Taiwan, home to 22 million savers and gateway to China, has opened its door wider to foreign banks. So why are they hesitating?
By Kazuhiko Shimizu
August 2001
Institutional Investor Magazine
If you throw a brick out of a window, you'll hit a banker on the head," says Chi-Chu Chen, executive vice president of the Taipei-based International Commercial Bank of China. "There are too many bankers."
Taiwan is effectively Asia's second-largest banking market after Japan. The small island of 22 million should be hugely attractive to bankers. It has total individual assets estimated at $1.1 trillion, a savings rate of 25 percent and GDP per capita of $12,961, higher by a third than South Korea's.
But ICBC, which was founded on the Chinese mainland in 1905 and moved with Chiang Kai-shek's Nationalists to Taiwan in 1949, is by no means the only bank looking to profit from this market. Taiwan has 53 local banks and 39 foreign banks, not to mention 350 urban credit, farming and fishing cooperatives. With so many fighting over the pie, only 13 local banks, the government-controlled ICBC among them, have managed to garner more than a 2 percent share of total loans and deposits. Even the largest, the government-owned Bank of Taiwan, has slightly less than 11 percent of deposits. The 39 foreign banks with branches in Taiwan together command only about 4 percent of the market. As a result, virtually no one is making much money. With several branches on practically every block in Taipei, banks are driving each other into the ground with fee cuts and interest rate wars that are slivering already slim profits (see table). The average return on assets for domestic banks is just 0.47 percent, less than half the 1.09 percent of the local branches of foreign banks. Of the top ten domestic banks, only two have a return on assets above 1 percent.
Taiwan has lagged behind other Asian countries in reforming its banking sector. Its financial markets were cushioned by foreign exchange and other financial controls from the worst shocks of the Asian crisis of the late 1990s. And its export-driven economy, buoyed by strong U.S. demand for electronics and computer components as companies tooled up for the information technology revolution, surged ahead while other nations in the region faltered. Now, with the U.S. slowing, Taiwan's economy is in decline, unemployment is rising, bankruptcies are soaring, and the prospect of additional loan defaults is on the rise. Especially troubled are loans to construction, real estate and traditional but declining industries like textiles.
After years of delaying the inevitable, the Taiwanese government has finally begun putting into place the necessary legal framework to open up the country's cloistered financial sector to foreign competition. Last November the parliament, known as the Legislative Yuan, passed the Financial Institutions Mergers and Acquisitions Law. It is intended to encourage industrywide consolidation of banks, insurance and securities companies by conferring preferential treatment of registration fees, stamp taxes, contract taxes and property taxes. The law also allows foreign banks to acquire 100 percent of so-called troubled banks, although it does not give a precise definition of what that means. For those not deemed "troubled," the existing foreign ownership limit remains at 25 percent. The law does not lift some restrictions: Non-Taiwanese banks can open only one new branch per year (versus five for domestic banks), and for each branch it opens in Taipei, a foreign bank must open one elsewhere in the country.
For all the hurdles still in their way, foreign banks are positioning themselves to snap up bargain-priced local banks. They view Taiwan as a strong base for cultivating Chinese-language expertise for an eventual expansion into mainland China (see story below), and they see the Taiwanese market, once it is rationalized, as promising. "We've always had our eye on Taiwan," says Mike Denoma, Singapore-based global head of consumer banking for Standard Chartered Bank. "There's tremendous franchise value in many of the consumer banking markets, but it's spread across so many players, and none have been able to break out. So if you make the right moves, there's a tremendous value creation possible with consolidation in the industry."
"Everyone - foreign banks, good banks or troubled banks - is talking to each other about possible M&A so that they do not lose out in the race," says Sherry Lin, a specialist in mergers and acquisitions at Taiwan's biggest mergers law firm, Lee and Li. There are several reports about mergers of local banks or foreign banks acquiring domestic institutions every week in Taiwan. Industry executives say Hongkong and Shanghai Banking Corp., Citibank, Standard Chartered, ABN Amro Bank, ING Bank, BNP Paribas, Development Bank of Singapore and Fortis Bank are all quietly negotiating with local banks, though none want to confirm details.
But thus far no mergers have been announced. Deals are in the pipeline, and within a few months some major tie-ups may be announced, says Gregory Gibb, a principal at McKinsey & Co. in Taiwan. McKinsey is currently advising local banks and foreign global financial institutions on mergers and acquisitions in Taiwan. Gibb notes that the Ministry of Finance, having announced it wants to consolidate the 53 local banks into ten or fewer big banks, is very supportive of foreign bank acquisitions. "The MOF would like to see a couple of deals happen because it would put psychological pressure on local banks," he says. "Look at Korea. It took a while. Once the first deal happens, it flows quickly."
Deputy Finance Minister Sean Chen tells Institutional Investor: "A few cases of foreign banks' acquisitions of local banks are under way. That would help increase local banks' mergers and acquisitions."
In May 2000, well before the M&A law was enacted, Citigroup acquired, for $650 million, a 15 percent stake in Fubon Group's financial businesses: Fubon Insurance Co., Fubon Asset Management, Fubon Securities Co., Fubon Commercial Bank and Fubon Life Assurance Co., Taiwan's biggest life insurer. Citigroup intends to make use of Fubon's 20 percent share of Taiwan's life insurance market to expand its own insurance business on the island and to position itself for additional joint ventures throughout Asia. Citi already has the highest market share among foreign banks in Taiwan, where it has operated since 1964, but its share amounts to just 1 percent of loans and 1.3 percent of deposits. The deal with Fubon left Fubon's banking and securities operations independent from Citi's, though the two have merged their asset management and life insurance companies in Taiwan. "The alliance only allows Fubon to share Citigroup's training program and to form joint ventures in insurance business in Asia," says Sophia Cheng, vice president and banking analyst at Merrill Lynch Taiwan. The transaction itself is viewed locally as innovative, not only because it was the first time a foreign bank had taken a stake in a domestic institution, but also because it left Fubon with the freedom to continue to run its banking operation. Fubon will benefit from Citi training and technology while Citi gets a ground-floor position in Taiwan's insurance market.
Few of Taiwan's banks can expect to cut similar deals, though. Many are saddled with nonperforming loans, both acknowledged and hidden. "I do not think a local bank can negotiate such a deal unless it is a well-run bank," says Christine Kuo, associate director of financial services ratings at Taiwan Ratings, a 50-50 joint venture between the Taiwan Stock Exchange and Standard & Poor's of the U.S. In the aftermath of the Asian financial crisis, foreign bank executives say they intend to look very carefully at potential partners or acquisition targets before making any serious commitments. Consider HSBC, which has only a 0.53 percent share of deposits. It has had a strategy of trying to grow on its own rather than by acquisition. "If an acquisition opportunity comes along, I would be keen for it, but we are not going to acquire something for the sake of acquiring it," says Stuart Davis, CEO of HSBC in Taiwan. "Any potential target will need to increase our customer base and increase our distribution and product range. And it will be at a reasonable price."
However, bargains are hard to come by. The only banks on sale appear to be troubled ones with very high levels of nonperforming loans, and their prices are relatively high. Moreover, the Ministry of Finance habitually interferes in local banking operations (to the point of ordering rescheduling for certain loans), and lifetime employment is the custom, making cost-cutting layoffs extremely difficult. Taiwan has 12 banks that are either wholly or majority owned by the government. The rest are private, but a quarter of those are said to be nearly insolvent. Fully 40 Taiwanese banks are struggling for survival, with deteriorating asset quality and rising piles of nonperforming loans, says Jason Wang, CFO of Chinatrust Commercial Bank.
Nonperforming loans are emerging as a critical issue impeding consolidation. Strong local banks and the foreign banks have, thus far, proved unwilling to merge with institutions crippled by bad loans for fear of the impact on their own balance sheets. "We only want to merge with banks which have synergy with us, not with weaker banks, which would worsen our balance sheet," says ICBC's Chen.
Banking analysts estimate that as many as 15 percent of outstanding loans may be nonperforming, though the Ministry of Finance officially acknowledges a figure of only 6.2 percent as of the end of 2000, including those for domestic banks, local branches of foreign banks and credit cooperatives. The nonperforming loans of domestic banks alone were reported at 5.47 percent, or $21.9 billion, at the end of 2000. "In reality, no one knows," Christopher Wood, strategist at ABN Amro Asia, wrote in a recent research report. "The banking problem has been there for a long time, but the bad point is that the loans are not being addressed and are getting worse. With total loan growth running at only 1.6 percent, nonperforming loans are rising as a percentage of the whole system."
Obscuring the extent of the nonperforming loan problem is Taiwan's practice of using its own definition. Most other countries recognize a loan as past due after three months. In Taiwan loans with principal payments overdue more than three months are classified as nonperforming, but those with interest payments late are deemed nonperforming only when they become overdue by more than six months. Since 1999 the Ministry of Finance has been telling local banks to restructure loans to the real estate, construction and textiles industries, either by lowering rates or extending maturities. "If a bank does not follow the order from MOF, it will investigate or not allow you to do new business," says Norman Yin, a professor in the department of banking at National Chengchi University in Taipei. "They make all kinds of threats." Moreover, banks don't have to include these restructured loans in their nonperforming loan reports. So the banks perpetually tinker with terms on loans and roll them over, rather than report them as nonperforming. For acquirers these hidden bad debts are land mines.
To charges that the government interferes in the banking business, Deputy Finance Minister Chen responds that such allegations are "very creative."
Taipei has moved to ease the banks' bad-debt burden by cutting revenue taxes by 3 percent and by including in the M&A law a provision for setting up asset management corporations to sell off bad debts. So far, banks have been reluctant to sell their bad debts at a discount of up to 50 percent, and most banking analysts believe the government will have to commit public funds if the program is to succeed. "We do not see much business for our AMC business until the government shows a strong political will to urge shaky local banks to sell their bad loans. We are waiting for government action to make local banks sell their bad assets at market value," says Wang of Chinatrust, one of Taiwan's most competitive and profitable banks. Goldman, Sachs & Co. signed a memorandum of understanding to set up a joint AMC with Chinatrust in April, but their efforts have yet to materialize.
However, as long as President Chen Shui-bian's Democratic Progressive Party holds less than one third of the seats in the Legislative Yuan, the government is politically too weak to do anything drastic to resolve the banking sector's problems. Layoffs at banks or pressure on farmers or fishermen to repay overdue loans would be political poison. The upcoming parliamentary election in early December adds to the constraints. In May Taiwan reported annualized economic growth of 1.06 percent for the first quarter, the lowest in 26 years and well below an earlier government forecast of 4.02 percent. "The government is trying to drag on the present status quo and doing nothing," says National Chengchi's Yin. In any case, many officials are convinced that the loan problem will resolve itself once solid growth resumes. Says Shing-Shiang Ou, chief economist of the economic research department of Bank of Taiwan, "If Taiwan's economy recovers, the nonperforming loan problem will disappear automatically in two to three years."
Local and foreign bank executives agree that only about a half dozen Taiwanese banks are promising candidates for acquisition. Chinatrust, Taishin International Bank, Bank SinoPac and E. Sun Commercial Bank are the four best privately owned commercial banks. The others are former state banks in which the government still has an ownership stake, such as ICBC, a privatized commercial bank with the biggest foreign exchange business share; United World Chinese Commercial Bank, a privatized commercial bank with the largest stock settlement business in Taiwan; and China Development Industrial Bank, Taiwan's only investment bank. Taishin is among the few to openly acknowledge shopping for a partner. "We are talking to local and foreign banks and considering a lot of proposals. We are a very small bank even by Taiwan standards. We need to merge with foreign banks or local banks to survive," says Julie Chen, CFO of Taishin, which has a market share of 1.2 percent in deposits and 1.6 percent in loans.
Understandably, however, most well-run local banks want to acquire rather than to be acquired. "If you are one of the good banks, are you willing to be acquired and lose your name?" Chinatrust's Wang says. "We have a target list of banks to acquire, such as UWCCB, Taipeibank, CDIB, SinoPac and Taishin International Bank."
McKinsey's Gibb, co-author of the book Banking in Asia, says merger talks between banks, foreign or local, tend to break down within several weeks because of unrealistic expectations on both sides. The concept of M&A is so new to Taiwan that the players don't seem to know how to carry on constructive negotiations. "The idea that you should go through and you should think: This is what I will bring in terms of strength, and this is the kind of direction I can take in Taiwan. Therefore, the best partner for me, local or foreign, has to have the capability to create synergy - that is missing," Gibb says. Further discouraging mergers among local banks is the fact that most offer the same products, from basic banking services to mortgages, and cater to the same all-encompassing customer segment. "What can you do after you acquire local banks?" asks Wong See Meng, managing director of the Taipei and Tokyo branches of the Development Bank of Singapore. "The banks on sale are small and do not have much value to add even if you buy them."
So far only one big merger is known to have been arranged - at the direct behest of the Ministry of Finance. In March it announced that after on-and-off negotiations the Bank of Taiwan, the Land Bank of Taiwan and Central Trust of China will join to create a bank with pro forma combined assets of $114.7 billion as of the end of 2000. The combined bank will control 20 percent of total deposits in Taiwan and 19.5 percent of all loans. Whether the formation of the megabank will result in improved profitability remains to be seen. Deputy Finance Minister Chen admits that there will be no layoffs because the three banks' employees are civil servants, but he contends that "there is synergy in terms of economic scale."
The Ministry of Finance has announced other government-led mergers, though none have yet been finalized because they are still subject to due diligence. Finance Minister Yen Ching-chang announced in February that Taiwan Cooperative Bank will take over the almost insolvent Chinfon Bank and that First Commercial Bank, one of Taiwan's largest government-run banks, would merge with two smaller private banks, Dah An Commercial Bank and Pan Asia Bank, both of which are also close to insolvency. The ministry, hoping to push along the process of merging all 12 government-owned banks into three or four big institutions, told the senior executives of those banks in January to come up with wish lists of ideal partners. Some in the industry take a dim view of this approach. "It does not make sense at all to talk about M&A without layoffs," says Chinatrust's Wang. "I do not see any synergy brought together after the three merger cases announced by the Ministry of Finance." The government says the mergers ultimately will be voluntary. "All financial institutions enjoy their constitutional rights, so we cannot force them to merge," insists Deputy Finance Minister Chen. "What we can do is education."
It may take until the next phase of government financial reforms to get the consolidation rolling. Some mergers are likely being delayed in anticipation of implementation of the Financial Holding Company Act. The Legislative Yuan passed the legislation on June 27 after an extraordinary session, and it takes effect November 1. The law would allow foreign financial institutions to purchase, through onshore or offshore holding companies, 100 percent stakes in even healthy banks. And it would enable local banks to acquire troubled banks at arm's length through holding companies and restructure their assets without doing harm to their own balance sheets. The holding company formula will benefit such banks in another way by allowing them to cross-sell financial products within their group. As an example, banks currently aren't allowed to sell insurance, even if an insurer belongs to their group. At the same time, the law will increase the number of options available to banks hoping to fatten their balance sheets by, for example, pursuing other business areas such as credit cards.
"We are waiting for the holding company law to make a move to buy out local banks," says Paul Lo, president and CEO of SinoPac and a former executive of Citibank in New York and Taiwan. SinoPac, one of Taiwan's stronger banks, has expanded into life insurance, securities and credit cards. It is determined to be among those remaining after consolidation. "We would not be owned by foreign banks, but want to keep our bank a Taiwan bank," says Lo.
Foreign banks are also waiting to see if local bank prices moderate as asset prices fall further. But price isn't everything, says Terry King, the Taiwan-based head of global financial markets for Greater China at ABN Amro Bank. His company is doing a study on acquiring local banks. "If you want to gain a sizable market share in Taiwan, it is too late to do so by opening branches," he notes. "But we have to ask many questions: Is it a niche that we would like to develop? What do you want to achieve by buying out local banks? Can we benefit from buying troubled banks?"
Thus far the Taiwanese government seems to be hoping that foreign banks and the handful of strong domestic banks will buy up the large number of troubled banks, nonperforming loans and all, and combine operations without any layoffs. What the solvent institutions are saying is that they are unwilling to weaken themselves in order to achieve the consolidation the government wants. Sooner or later the government is going to have to act to take the worst loans off the books of the banks, in much the same way as the U.S. did with the savings and loan mess in the 1980s. Even so, it will have to permit reductions in employment and offer significant concessions to make such acquisitions worthwhile. Until the government bites that bullet, consolidation of Taiwan's banking industry will lag, and foreign banks will remain frustrated.
China connection
As attractive as Taiwan's banking market is in its own right, local as well as foreign banks operating on the island are eyeing the mammoth opportunity across the Taiwan Strait - the 1.3 billion potential customers on the Chinese mainland. Chinese bank deposits amount to a massive 12.38 trillion yuan ($1.51 trillion). And China is the real reason that bank consolidation is bound to take place in Taiwan, despite less-than-advantageous conditions (story).
Beijing has pledged to open China's banking sector and to extend to foreign banks the same treatment as domestic ones to meet the conditions for joining the World Trade Organization. At present, 16 foreign banks can do local currency business for foreign or foreign joint venture companies in just two Chinese cities - Shanghai and Shenzhen. Foreign banks are to be allowed to do local currency business with Chinese companies two years after China joins the WTO (expected by the end of this year). And five years after, foreign banks will be able to do local currency business with individual Chinese and enjoy so-called national treatment.
For foreign banks wanting to expand on the mainland, a big challenge will be finding qualified staff. Although Hong Kong banks' services are as sophisticated as any in the Western world, their staffs for the most part speak Cantonese rather than Mandarin, the dialect that prevails on the mainland and on Taiwan.
"If you buy a good bank and build a good bank in Taiwan, you'll have 50 good managers that you can develop in the next three or four years," argues Gregory Gibb, a principal at McKinsey & Co., which is advising local and foreign banks in Taiwan on mergers. "When mainland China opens up, then you'll have a force you can throw at it."
But Beijing is not the only barrier to doing banking in China. Taiwanese companies have poured $40 billion into the mainland since Taipei selectively lifted restrictions on their doing business there in 1987; about 40 percent of Taiwan's information technology products are now manufactured on the mainland. But Taiwanese companies operating in mainland China must obtain their financing from Chinese banks. The reason: Taipei still forbids Taiwanese banks from doing business in China for fear that large capital outflows could compromise national security.
Nevertheless, the Taiwanese government announced in May that local banks would be allowed to set up representative offices on the mainland to gather market information, though not deposits. This is viewed as a small first step. "We have been trying to push our government to let us into mainland China," says a top official at one Taiwanese bank. "We know that we could be very competitive in the China market, but most government officials have never been to China, and they do not see the market potential that most foreign banks see." Jason Wang, CFO of Chinatrust Commercial Bank, is even more emphatic. "If you do not let us into China, we will lose even our Taiwan customers," he says. "That is why we have been pushing the government to let us into the mainland."
Despite the prevailing restrictions, a Taiwanese bank, Bank SinoPac, was able to acquire a de facto representative office in 1997 by purchasing Far East National Bank. The American bank, which has 13 branches in California, already had a Beijing representative office. SinoPac plans to increase its assets from $13 billion to $20 billion through acquisitions over the next two years. Why that particular sum? It's the minimum required to open up a branch in China, explains Bank SinoPac CEO Paul Lo.
