Taiwan’s Asset Management Corporations
I. Introduction:
When a bank has serious financial problems, such as holding too much bad debt, there are two possible solutions. The first is to create an asset management corporation (AMC), which Taiwan did, and the second is to create a resolution trust corporation (RTC), which America did. The main difference between an AMC and an RTC is that the former does not decide when a bank is bad or remove it from the market. On the other hand, the RTC will take over the bad bank, while the objective of the AMC is to provide assistance to banks that have problems with financing. This article will explain why the Taiwanese government needed to create an AMC and discuss the advantages and disadvantages, as well as ethical concerns.
II. Why Taiwan Needs an Asset Management Corporation
The Asian financial crisis did not start in Taiwan, but in 1997 the Taiwanese faced another serious problem: overbanking. Most of the banks over-lent to their customers in order to compete with other banks. Additionally, because Taiwan’s domestic market is very small, Taiwan relies heavily on international trade. In 2001, the global economy declined, and Taiwan’s exports were seriously affected. Many companies went bankrupt, which also affected the stock market. Therefore, many companies and individuals could not repay their loans, a large number of which became bad debt.
By 2001, the bad debt rate in Taiwan had increased to 11.27 percent from 1.82 percent in 1994. [1] To prevent the collapse of the banking and financial system, the Taiwanese government needed to help the banks clear their bad debt. Therefore, in 2000, the Taiwanese Congress passed the Finance Institution Merger Act. Based on section 15 of the act, foreign companies such as Lone Star, Merrill Lynch, and Lehman Brothers could fund an asset management corporation (AMC) in Taiwan. At the same time, many Taiwanese banks jointly funded some AMCs.
III. What is an asset management corporation?
A. The function of an AMC
The main function of an AMC is to purchase bad debt from banks by transferring creditors or trust. An AMC can help control the risk of financial activities and relieve the pressure of a bank’s bad debt.
B. The advantages of an AMC
An AMC is in a better position to deal with bad debt than banks because:
(1) AMCs can help a company to apply reorganization.
In Taiwan, reorganization usually involves the many banks from which a company borrowed. Because there are a lot of creditors, it can take years to reach an agreement about the company’s repayment plan. When banks sell their bad debt to an AMC, however, the number of creditors is decreased, and it will be easier to reach an agreement.
(2) AMCs have many methods to help companies recover.
An AMC can always buy bad debt at a lower price (because banks want to get rid of bad debt as quickly as possible), so an AMC’s capitalization cost is lower. An AMC can offer many different methods to help companies repay debt and improve financial structures, such as issuing stocks to buy the debt, lowering the interest rate, or offering capital discounts. An AMC also owns a lot of creditors’ rights, enabling it to manage a company’s finances. AMCs can also require companies to include them in recovery plans, thereby allowing AMCs to help manage financial problems and rebuild the companies. This can be a win-win plan for the companies and the AMCs.
(3) AMCs can deal with large real estate.
Landowners will typically mortgage large areas of land to more than one bank, so there are too many creditors to reach an agreement. If this kind of bad debt can be sold to an AMC, then the AMC will become the sole creditor, which will assist in financial negotiations, such as sales.
(4) AMCs have flexible ways to deal with security.
Based on section of 76 of the Taiwanese Bank Law, if banks want to handle securities by themselves, they must sell them by auction in court, [2] which can be time consuming. However, the bank law does not regulate AMCs, so AMCs can purchase the securities and have many options to sell them.
(5) AMCs are private, not owned by the government.
In Taiwan, the government does not fund AMCs, so an AMC can maintain its independent position. Because all laws regulating public office, government purchase, or accounting will not apply, an AMC can have independent power to appoint its managers and make its own policies based on the benefits and needs of the market.
IV. Ethical Issues of AMCs
Consequentialist theories propose that only the consequences or outcomes of actions are morally relevant. Based on foreign experience, asset management institutions appear only in cases of serious and emergent financial crises. Therefore, the outcome is good for society, because AMCs will remove bad debt from banks, preventing bankruptcy and protecting the financial system. Utilitarianism states that actions are morally right if and only if they maximize the good. AMCs do maximize the good for the financial system.
On the other hand, deontological theories base morality on certain duties or obligations and claim that certain actions are intrinsically right or wrong, regardless of the consequences. Asset management institutions are created to deal with financial crises and will usually be granted many privileges that are unfair to other companies. Some potential methodological problems include: [3]
A. Price usually is disputed.
When banks have bad debt, they can negotiate the debt’s price with an AMC in order to sell it; however, the bank is usually one of the AMC’s shareholders. Therefore, when the bank negotiates the price with the AMC, is the process really meaningful? If the bank is a shareholder of the AMC, the AMC will pay the lowest price to buy the bad debt. Since the AMC is profit-based, this scenario defeats the AMC’s primary purpose: making a profit.
Moreover, when the economy is good, banks will not worry about the risk of over-lending because debtors can usually repay the money. Even if the debtors cannot repay, the banks can sell their bad debt to an AMC. However, in the long run, AMCs could become safe harbors for banks, and ultimately all the bad debt will belong to AMCs. When the economy declines and AMCs cannot handle bad debts, the AMCs may go bankrupt. The result will be more serious than if one or more banks go bankrupt, because AMCs take all the financial risk on their own. In the end, the financial system may suffer.
B. They lack legal oversight.
Banks are different from other companies because they have a public mission to maintain the regular operation of a country’s financial system. Therefore, compared to other companies, banks have many restrictions, and the government supervises banks very closely.
However, an AMC’s main purpose is to help banks deal with their bad debt, so the Taiwanese Bank Law does not apply to AMCs. This is an effective way to let AMCs be more flexible in handling bad debt based on the market’s supply and demand. On the other hand, there is a risk that a bank can transfer the investment to set up an AMC and sell all its bad debt to the AMC. Therefore, a bank that has a lot of bad debt will become a good bank. In this scenario, the bank would be out of the government’s legal control.
C. They violate the rule of equality.
This also relates to the price issue. How can a bank and an AMC decide the value of bad debt? If they can decide the price by themselves and without conditions, this will advance the AMC’s function to deal with the bad debt. As banks can sell their bad debt very easily, there will also be ethical concerns. In the long run, banks might lose self-control, knowing that if they keep over-lending and accrue a lot of bad debt, they can just sell it to an AMC. This situation could cause other big companies to similarly invest in the creation of AMCs and then let “their” AMC purchase their bad debt, which is unfair to other companies and individuals.
D. Who can invest in an AMC?
The Taiwanese government wants AMCs to be independent, so the government does not invest in AMCs. Currently, banks can invest in AMCs to make the process easier and quicker and keep the relationship between creditors and debtors simple.
However, the disadvantage is that there is no effective way to control the price. In order to prevent banks, as AMC shareholders, from selling their debt to AMCs at a low price, the government can require individuals or companies other than the banks to invest in AMCs or require AMCs to appoint external directors.
V. How to decrease ethical concerns
As discussed above, the main ethical concern is how to determine the price of debt. Bad debt cannot be sold too high, because no one will want to buy it. On the other hand, if the price is too low, the AMC will become a safe harbor for banks to unload their bad debt. Finally, if an AMC collects all kinds of bad debt and risks simultaneously, it will become dangerous to the financial system and violate the original purpose of its creation. Next, we will discuss how to decide the price, as well as how the Financial Institution Merger Act regulates the price and benefits when an AMC wants to sell bad debt purchased from a bank. [4]
A. How to price the bad debt
According to experiences in other countries, there are two ways to decide a reasonable price for bad debt: through an impartial appraisal consultancy or regulation by law.
Taiwan has no professional, impartial appraisal consultancy. Therefore, a bank and an AMC will usually determine the price by negotiation. Because there is no national standard to negotiate the price, it is sometimes unreasonably low. Additionally, as the bank wants to divest the bad debt as soon as possible, the AMC wants to set the price as low as possible. As discussed above, the result will cause banks to think they can easily unload their bad debt. However, even if banks sell their bad debt, it will not help their financial situation because they do not get all the money back. When a bank and an AMC want to negotiate a price, they should invite an impartial third party to join the negotiation.
Regulation of the price by law is very difficult because it is hard to decide what range is reasonable. Every case is different. If the law regulates the price, it will limit the negotiation space. Therefore, we should not use the law to decide the appropriate price range.
B. Allow an AMC to be involved in a company’s reorganization.
As we know, the main purpose of an AMC is to purchase bad debt from banks, but why would individuals or other companies want to invest in an AMC to buy the bad debt? One reason is that under section 15, item 5 of the Taiwanese Financial Institution Merger Act, when a debtor applies for a bankruptcy or reorganization procedure, the controlling organization has to get the opinion of the AMC. If the AMC is the biggest creditor of the debtor, the court has to appoint the AMC to be the receiver or bankruptcy administrator.
Therefore, when an AMC becomes a company’s creditor by purchasing its bad debt from the bank, the AMC can participate in the plan to help the company reorganize. If the reorganization succeeds, the AMC can share in the profits. This procedure encouraging the AMC to deal with the bad debt can create a safe harbor for the bank, because the AMC can actually make a profit.
C. Auction
Under section 15, items 3-4 of the Financial Institution Merger Act, when an AMC wants to sell its bad debt, it must do so through an impartial third party auction. [2] The act does not require an AMC to have a court auction, because this would involve considerable time and money, with an uncertain result. On the other hand, it is fast and easy to use the private auction procedure.
However, private auctions can cause some problems. First, when the debt involves land on which there are many mortgages, the bidder still has to take inferior mortgages. Only a court auction can eliminate inferior mortgages if the mortgagees do not join the auction. Second, if the debtor has different opinions about the debt during the auction, he or she can submit a motion to the court but would have no such rights in a private auction. Although the Financial Institution Merger Act allows the results of a private auction to have the same effects as a court auction, the bidder can force the debtor to give up his or her property. If there are arguments between bidders and debtors, there will be no public authority to arbitrate, and the parties have to go to court to solve the problem. This will discourage people from purchasing debt from AMCs.
There are two solutions to these problems. First, the Financial Institution Merger Act does not prohibit AMCs from applying for a court auction. Therefore, if the bad debt involves a land mortgage or complicated debt relationship, an AMC can apply for a court auction to sell the debt. Second, the act can allow some private auctions to have the same effects as court auctions so the advantages of court and private auctions can be combined.
VI. Summary
When an AMC can purchase bad debt from banks, debt will not accumulate and complicate the bank’s function in the financial system. However, because banks are allowed to invest in AMCs, there will be ethical issues. As AMC shareholders, banks will sell bad debt at a low price as soon as possible. This situation will prevent the intended purpose of the AMC and assemble all the risks together, potentially causing AMCs to become a wasteland for banks. Ultimately, if an AMC becomes bankrupt, there will be a more serious financial crisis.
Therefore, the Taiwanese Financial Institution Merger Act allows an AMC to use bad debt to become a shareholder of a company and be involved in that company’s reorganization or sell the bad debt through private auction. The act uses these methods to guarantee that an AMC can have a chance to make a profit from the procedure. However, the act does not regulate how to determine the price of bad debt, because there is no professional, impartial appraisal consultancy and it is difficult to set up a national standard by law. If the act can require banks and AMCs to invite an impartial third party to participate in their negotiations, it will mitigate the ethical and methodological problems.
BY: ERIC WANG
Editor: Angela Lutz
Reference:
1. “News & Important policy.” Taiwanese Financial Supervisory Commission. 30 June 2011
<http://www.fsc.gov.tw/Layout/main_ch/index.aspx?frame=1>
2. 全國法規資料庫. 1 July 2011.
<http://law.moj.gov.tw/LawClass/LawAll.aspx?PCode=G0380098>
3. “我國成立不良金融資產處理機構之可行性研究(期中報告)”，行政院經建會委託中華經濟研究院。
4. “淺論不良債權資產管理公司市場概況”，華南金控 37，頁9-22，朱志忠 (2006).
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