Background

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1. Introduction

Since open-door policy was implemented in the 1980s, the China government undertook major reforms and deregulation of the financial system. Various types of financial institutions were established and transformed, and foreign financial institutions started to return to the Chinese market, resulting in a great leap in the development of financial market during the last ten years. Foreign financial institutions started to enter the market by taking the forms of mergers and acquisitions and establishing branches, subsidiaries, or sole ownership when China government promised to completely open the financial market after it joined the WTO. As a result of the signing the Memorandum of Understanding (MOU) between China and Taiwan and the ongoing negotiations related to the supplementary agreement of Economic Cooperation Framework Agreement (ECFA), it is expected that cross-strait financial exchanges will become increasingly frequent. Opportunities to develop Chinese businesses in order to solve the problem of fierce competition that causes narrowing profit margins in Taiwan will be the most important goals and issues facing the domestic financial institutions today.

1.1 Background

With the booming economy and rapidly growing domestic consumption market, together with a commitment to foster a healthy operating environment, foreign financial institutions have been taking the approach of operating the Chinese market on a local basis, where the local unit assumes the responsibilities of operating and investment of the decision-making process. The rationale behind the market growth strategies is based on its own competitive advantage, motive behind the expansion, target profit, and the deregulation process. The vast Chinese market has caused the various economic zones to grow rapidly, and thus, foreign financial institutions have also been active in accelerating its growth to achieve the economies of scale. Initially foreign financial institutions focused on its own customers by offering corporate loans, foreign exchange, treasury, and derivative products to maintain their competitive advantage. However, the extensive spread in loans and deposits and improvement in people’s livelihood has meant that foreign financial institutions today have adopted the approach of becoming a sole ownership, taking equity stakes or formed a strategic partnership with local banks to capture the retail and wealth management businesses opportunities.

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Additionally, the wealthy level of local citizen in China has been cumulated to significant level under high-speed economic development in recent year, and the whole wealthy management market grows up rapidly and leap enormously more than 15% growth rate of million wealth family. With the more diversification of wealth management, tendency of development in district of non-along the coast, raise in the middle bourgeoisie gradually, and importance of asset portfolio in offshore, foreign financial institutions should take this opportunity to develop relative business scope under the consideration of advantage and disadvantage in oneself, and expand to the non-traditional niche banking market further.

The participation of foreign financial institutions in China’s financial market has resulted in improvement of depth and width of financial services offered, asset quality, risk management, capital adequacy, operating structure, and corporate governance.

Allowing foreign financial institutions to take a strategic stake in Chinese banks, the gaps between Chinese local banks and foreign financial institutions have narrowed under healthy operating environment, and the performance and profitability of Chinese banks have since improved sharply.

There are four types of Chinese banks: stated-owned commercial banks, joint-stock commercial banks, city commercial banks, and rural cooperatives. Four state-owned banks take up sixty percent of market shares; the market shares increase to more than eighty-five percent if joint-stock commercial banks are considered. Due to the poor performance of Chinese banks in the early years, including the high rate of non-performing loans and meeting of certain threshold of capital adequacy ratio required by the regulatory body, many banks utilize the advantages of vast customer base and large scale of operations to invite foreign financial institutions to take a minority equity stake. The move also benefits foreign financial institutions due to lower funding costs and the opportunity to develop new products that match the market demand, and to be the supplement of other entry model such as establishment of wholly-owned subsidiary bank or branch with in the face of defect that local business and network is hard to expand rapidly in short-term.

Moreover, China's 12th five-year plan, which is ready to implement a deeper reform on economic development transformation and proceed to make a comprehensive well-off society, will open its financial market and become a trend and main driving force to continue growing the China’s economy. Most foreign financial institutions, along with local regulations, proceed with different strategies and objectives according to their own advantages and choose the most effective way to enter the market by building networks and developing multi-services. Therefore, any

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institution that wishes to make a fine performance and be profitable in a competitive market will need a comprehensive plan to move ahead.

China has recently became world's fastest-growing emerging market, and many foreign financial institutions, including Taiwan’s, have targeted it as the next primary expansion market as matter of course. Other than following the relevant laws and regulation, investors make full use of their own advantages actively, and utilize the advantages to achieve a breakthrough on existing scale of operations in order to make maximum profit possible in the market in China. Looking at the new trends and future development cross strait, as the topics of Economic Cooperation Framework Agreement continues to ferment and China keeps on expanding its domestic demands and accelerates the financial development, the financial economics and trading across strait will expect to be an interactive and two-way development. Taiwanese banks hence believe investing in China is necessary to grow business and make profit, in order to be the regional financial institutions in the near future.

As compared to the saturated financial market in Taiwan, China’s financial market and the economy has shifted its development focus from the coastal area in early years to the more potential inland area in recent years. In addition as the economy advances it also improves the average income per capita in first tier cities in China, thus it is foreseeable in the near future that consumer finance and wealth management offered by the banks will be in hot demand. Since both Taiwan and China are sharing the same languages and cultures, it is expected that there will be room for Taiwanese banks to tap into the potential personal financial services in China with the precondition that the Taiwanese player must adjust its own strategy and their operation to fit into China’s vast geographical and cultural differences.

In consideration of Taiwanese banks are mainly focusing on serving Taiwan-based companies doing business locally in China, the business scope would be limited if banks only continue with the same customer structures when going west.

Looking at the recent change of Chinese economics structure, core operating entity has gradually transformed from state-owned enterprises into more balanced development between state-owned and medium and small-sized enterprises.

Meanwhile, China authority aims to increase the domestic demand and reduce the disparity between urban and rural areas development is advantageous for Taiwanese banks giving that are more familiar with the financial services of SMEs. It is essential for Taiwanese banks to transform their services to local enterprises and consumers rather than serving Taiwan businessman merely in order to create unique opportunity, produce additional profit, and expand its foothold in China in the long run.

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Taiwanese banks currently face potential challenges on planning strategic schemes in China. Other than rigorous financial regulations between Taiwan and China, limitations, such as slow expansion on operating sites, lacking sound personnel training and management system and having a considerable degree of compliance risk make Taiwan’s banking sector in general is deficient in meeting the risk-based capital ratio and maintaining sufficient capital reserves than the international standards. The abovementioned problems hence restrict Taiwan banking sector in promoting business.

In other words, the overall scale of operation and competitive ability of Taiwan banking sector are relative weaker than local Chinese banks and foreign financial institute congenital. If Taiwanese banks maintain the same operating mode and enter China as individuals, banks will likely to face the same situation in which having excessive competition with the same nature in one cluster area, and, in other words, not having sustainable developments. Eventually, the performance and profit would be damage once the market shows obvious overlapping on banking products and targeted customers.

In summary, as China has risen to become the world’s largest emerging economy, both foreign and Taiwan financial institutions all target China as their next breakthrough market. In order to create optimal market entry strategy, therefore it is vital for all institutions to reassess their competitive advantages to achieve maximum operational efficiency.