Taiwan has long been Asia's most saturated banking market. With almost 70 banks serving a population of 23 million, the streets of central Taipei are testament to this cut-throat environment, where there are often three or more banks directly facing each other. Given the intense competition to offer the best rates, services and quality, Taiwan's banks have among the lowest return on equity, return on assets, dividend yields and interest margins in Asia.
Against this backdrop, the imminent signing of an Economic Co-operation Framework Agreement (ECFA) between China and Taiwan, a manifestation of warmer cross-strait ties between the two countries, has generated much excitement among local industry chiefs and politicians alike. The agreement is expected to facilitate a huge increase in cross-border economic interaction, cutting tariffs and red tape on hundreds of products, including financial services, and potentially increasing the value of trade between the two countries to $100bn annually. The recent explosion in cross-strait tourism and the inauguration of direct flights between the two economies gives an idea of Taiwan's potential: according to official statistics, 181,000 Mainland Chinese visited the island in April 2010, up from barely 35,000 at the end of 2008.
Though the ECFA has become highly politicised in Taiwan, symbolising the division of Taiwanese society between supporters and detractors of China, the agreement's finalisation has been inching ever closer in recent months. In early June, the Taiwanese government, which supports the ECFA, ruled out holding a national referendum on the agreement. Meanwhile, on June 13 the two countries held a third round of negotiations on the ECFA's details, unravelling many of the knottiest issues, with news headlines declaring that the two countries are very close to signing the landmark agreement.
Banking boost
The prospect of Taiwan's fittest banks finally breaking free from Taiwanese claustrophobia is certainly alluring. "For the big banks, this is an absolute must," says Morris Li, chairman of Citibank Taiwan. Seven Taiwanese banks have already set up representative offices in China, and their plans for expansion have become increasingly ambitious. Fubon Bank (Hong Kong), one of the country's largest private banks, already has a 20% stake in China's Xiamen Bank, and hopes to set up as many as 200 branches in Fujian province, directly across the Taiwan strait. Fubon recently signed letters of intent to set up a joint-venture securities brokerage arm, a fund management arm and an insurance arm on the mainland. Chinatrust Commercial Bank (CCB), another major Taiwanese bank, has sent an application to China's Financial Supervisory Commission to set up a Rmb3.2bn ($468m) subsidiary in the country, which it hopes to obtain approval for by early next year, according to CCB chairman Daniel Wu.
For such banks, the major potential money-spinner is tapping into the domestic Chinese market. Taiwan's banks would like to obtain licences to fully engage in renminbi retail banking - this is by far the most lucrative business. In theory, matching China's macro-financing needs with Taiwanese banks' service capabilities would be a logical place to start. China's post-financial crisis strategy has been one of massive state-driven credit growth, funnelled largely towards colossal infrastructure spending and property development. As this phase of credit growth looks to be slowing down, much has been made of a shift in focus towards small and medium-sized enterprise (SME) lending (in China, SMEs account for up to 70% of urban employment), and rural finance, in a bid to stimulate rural consumption and narrow the ever-yawning development gap between China's rich coastal areas and its poor hinterland. China needs to increase the volume and sophistication of its consumer lending, wealth management, private banking, insurance, and investment products services. Taiwan's banks have unmatched aptitude in many of these business areas, and in particular consumer and SME lending - more than 70% of Taiwanese economic growth is accounted for by SME activity.
But success on the Chinese mainland is by no means a given for Taiwan's banks, even presuming financial liberalisation goes ahead. China's banks are among the most profitable in the world, partly because interest rates are set by the state, enabling them to enjoy high net interest margins. However, it is precisely because retail banking is so lucrative that Chinese banks are unlikely to want their Taiwanese counterparts to grab market share.
Moreover, success in retail banking is based on scale: given the immense size and capitalisation of China's banks, Taiwanese banks will struggle to compete on funding costs or scale, as long as Chinese banks want their full slice of the pie, according to some Taiwanese bankers. "At most, the Chinese government may let Taiwanese banks expand into China's rural areas, but it is more challenging to turn profits in in this field," says John Li, head of HSBC Taiwan's global banking and markets division.
For now, Taiwanese banks' strategies in China will focus mainly on the hundreds of thousands of Taiwanese expatriate residents living in the mainland, with a view to entering the domestic market perhaps in the next five years. Hundreds of thousands of Taiwanese people there have relocated across the Taiwan Strait for business reasons in the past decade, as Taiwanese manufacturing companies - such as Foxconn - outsource their low-end operations to China.
Taiwanese banks will look to follow these people, while also looking to position themselves in Chinese cities with high gross domestic product per capita, good growth prospects and investor-friendly local governments. Taiwan also has a particular cultural affinity with the Chinese coastal province of Fujian, from which many of Taiwan's inhabitants originate.
Victor Kung, president at Fubon Financial
Supply-Side Reforms
The Taiwanese exodus has resulted in huge volumes of capital outflows from Taiwan, seeking political safety and higher returns. As Victor Kung, president at Fubon Financial, put it: "Taiwan is unduly worried that its manufacturing industry is waning, particularly as profits are declining, but Taiwan shifts ever further towards a services-based economy." In late May, Taiwan slashed its corporate income tax from 20% to 17%, the second lowest in Asia after Hong Kong's 16.5%, and on a par with Singapore. The idea is to attract more foreign and overseas Taiwanese investment to kick-start services and higher value-added industries. Even some lower-end manufacturing may be relocated back home.
Despite increased investor-friendliness however, Taiwan has already begun sounding the alarm on excessive financial flows into the country's asset markets. Taiwan's banking market is known for its high levels of liquidity, and with speculators suspected of parking large volumes of short-term money in Taiwanese assets such as short-term bills and 10-year notes, betting on a rise in the new Taiwan dollar exchange rate, Taiwan's central bank governor warned in May that capital controls may be necessary, particularly at a time when central banks are seeing shortages of US dollars because of concerns over the eurozone.
However, many believe that the capital controls threat is a scare tactic to dissuade people from speculating in the new Taiwan dollar. Implementation of such measures is relatively unlikely because, in addition to scaring away investors and denting turnover on the local stock market, such measures would require a lot of complex coordination from different agencies.
A Property Bubble?
Another area of concern for the Taiwan banking industry is the Taipei property market. A slashing of Taiwan's inheritance tax from 50% to 10% in late 2008, coupled with stimulus spending and economic interaction with China, attracted volumes of repatriated capital back to Taiwan. This fuelled a 21-month rally, including a 30% average increase in Taipei property prices. This was particularly acute in the luxury residential market.
In the past two months, Taiwan's government has begun tightening control over land supply, emphasising (if not enforcing) transparency in transaction pricing, while banks have already begun hiking significantly the interest rate on mortgages for buyers of second homes. This appears to have already been effective: the Central Bank of Taiwan (CBC) reported that, in the last two weeks of May, mortgage loans to second home buyers had decreased by 40%.
Given that the government may have a vested interest in seeing a slow cooling of property prices before municipal elections in December, there have been worries of a rise in industry non-performing loans (NPLs) and mortgage delinquencies. According to the CBC's Financial Stability Report published in May, total bank loans related to real estate reached 43% of aggregate lending by the end of 2009, of which 30.6% was residential and 12.5% was in commercial real estate. With bank NPLs at a very low 1.1% as at December 2009, a rise in NPLs seems inevitable.
However, many people in Taiwan are not convinced that this increase would be substantial, given that property risk remains diversified and concentrated in the Taipei luxury sector, while price increases in the national mass market have been comparatively tepid. "Moreover, Taiwan has one of the highest rates of home-ownership in the world, at more than 80%, and of these only 30% take out a mortgage," says Greg Gibb, chief operations officer at Taishin Financial Holdings.
"General leverage levels on the retail side are relatively low, following the credit card and consumer loans bust in 2005, when the unsecured consumer market shrunk by 40%. The corporate environment has also been deleveraging over the last five years, ever since Taiwan was hit by the bursting of the high-tech bubble earlier in the decade."
Indeed, despite the 2009 rises, Taipei's property market has lagged behind the likes of Hong Kong, Shanghai and Seoul over the past decade. With limited land supply, a dense population and the increasing integration with China, many still think Taiwanese property is a good long-term bet.
Daniel Wu, chairman, Chinatrust Commercial Bank
Structural oddity
Despite an expected decline in mortgage lending, overall loan growth in coming months is likely to improve, with average growth at the major banks in the mid-single-digit range. Corporate loan growth in particular will be strong, 80% of which has gone to high-tech industries over the past 12 months as a cyclical recovery has boosted demand for Taiwanese exports, in addition to political campaign spending prior to municipal elections in December.
However, in the long run, Victor Kung of Fubon expects a secular trend towards slower loan growth, as Taiwan shifts to a services-based economy. "What I would really like to see between China and Taiwan is a free-trade agreement in services", he says. "Imagine the potential opportunities if Taiwan companies could build hospitals in China, and if people from the Chinese mainland came to Taiwan for medical services."
Mainland China is not the only player in the internationalisation of Taiwanese bank strategy - Chinatrust, for example is considering expansion in Indonesia. As with Japan and South Korea, saturated consumer markets and low birth rates in Taiwan will force many banks to consider expanding into Asia's fast-growing emerging markets.
Taiwan's banking sector still remains highly fragmented between the state-owned banks, which account for the majority of corporate and industrial lending and about 65% of the mortgage market, and private banks, which dominate the consumer and retail market, and are left to battle it out over best mobile banking and customer service offerings.
In this respect, Taiwan's banking market remains something of a structural oddity. Despite the island's transition to a market economy and democracy, Taiwan remains the second most state-owned-dominated banking market in the region, after China. Roughly 50% of Taiwan's total banking market share is in the hands of eight government banks, while about seven sizable, family-run banks hold a 3% to 4% market share each.
Given that Taiwan has almost 70 banks, consolidation would seem a natural evolutionary step. However, large private banks are loath to merge with each other as they are mostly family run and would face huge shareholder pressure over issues of control in the event of a merger. These large banks have also made no attempt to acquire dozens of smaller banks with 1% or less national market share, as this would add little value to their business.
Meanwhile, the idea of any mergers between state banks - or state banks acquiring private banks - is fraught with potential political problems. The scandals surrounding former Taiwanese president Chen Shui Bian - who is serving 20 years in prison having been found guilty of embezzlement and bribery in relation to the privatisation and merger of financial companies - are clear testament to that.
But Tony Phoo, economist at Standard Chartered Taiwan, thinks that the China factor could again prove pivotal in banking consolidation in the years ahead.
"Pushing to expand in China would require a degree of scale and capital that only a few select banks could afford," says Mr Phoo, "and as their businesses continue to grow this could become an eventual catalyst for banking mergers and acquisitions."
Market watchers will continue to eagerly anticipate the ECFA, which may prove instrumental in the next phase of Taiwan's banking sector development.
