Central Bank of the Republic of China (Taiwan) Financial Stability Report May 2016 | Issue No. 10 Table of contents About the Financial Stability Report ..................................................................................... I Abstract ..................................................................................................................................... I I. Overview................................................................................................................................ 1 II. Macro environmental factors potentially affecting financial sector ............................ 13 2.1 International economic and financial conditions .......................................................... 13 2.2 Domestic economic conditions ..................................................................................... 29 2.3 Non-financial sectors .................................................................................................... 34 III. Financial sector assessment ............................................................................................ 49 3.1 Financial markets .......................................................................................................... 49 3.2 Financial institutions ..................................................................................................... 58 3.3 Financial infrastructure ................................................................................................. 89 IV. Measures to maintain financial stability ....................................................................... 96 4.1 Measures taken by the CBC to promote financial stability .......................................... 96 4.2 Measures undertaken by the FSC to maintain financial stability ................................. 99 Box 1 The CBC adjusted targeted prudential measures on real estate lending ............... 45 Box 2 Modification to VaR model for measuring banks’ market risks under Basel III .. 81 Box 3 FinTech developments and their influence on the domestic banking industry ..... 84 Appendix: Financial soundness indicators ........................................................................ 102 Explanatory notes: Compilation of financial soundness indicators ................................ 105 Abbreviations ....................................................................................................................... 114 About the Financial Stability Report Key points of the task to promote financial stability Promoting financial stability not only is one of the operational objectives pursued by the Central Bank of the Republic of China (Taiwan), the CBC, but also lays the cornerstone for the effective implementation of monetary policy. To achieve this objective, in addition to serving as lender of last resort when necessary, the CBC regularly monitors the financial system and the overall economic and financial environment. This allows it to be constantly aware of the potential vulnerabilities and risks that could threaten financial stability so that the relevant financial authorities and market participants can respond in a timely manner to avoid financial turbulence. In its work to promote financial stability, the CBC focuses primarily on the risks that could affect the stability of the overall financial system. Nevertheless, the CBC still pays close attention to the status of individual institutions as their weaknesses can trigger systemic risks. Purpose of this report The Financial Stability Report is issued annually. The aims of this report are to offer insight into the state of Taiwan’s financial system and its potential vulnerabilities and risks, and to spark broad-based discussion that will enhance awareness of risk among market participants and spur them to take responsive action in a timely manner. This does not mean, however, that the risks mentioned in this report are sure to occur. Furthermore, this report is intended to serve as a reference for financial authorities, market participants, and others interested in the subject. Readers are advised to interpret or quote the information contained herein with caution. Definition of financial stability There is as yet no universally accepted definition of “financial stability.” Defined positively, “financial stability” can be thought of in terms of the financial system’s ability to: (1) facilitate an efficient allocation of economic resources both spatially and intertemporally; (2) FINANCIAL STABILITY REPORT MAY 2016 I assess and manage financial risks; and (3) withstand adverse shocks. From a negative view, “financial instability” refers to the occurrence of currency, banking, or foreign debt crises, or inability of the financial system to absorb adverse endogenous or exogenous shocks and allocate resources efficiently, with the result that it cannot facilitate real economic performance in a sustained manner. Note: Except as otherwise noted, all data and information cited in this report is current as of 30 April 2016. II FINANCIAL STABILITY REPORT MAY 2016 Abstract Abstract In 2015, the global economy experienced a slow recovery and financial stability risks increased. While the growth momentum of Taiwan’s economy moderated, financial markets continued evolving and financial institutions stayed healthy. These circumstances, coupled with smoothly operating payment systems, underpinned a stable financial system. Meanwhile, the CBC revised targeted prudential measures for real estate loans given that financial institutions have strengthened associated credit risk management. The Financial Supervisory Commission (FSC) reinforced banks’ risk management on complex financial derivatives business to promote the soundness of banking operations. The dynamics of economic performance across the world’s major economies were uneven in 2015. The US grew steadily, while euro area growth remained sluggish and economic recovery in Japan was worse than expected. For emerging economies, growth momentum waned. The recovery in advanced economies is expected to proceed at a moderate pace in 2016, as predicted by IHS Global Insight, while growth momentum in emerging economies will remain subdued. Meanwhile, owing to uncertainties in the global economic outlook, plunging oil and commodity prices, and economic slowdown in Mainland China, financial stability risk elevated and volatility in major stock and foreign exchange markets heightened. Moreover, banking sectors in some economies were still exposed to particular negative shocks, such as deteriorating asset quality of banks in the euro area as well as mounting debt burdens and weakening debt servicing capacities of corporate sectors in emerging economies. In 2015, owing to a substantial decline in exports amid subdued global demand and the threat from industrial supply chain localization in Mainland China, Taiwan’s economy saw slower growth momentum along with stable inflation. On account of the continuous balance of payments surplus, the amount of foreign exchange reserves climbed to US$433.2 billion at end-April 2016 and the scale of external debt contracted, suggesting an enhanced external debt servicing capacity. Fiscal deficits shrank; nevertheless, the government’s debt level mounted. The Fiscal Health Plan was carried out continuously to enhance fiscal soundness. With regard to the non-financial sector, the profitability of listed companies dropped; however, their financial leverage ratio declined, short-term debt-servicing capacity enhanced, and the credit quality of corporate loans stayed healthy. Household borrowing increased FINANCIAL STABILITY REPORT MAY 2016 I Abstract marginally, yet the ratio of household borrowing to disposable income decreased and the credit quality remained satisfactory. Real estate market trading volume contracted while house prices declined gradually. However, the mortgage burden remained heavy. The financial system in Taiwan remained stable in 2015 amid heightened international and domestic economic and financial volatility. As for financial markets, bond issuance in the primary market expanded, but the turnover of transactions in the secondary market remained at a low level. Meanwhile, volatility in stock markets reversed to fall after rising up and foreign exchange markets remained dynamically stable. With respect to financial institutions, the profitability of domestic banks declined slightly in 2015; however, their sound asset quality, sufficient provisions, adequate capital levels, and ample liquidity persisted. Life insurance companies and bills finance companies both reinforced business performance and their financial conditions exhibited sound fundamentals. With regard to financial infrastructure, the major payment systems operated smoothly during 2015. While the foreign currency clearing platform planned by the CBC has been broadly completed, the CBC is attentively facilitating the development of a mobile payment platform in Taiwan. To pursue the operating objective of promoting financial stability, the CBC successively adopted appropriate monetary, credit, and foreign exchange policy measures in 2015 in response to the uncertainties surrounding the evolution of global and domestic economic and financial conditions. The underlying measures included lowering policy rates three times, maintaining the growth of broad monetary aggregates at appropriate levels, and implementing a flexible managed float foreign exchange rate regime. Moreover, the CBC also revised targeted prudential