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Bad loans are a crisis in the offing

`Because loans acquired through political means have the highest default rates, they crowd out the financial resources of healthy traditional industries, thereby creating a vicious cycle.'

Taiwan's stock market has slumped ever since the new government came to power on May 20. To rescue the market, the government has even announced that it will cancel the current two percent business tax on financial institutions. The purpose of this measure is to help to do away with bad loans at domestic banks.

But even though the non-performing loan ratios at our financial institutions fell briefly after the business tax rate was cut down from five percent to two percent last year, the ratio has climbed up again since early this year, to the point of setting a record high of around six percent. The non-performing loan ratio at Taiwan's grassroots-level financial institutions has also soared to 15 percent -- up from around eight percent in 1997. We can therefore see that lowering the business tax on financial institutions does not help reduce non-performing loans.

In fact, the main problem at all Taiwanese financial institutions is the indiscriminate granting of loans. The financial institutions are heavily saddled with loans secured through political and personal relationships. A politician can easily acquire a hefty loan from banks through political ties. When the politician later fails to pay up, the banks are compelled to absorb the non-performing loan. Because loans acquired through political means have the highest default rates, they crowd out the financial resources of healthy traditional industries, thereby creating a vicious cycle.

The root of these problems lies in the improper ties between politicians and businesses. To solve this problem, the government should start with institutional reforms, reviewing the whole financial framework, instead of lowering the business tax on financial institutions. Reducing the tax simply makes the domestic banks more audacious. Because the government will not look on with folded hands when a bank's operations are faced with a major problem, a serious moral crisis ensues.

Such a situation is no different from Thailand before 1997. When the Bangkok Bank of Commerce, which had good political ties, was faced with a crisis due to a high non-performing loan ratio, the Thai government did not initiate institutional reforms. Instead, the finance ministry and the Bank of Thailand pumped in even more money to rescue the bank. This eventually led to Thailand's 1997 financial crisis.

After the financial crisis, however, Thailand accepted advice from the International Monetary Fund and launched institutional reforms, including the closedown of 56 financial companies that had not been run well; setting up a strong legal framework; undertaking corporate debt management plans; setting the framework for the mergers of financial institutions and a clear schedule for their privatization; and so on. In contrast, Taiwan is still resorting to short-term methods and partial solutions in handling its financial problems. The government either lacks the determination to begin institutional reforms, or is impeded by opposition from people who have the power to veto the reforms.

The amendment of the Farmers' Association Law (農會法) is a glaring example. According to statistics from the Ministry of Finance, the non-performing loan ratio at Taiwan's grassroots-level financial institutions (including farmers' and fishermen's associations) reached 14.83 percent by June of this year, very close to the 15 percent level the finance minister recently presented to the Legislative Yuan as a criterion for the outbreak of a financial crisis.

Now, reforms for the credit departments of farmers' associations are ready for launch. The amendments to the Farmers' Association Law, however, which contain provisions excluding "black gold" elements from the management of farmers' associations -- have been rejected by lawmakers on the Legislative Yuan's Rules Committee.

In the late 1990s, quite a few bank runs occurred at Taiwan's grassroots-level financial institutions. Behind those bank runs was the collusion between local political factions and the managers of these financial institutions. Such collusion is most serious in the credit departments of farmers' associations, which have long been a target of public criticism for being the treasuries of local factions and for being major vote-buying machines during elections.

The transition of political power has ushered in an opportunity to tackle these problems, but the reforms have faced strong opposition from legislators, simply because they will have an impact on the legislative, mayoral and county commissioner elections at the end of next year. Thailand's experience tells us that, under the current circumstances, Taiwan's grassroots-level financial institutions are time-bombs waiting to explode.

Aren't our legislators alarmed at all by a possible explosion and the ensuing crisis?

Chen Shang-mao is associate researcher at the Foundation for National Development Research.
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