Taiwanese banks' shift away from China likely to continue: Fitch

The banks' mainland China exposure fell to 6.2% by end-2016.

Taiwanese banks have reduced their direct exposure to mainland China in the last two years, which puts them in a stronger position to deal with contagion risks stemming from China's debt overhang, pressure on the renminbi, or a potential deterioration in cross-border relations, says Fitch Ratings.

Here's more from Fitch Ratings:

The mainland China exposure (MCE) of Taiwanese banks had fallen to around 6.2% of system assets by end-2016, down from a peak of 8.4% at end-2014. This shift away from China is likely to continue. Taiwan's regulator has capped banks' permitted exposure to China at 100% of their equity, and is unlikely to relax that limit in the near term.

State banks are under pressure to limit growth in their China exposure, and would come under government scrutiny were they to pursue rapid expansion in the mainland. Moreover, the incentive to increase exposure to the mainland will continue to be limited by slower growth in China and cooler cross-strait relations since the new Taiwan government took charge in May 2016.

Taiwanese banks are also now in a stronger position to weather volatility in the renminbi than they were a few years ago. Sales of target redemption forwards (TRF) - a structured derivative product which some investors have used to hedge renminbi exposure and to speculate on currency moves - have fallen significantly from their 2014 peak.

We expect sales to remain subdued, reflecting stricter regulation on mis-selling and speculation as well as the more uncertain outlook for the renminbi. Most banks now have a neutral position with respect to the renminbi, and Fitch estimates that the potential losses from TRFs would be small relative to bank earnings - even if the renminbi were to depreciate more sharply than we currently forecast.

We would now expect the bigger impact on Taiwanese banks from a Chinese shock to be felt indirectly, through the repayment capabilities of Taiwanese borrowers. Exports to China and Hong Kong represent nearly 40% of Taiwan's total exports, and mainland China acts as an important production hub for Taiwanese manufacturers.