The Asian Financial Crisis and Non-Performing Loans: Evidence from Commercial Banks in Taiwan

Article excerpt

Financial crises have been a worldwide phenomenon in the last decade. This study tries to investigate how the 1997Asian financial crisis affects the non-performing loans of Taiwan. We adopt a panel data set with 40 Taiwanese commercial banks (established before 1996) for the period of 1996-1999 for empirical analysis. We find that both banks' loans and sizes are positively related to the rate of non-performing loans, but at a diminishing rate; rates of non-performing loans steadily increased from 1996 to 1999, possibly resulting from the 1997 Asian financial crisis; banks established after deregulation, on average, have a lower rate of non-performing loans than those established before deregulation.

I. Introduction

Has Taiwan come to a local financial crisis? The Economist pointed out, Nov. 11, 2000, that bad loans in Taiwanese domestic banks reached new highs, and that a local financial crisis is immediate. The New York Times, Dec. 5, 2000, and Business Week, Dec. 11, 2000, followed suit by citing Salmon Smith Barney that the non-performing loans (NPL) ratio among listed banks in Taiwan had amounted to over 6 percent, and because of the narrow definition in official non-performing loan statistics, the NPL ratio could in reality be as high as between 10 to 15 percent. Standard & Poors also revised its outlook on Taiwan from stable to negative on December 6, 2000.

Loans are one of the major outputs provided by a bank, but the loan is a risk output. There is always an ex ante risk for a loan to eventually become non-performing. Nonperforming loans can be treated as undesirable outputs or costs to the bank that does the loaning, which decrease the bank's performance (Chang, 1999). The risk from NPL arises as the external economic environment becomes worse off such as economic depressions (Sinkey and Greenawalt, 1991). Since the 1997 Asian financial crisis, NPL have swiftly accumulated in many Asian economies (Chang, 1998; Lauridsen, 1998; Robinson and Posser, 1998; Wade, 1998). Controlling NPL is thus very important for both an individual bank's performance (McNulty et al., 2001) and an economy's financial environment.

Financial crises have been an increasing international phenomenon in the last decade, possibly a result of deregulation and liberation of financial systems. Taiwan's government in 1991 released the Commercial Bank Establishment Promotion Decree in order to relieve the legal entrance barriers to banking markets. The banking industry faced new competition and shocks when deregulation began to take place, and Taiwan's government is still today trying to make its banking markets more competitive. Because of the increasing competition, many banks have expanded into multiple ventures, effectively increasing their running risks, which has led to declines in productivity and management efficiency. Banks established after deregulation seem to have different business cultures and/or strategies in comparison to those established before deregulation. Furthermore, those banks established after deregulation are private, whereas public and/or mixed banks are all established before deregulation. State-owned banks monitored by both the administrative and legislative branches are easily distorted by interest groups engaged in political lobbying. As a result, the difference between old and new banks is worth further investigation.

The Asian financial crisis is a good example of something that has greatly impacted Taiwan's economy. Listed companies are now reportedly facing a series of their own financial crisis. Though on the surface the banks have collaterals for their loans, due to a steep fall in the local stock market caused by the financial crisis, stock collateral pledged to banks have grown into a silent crisis for banks. According to statistics by the Bureau of Monetary Affairs, Ministry of Finance, the NPL ratio is indeed rising. This study will examine how the Asian financial crisis has affected the NPL of Taiwan. …