Taiwan Today

In early August 1991, Minister of Finance Wang Chien-shien (王建煊) participated in a lecture series for business managers, entitled" Leaders, Life, and Learning. " Wang's remarks provide in­ sight into the government's policymaking steps toward greater financial liberalization. The following is a translation of excerpts from his lecture, which was published in three parts by the Economic Daily News on August 13,14, and 15.

How is government policy made? In most cases, a decision is made after a problem arises which calls for immediate solution. In other words, the government takes measures to meet certain needs. And once a measure is announced, it becomes government policy. Financial liberaliza­tion is an example of a policy that the government adopted because of a need.

The development of Taiwan's finan­cial system is lagging behind that of the general economy. At present, legal and il­legal financial markets coexist, and statis­tics show that they have an almost equal business volume, with the companies and firms in the underground market often drawing in more capital from the public. But how can illegal firms, which exist mainly to provide loans, operate on a much larger scale than legal institutions? The primary reason is that the government controls the legal financial market, and liberalization has been slow. It influences interest rates and has limited financial in­stitutions from expanding their markets. For decades, it did not allow the establish­ment of new commercial banks. Mean­while, it imposed strict restraints on the number of branches existing banks could have. Foreign banks were also limited in their attempts to set up branches here.

Extensive government control re­stricted the development of the financial market, and encouraged the rapid growth of an underground market. We may wonder to what extent these two markets differ. Recently, the Central Bank com­missioned the three commercial banks [First Commercial, Hua Nan, and Chang Hwa] to do a survey on the capital sources of 150 enterprises. The results showed that from 1986 to 1991, the average annual interest rate on long-term loans from underground firms ranged from 19 to 24 percent. The highest was a staggering 40 percent.

Despite the high interest rates, en­trepreneurs of small and medium-sized companies dare to take the risk. Often they have no alternative but to acquire their capital from the underground market because they do not have adequate col­lateral security to qualify for bank loans and have yet to establish their businesses as good credit risks. Even worse, in order to make a profit despite the high cost of borrowing capital, they falsify their books and evade taxes. The survey clearly showed the close link between the finan­cial market and the whole economy. The question that remains is what must be done about the illegal market.

First, we have to ease government influence on interest rates. We are doing this now. Second, restrictions on the es­tablishment of new financial institutions should be relaxed. Thus, the government recently approved the establishment of fifteen new commercial banks. How did we arrive at this decision? We realized that if we expect the economy to continue developing, the banking, insurance, and securities industries must first be mod­ernized and strengthened. And so the government made it a policy to allow the establishment of new, private commer­cial banks.

But why fifteen? After studying for­eign financial markets and the needs of the domestic market, we believed that fifteen new banks were more than enough. The decision led to quite a bit of controversy. Some people thought the market would be saturated. On the other hand, it's usual in many countries to es­tablish a new bank every year. So there were people who thought that the gov­ernment should allow for thirty new banks because none had been allowed for the last three decades.

It is also becoming apparent that fi­nancial liberalization brings many ben­efits. For example, competition will become more intense. As a result, the discrepancy between interest rates on de­ posits and on loans will narrow. The banks will have to make their profits by offering modernized and convenient service, and new financial products. Fur­thermore, since the government will continue to allow the establishment of more new banks, banking will eventually turn from a market favorable to banks to a market favorable to borrowers.

To implement financial liberali­zation, the government will have to strengthen the regulatory system. People say that the new banks have bad inten­tions, but the Ministry of Finance is un­willing to see the problem of regulation from this angle. In the past, some credit cooperatives and securities firms caused problems for the economy by transferring deposits to their own businesses. Every­ thing was fine as long as the firms existed. But once they were closed down, the fi­nancial market was affected, and the public's deposits endangered. The gov­ernment was forced to deal with the re­sultant financial crises.

In the future, when the financial market is liberalized, it will be impossible for the government to deal as freely with the problems of financial institutions. Although we don't want to see bank runs or banks being closed down, they are unavoidable and should be handled ac­ cording to legal procedures. But what if the new banks transfer funds to the busi­nesses of their sponsors? The regulatory system will have to be strengthened so that the banks can be effectively moni­tored for irregularities. While we feel that financial liberalization and deregulation are necessary, we worry that thorough monitoring will be difficult. Frankly speaking, we felt that the regulatory sys­tem was weak, primarily because the Department of Monetary Affairs has only eighty personnel. Later, the number was increased to one hundred people. Four­teen handle the insurance companies, and eighty-six are responsible for depository institutions.

The personnel shortage worried me, and I took this into consideration when approving the applications for new banks. The Department of Monetary Affairs has since been elevated to the bureau level, and as a bureau it can have a minimum of 230 staff and a maximum of 329. This year, over 120 people will be added to the bureau. And the insurance section, after it is reorganized into a department, will have a staff of eighty.

An increase in staff does not mean that the bureau will be successful in car­rying out its regulatory role. The prereq­uisite to its success is a sufficient number of high-quality personnel. The establish­ment of the Bureau of Monetary Affairs is very much related to the lifting of restrictions on new banks. In order to carry out financial liberalization, as well as lift re­strictions on the setting up of commercial banks and quicken the pace of liberalization, we need a sound regulatory system. And to maintain a good system, the number and quality of the regulators must be raised. With all these in place, further deregulation of the banking industry will be forthcoming.

Now the new banks will have to raise the required minimum capital of NT$10 billion [approximately US$370 million]. But according to press reports, some banks might be unable to do so. This is because they will have to raise their capital by issu­ing stocks. But people are unsure about the profitability of investing in bank stocks, and are therefore hesitant to buy them. I have been told that if I had approved only three to five new banks, the price of the stocks would appreciate. But this would have resulted in windfall profits for the sponsors of the new banks. The government would definitely have been criticized by the public, who would blame the situation on the government's slowness in lib­eralizing the financial market.

More new banks will be allowed, and we will continue to liberalize the market until we feel that there are too many new banks. Then the government will an­nounce the deadline for applications and when applications will again be accepted. Unless there is such a formal announce­ment, the establishment of more new banks will be approved. There is some concern that further deregulation would lead to an increase in the number of banks to fifty or even five hundred. The fears are groundless. The banks are protected now, and so their profits are assured. But be­cause of increased competitiveness, the new banks are not at all assured of a profit. The benefit of financial liberaliza­tion, after all, is the creation of a normal and stable financial market.

The government is also looking at correcting the highly speculative nature of our stock market. In 1989, the turnover rate was 590 percent. In other words, each stock changed hands six times. Although the turnover rate went down to 506 per­cent in 1990 and again to 450 percent in 1991, there is still much more speculation in our stock market compared with the bourses of other countries. One of the major reasons is that individual investors account for 95 percent of stock market investors. In more advanced economies, individual investors make up 20 to 30 percent of all investors, and therefore the markets develop more steadily.

The government has been trying to encourage institutional investment rather than individual investment. Toward this end, a percentage of the labor pension fund was invested in the stock market. Another step taken was to lift the ban on foreign in­stitutional investment. So far, fifteen applications have been submitted, and twelve have been approved. Although the foreign institutions committed a total of US$500 million, only US$200 million has been re­mitted thus far. Some foreign investors who are optimistic about our stock market hope that the government will relax present limitations, and allow a total investment amount of US$2.5 billion.

Another aspect of financial liberali­zation is the privatization of government­ owned enterprises. If they are privatized, then according to government regula­tions, they will have to issue stocks. Therefore, a large amount of stocks will be released into the bourse, and this will cause prices to drop. Issuing stocks is also a way to raise funds for the Six-Year Na­tional Development Plan. The first nine­teen state-run enterprises to be privatized will issue stocks worth US$18.5 billion.

The securities market will also have to be readjusted. A normal securities market should include both stocks and bonds; but in Taiwan, stocks take up 95 percent of the market, while in other advanced econo­mies, they account for only 30 percent. To correct this, the government will strengthen and enliven the bond market by urging more bond issuance.