VZCZCXRO4832
RR RUEHGH
DE RUEHIN #2525/01 3300203
ZNR UUUUU ZZH
R 260203Z NOV 07
FM AIT TAIPEI
TO RUEHC/SECSTATE WASHDC 7443
RUEATRS/DEPT OF TREASURY WASHDC
INFO RUCPDOC/USDOC WASHDC
RUEHBK/AMEMBASSY BANGKOK 3889
RUEHBJ/AMEMBASSY BEIJING 7468
RUEHUL/AMEMBASSY SEOUL 9060
RUEHGP/AMEMBASSY SINGAPORE 7061
RUEHKO/AMEMBASSY TOKYO 9269
RUEHML/AMEMBASSY MANILA 0197
RUEHJA/AMEMBASSY JAKARTA 4145
RUEHKL/AMEMBASSY KUALA LUMPUR 3827
RUEHHI/AMEMBASSY HANOI 3404
RUEHBY/AMEMBASSY CANBERRA 4646
RUEHWL/AMEMBASSY WELLINGTON 1912
RUEHHK/AMCONSUL HONG KONG 8757
RUEHGH/AMCONSUL SHANGHAI 1491
RUEHGZ/AMCONSUL GUANGZHOU 0675

UNCLAS SECTION 01 OF 03 TAIPEI 002525 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
STATE PLEASE PASS USTR 
STATE FOR EAP/RSP/TC, EAP/EP 
USTR FOR KATZ AND STRATFORD 
USDOC FOR 3132/USFCS/OIO/EAP 
TREASURY FOR OASIA/TTYANG AND HAARSAGER 
TREASURY ALSO PASS TO FEDERAL RESERVE/BOARD OF 
GOVERNORS, SAN FRANCISCO FRB/TERESA CURRAN, AND NEW YORK FRB MARI 
BOLIS 
 
E.O. 12958: N/A 
TAGS: EINV EFIN ECON PINR TW
SUBJECT:  Taiwan Banks - Too Much Money but Low Profits 
 
 
Summary 
------- 
¶1.  (SBU)  Summary.  Taiwan's banking system is stable but anemic, 
financial analysts and local U.S. bank representatives told 
officials from the San Francisco Federal Reserve Bank.  The banking 
sector faces low profitability and too much competition.  Taiwan's 
large banks have excess liquidity due to a high savings rate and low 
domestic investment.  They are largely unable to follow corporate 
customers overseas, namely to China.   Local banks have high hopes 
of developing a potentially lucrative asset management business, but 
today much of Taiwan's savings and investments are flowing out of 
Taiwan, chasing higher returns and perhaps avoiding tax.  Although 
regulators have begun financial sector reforms, progress is too slow 
and state-owned or state-controlled banks still hold over half of 
Taiwan's banking assets.  Little will change before the presidential 
election in March.   End Summary. 
 
¶2.  (SBU)  Federal Reserve Bank of San Francisco Senior Vice 
President Stephen M. Hoffman, Jr. and Senior Manager Walter Yao 
visited Taiwan November 7-8 and met with a variety of local 
representatives of U.S. banks as well as local financial analysts 
who provided their assessments of Taiwan's financial sector and its 
regulatory and supervisory framework. 
 
Taiwan Financial System - Stable Medium-Term Outlook 
--------------------------------------------- ------- 
 
¶3.  (SBU)  Analysts at Taiwan Ratings, the local partner of Standard 
& Poor's, place Taiwan at level  4  "moderate risk" on a scale of 1 
to 10, with one being the most stable.  They highlight the key risk 
as profitability, which last year was "close to zero," with a 0.2% 
to 0.3% return-on-assets.  This is low in absolute terms, and weak 
compared to the rest of the region.   Taiwan Ratings, along with 
other analysts, noted that this poor performance was in part due to 
too many banks and stagnant demand for loans.  Although much of 
corporate Taiwan has relocated manufacturing operations out of 
Taiwan, particularly to China, Taiwan banks cannot follow them 
there.  Domestic demand is still sluggish. One equity analyst called 
Taiwan's financial sector "the worst-performing in the region - bar 
none." 
 
¶4.  (SBU)  Taiwan's high savings rate, currently 26% of income, 
means that banks are awash in deposits, creating excess liquidity. 
This excess liquidity in turn drives down interest rates, which then 
triggers capital outflow as depositors chase higher returns 
elsewhere.   But competition in Taiwan is fierce.  There are 41 
banks competing for business, and over half of Taiwan's banking 
market share is held by state-owned or state-controlled banks.  This 
leads to intense competition which erodes margins.  It can also lead 
to other problems.  Taiwan Ratings highlighted the credit card 
crisis that appeared in late 2005.  With excess deposits, banks 
looked for high-margin products and began heavily promoting credit 
cards.  Over-competition led to a loss of underwriting discipline 
and banks wound up holding substantial amounts of sub-prime consumer 
loans, many of which had to be written off. 
 
Regulators Slow, but on the Right Track 
--------------------------------------- 
¶5.  (SBU)  Taiwan Ratings largely praised the efforts of Taiwan 
regulators to stabilize the banking system and to advance financial 
reforms.  They lamented, however, that many of their actions seemed 
driven by political considerations.  They cited the instance of Bowa 
Bank, which eventually was taken over by the authorities.   Taiwan 
Ratings claimed that the authorities, rather than acting quickly 
when the bank's problems became apparent, instead directed a 
state-owned bank to prop it up with interim deposits.  This simply 
 
TAIPEI 00002525  002 OF 003 
 
 
prolonged and worsened the problem.  They also criticized the 
regulators as not being transparent enough and not moving fast 
enough on financial reforms.  Other analysts echoed these concerns. 
 
 
¶6.  (SBU)  Two major goals of Taiwan's financial sector reform are 
to reduce the number of banks and to decrease the percentage of bank 
assets held by state-owned or state-controlled banks.  After 
industry consolidation, regulators want to wind up with three to 
five "national champions," local banks each with over 10% market 
share.  Although the number of banks has already been reduced from 
41 to 56, most of the consolidation has involved small banks, and no 
single bank holds 10% market share.  Efforts to divest state-owned 
banks have been hampered by strong unions and political 
considerations. 
 
¶7.  (SBU)  Politics divided the analysts.   Many called the current 
DPP government inexperienced in financial management and noted that 
staff in key leadership positions changed constantly.  Others, 
however, praised the regulators as "on the right track," although 
lamenting that they needed to move faster.  Our most hopeful 
interlocutor stated that although the DPP got a rough start, it has 
finally assembled a good financial regulatory team that knows what 
it needs to do.  Political considerations, however, were likely to 
slow its work.  All agreed that not much would happen before the 
March presidential election. 
 
Local Reps of U.S. Firms Agree 
------------------------------ 
¶8.  (SBU)  Local representatives of U.S. banks echoed many of the 
analysts' views.  Not only did they think the pace of reform should 
be faster, they expressed concern about what they called "ad hoc 
regulation" and complained that policies and rules were not always 
clear.  U.S. bankers also worried that regulators were not 
independent enough.  They also argued that regulators needed to make 
reporting requirements less burdensome.  At the same time, however, 
they noted that Taiwan regulators, unlike many others in the region, 
are friendly to foreign banks and encourage them to buy distressed 
local banks and enter the market.  Six banks have already been 
purchased by foreign institutions or private equity firms. 
 
¶9.  (SBU)  U.S. bankers note that international banks are in a very 
strong position to be competitive in Taiwan.  They will have access 
to Taiwan customers and can service them most anywhere in the world, 
including China, offer global asset management services, and operate 
with international best practices.  Foreign banks are already tough 
competitors in Taiwan.  Citibank, for example, is a major player in 
Taiwan retail banking and generates more profits with 11 branches 
and 3,000 employees than local competitors with over 150 branches, 
according to one U.S. banker. 
 
Do Taiwan Banks Have a Future? 
------------------------------ 
¶10.  (SBU)  With competition from the state-controlled banks and no 
way to lend to Taiwan firms in China, how will Taiwan banks grow? 
Analysts note that although Taiwan banks are still locked out of 
China, they are making headway in Vietnam, although it will be 
probably two to three years before this expansion positively affects 
their bottom line.  Most believe that China will eventually open up, 
but in China they will have to compete with low-cost local players 
as well as some of the world's most accomplished international 
banks.  Local analysts see opportunity in China over the long term, 
but U.S. bank representatives in Taiwan caution that it won't be 
easy.  Their strong point will be their knowledge of their Taiwan 
customers.  One analyst noted that Taiwan banks are trying to reach 
out to Taiwan customers in China via branches in Hong Kong, but like 
 
TAIPEI 00002525  003 OF 003 
 
 
their parent banks, these branches hold deposits far in excess of 
their loan portfolios. 
 
¶11.  (SBU)  Most analysts see the best opportunities for Taiwan 
banks in fixing things at home and turning more attention to asset 
management.  Taiwan households hold about US$1.3 trillion in assets, 
of which 41% is cash.  Combine this with an aging population and a 
new government-mandated pension plan, Taiwan has a real need for 
wealth-management services.  Excess liquidity has driven down 
interest rates and has led to capital outflows as Taiwan people 
chase higher returns elsewhere.  Comparatively high tax rates also 
keep money out of the country.  "It is quite sad," remarked Sophia 
Chen, head of Research at Merrill Lynch, "that Taiwan money has been 
helping private banks in Hong Kong and Singapore" build their wealth 
management business. 
 
¶12.  (SBU)  Chen forecasts that by making a few changes, the Taiwan 
authorities can give a big push to developing Taiwan's wealth 
management business.  First she suggests cutting the inheritance 
tax, which at its current maximum rate of 50% compares unfavorably 
to zero in Hong Kong and 5-10% in Singapore.  Unlike cutting 
individual and corporate income tax rates, which would have a larger 
impact on government revenues, inheritance tax does not generate 
near as much revenue.  It would also encourage households to keep 
more of their assets in Taiwan.  Tax avoidance, she said, is one of 
the main reasons Taiwan investors choose to take their assets 
offshore. 
 
¶13.  (SBU)  It is also possible that there will be a pick-up in 
corporate loan activity in Taiwan.  One analyst argues that as costs 
quickly rise in China, Taiwan becomes a more attractive 
manufacturing location, particularly if Taiwan authorities lower 
corporate tax rates and streamline some investment procedures such 
as acquisition of land.  The cap on China investments at 40% of a 
company's net worth also limits the amount of funds that firms want 
to bring into Taiwan. 
 
Comment 
------- 
¶14.  (SBU)  Comment:  Virtually all of the analysts and U.S. bankers 
told the same story:  Taiwan's financial system is stable and it 
regulators are on the right track, but further financial reform is 
needed to strengthen Taiwan banks.  Unless Taiwan's regulators pick 
up the pace, however, Taiwan clients are likely to be sending more 
of their business overseas.  End Comment. 
 
¶15.  (SBU)  This cable has been cleared by Walter Yao, Senior 
Manager, Country Analysis Unit, Federal Reserve Bank of San 
Francisco. 
 
YOUNG