Council says in a statement after a meeting led by Premier Li Keqiang (李克强) on June 24.

The ratio of total loans to deposit gives a picture of the bank's liquidity. A ratio that is too high means banks may run into some liquidity problems to cover certain fund requirements. If it's too low, it could mean that banks may not be earning enough.

"We think the impact of the LDR removal on overall bank lending should be limited in the near term. However, for some small/regional banks, which do not have the same capacity to source deposits as their large/national counterparts, the LDR is a more binding constraint," says Aidan Yao, senior emerging market economist at AXA Investment Managers.

Jiang Chao (姜超), chief macro economist at Haitong Securities explains in a note to clients that as of first quarter 2015, Chinese banks' LDR overall stayed at 65.7%, well below the 75% limit. However, some joint-stock banks have reached the upper limit, such as China Merchants Bank and China CITIC Bank.

The removal of the limit may enable LDR in some banks to exceed 100%, and "that will enhance banks' capability to serve the real economy," says Jiang.