The adoption of the three-tier risk-control mechanism meant to correct the bad loan situation in the credit units of farmers' and fishermen's associations, which is part of the Cabinet's financial reform program, has finally been suspended as a result of loud protests from various circles.
Even though this decision by the authorities shows an over-simplified understanding of the problems facing grassroots financial institutions, we believe that the ability to amend a policy when it encounters problems is a good way to limit social cost. However, we would also like to take this opportunity to submit a few suggestions that could serve as points of reference for future government reform of these institutions.
First, the government never seems to have had a clear understanding of the true factors behind the bad loan problem in the credit units, believing the problem was one of bad management and embezzlement.
We don't deny this. In many farmers' and fishermen's associations the excessive amount of bad loans is indeed a result of uneven staff quality, poor credit evaluation, political interference and even high-level corruption. But this is by no means the whole truth. If we look back in time, we will see that these credit units used to stand out among financial institutions and that they used to outperform regular commercial banks.
The performance of the credit units peaked in 1990. That year, the overall net return of credit units reached 26.46 percent, the return on assets was 1.04 percent and non-performing loans (NPLs) stood at a mere 1.8 percent. Same system, same operations. Why is the situation so different 12 years later? We can not blame bad management and inferior systems for the overall problem.
We believe that the true reason for the build-up of bad loans in these credit units are the problems in Taiwan's rural economy following the continuous outflow of Taiwanese capital and industry to China.
Taiwan's loan problem is an economic problem. The most important question when handling the credit units' bad loans is how to prevent the attraction of China and how to revive the rural economy. If these aspects are not considered, any measures to handle the loan problem will come to naught.
However, judging from the Ministry of Finance's (MOF) past behavior, its decision-making process seems to have completely ignored this basic fact. Maybe the MOF believes that this is the responsibility of the Ministry of Economic Affairs.
It isn't, because finance and the economy are inseparable. Unless Taiwan is made the point of departure, proposed measures will not follow the real situation, and they may even run counter to the original goal.
The abrupt lifting of restrictions on overseas banking units lending to Taiwanese businesses in China is one obvious case in point. Even though this will satisfy the capital requirements of Taiwanese businesses in China and the wishes of banks to expand their operations, it will clearly also draw more Chinese investment from Taiwanese businesses, and lead to more Taiwanese capital participating in building China. This is detrimental to the overall Taiwanese economy, and will increase the seriousness of the NPL problem in banks.
The reason for this decision by the MOF is the inability to gain a deeper understanding of the fact that the NPL problem is an economic problem. The handling of credit unit NPLs is also a result of this.
Second, the MOF's reconstruction of Taiwan's overall financial sector has also ignored the significance of local financial institutions. In the past, there were agricultural financial institutions in rural areas and credit co-operatives in urban areas, while regular commercial banks served the industrial and commercial sectors. Each had their own specialties, complementing the shortcomings of the others.
They created a quite stable financial environment over the past 40 to 50 years. However, with increasing internationalization and globalization, Western ideas and opinions have gradually become the main ideologies influencing the nation's financial policies. They believe that Taiwan's banks should be turned into megabanks, which naturally would create more "financial holding companies".
For example, the Cabinet's "Financial Reform Task Force" (金改小組) has suggested that farmers' and fishermen's associations turn their credit units into new banks, to invest in local banks or be merged with them. This suggestion would force the credit units to gradually disappear from the financial sector.
But these foreign companies seem have forgotten the fact that farmers' associations and similar agricultural financial systems also exist in Japan, South Korea, Germany, the US and some other countries.
We don't deny that the agricultural portion of Taiwan's gross national product has gradually dropped over the years.
This trend is a result of industrialization and occurs in every developing country. Nevertheless, the importance of agriculture in other countries has not declined.
Policy makers may cause an improper imbalance between the financial sector as a whole and society if they define farmers' and fishermen's associations as institutions about to disappear. This is one of the main reason why the government's reforms have been mistaken as an attempt to destroy the farmers' and fishermen's associations. The MOF should understand that having commercial banks fully and effectively replace agricultural financial institutions is a practical impossibility.
Third, it is worth considering whether the Bureau of Monetary Affairs' (BOMA) previously proposed risk-control mechanism is excessive. In fact, these measures are not an MOF invention, and they were already proposed by the Council of Agriculture (COA) when the Cabinet established its reform task force in 2000.
Essentially, the idea behind the mechanism is sound. The problem lies in the MOF's ignorance of the fact that the NPL ratios of 176 of the total of 285 credit units (about two-thirds) have exceeded 15 percent. To be honest, the measures would definitely be effective if only 10 percent of the credit units had NPL ratios above 15 percent. But the measures are obviously too excessive in a situation when about 62 percent of the credit units suffer from NPL problems.
The result of such measures is predictable, as most credit units would be regulated and restricted by them, which may paralyze the nation's agricultural finance. Therefore, Taiwan's farmers' and fishermen's groups have strongly protested against the measures.
We believe the three-tier risk control mechanism merely served as a trigger for the resistance of the farmers' and fishermen's self-help group. The real problem is in the economic hardships facing farming villages. Farmers have been in despair for more than 10 years following the capital outflow and industrial migration to China.
The foot-and-mouth disease epidemic in March 1997 worsened the problem. Farms were laid waste and farm land prices slumped. Now Taiwan's farming villages have finally found an outlet for their long-suppressed sadness. We therefore believe that it is inappropriate for the government to view the farmers' and fishermen's demonstration this time simply as a case of resistance against the government's financial reforms. Rather, it should be viewed as an explosion of grievances accumulated over the past 10 years or so due to industrial migration, asset devaluation, bankruptcy of the farming villages and increased unemployment. And the government should respond appropriately.
To be fair, both the ruling and opposition camps should take equal responsibility for recent developments. The government should take this opportunity to contemplate a proposal for salvaging farming villages and rebuilding a sustainable agricultural financing system.
The upcoming meeting on agricultural financing should also conduct a probe into issues such as the transformation of the farmers' and fishermen's associations, the proposed shareholder system, the Agricultural Financing Law (農業金融法) and an agricultural bank. If any legislation is needed, the content of the laws should be planned in an all-round manner -- including the structure, capitalization and operations of the proposed agricultural bank (if such a bank would have to be established), and its relationship with the credit units.
All told, we believe a country with a population of 23 million can do without neither agricultural industry nor agricultural financing.
We acknowledge the government's efforts and determination to resolve the NPL problem in the credit units of farmers' and fishermen's associations. However, we also hope that the people of Taiwan and the government put even more effort and determination into improving the economic situation in farming villages and vitalizing the industry.
Taiwan's NPL problem is a result -- not the cause -- of China's magnetic pull on Taiwan's overall economy. If through this lesson the government can gain a better understanding of the nature of NPL problems in the credit units, this would be a benefit for the people of Taiwan.
Only then would the government be able to apply the appropriate remedies in the reform of the credit units.
Translated by Eddy Chang, Francis Huang and Perry Svensson
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