Taiwanese banks' mainland China exposure down to 6.2% in 2Q16

It reduces the risks from deleveraging spilling over into Taiwan.

Taiwan's banks face many of the challenges that are weighing on the outlook for financial institutions across much of Asia, including low interest rates and difficult economic conditions.

However, Fitch Ratings' outlook for the Taiwanese banking sector is stable. Risk buffers have been bolstered in recent years, while exposure to China and the property and technology sectors has fallen since 2015. Taiwan is one of just four Fitch-rated banking sectors in Asia where we have a stable sector outlook - the other 13 are on negative outlook.

Here's more from Fitch Ratings:

Fitch expects that Taiwan's banking sector will continue to face pressure from low interest rates and a flat yield curve next year. However, operating conditions remain stable.

We expect modest real GDP growth of 1.5%-2% in 2017-2018, up from an estimated 1% in 2016. Loan demand is also likely to pick up slightly, along with a small improvement in interest margins - albeit from subdued levels. The sector's return-on-assets should remain broadly steady, at around 0.6% in 2017.

Banks are still likely to continue seeking better yields and earnings growth through offshore expansion, as well as M&A if opportunities arise. Expansion into less-familiar overseas markets has already added to the risks faced by some Taiwanese banks.

However, Taiwan banks have generally reduced their most risky exposures. Mainland China exposure (MCE) accounted for 6.2% of system assets in 2Q16, down from a peak of 7.9% at end-2014, which should help to limit the possibility of risks associated with China's slowdown and deleveraging spilling over into Taiwan. MCE is equivalent to 28% and 12.5% of system assets in Hong Kong and Singapore, respectively.

The property market remains a source of potential risk, but several macro-prudential measures have tempered mortgage growth. Adequate collateralisation and increased general provisioning have also moderated risks associated with property exposures. As a result, the banking sector is better-positioned to cope with a modest and gradual correction in property prices, which is Fitch's base scenario.

Finally, lending to the highly-cyclical technology sector represents a much smaller share of banks loans than it did a few years ago. We expect lending to diversify further over the medium term, reflecting a shift away from the manufacturing sector and lacklustre capital investment opportunities in Taiwan.

Taiwan's banking sector has also strengthened in terms of loan-loss provisions and capitalisation. We expect the sector's Tier 1 capital ratio to rise above 11% by 2018, and most banks are on track to meet Basel III minimum requirements, both in terms of capitalisation and liquidity.

Capitalisation compares well with regional developed-market peers, after adjusting for Taiwan's higher capital charges for mortgages. Leverage is also likely to remain lower than in most other advanced markets in Asia.