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

Heh-Song Wang (王鶴松)**

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 and
NT$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 in
reducing 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 of
China, 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 lengthy
court 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 will
purchase 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

Taiwan’s 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 of
this 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 provisions
to 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 regulatory
structure 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.