5. Timing and Layout in China by Taiwanese Banks
5.2 Analysis and Application of Real Option Model
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By the Regulations of the People’s Republic of China on the Administration of Foreign-invested Banks and Measures for the Administration of the Investment and Shareholding in Chinese-funded Financial Institutions by Oversea Financial Institutions, the requirements that shall meet respectively to establish representative offices, branches, wholly foreign-invested banks, sino-foreign joint venture banks and the investment and shareholding in Chinese-funded financial institutions are enumerated shown in Table 16. According to the Cross-straits Economic Cooperation Framework Agreement which is effective on September 12, 2010, the commitments of Mainland side on liberalization of financial sector are listed on the Annex IV:
Sectors and liberation measure under the early harvest for trade in services shown in Table 17. For the banking and other financial services, to set up wholly owned banks or branches in the Mainland as well as the application to conduct RMB business are listed in the early harvest but without the commitment to the equity stakes acquisition in Chinese banks.
Taiwanese banks provide mainly the financial service for SME of Taiwan in China by establishment of representative office or branch at present. Besides that Fubon Bank (Hong Kong) was on behalf of Taipei Fubon Bank to invest equity of Xaimen Bank around 19.99% with 230 RMB million in November 2008, for those banks that established representative office in early stage such as Land Bank of Taiwan, First Commercial Bank, Hua Nan Commercial Bank, Chang Hwa Bank, Taiwan Cooperative Bank, Cathay United Bank and Chinatrust Bank, they had got approval from Financial Supervisory Commission to set up branch in China in September 2010 and then operated business in December. For the other Taiwanese banks such as Bank of Taiwan, Mega International Commercial Bank, E. sun Bank and Taiwan Business Bank, they continued to set up branch with the reference to the regulation that shall have representative office in the Mainland for more than one year before application under ECFA. The present entry model and location of Taiwanese banks in China are summarized in Table 4.
5.2 Analysis and Application of Real Option Model
The accession to WTO in 2001 facilitates China’s market to be the business battle ground for foreign financial institute to join and expand its territory with different kind of entering method. In addition, the Chinese market is gradually opening up to join with the ongoing negotiation on ECFA, significant relaxation of bilateral relations and increased frequency of trading; Taiwan banking industry has changed its conservative attitude of establishing only representative offices to a more
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aggressive action recently. Therefore, we would like to understand with many other foreign financial institutions have entered China’s market in certain period of time, what are the incentives and conditions for Taiwan banking industry entering the market.
In this sector we will adopt a real option to analyze the situation. The foreign financial institute (exclude Taiwan banking industry) is the leading financial institutes since it entered the market ahead of us, and Taiwan banking industry is the following financial institutes because of the late release to Chinese market. For any financial services provide by foreign financial institute that are beneficial on cooperating banking, retail banking, credit card and wealth management business overall will be seen as inverse market demand function
q of financial services that foreign financial institutions provide where equals to the amount of the financial services provided by leading financial institutes and equal to the amount of the financial services provided by following financial institutes.
q1
q2
Furthermore, we also assume follows the process of geometric Brownian motion as instantaneous expected rate; is the incremental and follows wiener process with initial value
dw
0.
To simplify the analysis, this model also assumes the linear demand function of financial services provided by foreign financial institution does not have externalities and no variable cost. Therefore, once the following financial institutes enter the market, the operating flow at time for leading financial institutes ( ) and following financial institutes ( ) would be
t i1 The discounted value for operating flow and net present value will respectively be
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I is the fixed cost that leading financial institutes and following financial institutes i
have injected after entering the market.
Once the market reaches Cournot-Nash equilibrium of competitions, the reaction function for leading and following financial institutes will be
) 2
The competitive equilibrium would be
2 3 the net present value under the equilibrium of competitions on leading and following financial institutes to both be
i When the staring amount of investment, , is known with great fluctuations on the overall financial services demand, the market is believed at its expansion period, which shows higher profitability for both leading and following financial institutes.
We can further apply this concept on analyzing the potential business type and location for foreign financial institute to find its niche market.
Ii
In addition, although the leading financial institutes (exclude Taiwan banking industry) own the advantages of early entry so that monopolizing the market, they will soon face the competition from following financial institutes due to their aggressive moves. We further examine the strategic investment decision on entering the market, factors that would have an effect on optimal entry threshold and static analysis according to the above condition for following financial institutes.
We assume the condition of instantaneous equilibrium return in starting point before the following financial institutes enter the market to be
dt rV dV
E[ 0()] 0() ; (28) here )V0( is the operating value of staring point and r is the risk free rate. We then adopt Ito’s lemma to get
dt
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From (28) and (29), the Bellman function will be
This explains the operating value of following financial institutes fit above equation under the dynamic random uncertainty with the operating value at starting point satisfy the boundary condition lim0V0()0. The polynomials solutions of the following equation
0
In the Cournot-Nash equilibrium of competitions, we have and the operating value at the starting point for following financial institutes will be
2 0
V . Assuming the fixed cost for following financial institutes be I , we have the net present value of investment NPV0()V0()I.
If the business plan for following financial institute contains features on existing uncertainty, having irreversible cost or optional investment plan, as the future stochastic demand shift parameter, , exceeds the fundamental thresholds of investment , then the optimal waiting to invest operating value will be equivalent to the net present value when executing the business plan by then. The equation will be here E is the operating value of risk-neutral expectation operator at starting point.
Dixit and Pindyck (1994) indicated when T inf(t 0:t *), we have
. Therefore, the optimal waiting to invest operating value will be also shown as
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)1
9 )(
( )
( * * *
I
NPV . (34) By the first order condition, the thresholds on optimal operating stochastic demand shift parameter for following financial institutes will be
3 2
1
* 1
I . (35)
As stated above, when the demand volatility for financial services, , is rising, the instantaneous expected rate of unit time, , is decreasing, the investment fixed cost at starting point, I , is growing and risk free rate, r, is also increasing, then the thresholds on optimal operating stochastic demand shift parameter, , will enhance at the same time. This also means the longer waiting period on operating for following financial institutes.
*
Taiwan banking industry is able to take more aggressive and diversified means to enter as well as expand the market benefit from improved bilateral relations in economics and trade with open financial market as a result of ECFA in recent years.
The following financial institutes, such as Taiwanese banks, are facing the challenge that many other foreign financial institutions have entered the really competitive market and operate for a period of time. However, the demand for Chinese financial services market has not yet reached its saturation and would continue to expand, Taiwanese banks, considered as the following financial institutes in this model due to the late entering, can still be profitability under specific conditions and environmental factors.
The model shows us when the demand of Chinese financial services markets is highly uncertain and the average demand growth of is reducing, the optimal stochastic demand shift parameter to enter the market will be increased respectively. However, there are some conditions could help Taiwan baking industry lower the uncertainty toward to the Chinese market, for example, they have more stable customer sources compared with other foreign financial institutions because many existing customers are Taiwan-funded enterprise. In addition, while as waiting the right time to enter the market and starting the RMB business, Taiwanese banks promote the representative office to a branch, establish subsidiaries or acquire equity stake to reach right customers in a timely manner. Therefore, if Taiwanese banking industry committees to develop the existing market, the demand of Chinese financial services market will increase as China's economy remains strong in which facilitates Taiwan-funded
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enterprise continue to develop and grow in China. Therefore, the barrier for Taiwan's banking industry to entry the Chinese financial market would be reduced under the above factors e as well as expand the Chinese financial market.
The global economy is slowly recovered from financial and credit crisis, the growth momentum, however, does not remain the same. In addition, as a result of strong domestic demand and highly economic grow, China government adopts macro-economic control to mitigate the market from overheated economy into economic bobble, which reducing the entry and startup cost on acquire equity stake or operating setup indirectly for foreign financial institutions. Besides, many governments choose not to raise the current interest rate in order to protect the slowly recover global economy since the subprime mortgage crisis, which creates a reasonably threshold to invest in Chinese market and creates motivations for Taiwan banking industry.
After analyzing on the model, we verified that among several strategies to enter the Chinese financial market, setting up a representative office to cope with the procedure on becoming a branch soon possible under the promise of ECFA have lower optimal operating stochastic demand shift parameter on following financial institutes with the same expectation profit compared with establishing a wholly owned subsidiary or acquire equity stake. Furthermore, with this application, Taiwanese banks could reduce the demand uncertainly because of the main operating business for Taiwanese banks would be serving Taiwan-funded enterprises and gradually expending the RMB business in accordance with regulations. As we expect the Taiwan-funded enterprises continue to grow in the unsaturated market, the demand for better financial services would help Taiwanese banking industry to maintain the current application to Chinese market and reach a goal to have low threshold on optimal operating stochastic demand should be positive.
On the other hand, for banks chosen to enter the China market by establishing a wholly own subsidiary can attain the retail RMB business and expand business to different levels with less constraints compared with other mode of entry. However, the operating cost is much higher with minimum registered capital for setting up a commercial bank is 1 billion in RMB per branch. Once the operating cost increases, the threshold on optimal operating stochastic demand will be increased so that extend the waiting period on investing under this mode. Furthermore, most international foreign institutions, in recent years, have chosen to establish wholly-own subsidiaries and make market segment to distinguish their services from locals’ in order to create a niche market with their experiences and specialty when working in Chinese market.
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立 政 治 大 學
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Consequently, Taiwanese banking industry will face severe competition, from both local and foreign, if applying the same mode as leading foreign financial institutions.
Unless having had distinguish services or ability to create a niche market, Taiwanese banks choose to establish wholly-own subsidiaries would only bring more uncertainly to the decision and increase the optimal investment threshold thereby decrease the effectiveness on investment.
5.3 Equity Stakes Acquisition under Optimal Probability Hazard Threshold