Foreign banks in Taiwan are taking off their rose-tinted glasses. They have discovered, a bit late in the day, that high economic growth does not always mean high profits.
Since the beginning of 1980, their number has grown from 12 to the current 32 branches. Newcomers flooded into what looked like a highly lucrative market. Taiwan’s economy had grown by an average annual rate of 9.6% over the previous two decades. Export expansion during the same period exceeded 20% A year.
This performance produced mounting trade surpluses. Taiwan entered the current decade with a debt service ratio of less than 5%. What’s more, the frugal lifestyle of its citizens contributed to a savings rate that hovered above 30% of the gross national product.
Why the disappointment now? “A few years ago, Taiwan was often erroneously described as a Klondike for bankers,” said a local bank executive. “It was a speculators’ paradise that attracted foreign banks like flies to carrion.”
The numbers bear him out. Despite the rush of newcomers, the foreign banks’ share of total bank assets in Taiwan slumped from 9.6% to 5.1% in the five years to the end of 1985. And, by the official estimates of the central bank, 13 of the banks lost money in 1984. Foreign bankers, however, placed the number much higher, because the central bank’s definition of non-performing loans is rather narrow. One banker predicted worse results would show up in official 1985 figures.
Major losers include Lloyds, European Asian Bank and Grindlays — all of which opened branches in the stampede of 1980-81. But almost all foreign banks are suffering, and none has escaped the market turnaround in the last four years.
Before 1981, foreign banks could offer dollar credits at attractive rates that undercut those on local currency loans from Taiwan’s domestic banks. In the last four years, however, the situation has been reversed. As a result, the central bank has pushed major state-owned enterprises to convert their dollar debt into lower cost local currency credits. Many of the newcomers also discovered that major corporate borrowers in the private sector had full credit lines from domestic banks and the established foreign banks.
Faced with a heightened competitive environment, many of the 20 new foreign banks scrambled downmarket, showering smaller companies with loans. Most followed normal American and European cash flow lending practices, relying on audited financial statements to determine a company’s credit risk and business cycle.
These funds were extended, for the most part, without collateral. Taiwan’s domestic banks are highly conservative asset-based lenders. They are in most cases government-owned and tightly regulated. They lend, even to large private companies, on a fully secured basis.
Most private companies in Taiwan are small; fewer than 80 industrial corporations have annual revenues of more than $60 million. Most are highly leveraged. On average, manufacturing enterprises have more than twice as much debt as equity.
Local companies are for the most part family-controlled and secretive. Financial statements presented to foreign banks are notoriously inaccurate, and sometimes deliberately falsified.
“I doubt if some companies know what their actual costs are,” said one of Taipei’s European bankers. “This problem is compounded by the frightful dishonesty that goes on here.”
Foreign bankers hoped to reap profits with high spreads on small company loans. Many of the borrowers, however, used the rush of new funding in wildly speculative ventures, and soon developed serious liquidity problems. Over the last few years foreign bankers have watched their troubles increase as many borrowers defaulted. Recent estimates put the total of these problem credits at $600 million.
This figure represents 20% of all foreign bank assets booked in Taiwan at the end of 1985, and more than three times the value of their paid-in capital. Worse still, foreign banks have little hope of repayment. “There are no current assets; all the fixed assets have been pledged, and there is no inventory,” explained Steven Champion, general manager of Continental Bank’s Taipei branch.
The resulting jitters among foreign bankers were at their worst last year. The economy slipped to growth of a mere 4.7% after advancing 10.5% in 1984. Two banking institutions controlled by Taiwan’s second largest private business empire collapsed in the wake of a major financial scandal, taking many affiliated companies. Government-owned domestic banks had to bail out more than 60 other corporations.
Official aid stopped short of a collapsing company, controlled by the ruling Kuomintang Party, which foreign banks had usually put into their sovereign risk category. This inaction led to what Liang Kuo-shu, chairman of Taiwan’s Chang Hwa Commercial Bank, called an “overreaction”. A few long-established American banks quickly withdrew their lines of credit from a troubled state-run enterprise that was losing money on a new stainless steel plant.
These banks may never get such business back. But their drastic move made sense. “These banks are asking whether a government enterprise can be considered the same as national risk,” said a Finance Ministry official. “They feel you have to test the waters.”
After the chairman of a publicly listed manufacturer fled the country with a reported $25 million, the plant had to close and lay off most of its workers. Only later did Bank of America, which had lent several million dollars, discover that stock certificates pledged as collateral were virtually worthless.
Bank of America was able to recoup some of its losses, but most other foreign banks will ake a long time to get the bad loans off their books.
Under pressure from their head offices, many are paring down their loan assets and cutting staff. One European bank has recently moved into less expensive office space, and others may follow that example.
On the brighter side, the economy is expected to grow at a rate of 8% this year, and major corporate failures are receding from the headlines. “The crisis is over for the banking system in terms of being afraid to read the newspapers,” says one American banker.
Given the recent experiences with Taiwan’s “middle market” of smaller companies, there has been a flight to quality as foreign bankers search for more solid customers. Champion of Continental said: “There’s more competition at the high end of the market now. There are good borrowers, but maybe not enough to satisfy all the banks.” Margins are thin. “It’s anywhere from 20 to 50 basis points for the top borrower short term.”
The drive to quality has also changed risk analysis. Foreign banks are still relying on corporate balance sheets, but are being more sceptical about the quality of the auditors.
Some foreign banks are also shifting away from direct lending to fee-based business, such as letters of credit. Their reasoning is not solely based on the headaches of the past. The whole banking system is awash in liquidity. This reflects industrial uncertainty. The light industries that fuelled the country’s massive export trade fear protectionism in major overseas markets. Yet entrepreneurs are resisting the government’s call to move into more sophisticated, capital-intensive industries.
The result has been a massive build-up of funds in the banking system. In 1985, deposits in all monetary institutions rose 22% over the previous year, while loans limped along at a 5.5% rate of increase.
With Taiwan’s exports now above $30 billion a year, foreign banks have come to see that they can be profitable merely by negotiating such documents as letters of credit, and by offering trade finance.
Standard Chartered Bank, which opened a Taipei branch only last year, has the right sort of expertise. “We are concentrating on our traditional field of business in trade finance,” said Stuart M. Horsewood, manager of the Taipei branch of Standard Chartered.
