FCR: A number of issues have recently been raised with regard to credit unions and cooperatives. How do these institutions fit in with Taiwan's finance industry, and what are the problems?
Christian Murck: First of all, these credit co-ops and credit departments are not banks. One of the problems that occurred when runs on the credit co-ops started was that the MOF [Ministry of Finance] did not have legal authority to mount the kind of rescue that they would do in the case of banks. They came out with the suggestion that these credit co-ops and other institutions should be merged into another entity, but the local people involved said no. They delayed for several months, until it eventually became clear that there was no alternative.
I think the fundamental issue with respect to these credit cooperatives is that they are a type of community financial institution whose time has come and gone. They are very small, local, one-product financial organizations. They can take deposits and they can lend money. Thirty years ago, when Taiwan desperately needed capital and didn't have money, they were very useful, because they provided a way for people to pool their funds and make loans for purposes of local economic development.
Today, that's not a problem. Taiwan is a capital exporter. And financial consumers are usually looking at a bank not only as a place to put deposits and get loans, but also as institutions that supply remittance services, credit cards, checking accounts, all kinds of other things, which these other organizations cannot by their nature provide. Therefore, the amount of money in credit co-ops has grown, but their ability to make a profit through providing financial services has decreased. They are less and less competitive vis-à-vis banks. And they've become more and more subject to malfeasance on the part of their managers.
I'm told that in almost every instance where there was a run this past summer, a problem with the integrity of a manager was at the bottom of it. There are two short-term responses to the situation. One is to do something about the liquidity problems that these institutions face when there's a run. You can get them to pool back-up funds—something to help the situation in terms of restoring public confidence. The other response is to tighten auditing standards. They've been encouraging these organizations to join the CDIC [Central Deposit Insurance Corp.], which would put them under the aegis of a more professional regulatory body. That's certainly a very good step, and it would help stabilize the situation. What it doesn't answer, however, is the long-term issue: What role should these small, community-based, financial institutions play in the future? I think most people in the banking industry feel that such institutions are not competitive, and that they're not going to be competitive. The MOF is reluctant to address this issue because it's highly political.
Are there any comparable institutions in the United States or other developed countries?
The comparable institutions are in Japan. Taiwan, generally speaking, follows the Japanese model in the way its financial system is set up. There's a whole group of agricultural and credit cooperatives in Japan. Just as Taiwan has the Cooperative Bank and the Agricultural Bank, in Japan there is the Norinchukin, which serves as a central bank for all the country's agricultural co-ops and associations. But those organizations have an enormous amount of bad debt, as is the case here, and they face a major problem in terms of their long-term competitiveness.
Problems similar to those we're seeing here have also occurred in Japan. There's a short-term problem with public confidence. You can address that by taking measures to assure liquidity, and by trying to tighten discipline, such as making sure that the people who are running these things are not making loans to their friends or pocketing the money. But the long-term questions are: How are these institutions going to make a living? What's their function? Do we need them anymore? I think that the answer to the last one probably is that we don't need them anymore. You also get a hint of that from the MOF when they say, "Well, the larger ones can turn into banks." And what about the smaller ones? Well, they either get merged or they disappear. But the MOF hasn't been saying that directly.
Does the MOF just want to take care of the problem quietly?
I'm sure that the issue, as a medium and long-term issue, has occurred to them. These are smart people. I think that they are taking care of the immediate issues quietly—things like depositor safety and public confidence. One of the problems is that the public does not draw a distinction between these institutions and banks. And I think that the MOF has found, a little bit to its surprise, that whenever there's a run on a credit co-op, it's immediately described as a bank run. In fact, it's not. This is a situation where the MOF has responsibility, but not enough authority.
Why are these institutions outside the MOF's authority?
Well, the agricultural co-ops are supervised by the Ministry of the Interior. And the credit co-ops are very local institutions. If they join the COIC, they come under the control of that organization. But the law with respect to these organizations is much less precise, and responsibility and authority are divided up in ways which mean that there's nobody who is clearly able to orchestrate a solution when a problem occurs and then impose it on the party in question.
The situation is very different with respect to banks. As we've seen with the. Overseas Chinese Bank situation [a run on the bank occurred when depositors learned of the huge loans made to a bank director without sufficient collateral], the MOF was able to take a very strong position. First, acting through the CDIC, they put a team of managers into that bank. Then they got other banks organized to provide liquidity support and orchestrated a complete change in the bank's senior management, including sending one of their own vice ministers to be the chairman.
The MOF could not easily exercise that kind of strong control in the case of an agricultural or credit co-op. They would have to change some regulations and laws before they could do that, which means that they'd have to get it through the Legislative Yuan. So I have a lot of sympathy for the MOF's position. I think the MOF has responded quite actively and has really done a pretty good job given the situation.
Is the MOF doing the right thing by redistributing auditing and oversight authority, while at the same time rejecting the idea of a single agency to supervise the whole thing? Is there some kind of international standard?
A single agency to regulate and supervise banks would be very difficult to achieve here in the short run, although it would be beneficial. What happens in other countries varies.
In the United States, for example, Chemical Bank is regulated by the Federal Reserve, the Controller of the Currency, the Banking Department of New York State, and by other agencies for other situations, including the FDIC [Federal Deposit Insurance Corporation]. There have been various proposals in the United States that this should be unified and should all be put under the control of the Fed or somebody else. It's said that in terms of government efficiency, we should get rid of some of these agencies and have only one professional agency. Or maybe we would have one agency doing the very large banks, and another type of agency focusing on community organizations. None of these plans has proceeded in the United States. The agencies involved always resist, there are differing political opinions about bank regulation, and we haven't been able to solve this problem. Yes, the system in Taiwan is not very efficiently organized, but politically and bureaucratically it would be a major task to change it.
Then many of these problems aren't unique to Taiwan?
No. There's also a lot of overlap in the United States. There are probably countries that organize this more efficiently than the United States, where the banking system is famously inefficient. For many years you could only bank in one state, you couldn't have true national banking, and very sharp restrictions separated commercial banking from investment banking. I don't know exactly what the situation is in other countries, but I think Taiwan's position is probably not unique.
Are they right to talk about putting more of the responsibility for auditing on the banks themselves?
I think one problem of the Taiwan banking system is that the branch operations of local banks are remarkably independent. The MOF and the CBC [Central Bank of China] may be correct in their view that internal controls within banks—I'm talking about the banking system, not the credit co-ops—are not the best. And one of the areas of weakness is the extent to which the headquarters really knows what's going on, and inspects and controls the branches. That should be improved.
Is it difficult to find enough qualified auditors?
I think it's true that they are under-staffed. Most foreign banks feel that their internal auditors are more professional and more stringent. So yes, they could improve their standards, although I'm not sure how they would go about bringing in better people. Perhaps establishing some kind of professional body to provide certification and training courses would help.
Is there a precedent for bringing in an outside auditing agency?
Not in the United States. There are related precedents in the UK, where auditing firms do have an affirmative responsibility to report problems to the Bank of England. And the Bank of England in practice relies on the bank's own external auditor for a good deal of its regulatory information. That's not done in the United States. The reaction from the banking industry and the accounting profession in Taiwan was mixed on that idea, and there are problems in implementing it. For example: What is the liability of the auditors? How confidential is the information? Who is going to pay for it? Which firms get the work—does it go to the big inter national accounting companies, or do you allow some of the smaller local firms to participate? How would you decide that? All of these are fairly troublesome practical problems. I don't know the status of the plan, but it seems to me that it's been put on the back burner and they're trying to proceed by reorganizing among themselves.
Banking in Taiwan involves massive paperwork and bureaucracy. Why doesn't this result in a better system of internal control?
One of the problems with audits is that the auditors tend to look at the paper flow. Have you got all the documents that you're supposed to have? Have you followed all the procedures that you're supposed to follow? But the broader issue is, are you properly controlling risk? The two are not necessarily the same.
It seems that the MOF and the CBC are aware of the issues and have an idea of what needs to be done. What is tying their hands?
That's a much more complicated issue. In general, it does seem to me that the plan the CBC is advocating on the regional financial center issue has become much more realistic in the past year. I think they understand that what they really need to do is build a financial center based on Taiwan's special characteristics, and that the first thing they need to consider is how to serve the financial needs of the manufacturing companies that are based here. Having said that, they are not inclined to move very aggressively, because they're worried about being able to maintain a stable exchange rate and being able to control hot money coming in or going out of the stock market. So the target date is now the year 2000 for deregulating the capital accounts. I think that between now and then there will be measured incremental progress made on a whole range of fronts, but I don't expect very dramatic or very sudden moves to be made.
The CBC is making an intensive effort to study the functioning of the interbank market and they have been consulting the foreign banks on that. They've made some trips to markets abroad, they've gathered a number of specific suggestions, and I think they're trying to do their best to improve the functioning of that market. The issues now are how to create a market that provides liquidity at a range of maturities. Right now it's essentially an overnight market. If you're going to have a mature financial market, you need a system where you can get one week money, one month money, three months money, six months money—you want a yield curve so banks can engage in asset liability management. How to get from here to there involves a lot of policy and practical problems, but they are addressing it in a very serious and systematic way. I think there's a good chance that something will be done.
Establishing better auditing procedures is only part of the agenda. Some credit co-ops and similar institutions have lost their relevance. They can't match the offerings of today's full-service banks.
Are there any nuts-and-bolts issues which are holding things back?
Zoning in Taipei city is a big problem for banks. Basically, a lot of the city is zoned as residential area, and banks can only be located on the ground floor. So it's very hard to move premises in the city. Something else that would improve the environment considerably is better telecommunications services. I have to call Hong Kong quite frequently and I find that three or four times a week, I pick up the telephone, dial a number, and I get a recording telling me that all [outgoing] lines are busy, please call back. That's ridiculous. You cannot be a financial center with that kind of telecommunications environment.
I think it's appropriate for the MOF and CBC to address the problem of internal controls, and I'm glad they're doing so. But it doesn't have much relation to whether international banks will find Taiwan attractive. It's more an issue of healthy development of their own domestic banking system within Taiwan and providing a reasonable degree of confidence to the public. It's something that requires continuous effort and attention.
If you look at the prospects for an Asia-Pacific financial center, the issues that are most disturbing to banks are the emergence of new regulators, who are beginning to have an impact on the financial system. For example, the Fair Trade Commission, which is looking at issues like loan documentation; the Computer Data Protection Act, which in its original form would have made it impossible to run a credit card business or any kind of direct marketing in Taiwan; or the Council of Labor Affairs which is planning to extend the Labor Standards Law into the banking industry, even though it is quite inappropriate to that industry and very much at variance with international practices. These are examples of different agencies or the Legislative Yuan taking actions that will have a dramatic impact on the banking system and financial services.
From the point of view of foreign banks and Taiwan's ambitions to become a regional financial center, the situation has become more complicated. Now we don't have to deal just with the Banking Law, the MOF, and CBC. Now we have all these other players in the game and, in general, they tend to understand the industry less than the MOF and CBC do. The real issue is: Do you want to attract people, or do you want to set up barriers? Right now I would say that there are mple, or do you want to set up barriers? Right now I would say that there are more barriers popping up, not from the MOF or CBC, but from other agencies.