COVER STORY

Unlocking Banking’s Future

A series of developments is pointing to some new directions for Taiwan’s banking industry. After several years of seeming lack of interest in promoting industry consolidation, the government is again talking about tackling the “over-banking” phenomenon in the sector. At the same time, cross-Strait negotiations may soon open the way for domestic banks to engage in renminbi business, and the Financial Supervisory Commission will soon go through some reorganization.

Major M&A Activity

INTERVIEW - “The Financial Status is Quite Sound”

Of the six chairmen that have led the Financial Supervisory Commission since its establishment in mid-2004, the incumbent, Chen Yuh-chang, is the longest-serving, having been in office for nearly two years. An MBA from National Taiwan University, Chen was previously chairman of First Financial Holding and First Commercial Bank (2008-2010) and chairman of the Taipei Smart Card Corp. (2006-2008). He also served for eight years as secretary-general of the Taipei City Government and in 2006 was appointed Deputy Mayor. He was interviewed for TOPICS by Editor-in-chief Don Shapiro.

BY DON SHAPIRO

With a new premier coming from a financial background now in office, and with the Financial Supervisory Commission (FSC) slated to undergo a major revamping in July, observers of Taiwan’s banking sector have been wondering whether new approaches to Taiwan’s financial-industry development might be in the offing.

In recent years, dissatisfaction in the industry had grown as government regulators largely refrained from mapping out a clear vision for where the sector is headed. The authorities had also appeared unwilling to promote further consolidation in the highly fragmented banking sector, and the previous frequently publicized goal of establishing Taiwan as a regional financial center – which would mean benchmarking Hong Kong and Singapore as models for liberalization – was no longer being enunciated.

But comments to the Legislative Yuan on March 16 by Premier Sean Chen in his second month on the job have stirred hope that the government may be returning to a bolder, reform-minded approach. Chen, whose career has been almost entirely in finance as both banker and regulator, told the lawmakers that now would be a good time to proceed with consolidation, since the banking sector currently is in sound shape in terms of both non-performing loans and capital adequacy ratios.

There have even been indications that the government may be willing to allow state-owned financial institutions to take part in merger and acquisition activity, a topic formerly considered highly sensitive. According to local media reports, a bill being drafted by the Executive Yuan would eliminate a requirement that financial institutions with at least 10% of their shares held by the government must report to the legislature on any M&A plans. Five of Taiwan’s largest financial holding companies (Hua Nan, First, Mega, Taiwan Financial, and Taiwan Cooperative) are majority government-owned.

In addition to noting the apparently changed attitude toward consolidation, industry observers are awaiting a restructuring of the FSC to take place in mid-year. The terms of the incumbent nine commissioners (including the chairman and two vice chairmen) will come to an end, and the nature of the body will be transformed from the present collegial system in which decision-making is shared by all commissioners to one in which ultimate authority resides in the chairman. The likely impact of the revision on policy is unknown, but it should heighten efficiency and accountability. “Under the current system, if every commissioner has equal rights, then who should really be responsible for the final policy?” notes Shen Chung-hua, professor of finance at National Taiwan University. “Now the lines of responsibility and communications will be much clearer.”

Further, at a time when cross-Strait business opportunities are of steadily increasing importance in the financial sector, the Central Bank has appeared optimistic about being able to reach agreement with its mainland counterparts within the next several months on the establishment in Taiwan of a renminbi (RMB) settlement mechanism. Speaking to journalists, Central Bank Governor Perng Fai-nan said this month that the negotiations have been going well, and that an agreement – which would give domestic banks the capability to conduct RMB-denominated business – could be concluded before the middle of the year. At present, local banks are allowed to engage in RMB-denominated business only through their Offshore Banking Units (OBUs). But in view of the large volume of cross-Strait trade and investment, as well as the desire to gain competitiveness vis-à-vis Hong Kong, the banks have been pressing the government to work out an arrangement to permit extension of the business to the domestic banking units.

The Taipei branch of China’s Bank of Communications is considered most likely to serve as the settlement bank. Besides the Bank of Communications, the Bank of China has also received permission to upgrade its local representative office to branch status, while the China Construction Bank and China Merchants Bank are currently operating rep offices here.

Consolidation stigma

If M&A activity in the banking sector is now resumed, it is likely also to revive some of the controversy that surrounded previous rounds of consolidation during the Chen Shui-bian administration. Although the efforts to reduce the extent of Taiwan’s “overbanking” brought down the number of domestic banks in the market from 53 in the year 2000 to 37 at the end of last year – while also eliminating the most financially troubled players – the process left the public and policymakers with the sense that banking consolidation is a subject fraught with politically sensitivity.

Fueling that impression were allegations that President Chen and members of his family were involved in influence-peddling as certain merger deals proceeded during his term of office. In addition, angry protest demonstrations by employees of state-owned banks fearful of losing their privileges as civil servants received considerable media attention. And there was uneasiness among legislators and certain opinion leaders about the prospect of selling off national assets to private conglomerates, particularly when it would appear to be increasing the economic power of a handful of wealthy families.

In interviews with Taiwan Business TOPICs that preceded Premier Chen’s remarks about fostering consolidation, some financial industry leaders spoke about the importance of having fewer, larger banks and how the process could be facilitated. “The financial services industry needs a lot of scale, and Taiwan doesn’t have it,” said Victor Kung, president of Fubon Financial Holding Co. “Within Taiwan, we are a very fragmented industry, so our banks are very small. Even the largest, the Bank of Taiwan, is ranked number 100 in the world. While all the other economies in East and Southeast Asia have consolidated their banking industry during the Asian financial crisis, Taiwan has never really developed a giant or a national champion. We do need such a national champion, but in my view it shouldn’t be a government-controlled bank, because as we know, the vitality of the Taiwan economy is in the private sector.”

Kung went on to discuss what the private sector might be able to do to make it easier for the government to privatize the state-owned banks. “Right now the leading private-sector banks are all family-controlled, which makes it politically more difficult,” he noted. “If you sell to Fubon, you’re selling to the Tsais. If you sell to Chinatrust, you’re selling to the Koos. It’s tough.”

He suggests that the key issue should not be the proportion of shareholding in the hands of the family members but whether they are calling the shots in the bank’s operations. That question could be answered by installing stronger corporate governance, including a majority of independent directors on the board and reliance on professional chief executives. To give the families some incentive to step back, he says, the government could give priority in privatization to M&A with groups that have sufficiently institutionalized and adopted strong corporate governance.

Noting that the government-owned financial institutions account for over 50% of the local banking market in terms of lending and assets, Yuanta Financial Holding Chairman Yen Ching-chang, who served as Finance Minister from 2000 to 2002, told TOPICS that “unless the government is willing to privatize the state-owned banks, there is no room for meaningful banking consolidation.” In the two other major segments of the financial industry – insurance and securities – the companies are privately owned “and so the market mechanism can be the driving force for consolidation,” he said. But in banking, the market mechanism has been unable to operate as long as the government dominates the scene.

Echoing Victor Kung’s remarks about the importance of corporate governance, Yen noted that Yuanta was previously considered synonymous with the Ma family (no relation to President Ma Ying-jeou), the major shareholders. But after taking on the chairmanship seven years ago, he worked on professionalizing the group’s management, and “today Yuanta Financial is widely viewed as a role model for corporate governance,” he said. “Corporate governance has nothing to do with whether the company is family owned or not. No member of the Ma family is involved in the management.” Yen proudly shows off the suite of offices Yuanta provides for its independent directors, and he notes that those directors determine his own compensation through the board’s remuneration committee.

FSC Chairman Chen Yuh-chang, in an interview with Taiwan Business TOPICS [see the accompanying article in this section], said he hopes that “the domestic banks can continue their M&A efforts so that their scale of operation can be expanded,” and that it is the role of the regulator to provide a clear and transparent environment for M&A to take place, without seeking to force consolidation. He declined to comment on whether state-owned banks should be privatized, describing that as the purview of the Ministry of Finance, which controls the government’s shares.

With regard to private-sector initiatives, media speculation began soon after Premier Chen’s remarks to the legislature that consolidation should be welcomed. Fubon Financial and Yuanta Financial were both said to be interested in acquiring the 36% stake in Ta Chong Bank currently held by the large private equity firm, the Carlyle Group. Chinatrust Financial was also mentioned as being actively interested in expansion through acquisition.

Building a base

Given the relatively small size of Taiwan’s domestic market and the fierce competition in the banking sector, many of the leading financial institutions see the necessity of looking beyond Taiwan’s borders to secure their future business. Chairman Susan Chang of the state-owned Bank of Taiwan recently pointed out that although her banks’ overseas branches and Offshore Banking Unit (OBU) represent only 10% of the institution’s assets, they last year accounted for roughly half of the overall profits. The implication was that overseas business – particularly in the mainland China market – will take on increasing importance.

Growth domestically and overseas may certainly be linked. “I’ve always believed that if you want to be influential internationally, you have to be influential domestically,” says Victor Kung, explaining one of the motivations for Fubon to be a domestic consolidator. He notes that nearly all major banks in the world can rely on a strong base in a given home market.

But if M&A opportunities in Taiwan are not available to enable domestic institutions to expand their scale, they still feel the need to move ahead to try to take advantage of market opportunities presented by the opening of China. Currently, seven Taiwan banks are operating branches on the mainland: Cathay United, Chang Hwa, Chinatrust, First Commercial, Hua Nan, Land Bank, and Taiwan Cooperative. Three others – the Bank of Taiwan, E. Sun, and Mega International – have received approval from the China Banking Regulatory Commission to set up branches, and Taiwan Business Bank has received FSC approval but not yet China’s. Fubon has had access to the China market through its Hong Kong subsidiary’s stake in a bank in Xiamen. In addition, some Taiwanese banks are reportedly considering taking minority shares in Chinese counterparts, and several Taiwan financial institutions have been licensed to operate leasing companies in China, mainly to help finance purchases of production equipment by Taiwanese-invested enterprises (the so-called Taishang).

Fubon’s Kung urges the Taiwan authorities to be more aggressive in seeking fairer competitive conditions in China for the Taiwanese banks. “Taiwan has its natural advantages vis-a-vis mainland China,” he says, noting the common language and culture, and the impressive success of many Taiwanese companies that have invested there. “If we have a level playing field in the financial services sector, we can also be as successful in China as we are on the manufacturing side.”

Kung says the Taiwan side has been reluctant to push for more regulatory relaxation from China for fear that the PRC in return will ask for more concessions for their banks in Taiwan. “The government says ‘we want to protect you – we don’t want the Chinese banks to tromp on you in Taiwan,’” he explains. “But if we can gain access to a much larger and more fertile market, do it! We never said we’re afraid of their competition. We’re not afraid of Citi’s competition or Standard Chartered’s or HSBC’s. Would we be afraid of competition from ICBC?”

National Taiwan University’s Shen Chung-hua agrees that Taiwan’s banks should have little to fear from the entry into this market of mainland banks. He believes the main role of the Chinese branches here will be to assess the creditworthiness of Taiwanese enterprises with operations across the Strait so as to introduce potential borrowers to their branches in China. “But we have an advantage in that our banks in China know the Taiwanese businessmen better than they do,” he says. “And Taiwanese businessmen trust Taiwanese banks more than Chinese banks.”

Shen adds that if the Central Bank can succeed in negotiations to have China establish an RMB settlement mechanism in Taiwan, it would further bolster the competitiveness of domestic banks. “Currently to make settlement, our banks have to go through their Hong Kong branch or subsidiary or a correspondent bank to deal with the Bank of China in Hong Kong,” he says. “It’s like the previous issue of direct flights versus indirect flights. We can think of it as ‘financial direct flights.’ The settlement could be done here, instead of in Hong Kong.” At present, Hong Kong is the only location outside of China proper for RMB clearance, although Singapore and London are reportedly interested in gaining that status.

Regulatory approaches

Besides consolidation and the facilitation of cross-Strait business, many bankers also stress the need for regulatory reform to increase the competitiveness of banks operating in this market. One frequently cited example is the need for greater differentiation between rulings applicable only to the retail market – where consumer protection is a central principle – and those also applied to institutional or professional investors, who should be sophisticated enough to make their own judgments. Jane Hwang, vice president and general manager of the State Street Bank and Trust Co. Taipei branch, notes that under current regulations, institutional investors may be barred from buying less than investment-grade instruments or may face a cap on the amount of investment they can put into a given fund. “That’s too micro,” says Hwang, who is also co-chair of AmCham Taipei’s Capital Markets Committee. “It’s your asset allocation decision and you should know how to assess your own risk.”

Fubon’s Kung says such micro-management extends even to the internal organizational structures financial institutions are permitted to adopt, and feels that the aftermath of the Lehman Brothers collapse of a few years ago was used as an excuse to tighten up on regulations in areas generally unrelated to that case.

Some of the foreign banks in Taiwan have recently had tense dealings with the regulators over such issues as data processing and dual licensing. Under pressure, banks that had moved their data centers offshore in line with global trends toward centralization have now agreed to return that function to Taiwan for their consumer banking within four years. Some institutions argued in vain that the move would impose an extremely heavy cost burden on them, while the benefit in terms of added data protection would be non-existent. Currently only two other countries – South Korea and China – have such requirements for onshore data centers, and Seoul will need to change its policy under the conditions of the Free Trade Agreement it recently entered into with the United States.

The licensing issue would affect certain foreign banks that established subsidiaries in Taiwan in recent years after expanding in this market by acquiring domestic banks. They are now being pressed to give up their original branch license, which previously could be held simultaneously with the subsidiary license. Because Taiwan regulations limit bank loans to a single borrower to 5% of a bank’s net worth, having a branch license permits much larger loans to be made, as the net worth is treated as that of the parent institution. Critics of the proposed change note that dual licensing is a common practice internationally, and that three Taiwanese banks in the United States fall in that category.

Despite certain shortcomings, the Taiwan banking industry is seen as having the potential to play a more important role within the region. “Taiwan really has all the trappings it takes to be an international financial center,” says Ajay Kanwal, who recently assumed the post of president and CEO of Standard Chartered Bank Taiwan after a six-year assignment in Singapore. “We have the three things that I think are crucial ingredients: a) good law, b) a good banking system and regulatory system, and c) talent. With those three basic elements, you could have the ambition to do things on a much broader scale in the financial industry.” He adds that providing an RMB settlement mechanism would further add to Taiwan’s qualifications.

For the talent component of the mix, Kanwal stresses that it is not enough to rely on the local pool of human capital. International-class banking institutions also need people with specialized skills and knowledge of world markets – talent that will not be available in sufficient supply unless brought in from abroad. In most respects, including the quality of housing and schooling, as well as the safe and friendly nature of the society, he sees Taiwan as a highly attractive location. “As a place to stay for global talent, I would give it high marks,” he says. “But I don’t think a lot of people outside Taiwan realize how good living conditions are here. We certainly have to do more to market it as a location.”

The major drawback he cites is the high level of taxation on personal income, which could deter many executives and specialists from accepting job offers in Taiwan. “Because we’re competing with Singapore and Hong Kong, personal income tax rates are certainly something we should think about as a crucial factor when people consider whether to come here,” he says.

Kanwal says he believes the vision for Taiwan’s banking future is gradually evolving, after being held back by the “missing link” of pinning down the cross-Strait financial relationship. Now with the implementation of the Economic Cooperation Framework Agreement (ECFA) and the opening of opportunities for cross-Strait operations by Taiwanese and Chinese financial institutions, the time may be coming for Taiwan to re-evaluate its potential in the Asia-Pacific financial sector, and decide on its level of ambition. “Do we want to establish ourselves as a hub, and if so, how big of a hub?” asks Kanwal. “Would it be a Greater China hub, which we certainly can be very easily, or something bigger – for which the possibility also does exist?”

Major M&A Activity

2003. Cathay United Bank, which comes under the Cathay Financial Holding Co., was formed through the merger of the Cathay Commercial Bank and the United World Chinese Commercial Bank.

2005. Taipei Fubon Bank, part of Fubon Financial Holding Co., was created through the merger of Fubon Bank and the Taipei city government’s TaipeiBank.

2006. The state-owned Farmers Bank of China was acquired by another government institution, the Taiwan Cooperative Bank.

2006. Standard Chartered became the first foreign bank to take over a domestic one when it acquired the Hsinchu International Bank.

2007. Citigroup completed the purchase of the Bank of Overseas Chinese.

2007-2008. Three foreign banks acquired the “good bank assets” of distressed local banks through the resolution trust system: HSBC absorbed the Chinese Bank, ABN Amro the Taitung Business Bank, and DBS the Bowa Bank. ABN-Amro later acquired the Taiwan operation of the Royal Bank of Scotland, before itself being acquired by the Australian and New Zealand Banking Group (ANZ).

2008. Standard Chartered further amalgamated with American Express Bank and the good bank portions of the Asia Trust and Investment Corp.

“The Financial Status is Quite Sound”

How do you envision Taiwan’s financial sector evolving over the coming decade? What government measures will be needed to facilitate that development?

We are very confident about the development of the financial sector for two reasons. First, thanks to the efforts of both the government and the private sector in recent years, the sector's financial status has became quite good, last year posting total profits of NT$200 billion [about US$6.7 billion] – the highest amount in years. Second, the asset quality is rather good, with the nonperforming loan (NPL) rate as low as 0.42%. Furthermore, the banks’ debt coverage ratio is 260%, while the coverage of credit assets is 103%. So the financial status is quite sound, providing a firm basis for future development.

Besides a good financial status and good business operations, for that further development the banks also need to have a law-abiding mindset, proper internal control mechanisms, and good corporate governance.

The second foundation for development is better cross-Strait trade relations, now that ECFA and the subsequent financial MOUs have opened a new door. The previous barriers to cross-Strait trade and financial cooperation have been gradually removed. This is a good opportunity for Taiwanese banks because they can be headquartered in Taiwan while reaching out to a new market in mainland China.

For these two reasons, we are optimistic about the future development. During his re-election campaign, President Ma announced his “Golden Decade” platform in which development of the financial sector was particularly highlighted. It showed that the government takes the financial sector seriously and is willing to help. One focus of the platform is to develop financial services “with cross-Strait characteristics,” and a second is to fully utilize our domestic talent to develop asset-management operations.

Meanwhile, the industry is also looking for further liberalization. The FSC has been working on it, especially regulations governing cross-Strait dealings, which had been quite stringent in the past. The FSC, the Mainland Affairs Council, and the Central Bank have set up an inter-agency working group to discuss and review all related issues.

With such a liberalization initiative from the government side, I think we can expect a brighter future for the sector.

Has the government set any specific targets?

As for now, we are working on liberalizing the regulations and no further goals have been set. After the liberalization is accomplished, maybe we can meet with representatives from the industry to establish concrete quantitative goals.

What about the liberalization of RMB business in Taiwan?

The key element in this issue is negotiating a cross-Strait clearance and settlement agreement. For now, the government can only allow OBU operations. Currently, the domestic banks can provide RMB-related services through their OBUs, but we hope to assist the banks to further expand their business, such as by allowing them to issue RMB securities.

Another area is wealth management, in which we hope to further liberalize restrictions to allow Taiwanese to buy more kinds of RMB financial products through the OBUs.

For the domestic market, RMB services can be realized only after the agreement is signed and the clearance and settlement mechanism is implemented. The Central Bank is working on the preparation.

When all elements are in place, RMB will be treated like any other foreign currency, which means Taiwan citizens can buy RMB as needed, and the financial institutions can sell RMB financial products to the general public.

Does Taiwan still aim to be an Asia-Pacific financial center?

That is always on our radar. We always hope that domestic financial players can increase their assets, size, services, and operations. If all these elements are realized, Taiwan would surely take an important role in the Asia-Pacific region. We do not proclaim that goal loudly, but we are indeed working toward it.

To be a funding center, we have to develop our own unique niche, part of which is ECFA. We have placed extra attention on cross-Strait trade and financial cooperation, because the trade volume is quite high and Taiwan enjoys a substantial trade surplus with mainland China.

With such a large surplus, if the Tai-shang [Taiwanese enterprises in China] can achieve higher performance in RMB investment and enjoy easier access to RMB services, they would certainly be more willing to accommodate more RMB products in their portfolio. A higher level of RMB holdings means that more financial products can be introduced to the corporate clients, and more products being made available makes it more likely that Taiwan can be a regional funding center.

Meanwhile, we are still promoting the TDR [Taiwan Depository Receipts] initiative to encourage more foreign companies to list on Taiwan's stock exchange. To enhance the future for TDRs, we will focus on fine-tuning the regulations in certain aspects, such as qualification review, the introduction of new products and services, and risk disclosure.

Critics have said that Taiwan should have fewer but larger banks to be competitive. Do you agree and if so, how can consolidation best be carried out?

Basically, we hope that successful M&A activity can take place. But as to the definition of over-banking, it depends which side are you on. Indeed, there are many banking outlets in Taiwan, but do we have banks that are large enough? The domestic banks are indeed of relatively small size. At the same time, the financial crisis that started in 2008 and the recent debt crisis in Europe provide counter-evidence about the problem with banks that are too big to fail. So the answer is “it depends.”

Of course, we would like to have some large banks because they are less vulnerable to risk. Therefore, on the M&A issue, I hope the domestic banks can continue their M&A efforts so that their scale of operation can be expanded. Surely, M&A is worthwhile if it can help banks create synergies, strengthen their foundation, and lower their costs.

As for how to encourage M&A, I don’t think the government should take an overzealous role to the degree to coercing who should merge with whom. It is better to leave the decision to the financial players. The government's role is to ensure that all stockholders' rights are protected and the process is fair. In addition, the government should provide clear and transparent regulations so that all players can follow the rules. Currently, the laws are clear and transparent enough, and the government has streamlined the administrative process to facilitate M&A activity. The success of the Capital Group-Taiwan International Securities and Yuanta Financial Holdings-Polaris Securities cases prove that the mechanism works.

Will the government allow state-own banks to be included in the M&A process?

That is the responsibility of the Ministry of Finance. The FSC's duty is to protect stockholders' rights.

In the life insurance industry, a number of foreign companies have exited the market in the past few years, and some of the local players have faced financial problems. How do you see this sector being strengthened going forward?

Indeed, some players left the market, but some newcomers have decided to enter, such as Zurich Insurance, Cardif Assurance Vie [the insurance arm of BNP Paribas], and Cigna. AXA Insurance is also considering returning to the Taiwan market.

Of course, the insurance companies have their own considerations. For example, AIG sold its assets to pay its debts, not because they were worrying about the health of the Taiwan market. For the European companies, the consideration is the new accounting and supervisory requirements.

Generally, the domestic insurance industry is on track, and the government is willing to assist its development, for example with the new foreign exchange valuation reserve mechanism that was implemented March 1. The cap on overseas investment for foreign insurance polices has also been raised, so operational flexibility has been on the increase.

What about the financially troubled domestic players?

We are always watchful about their operational and financial status. We placed some restriction on their operations and required them to increase available capital. They are now getting back on track, and because those companies are small in size, they wouldn’t have much effect on the market as a whole.

With increasing cross-Strait economic integration, what are the challenges and opportunities for Taiwan’s financial institutions?

The question of cross-Strait investment involves not only banking, but also insurance and securities. China has permitted six Taiwanese securities companies to enter its stock market as RQFII [RMB qualified foreign institutional investors], and five of the six have been granted investment quotas, which means they can truly buy and sell in the market.

The Chinese government is trying to introduce more financial products to the market and more innovations in financial services, which presents a good business opportunity for Taiwanese companies.

As to the risks, they are under effective control, such as the cap on total exposure. The FSC continues to carefully supervise all related activities.