Editorial: Xenophobia should not block reform

Recent reports that some small banks were either taken over by the government or acquired by foreign investors highlights the negative effects of weakness in those lenders' capital and liquidity as well as in their profitability and risk-taking capability.

Obviously, smaller and under-capitalized banks face more challenges as their stronger rivals are making the competition fiercer, whereas the industry as a whole is still fraught with the problems of fragmentation and interest-margin compression.

Some standalone or small banks that got into financial difficulties because of bad consumer debts have been trying hard to stay afloat. They have done so through improving asset quality and increasing diversification of revenues, as well as by focusing on fee income growth and enhancing risk management.

But the lack of significant progress has left them open to failure and such a failure, as Fitch Ratings warned last week, is very likely to weigh down the overall industry and make it vulnerable to a credit cycle downturn.

In an interview with Taiwanese media on Friday in New York, Financial Supervisory Commission (FSC) Chairman Hu Sheng-cheng (胡勝正) said the government is promoting financial reform in the banking industry. He stressed that foreign investors, including private equity funds, can play a key role in bailing out small and problemic lenders.

Hu said there is concern about private equity funds' entry into the banking industry, but these funds could help the government's reform effort. His comments suggest that the government is welcoming the entry of private equity funds into the financial sector, despite concerns of the potential impact on local capital markets and financial stability.

In fact, the FSC has already shown a tendency to rely more on market-based solutions -- such as buyouts -- than the government's financial restructuring fund to bail out capital-strapped banks.

It started with Longreach Group's purchase of a 51 percent stake in EnTie Commercial Bank and ABN AMRO Bank's acquisition of Taitung Business Bank in June. Then the Carlyle Group agreed to buy a 36.9 percent share in Ta Chong Bank in July and SAC Private Capital Group and GE Money signed a memorandum of understanding with the Cosmos Bank on a capital injection last month.

As the commission has moved to facilitate the pace of industry consolidation by targeting small and under-capitalized banks, it should come as no surprise that some critics and bank staff dislike the trend toward foreign company acquisitions. They see such deals as the cheap sale of local assets to foreign investors. Given that some critics see private equity funds as vultures, they have demanded stringent regulatory requirements for foreign buyouts.

But the problem is that under-capitalized banks badly need fresh blood. Good or bad, the new breed of foreign investors do have their eyes on profits and they will bring in Western-style management and design a new business model to make returns within three to five years.

Foreign ownership should not be seen as evil, as long as the acquisitions were made through a transparent process and a level playing field.

But private equity firms' financing, which has long relied on cheap debt for high-return buyouts, will be an issue as bank loans to these funds have been curtailed due to US subprime mortgage problems. The FSC should pay attention to whether global credit woes will hit these funds and affect their financing of local acquisitions.