Second Phase of Financial Reform Is about Industrial Maturity

On October 20, 2004, President Chen announced the four primary objectives of Taiwan's second phase of financial reform, all of which are to be accomplished by the end of 2006: Three firms with over 10% of the capital market; reduction to six of the number of state-run financial organizations; a reduction by half of the number of financial holding companies, and; facilitating foreign investor operation or overseas listing of at least one organization. These explicit objectives and their schedule are bound to set off a new wave of discussion and debate within industry, government and academia. With, in addition, some eighteen financial organizations holding board elections from December 2004 to mid-2005, and a succession of government-run banks set to be privatized, the markets are continually buzzing with rumors of who'll be sworn in here and who will pair up there. From Taiwan's hyper-competitive financial market conditions, the trend towards banking reform and consolidation of the past five years, and the increasing competitiveness that comes with globalization, etc., one may get a rough understanding of the urgency and necessity of a second round of financial reform.

Consider the 2004 market distribution: Except for a few leading firms in life and property insurance that have achieved significant scale, most firms have less than 10% market share, including about 40 local banks, 23 life insurers, 15 property insurers, 140 securities firms and 28 investment trust companies fighting over about 30% of the market. Clearly, current market participants are too numerous and too small.

For years, layer upon layer of controls in banking laws and regulations have limited the leeway for diversification of Taiwan's domestic financial organizations. Financial firms typically have a high degree of homogeneity but insufficient creativity. Moreover, the financial sector liberalization of the early 1990s failed to control the number of new entrants even as a slowing trend in population and income growth was limiting the markets' capacity to accommodate them. Exacerbating this situation, interest rates were in relentless decline, and many came under the curse of cutthroat competition, so the weak grew weaker and profits at the larger scale firms also suffered compared to previous years.

Although a large scale is not an absolute guarantee of profitability, it does confer absolute advantages in terms of ability to bear risk and spread fixed costs. From the Tenth Credit Cooperative Association embezzlement/bankruptcy case (1985) to more recent government takeovers of Kaohsiung Business Bank and Chung Shing Bank, Chungli Farmers' Association and other financial institutions at all levels, time and again such cases have shown insufficient risk-bearing capacity to be a widespread problem; and since market exit mechanisms and legislation remain incomplete, losses are ultimately borne by the taxpayer in all but a minority of cases.

Secondly, when Taiwanese businesses set up manufacturing facilities or new businesses abroad, our relatively small-scale financial organizations are generally unable to provide timely service or support of the same quality they offer domestically due to limited funds, locations and people; and they are also harder pressed when it comes to fund procurement. Compared to large US, Japanese or EU producers that have international-class banks providing dependable funding, and at lower cost, Taiwanese businesses are several strides behind their foreign competitors before the race begins.

Once the Asian financial crisis had passed, foreign capital returned to Asia in abundance. Besides introducing sufficient capital stability to the various markets and economies of the region, it also introduced a host of new financial products and risk management mechanisms. Financial reconstruction efforts in South Korea, Thailand and Malaysia have also strengthened the government's determination to hasten reform. Since 2000, besides passing and amending a succession of related laws and rules, the government has also progressively lifted restrictions on foreign investment and accelerated privatization of state-owned banks while providing incentives and a supportive investment climate for M&A.

Medium-to-large M&A deals in the financial sector in recent years include the Yuanta/Core Pacific Securities merger in 2000, Taishin Bank's absorption of Dah An Commercial Bank in 2001, and the formation of 14 bank holding companies by domestic financial institutions. The number of deals and their total value reached historical peaks in 2001. Beginning in 2003, however, the number and value of deals fell greatly.

One reason for the decline in M&A is that after most of the large deals of 2001 and 2002 took place, integrating different corporate cultures and employee organizations demanded Herculean efforts. Another reason is the effect of a surge in so-called "landmine" companies - financially weak companies that do the acquirer more harm than good - as well as a recession-induced fall-off in profit levels. Also, the lack of an adequate exit mechanism and greater consciousness-raising on labor's part served to dampen the effect the government originally hoped to achieve from using financial holding companies to consolidate the domestic banking sector.

While under WTO rules, regions around the world are linking up to form trading blocs, from the European Union and North America to ASEAN, and Mainland China's high economic growth rate has attracted countries around the world to pour in investment as they scramble for markets. Despite its advantages of a shared language and culture, Taiwan has gradually seen markets on the mainland slip away on account of cross-strait political factors. If Taiwan wants to get into a regional trade grouping, its domestic financial sector cannot be left out. In the meantime, the road to internationalization runs unavoidably through application of the Basel II accord and alignment with international accounting and financial reporting standards (IAS and IFRS).

International or regional size financial firms rely on their very deep pockets, winning through large-scale international trading and M&A deals. In Taiwan, financial organizations that internationalize not only strengthen their risk management and financial transparency, they also help dispel foreign investors' doubts, making it easier to attract investment or form strategic alliances.

Now that the latest round of Legislative Yuan elections is past us, it is hoped that the new legislature and the executive branch team can make room as soon as possible for harmonious and reasoned debate on promoting the reform of Taiwan's financial institutions, completing the establishment of financial oversight and market exit mechanisms, and relaxing investment restrictions, with the aim of accelerating internationalization and creating a superior investment climate. We believe that the President's stated objective means actively fostering the formation of domestic financial institutions into regional-scale financial groups that will serve as the biggest pillar and back-up support for Taiwanese businesses when they face the foreign competition. Let us remain confident, meanwhile, and welcome the challenges of the coming second and third waves of M&A in the financial sector.