Why Taiwan's Large Banks Have Systemic Importance And Large Insurers Don't

Primary Credit Analyst: Eva Chou, Taipei (8862) 8722-5822; eva.chou@taiwanratings.com.tw Secondary Contact: Andy Chang, CFA, FRM, Taipei (8862) 8722-5815; andy.chang@taiwanratings.com.tw

Table Of Contents
Unlike Insurers, Banks Fulfill Crucial Functions That Could Qualify Them For Systemic Importance Life And Non-Life Insurance Models Pose No Systemic Risk To The Financial System Insurers Are Unlikely To Become Systemically Important Despite Strong Growth Related Criteria And Research

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Why Taiwan's Large Banks Have Systemic Importance And Large Insurers Don't
(Editor's Note: Taiwan Ratings Corp., a partner of Standard & Poor's Ratings Services, issues rating symbols accompanied by a "tw" prefix to denote Taiwan and the rating scale's focus on Taiwanese financial markets.) Taiwan Ratings Corp. believes the government of Taiwan will provide extraordinary support to domestic banks of moderate and high systemic importance in times of financial stress. But the government is unlikely to extend the same support to Taiwan's large insurance companies. As of October 2013, we assess ten domestic banks as systemically important to the island's banking system according to our banking criteria, with factors such as deposit market share. Of these banks three have high systemic importance and seven have moderate systemic importance. In contrast, we do not view insurance companies as having systemic importance under our rating criteria, despite some insurers' higher market share in their respective business area or the larger total assets of some leading life insurance companies compared with banks. Taiwan's top three life insurers held a combined 56% market share of total premiums as of the end of 2012, whereas the top three banks held just 27% market share of deposits at the same time. And despite the strong growth momentum of Taiwan's insurance industry over recent years, we don't expect our criteria to recognize systemic importance for insurers in the near future. Overview The government of Taiwan is only likely to provide extraordinary support to systemically important banks and not extend such support to insurance companies with strong market share. Governments act to support the national economy and financial system from the adverse effect of bank failures. The insurance business model has no systemic risk due to the absence of on-demand liabilities and therefore no threat of an immediate withdrawal of funds by policyholders.

Unlike Insurers, Banks Fulfill Crucial Functions That Could Qualify Them For Systemic Importance
Banks' role in safeguarding national savings, allocating deposits to companies and individuals in the form of loans and investments, and serving as intermediaries and agents in financial transactions gives them a degree of importance in the functioning of an economy. In addition, governments implement monetary policy via the banking industry and maintain lending arrangements for banks to balance their books on a daily basis and to meet short-term liquidity needs. That is why governments closely regulate banks to ensure that the industry as a whole can perform these crucial roles in a manner that maintains the confidence on which the modern financial system depends. Because we believe the Taiwan government shares this view, we classify Taiwan as being "highly supportive" of banks. We view a bank's systemic importance as the degree to which the bank's failure would affect all or parts of the

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Why Taiwan's Large Banks Have Systemic Importance And Large Insurers Don't

financial system and the real economy of the country where it operates. A bank has high, moderate, or low systemic importance. The failure of a bank we classify as having high systemic importance is likely to have a highly adverse effect on the financial system and the real economy. Excluding Bank of Taiwan and Agricultural Bank of Taiwan, which we classify as government related entities, we assess Taiwan Cooperative Bank Ltd., Land Bank of Taiwan, and Mega International Commercial Bank Co. Ltd. as being of high systemic importance given their significant deposit market share or important role in the foreign exchange market. The failure of a bank we classify as having moderate systemic importance is likely to have a material but manageable adverse effect on the financial system and the real economy. Several large banks with meaningful deposit market share or in which the government holds part ownership or some decision-making power fall under this category. A bank has low systemic importance when it does not fit the criteria for high or moderate systemic importance. We view the majority of banks in Taiwan as having low systemic importance.

Life And Non-Life Insurance Models Pose No Systemic Risk To The Financial System
We don't expect governments to provide insurers with capital or liquidity in times of need because insurers do not possess the same functional characteristics as banks. Taiwan insurers' business models do not involve on-demand liabilities that are akin to bank deposits, and insolvent insurers can generally be wound down in an orderly fashion, whereas banks generally cannot. In addition, the Taiwan government provides bank deposit protection of up to New Taiwan dollar (NT$) 3 million per depositor in domestic banks. However, the Deposit Insurance Law stipulates that the protected amount is not limited to NT$3 million if there is systemic risk involved. The government actually provided a full deposit guarantee during the period of financial market dislocation from late 2008-2010. This also echoes our point that banks' failure may cause financial instability. Banks play a major intermediary role in an economy's financial payment system and the failure of one bank could lead to the default of other participants in the interbank market or other transactions. By contrast, insurance firms are merely participants in the market but do not function as intermediaries. In Taiwan, insurance policy holders are protected through an industry-funded compensation scheme. When an insurer becomes insolvent and falls under the regulator's control, the compensation scheme will reimburse 90% of claims up to NT$3 million. However, the surrender payment--the amount the insurer will pay a policy holder when the policy holder voluntarily surrenders the policy--would be only 20% of the contractual obligations for which the insurer is liable, and to a maximum NT$1 million for life contracts and 40% for nonlife contracts. The high surrender charge embedded in insurance policies has also prevented a "bank run" for insurers and removes the threat of systemic risk.

Insurers Are Unlikely To Become Systemically Important Despite Strong Growth

Taiwan's insurance sector has shown significant asset growth over the past few years, partly as a result of over liquidity in the banking sector. Banks have been successful in promoting deposit-like insurance policies over the past

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Why Taiwan's Large Banks Have Systemic Importance And Large Insurers Don't

five years amid rising excess liquidity and low interest rates. Taiwan's largest insurer held assets of NT$3.6 trillion as of the end of 2012, which was close to the size of Taiwan's largest bank at NT$4.1 trillion. We don't believe the insurance industry can sustain such growth in the coming two years, but even if it does, we don't expect insurers to benefit from direct extraordinary government support as a result.

Related Criteria And Research

Possible Ratings Implications For Global Systemically Important Insurers, July 19, 2013 Banks: Rating Methodology And Assumptions, Nov. 9, 2011

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