Starting in mid-December 2006, the Financial Supervisory Commission (FSC) announced the government takeover of three ailing banks – Taitung Business Bank, Enterprise Bank of Hualien and The Chinese Bank – within less than a month. The moves prompted daily recriminations and suspicions, with many wondering how Taiwan's regulatory framework could improve the situation in the future and how troubled financial institutions could be revived.

Syndrome 1: The Roots Run Deep

Industry insiders were clearly already aware of the problems plaguing the banks.

“Were the problems unexpected? (I think) it was simply a question of when,” says Bank SinoPac senior executive vice president and chief operating officer Chia Chen-I, not in the least surprised over what happened. 

Chung-hua Shen, a professor in National Chengchi University's Department of Money and Banking, concurs. “The question everybody's asking is how it took so long before things erupted,” Shen says.

Early signs of trouble were clearly evident at all three banks. Enterprise Bank of Hualien's capital adequacy ratio had not exceeded the 8 percent international standard since 2000, and its net worth became negative in 2005, its capital having been drained by the bank's continuing losses.

Taitung Business Bank had faced a capital shortfall since 2002, and its net worth turned negative last year.

In 2003, the Bureau of Monetary Affairs (the predecessor of the FSC's Banking Bureau) referred Wang You-theng, CEO of The Chinese Bank, and his daughter Wang Lin-ke to the Taiwan High Prosecutor's Office Investigation Task Force for Criminal Profiteering Crimes on suspicions of lending money illegally.

The Chinese Bank was repeatedly warned, penalized and threatened with legal action, but its doors remained open for business on a daily basis. 

“I wonder when they'll close their doors and declare bankruptcy,” one analyst wrote prophetically in the third quarter of 2006.

Syndrome 2: Financial Data Manipulation

One insider suggested that the hidden key to the problem has been how accurately financial data and delinquent loans were reported.

Former deputy finance minister Yang Tze-kaing, who has more than two decades of experience in the fields of banking, investment and appraisal, contended that the value of non-performing loans was closely linked to expectations of future performance.

To a bank with a small net worth of NT$10 billion to NT$20 billion, for example, errors in estimates of its non-performing loans – sometimes to the tune of tens of billions of Taiwan dollars – can directly influence whether its net worth is positive or negative.

Complicating the equation, the government virtually asked banks to cook their books. In 2002 when the non-performing loan ratio in Taiwan's banking industry exceeded 10 percent, the government encouraged banks to liquidate these bad loans and get them off their books. To ease the potential impact of one-time charges from these write-offs on profit/loss statements, the authorities allowed banks to amortize the liquidated non-performing loans over a five-year period. As a result, many banks showed a profit on their financial statements when in fact they were losing money.

The consequences of such financial manipulation became evident on January 5, when the financial crisis engulfing The Chinese Bank's parent company China Rebar Co. triggered a run on the bank. That afternoon, Financial Supervisory Commission chairman Jun-ji Shih publicly vouched for the bank by declaring it had a net worth of NT$11.7 billion and appealed to the media for measured reporting to avoid provoking panic.

But after financial authorities took over The Chinese Bank later that night and checked the value of its non-performing loans, they found the bank's net worth to be a negative NT$11.5 billion, NT$23.2 billion less than Jun-ji Shih had reported earlier in the day.

Syndrome 3: Inadequate Tools to Take Control

The FSC is of course aware of the black holes in the financial statements of local banks. The real question is whether it can effectively deal with them.

The FSC lacks the tools needed to rein in wayward banks. Fines, operating restrictions and the threat of legal sanction are the most common forms of punishment, but their effectiveness as deterrents is limited and they take too long to work. At the end of last year, for example, Enterprise Bank of Hualien's internal control systems showed flaws, but the bank was only fined NT$6 million. The Chinese Bank was forced to suspend some of its operations, but still went about its business as if nothing had happened. Wang Lin-ke, suspected of doling out excessive loans, remained as the bank's vice president of finance. It was only when the recent crisis hit that she suddenly stepped down.

If a financial institution is structurally weak – with a capital adequacy ratio below 8 percent, negative net worth or a high non-performing loan ratio, for example – the first tool the FSC can use to redress the situation is to request the institution to increase its capital.

All the banks identified by the government as in need of special oversight ?]See Table?^were asked to increase their capital levels, at least a year and a half ago. When deadlines arrived, however, many of the banks stalled, promising that the funds were about to be raised and then failing to deliver.

In the process, however, some banks have tried to raise their capital. “But those that think their situations are hopeless make use of the time left to think of ways to get back the money they put in initially,” one former financial official suggests. “They're racking their brains around the clock. How can the government stop that?”

The FSC's silver bullets are also in short supply. Before it took over Enterprise Bank of Hualien, Taitung Business Bank and The Chinese Bank, only NT$40 billion was left in the Financial Reconstruction Fund. But the problem banks need injections of about NT$100 billion.

If the government did not assume control of the ailing banks, however, the money pit would have only grown larger. KMT legislator Lee Jih-chu calculated that in the past year and a half, as the banks' losses accumulated, another NT$10 billion was essentially thrown away. 

Sophia Cheng, managing director of equity & research at Merrill Lynch Global Taiwan Ltd. and one of Taiwan's top financial analysts, said the FSC faces a twofold dilemma. “The government's pockets aren't deep enough, and no matter what it does there will be people who criticize it,” she indicates.

Syndrome 4: Lackadaisical Legislature

The Legislative Yuan has been the fiercest critic of the crisis but is also itself the object of financial insiders' ire.

Many bills conceived to strengthen the FSC's functions and powers have been pushed aside. The legislature ignored or rejected amendments that would have required financial authorities to publish the names of big delinquent debtors, or have weaker financial institutions pay higher deposit insurance rates, or eliminate the five-year amortization of bad debts. Also, the FSC is sometimes blocked by self-interested lawmakers when it wants to sanction an ailing financial institution.

The most important issue at present is how to use limited government resources to solve the problems.

Solution 1: Prepare Adequate Funds

With the Financial Reconstruction Fund so strapped for cash, many are worried over the number of troubled banks that still need to be rescued. Thomas Lee, a former lawmaker and now a professor in National Chengchi University's Department of Money and Banking, suggested that everybody should calculate how much money they need and then figure out a way to raise it. 

“If there isn't enough money, we'll think of something,” said Financial Supervisory Commission acting chairwoman Susan Chang when she temporarily took over the agency's reins. She suggested that the deposit insurance fund and reductions in the financial sector's business tax exemptions could provide NT$200 billion in a pinch.

Liquidating the assets of ailing banks or increasing deposit insurance premiums could also contribute to the fund in the future.

Solution 2: Problem Banks Must Pay a Price

Many observers argue that the current deposit insurance system and Financial Reconstruction Fund have allowed bad institutions to flourish at the expense of good ones.

One problem is that there is no limit to the amount of deposits guaranteed by the government at banks they have taken over. Some elderly men waiting to withdraw their money from The Chinese Bank were asked why they had deposited their life savings there. “The interest rate on savings was higher,” and “Deposit insurance will cover any losses,” were the most common responses. 

Susan Chu, director of financial services ratings at Taiwan Ratings Corporation, says her friends in the financial sector often like to joke that by saving money in these troubled banks, you can earn more interest without worrying that the bank will fail.

The FSC therefore believes three changes are needed in the future: not every bank should be eligible for deposit insurance, insured amounts will have to be adjusted, and poorly run banks will have to pay higher insurance premiums. 

Solution 3: Accelerate Capital Expansion and Consolidation

At the same time, the FSC needs to be firmer in enforcing its will. Merrill Lynch's Cheng suggested that when the authorities require banks to increase their capital by a certain deadline, it should be enforced. Ailing banks should not be allowed to play on their weakness to appeal for sympathy.

Susan Chu of Taiwan Ratings contends, however, that after this most recent crisis, banks with weaker structures will feel more pressure to increase their capital levels. 

“They originally were unwilling to sell their shares at NT$3 per share, but now they might consider it,” Chu says. “Otherwise, the banks could be taken over and liquidated, and the shares won't even be worth NT$1.”

Solution 4: Amend Laws As Soon As Possible

The recent financial storm – set off when China Rebar Co. and Chia Hsin Food and Synthetic Fiber Co. applied for restructuring under bankruptcy protection – did not leave behind many aftershocks. Taiwan Ratings Corporation estimated that the two companies' debts accounted for only 0.2 percent of the outstanding loans issued by Taiwan's domestic banks, and the entire Rebar Asia Pacific Group was liable for less than 1 percent of the total.

“Everybody knew early on that they were landmines and were afraid of dealing with them,” a general manager of a foreign financial institution said.

The most obvious result of the crisis is that the financial amendments mired in the legislature have suddenly found new life. Within one week after the storm struck, lawmakers were mobilized and procedures to review the measures began.

Revealing the helplessness he felt during his less than six months on the job, Jun-ji Shih said in the text message announcing his resignation: “The abuses in the financial sector that have become deeply rooted over the past ten years suddenly exploded.” 

But the message also hinted at a warning for the future, that while The Chinese Bank crisis was gradually coming to a conclusion, new battles to straighten out other ailing financial institutions loom in the offing.

Translated from the Chinese by Luke Sabatier