Asset quality risks grow as Taiwanese banks grapple with China's slowdown

Delinquencies climbed in the overseas loans of cyclical sectors as well as loans to China and Southeast Asia.

Domestic banks in Taiwan ended 2018 on a solid footing in terms of asset quality, shrinking their non- performing loans (NPLs) whilst growing their total loans, resulting in a healthy improvement in their NPL ratios, but it will be increasingly hard to maintain this momentum in 2019. Foremost amongst the looming risks this year is weakening global growth, and already the latest manufacturing data has pointed to a slowdown that will not likely abate. In search of margin growth, some domestic banks in Taiwan have been accelerating their international expansion, whilst regulators are looking to support the industry through initiatives through measures such as the awarding of Internet-only banking licences.

“We view that the most challenging issues for Taiwan banks in 2019 is to maintain a stable asset quality and earnings performance amid the global economic uncertainty,” Eunice Fan, director at S&P Taiwan told Asian Banking & Finance. “We expect non-performing loans and credit costs to marginally increase in 2019, whilst the still-constrained margin growth from stiff competition and low interest rates at home would continue to pressure profitability.”

The warning came amidst an improving trend in the NPLs of domestic banks in Taiwan, which slid to $2.25b (NT$69.38b) by end-2018 from $2.46b (NT$75.84b) from the year-ago period, data from the Central Bank of the Republic of China (Taiwan) showed. The NPL ratios – a key indicator of asset quality – of domestic banks in Taiwan also dropped to 0.24% from 0.28% over the same period. The bad loan ratios of domestic banks also held steady at 0.24% in January 2019 compared to the prior month, although their NPL coverage ratio slipped to 569.56% from 575.44%.

Taiwan’s heavy dependence on China threatens this stable set-up which renders the domestic economy and the banking sector by extension particularly vulnerable to the tit-for-tat tariff war. More than 2% of Taiwan’s GDP will be affected by US tariffs on Chinese goods via supply chains, data from asset management firm Schroders show.

Domestic manufacturers form a key part of the country’s consumer goods supply chain. Already, sentiment has soured after the Nikkei Taiwan purchasing managers index (PMI) dropped into contractionary territory with a reading of 48.7 in October as manufacturers brace for sluggish demand and order volumes. “This informs our outlook for exports and investment activity to be negatively impacted as manufacturers pare back their production capacity in anticipation of weaker order volumes, which would reduce loan demand, choosing instead to clear existing inventory,” Fitch Solutions said in an earlier report.

Industrial production also shrunk further to -1.86% year on year in February from -1.22% in the previous month. “We think there is little that monetary policy or fiscal stimulus can do at this point to support growth,” Iris Pang, economist at ING said in a note. “The slowdown in the manufacturing sector is expected to continue until sales of new smart devices produced by Taiwan improve and we believe this could take up to a year.”

The central bank’s options to bolster the economy are limited, Pang reckoned, as cutting the policy rate by at least 12.5 basis points at a time would do little to boost credit and brighten the weak economic outlook. “We believe the economic environment will continue to be difficult for most of 2019, and forecast the economy to grow by 1.8% in 2019,” she said.
In anticipation of the economic downturn, banks in Taiwan have been beefing up their defenses as loan loss provisions as a share of NPLs grew from 471.1% in the first half of 2017 to 529.6% in H1 2018.

Overseas expansion

Against the backdrop of heightened risks and stiff competition that have squeezed profit margins on domestic loans, Taiwanese banks have been turning overseas in search of faster growth and betterp rofitability.

CTBC Bank, the largest private commercial bank in Taiwan, has spent the past half-decade expanding its overseas footprint, including the acquisition of TokyoStar Bank in Japan in 2014 and purchasing a 35.6% stake in LH Financial in Thailand. Overseas businesses currently account for about one-third of the bank’s total revenue, CTBC Bank Chairman Chao-Chin Tung said in a local media interview, as he aims to boost this to 50% in the next five years.

The greater focus on overseas growth comes as domestic banks face a crowded and increasingly competitive market in Taiwan. In an attempt to create a more level playing field for foreign banks operating in the country, the FSC recently introduced amendments to help subsidiary banks of foreign banks increase capital utilisation efficiency, lower financial costs and enable greater flexibility in offering financing services to corporates.

Playing catch-up

Banking regulation is also encouraging Taiwanese banks to embrace financial technology adoption, although Fan said the pace of deregulation in this area has been more gradual in the country compared to regional peers. An S&P report assessed that the digitisation efforts of Taiwanese banks have traditionally fallen behind that of their Asia-Pacific counterparts, although in 2017 the country’s legislators passed the Act on Financial Technology Innovations and Experiment in December 2017 that allows developers to experiment with new financial products and services with fewer regulatory constraints during the trial period.

“We expect the actual rollout of such new products or services will still take time for the 1-2 years,” said Fan.

In February 2019, the FSC began accepting applications for setting up Internet-only banks. In February 2019, the commission said it will set up a panel comprised of its officials as well as external experts and scholars to review the applications, with the final results to be announced by end-June.

Three teams led by Chunghwa Telecom Co, Line Financial Taiwan Corp and Waterland Financial Holdings Co have expressed an interest in the licences. Chunghwa Telecom established a preparatory office in October 2018 for an Internet-only banking business with three shareholders – Mega International Commercial Bank, Shin Kong Financial Holding Co and domestic supermarket chain operator Pxmart Co Ltd. Line Financial Corporation, a subsidiary of Japan’s Line Corporation, has said it intends to offer repackaged financial services from other providers – excluding insurance, stocks, bonds or credit card products – to younger customers if awarded with an Internet-only banking licence in Taiwan. Meanwhile, Waterland Financial will reportedly invest $159.07m (NT$4.9b) or a 49% share in an Internet-only bank, with Japanese e-commerce giant Rakuten, which already operates an Internet-only bank in Japan, holding the remaining 51% stake.

However, the move to grant two Internet-only banking licenses will not have a significant impact on the industry in over the next one to two years, “but rather could gradually change how the customers use banks and accordingly influence banks’ strategic business direction.”