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RegulationsMay 4 2009

Saturation point

Vivian Shyy, managing director of customer experience management, consumer banking, Standard Chartered Bank TaiwanTaiwan's banking industry is in dire straits and remains in desperate need of consolidation. Many banks are hoping better relations with China may open up new revenue opportunities but this remains to be seen. Writer Michelle Price
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Saturation point

In Taipei, retail bank branches are almost as prevalent as people. Hubs of ATMs, mini-branches and full-scale premium branches litter the city, jostling for space among shops, malls, railway stations and the metro. One such branch can be found at the Taiwan headquarters of Standard Chartered Bank Taiwan, which first entered the Taiwan market in 1985. Downstairs, in the bank's luxurious 'priority banking' branch, a gleaming mini-grand Yamaha piano sits amid the decorative water feature and coffee bar.

In this impressive space, the bank's wealthy priority customers may work, book flights, socialise with friends, and even throw a small party, says Vivian Shyy, managing director of customer experience management, consumer banking, Standard Chartered Bank Taiwan. "We are not trying to position ourselves as traditional banking, we are trying to position ourselves as the six-star hotel: we focus on loyalty, not only pricing," she explains, adding: "Priority banking is about lifestyle."

But the bank's sumptuous priority banking proposition is not only about luxury and lifestyle, it is also about the extreme edge of competition. It is a long-held complaint of industry analysts and Taiwan bankers alike that the island's banking industry is dangerously over-saturated: in an island of just 23 million people, 37 local banks, 32 foreign banks and 27 credit unions compete fiercely for the same target market. In September 2006, Taiwan's Financial Supervisory Commission (FSC) revealed that the country's top five banks account for merely 38% of the market, compared with 87% and 76% for South Korea and Hong Kong, respectively. According to McKinsey Consulting, Taiwan's banking sector is only half as concentrated as it should be, relative to its economic development, reflecting an entrenched malaise that is slowly but steadily suffocating the entire industry.

Disrupting the mechanism

During the past 15 years, what the Taiwan Institute of Economic Research refers to as "malicious" competition has badly disrupted the sector's pricing mechanism. Banks find it extremely difficult if not impossible to charge fees based on transactions, says Anthony Cheng, associate for investor relations at E-Sun Bank Commercial Bank. The yield on financial products is also negligible, says Chen Hock U, senior vice-president and head of personal financial services at HSBC, Taiwan. "Everyone offers the same products and everyone is so concerned with market share and trying to gain volume that pricing becomes no issue: you just price your products away."

This leaves services as one of few growth areas. In recent years, many banks such as Standard Chartered have pushed aggressively into the wealth management space, but the fees from this business line are also in decline. Tom Ko, CEO of wealth management at Jih Sun Financial Holding, says that the severe downward pressure on costs has become "an industry-wide problem" while profits, he says matter-of-factly, grow "less and less" each year.

The global economic downturn has exacerbated these systemic problems. A heavily export-dependent economy, Taiwan reported a record decline in gross domestic product of 8% for its fourth quarter 2008, prompting the central bank to slash the base rate by 25 basis points in February. The move has dramatically eroded the sector's net interest margin, one of its only remaining revenue streams. "We have been losing a chunk of that income so we're struggling - all banks are struggling - to make money," says Mr Hock U. With a return on equity (ROE) of just 2.47% for 2008, Taiwan's consumer banking sector is already the least profitable in Asia, while its non-performing loan ratio is on the rise.

Having posted two loss-making years in 2002 and 2006, the sector is due another disappointing year, with Fitch Ratings forecasting a return on assets of just 0.5% for 2009. As the sector is forced to support ailing corporate clients, the average capital ratio is likely to fall 2% below the BIS statutory 8%, predicts Fitch. "The business situation is really, really terrible, especially in the banking industry," says Morris Li, Citi country officer for Taiwan. "Our over-banking situation is very severe."

No one is in any doubt that dramatic consolidation is the answer. Yet despite repeated reforms designed to shake up the industry - including legislation, tax incentives and subsidy schemes - the sector has only a handful of significant mergers and acquisitions to show for it. Although, in the past two years, a short sharp wave of foreign acquisitions by the likes of Standard Chartered, Citi and HSBC have been much-trumpeted by local market-watchers, the pace of change has slowed again due to what Eunice Fan, a financial services ratings analyst at Taiwan Ratings, a partner of Standard & Poor's, refers to obliquely as "political issues". These include visceral opposition on the part of the sector's state-owned banks - which dominate some 50% of the sector's assets - to the consolidation process, in particular privatisation; strong unionisation among workers fearful of job losses; and a general lack of political will. "The momentum will slow down and things will really depend on the government and the decision to push out the privatisation project," says Ms Fan. This, she adds, could take three to five years.

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Chen Hock U, senior vice-president and head of personal financial services at HSBC, Taiwan

A new platform?

Taiwan's banks, to say nothing of its economy at large, may not have this long. All institutions are in the process of seeking out new revenue streams, reports Peter Wei, a senior vice-president at Chinatrust Commercial Bank. For many Taiwan-based banks, mainland and greater China have long-been regarded as the most tantalising new area of growth. With a vast consumer population and burgeoning corporate base, united by a common language and culture, the cross-strait market, in particular the provinces of Fujian and Zhejian and, of course, Hong Kong, are perceived as the key targets. As the lowest Chinese base rate in recent memory is still twice that of Taiwan, at 5.31%, it is also a much more appealing market, from a pricing point of view, in which to establish a lending subsidiary. For this reason, Taiwan's banks, although over-saturated, have historically been regarded by analysts as attractive investments for sophisticated international foreign players wishing to enter China.

 Until the first quarter of last year, however, Taiwanese restrictions on cross-strait financial services investments had largely frustrated this ambition. But in May 2008, the inauguration of Taiwan's new China-leading Kuomintang (KMT) government, led by President Ma Ying-jeou, brought a softening of relations between Taiwan and Beijing. According to the China Post, Taiwan and Beijing are due to sign a much-anticipated bilateral financial services memorandum of understanding (MOU) in May, which will allow Taiwan banks to directly enter the Chinese market under a joint financial supervisory framework. Several domestic banks are already preparing their cross-strait entry. E-Sun Commercial Bank, which is still awaiting Beijing's approval for its branch licence in Hong Kong, is focusing on China, says Mr Cheng, while state-owned Bank of Taiwan is also awaiting the go-ahead. Most notably, the Fubon Financial group, one of Taiwan's largest financial services conglomerates, acquired almost 20% of Xiamen Commercial Bank in China's Fujian province early last year. Privately held Chinatrust Commercial Bank is also considering the Chinese market, reports Mr Wei.

 For global banks such as Citi, the ability to serve Taiwanese corporate customers, particularly Western information technology companies (many of which also used Taiwan as the staging post to enter the Chinese market), across a broader Chinese platform is a vitally important competitive advantage. The magnetic appeal of China has led Taiwan corporates, on a government-approved basis, to invest some $76bn in the country between 1991 and 2008, although the real figure is thought to be much higher due to capital that is routed indirectly through third parties, according to Thomson Reuters. Servicing these firms' China operations has enabled Citi to become one of Taiwan's most profitable banks. "All these global players want to go into the Chinese market and co-operate with Chinese customers, so we have become a very important intermediary for their investment and banking transactions," says Mr Li.

Limited prospects

Research performed by Taiwan Ratings suggests that the ambitions of Taiwan banks are very much focused on what the Taiwan government estimates are some 50,000 China-based Taiwan corporates, says Eva Chou, a financial analyst at the firm. "They are not really interested in lending to China's corporations, so I think the move will [provide an opportunity] for Taiwan banks to service Taiwan customers. But to really expand their revenue engine to Chinese corporations - that would be a long way to go." Ms Chou adds, however, that the opportunities for Taiwanese retail banks in China are much fewer - especially for those banks initially focusing on operations in Hong Kong. "I think the benefit is very limited because the exposure of Hong Kong branches is very small," she says.

However, Mr Li, who also chairs the American Chamber of Commerce in Taipei Banking Committee, believes that the majority of local banks - whose growth has been stunted by the overcrowded market - are not capable of operating on a greater China platform. Despite having some operations in Hong Kong and Vietnam, local banks are not properly internationalised and most do not have the skills required to run a sustainable cost base across the greater China region, he says. In order to compete against immense and well-entrenched domestic Chinese banks, and world-class foreign banks, Taiwan's banking sector would have to invest more than $500m in their existing operations, according to research by Taiwan-based law firm Tsar and Tsai - funds the sector does not have.

Even if Taiwan's banks were much bigger and more robust, Mr Li believes that the window of opportunity to capitalise on China's Taiwan-based corporate community has probably passed. Chinese banks - which according to The Banker's Top 1000 rankings for 2008 account for a staggering 40% of the entire Asian banking industry - are growing at a breathtaking pace, while many other Asian players are also making advances, he says. Analysts at the Chung-Hua Institution for Economic Research agree that Taiwan's entry is relatively late. It also remains unclear whether Beijing is prepared to waive the statutory three-year grace period which prevents Taiwan banks from immediately operating yuan-denominated businesses upon entering the market.

Furthermore, as Taiwan's vehemently anti-China opposition party, the Democratic Progressive Party (DPP), "still has some influence and power regarding the deregulation process", says Ms Chou, it is still possible that the number and type of local banks that will be allowed to fully enter the market may ultimately be restricted. These constraints, coupled with the prevailing economic climate, put Taiwan's banks in an intractable position, says Mr Li. "They cannot grow and they cannot compete with the Asian banks [on a] greater China platform," he says.

Beyond marginalisation

 Nevertheless, as the island's primary trading partner, Taiwan is increasingly beholden to China. Research by The Chung-Hua Institution for Economic Research claims that 110,000 jobs would be lost in Taiwan as an indirect result of the marginalisation the country will face once the extended regional economic blocs formed between China, Japan and South Korea and the Association of South-east Asian Nations (ASEAN) countries come into being in 2010 - a much-quoted piece of research among KMT politicians. Conscious of the island's increasingly vulnerability, the KMT has entered into broader discussions about a highly controversial free-trade agreement that would bring a much deeper economic integration between the two formerly estranged countries.

However, China will likely demand reciprocal treatment where its banks are concerned, under the MOU. Prior to Taiwan's precipitous slump into recession earlier this year, Taiwan's FSC suggested that it would introduce an initial 20% investment cap on inward-bound Chinese investments in its banking sector in the event of signing the MOU. But some bankers believe that this restriction may no longer satisfy Beijing, upon whom the KMT is relying to resuscitate Taiwan's economy, or so the party's critics claim. If the KMT is forced to raise this cap or grant full reciprocation, Taiwan banks face "a big threat", in the words of Ms Chou, given their size and decreasing capital strength.

According to a Law Business Research report authored by legal analyst Stephen J Hanley, there is anecdotal evidence that Chinese firms have begun indirectly acquiring stakes in Taiwanese corporate targets through their China-based subsidiaries. There is no reason to believe that Taiwan's enfeebled banking industry will not be next under a mutually reciprocal arrangement, particularly given the power and profitability of China's mega-banks: according to the China Banking Regulatory Commission, the Chinese banking sector ROE reached 17.1% in 2008, 14.63% higher than that of Taiwan.

Amid Taiwan's highly charged political atmosphere this is an explosive prospect. The Democratic Progressive Party has loudly accused the KMT of using the economic discussions with China as a vehicle for greater political unity, a concept to which much of Taiwan's population is extremely hostile. Ironically, should China's banks be allowed to invest extensively in the Taiwan market, they could play a much-needed role in driving forward the industry's long-awaited consolidation.

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