Money and Banking

As introduced by the Yearbook of the Republic of China:

Monetary Aggregates

Given the precondition of price stability, the CBC continued the accommodative monetary policy with an aim to encourage bank credit expansion and foster economic recovery. Mainly due to the rising demand for bond funds in place of bank deposits, the economic slowdown, and banks' conservative attitudes towards lending, however, monetary aggregates showed sluggish growth during the year 2002. At the end of 2002, the size of domestic bond funds reached NT$1,847 billion, and the net asset value held by the nonbank private sector was NT$1,124 billion, approximately 5.55 percent the size of M2. M2 plus bond funds held by the nonbank private sector, the broader concept of monetary aggregates, grew by an annual rate of 5.64 percent in 2002, lower than the 6.47 percent of the previous year.

Although economic activities bottomed out in the first quarter, domestic demand remained weak throughout the year. Consequently, banks' demand for reserves grew moderately. In 2002, the annual growth rate of daily average money reserves was 1.78 percent, slightly higher than that of the preceding year. The year-on-year growth of reserve money was 1.93 percent in December.

Banking Sector

Financial institutions involved in indirect financing and money market activities included commercial banks, trust and investment companies, credit cooperatives, credit departments of farmers' and fishermen's associations, the Postal Remittances and Savings Bank, bills finance companies, financial holding companies, and local branches of foreign banks. There were 404 depository institutions (including deposit money banks and the Postal Savings System) in Taiwan at the end of 2002, a decrease of 12 institutions compared with the previous year-end.

Depository institutions continued to adjust and consolidate in the face of growing competition. The decrease was in part due to merger activities of one domestic bank, two foreign banks, and one credit cooperative association. The other eight poorly performing community financial institutions, including seven credit departments of farmers' associations and one credit cooperative association were taken over by three domestic banks under the government's financial restructuring policy. As of the end of 2002, thirteen financial holding companies had been set up since the Financial Holding Company Act took effect in July 2001, an increase of nine companies as compared to the previous year-end.

In spite of the consolidation, market shares of deposits or loans remained little changed for each type of depository institution compared with the previous year. With regard to sources and uses of funds in depository institutions, time deposits remained as the main source of funds in 2002, and loans still constituted the primary use of funds. The total deposit balance of depository institutions increased by an annual rate of 2.11 percent, a slower rate as compared to 4.59 percent in 2001. With lower transaction demand for cash balances in line with the sluggish stock market, the growth rate of demand deposit decreased from 13.52 percent at the end of 2001 to 10.31 percent at the end of 2002. The growth rate of time and savings deposits also dropped, from 2.12 percent to 0.30 percent. Of the different kinds of time and savings deposits, NT dollar time deposits registered a negative annual growth of 3.18 percent at the end of 2002, as a result of narrowing interest rate spread between demand deposits and time deposits. The annual growth rates of postal savings deposits declined to 0.67 percent at year-end. The annual growth rate of foreign currency deposits dropped from negative 4.94 percent to negative 6.81 percent, reflecting the fact that the interest rates on US dollar deposits at home were lower than those on NT dollar deposits. Government deposits in depository institutions also declined, by 10.26 percent over the year.

In 2002, the annual growth rate of loans and investments for depository institutions continued to slide during the year and reached 3.30 percent at year-end, while only in consumer loans, a growth of 3.56 percent was registered. Among these, the annual growth rate of loans was negative 2.54 percent, after a contraction of 2.92 percent at the previous year-end. The reasons for this fall included: (1) banks continued actively dealing with non-performing loans (NPLs) and writing off bad loans; (2) more firms resorted to the issue of corporate bonds for raising funds, partly replacing borrowings from banks; (3) amid the soft pace of the economic rebound, firms were still hesitant about increasing investment, leading to weak credit demand; (4) banks were cautious in lending due to their high NPL ratios; and (5) the falling value of collateral against loans prompted banks to curtail lending.

Manufacturing and wholesale and retail businesses remained as major borrowers. Banks' cautious lending attitudes toward real estate-related industries led to the fall of loans to the real estate and construction industries. The NT dollar loan-to-deposit ratio dropped from 71.43 percent a year earlier to 67.52 percent at year-end. Taking into account the loans provided by non-bank financial institutions such as life insurance companies, and investment and trust companies; the reclassifying non-accrual loans and bad loans written off by financial institutions; and market financing; the total demand for funds of the government, enterprises, and individuals still showed an increase in 2002. In terms of cash flows, the ratio of funds borrowed from financial institutions (intermediate financing) fell substantially to 40.18 percent in 2002 from 89.52 percent a year earlier. Conversely, the ratio of funds raised from non-financial sectors (market financing) increased from 10.48 percent to 59.82 percent, due to greater issuance of government securities and the decline in loans and investments of financial institutions.

The annual growth rate of depository institutions' portfolio investments dropped significantly to negative 8.32 percent at year-end from 15.73 percent at the previous year-end. Government bonds accounted for the largest share of portfolio investments, followed by commercial paper.

With the efforts made by local asset management companies and financial institutions, the accumulated amount of non-performing loans sold reached NT$146.8 billion by the end of 2002. In addition, banks continued to write off bad loans with funds from their own earnings and the compensation received from the Financial Restructuring Fund for loses resulting from banks' take-overs of problem community financial institutions. These actions greatly improved the NPL ratio. Furthermore, in order to help banks deal with non-performing assets, the Legislative Yuan passed the Financial Asset Securitization Act on June 21, 2002, to raise the liquidity of financial assets and lower the NPL ratio. As an uncertain economic climate took its toll on some companies and as the slack job market worsened individuals' debt-servicing ability, the NPL ratio of overall financial institutions rose from 8.16 percent at year-end 2001 to 8.78 percent at the end of March 2002. Thereafter, as economic conditions steadily improved and banks actively dealt with non-performing loans and wrote off bad loans, the NPL ratios gradually declined to 6.84 percent at year-end 2002. The corresponding NPL ratios for domestic banks and medium business banks were 7.48 percent, 8.04 percent, and 6.12 percent over the same period.

Interest rates posted by banks showed a downward trend throughout 2002. In the case of the interest rates of the five major domestic banks, the respective average fixed rates on one-month and one-year time deposits dropped to 1.48 percent and 1.86 percent in December 2002 from 2.13 percent and 2.41 percent a year before. The five major banks' prime rates fell only slightly from 7.38 percent to 7.1 percent over the same period. Under the urging of the CBC, as of the end of 2002, there were 37 domestic banks offering adjustable rate mortgages and 7 adopting the new flexible prime rate benchmark scheme. On the other hand, the average rates on new loans of the five leading domestic banks fell throughout the year and hit a record low of 3.49 percent in December 2002. In particular, banks' mortgage rates were brought down by the ongoing mortgage price competition, which stemmed from the introduction of adjustable rate mortgages, bargain-hunting borrowers switching their mortgages from one bank to another, coupled with competition from life insurance companies. The weighted average rates for all deposits and loans of domestic banks also continued to drift downward throughout 2002. For the year as a whole, the weighted average deposit rate fell to 2.38 percent from 4.09 percent a year earlier, while the weighted average lending rate fell to 5.53 percent from 6.99 percent.

The profitability of banks declined significantly during 2002. The combined pre-tax earnings of all depository institutions plunged by NT$189 billion and posted a loss of NT$105.5 billion in 2002. The average return on assets (ROA) for all depository institutions dropped to negative 0.37 percent in 2002 from positive 0.30 percent recorded a year earlier, while the average return on equity (ROE) plunged to negative 6.54 percent from positive 4.65 percent. Despite lackluster profitability, banks issued more subordinated debentures to strengthen their capital bases. The average capital adequacy ratio for all depository institutions thus rose to 10.63 percent at the end of 2002, compared with the previous year's 10.40 percent.

Financial Holding Companies

Around 1990, amid a period of regulatory liberalization, the number of domestic banks in Taiwan grew from 25 to more than 50, insurance companies increased from 25 to 38, and securities companies increased from 24 to 162, contributing to over-saturation of the financial market. To increase competitiveness as part of a host of financial reforms, the government has been encouraging companies offering financial services to consolidate. Four holding companies formed in December 2001, since then another 14 have been established. Most have banking as their core business. The newly promulgated Financial Holding Company Act encourages financial institutions to integrate and diversify services, and enlarge economies of scale. It allows the establishment of financial holding companies, and their investment in subsidiary institutions engaging in different kinds of financial services such as banking, insurance, securities, bills financing, and venture capital. Cross-selling of financial products will be partially allowed under the holding company structure. Information and equipment may also be shared under one roof. In addition, financial holding companies are required to focus on areas of (1) internal control and audit mechanisms; (2) comprehensive risk management policies and guidelines; (3) consumer protection and privacy issues; (4) information disclosure and market discipline; (5) supervision of related party trading; and (6) enhancement of accountability.

Cathay Financial Holdings is currently Taiwan's largest holding company with over 10 million clients and total assets valued at NT$2.1 trillion (US$60.9 billion). Late in 2003, Cathay, which was largely engaged in insurance services, acquired the United World Chinese Commercial Bank (UWCCB), and recently combined the bank with its own banking operation to form a new subsidiary. The merger gives Cathay access to UWCCB's existing relationships with securities companies and its vast information technology network, and allows the holding company to build further strategic alliances with securities houses. On the global front, however, Taiwan's holding companies are not yet competitive enough because of their small size compared with their international counterparts. Cathay's return on equity last year was 18 percent, well above the 3 percent average of other local banks, but still much lower than US-based Citibank's 25 percent.

Foreign investors are also being encouraged to enter the sector. The Financial Holding Company Act allows foreign holding companies to invest in local financial institutions or own up to 100 percent of their own operations with the hope that foreign investment will add to local holding companies' capital, enhance their competitive edge in the global market, and introduce advanced strategies.

The biggest challenge for a holding company is to effectively evaluate the risks of integration and establish sound risk-control mechanisms. A new Basel Capital Accord, introduced by the Bank for International Settlements, will be implemented in 2006. (The Bank for International Settlements is an international organization established in 1930 in Basel, Switzerland, to foster international monetary and financial cooperation and contribute to the health of financial institutions.) It is intended to improve market discipline and establish a supervisory review process. Known collectively as Basel II, in contrast to the 1988 Basel Capital Accord, the new regulations will be more flexible and risk sensitive.

The task of financial supervision was formerly split among three MOF agencies, namely the Bureau of Monetary Affairs (BOMA), Securities and Futures Commission (SFC), and Department of Insurance. On July 1, 2004, the Financial Supervisory Commission (FSC) under the Executive Yuan was formally established, marking the beginning of a new era in Taiwan's unitary financial monitoring system. With rapid changes in both domestic and overseas financial environments, the FSC's top priority will be the continual promotion of domestic financial reform so as to develop a system of laws and institutions that maintains long-term stability and healthy operation for Taiwan's financial market.

Money Market

Activity in the interbank call loan market slowed down in 2002, with a total turnover of NT$9,687.7 billion, a contraction of 15.71 percent over the previous year. This reflected reduced borrowing from major market players, which was caused by sluggish business and consumer spending, and a lackluster stock market.

Domestic banks replaced foreign banks as the largest borrower during the year, accounting for 44.94 percent of total trading, up 12.34 percentage points from the previous year, followed by bills finance companies and foreign banks, with shares of 30.53 percent and 19.18 percent, respectively. With regard to lenders, domestic banks continued to be the largest supplier of funds, accounting for 73.34 percent of total transactions, but down 5.3 percentage points from a year ago, followed by medium business banks and foreign banks, with respective shares of 10.19 percent and 9.54 percent. Trading of the shortest maturities was most active in the interbank call loan market. Overnight interbank call loans accounted for the major share of 58.76 percent, followed by those with maturities of one week and two weeks with shares of 28.65 percent and 8.55 percent, respectively.

Issues of short-term bills totaled NT$8,378.1 billion in 2002. Commercial paper continued to predominate, accounting for the lion's share of 89.82 percent, followed by negotiable certificates of deposit with a share of 7.55 percent, and bankers' acceptances 0.48 percent. Total issues of short-term bills dropped sharply 15.39 percent from a year earlier. At the end of 2002, outstanding bills amounted to NT$1,309.5 billion, a reduction of 11.98 percent from the previous year-end. The total turnover of short-term bills in the secondary market fell to NT$53 trillion, posting a drop of 8.63 percent from the previous year. Of the total trading amount, commercial paper still made up the largest share with 81.29 percent, followed by negotiable certificates of deposit at 11.65 percent and Treasury bills, at 6.17 percent.

Money market rates continued to edge downward during the course of 2002. With inflation looking under control, to help bolster the domestic recovery, the CBC continued to pursue relaxed monetary policy. In 2002, the CBC twice lowered the discount rate by a total of 50 basis points to a record low of 1.625 percent. The interbank overnight call loan rate fell from 2.39 percent in December 2001 to 1.61 percent in December 2002. The average issuing rate of commercial paper with maturities of one to 30 days declined from 2.71 percent to 1.78 percent over the same period.

Foreign Exchange Market

At the end of 2002, the NT dollar closed at 34.753 against the US dollar. Compared with the rate of 34.999 registered at the end of 2001, the NT dollar had appreciated slightly by 0.71 percent in 2002. On a daily average basis, the NT$/US$ exchanged rate for 2002 was 34.575, representing a depreciation of 2.2 percent when compared with 33.8 in 2001. With respect to other major currencies, the NT dollar depreciated against the Japanese yen and the euro by 9.14 and 14.54 percent in 2002. When based on the trade-weighted average exchange rate including 14 major trading partners (weighted by the sum of imports and exports of commodities), the NT dollar depreciated by 4.94 percent between the end of 2001 and 2002. Trading on the Taipei foreign exchange market increased in 2002.

The following figure shows the exchanging rate of the NT dollar against the US dollar between 2001 and 2004:

Total net trading volume increased by 21.5 percent from the previous year to reach US$1,410.37 billion. The average daily turnover stood at US$5.61 billion, representing an increase of 19.2 percent over the previous year. Transactions between banks and non-bank customers accounted for 36.8 percent of total net turnover. Interbank transactions accounted for 63.2 percent, of which 26.1 percent was for exchanges among local banks and 37.1 percent was for transactions between local and overseas banks.

Transactions in third currencies accounted for 45.5 percent of total trading volume, with trading in currency pairs of US dollar-Japanese yen and US dollar-euro accounting for 23.5 percent and 12.6 percent, respectively. NT dollar trading against foreign currencies accounted for 54.5 percent of total trading volume, of which the share of NT dollars against US dollars was 51.6 percent. With respect to types of transactions, spot transactions accounted for the highest share with 61.9 percent of total turnover, followed by foreign exchange swap transactions at 16.9 percent, options transactions at 10.6 percent, forward transactions at 8.1 percent, margin trading transactions at 1.8 percent, and cross currency swap transactions at 0.6 percent. Compared with 2001, trading volume of options and swaps witnessed the highest growth of 41.7 percent and 38.4 percent, respectively. By the end of 2002, the other forex derivatives allowed to trade in local markets included forwards, swaps, and options on foreign currency interest rates, commodity and stock indices. The turnover with respect to these products amounted to US$62.63 billion. Of this amount, interest rate-related derivatives accounted for the lion's share with US$59.94 billion or 95.7 percent.

The foreign currency call loan market continued to grow over the course of the year. The CBC released an additional US$10 billion of its international reserves from 16 August 2002 to satisfy market needs and the total amount of US dollar seed funds provided by the CBC in the call loan market was doubled to US$20 billion. The CBC's provision of seed funds for euro-and Japanese yen-denominated loans in the market remained unchanged at one billion euros and 15 billion Japanese Yen, respectively.

The transaction volume in the foreign currency call loan market in 2002 was equivalent to US$1,046.3 billion. Of this amount, US dollar transactions accounted for US$1,045.1 billion, a marked increase of 22 percent over 2001 due to the shortening of maturities of call loans with expectation of falling US dollar interest rates.

At the end of 2002, there were 72 offshore banking units (OBUs) in operation. Domestic banks operated 42 of the OBUs, while foreign banks ran the other 30. The combined assets of all OBUs totaled US$50.32 billion at the end of the year, representing a slight decrease of US$0.59 billion or 1.2 percent from the previous year-end. Domestic bank OBUs accounted for US$36.0 billion or 72 percent of these combined assets, and foreign bank OBUs accounted for US$14.32 billion or 28 percent of the total.

The OBUs' main sources of funds were from affiliated branches as well as deposits by financial institutions. Together these accounted for 66 percent of total liabilities. Of these, affiliated branches made up 48 percent, while deposits of non-financial institutions accounted for 29 percent. The main uses of funds were for affiliated branches and deposits with financial institutions. These accounted for 54 percent of total assets, while loans extended abroad and locally had a 30 percent share. Portfolio investments accounted for 12 percent of total assets, and the outstanding balance at the end of the year grew by 40 percent over the previous year, posting the largest growth among all types of assets.

The forex trading turnover of all OBUs in 2002 was US$39.06 billion, of which US$29.21 billion was for spot transactions, US$7.82 billion for currency swap transactions, and US$2.03 billion for forward transactions. The total turnover of other derivative products, including margin trading, options, foreign currency interest rate swaps, financial futures, foreign currency forward rate agreements, cross currency swaps, and commodity swaps, amounted to US$31.8 billion.

Stock Market

The Taiwan Stock Exchange (TSE) weighted average price index (TAIEX) closed at 4,452 points at the end of 2002, a decrease of 1,099 points or 19.8 percent from the end of 2001. Average daily turnover for the year posted a 17.3 percent increase from the figure recorded in the previous year to NT$88.2 billion, a mild increase when compared with the previous year's NT$75.2 billion, while the Over-the-Counter (OTC) weighted average stock price index slipped by 30.7 percent. Average daily turnover in 2002 increased to NT$11.3 billion, a rise of 19.0 percent compared to the previous year. Uncertainty toward economic prospects led investors to shorten the period for holding stocks and resulted in a slight increase in turnover rates. The turnover rate rose from 207 percent in 2001 to 217 percent in 2002.

There were a total of 638 listed companies at the end of 2002, representing an increase of 54 companies over the previous year-end. Market capitalization amounted to NT$9.1 trillion, a 10.8 percent decrease compared with the end of the previous year. Among all industrial sub-indices, the electrical and financial stocks were the biggest decliners. Electrical stock prices plunged sharply by 36.8 percent during the year against the backdrop of lackluster US hi-tech shares and the anemic recovery in local electronics industry. Financial stocks slipped slightly by 4 percent as bank profits were eroded by bad loan write-offs. However, shares in traditional industries saw a hike in prices, as profitable investments in China and a rise in international commodity prices both contributed to their improved earnings.

For the FY 2002, foreign investors were the most active institutional buyers in the local market with net buying amounting to NT$27.9 billion worth of shares. Local securities investment and trust companies as well as securities dealers also posted net purchases of NT$6.9 billion and NT$3.1 billion, respectively. Stimulated by heating US semiconductor shares and the enhanced capacity utilization rate of a well-known local bellwether company of wafer foundry, foreign investors actively bought shares in March and April, and registered a year high of NT$57.7 billion in net purchases in March. Local securities investment and trust companies registered somewhat flat positions in the first quarter of 2002. The net sale of foreign investors and heightened fears toward war between the US and Iraq caused these local companies to register a net sale during the last four month of the year, however.

The number of listed companies in the OTC market increased by 51 to 384 at the end of 2002. Market capitalization shrank by 38.9 percent over the previous year to NT$862.3 billion. The OTC weighted average stock price index closed at 94.4 points in 2002, indicating a 30.7 percent decline from the previous year-end. The index began 2002 with a boost, reflecting a booming electronics sector, and reached an all-year high of 163.0 points on April 22. As the crisis of the military campaign against Iraq abated and the US electronics equities rebounded, investors displayed restored confidence in the local stock market later in the year.

In terms of different sectors, shares in the electronics sector declined most severely, with a dive of 41.0 percent. Those of the securities sector also dropped, registering a decline of 15.5 percent over the previous year. On the other hand, stocks in traditional industries all registered advances. Among these steel and iron, and textile shares outperformed the others, rising by 35.3 and 44.2 percent for the year, respectively. Average daily turnover increased by 19 percent to NT$11.3 billion in 2002. This pickup was mainly due to the increased trading volume during January-April in line with the stock market rally. Turnover started from its year high of NT$21.2 billion in January. From May to December, however, turnover fell recording a low of NT$5.2 billion in December.

The following figure shows the price indexes and turnovers of the Taiwan Stock Exchange (TSE) between 2001 and 2004:

Bond Market

The bond market was very active in 2002. Total issues of bonds amounted to NT$962.3 billion, a growth of 18.1 percent from a year earlier. Among these, the issuing of central government bonds to meet budget deficits recorded the second highest issue value in history, a close second to 2001. Issues of corporate bonds hit a historic high in association with the weak stock market and declining interest rates. Moreover, bank subordinated debenture issues also significantly increased as banks managed to improve their capital structure. NT dollar-denominated bonds issued by international financial institutions in Taiwan fell substantially due to rising issuance costs and declining real returns, however.

Owing to falling interest rates, the repeal of the bond transaction tax, and implementation of a computerized pricing negotiation system of government bonds, transactions in the secondary market registered a record high for the year. Bond yields were generally on a downward trend during the last three quarters of the year after a mild recovery in the first quarter. Bond funds continued to grow in 2002 because of their higher returns and tax-free advantage, along with sluggish stock market performance and declining bank deposit rates.

The MOF issued central government bonds to the value of NT$426.2 billion in 2002, the second highest level ever recorded, reflecting the tight fiscal position of the government budget. In order to establish the benchmark yield curve, four different maturities of government bonds, namely 2, 5, 10, and 20 years, began to be issued regularly. Moreover, due to easy funding conditions, the weighted average interest rates on winning bids with different maturities all moved down during the year.

Demand for corporate bonds strengthened owing to the continuous expansion of bond funds, which was associated with a weak stock market and declining bank deposit rates in 2002. The new issue of corporate bonds was NT$285.8 billion for 2002, a robust upsurge of 44.34 percent from the previous year. Of the total issue, unsecured bonds accounted for 80 percent. Bank debenture issues recorded an all time high of NT$214.3 billion in 2002, growing by 80.1 percent from a year earlier.

In 2002, as narrowing interest rate spread and NT dollar depreciation led to rising issuance costs and declining real returns, the new issues of NT dollar-denominated bonds by international financial institutions decreased to NT$26 billion, a decrease of 35.8 percent from the previous year. Of these issues, the Inter-American Development Bank (IADB) accounted for the largest share of NT$10 billion. The weighted-average issuing rate on 5-year NT dollar bonds was 2.16 percent, lower than those on bank debentures and corporate bonds with the same maturity.

The downward trend in interest rates from April 2002 onwards prompted bullish sentiment in the bond market, pressing yields of government bonds down to new lows at the end of the year. Taking 10-year government bonds as an example, from January to April, the weighted average yield rose slightly from 3.52 percent to 4.12 percent due to the recovery in the local and international economies, new issues of government bonds and the local stock market's rebound. Since then, the average yield of government bonds slid month by month to a record low of 2.48 percent in December, owing to the downturn of the TAIEX, uncertainty over economic recovery, and the rising tensions between the U.S.A. and Iraq.

Total trading in the bond market was very active and amounted to a record high of NT$134,399 billion in 2002, an annual increase of NT$15,406 billion, or 13 percent. Outright transactions rose by 14.4 percent and repurchase agreement transactions went up by 11.8 percent from the previous year. The share of outright transactions and the share of repurchase agreements in total transactions were 45.1 percent and 54.9 percent, respectively.

Owing to the sluggish stock market and declining bank deposit rates, local bond funds continued to expand during 2002. At the end of the year, the net value of bond funds amounted to NT$1,847 billion, an impressive increase of 29.7 percent from the previous year-end. With respect to portfolio allocation, local bond funds were invested primarily in outright purchases of corporate bonds, repurchase agreements of government bonds and bank time deposits. Of total investment at the end of 2002, outright purchase of bonds accounted for 43.3 percent, bonds with repurchase agreements made up 25.6 percent, and deposits with financial institutions represented 28.2 percent.