Taiwan banking sector is very vibrant, though it can be considered overbanked. Presently, there are 40 domestic banks, 25 credit co-operatives operating in Taiwan that offer credits to business people and members of the cooperatives and 28 foreign banks with a presence in Taipei (“Treasury management profiles: Taiwan”, n.d.). These are totals to over 93 banking institutions targeting only 23.2 million. This banking concentration is very high when compared to the economic zones that have larger target populations. This banking industry in Taiwan is dominated by the state-owned Banks, which presently control about 12% of the banking sector’s total assets. It is also important to note that the government owns and runs several domestic banks. For instance, the government owns 100% of the Bank of Taiwan, 100% the Land Bank of Taiwan and 36.7% of the Taiwan Cooperative Bank (“Treasury management profiles: Taiwan”, n.d.). Further, the government holds minority shares in the three largest privately owned banks, which are; the Mega International Commercial, Hua Nan Commercial and First Commercial. However, it is significant to note that the government is currently considering privatization of the banks and plans to reduce the number of state-controlled financial institutions by half, especially the financial holding companies.
Banking Sector Depth
As noted earlier, there are several banks operating in the Taiwan region with the top seven banks by assets by December 31, 2011 being Bank of Taiwan $130,517 million, Taiwan Cooperative Bank $91,162 million, Mega International Commercial Bank $76,380 million, Land Bank of Taiwan $75,619 million, First Commercial Bank $66,938 million, Hua Nan Commercial Bank $64,050 million, and Chinatrust Commercial Bank $62,421 million (“Treasury management profiles: Taiwan”, n.d.). The growth of the banking industry had also been on an upward trend resulting into new entries into the market and expansion into other areas including the mainland of China. For instance, in 2008, Fubon Financial Bank in its expansion plan became the first Taiwan bank to set up its existence in the mainland of China through acquisition of 20% stake in Xiamen City Commercial Bank. This was after the Chinese banking regulator body sanctioned the move in November 2008 (“Treasury management profiles: Taiwan”, n.d.). This approval indicated the beginning of the liberalization process and long term future cooperation between China and Taiwan in relation to the provision of financial services. The deal was sealed through a signed memorandum of understanding in November 2009.
The banking sector has proved some level of stability in the last few years and a relaxed business environment. In 2008, the FSC licensed the operations of the Bank of Communications and Bank of China, which are two Chinese banks that operate in Taipei City. The same years in August, Taiwan and China sanctioned the move by Taiwan banks to authorize RMB transactions and Chinese banks to authorize TWD currency transactions. This stable outlook indicates the expectation that Taiwan’s economy will grow in the next 12 to 18 months and facilitate the banks to sustain their credit metrics (Irwin et al, 2004). The projection by Moody’s indicates that Taiwan’s GDP is expected to grow by between 2.5 to 3% in 2013 and by 3 to 4% in 2014, compared to 1.3% growth recorded in 2012. This presents positive future prospects for the banking sectors, since this improves bank liquidity (Irwin et al, 2004). Any other pressure in relation to the asset quality is expected to be offset by adequate liquidity of the banks, sufficient capital positions, and enhanced profitability.
Averting Risks of the Sector
In order to continuously perform, it is expected that Taiwan’s government will support the banks when a stress situation arises in order to avert possible risks. Taiwan banks are extensively exposed to local exporters. This means that when a global demand becomes weak, the domestic banking sector is likely to face an increased risk owing to the fact that their asset quality is linked to the country’s export orders. Another likely risk to be experienced is the emerging disproportion in the domestic property market brought about by the high housing prices but stagnant household incomes making it difficult for households to own homes. These high real estate prices are especially witnessed in the greater Taipei region and places such as Taoyuan and Kaohsiung (Irwin et al., 2004). This to a larger extent affects the banking sector, since most people cannot afford credit that adequately covers the price of the houses, thus reducing the amount of mortgage lending. This is a major concern, particularly in the current situation where there is a worrying rise of household debt, which reached a rate of 86% of Taiwan’s GDP in 2012. This can only be contained when the lending interest rates are maintained low and the job market is stable. Regulators of the Taiwan banking industry therefore, need to be careful when setting the interest rates for the banking industry to remain stable.
Financial Sector Depth
The Taiwan’s financial sector and markets is presently saturated with 68 banks, 25 credit cooperatives, 60 insurance companies, and over one hundred security companies. For further growth, it is evident that the Taiwan’s financial institutions may have to consider expanding to the foreign markets, to bridge the growing competition locally (“Treasury management profiles: Taiwan”, n.d.). For the immediate market in the mainland of China, the Taiwan government needs to try improving its political relationships with China in order to facilitate the penetration of the Taiwanese banks into the populous Chinese market, thereby making Taiwan the regional financial center as it continues to improve its financial technology.
Despite the competition and oversaturation of the financial market from domestic and foreign banks as well as the credit cooperatives targeting the same customers, the outlook on the banking sector of Taiwan is stable. Financial strength of the system has been recovering steadily, especially after the remarkable efforts put up to remove nonperforming loans from their recent records. To this end, most of Taiwan banks have relatively stable financial profiles that are identical to the improving stability in the broader economy. However, the risks of the financial industry are still reasonably high as because of the structural problems and low profitability due to extreme competition. The low profits are also attributed to the low lending rates to self-regulate the sector and check on the household debt that is already high. This low interest rate in turn leaves the industry with limited financial ability contain possible problem assets. In this regard, the financial sector should make effort to enhance the risk management ability in order to manage the increasingly dynamic banking operating environment.
Taiwan’s financial institutions involving commercial banks, investment banks and the insurance companies target more on Taiwan people living or doing business overseas. Currently, Taiwan’s financial institutions are wooing Taiwan nationals working in other countries, and this trend is expected to proceed as the firms become more effective and Pacific-Rim institutions oriented, with their presence in a number of countries. It is noted that the potential Pacific Rim market is large enough to offer substantial market to the Taiwan financial firms (Irwin et al., 2004). Presently, the Taiwan’s securities firms are already playing a significant role in leading other sectors in this expansion strategy. The entry into the foreign markets is because it is typically easier to institute a security firm in another country than enter the highly regulated banking sector. This strategy prospects that once Taiwan securities firms have established a market base with sound reputations. The Taiwanese bank will ride on that goodwill to win banking and insurance licenses in the future. This strategy is operational and Taiwanese security companies are already operating in Hong Kong, Korea, and Thailand (Irwin et al., 2004).
This is a move that will later help the banking industries in Taiwan remain stable. This commercial pressure emanating from the stiff competitive environment may result into consolidation of a few banks and securities as well as insurance firms. This is because it may be extremely difficult for smaller banks to effectively compete with the larger more sophisticated banks that have advantage of strong capital and asset base and earn profits. To make operation easier, smaller banks may ride on the popularity, branch network, and financial base of the leading banks to grow and make their products known to the potential customers. This consolidation of the banking sector or privatization of the state-owned banks is to some extent dependent on the regulators’ approval.
Banking Sector Depth: Loan to GDP
Economic development in a country is usually indicated by the real GDP and per capita income. The level of financial repression and control of the banking system through financial repression policies such as controls of lending interest rates, direct credit programs, and influence on the reserve and liquidity requirements have a direct impact on the overall performance of the banking industry, which in turn influences the GDP (Hu, 2002). In Taiwan, there is a strong correlation between the pattern of real GDP growth and that of banking development, both in size and activity and in stock market development. This means that the growth in the banking system, which is always dependent on the loan book value spur the economic growth. Banking on its face value involves attracting financial deposits and using the deposits to do business which is mainly lending to other financial seekers at a profit, based on the interest rates charged on the issued loans. The ability of the bank to make profits and expand their operations, which will eventually contribute to the growth in the GDP, is therefore dependent on how well the bank attracts and issues performing loans.
Characteristics of the Banking Sector
Commercial and Investment Banks
Taiwan banking industry comprises both commercial and investment banks. Some of the top largest commercial banks include BOT, FCB, Cathay United Bank, and Chinatrust Commercial Bank among others. BOT is the largest major commercial bank ranked by “The Banker” magazine as 124th among the top 1,000 international banks. Most of these banks have subsidiaries spread in different parts of Taiwan with some having international presence. For instance, Cathay United Bank is an exclusively owned subsidiary of Cathay Financial Holding Company, which is Taiwan biggest financial holding firm. The bank offers a range of consumer banking products ranging from accounts, loans, and mortgage products to satisfy the financial needs of individuals and families.
There are also a number of investment banks operating in Taiwan. Some of these include ABN AMRO, Aldare Investments Ltd. American Express Bank, ANZ Bank and Bangkok Bank among many others. These financial institutions help individual investors, corporations, and government agencies in raising capital required to carry out the investment activity. This is done by either underwriting or acting as the agent of the client during issuance of securities. The investment banks in Taiwan also help the commercial banks in negotiating mergers and acquisitions, especially between the local and foreign banks that gain access to the Taiwan banking market. They also offer ancillary services like trading equity securities, market making and FICC services. Unlike the retail and commercial banks, the investment banks in Taiwan do not accept deposits. This creates institutional separation of services offered by investment banks from those offered by commercial banks to ensure sanity in the financial sectors and avoid conflict of interest.
Publicly and Privately Owned Banks
There are also publicly and privately owned banks in Taiwan. Most of the public owned banks are domestic where the government owns substantial stake, like the Bank of Taiwan which is 100% owned by the government, the Land Bank of Taiwan 100% owned by government and the Taiwan Cooperative Bank in which the government owns 36.7% stake. There are also privately owned banks, comprising both domestic and foreign banks licensed to operate within the market. First Commercial Bank (FCB) is one of the largest privately owned banks with several subsidiaries in overseas markets. It has branches in London, Los Angeles, New York, Taiwan’s Tokyo, Guam, Hong Kong, Singapore, Phnom Penh and Palau. The bank also has two representative offices in Ho Chi Minh and Bangkok City. In addition, the bank has a 100% owned subsidiary called First Commercial Bank (USA) situated in Alhambra, California with three branches located at Silicon Valley Branch, City of Industry Branch, and the Irvine Branch. This privately owned bank enjoys solid financial and asset base making it very competitive in the Taiwan banking market. There are also other private banks like the Mega International Commercial and Hua Nan Commercial where government holds a minority shares.
Chinatrust Commercial Bank Limited (CTCB) is another large private banks operating in Taiwan. The business scope for all these public and private banks include loans, deposits, guarantee, foreign exchange, trust, OBU, credit card, debit card, securities, derivative products, bonds, factoring, safe deposit and electronic banking among many other services.
Participation of Foreign Banks
As noted earlier, under privately owned banks, there are several foreign banks operating in the Taiwan banking sector as independent banks, as mergers or through acquisition of a domestic bank. The entry of foreign banks into the Taiwan banking sector was partly as a result of the efforts of the financial sector regulator (FSC) to intensively attract foreign banks to open branches in the country in a bid to position Taiwan as a global financial market. Partially, this effort to attract foreign banks involved reforming policies in the industry that included permitting domestic banks to be absorbed by foreign banks through establishing subsidiary banks, which are later acquired or merged with domestic institutions. Some of the examples include; Bowa Commercial Bank being acquired by the Development Bank of Singapore’s; Chinese Bank acquired by the HSBC; Hsinchu International Bank acquired by the Standard Chartered Bank; and the Citigroup’s acquisition of Bank of Overseas Chinese (“Treasury management profiles: Taiwan”, n.d.).
There are a number of regulations initiated by the Financial Supervisory Commission that are charged with the responsibility to regulate the banking and financial sector. Initially, there were regulations that hindered Taiwan banks from entering the mainland of China markets. This, however, changed when the two regulators from the mainland of China and Taiwan signed a memorandum of understanding on April 1 in Taipei City, thus relaxing the regulations that originally hindered cross-strait investment in each side’s financial institutions. The agreement aids in strengthening financial cooperation between the two countries and means a wider market for the Taiwan financial institutions. Under new regulations, the mainland Chinese banks are allowed to take a maximum stake of 15% in the unlisted Taiwan banks and financial holding companies. Equally, an individual investor from the Chinese mainland can hold a maximum of 10% of a listed bank or the financial institution in Taiwan. The Chinese commercial banks are also authorized to invest in Taiwan stocks, while banks setting up branches across the borders must have at least two to five years of operational experience in the industry, before they are allowed to set up branches and liaison offices or acquire stakes in their cross-strait counterparts. Taiwan banks, on the other hand, are allowed to set up branches in the mainland of China and are accorded preferential treatment for setting up branches in different cities and establishing their operations to the North Eastern and Central Western regions.
The interest rates charged on loans are regulated by the FSC. For this reason, the loan rates are always low in order to contain the household debt, which is already high and minimize the number of nonperforming loans. Because of this regulation, loan interest rates charged in Taiwan is even lower than the rates charged in the mainland of China. It is also important to note that in the 1980s, Taiwan government fully regulated the domestic financial system. The central bank of Taiwan had the sole right for lending, thus regulated the interest rates and exchange rates (Wu & Hu, 2000). This later changed when the government cancelled the regulations related to setting interest rates and lifted the exchange controls at the beginning of the 1990s.
Are Banks Free to Allocate Loans or Regulators Direct Credit Policy?
The banking industry initially allocated loans without any limitations. This freedom however resulted into the increase of nonperforming loans especially in the 1990s and early 2000s. Through the intervention of regulators, tighter lending regulations were put in place between 2001 and 2003. This was to ensure that banks allocated fewer loans that were thoroughly screened and not likely to go into arrears. Similarly, the banks upon guidance of the regulators embarked on aggressive write-offs activities that resulted into reduction of NPLs by over 50%. This was a result of the pressure from the regulator for banks to narrow NPL ratios to fewer than 5% by the end of 2003. This is a clear indication that banks are not completely free to allocate loans to the customers without thorough scrutiny to ensure that the banks do not sign in nonperforming loans. Presently, the regulatory target of less than 5% had been attained by most Taiwan banks. In 2001, approximately NT$900 billion of nonperforming loans were written off by Taiwan’s banking industry. This amount is equivalent to approximately 60% of the banking sector’s cumulative net worth. This was a great loss to the Taiwan banking industry and must be guarded to avoid future occurrence. Further, the Asset management companies (AMCs) assisted the banks in facilitating the clean-up process of the nonperforming loans by purchasing about NT$400 billion worth of the problem assets in the same period.
As a result of the initiative, the value of nonperforming loans and problem assets experienced by the banking industry in Taiwan had been constantly reducing from 11.3% in 2001 to a 4.9% by 2004. This has immensely improved and met the rate allowed by the regulators.
Are Banks Operations Affected by Foreign Exchange and International Capital Flows Controls?
Taiwan banks are extensively affected by foreign exchange and international capital flows. This is because they rely on local exporters to the extent that when the global demand reduces, the domestic banking sector is likely to face an increased risk on the basis of the fact that their asset quality is linked to the country’s export orders. Equally, Taiwan’s financial institutions also target a larger number of Taiwan people living or doing business in the foreign countries, meaning that in case their remittances drop, the performance of some banks is likely to drop.
In order to minimise the effects on the reduction international capital flows, the Taiwanese authorities adopted a more flexible approach to facilitate a more efficient flow of financial resources from foreign exchanges and in allocation of credit. To this effect, the originally imposed limit on New Taiwan (NT) dollar deposits, which every branch of a foreign bank could take, has been lifted (Allison, 2000). People who do not reside in Taiwan have also been allowed to open NT dollar bank accounts to improve their capital-flows from overseas countries, and the branch banking limits have been lifted.
Equally, the government also removed the restrictions that were initially imposed on capital flows related to portfolio investment, has liberalised laws governing the insurance and security industries and opening the industry to foreign investment as well as allowing the foreign institutional and individual investors to access Taiwan’s securities markets. However, the portfolio investment is governed by Taiwan regulatory system that qualifies the institutions to engage in portfolio investments like large banks, security firms, insurance companies, and mutual funds to carryout portfolio investment (Allison, 2000).
All this liberalization is done in order to improve the international capital flows and amount of foreign exchange. For instance, the Taiwan authorities opened portfolio investment to individual and corporate foreign investors in addition to the ‘qualified foreign institutional investors’ (QFIIs) companies in March 1996. Despite this liberalization, it is important to note that the foreign individual investors are allowed a portfolio investment limit of USD5 million and a maximum of USD50 million for non-QFII foreign companies are currently allowed to move their capital freely. Presently, these restrictions are not applicable to the QFII companies (Allison, 2000).
Issues on Prudential Regulations. Is the Country Adopting Basel II?
The regulations relate to the functions of the FSC that monitor the performance of the banks operating in Taiwan. Taiwan, assuming that it falls in the Asia Pacific region, adopted the Basel II Capital Accord commonly referred to as ‘Basel II’ after more than five years of the financial and banking sector and regulatory consultation. The aim of this Basel II accord is to help in aligning the regulatory capital factors with the common risk profile that banks normally face especially when considering credit, operational activities, market development, and other risk factors (Deloitte, 2005). The Basel II accord involves three pillars; (1) minimum capital requirements, (2) supervisory review and (3), market discipline. This accord helps the Taiwan banking sector to adopt a more flexible and comprehensive approach to measure and manage risk and, being increasingly risk sensitive, it recognizes operational risk as a new charge in the business, promotes internal risk managing techniques in the banks and integrates supervisory evaluation and market discipline (Deloitte, 2005). Since Taiwan has a well-developed banking system, the Basel II is intended to preserve and strengthen the country’s positions as leading financial centers.
Taiwan banking sector plays a leading role in the Asia Pacific region in the sphere of offering banking services for both local and foreign customers. The country currently has over 68 banks and over 25 credit co-operatives operating in Taiwan to offer accounts, loans, credit cards, mortgage services among others. This essay has also discussed the characteristics of the banking sector and the economic regulations that the Taiwan banking industry faces. It is noted that the banking industry has to a larger extent relaxed their control in the international capital flows to encourage more foreign investors in joining the Taiwan banking sector.