For Taiwan’s bankers, September 16 marked a turning point. That’s the day that First Commercial Bank, Chang Hwa Bank, Land Bank of Taiwan and Taiwan Cooperative Bank became the first of the island’s financial institutions to get the green light from China’s regulators to open branches in the mainland. But in a market in which foreign players struggle to compete profitably against home-grown competitors, the hard work is only just beginning for Taiwan’s banks, say analysts.


The good news is that Taiwan’s banks aren’t starting from scratch. They already have thousands of customers in China thanks to the taishang, the Taiwanese firms doing business in the mainland. Up until now, the taishang have had to do all their essential banking in China with the big state-run institutions, or with other foreign banks, such as Citigroup or Standard Chartered. In a 2007 survey of taishang by UBS, more than 80% said they would switch to a Taiwanese bank if and when they were allowed to, citing their existing relationships with the financial institutions back at home as the main reason why.


With access to so many existing corporate customers in China, “we have to follow in their steps,” says a spokesperson from First Commercial Bank, which plans to open a branch in Shanghai by the end of the year. “Taishang already have good relations with us, so we think it will be more convenient for them to bank with us in the mainland, too.”


What’s more, Taiwan banks will have a competitive edge over other foreign rivals because of a memorandum of understanding (MOU) on cross-strait banking that took effect in January and the cross-strait Economic Cooperation Framework Agreement (ECFA), which was signed in the summer. Both are the fruit of remarkably warmer China-Taiwan relations since Taiwan’s China-friendly president, Ma Ying-jeou, took office in 2008. The MOU allows Taiwan’s banks to upgrade representative offices in China, which essentially only provide consulting services, to branches, with the promise of being allowed to conduct business in renminbi (RMB).


ECFA fast-tracked that process so that Taiwanese banks can upgrade rep offices to branches a year after being opened, rather than two years under the old regulations. They can also do business in RMB after operating a branch for two years, including one profitable year — previously it took three years, with two profitable years.


Over the past 10 years, eight Taiwanese banks established representative offices in the mainland. It’s easy to see why expansion into China was so attractive. For one thing, a common language and culture would give them an advantage over foreign and local rivals. For another, China offered them more growth opportunities, especially in comparison with to the island’s own market, which experts say over-crowded with nearly 40 domestic and 30 foreign banks, well over twice as many needed to serve the customer base profitably.


A bank’s average return on equity in China is 27%, compared to between 2% and 5% in Taiwan. That’s not likely to change soon. In Taiwan, state-run banks account for about half of the crowded market, and while their consolidation could improve profits at home, it would mean layoffs — a politically unpalatable option.


How big is the pie in China? According to UBS, the country had some RMB 45.7 trillion (US$6.8 trillion) in loans outstanding as of August 2010, with RMB 68.6 trillion (US$10.2 trillion) in deposits.


Are China’s Banks Worried?


But competition is going to be no less fierce in China. Taiwan’s banks will be facing some of the world’s largest banks. Bank of China, China Construction Bank, Industrial & Commercial Bank — the country’s three largest state banks — have nearly RMB 30 trillion (US$4.5 trillion) in assets. In comparison, the three largest Taiwanese banks — Bank of Taiwan, Taiwan Cooperative Bank and Land Bank — have about NT$8.6 trillion in assets (US$274 billion).


Indeed, even China’s smaller banks need not worry about the Taiwanese newcomers breathing down their necks — at least, not initially, say analysts. They expect Taiwan’s banks to first focus on grabbing market share from their taishang customers before even thinking about trying to woo local Chinese customers. “For the first few years, expansion will not be very rapid and the target will be very limited to Taiwan-related customers,” says Pandora Lee, a banking analyst at UBS in Taiwan. “This is definitely going to be a long-term thing.”


As the spokesperson from First Commercial Bank sees it: “If it goes smoothly, we’ll expand beyond the taishang market. But it won’t be easy.”


But the analyst community agrees growth won’t be neither easy nor fast. One reason is that Taiwan’s banks collectively don’t have much of a track record of overseas expansion. Though they have branched out to the likes of Hong Kong, the U.S., Australia and various parts of Southeast Asia, their presence in those countries has been small.


Analysts also note that Hong Kong’s banks needed between six and 12 years before the mainland began making even a 5% contribution to their bottom lines. “If you want to see a meaningful impact, it will take five years, or maybe longer,” says Dexter Hsu, a Taiwan-based banking analyst for JP Morgan.


The wait, however, could be worth it. UBS says there’s an estimated US$56.4 billion of taishang lending up for grabs, and in a best-case scenario, Taiwan’s banks could snatch a third of that business. Still, that could give a boost to Taiwan’s banks, adding an average 6% growth to their loan portfolios and between 2% and 8% of earnings.


Many Hurdles


The battle among banks to win Chinese customers will be another matter. Because China’s banking sector is dominated by the state-run banks, getting a foothold in the country is daunting for outside players. Foreign banks face stricter regulations, including only being able to accept a minimum deposit of RMB 1 million (US$150,000). “That means they can only take deposits from large businesses, not the average Chinese depositor,” says Norman Yin of National Chengchi University. Taiwan’s Financial Supervisory Commission (FSC) is in discussions with mainland authorities in the hope that the amount will be cut for Taiwan’s banks, say an FSC official.


Even foreign players with deep pockets, like HSBC and Citigroup, haven’t been able to compete head on with home-grown rivals, according to The Wall Street Journal, citing a recent report by KPMG. Their profitability has been slipping while that of the mainland banks have soared. A case in point: HSBC’s after-tax profit from its China unit fell 60% in 2009 from the previous year, while China’s biggest lender, Industrial & Commercial Bank of China, posted a 16% increase in net profit.


In addition, foreign banks already face tighter lending criteria compared to mainland peers, and China may also soon require foreign banks maintain a 75% loan-to-deposit ratio, as opposed to the typical 150% today. The capital adequacy ratio will be overhauled too, in line with global reforms. “In the next three years, capital requirements will only get tighter,” predicts UBS’s Lee. “So how will [Taiwan’s banks] have more capital for a rapid expansion in China?”


Branching Out


But Taiwan’s bankers are clear-headed about what lies ahead. “We must work hard,” says the First Commercial Bank spokesperson. “We’ve already been busy for many years trying to start the mainland business. We understand our customers better [than Chinese or foreign banks]. If we go to the mainland, most of them should switch to Taiwan banks — I can’t say all of them, but most.”


Their reputations will certainly help. Taiwan’s banks are widely seen to run tighter operations than their mainland peers. “In terms of technology, the way they do business and their service, Taiwan banks are much better than Chinese banks,” says JP Morgan’s Hsu.


There’s also room to build beyond the branches that they open in China. One way would be to acquire stakes in local banks, and then expand. That’s the route Fubon Financial Holding has taken. Through a subsidiary in Hong Kong, it has a 19.99% stake in Xiamen Bank, a small institution with 32 branches in Xiamen City in Fujian Province. Located just across the Strait from Taiwan, Xiamen City’s locals speak the same Minnan dialect as the Taiwanese and are most culturally similar. Fubon, which is part of the Fubon Financial Group with some NT$2.7 trillion (US$85 billion) assets, says it now also wants to open its own branches in the mainland.


Strategically, Taiwan’s currently banking expansion in the mainland is relatively low risk. For example, other foreign banks in China have been operating on a subsidiary model, rather than opening branches, like Taiwan’s banks are now doing. Subsidiaries generally have advantages — such as not having to adhere to regulations in parent country, as branches must. There are also drawbacks. One is the high capital requirement for establishing a mainland subsidiary. But eventually, Taiwan’s banks use a mix of subsidiaries and branches, predict analysts.


“Now, the mainland’s attitude is to encourage bank branches, not subsidiaries” for Taiwan banks, the First Commercial Bank official says. “We’ll have to wait and observe their policies. It’s very uncertain. It’s a question of the government’s attitude, and cross-strait relations.”