With Chen's political capital steadily shrinking, there's a real danger that there will be backpedaling on broader changes in the banking sector as well. "It's a setback for financial reform," says Norman Ying, professor of banking at National Chengchi University in Taipei. Foreign analysts now fear a key bill to expand a government bank bailout fund from $4 billion to $31 billion will become hostage to Chen's populist leanings.
CRISIS OF CONFIDENCE. With reform-minded Finance Minister Lee gone and his successor as yet unknown, the legislation likely will be delayed, perhaps even abandoned, until after presidential elections in 2004. Says Merrill Lynch banking analyst Sophia Cheng: "Emotionally, this is negative. It causes a loss of confidence in the government's ability to deliver what they have planned."
The perception that the government is retreating on reform couldn't come at a worse time. Since the election of Chen -- Taiwan's first democratically elected President in 50 years -- the country has seen the passage of two key bills aimed at cleaning up the banking sector. One allows the creation of financial holding companies, which would enable banks to merge, and a second permits the creation of asset-management companies.
After his appointment in February, Lee leaned on banks to get nonperforming loans off their books -- and bad debts of more than $4.2 billion in face value have since been sold at public auction, most going to foreign distressed-debt specialists like LoneStar. But the perception that Chen has dropped the ball on reform could jeopardize further sales. "It's a big mess," says one banking analyst. "It puts the government in a very bad light."
COMPLEX ISSUE. Admittedly, Chen's handling of the credit cooperatives was a botched affair. Between April and August, the government froze lending at 36 credit cooperatives as part of a process intended to see healthier commercial banks absorb them. The move deprived farmers of financing for seeds and fertilizers, but it also cut off funding to farmers' associations backed by members of the powerful Kuomintang Party (KMT), which for years have milked cooperatives for their own purposes. "This was a very complex social and political issue," says Philip Yang, professor of political science at Taiwan National University. "This cannot be solved simply by financial means."
Others argue that Chen, himself the son of a farmer, intended all along to break the KMT's rural machine, and that he badly miscalculated the reaction of farmers who were denied credit. In the absence of alternative sources of funds -- commercial banks don't consider farmland valid collateral -- the plan was doomed to failure. Furthermore, the roughly 280 credit cooperatives, which primarily serve farmers and fisherman, account for less than 8% of total nationwide deposits, according to Salomon Smith Barney.
Despite his rout in the countryside, Chen should stick to his guns in the cities. A nation of 25 million people, Taiwan has 53 banks, many of which should be forced to go belly-up. While official levels for nonperforming loans (NPL) are just 8%, analysts say the figure is practically double that when international standards of reporting are applied. Even so, if targets set earlier this year for banks to reduce NPL levels to 5% within two years and meet an 8% capital adequacy ratio are to be achieved, the government must play hardball with the banks and their customers, however politically well connected they be.
BAD COP. Given that Chen's popularity has already sunk so low, now is the ideal time to play bad cop. That means pushing ahead with the bill to finance a financial restructuring fund and sending a clear signal to deadbeat borrowers that the time has come to pay for their profligate ways. It also requires a firm show of official resolve -- a demand that many family-owned banks replace their managements in exchange for government bailouts.
Indeed, Taiwan need only look at its two closest neighbors when deciding which path to choose. It can follow Japan's example: try to keep all the banks on life support and settle for years of economic stagnation. Or it can take South Korea's lead: force banks to bite the bullet and allow distressed-debt vultures to help rebuild the financial sector from the ground up. Balfour writes for BusinessWeek in Hong Kong