Can Taiwan bank mergers change the market landscape?

Efforts have been made to promote consolidation.

The Taiwanese government's efforts to promote consolidation between several state banks, while enabling them to compete better in Asia, will not necessarily resolve the sector's structural weaknesses - including thin margins and moderate capitalisation.

According to a release from Fitch Ratings, state banks, with an aggregate 50% market share by assets, tend to be less commercially oriented, which leads to depressed loan pricing and weaker margins than their private-sector counterparts.

Surplus liquidity alongside weak domestic credit demand has contributed further to the sector's thin margins.

The regulatory moves to consolidate the banking sector aim to address some of these issues by improving competitiveness through the creation of one to two large, regional banks.

Notably, though, Taiwan's state banks are less capitalised than the larger private banks. They are not in as strong a position to withstand potential shocks that could emerge from overseas operations, especially in emerging markets.

Here's more from Fitch Ratings:

Any domestic merger is unlikely to benefit banks' Viability Ratings. Consolidation will increase the scale of some of Taiwan's lenders, but there is less likelihood for substantial operational synergies to improve the sector's structural weaknesses.

Implicit policy roles, including branch presence in unprofitable regions and taking above-average-cost policy deposits, will continue to burden the profitability of the state banks. Less flexible compensation has also contributed to their limited product differentiation and significantly lower fee income generation than at the large private banks.
Resistance from labour unions and political opposition will constrain the operational efficiency gains in the form of branch and staff rationalisation from mergers.

Consolidation would not enhance state banks' credit strength in the near term, while it will reinforce the systemic importance of the banks which merge, and government's propensity to support, in Fitch's view. As a result, mergers are likely to be positive for some banks with a Support Rating of '2'.

Taiwan's state bank Issuer Default Ratings are driven by their Support Ratings, which reflect an extremely high or high probability of support from government in the event of stress, as reflected in their Support Rating levels of '1' or '2'.

State banks' Support Ratings and Support Ratings Floors are at a higher rating level than the banks would have on the basis of their standalone creditworthiness - owing to the state's majority ownership/control, their systemic importance, and implicit policy roles.

Fitch expects Taiwan's regulator to remain highly supportive of the banking system as a whole, and state banks in particular. The implementation of resolution regimes for domestic systemically important banks (D-SIBs) has been a key point of discussion among national banking regulators in Europe, the US and Asia in the last few years, but we believe that Taiwan's regulator is less likely to follow suit over the medium term. The authority often calls upon state banks to support or merge financial distressed institutions for system stability.

Taiwan's Financial Supervisory Commission (FSC) has made tentative steps over the past year to set the stage for consolidation within the banking sector.

The FSC measures include selecting better performing state banks - Mega ICBC and First Bank - as potential acquirers, lifting overseas investment caps for Taiwanese banks, and a series of rights issues for state banks to meet stricter capital requirements for offshore expansion. Fitch expects the consolidation to remain slow, due to labour issues and political hurdles.