US embassy cable - 05TAIPEI2546

UNCLAS SECTION 01 OF 03 TAIPEI 002546 
 
SIPDIS 
 
STATE PLEASE PASS AIT/W AND USTR 
 
STATE FOR EAP/RSP/TC, EAP/EP AND EB/IFD/OIA 
 
USTR FOR SCOTT KI 
 
USDOC FOR 4420/USFCS/OCEA/EAP/LDROKER 
USDOC FOR 3132/USFCS/OIO/EAP/ADAVENPORT 
 
TREASURY FOR OASIA/ZELIKOW AND WISNER 
 
TREASURY PLEASE PASS TO OCC/AMCMAHON 
 
TREASURY ALSO PASS TO FEDERAL RESERVE/BOARD OF 
GOVERNORS, AND SAN FRANCISCO FRB/TERESA CURRAN 
 
E.O. 12958: N/A 
TAGS: EINV, EFIN, ECON, TW 
SUBJECT: TAIWAN:  NOT ENOUGH FUNDS FOR BANK RESOLUTION 
 
 
1.  (U) Summary: On May 31, 2005, the Legislative Yuan (LY) 
provided additional funding to extend the life of the 
Financial Reconstruction Fund (FRF).  Much of the additional 
funding is earmarked for specific uses, including a bailout 
of shareholders in a credit association favored by the 
opposition Party.  The remaining funds are unlikely to be 
sufficient to resolve existing problems at financial 
institutions.  Prior to July 10 the Financial Supervisory 
Commission must designate institutions eligible for FRF 
funding.  This deadline may encourage some additional bank 
consolidation.  On a positive note, this same legislation 
caps the size of accounts eligible for deposit insurance 
coverage.  This move may instill some market discipline in 
the banking sector.  End Summary. 
 
New Funds for Bank Resolution 
----------------------------- 
2.  (U) On May 31, 2005, the LY passed amendments to provide 
additional funding of NT$110 billion to temporarily extend 
the life of the FRF.  First established in 2002 with NT$140 
billion, the FRF was to address Taiwan's banking crises of 
2001, but has been plagued by under funding and legislators' 
efforts to direct support to particular financial 
institutions.  Three quarters of the additional funding, 
barely ten percent of the NT$1.05 trillion requested by 
authorities in 2002, is already designated for specific 
uses.  The remainder is well short of funding needed to 
resolve existing problems at financial institutions.  Prior 
to July 10 the Financial Supervisory Commission (FSC) must 
designate institutions eligible for FRF funding. 
 
Lingering Financial Problems 
---------------------------- 
3.  (U) Taiwan's widespread banking crisis in 2001 caused 
severe losses in a wide range of institutions, including 
banks and credit associations.  Four years later, many of 
these losses have yet to be resolved.  The insolvent 
Fengshang Credit Cooperative Association (FCCA) is a case in 
point.  Under procedures and criteria established by Taiwan 
banking officials, FCCA shareholders (and those of other 
insolvent institutions) would not receive compensation for 
losses.  Depositors, on the other hand, are guaranteed to 
receive full compensation for all deposits in the banking 
system in the event of an institution being shut down for 
insolvency.  Opposition Nationalist (KMT) Party legislators 
have repeatedly stalled efforts to increase funding for the 
FRG until compensation is provided for FCCA shareholders. 
The May 31 legislation provides NT$500 million compensation 
specifically for FCCA shareholders.  In April 2004, FCCA had 
a non-performing loan (NPL) ration of 45% and negative net 
worth and was placed in receivership.  In July 2004, 
ChinaTrust Commercial Bank won a bid to take over FCCA and 
received NT$1.1 billion from the FRF as part of the deal. 
 
4.  (U) Besides the NT$500 million set aside for the FCCA 
shareholders, the amendments specify that NT$58 billion is 
to be used to finalize the last bank resolution undertaken 
by the FRF.  Chong Shing Bank (CSB) was placed in 
receivership in March 2001 and had outstanding liabilities 
of NT$58 billion in inter-bank loans.  In December 2004, the 
Union Commercial Bank (UCB) bid on and won the right to take 
over CSB.  FRF paid UCB NT$7 billion in the deal, exhausting 
FRF's original funding of NT$140 billion.  The NT$58 billion 
in outstanding inter-bank loans remained on the books of CSB 
(now part of UCB) and the creditor banks until such time as 
the FRF receives additional funding and disburses payment. 
 
5.  (U) Another NT$22 billion of the FRF's additional 
funding is earmarked for resolving ongoing financial issues 
at the credit arms of Farmers and Fishermen Associations 
(FAs).  There are 278 FA credit arms operating 1,146 offices 
island-wide.  FA credit arms are small, accounting for only 
three percent of Taiwan's lending markets.  However, their 
NPL ratios average 14%, much higher than the 3.7% for 
domestic banks and the 3.3% for credit cooperative 
associations.  Taken together, the designated amounts of 
NT$500 million for FCCA, NT$58 billion for CSB and NT$22 
billion for FA credit arms, total to NT$80.5 billion.  The 
FRF is thus left with NT$29.5 billion to tackle the 
financial losses left over from the 2001 banking crisis. 
 
Funding Insufficient 
-------------------- 
6.  (U) Taiwan's banking community tells AIT/T that NT$29.5 
billion is insufficient to deal with financial institutions 
that report higher than average NPL ratios and lower than 
average capital-adequacy ratios.  However, there is 
consensus that "it is better than nothing." 
 
7. (SBU) AIT/T believes that there are at least seven 
institutions requiring immediate attention, including four 
domestic banks, two credit cooperative associations, and a 
trust company.  These seven institutions have NPL ratios 
above 10% and capital adequacy ratios below 10% as of March 
2005.  Their combined NPLs totaled NT$82 billion, far more 
than NT$29.5 billion available to FRF.  These problem 
institutions are likely to be designated for assistance 
under the requirements of the May 31 legislation.  Following 
designation of an institution, FRF involvement in a 
designated institution can go well beyond the July 10 
deadline. 
 
8.  (U) Without sufficient funding for the FRF, we expect 
Taiwan authorities will urge problem institutions to improve 
their quality by increasing capital or merging with better- 
quality banking institutions.  There could be efforts to 
inject new at-risk capital and increased merger activities 
prior to the July 10 deadline. 
 
FRF Out of Business 
------------------- 
9.  (U) FRF will pay non-deposit liabilities, such as inter- 
bank loans, only for institutions put under receivership 
prior to July 10.  FRF compensation must be paid by July 31, 
2005. 
 
Deposit Insurance Capped at NT$1 million 
----------------------------------------- 
10.  (U) One provision of the May 31 legislation seeks to 
mitigate future banking problems.  Taiwan's Central Deposit 
Insurance Corporation (CDIC) currently provides unlimited 
coverage for bank deposits.  Starting from July 11, 2005, 
CDIC will only cover up to NT$1 million per depositor.  The 
LY and banking regulators hope that by reducing the level of 
insurance coverage, bank customers will be more stringent in 
choosing a bank.  Banks with bad reputations could suffer a 
loss of deposits and thus face greater pressure to consider 
merging with other, stronger, banks. 
 
FRF Financing Mechanism Extended 
-------------------------------- 
11. (U) Much of the FRF funding has come from extending the 
collection period for the Gross Business Receipt Tax (GBRT). 
This tax, formerly set at 5%, had been due to expire.  The 
original FRF legislation directed that the FRF funding would 
come from a temporary extension of the GBRT, which would be 
set at 2%.  The extended 2% GBRT will now continue for an 
additional four years until December 2010.  The additional 
funds collected between 2006 and 2010 will go to the CDIC 
and increase its deposit insurance reserve. 
 
Comment 
------- 
12. (SBU):  The now four-year long saga of the FRF 
illustrates a longstanding political struggle between the 
ruling Democratic Progressive Party (DPP) and the opposition 
parties, in particular the KMT.  By delaying funding for the 
FRF since 2002, the opposition has continuously stymied 
efforts to resolve the banking crisis of 2001.  Insolvent 
financial institutions that should have been shut down or 
sold off long ago have been allowed to continue doing 
business.  The LY has declared victory by establishing an 
end date for the FRF, but has provided far too little in 
funding to handle the outstanding losses.  The end result is 
that resolving these losses will drag on for some time.  The 
longer it takes for resolution, the less pressure individual 
bankers will feel to make needed reforms and the longer it 
will take for Taiwan to develop an efficient banking sector. 
End Comment. 
PAAL