Review of Pacific Basin Financial Markets and Policies

Over the years, Taiwan has made great progress in financial internationalization. At the same time, foreign exchange controls have been relaxed significantly and restrictions on capital movements have been lifted in a gradual and orderly manner. Taiwan has also been actively developing itself into an Asia-Pacific financial center since 1995. When both sides of the Taiwan Strait enter the WTO in the future, they will have to address the new conditions of opening up domestic markets and competition from international businesses. Actually, there are some issues concerning financial internationalization after Taiwan's accession in the WTO. They are appropriate capital account management, increasing cross-Strait financial activities and maintaining financial discipline and emphasize risk management. In order to maintain financial discipline, the monetary authorities should strengthen financial supervision, by conducting on-site and follow-up examination of financial institutions. On the other hand, financial institutions should abide by the rules of the game and should especially emphasize risk management. Taiwan and mainland China are expected to enter the WTO at the same time in the near future. In order to promote international stability, it is an opportunity for the two sides of the Taiwan Strait to work together toward establishing an East Asian financial cooperation mechanism.

In order to cope with the changing financial landscape, the government in Taiwan has put forth financial reform measures and supplementary packages. In this paper, we shall discuss four main themes including the establishment of Asset Management Company/Resolution Trust Corporation to help financial institutions quickly clear up bad loans, the disclosure of open public financial information to increase market transparency, the set up of a Financial Supervisions Commission to unify the work of financial supervisions and financial examinations, and the promotion of merger, shareholdings, and alliances among financial institutions to raise the competitive power of Taiwan banks in international financial markets. Each topic begins with a description of the current status, government policies and strategies, and then brings up some issues worth discussing.

Strong, developed economies need well-functioning equity markets. Such markets require openness. Open equity markets attract different types of investors, some more useful than others. Just like in the debt market, the equity investors who best serve the social good are those who seek to understand the economic fundamentals underlying corporate profitability. Other, momentum, investors are more like gamblers whose presence is largely unavoidable, and who contribute little to economic efficiency or financial stability. The regulatory challenge is to mitigate the effects of momentum investors without discouraging the fundamental investors.

There is heightened interest in reforming government regulation of financial institutions to make better use of market discipline and data. We strongly support such reforms, which are being implemented to some degree by the Federal Reserve System. However, market oriented reforms will not work unless government policies are credible in putting market participants, especially those at the largest financial institutions, at risk of loss. Establishing credible policies requires that governments address the time-consistency problem head-on. As a result, we recommend policies that establish credibility by directly reducing the incentive that policy-makers have to protect the creditors of financial institutions. Other policies, which do not address the fundamental reasons why policy-makers bail out creditors, are therefore likely to be circumvented when large banks get into trouble.