Financial Holding Company Merger and Implicit Concerns of Financial Groups

Transcription

1 Financial Company Merger and Implicit Concerns of Financial s I. Introduction Hsu Chen-Min Taiwan s financial reform can be traced back to the 1980s. Financial deregulation took place and financial internalization started in the 1990s. However, since the onset of the Asian financial crisis, Taiwan has been frequently buffeted by financial problems. It had large foreign exchange reserves and barely any public foreign debt to keep it almost free from damage. Nevertheless, since the second half of 1998, financial problems began to emerge in Taiwan. A local financial crisis started affecting financial institutions and their profit gain, while their non-performing loans have increased. The overall bank non-performing loan ratio climbed from 3.71 percent at the end of 1997 to 7.48 percent by the end of December The financial environment was jeopardized, and there were concerns over whether a new Asian financial crisis was going to break out. As a consequence, the government finally decided to engage in comprehensive financial reform in In July 2002, the Executive Yuan established a Financial Reform Project Team and actively took a series of measures, which included five work divisions for bank, insurance, capitalistic market, fundamental finance, and financial criminal research in order to enhance the overall competitiveness of the financing industry. New financial laws and regulations were laid down. All this is known as the first financial reform. It focused on fraud management and proclaimed as the policy goal. Bank operators began disposing of massive non-performing loans in order to reduce their overall bank NPL ratio under 5 percent, and raise the BIS Ratio over 8 percent in two years. After that reform had been implemented, the overall NPL ratio significantly dropped from percent in April 2002 to 2.53 percent in In terms of bank credit, negative growth rates also changed to positive ones. Meanwhile, economic growth was stimulated, which in turn alleviated high unemployment. However, some problems had yet to be solved. They included a relatively low BIS ratio and an excessively large number of banks. There was only a slight drop in the number of banks to 48 from 52. In addition, bank profit earnings still remained unfavorable, and there was inadequate innovative creativity. Deposit interest rates and lending interest rates spread still served as the main source of income for banks. However, the overall results of the first financial reform were generally satisfactory. The success of the financial reform is partially due to the global economy recovery, which has benefited Taiwan. As Taiwan s financial body gradually improved, a second financial reform was proposed in the first half of 2004 by the Council for Economic Planning and Development. Subsequently, the Financial Supervisory Commission called a national service industry development meeting in September With profitable gain as incentive, financial internalization and deregulation were promoted to enhance financial international competitiveness. It is especially intended to improve financial development across the Taiwan Strait. At a presidential economic advisory meeting in October of the same year, a crucial decision was made to achieve four main goals of financial merger. They included: 1) reduction of state-owned companies by half to only six, 2) merger of 14 1

2 financial holding companies to seven and listing of at least one of them on an international security exchange or induction of foreign direct investment in domestic financial institutions; 3) and an increase by three financial holding companies of their market shares to more than 10 percent each. The second financial reform is aimed at the expansion of the scale of financial holding companies and the reduction of government-owned banks. The latter is intended to achieve the former by Other aspects of the financial reform should also be completed by the end of II. Summary of Financial Company Merger Proliferation of banks makes merger necessary. It has caused over-banking, a high resemblance in attribute, a scatter in scale, and inadequate international competitiveness. A Financial Institution Merger Law was promulgated in Banks have also reinvested in other financing businesses. Beginning from 2002, after the Financial Company Law had gone into force, the financial holding companies were allowed to operate in other industries. Altogether 14 financial holding companies were established. Meanwhile, 50 banks, securities, insurance, and peripheral financial institutions were merged. Among the major mergers in 2002 were those between Cathay Financial and Cathay United Bank; between Fubon Financial and Taipei Bank; among Mega s, China International Commercial Bank, and Chung Kuo Insurance Co.; and between Fuwah Financial and Asia Pacific Bank. In 2003, Chinatrust Financial merged with General Bank. In 2004, Shin Kong Financial merged with Comerica Bank, and E. Sun Financial with Kaohsiung Business Bank. In 2005, Union Bank merged with Standard Bank, while Taishin Financial merged and acquired Chang Hwa Bank, while SinoPac Financial merged with Taipei International Commercial Bank. In 2006, Cooperative Bank merged with Farmers Bank, Mega Bank merged with Commercial Bank of China and Bank of Communications. Over the past four years, the number of domestic banks in Taiwan was reduced from 53 in 2001 to 43 in Generally speaking, this number is still regarded as excessively large. It shows that financial integration has not yet significantly reduced the number of banks. What is true is that the number of credit cooperatives was reduced. The market share of government-dominated financial institutions is yet to be lowered. Official shares in financial institutions were reviewed and merger was conducted. At present, this ratio still stands at 50 percent. In order to develop internationally competitive financial institutions, the government has to continue pushing for merger and reducing its stock holding in state-owned banks. As for financial holding company merger, it was even more difficult. Finally on July 22, 2005, after three years of organizational reform, Taishin Financial merged Chang Hwa Bank. It was the first case of merger between a government-owned bank and a financial holding company. The Ministry of Finance proposed a Central Government Public Share Right Management Execution Plan on December 28, On March 1, 2005, the ministry set up an Official Share Right Management Team. The new team has completed the following six projects: (1) Overseas Chinese Bank was taken over in December 2004 by the Polaris. (2) Taiwan Development Corporation (TDC) sold its trust department to Jih Sun Financial Company in January TDC is no longer a regular financial institution. (3) Chang Hwa Bank was taken over by Taishin Financial in July

3 (4) Cooperative Bank and Farmers Bank merged on November 8, (5) The Bank of Taiwan merged with the Central Trust of China. Currently, the feasibility of its merging the Land Bank of Taiwan is under study. (6) Mega s merged with Commercial Bank of China and the Bank of Communications in August In addition, the new group would merge the Taiwan Business Bank in Table 1 Summary of Domestic Financial Institution Mergers Merged (Merger & Merger(Merger & Merger(Merger & Acquisition) financial Acquisition) Acquisition)body institution Cut-off date Taishin Bank Dah An Commercial Bank Sunny Bank The Fifth Cooperation of Tainan Cathay Financial Cathay United Bank Mega s Bank of China China Trust Financial General Bank Cathay United Bank Cathay Bank E. Sun Bank Kaohsiung Busniss Bank Shin Kong Financial Comerica Bank China Trust Bank Fengshan Credit Cooperative Taishin Bank Hsinchu Credit Cooperative Taipei Bank Fubon Bank Cooperation Commercial Bank The First Cooperation of Chiayi Union Bank Standard Bank

4 Merger(Merger & Acquisition)body Merged (Merger & Acquisition) financial institution Merger(Merger & Acquisition) Cut-off date Fuhwa Commercial Bank The 7 th Cooperation of Tainan Taishin Financial Jih Sun Financial Chang Hwa Bank Taiwan Development Corporation Trust Dept (won the bid) Cathay Financial Shin Kong Financial The 7 th Commercial Bank Macoto Bank Sunny Bank Kao Shin Bank Fuhwa Financial SinoPac Financial s Macoto Commercial Bank The 6 th Cooperation of Tainan Taipei Commercial Bank Shin Kong Commercial Bank COTA Commercial Bank Fong Yuan Credit Cooperative Cooperative Bank Farmers Bank Mega Bank Commercial Bank of China Mega Bank Bank of Communications Sources: :Financial Supervisory Commission, Executive Yuan, Wealth Magazine A financial holding company is supposed to merge and acquire another financial institution through capital increase funding (self-capital) rather than through borrowing from among banks. Borrowing not only makes assets unclear in the merger and acquisition process but also makes smaller local/regional financial institutions intimidated by more advantageous financial holding companies. Monopolistic financial markets will eventually lead to the shrinking of consumer rights and further worsen the situation. On the other hand, vicious merger and acquisition methods will also deprive bank staff of their rights and benefits. They may be jeopardized to the point of getting laid off. In the 4

5 face of official share merger and financial group acquisition of government-owned banks through illegal means, the benefits of all citizens may be harmed, and concerns over justice and fairness will arise. Implicit Concerns of Financial s Although the merger of financial holding companies is a policy directed toward internationalization, it is something that should be determined by market mechanisms. The government should not set the timetable to reduce the number of financial holding companies, however. Its disrespect for market mechanisms seems not to reflect reasonable merger and acquisition prices and the optimum number of mergers. Drawbacks such as unfair competition may also arise. Over the past few years, financial mergers have caused financial group assets to multiply. Public concerns have remained over whether or not financial groups were paid under the table and whether public benefits were compromised. Moreover, as financial groups continue to expand in scale without any package countermeasures, it will have an extensive impact once problems occur. As for government-owned banks, hastened privatization or the reduction by half should not be done promptly lest financial management institutions and the Ministry of Finance might be under pressure to reach the goals set for the second financial reform.. The greatest disadvantage of the second financial reform is that the fixed number of financial holding companies and government-owned banks has to be reached within the given time. As a consequence, what was conceived as the internationalized financial merger reform has been reduced to a money game played by politicians and businessmen (executors and financial groups), thanks to inappropriate policies adopted for the merger. The goal to expand the scale of financial holding companies is open to discussion. If desirable financial holding companies merge with undesirable financial institutions, the overall financial system may benefit positively. Meanwhile, we may also learn from the multiple-business operation methods in the United States for the benefit of financial modernization. If desirable financial holding companies merge with desirable financial institutions, concerns over monopolistic financing may arise. Besides, the banking industry should strive for innovative capability and value added creation. Small-scale banks that are innovative often do not have difficulty attracting foreign investment. Similarly, it will be impractical just to expect financial holding companies to expand in size and go international like HSBC (Hong Kong) and Chartered Bank without taking into consideration that both of them are desirable bank systems that have already expanded in scale. Taiwan did exactly the opposite. It tried to expand the scale of financial holding companies and let them go international before establishing a comprehensive financial institution system. Since tens of billions of dollars is required to join in the game of merger and acquisition, only large financial groups are entitled to play. These groups often utilize money from the great masses such as insurance, bank deposits and loans rather than their own capital to play the game. This is an abuse of social capital. Concerns arise over the monopolization of business control by a minority group of shareholders. Privatized financial businesses that are relatively smaller in scale are merged and acquired by larger hostile groups. The Legislative Yuan passed the law that requires the board chairman or the chief executive officer and the general manager of a government-dominated financial institution to be appointed by the government. However, the Ministry of Finance did not follow that stipulation in the Development Financial s case. The ministry only required the Koo family to hold 15 percent of the Development shares. Self-funded capital was not specified. Therefore, the self-funded capital of the Koo family was a 5

6 mere one percent, while 99 percent of the money was borrowed. As a result, the strong are made stronger and the weak weaker. Cathay Financial supplies another example. Its flagship is Taiwan s top insurance company. It then merged and acquired Cathay United Bank, together with subsidiary companies including Cathay Insurance, and Cathay Security, to become a relatively competitive financial holding company. On the contrary, Jih Sun, and Waterland have relatively smaller-scaled subsidiary companies and fail to evolve into large financial holding companies. Concerns also arise over whether policy executors sell government-owned banks at excessively low prices. Chartered Bank merged and acquired control of Hsinchu Commercial Bank by paying a price 50 percent higher than market value per share. This is in line with international custom. However, Fubon and Cathay purchased Taiwan Business Bank in 2006 at a price only 30 percent above the market value per share. The government undersold and incurred a loss of at least NT$100 billion to the national treasury. Corruption is likely to occur with poor monitoring. The following chart shows that seven of the current top ten financial groups in Taiwan are financial holding companies, including Shin Kong, Cathay, Chinatrust Financial, Fubon, Mega, Yuanta, and Nice. In recent years, financial holding companies have formed like a collective body of financial institutions. They make up an industry that accumulates assets most rapidly. The assets under these companies amount to over NT$140 billion each. Their scale parallels Alliance and it is not an exaggeration to say that getting hold of a financial institution is getting the entry ticket to the top 10 financial groups. Table 2 Current and Past Top 10 Financial s in Taiwan(Unit::Trillion dollars) Ranking in Ranking in financial Total assets Financial Total assets June groups groups (83) 1 3 Affiliated Cathay Shin Kong 2 1 Cathay Koo Chinatrust Affiliated Shin Kong 4 11 Fubon Asia World International 5 6 Formosa Far East Plastics 6 27 YFY Formosa Plastics Far East Chinfon Yuanta Ruentex Nice EverGreen EverGreen Tuntex

7 Financial Merger Policy Recommendation The second financial reform has not proceeded well over the past two years. The Legislative Yuan held an overall review of the financial reform and reached three conclusions. They included a unanimous agreement to terminate the reform, a suspension of stock release and transfer as well as official share right transfer, and establishment of government-owned financial holding companies. The financial reform has been going on without regard to the Legislative Yuan conclusions. Under the circumstances, policy directions should be reconsidered and financial management institutions should inspect financial management laws and regulations as well as related financial monitoring systems. In order to prevent financial groups from expanding without control and causing great potential risks that might adversely impact the economy, we recommend that the government conduct a general review on the entire financial merger and acquisition process and related laws and regulations. Financial holding companies should be restrained from using their subsidiary bank and insurance funds for merger and acquisition. Also, financial group parties should clearly specify financial institution share holding to avoid interested parties from making actual merger and acquisition. Only through clearly defined laws and regulations can loopholes in financial laws and regulations be stopped. Financial groups will not be able to find ways to make an end run against the laws during merger and acquisition. During merger or stock release of government-owned businesses, transparency should be maintained in the release of government stock. Strict monitoring is necessary to ensure social justice and reasonable revenue. Otherwise, the fight over control of Development Financial and Chang Hwa Bank will be repeated. In addition, the financial scale in Taiwan is smaller and banks are similar in attribute. Competition from large and high quality international financial institutions makes financial merger in Taiwan a feasible route to cope with it. To prevent the market oligopoly by a few financial groups, the government should resort to a fair, open and transparent mechanism to induce international financial institutions to participate. Large-scale financial holding companies are likely to monopolize the financial market. On the other hand, the government should allow domestic banks to invest in the Chinese market. Otherwise, profit gains of domestic financing industries will gradually shrink. As a member of the World Trade Organization, China has promised to open its financial market. If the government has not changed its seclusion policy, Taiwan s banking and financing industries will be inevitably marginalized. Journal of Asian Economics published The Role of Financial Development in Economic Growth: The Experiences of Taiwan, Korea, and Japan by Hsu Chen-min and Liu Wan-chun in The study covers the economic development in the three countries between 1980 and It proves that Taiwan was not jeopardized in after the Asian financial crisis had broken out. Its entire financial system was better than that in Korea and Japan. However, after 2001, the financial environment in Taiwan gradually changed. A series of major financial reforms was then conducted but with limited positive effect. Not only did the financial system show no improvement but there also occurred the disadvantage of unfairness. Financial reform is going on in Korea and Japan. If Taiwan does not take more caution in continuing its financial reform, it will see its 7

8 financial system turn inferior to the one in Japan or Korea in the near future. It is important for the Central Bank of China and the Financial Supervisory Commission to take prompt action to avoid the impact of the potential risks posed by the current financial consolidation. How to manage the financial and economic risks properly in the future is the most important task facing the government. Table 3 Bank Non-Performing Loan Ratio Unit::% Year/Month end Total Non-performing Loan Ratio Domestic banks 1995 December December December December December December December December December December December January February March April May June July August September October Data source: :Banking Bureau Website 8

9 Table 4 Domestic Bank Asset Return on Asset (ROA) and Return on Equity (ROE) Unit::NT$100 millions, % Year (month end) Average asset Average net value Surplus before tax Return on Asset (ROA) Return on Equity (ROE) ,020 15, ,578 15, ,189 15,096-1, ,190 14, ,232 15,083 1, ,903 16, January ,251 17, February 271,532 17, March 269,933 17, April 271,699 17, May 269,226 17, June 268,338 16, July 267,366 16, August 267,466 17, September 270,345 16, October 267,911 17, Data source: :Banking Bureau Website 9

10 Table 5 Summary of Government-Owned Official Stocks in Financial Institutions Affiliated public stock Asset Amount Market Remark Name of institution Stock-holding ratio (%) (million dollars) Occupancy Ratio (%) Mega s ,129, Mega s is Taiwan Business Bank , expected to purchase Total - 3,099,781 26% of stocks from Taiwan Business Bank before the end of 2006 Bank of Taiwan ,605, Merger is expected to Central Trust of China , be completed on July Total ,058, st, 2007 Cooperative Bank(including Farmers Bank) ,469, Land Bank of Taiwan ,782, Hua Nan Financial s ,644, First Financial ,505, Total asset 13,636, Chung Hwa Commercial Bank ,299, Bank of Overseas Chinese , These 5 financial Development institutions are not Financial predominated by the Corp , government Fuhwa Financial Corp , Waterland Financial ,

11 III. Data The majority of the data used in this study comes from annual reports of the banks is drawn from the TEJ (Taiwan Economic Journal) Financial Statement of Listed Banks in TSE Data Bank and TEJ Financial Statement of Public Banks Data Bank. Data on the NPL ratio and NTD Liquidity ratio are collected from Condition and Performance of Domestic Banks. We use data from 2000 to The maximum survival time is censored at 72 months. The sample consists of 52 banks, of which 8, or 15.38%, failed during the sample period. See Table 6. Table 6 Number of Exit Banks (2000~2005) Survival Banks Exit Banks Notes: Exit Banks are defined in our analysis as those which left the dataset because they were merged by another bank. In Table 7, we report major variables used in the study. These variables are to capture the effects of a bank s financial conditions, including measures of capital adequacy, asset quality, management, earnings, and liquidity. We used factor analysis to identify the common factors. Table 8 reports the rotated factor matrices. The individual factors are easy to identify by the variables they contain. Factor 1 represents capital adequacy. Factor 2 represents management. Factor 3 measures liquidity. Factor 4 measures asset quality. Factor 5 represents earnings. The five traditional CAMEL factor components provide insights into the financial soundness of Taiwanese banks. Table 9 reports the factor name and factor loadings. 11

12 Table 7 Definitions of Variables Variable Definition Equity Ratio =Equity Capital/ Total Asset Risk Capital Ratio = Total Risk-based Capital / Risk-weighted Assets Operating Expense ratio = Operating Expense / Operating Revenue Sales Per Employee = Operating Revenue / Number of Employee Deposit-Loan Ratio =Total loans/ total deposits NTD Liquidity ratio = Actual liquid reserves/ Total reservable liabilities The NPL ratio =Non-performing loans/ Total loans Overdue Receivable Ratio =Overdue Receivable Ratio =Overdue loans /Total loans Return on Total Assets =Net income after tax / total assets Net Income ratio =Net income after tax / Operate Income 12

13 Table 8 Rotated Factor Matrix Factor 1 Factor 2 Factor 3 Factor 4 Factor 5 Equity Ratio Risk Capital Ratio The NPL ratio Overdue Receivable Ratio Operating Expense ratio Sales Per Employee Return on Total Assets Net Income ratio Deposit-Loan Ratio NTD Liquidity ratio

14 Table 9 Factor Analysis Factors Variables Factor Loadings F1 Equity Capital/ Total Asset Risk Capital Ratio F2 Operating Expense ratio Sales Per Employee F3 Deposit-Loan Ratio NTD Liquidity ratio F4 The NPL ratio Overdue Receivable Ratio F5 Return on Total Assets Net Income ratio Factor Name Capital Adequacy. Management Liquidity Asset Quality. Earnings IV. Empirical Results Table 10 shows the summary statistics for major variables. Over the sample period, banks of financial holding companies have much higher average capital adequacy, asset quality, management, earnings, and liquidity than independent banks. Comparison of the financial performance of banks for survival and exit (merged), we find that the financial performance of survival banks is also better than exit banks. Table 11 reports the estimation results for the survival model. The asterisks ** indicate the error level at 0.05, all in a one-tail test. 14

15 Table 10 Descriptive Statistics ( ) Variables Whole Independent Survival Exit Banks Companies Banks Banks Banks(Merged Banks) Capital Debt to Asset Adequacy Ratio (%) ( ) (529.11) ( ) ( ) ( ) Risk Capital Ratio (%) (13.27) (5.99) (16.08) (6.79) (32.97) Asset Quality. Overdue Receivable Ratio(%) 6.35 (7.95) 3.27 (2.56) 8.49 (9.57) 5.44 (5.28) (17.23) The NPL ratio(%) (8.30) (2.08) (9.98) (5.31) (17.49) Earnings Return on Total Assets (2.73) (1.62) (3.19) (1.43) (6.37) Net Income ratio (76.76) 5.27 (28.36) (94.90) 1.23 (26.97) (196.78) (%) Management Operating Expense ratio (9.55) (8.54) (10.09) (9.05) (12.05) Sales Per Employee ( ) ( ) ( ) ( ) ( ) Liquidity NTD Liquidity (19.99) (21.97) (18.16) (20.97) (9.19) ratio Deposit-Loan Ratio (93.10) (30.25) (116.62) (98.72) (16.72) The Number of Banks Notes: companies including merged banks. 15

16 Table 11 Estimation results Exponential Weibull Log-normal Log-logistic Constant ** (0.1783) ** (0.9404) ** (0.1686) ** (0.1553) Factor ** (0.1421) ** (0.1557) ** (0.0954) ** (0.1038) Factor ** (0.1744) ** (0.1710) ** (0.1154) ** (0.1154) Factor ** (0.3782) ** (0.3712) ** (0.2395) ** (0.2512) Factor ** (0.0990) ** (0.1066) (0.0828) * (0.0746) Factor ** (0.0653) ** (0.0698) ** (0.0802) ** (0.0622) σ=1/p ** (0.0922) ** (0.1024) γ ** (0.0563) Log Likelihood Value χ 2 (5) Notes: Numbers in parentheses are standard errors. ** and * indicate significance levels of 5% and 10%, respectively. 16