Taiwan is experiencing scandals in its finance industry and problems in its state-owned financial institutions. These issues threaten to provoke a financial crisis, and also threaten Taiwan's economic development.
A recent series of scandals has encouraged Taiwan to consider reforms in its financial sector. The scandals include insider trading at First Financial Holding Company, the taking of banking assets by the chairman at Chung Shing Commercial Bank, the high ratio of non-performing loans (NPL) at the Bank of Overseas Chinese, and asset-stripping by president Won Da-min (
In addition, inefficiency in money-losing state-owned banks, and non-performing loans, have been a problem. NPLs at state-owned banks and private banking institutions were between 5.94 and 6.39 percent in June. Moreover, the high ratio of NPLs has shown the weakness of governance of banking institutions.
These financial scandals have shown a need to strengthen Taiwan's financial supervisory framework. In theory, a financial sector requires a good legal structure, an unrestrictive financial regulatory regime, efficient financial institutions, a capital market, and a low level of government ownership in the financial sector.
The purpose of creating a comprehensive financial supervisory framework is part of a drive to reduce financial crises, which affect both international financial markets and economic development.
A well-developed financial sector can help define a path of economic development characterized by sustainable, long-term economic growth. A financial institution is not only an intermediary but also a way to allocate credit to the public, which needs capital for private needs and corporate transactions.
In addition, the relationship between economic development and financial institutions is one of interdependence.
Because of the need to maintain a stable financial system, financial institutions are among the most closely scrutinized businesses in the world. However, the transformation of financial services has increased financial instability and presented challenges in maintaining financial stability.
Structures for financial regulation and supervision differ considerably from country to country. Nevertheless, the goal of financial supervision is to enhance the stability, reliability, transparency and efficiency of the financial sector in order to reduce systemic risks.
In addition, financial supervision is able to prevent criminal abuses in the financial sector, with a view to protecting the interests of clients and investors by safeguarding their financial resources and supporting the stability of a national monetary system.
In order to reach the goal of good financial supervision, a supervisory system should be designed to carry out two functions. First, the supervision system should be designed to detect illegality and unsound practices and to provide early warning of potential failure. Second, it should provide an array of enforcement techniques to financial regulators to rectify problems that have been identified.
Financial stability requires several types of vigilance. Individual financial institutions have to be run prudently, markets have to be open and transparent, and the financial supervision framework has to be robust. Specifically, financial regulations ought to provide supervision that promotes a safe and healthy financial market.
Capital markets should operate in an environment in which regulators are not participants. Most Asian countries share the problem of private firms and financial institution having too close a relationship. These close relationships were among of the factors that contributed to the Asian financial crises in 1997.
Therefore, in order to create a safe and healthy financial system, financial regulators should avoid participating in financial markets. Financial regulators should not become involved in financial markets and should avoid conflicts of interest. Taiwan's financial regulators should supervise financial markets rather than participating in the financial markets. Taiwan should promptly privatize state-owned financial institutions.
In terms of the fiduciary duties emphasized by the Organization for Economic Cooperation and Development's (OECD) principles of corporate governance, directors have an ongoing responsibility to monitor a financial institution's compliance with the law as well as its business performance.
Specifically, corporate boards of directors must design, implement and maintain information and reporting systems that are designed to provide timely and accurate information that will allow the directors to arrive at informed decisions.
With this in mind, the management in financial institutions should follow the business judgment of a majority of the directors.
The essence of effective risk management in financial institutions is identifying risks and taking positive action to keep them within manageable limits.
For a country to reap the full benefits of global capital markets and attract long-term "patient" capital, the corporate governance system must be credible and understood across borders.
For countries that do not rely primarily on foreign sources of capital, adherence to corporate governance will help to improve the confidence of domestic investors and reduce the cost of capital and ultimately create a more stable way to finance economic development.
Innovation, deregulation and globalization in the financial service industry have contributed to making finance more complex and riskier. The derivatives of financial services have presented new challenges to financial supervisors with respect to structuring their supervision practices. In response, financial supervisors have developed new methods and processes for monitoring and assessing financial institutions.
Particular attention is being paid to improving the quality of financial examinations and the development of systems that can assist supervisors and examiners in identifying changes, particularly deterioration, in a financial institution's condition as early as possible.
In the future, formal risk assessment and early warning systems will continue to be developed and adopted by bank supervisors in developed and emerging market economies and will contribute significantly to strengthening the process of financial supervision.
Taiwan has ignored the importance of risk assessment and early warning systems to financial supervision, and this may cause expensive financial scandals.
Financial supervision and the implementation of corporate governance in the financial services sector will strengthen the legal framework and help stabilize the financial system. No matter what may have caused financial instability, it is clear that enforcement will grow stricter.
In order to prevent financial instability, Taiwan's regulators should strengthen the framework of financial regulation and supervision.
Implementing corporate governance in the financial sector will be one of the mechanisms that will help management improve the safety and health of the financial system and protect the public interest.
David Jou is associate professor in the department of finance at National Taiwan University's College of Management. Lawrence Lee is assistant professor of law at Ming Chuan University's department of law and a visiting scholar at New York University's School of Law.
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