October 23, 2017 / 1:02 AM / a year ago

Fitch: Taiwan Banks Face Risks in New Markets in Southbound Push

(The following statement was released by the rating agency) TAIPEI/SINGAPORE, October 22 (Fitch) The Taiwanese government's "southbound" policy could encourage banks to lend to emerging Asian economies other than China, which would help to diversify their overseas exposure in the long term, Fitch Ratings says. However, these benefits could be at least partly offset by higher operational and credit risks associated with lending to unfamiliar and challenging markets. In any case, southbound lending is unlikely to rise strongly enough in the next few years to have a rating impact on Taiwanese banks. The southbound initiative aims to support Taiwan's next stage of development by strengthening economic ties across the region beyond northeast Asia. It also reflects cooler cross-strait relations since the election of President Tsai Ing-wen in January 2016, as well as caution over rising financial risks in the mainland. Under the policy, Taiwan's banks are encouraged to increase their lending to Taiwanese businesses operating or investing in 18 economies - the 10 countries in ASEAN, six in South Asia, and Australia and New Zealand - by 3%-7% per year between 2017 and 2020. Banks are likely to focus most on expanding into Asia's emerging economies, which offer higher yields and stronger potential for earnings growth, at least compared with Taiwan's domestic market. We expect exposure to emerging Asia (excluding China) to rise to 3% of system assets by 2019, compared with an estimated 2.5% at end-1H17. This would imply growth of over 10% per year, which is high but not excessive considering the low base. Taiwanese banks' lack of experience in these markets, along with competition from incumbents, will be a constraint on faster growth. Unfamiliarity could also be a source of potential risk. An improvement in economic conditions has eased negative banking sector trends in ASEAN and South Asia over the past year, but some continue to be characterised by poor governance and transparency, as well as elevated credit and operational risk. Structural macroeconomic problems, particularly the build-up of household and corporate debt, also pose a threat to asset quality in countries such as Malaysia, Thailand and Vietnam. That said, Taiwanese banks' lending to these markets is usually focused on Taiwanese enterprises or state-owned entities that are market leaders in their sectors. Opportunities for Taiwanese banks to engage in large-scale M&A activity in emerging Asia are limited, as only a few countries are open to foreign ownership of large local banks. Any significant acquisitions would have some potential to put downward pressure on the rating of the acquiring Taiwanese bank, especially if the acquisition diluted the Taiwanese bank's capitalisation. Downward pressure could also come from the acquired bank almost certainly facing a more volatile operating environment and having a weaker risk profile than the Taiwanese acquirer. Growth in lending to these countries is unlikely to come at the expense of lending to China in the short term. Indeed, Taiwanese banks' China exposure rose by 9% from end-2016 to end-June 2017, as tighter Chinese lending conditions spurred demand for external US dollar funding. We expect mainland-related exposure to increase to 7%-8% of Taiwan's system assets by 2019, from 6.8% at end-1H17 (see chart), with the bulk of this accounted for by Taiwanese companies operating in China. China will therefore continue to have a strong bearing on Taiwan banks' risk profile over the medium term. A sharp economic slowdown in the mainland would have a direct impact on Taiwanese banks' China-related exposure, but the bigger impact could come indirectly, through the ability of Taiwanese borrowers to service their debt. Exports to China and Hong Kong represent nearly 40% of Taiwan's total exports, and mainland China acts as an important production hub for Taiwanese manufacturers. <iframe src="https://e.infogram.com/1d42764e-b2a7-489f-bf0a-b9a3f7942133?src=embed " title="" width="550" height="722" scrolling="no" frameborder="0" allowfullscreen="allowfullscreen"> Contact: Cherry Huang, CFA Director Financial Institutions +886 2 8175 7603 Fitch Australia Pty Ltd, Taiwan Branch Suite 1306, 13F, 205, Tunhwa North. Rd., Taipei City Jonathan Lee Senior Director Financial Institutions +886 2 8175 7601 Dan Martin Senior Analyst Fitch Wire +65 6796 7232 Media Relations: Leslie Tan, Singapore, Tel: +65 67 96 7234, Email: leslie.tan@fitchratings.com; Wai-Lun Wan, Hong Kong, Tel: +852 2263 9935, Email: wailun.wan@fitchratings.com. The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at www.fitchratings.com. 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