Case Study: Taiwan’s Bank Regulation
5.1 Brief History of Taiwan’s Banking System
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Chapter 5
Case Study: Taiwan’s Bank Regulation
In this chapter I review Taiwan’s bank regulations since 1970s when Taiwanese government started bank reforms through liberalization and privatization of banks, as well as adjust domestic bank regulations that complied better with Basel Accords. In the first section of this chapter, I briefly review the history of Taiwan’s banking system. It discusses the structure, environment, and challenges of financial system in Taiwan. The next two sections proposed international and domestic factors that affect Taiwan’s compliance with Basel Accords. They will be followed by detailed empirical studies of Taiwan’s amendment the Banking Act in 1985, 1989, 2000, and 2008.
While the latter three times of amendments related more to Basel Accords, the discussion of the first one is necessary because it provides a general picture of Taiwan’s financial situation before its compliance with global standards. It was also the first comprehensive amendment of the Banking Act since its promulgation in 1931. The last section give a general discussion that connects the proposed theoretical model to the amendments.
5.1 Brief History of Taiwan’s Banking System
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After overthrown by the Communist Party of China in 1949, the Republic of China (ROC) retreated to Taiwan. The government subsequently relocated national banks to Taiwan, such as the Central Bank, Bank of China, Bank of Communications, Farmer’s Bank of China, and the banking department of Chunghwa Post. At the meantime, Taiwan had already had six domestic banks controlled by provincial government, which took over those banks from the former colonial Japan after its defeat during the World War II. Those banks, in their present name, are Bank of Taiwan, Land Bank of Taiwan, Taiwan Cooperative Bank, First Bank, Hwa Nan Bank, and Chang Hwa Bank. In addition, there were also 71 local credit cooperatives, and 86 farmer’s associations (Yu and Wang 2005:30-31). The administration considered that existing banks were approaching the maximum capacity for Taiwan’s society. Therefore those national banks relocated from the mainland did not function right after 1949. Aside from Bank of Taiwan and Land Bank of Taiwan that were 100% controlled by the government, the other four banks were controlled by the government at more than 50% share (Central Bank of the Republic of China (Taiwan) 2013:28). Those banks were directed by the authority for specific economic mission. For example, First Bank, Hwa Nan Bank, and Chang Hwa Bank, which was coined as “the three commercial banks” cooperated with the government to facilitate the development of domestic industries while Land Bank of Taiwan was government’s financial supports for implementing land policies. For local agricultural and business development, the responsibility fell into the hands of local credit cooperatives and farmers’ associations.
The banking sector back then was tightly controlled by the ROC government, which used a financial system that supported its state-directed economic development.
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Table 5.1 Distribution of Taiwan’s financial institutions and percentage of assets
Year Domestic Num Asset Num Asset Num Asset Num Asset Num Asset
1949 7 - 0 - 0 - 71 - 86 Note: “Num” and “Asset” represent the number of financial institution in each category and the percentage of their assets held relative to total assets in the banking industry.
Source: Data comes from Financial Statistics Monthly, Republic of China (Taiwan) published by the Central Bank of the ROC and Yu and Wang (2005:87, 93, 106)
Banking was a chartered business and the establishment of a new bank required discussion and approval in the plenary session of the Executive Yuan. However, the financial institution did not keep up with Taiwan’s fast-growing economic development since late 1950s. The government, as a consequence, reopened Bank of Communications and Bank of China reopened in 1960, the Central Bank in 1961, Chunghwa Post’s banking department in 1962, and Farmer’s Bank of China in 1967 (Yu and Wang 2005:31-33). Several regulations were released. For example, in response of the end of U.S.’s foreign aid that provided abundant financial resources for middle-to-long term loans, in 1960 Executive Yuan promulgated the Standards Governing the Establishment of Trust and Investment Companies and the Standards Governing the Establishment of Foreign Banks and the Scope of Businesses in 1964. It was evident that since 1960s, more financial institutions, especially foreign banks and trust and investment companies, were approved and opened and assets they held also increased at the expense of major domestic banks. In term of performance, there was
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too little information to tell the difference but Yu and Wang (2005:101-04) suggested that local financial institutions underperformed due to its low loan to deposit ratio. They considered 80% as a threshold and banks way below it deals with their deposits inefficiently. The ratios for domestic banks and foreign banks, on the contrary, indicated potential risk of liquidity crises. As a whole, the performance of Taiwan’s financial institutions back then was neither efficient nor safe.
Table 5.2 Loan to deposit ratio of financial institutions in Taiwan
Year Domestic Source: Financial Statistics Monthly, Republic of China (Taiwan) published by the Ministry of Finance
and the Central Bank of the ROC
The regulatory regime from 1950s to 1970s was disperse. The competent authority for administrative management to banks was the Ministry of Finance but it had to work with Ministry of the Interior and Council of Agriculture to manage farmers’ and fishermen’s associations. The authority for supervision diverged even more in different types of financial institutions. Although, according to the law, the Ministry of Finance should shoulder responsibility for supervising all financial institutions. But it did not have enough staffs; therefore it delegated the supervision on domestic banks, credit cooperatives, farmers’ and fishermen’s associations to the Central Banks, Central Deposit Insurance Corporation, and Taiwan Cooperative Bank (Grossman and Woll 2014:54). The dispersion of authority in Taiwan’s financial system continued until early 2000s. Although businesses of all kinds of financial institutions were simpler and more
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similar before 1980, a more efficient and united regulatory regime was lacking; leading to inefficient and incompetent regulations that resulted in a fragile and corrupt financial circumstances and local bank crises. In such system, the accountability was unclear while the problem of crony capitalism created strong government-to-business relationship (Kang 2002, Kang 2003, Kim and Im 2001).
The connection can be built in several ways. For example, the non-profit organization funded by a bank can purchase a large number of meal coupons issued by the candidates running for elections; the banks pay for the assistants hired by the legislators; banks can also exert pressures on the media to produce positive reports for the legislators or they will withdraw the advertisements. In exchange, the legislators speak for the bankers in the Legislative Yuan.1 It opened a door for mismanagement and corruption. During the first half of 1980s, banking crises broke out in 3 trust and investment companies and 1 in credit unions. All four incidents were related to high non-performing loans that caused liquidity crises. Those crises resulted from banks’
concentration of loans to close friends and related companies, or investments in risky businesses (Yu and Wang 2005:268-27). A series of financial crises, although the scope was limited (total proportion of assets in credit cooperatives and trust and investment companies in 1981 was merely 9.3%), it led to the amendment of the Banking Act in 1985 and expected to correct the corruptive behaviors in the banking sectors. This will be discussed more in the following paragraph.
In the late 1980s the government started to liberalize banking industry for more efficient and flexible management of wealth coming from Taiwan’s outstanding
1 Author’s interview with a former senior manager of a POB, 2014/9/1.
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economic growth. It also confronted pressures from the U.S. to open Taiwan’s financial market to foreign banks at the time when Washington tried to narrow the gap of trade deficit with Taiwan (United Daily News 1989). In 1988 the introduction of Basel 1 set an 8% CAR threshold for banks that planned to open foreign branches. Since the U.S was one of the main promoter for Basel 1, many Taiwanese banks feared their applications for establishing branches would be rejected by Washington. Such pressure in turn went back the government. The combination of the external and domestic pressures for liberalization and internationalization motivated the amendment of the Banking Act in 1989. Subsequent promulgation of administrative orders that allowed the application of private banks and foreign banks led to a large increase of the amount of financial institutions. According to table 5.1, for example, the number of domestic banks increased from 25 in 1991 to 53 in 2001.
However, the liberalization of financial system did not come with proper financial supervision other than Basel 1 standard. The regulatory regime remained weak but was responsible for more complex financial system. The problem was especially serious in trust and investment companies and local financial institutions. According to Yu and Wang (2005:274-76), there were 34 bank runs on local farmer’s associations, 15 bank runs on credit cooperatives, and 4 bank runs on domestic private banks from 1994 to 1999. Most incidents were results of over-lending made possible by guanxi or political pressures, high leveraged investments, embezzlement, and excess loans (Yu and Wang 2005:283). Most problematic credits went to individuals or companies in trouble that were unable to pay interests. Increasing competition in banking industry without effective regulation, as a consequence, gave rise to an even weaker financial system.
As shown in table 5.5 below, Taiwan’s non-performing loan ratio peaked at 11.26% in 2001 while the ratio for credit cooperatives in the same year was 11.66 and farmers’
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and fishermen’s associations was 19.37%. The government thus set up the Corporation Resolution Trust that indemnified the depositors for financial institutions’ losses. Many institutions in utter troubled were forced to be purchased or merged by domestic banks.
The number of local financial institutions started to drop, especially the credit cooperatives (see table 5.1). In addition, Taiwanese government planned to set up a new department that unified the functions of administrative management, supervisions, and punishments to all financial institutions. Without it the disperse authority would create moral hazard for the banks. For example, when the liquidity crisis occurring in the Chang Hwa 4th Credit Cooperative in 1995, the supervisory agencies, Taiwan Cooperative Bank and Central Deposit Insurance Corporation had no disposition authority and the banks in trouble was waiting for government’s funds to bail them out.
To solve the problems, Financial Supervisory Commission (FSC) was established in July, 2004.
According to Organic Act Governing the Establishment of the Financial Supervisory Commission that was promulgated in 2003 and amended in 2011, FSC takes full responsibility to financial supervisions in all financial institutions, including domestic and foreign banks, credit cooperatives, farmers’ and fishermen’s associations, securities and futures, and insurance, which is prescribed in article 2. The authorities of administration, supervision, and penalty are now united under FSC by law. Article 3 prescribed that FSC shall be in charge of amending financial regulations, regulating financial institutions, punishing violators, and collecting related information. Article 5 empower FSC to “produce relevant account books, documents, electronic files, and other such materials … notify an examinee to appear at a designated office for questioning.” For disobedience FSC has the power to punish. Taiwan’s financial supervisory system was thus unified.
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After a brief discussion of Taiwan’s changing financial system, it becomes clear that, from 1950 to late 2000s, the importance of local financial institutions rose at the expense of major domestic banks during 1980s and 1990s. During the period Taiwan had seen a chaotic financial system without an effective regulatory system to manage.
Although Taiwan escaped from Asian financial crisis in late 1990s, its banking system was coincidentally harmed by non-performing loans resulting from bankruptcies and financial crisis of large corporations (Yu and Wang 2005:284-85). Financial system was fragile that triggered a series of financial reforms to bail out illiquid banks, as well as, strengthen and unify the competent authority. A brief review above gives a general picture of Taiwan’s financial system when it started to implement the Basel Accords.
The following sections deal with possible international and domestic political factors that influence Taiwan’s choice of compliance with Basel Accords. They are followed by detailed investigation of legal amendments regarding the control of financial risks and implement the Basel Accords.