The Taiwan Banker

The collapse of Lehman Brothers in September 2008 can be considered an important milestone in the development of modern finance. The subsequent global financial crisis and an economic recession brought about changes in international regulation and risk management in financial institutions, such as Basel III. Increases in capital provision and liquidity management requirements for banks, as well as new requirements for various systemically important financial institutions (G-SIFIs, G-SIBs, D-SIBs, and SIFIs) have significantly affected financial operations.Looking back at the rooted causes of the financial crisis, perhaps financial innovation outpaced regulation, as said by Christine Lagarde, then IMF chief and now president of the European Central Bank (ECB). Globalization of the banking industry and financial services, as well as regulatory arbitrage, led to the collapse of Lehman Brothers and helped the disaster spread.In the aftermath of the crisis, regulators around the world concluded that the root cause lied in banks which were “too big to fail.” The G20 first promised to fundamentally reform the global financial system, rectify the fault lines that led to the crisis, and establish safer, more flexible sources of financing to better meet the needs of the real economy. Concerns about systemic risk led the international organization to review and propose more stringent regulations.A set of financial regulatory reforms was proposed at the G20 Summit in November 2008. Since then, major international financial organizations have followed those plans to update a number of regulations, focusing on strengthening the resilience of financial institutions, ending “too big to fail,” establishing a safer derivatives market, and strengthening management of shadow banking. Countries were urged to comply with these rules and regulations through regular evaluations.In addition, major economies underpinning the international system such as the US, EU and UK also proposed regulatory reforms. In the US, the Dodd-Frank Wall Street Reform and Consumer Protection Act was passed in July 2010, focusing on strengthening monitoring and control of systemic risks, strengthening regulation of large financial institutions, enhancing consumer protection, and strictly regulating derivatives, among other provisions.The EU implemented significant reforms, including establishment of a special committee to monitor systemic risk, establishment of a single supervision and clearance mechanism, and implementation of the European Market Infrastructure Regulation in 2012 and the Markets in Financial Instruments Directive II in 2014. These measured aimed to improve cross-national supervision and systemic risk monitoring, strengthening financial market regulation and investor protection.The UK made a number of legislative amendments to reorganize the financial regulatory framework starting in 2009. It expanded the supervisory powers of the Bank of England (BOE), required large banks to separate their retail and investment banking businesses in order to segregate risks, and also set up a permanent mechanism for liquidating problematic financial institutions.The most extensive and far-reaching of these financial reforms were of course the regulations set by the Basel Committee on Banking Supervision (BCBS). Basel III, released in December 2010, aimed to address vulnerabilities in the financial system and strengthen financial regulatory reforms, such as requiring the introduction of Capital Conservation Buffers and Countercyclical Capital Buffer (CCyBs). It later added the Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratios (NSFR), aiming to reduce the agency problem of financial institution managers and solving the phenomenon of “too big to fail.” The Financial Stability Board (FSB) also established a detailed supervisory system, introducing a number of evaluation indicators to measure the effectiveness of the reform. These organizations have helped strengthen the resilience of the financial system, as shown in Table 1.Of course, the rights of the general public and taxpayers have not been neglected, including the aforementioned Dodd-Frank Act, as well as financial consumer protection measures and financial inclusion policies, which are believed to have added to the defense of the global financial system.Shoring up Taiwan’s financial system Looking at Taiwan’s domestic financial system, regulators have worked to strengthen financial supervision and implement corporate governance in line with the pace of international efforts, as well as to enhance the financial resilience of the domestic financial system and financial literacy of the general public. The private sector has also invested in resources to complement these policies, helping jointly build a more stable and safer financial system.With respect to capital adequacy and liquidity, in order to comply with Basel III, the Financial Supervisory Commission (FSC) increased the statutory capital adequacy ratios in 2013, requiring the common equity ratio, Type I capital ratio, and capital adequacy ratio to reach 7%, 8.5%, and 10.5%, respectively, starting from 2019. As of the end of the first quarter of 2023, as shown in Fig. 1, the three respective ratios were 11.55%, 12.88%, and 15.08%. The average capital adequacy ratio and leverage ratio of banks under stress was also higher than the statutory minimum, indicating that the banking sector has a certain degree of resilience. Of course, there is no room for complacency. This March, the FSC said that the top priority for this year is to “enhance financial stability and resilience” and listed bank supervisory stress tests as the first of its five major tasks. According a report from the Central Bank, the average liquidity coverage ratio and net stable funding ratio of domestic banks in 2022 were 134.13% and 138.41%, respectively, which are much higher than the statutory minimums of 100%, indicating low overall liquidity risk.As for the indicators related to asset quality and risk resilience, the NPL ratio of domestic banks has been decreasing in recent years, as shown in Fig. 2, reaching 0.15% at the end of 2022 – the best result ever. In terms of profitability, the pre-tax net income of banks in 2022 was a record NT$ 391.9 billion, a significant increase of more than NT$ 50 billion or 15% from 2021. The average ROE and ROA increased from 8.14% and 0.58% in 2021 to 9.33% and 0.62%, respectively. In addition, the six banks designated as systemically important by the FSC (CTBC, Cathay United, Taipei Fubon, Mega, Taiwan Cooperative Bank, and First Bank) all met their capital adequacy ratios by the end of 2022, demonstrating the overall soundness of the banking sector.As for public financial literacy, as Mr. Huang Tien-mu, Chairman of the FSC, said “financial literacy enhances the resilience of the financial sector,” which mainly manifests in two respects. First, it enables the public to judge the financial risks of their investments; second, when consumers are able to discern the attitudes of financial institutions towards sustainability, it enables the institutions to not only rely on self-discipline and external regulation, but also to incorporate market feedback. With the concerted efforts of the FSC, financial institutions and peripheral units, public financial literacy has been enhanced in both quality and quantity in recent years, helping strengthen the overall resilience of the system.Valuable lessons for future developmentLooking ahead, due to factors such as supply chain reorganization and interest rate hikes, the banking industry may face slower economic growth and other broad economic challenges. Banks also face changes in financial risk patterns and tighter regulatory standards, as well as sustained inflation risks, increasing economic uncertainty, and a tougher operating environment overall. Geopolitical risks are meanwhile becoming a new risk factor. Nevertheless, the preparations made since the period of the global financial crisis in 2008 in terms of capital strength, risk management, and supervisory system policies (including consumer protection) have strengthened banks’ resilience, giving them the tools to manage the potential challenges.The past is a lesson for the future. Although it has been 15 years since the crisis, Taiwan’s financial industry must keep in mind the valuable lessons from that time, examine its strategies and practices for business development and risk management, and do a good job of scenario simulation and pre-planning for geopolitical conflicts in order to face possible changes in the future. These measures will be necessary in order to meet the challenges of the next 15-20 years. The author is an associate researcher at the Financial Research Institute, TABF