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The Role of the Public Sector in Non-Performing Loan Resolutions*

Heh-Song Wang ()**

It is a great pleasure for me to be here in Beijing to participate in

the Second Non-Performing Loan (NPL) International Forum. I would

like to give you a briefing about Taiwan's public sector experience in

NPL resolutions. My presentation will be divided into four sections.

Section One discusses the role of the government in NPL resolutions.

Section Two analyzes the problems and difficulties encountered by asset

management corporations (AMCs). Section Three presents pros and cons

of government involvement in NPL resolutions. I shall then close with a

brief conclusion.

I. Government Involvement in NPL Resolutions

In view of the increasing NPL ratio, the Taiwanese banks have

strengthened credit risk management and made use of the provision of

loan loss reserves to write off bad loans in recent years. The NPLs

written off by domestic banks amounted to NT$140 billion in 1999 andNT$163 billion in 2000. However, NPLs continued to increase in the

first nine months of 2001 and are likely to increase further in the coming

months.

The rising number of NPLs of Taiwanese financial institutions has

alarmed the banking sector. The rapid growth of NPLs and the

magnitude of NPLs have become unmanageable by banks themselves.

Obviously, there is a need for the government to assist the banks inreducing their NPL ratios in order to prevent a financial crisis.

Government involvement in NPL resolutions has taken on various

forms. First of all, the Central Bank cut the reserve ratio on deposits for

banks in February 1999. This was followed by a tax reduction for banks.

The Ministry of Finance reduced the gross business receipt tax (GBRT)

for banks from 5% to 2% in July 1999. The GBRT rate will be further cut

* Speech delivered at the 2001 Non-Performing Loan International Forum, Beijing,China, November 2, 2001.

** Senior Vice President and Chief Economist, The International Commercial Bank ofChina, Taipei, Taiwan, Republic of China.

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to zero effective January 2006. The extra revenue derived from lowering

the required reserve ratio and cutting the gross business receipt tax rate,

estimated to be NT$35 billion (or US$1 billion equivalent) per year, has

been earmarked exclusively for the write-off of bad loans.

Moreover, the government has provided a friendly legal

environment to accelerate the disposition of banks' non-performing

assets. The Merger Law of Financial Institutions (MLFI) was enacted on

November 24, 2000. The Law provides the legal framework for the

establishment and operation of the Taiwan Financial Asset Service

Corporation (TFASC) and Taiwan Asset Management Corporation

(TAMCO). Commercial banks may dispose of NPLs through TAMCO

and an independent third party, TFASC, without going through lengthycourt procedures. Tax incentives are offered to TAMCO and financial

institutions that sell NPL assets. The successful operation of the TFASC

and TAMCO will expedite the disposal and management of NPLs, lower

the NPL ratio and improve asset quality of banks.

As mentioned earlier, another financial problem in Taiwan is the

high NPL ratio of the community financial institutions. One possible

solution is to set up a quasi-Resolution Trust Corporation (RTC)mechanism. The Statute for the Establishment and Management of the

Financial Restructuring Fund was enacted on June 26, 2001. The Statute

provides for the establishment of a Financial Restructuring Fund in the

amount of NT$140 billion (or US$4.1 billion). Of the total amount of the

Fund, NT$120 billion will come from collection of the existing 2% gross

business receipt tax on financial institutions over the next four years, and

the remaining NT$20 billion will come from the proceeds of increased

deposit--insurance premiums over the next ten years. The Fund willpurchase the bad assets of troubled financial institutions. In September

2001, the government made use of part of the Fund to restructure and

liquidate NPL assets of 36 community financial institutions.

II. Problems and Difficulties encountered by AMCs

Taiwans first AMC was established in last May and open its doors

for business in early November 2001. Its operations have encountered

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some problems, including the shortage of capital, reluctance of banks to

sell NPLs to the AMC, and difficulties in fixing NPL pricing. A brief

explanation follows.

First of all, the capital of the AMC is only half a billion US dollars,

compared with the huge amount of NPLs totaling US$27 billion. Due to

the shortage of funds, the capacity of the AMC to dispose of NPLs is

severely constrained. To overcome the problems, the AMC is

contemplating engaging in the trust business at the initial stage, to

minimize the use of capital. In this regard, it may be necessary for the

government and the central bank to consider providing additional funding

to the AMC.

Secondly, many banks are reluctant to sell NPLs to the AMC because

the losses resulting from selling NPLs would be realized immediately.

This would reduce the banks profit and adversely affect their

achievement of annual financial targets. Notwithstanding this

consideration, the government authorities should stand firm in advising

banks to dispose of their NPLs and reduce their NPL ratios over a period

of time, say, 5 years.

Thirdly, with regard to the NPL pricing, it is understandable that

banks want to sell their NPLs at higher prices, whereas the AMC would

like to buy NPLs at prices as low as possible. There is an apparent

conflict of interest between the two sides, and it is difficult, if not

impossible, to reach a compromise. In this regard, it is noteworthy that

the government has taken the initiative in setting up an impartial third

party, called the Taiwan Financial Asset Service Corporation, to evaluate

the prices of NPLs. Nevertheless, due to the complexity and the nature ofthis issue, whether the Corporation can play an effective role in this

regard remains to be seen.

III. Pros and Cons of Government Involvement in NPL Resolutions

NPL resolution is a difficult task that requires cooperation and

collective efforts of the government and the commercial banks. There are

questions about what the government can do and what the government

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should do in NPL management. Some argue that banking is a high risk

industry--commercial banks themselves should bear all the risks arising

from their operations and must provide adequate provisions for possible

loan losses. It is hard to justify the use of tax-payers' money for the

clean-up of NPLs. Also, since the primary responsibility of the Central

Bank is to achieve and maintain price stability, its balance sheet should

not include a large amount of NPLs of the banking system.

On the other hand, some analysts say that delays in addressing the

NPL problem may lead to a financial crisis. Past experience shows that a

crisis could have a devastating impact on the real economy. The crisis-hit

economy would go into recession and banks would be saddled with huge

NPLs. Unfortunately, many banks have no adequate loan loss provisionsto deal with NPLs. Under this circumstance, the government is in a better

position to establish mechanisms to resolve the problem of NPLs of ailing

financial institutions.

There is no doubt that the public sector can play an important role

in the speedy disposition of NPLs. Government intervention should

contain the cost of bank recapitalization and also reduce the cost to the

taxpayer. Furthermore, the government has to strengthen the regulatorystructure and provide the legal framework for NPL resolutions. Setting

up AMCs and an RTC is not enough. They will need adequate funding,

government support, policy guidance and necessary actions. As the

lender of last resort, the Central Bank of China is expected to provide

short-term financing to commercial banks and AMCs to deal with NPLs

as requested.

IV. Concluding Remarks

Proper management and speedy disposition of NPLs is one of the

most critical tasks of banking reforms today. The government could play

an indispensable role and provide invaluable assistance to the banks to

effectively reduce NPLs. These include a supportive legal environment, a

sound financial regulatory framework, provision of operational guidance

and advice, tax incentives, appropriate asset valuation policy, financial

assistance, and establishment of AMCs and RTC. The main purpose of

active involvement by the government is to remove NPLs from the

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banking system quickly so that the banks can resume their normal

functions.

In conclusion, I would like to thank the Organizing Committee of

the Second NPL International Forum for this opportunity to brief you on

Taiwan's experience in government involvement in NPL resolutions. I

would also like to express my sincere gratitude to you all for your

patience in listening to my report.

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