Financial reform and the adequacy of deposit insurance fund: Lessons from Taiwanese experience

Financial reforms and capital adequacy are probably the most critical issues for the banking industry in the world. This study examines the effectiveness of financial reforms carried out in Taiwan recently and measures the adequacy of the deposit insurance fund (DIF), including financial restructuring fund and Designated Reserve Ratio (DRR) strategy in Taiwan. We have improved on the methodology of Episcopoc (2004) and report estimates of the cost of deposit insurance and implied reserves for each bank or financial holding company. Estimates of the implicit cost of government guaranty of the DIF are also included. To stabilize its financial environment in 2000, the Taiwanese government amended many bank regulations, including the enactment of the Financial Holding Company Act (FHC Act) of 2001 and the Financial Restructuring Fund Statute. Our evidence shows lower volatilities and average unit cost of deposit insurance for seven sampled FHCs compared to sixteen sampled banks, even though the FHCs are larger. These results indicate the effectiveness of the financial reforms put forward by the Taiwanese government. When implied reserves are compared with the Designated Reserve Ratio (DRR) strategy of 2%, imposed by the Central Deposit Insurance Corporation (CDIC) in 2007, we find that the DIF would have been sufficient in 2006, but not in 2000. The results imply that the fixed target ratio for the DIF may not be appropriate. In addition, the details of financial reforms in Taiwan starting in 2001 are provided and demonstrate resolve in implementing financial reforms. Finally, financial reforms of Taiwan and the calculations of DRR and estimates of the implicit cost of government guaranty of the DIF can be used as lessons for other countries.