The Taiwan Banker

At the end of May, Ayers Alliance Group, with NT$ 100 billion in assets, announced its bankruptcy, detonating the largest financial fraud case in Taiwan since the Hong Yuan scandal in 1990. Advertised as exchange rate arbitrage, the fund lost the money of 13,000 domestic investors. 13 listed companies were also caught up in the storm. Even as we point fingers for this incident, we should also take the opportunity to examine the utilization of private funds in Taiwan.The outside world is often concerned about Taiwan’s high current account surplus, excess savings, and net outflow from the financial account. When the current account surplus leads to excess savings and foreign revenues are greater than expenditures, the increase in net foreign debt or equity held by the private sector is recognized as net assets in the financial account, or a net outflow of funds.Although excess savings is a display of economic strength, it is also a source of pressure. Taiwanese businesses have been conservative in their use of funds ever since the financial crisis, which significantly changed the structure of national savings. Corporate savings have continued to rise, accounting for 52.6% in 2022, surpassing household savings, accounting for 43.1%. The domestic savings rate has continued to rise since 2017, reaching a 27-year high of 27.8% in 2022. Taiwan’s excess savings rate is significantly higher than that of Japan, South Korea, and Germany, all of which also have current account surpluses.Net financial accounts outflow over the past 10 years approaches one year of GDP Looking at the contribution of Taiwan’s economic growth sources, its economic structure has long shown a phenomenon of “exports over investment.” The net outflow over the past 10 from the financial account years reaches US$ 665.5 billion, equivalent to almost 90% of its GDP for all of 2022. Foreign securities investment accounts for as much as 90% of this; equity investment has shown a net outflow over the past decade.The issue of excess savings and net financial account outflows has been widely discussed. These long-term flows cannot be explained simply as capital flight. However, it is a fact that Taiwanese are very rich and capable of creating net outflows for 51 consecutive quarters. They also hold a lot of foreign assets. Although we have no data to show or prove how many of these funds have gone to high-risk assets or face the risk of fraud, we can track where the money has gone.Decomposition of private funding sources and utilizationFrom the beginning of 2023, the Central Bank has reported on the balance of financial assets and liabilities and flow of funds of all sectors in Taiwan, showing the sources and uses of private funds. By the end of 2021, the total financial assets of all domestic and foreign sectors reached NT$ 366.6 trillion, of which the domestic sector accounts for 90%, and the foreign sector accounts for 10%.Looking first at the household sector, the balance of financial assets reached NT$ 127.2 trillion. Adding in non-financial real estate assets at NT$ 49.6 trillion, total assets reached NT$ 176.8 trillion. In terms of allocation ratio, real estate accounted for the highest at 28.1%; financial assets including demand deposits, time deposits, foreign exchange deposits and foreign deposits accounted for 24.0%; life insurance reserves and retirement fund reserves were NT$ 34.9 trillion, accounting for 19.7%; stocks, bonds, funds and other domestic securities accounted for NT$ 20.1 trillion, accounting for 11.4%; and foreign securities accounted for NT$ 6.2 trillion, accounting for 3.5%. Household sector debts reached NT$ 19.7 trillion, of which loans from financial institutions accounted for 97.2%.The financial crisis caused the household sector to shift its portfolio from fixed deposits and foreign exchange deposits to assets with high liquidity and short-term flexibility such as demand deposits. As a result, the proportion of fixed deposits and foreign exchange deposits dropped from 26.2% to 15.3%, to below the 15.6% of demand deposits. In recent years, due to aging and declining birthrates, household expenditures on life insurance and retirement have continued to increase, rising sharply from 15.3% to 27.4% over the past 15 years, becoming the fastest growing financial asset in the household sector, as well as the largest single use of funds.For the corporate sector, the balance of financial assets is NT$ 47.5 trillion, mainly including NT$ 8.2 trillion of domestic and foreign deposits, NT$ 8.1 trillion of domestic listed equity, mutual funds, and corporate bonds, etc., and NT$ 10.2 trillion in foreign direct investment and securities. Total debt was NT$ 104.1 trillion, mainly including NT$ 13.0 trillion in lending and NT$ 70.2 trillion in stocks, bonds, and bills. The direct financial credit is 5.4 times that of indirect finance, but the asset-liability ratio is only 45.2%, indicating relatively conservative utilization of funds.For domestic financial institutions, the respective balances of financial assets and liabilities other than the central bank are NT$ 126.4 and NT$ 131.6 trillion, which are mainly loans, domestic securities, and foreign securities, accounting for 81%. Banks hold a total of NT$ 52.9 trillion of public funds, and have used NT$ 36.8 trillion for lending. Due to the economic slowdown, reduced demand for business lending, and increase in deposits, loan-to-deposit ratios have dropped from 82% before the financial crisis to around 70% in the past two years, so less capital is being lent out. For the overall financial sector, the proportion of capital in domestic and foreign investment has increased year by year, catching up with the other uses of funds.The fund allocation of financial institutions should be stable and safe, however the foreign securities investment of domestic financial institutions reached NT$ 29.1 trillion, accounting for 23% of their capital utilization, remaining over 20% over the past five years and growing at an average annual rate of NT$ 2.4 trillion, and approaching the NT$ 33.8 trillion position in domestic securities by financial institutions (accounting for 26.7% of their assets). That position is mainly made up of NT$ 18.8 trillion in overseas insurance bonds, accounting for 64.6% of foreign securities investment by financial institutions, and 64% of funds used by the insurance industry itself. Due to international geopolitical and economic uncertainties, the larger overseas positions in recent years have had a greater impact on the stability of the financial industry.Faced with the dual pressure of low deposit spreads and low deposit ratios, although liquidity risk is low, banks face an urgent need to improve their fund utilization. The market risks of investments such as short-term “quick money” or “opportunity wealth” are high, and such investments must be timed well. Only by thinking about the development of fund allocation channels for the stability needs of both financial investors and the real industry can long-term balance be achieved between cash flow assurance and the benefits of asset disposal.Since the main source of funds in the life insurance industry is premiums with long asset maturity, the domestic market has few suitable investment targets. The interest rate risks and hedging costs caused by the high proportion of overseas long-term bond positions have however brought the yields of insurance policies below those of banks and securities products. It will also be necessary to consider developing more suitable domestic investment targets.Next, looking at the foreign sector, the total balance of financial assets is NT$32.5 trillion, and liabilities are NT$80.5 trillion. In fact, the proportion of foreign direct and securities investment among domestic capital utilization has risen sharply from 8.9% before the financial crisis to the current 14.7%. The domestic sector has continued to increase its use of surplus capital, but the proportion of foreign capital used for domestic investment is still on the low side.Long-term net financial account outflow may offset momentum From the decomposition of Taiwan’s capital flow, the net outflow of the financial account has reached NT$ 2.9 trillion a year. Although the financial industry has increased its foreign investment position by NT$ 2 trillion, utilization of corporate funds and influence of foreign investment are all key factors playing important roles in capital allocation and transmission. This net outflow is not all negative. In addition to reflecting the current account surplus and business globalization, it also earns higher returns than would be available domestically. In the long term, however it may impact domestic investment momentum. In recent years, the geopolitical and economic risks of overseas investment have increased significantly. If Taiwan can improve its social and business environment and corporate competitiveness, capital will find its way back.Observing the utilization of private funds since the pandemic, potential business opportunities in social infrastructure construction are becoming increasingly apparent. Demand is increasing for well-located, convenient, and affordable living security facilities. Innovations in smart medical care have been supported by domestic venture capital funds, and strategic industries such as new energy, national defense, and cybersecurity are also in great need of capital. All these trends are expected to create new drivers of Taiwan’s economic growth over the next 20 years.However, the financial industry has the function of stabilization. New industries are inherently risky. While ensuring operating rights and risk controls, policies can encourage the insurance industry to expand its investment in venture capital and private equity, while moderately relaxing restrictions on investment in public and social welfare undertakings. Calculated on the basis of NT$30.8 trillion in insurance industry funds, an additional 1% injected into social infrastructure and key national strategic industries would already reach NT$ 308 billion.For the banking industry, Taiwan can relax the restrictions on total and net direct investment in venture capital, and promote “social infrastructure fixed deposits” to domestic business clients, utilizing the funds on medium-long-term support for retirement, medical care, nursing care, and long-term care infrastructure.Guiding securities funds into nursing and public welfare trusts The domestic investment credit investment and advisory industry manages a total of NT$ 8.2 trillion in assets, and total foreign assets under its management has also reached NT$ 3.6 trillion. Around 60% of those in the market have less than 5 years of investment experience, creating a new force in the market, but people have clamored into high-yield funds where fraud is frequent, and young investors lack experience and expert knowledge sources. The government and industry must strengthen investor education and supervision of misleading products for this NT$ 12 trillion pool of assets.The Financial Supervisory Commission last year greatly relaxed the previous restriction on the securities industry to only sell investment and wealth management trusts such as funds or securities trusts. It can now provide trusts for elder care, children’s education, disability, and charity, allowing clients’ funds to not only be used to earn money, but also for social benefit.Businesses should also play a role. The household sector has an aging population structure, and their savings rate will not be reduced in the near future; yet corporations also have a high savings rate. They should reduce their savings, improve social income distribution, and strengthen their operating systems. In addition to investing in the industry, they must invest in their employees. The government guides companies to adjust salaries, distribute profits to employees, and expand employee benefits and rewards through administrative preferential measures. This policy-oriented combination can not only improve labor productivity, but also income distribution, guiding corporate profits into consumption while strengthening investment in resilience.Looking at the allocation of private funds from a financial perspective, in addition to discussing the problems of excess savings and financial account outflows, it is also necessary to simultaneously formulate four major overall strategies: improving social income distribution, improving corporate resilience and competitiveness, balancing industrial structure, and creating new sources of innovation.