Catch-22 for Taiwan banks after rise in China provision
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Catch-22 for Taiwan banks after rise in China provision


New rules from Taiwan’s Financial Supervisory Commission (FSC) require banks to up their general provision for China loans by 50bp. While the move will push banks in Taiwan to exercise more caution when lending to the mainland, it leaves them in a dilemma when it comes to pricing loans, writes Shruti Chaturvedi.

The FSC has been stepping up its scrutiny of Taiwan's banking system’s exposure to Mainland China in recent months. The increased oversight is a result of a combination of factors, including a slowdown in the Chinese economy and Beijing’s anti-corruption crackdown that is exposing corporate governance issues. Throw in some high profile defaults that have stung the Taiwanese, and the regulator’s hawkishness is understandable.

The latest of the regulator’s measures to encourage its banks to exercise caution and discretion when taking on China business requires lenders to increase their general provision on Chinese loans to 150bp from 100bp.

Banks have also been asked to assign a 100% weight for three month interbank placements that are rolled over, instead of the current 20%. Additionally, their short term trade financing to China will be tracked more closely, according to a release on the regulator’s website on April 13.

“Banks’ short term trade financing is also going to be monitored,” said a banker at a mid-size Taiwanese lender. “From a country risk or from a government risk perspective it should be positive but for commercial banks’ [business profitability], it’s negative.”

Taiwanese banks’ China loan book has ballooned since their regulator relaxed rules on cross-strait lending five years ago. According to a Fitch report in July, Taiwanese bank exposure to China grew by a CAGR of 135% during 2010-2013.

China exposure, including loans, interbank placements, and investments, accounted for 68% of the system’s net assets at the end of 2014, up from 49% at the end of 2013, said Moody’s this week, citing FSC data.

Tough choice

The regulator is now seeking to curb some of that exuberance. But the new regulations come at a time of intense price competition in the syndicated loan market. Abundant liquidity on the mainland means certain Chinese borrowers are not even tapping overseas lenders for their funding needs.

Big international banks that enjoy a cost advantage over the Taiwanese when it comes to dollar lending have resorted to doing increasingly top heavy loans and thinly priced clubs for high grade borrowers in order to cope with the situation.

“Chinese and foreign banks are still very aggressive,” said a Taipei based banker. But she did not foresee the rule change or increased cost affecting ongoing loans for Chinese names targeting Taiwanese liquidity in retail syndication.

“Have you heard anyone say they [bookrunners and borrowers] will renegotiate pricing after this rule change?” she said. “People are using bilateral loans also. For big Chinese banks, a $100m-$300m [commitment] is not hard to do. Liquidity is very, very good so I don’t think there will be an impact on the [overall offshore syndicated loan] market.”

The Taiwanese already find it hard to join club-style deals, thanks to constraints on minimum pricing and hold appetite. Now, with the latest rule asking them to make a 50bp higher provision for Chinese companies, they are faced with the tough choice of either taking a hit on profitability or passing on the increased cost to borrowers — which could mean losing out on business.

One banker said small to mid-sized Taiwanese lenders would increase minimum pricing requirements by between 50bp-70bp to absorb the effect of the 50bp increase in China loan provisioning.

“If the provision is 150bp, we will have ask for 200bp for China deals,” said a banker at a state owned Taiwanese bank. “This will rule out all first tier names, which are paying a margin of around 150bp.”

Relationship matters

However, not all market participants felt the only outcome would be a direct price increase. After all, it may not be practical to ask borrowers to pay up at a time when overall market pricing, even for China credits, is displaying a downtrend.

Moreover, there are considerations other than pricing that shape banks’ decisions when it comes to going ahead and lending. The potential of relationships is a huge factor in making that call.

“It will be difficult for them [Taiwanese banks] to just pass on the cost [of the higher provision],” said Ginger Kao, an analyst in the Financial Institutions Group at Moody’s. “Banks often use the loan as a lead to secure other cross selling, wealth management and cash management business.”

”They will see the contribution per customer. Loans are not the only area the client is contributing, there are opportunities for other fee based income and business that will also help them [banks] improve profitability overall.”

Her sentiment was echoed by a Hong Kong based banker at a prominent Taiwanese lender. He saw the measures having a limited impact, as Taiwan’s banks have already been cautious about whom they lend to in China.

“Unless we are doing business with a very thin margin, we can face the additional provision,” he said. “For China transactions if it is more risky then the client will be willing to give you more. It’s your decision whether you want to take that risk. It will depend on the structure and relationship, not just pricing. We need to maintain credit discipline. ”

Profitability this year may be lower than in 2014, but because of potentially higher interest rates there could be a gradual improvement, as long as asset quality remains stable, said Kao.