As the overdue loan ratio moves into record territory, analysts said slowing economic growth is likely to exacerbate the situation.
"Taiwan has both the money and the resources to resolve the problem," said Anthony Lok, regional banking analyst at Nomura International in Hong Kong. "The question is whether it has the political will to push through reforms."
Spencer White, head of research at Merrill Lynch Securities in Taipei, believes that the sharp increase in the overdue loan ratio reflects "rising stresses" in the banking system.
Actual overdue loan ratios, he believes, are at least "50 to 100 percent" higher if calculated based on international standards.
In Taiwan, the government classifies loans as overdue when interest payments or principal are six months past due.
Analysts, however, say reasons for optimism abounds. "Taiwanese banks generally have a substantial amount of capital on hand, so their ability to absorb the damage is much higher," Lok said.
Taiwan's other strengths include lower corporate debt and strong exports, according to another analyst.
But overdue loans will not peak until the domestic economy picks up steam sometime next year.
"We still expect to see a further downside in the cycle before we see some pick up in the leading indicators," said Neal Stovicek, head of equities research at National Securities.
The government plans to counter the problem by setting up asset management companies with foreign institutional investors to clean up the bad loan mess in the banking system.
Merrill's White said that setting up asset management companies and a US-style Resolution Trust Corp are two feasible solutions.
However, the asset management companies may create a situation where corporations intentionally default on their loans.
"There is a risk of encouraging voluntary defaults by corporations so that they can buy [company collateral] back from asset management companies at a cheaper price," he said.
Analysts are not currently recommending most Taiwanese banking shares. But Lok said the business prospects of Chinatrust Commercial Bank (
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