Commentary: This "Reform" Won't Cure What Ails Taiwan

Allowing financial firms to merge falls way short of what's needed

By Frederik Balfour

On June 26, Taiwan President Chen Shui-bian called legislators back to Taipei from their summer vacations for a special session--only the fourth in Taiwan's 52-year history. Was China firing missiles across the straits? Had there been another earthquake? No. The Financial Holding Company Act hadn't been passed, and Chen considered it a high priority.

After two days of deliberation, the lawmakers did their duty and passed the bill on June 27. That they were forced to do so on a crisis footing underlines the sense of desperation that has overtaken the Taiwan government. Chen sees financial consolidation and reform as one answer to Taiwan's deepening economic malaise. The bill would for the first time allow Taiwan's 650-plus banks, insurers, securities traders, and other financial companies to combine into holding companies. Theoretically, these would create bigger and stronger financial institutions and start a badly needed process of natural selection in the overcrowded banking sector.

Taiwan is indeed in serious difficulty these days, and emergency moves are probably needed. Exports fell 14% in May year-on-year, after a 10% drop in April; unemployment is at a record high, and the economy's annualized 1.1% growth rate in the first quarter was the worst in 26 years, reflecting Taiwan's dependence on tech exports to the U.S.

But the Holding Company Act is not likely to solve Taiwan's economic problems. Indeed, it won't even do much for the banking system, which suffers from stifling government control and an abundance of tiny local banks. Twelve state-controlled banks hold 55% of outstanding loans. Public or private, Taiwan's banks are feeble. Collectively, they earn just 4.9% return on equity, and lumping small weaklings together only makes big weaklings.

The law also allows foreign financial institutions to buy 100% of Taiwan financial companies--the current limit is 25%--and this has raised some interest. But foreign bankers are wary of Taiwan banks' poor condition. Citigroup recently bought 15% of Fubon Group in anticipation of the law. ABN AMRO says it is exploring possibilities. Those are the only nibbles. Even as the bill was being debated, Finance Minister Yen Ching-chang was in Europe trying to persuade fund managers to invest in Taiwan.

The chief concern is the banks' high number of nonperforming loans. The government officially put the proportion of NPLs and shaky loans at 9.14% of all loans at the end of March. Analysts say the actual percentage is closer to 15%--about $57 billion--making banks increasingly reluctant to lend, especially in a slowing economy. The government lacks the will to make banks clean up their balance sheets, which would push some banks and borrowers into bankruptcy. So it encourages them to hide the problem by rolling over loans.

Chen and his government already have proof that simply enacting laws will not solve their problems. Last November, the legislature passed a new bank merger bill that was supposed to be a breakthrough. Since then, several banks have announced mergers, but none has gone through. That's mainly because banks would have to open their books to potential partners. So banks resist lending, and growth slows.

The bank cleanup is hostage to the political calendar. With December parliamentary elections, no one wants to dredge up the bad-loan problem now--not least because plenty of debt-ridden companies have ties to legislators. "Dealing with [the loans] would mean forcing through major structural changes, causing the loss of jobs and the closing of businesses, and politically that would be suicide," says one foreign banker.

Similarly, a November law allowed the creation of asset-management companies to buy banks' NPLs at a steep discount, then try to recover the money. But only one AMC has been created, and it isn't operating yet. There was an initial flurry of announcements, but little progress has been made. "We just can't find any nonperforming loans for sale," says a foreign banker.

What really hampers reform in Taiwan is not the failure of financial consolidation but money politics. The next time Chen or his successor feels the need to call an emergency legislative session, the debate should be about how politicians keep mortgaging Taiwan's future.

Correspondent Balfour covers Taiwan.

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