Financial technologies (more commonly known as fintech) are creating new efficiencies and services among the financial services sector globally. Taiwan Ratings Corp. believes that while the adoption of fintech is gaining traction in Taiwan, such technology is unlikely to break the stronghold of brick and mortar banks anytime soon.

Taiwan Is Still In The Early Phase Of Fintech Adoption

A simple comparison of fintech adoption by banks in Australia, Singapore, China, South Korea and Taiwan, shows that banks in Taiwan lag quite a way behind the wave of digital progress in competing markets. Indeed, banks throughout Asia-Pacific have been embracing digitalization for several years by riding on the wave of Internet growth and the public's adoption of mobile technologies.

Fintech not only brings new opportunities for banks to become more efficient, but also new threats, especially to the lower entry-barrier banking business such as payments. Indeed, newly emerging fintech companies have proven to be far more tech-savvy and responsive than their brick and mortar counterparts. So much so, that fintech companies could be on the verge of disrupting the traditional banking sector's intermediary roles in many Asia-Pacific markets by using new technology-driven business models. (For further reading please see "The Future of Banking: How Much Of A Threat Are Tech Titans To Global Banks?" published on RatingsDirect on January 15, 2018.)

In response to the challenges and opportunities raised by fintech, incumbent banks in Asia Pacific have largely chosen to update their technology systems first, to provide existing products digitally. This allows banks to compete with new fintech entrants on speed, cost, and ease of access. Some banks have also tried to up their game by cooperating with the more successful tech titans in the adoption of a customer ecosystem. In some cases, banks have even created their own ecosystem that integrates banking into customers' daily lives.

So why then has Taiwan yet to see the emergence of a vibrant ecosystem supporting financial technologies unlike that available in Singapore or even in China? The reason is largely two-fold. Firstly, the pace of deregulation paving the way for new financial technologies has been more gradual in Taiwan than in other countries. In fact, there was no clear guidance from the regulator until very recently, despite full government support for the development of fintech locally. This lack of guidance has hindered innovation among fintech firms as well as slowing banks' adoption of such technologies.

Taiwan's legislators passed the Act on Financial Technology Innovations and Experiment, more commonly known as a "regulatory sandbox," in December 2017. The Act allows developers to experiment with new financial products and services with an exemption from some regulations and liabilities during the trial period. Nonetheless, we expect the actual rollout of such new products or services will not take place until late 2018. While only time will tell how the regulator manages the application of its sandbox ruling, we note that Taiwan also lacks any meaningful incentives to accelerate the development of fintech, such as to attract investment and talent.

Secondly, Taiwan has a higher percentage of bank transfers and cash payments than in other regional banking sectors, due to an extensive island-wide ATM and bank branch network. Thanks to the convenience and relative security of such payment systems, customer motivation to go digital is less than in other geographically larger countries where the banking infrastructure may be less developed or consistent.

In addition, small enterprises such as eateries and taxis prefer cash payments because of the higher fees involved with digital and card payment systems as well as time needed to collect the actual payment from banks, which play an intermediary role. International payment systems such as Apple Pay and Android Pay have only recently entered the Taiwan market. There are also other third party mobile payment systems tapping in this new digital market, but we have yet to see a major catalyst to incentivize customers to adopt e-payment extensively.

Fintech Poses Limited Immediate Risk To Ratings

In our view, the expansion of fintech is unlikely to have a significant impact on Taiwan-based bank ratings over the next two years. This is because we don't see competition from technology companies as a material threat to Taiwan banks for at least that period. Similarly, we do not foresee Taiwan banks changing their business model to encompass fintech in a more material way over the same timeframe.

We believe that Taiwan banks will maintain their current competitive advantages in the core business, especially lending and deposits which higher level of customer trust and sophisticated underwriting professions are required. Meanwhile, the banks shall continue to enjoy the higher entry barrier of banking business, as financial stability and secured banking infrastructure remain the top of priorities of Taiwan banking regulators, We are likely to see continue careful support to the development of fintech with gradual advancement of relevant regulatory framework.

We also believe that Taiwan banks will have to continue to digitalize their business operations to remain competitive as well as bolster defenses around any related emerging risk from new technologies. Indeed, the use of advanced digitalization has helped some European banks to lower their cost-income ratio noticeably compared with the industry average, for example. We expect the extra investment needed for such digitalization will be manageable for most banks in Taiwan and will not affect their credit strength over the short term.

While we estimate that banks will be investing several hundred million Taiwan dollars in fintech over the next two to three years, the actual amount will vary greatly between banks. Indeed, the technological investments of most Taiwan banks have been made chiefly to upgrade their banking systems and digitalize existing products and services. Only a few banks have made more significant investments in the field of artificial intelligence, blockchain technologies, and to adopt some small-scale open-application interfaces over the past few months. In addition, we expect to see banks to acquire or collaborate with fintech companies over time. This could be anything from establishing venture funds to invest in fintech firms to the incubation or launch of their own digital finance companies; whichever best fits their strategic plans.

Fintech Could Dynamically Shift The Competitive Landscape

In fact, the biggest challengers to Taiwan banks are more likely to be peer competitors that are better equipped to leverage financial technologies over the mid-term. Digitalization and the gradual establishment of a supportive ecosystem mean that a physical presence or 'brick and mortar' store will no longer a constraint to participate in the local banking industry. More branches do not necessarily lead to a higher market share of deposits or lending; rather, larger branch networks are increasingly an expense burden if banks do not operate these efficiently.

We expect banks that excel at deploying new technology to see larger gains in terms of customer experience, revenue, and efficiency. On the other hand, banks that are unable to keep pace with the age of digitalization, innovativeness, and the adoption of an appropriate corporate culture will see their revenues fade. This would eventually hit their market competitiveness and threaten their creditworthiness over the long-term, including business position, earning and capital and funding capabilities. However, the process of digitalization and collaborating with fintech firms demands a scale and ability to invest that we believe not all Taiwan banks possess.

Differentiation among banks on how they will cope with or leverage fintech is far from certain. Ultimately, the impact of fintech on bank ratings and how soon this will happen depends on the response from banks as much as from regulatory evolution.

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