To help businesses affected by the financial crisis, Premier Liu Chao-shiuan (劉兆玄) directed the Ministry of Finance on Friday to formulate a reward and punishment scheme to force the heads of state-run banks to ease their lending policy. This might be helpful to businesses but portends increased risks for banks.
As the government has no control over private banks’ lending practices, the ministry said it would ask the Bankers Association of the Republic of China to establish a similar mechanism for private banks.
On Thursday, Financial Supervisory Commission Chairman Sean Chen (陳冲) said the commission was considering transferring the nation’s postal savings — totaling NT$4 trillion (US$119.2 billion) — to small and medium-sized private banks, hoping this move would help spur more lending to local businesses.
The government’s commitment to helping as many companies as possible given the severity of the ongoing financial turmoil is commendable. It is also encouraging to see the administration’s firm stance against banks tightening credit to local companies. The ministry went as far as to state bluntly on Friday that banks should grant more loans to businesses in need to show their good will given the government’s blanket deposit guarantees announced in October.
And with the unemployment rate surging to a five-year high of 4.37 percent last month, the government is evidently hoping that if banks could extend loans to businesses and help them weather the current turmoil, companies won’t have to resort to massive layoffs.
But none of these considerations is strong enough to ease concerns about potential lending risks and rising bad loans, especially if the government were to push through with its proposed reward and punishment scheme.
Banks earn profits mainly through lending. Empirical studies have shown a positive correlation between a bank’s profitability and the economic climate, meaning the current economic downturn is likely to undercut profitability.
Against this backdrop, what a responsible bank should and can do is adopt a conservative lending stance, maintain a cautious assessment of customers’ ability to repay their loans, adjust its organizational structure and implement cost-cutting measures.
Aside from taking their shareholders’ interests into account, banks should avoid the potentially negative consequences of irresponsible or politically motivated lending — an old but notorious habit that led to a sizable build-up of overdue loans at state banks under the Chinese Nationalist Party (KMT) government in the 1990s.
A report by the Chinese-language Economic Daily News last week estimated that local banks had extended NT$1.3 trillion in loans to chipmakers, flat-panel manufacturers, airlines, construction firms and the high speed railway, and banks may need to set aside about NT$100 billion in loan provisions next year to cover potential bad debts if the downturn continues.
Overdue loans are tolerable up to a certain level. What has raised people’s eyebrows is that the government’s reward/punishment scheme is likely to coerce more lending from banks — be they state-run or privately owned — while enhancing a potential moral hazard as the measure could allow corrupt government officials and legislators to press banks for privileged loans.
While it may sound reasonable to help businesses by loosening credit, it is not yet clear how the government can make it happen without compromising the nation’s financial stability. The government needs to be careful in implementing this measure when it comes out with a detailed plan.
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