Taiwan’s Bad Bank Debt Starting to Raise Concerns

Taiwan has long been proud of its sound economic fundamentals, a strength that allowed it to sail virtually unscathed through Asia’s devastating financial crisis of 1997.

But a worrisome crack has developed in Taiwan’s armor: A mountain of bad commercial bank loans is posing a real threat to future economic growth, according to those tracking the problem.

The volume of overdue loans is not nearly as serious a problem as Japan’s profound and long-running banking crisis and is still well below the levels that crushed the economies of South Korea, Thailand and Indonesia just a few years ago.

Moreover, Taiwan’s huge foreign exchange reserves, low external debt and sophisticated high-tech industrial sector still provide the island with an enviable shield against a regional economic crisis.

But glimmers of trouble in this regional bastion of economic stability are a source of worry around the globe. America’s high-tech producers, including computer giants such as Dell Computer Corp., Compaq Computer Corp., Gateway Inc. and IBM Corp., rely heavily on Taiwan for much of their production. Indeed, the U.S. technology slump has cut into Taiwanese production, something else to worry about here.

“I don’t think Taiwan’s banking system is in crisis, but what we do know is that there is a problem,” said Peter Banko, a senior Bank of America executive in Taipei. “It’s causing a confidence issue among the rating agencies and within the investor community that the government needs to address.”

Peter Kurz, chairman of Insight Pacific, a Taipei investment research company, agreed. “It drags on the monetary system. It doesn’t cripple it, but it slows it down,” he said.

Older, formerly state-owned banks, such as Chang Hwa Bank, are said to be especially affected, with several holding portfolios containing debt five years or more overdue. Municipally owned institutions also have a disproportionately high number of nonperforming loans, analysts say.

The nose dive of Taiwan’s stock market last year, worries about a downturn in the U.S. economy and a near-total lack of banking sector transparency lent credence to predictions of a slowing economy and put more pressure on the government to act.

Last month, Taiwan’s central bank reported that nonperforming loan volume--those debts six months or more overdue--had risen in 2000 for the fifth straight year to a record $23.5 billion.

By the stricter yardstick used by many nations, including the United States, that classify loans three months or more overdue as nonperforming, the official figure would be $36.5 billion, or 8.3% of all commercial loans.

Many independent analysts believe the real amount is much higher, possibly more than $60 billion, or 20%. But in Taiwan’s opaque world of banking, they admit that no one really knows for sure.

Stung by the sudden glare of attention, President Chen Shui-bian’s new government has begun to tackle the problem with an unaccustomed sense of urgency.

Since November, it has enacted laws that encourage consolidation of the overextended banking sector through a series of tax incentives, lift a ban on foreign takeovers of local banks and allow the creation of so-called asset management corporations--companies that purchase bad loans at a discount, then try to collect on them.

Goldman Sachs Group is seeking partners for one such corporation, and Taiwan’s Bankers Assn. is putting together another that reportedly includes Lehman Bros. and several domestic banks. Together, the two are expected to raise about $750 million in capital.

There are also signs the government is trying to open the sector to greater public scrutiny. Beginning in April, for example, banks will be required to post quarterly statements on their Web sites, including income, asset quality and profitability. More reform measures are in the pipeline, and Chen last month talked of “an overall transformation” of the island’s financial system this year.

“Taiwan needs reform to establish an open financial market, for without reforms, there will be no sound and open financial environment,” he said in a speech to members of the American Chamber of Commerce in Taipei.

These measures, together with a tentative recovery this year in the Taipei stock index, have eased the deep sense of foreboding that pervaded the sector just a few months ago.

But few believe they will be enough.

Serious weaknesses remain in the banking system and analysts worry that conditions could easily deteriorate further. They note, for example, that for years authorities seemed either unaware or uninterested that loan collateral--usually property or equities--had been eaten away by sharp declines in both markets. The situation is similar to that in Japan.

Taiwan’s property values today are roughly half their mid-’90s peak. The Taipei stock market index, which once hit 12,000, has recovered from last year’s lows, but hovers below the 6,000 mark, closing Friday at 5499.54.

“Of course we’re aware the situation isn’t good with so much collateral held in the form it is,” said Edward C.W. Lai, a senior central bank official. “That’s why we’ve taken measures to control the problem.”

In a banking sector suffering from severe overcapacity (there are 53 commercial banks and 362 community cooperatives serving a population two-thirds the size of California’s), many lending institutions have been prepared to take higher credit risks in the scramble for customers. As Taiwan’s older industries such as textiles and shoes began to move offshore, banks lent to fledgling high-tech companies they barely understood.

And as in so many Asian countries, there were also dubious deals between bankers and their cronies.

Too often, the loans failed.

“In this need to find borrowers, they were throwing out money to just about anyone,” Banko said.

Because of all this, any slowing in key Western industrial countries and a possible hard landing for the U.S. economy would probably add strains to Taiwan’s difficulties, analysts say.

“A global slowdown won’t help,” said Neal Stovicek, a strategist at National Securities Corp., a large Taipei-based securities firm.

The key question, observers in Taipei say, is whether Chen’s weak and inexperienced government can push through proposals that would commit public money to clean up the problem. A draft law that would create a public corporation to buy more than $1 billion in bad loans held by small local cooperatives is seen as a step in this direction.

But this bill is stalled in the opposition-controlled parliament. The largest opposition group, the Nationalist Party, balks at using public money to bail out commercial banks.

“The taxpayer shouldn’t have to pay,” said Nationalist Party spokesman Jonathan Shih.

The opposition also has blocked government efforts to eliminate a 2% tax on bank revenues, part of a quid pro quo in which banks would use the savings to increase their provisions for bad loans.

“It’s a trivial amount of money, but it’s emblematic that legislators don’t seem ready to put public money into this,” said one analyst who declined to be identified.

Still, there is a cautious optimism that Chen can capitalize on the public’s concern and clean up the mess, even if it takes a large chunk of taxpayer money.

“The good thing about allowing the problem to fester is that you build support for solving it,” Kurz said. “There’s been enough talk about a banking crisis . . . to make a commitment of public money politically possible.”

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Overdue in Taiwan

Commercial loans in Taiwan six months or more overdue:

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Percent U.S. dollars,* Year of total in billions 1996 3.68% $10.8 1997 3.70 13.1 1998 4.36 16.7 1999 4.88 20.1 2000 5.34 23.5

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* Converted at present exchange rate.

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Source: Central Bank of China, Taipei