Not long ago, word spread through the financial sector that the Bankers' Association planned to issue a restriction on loan interest rates by requiring that the rates exceed capital costs. The impetus for the restriction stemmed from a request by the Financial Supervisory Commission (FSC).
The proposal was immediately questioned by some who said that it amounted to organizing a cartel. Consequently, the commission clarified its position, saying that it was merely asking each bank to clarify its loan pricing strategy.
In the future, the FSC plans to include loan pricing as one of the items it uses to inspect banks. It will also ask that banks set up a reserve to cover losses induced by lending money at interest rates below capital cost.
However, statistics from the Taiwan Insurance Institute show that local life insurance interest rates were about 2.5 percent to 3 percent this year. Nevertheless, in August, the insurance industry deposited NT$259.8 billion (US$7.9 million) in banks at interest rates lower than 2 percent. The industry also invested NT$645.6 billion in securities at a low rate of 1.7 percent.
In total, the industry is suffering financial losses on over NT$900 billion worth of investments. And not long ago, the central bank called for bids on NT$100 billion worth of negotiable 364-day certificates of deposit. Total bids for the certificates reached NT$358.4 billion, resulting in an average interest rate of 1.839 percent and even more serious losses.
Although the commission's desire to prevent banks from lending money at loan rates lower than capital cost was well intended, the financial sector has yet to understand the problem.
In most business sectors, companies do not willingly sell their products at below cost, but the nation's lack of investment targets leaves institutional investors with few tools to work with.
Last month, several insurance companies said that they purchased Taiwan Power Company's corporate bonds with tears in their eyes, since the interest rates for its 10-year and 15-year bonds were below 2.38 percent. The insurance companies were clearly aware that they would lose money, but still had to buy the bonds simply because there was nowhere else to place their money.
This is the crux of the problem, and its is why institutional investors place their funds in such low-yield instruments.
The large amount of capital in the domestic financial sector shows a lack of investment channels at the same time that the nation's financial institutions engage in cut-throat competition by lowering interest rates to attract loan clients.
Many banks would find it unbearable if they were forced to appropriate reserves for possible losses caused by low interest rates. The nation's excessive number of banks certainly worsens the situation, but this is not the basic cause of the problem.
Licenses for doing business in many parts of Taiwan's service sector were formerly tightly regulated. After deregulation, the limited domestic market has meant that an excessive number of competitors can be seen in almost every market, including the financial sector. This situation leads to intense competition, falling profits and operational problems.
If the government continues to insist on its current deregulation policy, it must allow or assist businesses to develop overseas markets and allow capital to freely flow abroad. This is the only way to solve the problem. If the government only pays attention to pricing, it will be barking up the wrong tree.