Asia Times: Taiwan's banks: chickens come home to roost


	August 18, 2001	atimes.com

China

Taiwan's banks: chickens come home to roost
By Laurence Eyton

TAIPEI - Like a scene from The Untouchables, 200 government agents barged into Taiwan banks last week in the first real attempt to make an impact on the island's festering financial weaknesses.

The targets were 36 "second-tier" institutions, credit cooperative and agricultural associations, grass-roots savings institutions akin to United States thrifts. The combined negative net worth of the 36 banks is estimated at NT$30 billion (US$870 million).

Of the 36 targeted banks, 14 agreed to turn their management over to the Financial Rehabilitation Fund, an institution established only in June, similar to that of the Resolution Trust Corp set up in the US to sort out the savings and loan mess in the 1980s. The remaining 22 banks will have their management supervised by the fund for the next two months, with the fund retaining the option of taking over completely if their financial position does not improve.

The action last Friday marked the first real intervention of the fund in the management of Taiwan's financial institutions, and as such it has received some very mixed reviews.

On the one hand, banking sector analysts who have long been worried by the parlous state of Taiwan's banks have expressed relief that something at last appears to be happening to tidy up the sector. One the other hand, there has been criticism that the fund's actions are insufficient to make any real difference to Taiwan's bad debt problem.

Also, the lenient treatment handed out to managements replaced by the fund and the government's insistence that not a single Taiwan dollar of depositors' money will be lost as a result of its action has led the internationally respected ratings agency Standard & Poor's to issue a terse warning about the problems of "moral hazard" the government's behavior might generate.

And finally there is a doubt that the resources of the fund, amounting to NT$140 billion, are really enough to finance a general clean-up of Taiwan's banking system.

Evaluating the size of Taiwan's banking problems is difficult. According to the central bank, earlier this month the nonperforming loan ratio is 6.47 percent. But this figure is probably meaningless, partly because Taiwan waits twice the standard time - six months instead of three - before an unserviced loan counts as nonperforming, and also because banks have no standardized reporting procedures to the central bank, and those figures they do report are heavily massaged.

Taiwan Ratings, the Taiwan branch of Standard & Poor's, has estimated the real bad loan ratio to be 10 percent, probably rising to 12 percent, by the end of the year. If central bank figures about loan volumes are to be believed, then 12 percent of the total could be as much as a staggering NT$1.7 trillion.

Compared with this, the capitalization of the Financial Reconstruction Fund looks puny indeed. In fact, it is really only adequate to bail out the second-tier institutions, and most experts see it as incapable of making headway against the sea of red ink swamping the island's commercial banks.

That Taiwan is facing such problems might come as a surprise to neighbors who spent at least some of the dark days of 1997 being told how Taiwan had successfully avoided the traps that had plunged the rest of the region into financial crisis. The reality is that if Taiwan has avoided a Korea-style meltdown of its financial sector so far, it is probably because its government, sitting on foreign exchange reserves of around US$100 billion and minimal foreign debt actually could afford to bail out the sector if it had to.

Added to this is a reluctance on the part of politicians to score points at the government's expense over its rather lackluster attempts to handle the problem so far. And this has much to do with how the problems came about.

Back in 1997, Taiwan appeared to have an economy that was proof against the deleterious effects of the crony capitalism that laid so much of the rest of Asia low. This was something of a shock to old Taiwan hands who were well aware that crony capitalism was rife in Taiwan, that the leaders of most of the island's major conglomerates were members of the ruling party's 210 member-strong Central Committee, and that the party, the Kuomintang (KMT) itself, as well as filling the regulatory role of the political party in power, was also the island's third biggest business conglomerate.

They were, of course, also aware that the banking sector was dominated by state-run banks highly susceptible to political influence and that the grass-roots financial institutions were part of a political spoils system, the main function of which was bankrolling KMT election campaigns in return for a level of supervision verging on non-existent.

The result of this is that many of the biggest defaulters are connected with what has, since May last year, been the political opposition. That these companies depend on the goodwill of the government has bought it an easy time at the expense, perhaps, of properly addressing the problem.

Most independent analysts are in agreement that what the government should do is let some of the most indebted conglomerates, such as Tuntex, a chemicals giant trying to reschedule NT$50 billion in debt, go to the wall. What it has done instead is continue a KMT policy of rolling over problem loans until "the economy improves".

This government indulgence is motivated largely by a fear of unemployment. Keeping companies in business equates with keeping people in work. Given that Taiwan has minimal welfare provision for the unemployed and a government budget deficit running at a worrying 6 percent - thereby precluding more funding for unemployment relief - this is a government priority.

The problem here is, of course that the economy is not improving but lurching further into recession - growth is expected to drop to near zero this year for the first time in living memory. Indeed, on Friday the Directorate General of Budget, Accounting and Statistics announced that economic growth had plunged to minus 2.35 percent in the second quarter of the year. It said the poorer-than-expected performance would drive down the estimated growth for the whole year from 4.02 percent to minus 0.37 percent.

The government indulgence leads to two negative effects. The first is a moral hazard problem. Since companies do not have to pay for their bad business decisions, there is little incentive to conduct their affairs more prudently.

Secondly, the government's policy of rolling over loans waiting for an upturn has resulted in a liquidity shortage. Banks simply don't want to lend at the moment because they know that borrowers have what amounts to the government's carte blanche not to service their debt.

Even were the banks to foreclose on the assets of companies not servicing their loans, however, it is not at all certain that their problems would be eased. That's because at least 50 percent of the bad debt is collateralized with property and Taiwan's property market is in an all-time slump.

Some 1.25 million housing units are standing empty, the result of enormous over-building in the early 1990s. And while asset management companies have been established to buy up bad debt from the banks, many managers of such companies believe that housing prices would have to fall by up to 50 percent before such assets became marketable. Yet this kind of steep decline in property prices would have an ugly effect on the value of the collateral the banks still held.

Obviously something has to give. The problem is that nobody knows what. Tough action might precipitate the liquidity crisis that a number of outside observers, including The Economist and the Nomura Research Institute, have predicted. But less robust action is likely to just perpetuate the current mess, with Taiwan following Japan's lead down the road to resultant economic stagnation.

It is indicative of a lack of government resolve on this mater that in the wake of the raids last week Finance Minister Yen Ching-chang was quick to reassure that no second wave of raids was planned.

And the government's behavior has shown other areas in which moral hazard raises its head. Standard & Poor's pointed out earlier this week that knowledge that the government was prepared to step in when necessary hardly encouraged an improvement in lending practices. Nor does the government's guarantee encourage the public to eschew risky financial institution offering significantly higher interest rates in favor of more modest returns from more stable banks.

What the company did not say, though, was that all of the officials ousted from the 14 credit institutions taken over by the fund were moved to alternative work at the council of agriculture. Nobody lost their job as a result of mismanagement.

In addition to this, there has been no indication that criminal charges might result from a thorough auditing of the institutions' books, even though many bad loans were made in contravention of Taiwan's strict banking laws regarding collateral provision.

For the time being, the verdict on the first outing of the Financial Rehabilitation Fund to clean up the murky world of Taiwan's banks can only be approval that something is at last being done, mixed with apprehension that that is not nearly enough to avoid a deepening of the problem and a crisis in the future.

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