Case Study: Taiwan’s Bank Regulation
5.4 Changes of Taiwan’s Bank Regulations
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Figure 5.2 Number of POBs, bank performance and CAR
Source: Statistics from the Ministry of Finance, Financial Supervisory Commission, Lee (2002), and Lee and Tang (2007).
5.4 Changes of Taiwan’s Bank Regulations
In this section I discuss how Taiwan’s bank regulations were changed by international pressures, domestic pressures and exogenous shocks during the four major Banking Act amendments in in 1985, 1989, 2000, and 2008. They related more closely to the spirit and contents of Basel Accords.
Amendment of the Banking Act in 1985
Capital requirement is the core of a bank’s properness and health (Barth, Caprio and Levine 2006:110-31). It demonstrates how high a bank exposes to and how
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competent can it ward off to potential credit risk, market risk, and operational risk. A proper standard would lead the banks to raise its capital and reduce risky investments.
It can be manifest in a bank’s minimum capital entry requirement and capital adequacy ratio. By setting a minimum of capital entry requirement before issuing license, the authority can better ensure a bank’s initial quality. This can force new banks to maintain an acceptable financial quality at their initial stage. After entering the market, the capital requirement of a bank becomes an important indicator for a bank’s health. The measurement and calculation for the requirement varies. A more internationally agreed capital standard first appeared as Basel 1, which was embodied in the 1988 International Convergence of Capital Measurement and Capital Standards published by BIS in July 1988.5 It set a standard of 8% for capital to weighted risk assets. The standard was expected to be enforced in BCBS member countries by the end of 1992.
Such standard was later upgraded in the Basel 2, which treated capital requirement as one of the three pillars of a country’s regulatory regime. It was official released in June, 2004 and the final version, which is titled Basel 2: International Convergence of Capital Measurement and Capital Standards: A Revised Framework, came out in June, 2006.6 After series of financial crises damaging the U.S. and Europe, Basel 3, another upgrade of Basel Accords, was agreed by members of BCBS during 2010 to 2011 and expected observance around the world by 2015. Since Basel 3 is currently underway, this section will deal mainly to changes of Taiwan’s bank regulations from 1980s to 2010. I will discuss the amendments of Taiwan’s Banking Act in 1985, 1989, and 2008.
As mentioned in the previous section, Taiwan had experienced four local financial crises in early 1980s. They resulted in subsequent bank runs on Asia Trust and
5 The document can be retrieved in BIS’s website at http://www.bis.org/publ/bcbs04a.pdf.
6 The document can be retrieved in BIS’s website at http://www.bis.org/publ/bcbs128.htm.
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Investment Corporation in 1982, Tenth Credit Cooperative Association of Taipei City in 1985, Cathay Trust and Investment Corporation (CTIC) in 1985, and Overseas Chinese Trust & Investment Corporation (OCTIC) in 1985. The main cause came from financial frauds and poor corporate governance that led to a large number of low-quality assets and non-performing loans (Lee 1994:58-94, Wu 2008a, Yu and Wang 2005:267-71). Most of bad loans were approved by bank lenders’ guanxi, or personal relationship, with the borrowers. For example, The Tsai Family from the Lin Yuan (霖園) Group used its OCTIC to purchase their personal real estate assets with prices above market values. They also concentrated their mortgage loans to family members and their close friends who involved heavily in land and real estate speculations. OCTIC was put under great risk once the real estate market collapses. That actually happened as Formosa Incident, or Kaohsiung Incident, and the subsequent political unrests erupted in early 1980s and the real estate market was greatly hit (Lee 1994:58-94). A series of bank runs forced the government to restrain financial institutions from loans based on guanxi regardless of borrowers’ debt-paying ability and the appropriate market value of the collaterals. While working for a private family bank, a now top level banker recalled that when a big loan was applied, an internal committee consisted of about ten people from the core departments of the bank will be formed to review the application. But when the loan was applied by someone or companies related to the family business, a smaller committee that included only family member was formed. Those loans were hardly rejected. Unlike nowadays that financial professionalism precedes, the banking environment back then was dominated by personal relationship.7 Therefore, the first major attempt to amend the Banking Act in 1985 targeted exactly such problems.
Although it did not closely relate to the capital requirement but the underlying
7 An interview with a banker in Taipei on September 1, 2014.
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motivations was similar. Both are devised to control risks coming from banks’ loans and investments.
Before 1985 Basel 1 had not released and promoted globally; therefore the government had not yet confronted with high international pressures for complying Basel 1. The influence on bank regulations mainly came from domestic politics. Before the amendment in 1985, articles 32 and 33 of the Banking Act regulated who shouldn’t be loaned by the banks. Article 32 proscribed that “No unsecured credit and bank guarantee shall be extended by a Bank to its own responsible person, to its staff members”; article 33 prescribed that “For any secured credit extended by a Bank to its own responsible person, to its staff members, or loans extended to any interested companies or individuals of its own responsible person or of a staff member, the terms of such extended credit shall not be more favorable than other borrowers.” Invited by the Legislative Yuan to explain the amendment of the Banking Act during the 73th Session in March 12, 1984, the then Minister of Finance Hsu Li-teh (徐立德) stated that “the amendment should include the prohibition of unsecured credit extended to any interested party of its own responsible person or of a staff member.” As for the terms of extended credits and loans, Hsu stated that article 33 should be amended that “the terms shall not be more favorable than other same category customers.” Hsu also added that
“an augmented article 33-1 is needed to clearly define the meaning of ‘interested party’.”
To correct speculation on short-term investment, such as real estates by trust companies, which are agents of public’s saving for longer and more stable investments, Hsu proposed the need to amended article 101, which prescribed what trust companied can invest and what they can’t. The government wanted to prevent trust companies from dealing with real estates, direct investments in manufacturing businesses, and securities investment trust. (Legislative Yuan (Taiwan) 1984a:68-70) Such amendment was
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targeted to solve the mismanagement of credits extended, loans and investments emerged in the early 1980s. Confronting with financial crisis, in fact, the KMT government strived to regulate Taiwan’s financial market in a more stringent way, especially for trust corporations that attracted abundant wealth resulting from Taiwan fast economic growth better than inefficient GOB. The exogenous shock provided a stronger motivation for the authority to direct banks pursuing less-risky assets with higher quality.
Although international pressures were less obvious, domestic politics seemed to play some role during the bargaining occurring in the Legislative Yuan, even though in 1985 Taiwan was still in the middle of its democratization under a more unified government controlled by KMT’s centralized rule. Confronting the reform plan envisaged by the Ministry of Finance, several legislators strongly opposed it. In a closer look, those legislators were agents for the financial industry. During the meeting on May 2nd, 1984 of the 73th Session, at least five legislators close to major bankers stated different reasons to oppose official proposals. They were Liu Sung-pan (劉松藩), Wang Jin-pyng (王金平), Kuo Jung-tsung (郭榮宗), Li Tsung-jen (李宗仁), and Hung Yu-chin (洪玉欽), who were allegedly belonged to the “thirteen brothers in the Legislative Yuan (立法院十三兄弟)” led by Tsai Chern-chou (蔡辰洲), a legislator from Lin Yuan Group owned by the Tsai Family. They represented the interests of financial sectors, especially trust corporations when POB’s license was not opened for application. More than half of the members were in the board of directors of in local financial institutions (Lee 2003:115). According to many press reports, those thirteen brothers’ campaign contributions relied heavily from trust companies. In an interview with the United Daily News in 1984 when the rumors spread out before the amendment, Tsia said that
“according to his indirect understanding, local credit cooperatives had their local bases
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and they helped legislative candidates. After successfully elected, it is normal for them to reflect their (credit cooperatives) interests” (Chen 1984). One anonymous officials in finance ministry described trust and investment companies as the “national biggest group in influence peddling” (Huang and Kou 1984).
For example, when Wang was in personal financial crisis in the 1970s, he used a barren land in the countryside of Tainan as collateral to receive credits way beyond the market value from CTIC of Tsai’s family. Liu was seen as the most important figure among the thirteen brothers. He was considered a middleman between the Tsai family and KMT’s big shots, such as the Minister of Finance Hsu Li-teh (Yang 2002).
According to investigation conducted by the Control Yuan of the ROC, CTIC’s illegal loans surged to NT$3.8 billion during Hsu’s term as the Finance Minister, which was more than 3-fold compared to Hsu’s predecessor. He later resigned and was held responsible for the lack of bank supervision on CTIC (United Daily News 1985).8 While amendment of article 32 and 33 and the augmented article 33-1 strived to prevented risky and inappropriate loans and credits, Hung Yu-chin first argued against the amendment, saying that the scope and definition of ‘ the interested party’ was too extensive. He used Hong Kong and Singapore as examples to counter stringent regulations. Following Hung’s reasoning, Li Tsung-jen added that Taiwan had criminal law to punish misbehavior done by bank staffs and there is no need to further regulate.
He stated that “a bank is a financial institution for profits, any kinds of loans should be allowed.” Wang Jin-pyng further oppose by connect more restricted regulations to potential economic downturn, which was not allowed while Taiwan started to rise (Legislative Yuan (Taiwan) 1984c:83-93). Kuo Jung-tsung seconded the view of Hung
8 During an interview with the author on August 22, 2014, a central bank official recalled that Hsu’s crony capitalism and the subsequent weak regulation were the major cause for CTIC’s liquidity crisis.
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by adding Japan’s and Germany’s experience in regulating banks that are less stringent than the proposed amendments. Liu Sung-pan simply opposed by questioning the correlation between local financial crises and bad loans, credit extended, and investment (Legislative Yuan (Taiwan) 1984b:25-34).
Article 101 was another main battleground during the amendment of the Banking Act in 1985. The main point is whether trust corporations should be treated as banks and should be allowed to engage in short-term businesses, such as, issuing cheques, trading stocks or investing in real estate market and manufacturing businesses.
Although several legislators supported the Ministry of Finance’s view that forbid short-term operation on those items, the thirteen brothers strongly opposed and urged others to treat trust corporations as banks and allow the existence of short-term financial businesses. For example, Tsai Chern-chou used statistics to argue that the assets controlled by trust companies were too small to influence the market and the incident if Asia Trust and Investment Corporation in 1982 was not the result of management of short-term assets. His view was immediately seconded by Wang Jin-pyng, who stated that the high real estate prices was nothing to do with speculation by trust companies, which should be allowed to function as commercial banks. Li Tsung-jen jumped in right after Wang by providing a legal perspective to support that trust corporation should be allowed to issue cheques. He further said that it would be dangerous for customers to carry cash while the public security was poor (Legislative Yuan (Taiwan) 1984d:151-55).
Although confronted with oppositions, articles 32, 33, and 101 were successfully amended and article 33-1 augmented according to the Ministry of Finance’s initial proposal. Its success came from the pressures coming directly from the ruling party.
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The relationship between political party and state was coined as a state ruled by a Leninist party, which controlled administrative system in every level and scope.
Kuomintang was also adept at mobilizing the society for national policies (Cheng 1989, Chou and Nathan 1987). It needed to, at least, tackled problems resented by the most public and used a centralized decision-making all the way to the administrative apparatus to solve them. As conflicts in amending the Banking Act became intensive, Kuomintang invited its prime minister, legislator with opposing views, and several involving ministers, for a meeting. This time the party sided with the Ministry of Finance and refused to answer to the interests of trust and investment corporations by asking the amendment be passed with the most stringent standard. The party threatened to punish legislators who would not obey according to the party line. It was also evident that the then president Chiang Ching-kuo (蔣經國) was very disappointed with the crony capitalism phenomenon. He expressed his insistence that the government should follow the principle of anti-monopoly, anti-privilege, and anti-speculation during a conference. In fact, president Chiang despised close government-business relationship.
Right after the Tenth Credit Cooperative Association of Taipei City’s liquidity crisis in February 1985, the bank was taken over, Tsai Chern-chou was indicted, and the group of thirteen brothers was automatically dismissed and lost their power (Lee 2003:115-19, Su 1992:37-46). According to the summary for the amendment initiated by the Ministry of Finance in 1983, series of local bank crises caused by trust and investment corporations’ risky and corruptive investments was the main reasons for the reform.
Using the model in chapter 3, exogenous crisis changed the preference of domestic politics, which caused greater domestic pressures given the level of bank regulations.
With Kuomintang and the administration’s push, the Banking Act became more stringent.
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Amendment of the Banking Act in 1989
From the above analysis, the amendment of the Banking Act in 1985 was mainly influenced by financial crises that changed the ruling party’s and administration’s preferences and tolerance on bank regulations. After 1988 when Basel 1 was published by BIS, Taiwan was subject to different combination of factors that affected its bank regulations. The core of Basel 1 was to set an 8% CAR using its method to calculate the total of risk-weighted assets. In Taiwan, article 44, which prescribed the risk bearing capacity of banks, stated that the authority should set a maximum level for a bank’s ratio of liability to equity. For the bank that exceed the prescribed ratio, the authority can restrict the bank from distributing its profits. The Banking Act in 1988 obviously did not fit in Basel 1. On January 17, 1989, the Executive Yuan sent a comprehensive proposal of the amendment of the Banking Act to the Legislative Yuan for deliberation and approval. The package included article 44, which prescribed the risk bearing capacity of banks. The proposed revision stated that “To strengthen banks’ financial basis, unless approved by the Competent Authority, banks’ equity capital to its risk assets shall not be less than 8%. If a bank’s actual ratio is less than the prescribed standard, the Competent Authority shall restrict the bank from distributing its profits.”
It also give the power of prescribing the method of calculating equity capital and risk assets to the Competent Authority, which was the Ministry of Finance in 1989.
Regardless of actual performance of banks, Taiwan’s regulatory compliance was swift.
According to the theoretical framework, the change came from sensitiveness to international or domestic pressures and the preference of foreign or domestic sectors.
First, the international pressure was high from 1988 to 1992, which is the expected time for global harmonization of the Basel Accord. As discussed above, Taiwan’s
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international pressures mainly came from its tie interdependent relationship with the world, especially the U.S., which was the main initiator and promoter of it. Many banks that sought the establishment of foreign branches in the U.S. and other major western advanced industrial countries worried that the failure of attaining 8% CAR will lower their chances of the approval of application of branches. As mentioned above, Taiwan’s global economic adventure required home country bank’s foreign apparatus to facilitate financial service because the costs of credits are lower with Taiwanese banks because they have already built businesses connections at home and are more familiar with the overall situation of that Taiwanese overseas companies.9 One former central bank official, who later also serve in a GOB, recalled that Taiwanese bank was then required to observe both U.S.’s federal and state laws that asked for more stringent and complex capital requirement. Taiwanese banks, in turn, were forced to adjust capital structure in order to enter financial markets in America.10 Should the Taiwanese bank’s CAR could not exceed the 8% limit, it is very likely that the new application will be turned down.
Chang Hsiu-lien (張秀蓮), the deputy director-general of the Bureau of Monetary Affairs, the Ministry of Finance, once commented that if Taiwan’s banks cannot reach BIS’s 8% CAR standard by the BCBS members’ deadline (the end of 1992), they will face difficulties for establishing foreign branches in the future. Her comments came out when the bureau was urgently deliberating for formulating the scope and methods of calculation of capital and risk-weighted assets in order to assist banks to reach the target (Li 1991). Such international pressures not only put pressures on the governments but also major banks in Taiwan. Such pressure also push the Ministry of Finance to ask the
9 Although the majority of customers of banks’ foreign branches were overseas Taiwanese, which incurs less risks, in the long-run, banks also expect to do businesses with foreign individuals and companies. This view was shared by a vice-president of Taiwanese POB in Taiwan, during an interview on September 1, 2014.
10 Author’s interview in Taipei on August 1, 2014.
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Bankers Association of The Republic of China for drafting a reviewing standard for approving the establishment of foreign branches by Taiwanese home banks. The association recommended the ministry to include Basel Accord’s CAR in the application requirement (Chien 1991). Indeed, Taiwanese banks had suffered setbacks while applying for foreign branches.
In 1992, Taiwan Business Bank, while applying for a foreign branch in the U.S., received U.S. authority’s notification, asking to explain the failure of reaching 8% CAR.
A senior staff responsible for external affairs in Hua Nan Bank indicated that Hong Kong, which complied the Basel Accord in 1990, required foreign banks to sell assets if the 8% CAR was not met (Yeh and Lai 1992). Farmers Bank of China’s first application for setting up a branch in Los Angeles was rejected by the U.S. federal
A senior staff responsible for external affairs in Hua Nan Bank indicated that Hong Kong, which complied the Basel Accord in 1990, required foreign banks to sell assets if the 8% CAR was not met (Yeh and Lai 1992). Farmers Bank of China’s first application for setting up a branch in Los Angeles was rejected by the U.S. federal