One of Taiwan's biggest concerns in recent years is that the nation's banking system would end up in a malaise reminiscent of its former colonial master Japan and that Taiwan, now facing its deepest recession in history, would be forced to spend much of the next decade dealing with an embattled banking system.
But, if the current restructuring in Taiwan is any indication, that worst-case scenario is unlikely to come true. The country stands poised to avert such a predicament and the banking system -- perhaps after five years -- will very likely emerge stronger and more competitive.
Indeed, for both investors and observers, the most enlightening news in recent years is that the government is using the economic downturn to expeditiously introduce much-needed reforms in the banking system. The government has passed six major laws so far this year, the most important of which, the Financial Holding Company Law (
The new law will offer financial institutions the rare opportunity to form alliances by creating holding companies, which will directly hold ownership stakes in anything from insurance companies to investment banking.
While the benefits of the consolidation are still being debated, it should, at least, help Taiwanese financial institutions consolidate nonetheless. The private sector, which has joined the government in a chorus of mergers, acquisitions and restructuring, has finally accepted the importance of timely reforms. Almost all the major financial groups, including the large state-controlled banks, have announced plans to create holding companies. They are either seeking outside alliances or now regrouping their existing units under one holding umbrella.
The move should help them rationalize their operations, facilitate information sharing, integrate IT systems and back-office operations and develop cross-selling opportunities for their myriad financial products. For instance, Fubon Group (
Only time will tell which holding companies will emerge as winners. While there is no one secret to success, the ability to innovate along international lines and speedily revamp financial products will likely be the defining factors. As the new law allows banks to penetrate every segment of the financial sector, Taiwan will soon see a major reshuffling of market shares across various financial sub-sectors.
Several holding companies will inevitably fail, which may also spur further mergers among those companies. Following Taiwan's entry into the WTO, large international banks may also buy up or own stakes in local financial groups, as Citigroup has already done by holding a majority stake in Fubon Group.
But the caveat for both the government and the private sector is that they do pay heed to the lessons of history. They may very soon install the supervisory and regulatory infrastructures necessary to oversee this unprecedented change, which will reshape the banking landscape within the next five years. Taiwan still does not have a unified financial supervision body. Supervisory responsibilities, shared by the Ministry of Finance and the central bank, are vague, if defined at all.
Furthermore, deregulation -- for all its wonders -- usually unleashes a flurry of changes, which often unsettle systems unprepared to cope with the new realities. In the early 1990s, many Asian countries introduced a slew of policies of institutional reform and economic liberalization. They introduced reforms too fast, too soon, without putting into place the institutional framework and regulatory supervision necessary to ensure a smooth transition.
Taiwan has its own experience of well-meaning banking reforms gone horribly wrong. Beginning in the 1990s, the government tried to deregulate the banking system -- as a part of its goal to boost the competitiveness and efficiency of financial institutions. To that end, in 1991 the government awarded banking licenses to 16 new commercial banks.
The move earned accolades, but doubled the number of bank branches in a decade, turning Taiwan into one of the most over-banked economies in Asia. In 1980, there were a total of 535 banks (including headquarters and branches). The total figure rose to 737 in 1990 and 2,010 as of June this year.
A prohibitively high minimum capital requirement of NT$10 billion for the new banks ensured that only some of Taiwan's top conglomerates got the much-coveted commercial banking licenses. Several of them were also -- not merely by coincidence -- very well connected to the then-ruling KMT party.
Heavy initial investment pushed the banks to expand fast. Encouraged by the spectacular GDP growth of the 1990s, bankers threw caution to the wind by proceeding on a lending rampage.
The lax regulatory oversight and risk management are now being reborn as bad loans. Taiwan's bad loans have jumped to record levels. While the government's estimates put the total non-performing loan ratio at around 9 percent, independent estimates put the total non-performing loans at between 10 percent and 15 percent. Problem loans, which are a function of economic growth, are still rising fast.
To say Taiwan's banking system has long been the weakest link of its otherwise robust high-tech economy is to risk bordering on the tautological. But the country has long rejected, wrongly so, the commentaries about its rising bad loans by comparing them to the double-digit figures of its Southeast Asian neighbors.
While Taiwan did escape the Asian Financial Crisis, its resilience during the mayhem -- which rocked its competitors -- also denied it the opportunity to carry forward similar reforms. Such policies in other countries have included the rehabilitation of bad banks, the creation of powerful supervisory bodies (such as the Financial Supervisory Agency in Korea) and the formation of asset management companies to handle problematic assets (as they have done in Thailand). Taiwan is only beginning to do that now.
The costs are high. Following the savings and loans crisis, it cost the US 4 percent to 5 percent of its GDP to recover. For many emerging markets such as Indonesia and Thailand, the cost amounted to between 15 percent and 30 percent of GDP. It may take Taiwan around 10 percent of its GDP and at least five years before it has a financial system that will assist, rather than impede, its transition to a new level of competitiveness.
But the gravity of the current recession has at least given the government the wherewithal to persuade bankers to face up to reality. Despite the DPP government's relative lack of experience in dealing with financial matters, the new political climate should favor Taiwan's financial rebuilding. Political consensus to change is a key prerequisite for any successful reform. Leaders, which are activating change, must not be beholden to the legacy of the past regimes, which may partly have sowed the seeds of the current dilemma.
History shows that most economies, at a certain stage, must pass the test of financial restructuring. Taiwan's current reforms, over a due course, will also help it better withstand the competitive challenges of the future.
Tsering Namgyal is a freelance writer based in Taipei.
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