Thailand s Financial and Banking Systems

Transcription

1 Thailand s Financial and Banking Systems By Plearnpit Satsanguan and Sukanda Lewis Faculty of Economics Thammasat University

2 Thailand s Financial and Banking Systems 1. Introduction Thailand s financial system, which is dominated by the banking sector, remained robust in 2008 despite the economic slowdown due to the global financial crisis which began in the summer of The performances of Thai authorities in managing its money and banking affairs in 1960s and 1970s were impressive, partly due to successful development and diversification of its financial institutions. However, economic imbalances in the early 1980s and the rising tendency of government intervention put the financial sector under stress, thus reducing its efficiency in resource mobilization and allocation (U.S. Library of Congress). During the 1980s and early 1990s the Thai financial institutions particularly under the supervision of the Bank of Thailand, the Central Bank, had been under the process of financial liberalization that includes deregulation of international capital flows, a movement toward a more flexible exchange rate system, and financial innovation. In order to reach the ambitious goal of turning Bangkok to be a regional financial center, the Bangkok International Banking Facilities, BIBFs, was established in 1993 which eventually led to the East Asian Financial Crisis in The purpose of this paper is to explore the development of Thailand s financial and banking systems. The current situations of Thailand s financial and banking systems are also discussed. In addition, the paper covers the recent financial reforms and the weaknesses in the financial sector as well. This paper is organized as follows. Section 2 describes the overview of Thailand s Financial and Banking Sector. Section 3 summarizes the recent financial sector reform. Section 4 outlines various policy measures toward financial liberalization between the late 1980s and the early 1990s. Section 5 addresses the current weaknesses in the Thai Financial Sector. 2. Overview of the Thai Financial System Thailand s financial system can be classified into four major constituents, namely: i) commercial banks; ii) capital markets (including both the stock and bond markets); iii) government-owned specialized financial institutions (SFIs); and iv) non- 1

3 bank financial intermediaries comprising finance companies, credit foncier companies, life insurance companies, and various co-operatives (Disyatat and Nakornthab, 2003: 3). 2.1 Commercial Banks Table 1, which provides some salient features of these four constituents as of end-2002 and end-2008, indicates that commercial banks are the oldest financial institutions and dominate the Thai financial system, accounting for 56 percent of total financial sector assets (excluding capital markets) at the end of As of March 2009, there were 14 domestic banks, 16 foreign bank branches, 3 retail banks and one subsidiary. Commercial banks in Thailand are allowed to undertake universal banking. Banks can offer a wide range of financial services in both traditional and investment banking. Between 2004 and 2008, the local banks were focused primarily on commercial banking, with interest income accounting for about 80 percent of total income. Currently, banks turn from traditional corporate banking to retail banking and SME businesses because they offered better diversification and enhance profit. Facing with intense competition in the banking sector, banks implemented competitive strategy including modernizing their services, expanding their networks, and differentiating themselves by offering more financial products such as short-term bills of exchange (B/E), special deposits, and cross-selling of products such as by acting as broker for life insurance and selling of mutual fund products (Bank of Thailand, Supervision Report 2007: 13). Before the financial crisis in 1997, Thailand s financial system can be described as bank-based, with commercial banks dominating the landscape. However, after the crisis, the role of the banking sector becomes less prominent, as shown in Table 2. As of 2008, the banking sector still had the largest share of the whole financial system. However, the stock market and the bond market have more important presence. Changing Financial Landscape The structure of the Thai financial sector has changed significantly since the financial crisis. Before the crisis, the financial sector consisted of a large number of 2

4 financial institutions, and was heavily dominated by finance and securities companies. Of the total 176 financial institutions under the supervision of the Bank of Thailand, there were 91 finance and securities companies. Due to closures and mergers of many finance and securities companies after the crisis, this landscape changed. As of December 31, 2003, there were only 18 finance and securities companies left operating. Figure 1 shows the changing composition of the financial institutions under the supervision of the Bank of Thailand from 1997 to 2003 and Since 2003, the change in financial landscape has continued. 3

5 Table 1: Major Constituents of Thailand s Financial System Constituent 1. Commercial banks 2. Capital markets 3. Specialized Financial Institutions (SFIs) 4. Non-bank financial intermediaries First Est. Total Share of Total No. assets/values Financial institution ( Bt b) Assets (%) Domestic banks ,780 8, Foreign bank branch , SET market capitalization 1975 N.A. N.A. 1,986 3,568 N.A. N.A. Public bonds Outstanding 1933 N.A. N.A. 1,757 4,002 N.A. N.A. Corporate bonds Outstanding 1992 N.A. N.A ,002 N.A. N.A. Securities companies Mutual fund companies , Government Savings Bank BAAC Government Housing Bank IFCT N.A. 210 N.A. 2.2 N.A. Export-Import Bank SME Bank (formerly SIFC) Secondary Mortgage Corp Finance companies Credit Foncier companies Life insurance companies Agricultural cooperatives ,073 4, Non-agricultural cooperatives ,333 3, Source: BOT; DOI; SET; TBDC 1, 2, 5 Statistics at the end of Quarter3/ IFCT merged with The Thai Military Bank Public Company Ltd. since 1 September , 6, 7 8 Statistics at the end of the year

6 Table 2: Shares of the Thai Financial System (%) Bank Loans Equities (SET market capitalization) Domestic Bonds (par value) Source: The Thai Bond Market Association At present, the landscape is significantly different from the one in the postcrisis period, as shown in Table 2. We see a significant drop in the number of the financial institutions under the supervision of the Bank of Thailand from 83 to 42. This was due to the implementation of structural reforms as outlined in the Financial Sector Master Plan (FSMP) Phase I, which was implemented in 2004 and was completed in One of the three visions of the FSMP-I was to develop competitive, efficient, stable and balanced financial system. To achieve this vision, several measures were implemented, for example, the licensing reform and the Onepresence policy. 5

7 Figure 1: Structural Changes in Financial Institutions under the Supervision of the Bank of Thailand Source: Bank of Thailand According to the Bank of Thailand (BOT) s Supervision Report 2006, types of licensing for domestic deposit-taking financial institutions were reduced from six types- commercial bank, foreign bank branch, International Banking Facilities, restricted bank, finance company and credit foncier company - to four types - commercial bank, retail bank, foreign bank branch and subsidiary of a foreign bank. In addition, the One-presence policy requires that individual financial conglomerates are allowed to have only one deposit-taking financial institution in their group. Improved Stability Since the financial crisis, there has been improvement in the stability of Thai commercial banks. The ratio of gross non-performing loans (NPLs) to total loans has been decreasing steadily. As shown in Figure 2, the ratio of gross NPLs to total loans of commercial banks reached its peak of 50% around the first quarter of 1999, and has been declining gradually. By the fourth quarter of 2008, they were only around 8% of total loans. The ratio of NPLs to total loans of foreign banks has been low throughout the period. 6

8 Source: Bank of Thailand The increased stability is also reflected in the capital adequacy ratio (CAR), which is the ratio of bank s capital to risk-weighted assets. It measures how well banks can absorb a reasonable amount of losses. Figure 3 shows the evolution of CAR since the first quarter of As of the fourth quarter of 1997, the CAR of commercial banks was around 10% but by the end of 2008, this ratio almost reached 15%. Commercial banks are now much more resilient to negative shocks. This is mainly due to the financial reforms implemented by the Thai authorities in the last decade and the changes implemented by commercial banks facing increased competition. Source: Bank of Thailand 7

9 Higher Profits As shown in Figure 4, at the height of the crisis, commercial banks had more than a total of 100,000 million baht of losses. During , there have been several huge swings in the net profits of commercial banks. However, since 2002, commercial banks have higher and less volatile profits due to higher net interest rate income and stronger non-interest income (see Figure 5). Source: Bank of Thailand Source: Bank of Thailand Thai Banking System Remained Strong and Stable in 2008 Box 1 summarizes the health of the Thai banking system in The global financial turmoil had very limited direct impact on the Thai banking sector. This is due to the fact that Thai banks had low direct exposure to collaterised debt obligations 8

10 (CDOs) and other problem assets. As of September 2008, exposure to CDOs was 0.02 percent of total assets (Bank of Thailand, Supervision Report 2007: 38). Moreover, Thai banks are relying on local deposits as main source of funds. Table 3 confirms that the local commercial banks had been in solid positions between 2004 and Box 1 Thailand s Banking System Performance in the Year 2008 The banking system recorded a net profit of 99 billion bahts in 2008, up from the previous year when the strengthened NPL provisioning rule, in line with International Accounting Standard No.39, was completed. The strengthened provision helps to ensure that banks have adequate cushion against future risk. Return on asset (ROA) stood at 1% in 2008, while the ratio of capital to risk asset (or the BIS ratio) stood at 14.2% as of December 2008, when the strengthened capital requirement under Basel II became effective. (The ratio as of September was 15.7%, when under the Basel I standards). Loan growth accelerated in the first nine months but decelerated in the fourth quarter in line with the economic conditions. Overall, loan expanded by 11.4% for the year, up from the 4.7% growth recorded in Corporate loan (constituting 75.3% of total loan) and consumer loan rose at 10.5% and 14%, respectively. In contrast, deposit growth which fell in the first nine months of the year, accelerated in the fourth quarter, growing by 8.6% for the year, due to increased emphasis on mobilisation of deposit which constitutes core funding for liquidity enhancement, aided by low rate of return of risky assets in line with the downturn in the global stock market. Commercial banks also increased their fund mobilization via borrowing in the form of Bill of Exchange (B/E) which grew by 9.2%. With the convergence of deposit and loan growths, liquidity of the banking system improved, with the ratio of loan to deposit plus B/E easing to 88.3%. Gross non-performing loans (gross NPLs) amounted to 397 billion bahts a 56 billion bahts decrease from the end of The NPL per total loan ratio decreased with gross NPL and net NPL ratios standing at 5.3% and 2.9%, respectively. The decline in NPL resulted from loan repayment, debt restructuring, writing-off, and close monitoring of asset quality to prevent new NPL. The NPL ratio for both consumer and corporate loans decreased. However, there remains pressure on asset quality as indicated by the increase in special mentioned loan (i.e. loans which are past due by over 1 month but not exceeding 3 months), resulting from current global financial crisis which caused the slowdown in domestic and global economy, weighted down on loan repayment ability, thus commercial banks should remain vigilant and closely monitor their asset quality. Source: Bank of Thailand News 9

11 Table 3: Domestic Bank's Selected Financial Soundness Indicators Q4/2004 Q4/2005 Q4/2006 Q4/2007 p Q4/2008 p Capital Adequacy Ratio (%) Capital funds/risk assets Tier 1 Capital/Risk assets Asset Quality (%) Non - performing loan/loans Loans/Deposits Liquidity/Deposits and Borrowings n. a Off-balance-sheet Transactions/Assets Loan Classifications (% of Total Loans) Production Wholesale, Retail Sale and Repair of Motor Vehicles, Motorcycles, Personal and Household goods Financial Intermediation Personal Consumption Profitability (%) Net interest income and dividend/average net assets (Per year) (NIM) Net profit (loss)/average net assets (Per year) (ROA) Non-interest income/total income Source : Bank of Thailand 10

12 How Good is the Thai Banking Sector in 2009? The monetary authorities are cautious on the risk from the indirect impact from the global economic slowdown on the real sector and have emphasized the importance of vigilance on risk monitoring including implementing stress tests to ensure adequacy of capital, liquidity, and most importantly, risk management strategy (Bank of Thailand, Supervision Report 2007: 14). In the first quarter of 2009, the subprime credit crisis had caused a drastically drop in Thailand s exports, imports and a higher rate of unemployment. Eventually, it had resulted in a decrease in Thailand s GDP growth rate by 5-6 % in the same period. It is expected that banks loan growth will be slow. It is evidenced that the unfavorable macroeconomic environment in the first quarter of 2009 had forced most of commercial banks to adjust their loan growth from 8 percent to 5 percent in April 2009 (Thai Post, April 30th, 2009: 5). We can foresee that the performance of the Thai banking sector in 2009 may not be as robust as in the past few years. Fitch Ratings (Thailand) Limited predicted that Thai banks were likely to face renewed asset quality, higher funding costs and a decline in loan growth in 2009 (Fitch Ratings 2008:5). Major Developments The Implementation of Financial Sector Master Plan (FSMP) Phase I The FSMP-I has 3 visions: (i) provide financial services to all potential economically viable users whereby users should have access to basic financial products and services at the appropriate pricing; (ii) develop competitive, efficient, stable, and balanced financial system, capable of servicing the sophisticated and unsophisticated users; and (iii) ensure fairness and protection for customers. Several progresses have been made to strengthen the financial sector strategy and structure, improve the depth and efficiency of the financial sector, and ensure customers protection. However, the progress in improving access to financial services by small and medium-sized enterprises and low-income households still has not been fully realized. Regulatory Reforms Risk based supervision by the BOT and risk management in the banking system have been strengthened significantly since the crisis. In preparing for Basel II, 11

13 the BOT has developed a range of risk management systems and a set of prudential guidelines to enhance banks risk management practices. Furthermore, the BOT has continuously conducted risk based examination and supervision focusing on strategic risk, credit risk, market risk, liquidity risk, and operational risk of commercial banks. The BOT also implements consolidated supervision for commercial banks. So far, banks have undertaken organizational restructuring to enhance effective risk management, internal control, and corporate governance, as well as improving risk management tools. 2.2 Capital Markets The equity and bond markets make up the second most important constituent of the Thai financial system. The Stock Market Thailand s equity market, the Securities Exchange of Thailand (SET), was established in It operates under the legal framework laid down in the Securities and Exchange Act, B.E (1992). It main operations include securities listing, supervision of listed companies and information disclosure, trading, market surveillance and member supervision, information dissemination and investor education ( By the end of 1993 SET market capitalization had reached 105 percent of GDP (Disyatat and Nakornthab, 2003: 4). Figure 6 shows the SET market capitalization from The market capitalization faced a major reduction due to the stock index decline in As of January 2009, the market capitalization is around USD 100 billion. Figure 7 shows the SET index evolution from 1996 to The (SET) was badly affected by the 1997 crisis. The SET Index had experienced sharp declines since Before the crisis, the SET Index was over 1200 points. In the middle of 1998, at the height of the crisis, the index dropped to around 200 points. During the period between 1999 and 2003, the SET index stabilized at around 400 points. Due to better prospects in the economy, in December 2003, the SET index reached 772 points. The market stabilized at that level for a few years then fell back to 400 points in November 2008 due to the financial crisis in the United States and negative domestic factors such as the economic downturn and political turmoil in Thailand. 12

14 Source: Stock Exchange of Thailand Source: Stock Exchange of Thailand The Bond Market Bonds were first introduced in Thailand during the reign of King Rama the 5 th in 1905 when the Thai government issued bonds of one million pounds in London and Paris in order to develop a railroad project ( The Thai bond market did not progress significantly in the past due to two main reasons. First, the government did not issue any domestic bonds during 1987 and 1997 because of the budget surplus. Second, before the existence of the Securities and Exchange Act in 1992, the law prohibited limited companies from issuing debentures (Disyatat and Nakornthab, 2003: 4). Moreover, most bonds activities occurred off the Exchange floor, or so called Over the Counter (OTC) buying and selling through big commercial banks- which deter small investors and some institutional investors from investing in the bond market because the lack of transparency for both pricing and quantity ( To support the development of Thailand s secondary bond market, the Stock Exchange of Thailand (SET) officially launched the Bond Electronic Exchange 13

15 (BEX) on November 26 th, The SET committee allowed both government bonds and corporate issues to be traded in its Exchange. Since the crisis, the size of the domestic bond market has grown substantially mainly driven by the growth of the government securities. Figure 8 shows the relative size of the government securities and the corporate bonds according to the outstanding value. The Thai domestic bond market is clearly dominated by the government securities. Figure 9 shows the combination of new issuances of government securities, i.e. Treasury bills, state agency bonds 1, state-owned enterprise bonds, and government bonds. Since 2004, the new issuance of state agency bonds has increased tremendously. Source: The Thai Bond Market Association Source: The Thai Bond Market Association Before the financial crisis, the market for corporate bonds was virtually nonexistent. In the first quarter of 1997, the issuance of debt from the corporate sector amounted to only 3,709 million baht and remained at a very low level for several 1 State agency bonds consist of BOT bonds, Financial Institution Development Fund (FIDF) bonds and Property Loans Management Organization (PLMO) bonds. 14

16 years. As shown in Figure 10, there has been a continuous increase of the new issuance of private debt securities, starting from the third quarter of In the second quarter of 2008, the issuance of corporate debt amounted to around 400,000 million baht, reflecting a surge in investment demand in the corporate sector. However, there seems to be a downward trend of new corporate bond issues from the second half of 2008 onwards due to Thailand s economic recession. Figure 11 shows the relative importance of commercial papers in the new issues of corporate bonds in the last few years. Since 2006, the corporate sector has sought short-term financing for working capital from the bond market. This confirms the increasing prominent role of the bond market relative to the banking sector. Source: Bank of Thailand Source: The Thai Bond Market Association 2.3 Specialized Financial Institutions-SFIs The third constituent of the Thai financial system consists of six governmentowned SFIs (see Table 1), accounting for 14 percent of total assets in During the past few years the SFIs, in particular, the Government Savings Bank (GSB), the Government Housing Bank (GHB), and the Bank for Agriculture and Agricultural 15

17 Co-operatives (BAAC), had a more prominent role. This is due to the fact that SFIs had been actively used by the Thaksin government to carry out the populist policies in extending loans to the underserved segments of the population such as the poor and small and medium sized enterprises (SMEs). In Thailand, SFIs serve as a government s arm for the economic and social development as well as certain policy implementation agencies in order to provide financial assistance to specific sectors of the economy. With the range of services provided such as housing credits, credits to SMEs, export-import credits or microcredits, SFIs are able to reach various types of customers, particularly low-income groups who are unable to access the service of commercial financial institutions (Menkhoff and Suwanaporn 2006:7). The BAAC, established in 1966, has been the main source of credit for farmers. It was upgraded to be the rural bank in order to provide loans beyond the agricultural sector. Table 4 presents some financial indicators for the three most important SFIs. It demonstrates that all of these SFIs maintained Capital Adequacy Ratio-CAR at the level higher than regulatory requirement. GSB had the highest CAR of % in the third quarter of Even though ROAs of these SFIs were lower in the third quarter of 2008, the quality of capital of these SFIs remained strong. For asset quality, measured by the ratio of NPLs to total loans, only GSB had done a good job. Its NPLs/Loans ratio was the lowest at 3.72 % in the third quarter of 2008 and lower than that of local commercial banks. BAAC had made a lot of improvement in its asset quality in Its NPLs/Loans was 9.70 % in the third quarter of 2008 which was a lot lower than in 2007 which stood at %. GHB had the worst asset quality. Its NPLs/Loans was 16.40% in the third quarter of 2008 which was double that of 2007 since GHB had to comply with the populist policy implemented by the Thaksin Government in extending loans to build houses for the poor. It is not surprising for GHB to have higher NPLs/Loans ratio since its loan/deposit ratio of GHB was so high. It was 122 % in the third quarter of 2008 while those of BAAC and GSB were 102 % and 76.8 % respectively in the same period. Only GSB had higher return on assets (ROA) in third quarter of 2008 than that in 2007 whereas ROAs for BAAC and GHB in the third quarter of 2008 were about half of that in

18 Table 4: SFI s Selected Financial Soundness Indictors Institutions Ratio 2002* 2003* 2004* M2008 Capital Adequacy Ratio (%) GSB Capital funds/risk assets (BIS Ratio) GHB Capital funds/risk assets (BIS Ratio) BAAC Capital funds/risk assets (BIS Ratio) Asset Quality (%) GSB GHB Non - performing loan/loans Loans/Deposits Non - performing loan/loans Loans/Deposits BAAC Non - performing loan/loans Loans/Deposits n.a. n.a. n.a Profitability (%) Net interest income and dividend /Average net assets (Per year) (NIM) GSB Net profit (loss)/average net assets (Per year) (ROA) GHB BAAC Non-interest income/total income** n.a. n.a. n.a Net interest income and dividend/ Average net assets (Per year) (NIM) Net profit (loss)/average net assets (Per year) (ROA) Non-interest income/total income** n.a. n.a. n.a Net interest income and dividend /Average net assets (Per year) (NIM) Net profit (loss)/average net assets (Per year) (ROA) Non-interest income/total income** n.a. n.a. n.a Source: State Enterprise Review, State Enterprise Policy office * Specialized Financial Institutions Annual Report ** Calculated from State Enterprise Review 2007, Q2/2008 (only BAAC) and Q3/ Non-bank Financial Intermediaries 17

19 Non-bank Financial Intermediaries are the final constituent of the Thai financial system, accounting for 11 percent of total Thai financial sector assets in Life insurance companies play the most important role in this constituent, accounting for 5.2 percent of total assets whereas the significance of finance companies is negligible, accounting for only 0.3 percent of total assets as of Insurance Industry The Thai insurance market had been closed for decades until the government liberalized it in the late 1990s. This has resulted in about 100 insurance companies operating in the market. In 2009, there are 25 life insurers, 72 non-life insurers and 2 reinsurance companies. The Thai life insurance industry starts with the establishment of a foreign company, American Life Assurance, AIA, in Eleven years later the first Thai insurance company, Thai Life Insurance, was established (Karim and Jhantasana 2005: 21). The growth rate of the Thai insurance business between 2000 and 2007 was very impressive. It was higher than Thailand s GDP growth rate and reached its peak at percent in Since then it had continuously declined to 8.05 percent in 2007 (see Table 5). However, the life insurance companies had the highest growth rate at percent in Table 5: Growth in Insurance Industry (%) Item * 2007* GDP Insurance Business Life Insurance Non-life Insurance Remarks: * indicates estimates Source: Annual Report 2006, Department of Insurance, Ministry of Commerce. The insurance sector in Thailand is relatively small by world comparisons. In 2005, the Thai s insurance penetration ratio, which is a ratio of premiums to GDP, was 3.60 percent whereas the world average was 7.52 percent (see Figure 12). In 18

20 2003, only fifteen percent of population holds life insurance policies with a premium of about 3 billion dollars (Karim and Jhantasana 2005: 22). The Thai life insurance industry is heavily concentrated with the five largest insurers control 51 percent of the market share in 2007 (see Table 6). The market is dominated by AIA, a foreign branch, which holds percent of the market while the largest local company, Thai Life Insurance, has a market share of percent. In order to reform and strengthen the insurance industry, the Commission for Regulation and Promotion of Insurance Business Act 2007 established a new industry regulator, which is widely known as the Insurance Commission, to replace the previous one which was housed under the Ministry of Commerce. The new regulator is shifted to be under the supervision of the Ministry of Finance which is more suitable than the Ministry of Commerce in overseeing the insurance industry. Figure 12: Insurance Penetration (premiums in % of GDP in 2005) Source: Annual Report 2006, Department of Insurance, Ministry of Commerce Currently, new insurance products offered include voluntary motor insurance policy type 4, non-performing loan insurance, weather index insurance, unit-linked insurance, high-rise building insurance and universal life insurance (Annual Report on Insurance Business 2006, Office of Insurance Commission: 1). Table 7 presents profit and loss statements of life insurance companies in Thailand for 19

21 Table 6: Market Share of Direct Premiums of Life Insurance For the Year Ending 31 December 2007 Number Grand Total Companies Direct Premiums % 1 A.I.A 78,176, THAI LIFE INSURANCE 30,752, AYUDHYA ALLIANZ C.P. 19,234, MUANG THAI LIFE 13,684, BANGKOK LIFE 12,496, SIAM COMMERCIAL NEW YORK LIFE 12,132, OCEAN LIFE 8,975, KRUNGTHAI AXA LIFE 5,823, ING LIFE LIMITED 4,935, THANACHART LIFE 3,355, FINANSA LIFE 2,069, PRUDENTIAL TSLIFE 1,875, SOUTH EAST LIFE 1,565, THAI CARDIF LIFE 1,403, MAX LIFE ASSURANCE 1,228, ACE LIFE ASSURANCE 1,081, GENERALI LIFE 956, MILLEA LIFE INSURANCE 676, SIAM SAMSUNG 633, MANULIFE INSURANCE 507, SIAM LIFE INSURANCE 141, ADVANCE LIFE 140, SAHA LIFE INSURANCE 81, BUI LIFE INSURANCE 13, Total 201,942, Source: Office of Insurance Commission 20

22 the year 2003 to It indicates that life insurance companies had enjoyed profit every year. Moreover, the growth rate of the profits had increased almost every year (except 2006) during that time. However, it should be noted that foreign branches had a lot higher profits than that of domestic ones. This may reflect that Thai life insurance companies can not compete with the foreign counterparts. Nevertheless, since 2005 the profit share of local companies had improved significantly whereas that of the foreign ones had decreased. With the mission of the new regulator to enhance the strength and stability of Thai insurance industry, it is hoped that the new regulator will encourage more people to take out insurance policies despite the economic slowdown. Table 7: Comparative Profit and Loss Statement of Life Insurance Business (Unit): 1,000 (Bath) Year Net Profit Domestic Companies Increase(Decrease) Foreign Branch Grand Total Amount % ,356,630 (14.12%) 8,249,026 (85.88%) 9,605,656 (100.00%) 4,546, ,161 (7.31%) 9,804,212 (92.69%) 10,577,373 (100.00%) 971, ,644,298 (25.91%) 10,423,104 (74.09 %) 14,067,402 (100.00%) 3,490, ,089,773 (23.26 %) 10,193,002 (76.74 %) 13,282,775 (100.00%) (784,627) (5.58) ,280,371 (36.85 %) 9,047,258 (63.15 %) 14,327,629 (100.00%) 1,044, Source: Office of Insurance Commission 3. Recent Financial Sector Reform Since 1997, the Thai monetary authorities, especially the Bank of Thailand, have made several reform measures to strengthen the supervision framework and improve the financial system infrastructures. The framework has shifted to more market-oriented with the emphasis on corporate governance, internal control, and risk management (Bank of Thailand, Supervision Report 2003: 45). The risk management includes credit risk, market risk, liquidity risk, operational risk and information technology (IT) risk. For years, the Bank of Thailand has improved the supervision 21

23 framework in line with international standards. This has contributed to the improved risk management and resiliency of the banking system. In addition, the Bank of Thailand has introduced various prudential policies and supervision guidelines related to risk management in order to strengthen financial institutions, increasing competition and protecting consumers. In 2007, three new important laws which are necessary for effective banking supervision were enacted, namely, the Amended Bank of Thailand Act B.E. 2551, the Financial Institution Business Act B.E (FIBA) (replacing the Commercial Banking Act B.E and the Act on the Undertaking of Finance Business, Securities Business and Credit Foncier Business 2522) and the Deposit Protection Agency Act B.E (DPA)(replacing the blanket deposit guarantee scheme implemented right after the 1997 Financial Crisis). The amended BOT Act stipulates the independence, transparency and accountability of the bank of Thailand, as well as expanded the Bank of Thailand s capacity to manage assets and conduct monetary policy more efficiently (Bank of Thailand, Supervision Report 2007:36). Moreover, the law specifies explicitly the term, and the process for appointing and dismissing the Governor. The objective of the FIBA is to strengthen supervisory framework of the financial institution system by clearly separating the role and responsibility between the Ministry of Finance and the Bank of Thailand. The Bank of Thailand is empowered to supervise and close financial institutions whereas the Ministry of Finance is empowered to grant and revoke license. Moreover, the Bank of Thailand is offered additional power to conduct consolidated supervision over financial conglomerates, implement prudential regulation to comply with the Basel Core Principles, and oversee consumer protection (Bank of Thailand, Supervision Report 2007:36). The DPA Act is responsible for providing compensation to depositors when a financial institution s license is revoked and acting as a liquidator for such an institution (Bank of Thailand, Supervision Report 2007: 37). It will take five years to eventually reduce maximum coverage to one million baht per depositor per financial institution. However, due to the Global Financial Turmoil, the DPA Act has been revised in 2008 (see Table 1, Appendix I). 22

24 (Table 1, Appendix I summarizes the reform measures in the Thai Financial Sector taken in 2008 and 2009.) 4. Financial Deregulation and Liberalization Unlike many East Asian newly industrialized economies (NIEs) which embarked on their financial liberalization programs in the early 1980s, Thailand began its financial liberalization in the late 1980s and accelerated in the early 1990s (Zhang 2002: 1). Changes in the international environments, for instance, trade in services were included in the Uruguay Round. Pressures from developed countries and the International Monetary Fund (IMF) were the main factors that accelerated the Thai monetary authorities to liberalize the financial sector. In addition, the government s desire to become the financial regional center was an additional factor that prompted the pace of the financial liberalization in Thailand. The financial sector reform policy in the late 1980s was formulated in a regional context because the fundamental changes in the political and economic landscape of Indochina over the 1980 s were taken into account (Zhang 2003: 105). The Bank of Thailand had launched the first long-term financial reform plan ( ) with an ambitious goal to turn Bangkok into a regional financial center replacing the one in Hong Kong and Singapore (Nidhiprabha 2003: 40). The purpose of the financial sector reform was to ensure an efficient allocation of resources and greater flexibility in the economy s adjustment to changes and to the increasingly competitive environment (the Bank of Thailand Annual Report 1992). The Bank of Thailand implemented 4 major policies on financial deregulation and liberalization. They were as follows: 3.1 Interest rate liberalization. 3.2 Foreign exchange liberalization. 3.3 Relaxation in financial institutions portfolio management, and 3.4 Expansion in the scope of the operation of financial institutions (the Bank of Thailand Annual Report 1992). 4.1 Interest rate liberalization Prior to interest rate liberalization, financial institutions under the supervision of the Bank of Thailand which are commercial banks, finance companies and credit 23

25 fonciers were constrained by ceilings on interest rates and on the expansion of credit. This had caused the distortion in the financial markets and hindered efficient allocation of resources in the financial sector. These ceilings served as binding constraint on interest rate movement in an upward direction only (Wibulswasdi 1986: 30). The monopolistic power in the commercial banking sector, due to the high degree of concentration of the ownership, led to cartel-like organization in which commercial banks collectively, through the coordination of the Thai Bankers Association (TBA), set lending interest rates at any level below official ceilings (Wibulswasdi 1986: 30; Zhang 2003: 108). But for the deposit rate, there was a certain degree of downward rigidity as commercial banks were reluctant to offer interest rates lower than official ceiling rates (Wibulswasdi 1986: 30). In order to turn Bangkok to be the regional financial centre, interest rate liberalization is required. Ceilings of various interest rates of the aforementioned financial institutions were gradually removed. It took 3 years for the Bank of Thailand to accomplish this task, starting with the abolition of ceiling on commercial banks time deposit rates with maturity exceeding 1 year in June The rationale behind this was aimed at creating a more flexible interest rate system and encouraging longer-term savings as well (Wibulswasdi 1995: 2). The next two and a half more years, ceilings on commercial banks savings deposits were abolished in January And finally, in June1992 ceilings on all remaining interest rates including ceilings on deposits at finance and credit foncier companies were removed. 24

26 Table 8: The Abolition of Interest Control 1989 June Abolition of interest rate ceiling on commercial banks time deposits with maturity exceeding 1 year January Abolition of interest rate ceiling on savings deposits at commercial banks June Removal of ceilings on lending and borrowing rates of financial and credit foncier companies. Remaining ceiling on bank lending rates was removed October Commercial banks are required to announce the Minimum Loan Rate (MLR), the Minimum Retail Rate (MRR) and maximum margin to be added to MRR as a reference rate for customer other than those eligible for MLR. Source: Bank of Thailand Table 8 summarizes the process of removal of interest rates ceilings in Thailand s financial sector in the late 1980s and the early 1990s. Moreover, to safeguard the interest of small borrowers the Bank of Thailand in October 1993 introduced a minimum retail rate MRR as a reference lending rate (or bench mark rate) for small but good-quality borrowers. All commercial banks were required to announce a minimum retail rate-mrr which was based on each bank s cost of funds (Wibulswasdi 1995: 2). Theoretically, financial liberalization should benefit the general public in terms of lower interest spread and profit margin, smaller service charges, and greater access to credit lines (Vichyanond 1995: 18). Unfortunately, such gains did not materialize because Thailand financial deregulation concentrated on abolishing direct financial controls such as removing the ceilings interest rates rather than on increasing competition in the financial sector (Zhang 2003: 2). Higher degree of competition is required for interest rate liberalization to bring about efficient resource allocation. One of the long lasting implicit Thailand s monetary policy stances had been to protect Thai banks against foreign banks. For thirty years prior to the crisis, Thailand s monetary authorities did not allow any new entry into the banking sector. Thus, removing interest rate ceilings without keen competition in the financial sector had resulted in inefficiency in the Thai banking industry. This could be evidenced from larger interest rate spreads of Thai banks between 1990 and 1991 which was increased and was larger than that of foreign counterparts. Table 2, Appendix I indicates that the interest spread, the difference 25

27 between minimum lending rate and 12-month time deposit rate, after the Asian Financial Crisis were larger than that before the crisis. Prior to 1992 large banks acted as price leaders in setting up bank interest rates and small banks followed suit. Nidhiprabha demonstrated that after interest rate liberalization such practices are changed. The interest rate liberalization allows each bank to set its own interest rates according to its cost structure and own market niche and in some cases small banks became price leaders (Nidhiprabha 2003: 29). Currently, domestic interest rates particularly money market rates-inter-bank rates- are more volatile because they are sensitive to movements in the world interest rates especially the US Federal Funds rate. 4.2 Foreign Exchange Liberalization Thailand like most emerging economies relaxed the restrictions on capital controls in the 1990s. Thai monetary authorities thought that the turn of the 1990 decade was the right time to start foreign exchange liberalization since Thailand s external conditions then were relatively stable. The international reserves were high equivalent to 5 months of imports; low debt-service ratio which was 10 percent compared to 20 per cent in the first half of 1980s. Moreover, The country s practice of exchange control was, in practice, in conformity with Article VIII requirements for many years; i.e., there were no restrictions on payments for current account transactions and no discriminatory currency arrangements or multiple currency practices (Wibulswasdi 1992: 34). Thus, as a first sign or first stage of financial liberalization, Thailand in May 1990 accepted the obligations under the Article VIII of the IMF s Articles of agreement which lifted all controls on all foreign-exchange transactions on the current account. Many observers pointed that this marked the beginning of the series of financial liberalization measures and the origins of the 1997 Asian Financial Crisis. Commercial banks were allowed to (i) process customers applications for the purchase of foreign exchanges for trade-related transactions without prior approval from the Bank of Thailand and (ii) approve outward transfer of foreign exchange in small amounts not exceeding $US 500,000 for remittance of loans, sale of securities, or liquidation of companies. Funds for Overseas trip were limit to $US 20,000 per trip (Wibulswasdi 1992: 34). 26

28 The Bank of Thailand announced the second stage of foreign exchange control deregulation on April 1, 1991 allowing private businesses and the general public more flexibility in purchasing and selling foreign exchanges. Residents were permitted to open foreign currency accounts if the funds originated from abroad. However, the acquisition of real estate and investment in the stock market abroad were still required the Bank of Thailand s approval. On May 1992, further exchange rate liberalization measures were pursued; prior approval from the Bank of Thailand was not required for exporters to use foreign exchange receipts to repay foreign debts. Nonresidents were permitted to open foreign currency accounts (Nidhiprabha 2003: 31). In February 1994, more investment or lending abroad was allowed and more baht notes were permitted to be carried into neighboring countries. In general, there were fewer constraints on commercial banks portfolio management by the mid 1990s (Institute for International Monetary Affairs 2006: 20). Bangkok International Banking Facilities (BIBFs) The second milestone in opening up of the Thai financial system was the gradual opening of the capital account through the launching of the Bangkok International Banking Facilities (BIBFs) in 1993 (Siamwalla 2000: 3). The Bangkok International Banking Facilities (BIBFs) provided three types of services: (1) banking to nonresidents in foreign currencies and Baht ( out-out transactions),(2)banking to domestic residents in foreign currency only ( out-in transactions), and (3) international financial and investment banking services. The BIBF units must mobilize fund from overseas and extend credits only in foreign currencies (Financial Institutions in Thailand 1998:50). To enable BIBFs to compete with financial institutions in other financial centers various tax privileges were granted: the corporate income tax was reduced from 30 to 10 percent; exemptions were provided for the sales tax and stamp duties; and the withholding tax rate on interest payments was reduced from 15 to 10 percent for out-in transactions (Annual Economic Report 1993, Bank of Thailand: 54). Financial liberalization through BIBFs induced a flood of capital inflows into Thailand, especially into its banking sector in the period The BIBF s credits reached its peak in 1997 at 1,882 billion Baht or about 40 per cent of GDP compared with 1,290 billion Baht in However, the BIBF s credits had been decreasing 27

29 since 1998 but it was still at high levels. In 2005 this figure drastically dropped to 76 billion Baht (see Table 3.3). Since September 2006 according to One Presence Policy under the Financial Sector Master Plan (FSMP) the BIBF operations were abolished. Commercial banks registered in Thailand and foreign bank branches had to return IBF licenses to the Ministry of Finance. Four years after the Bank of Thailand had launched the BIBFs, Thai banks were the major players in out-in business (except year 1995) due to strong customer base; whereas foreign banks BIBF units with no branches in Thailand dominated the out-out business. But after the 1997 Asian Financial Crisis foreign banks with Full Branches in Thailand had become the major players in both out-in and out-out businesses. The Bank of Thailand hoped that the BIBF lending would concentrate on the out-out activities fund raised abroad and lent to the Indochina countries- rather than on the out-in business. But it turned out that the size of the out-in lending was about 80 % of the total BIBF lending between 1993 to 2005 (see Table 3 Appendix 1) This was attributed to the relatively high interest rates in Thailand. The out-in capital flows led to excessive credit expansion to private sectors. This fuelled investment spending in the non-traded goods sector, speculation, and current account deficits. Speculative and imprudent lending from BIBFs inflated several bubble sectors especially in the stock markets and the real estate sector. The BIBFs operations were the main cause of the rapid increase in Thailand s external debt particularly the short-term ones. The debt-to-gdp ratio rose from 39.2 percent in 1992 to 48.7 percent in 1996 (Annual Economic Report The Bank of Thailand: 104). Table 10 and Figure 13 indicate that Thailand s short-term external debt had increased between 1992 and 1995 and BIBFs were the main factor responsible for such increase especially for banks. The monetary authority believed that the establishment of the BIBF was the first step in the process of promoting Thailand as a financial center of the region (Annual Economic Report 1998, The Bank of Thailand: 58). But it turned out that BIBF had contributed to the East Asian Financial Crisis. 28

30 Table 10 Thailand s Short-term External Debt, ( In Billion US dollars) Total Short-term Bank Commercial Banka BIBF Public Non-bank Source: Annual Economic Report 1996, Bank of Thailand; pp Relaxation in Financial Institutions Portfolio Management Previously, financial institutions were subjected to various kinds of bank regulations which contributed to higher costs of banking operations. In order to make banks more stable and restore the solvency of the financial system, the Bank of Thailand relaxed constraints imposed on financial institutions as follows. Figure 13 Million of US dollar 100, , , , , Source: Bank of Thailand Thailand External Debt Short-term Debt Long-term Debt Year Branch opening. Earlier, before opening up branches commercial banks were required to hold a certain amount of government bonds to finance government budget 29

31 deficits. Starting in November 1990 the Bank of Thailand lowered the ratio of bond holding requirement from 16 percent of total deposits to 9.5 percent. Then the ratios had been decreased to 8 percent in September 1991, 7 percent in February 1992, 6.5 percent in October 1992, 5.5 percent in February 1993 and nil in May 1993 (Vichyanond 1995) Rural credit requirement. Previously, commercial banks had an obligation to allocate no less than 20 percent of their deposits to the agricultural sector. Commercial banks found it difficult to comply with this regulation since the definition of the agricultural credit was too narrow. Thus in 1987, 1991, and 1992 the Bank of Thailand changed the name of the agricultural credit to the rural credit and modified the loan to cover more related occupations which included regional smallscale industries, wholesale trading of agricultural produces, regional industrial estate, farmers secondary occupations and the exportation of farm products (Vichyanond 1995). The rationale behind this modification was to support the rural development strategy implemented then (Wibulswasdi 1987) Reserve requirement. In June 1991, the Bank of Thailand required financial institutions to maintain a liquidity ratio in place of the reserve requirement ratio. This allowed commercial banks to substitute other securities for government bonds and manage their assets more efficiently. Commercial banks are now required to hold liquid assets at no less than 6 per cent of total deposits Capital adequacy ratio. On the first of January 1993, the Bank of Thailand modified the regulations on capital adequacy ratio in order to comply with the guidelines of the Bank for International Settlements (BIS). Commercial banks capital funds are divided into first tier and second tier. First tier capital comprised paid-up capital, legal reserves; reserves appropriated from net profits and retained earning. While the second tier capital funds are 50 percent of the revaluation of buildings and land, hybrid debt instruments and subordinated term debts (the Bank of Thailand Annual Report 1992: 109). 30

32 Thai commercial banks were required to maintain a minimum capital ratio of 7 percent of total assets and contingent liabilities (off-balance-sheet items); within with at least 5 percent must be first tier capital. By the end of 1994, these two ratios were adjusted upward to 9 percent and 5.5 percent respectively (Vichyanond 1995). Branches of commercial banks incorporated abroad or foreign banks were required to maintain capital funds in Thailand as well and the adequacy ratio was 6.25 percent of total assets and contingent liabilities. Thai commercial banks are now required to hold 8.5 percent of the capital adequacy ratio. 4.4 Expansion in the Scope of the Operation of Financial Institutions To promote greater competition in the supply of financial services the Bank of Thailand allowed financial institutions to undertake new related businesses. Effective 14 March 1992, commercial banks were permitted to carry out three new types of business namely, underwriting government s and state enterprises debt instruments, providing economic, financial and information services, and providing financial advisory services in mergers, acquisition and take-over cases. In June 1992, additional businesses were added for commercial banks to operate including managing, issuing, underwriting and trading of debt instruments. Nevertheless, approval from the Bank of Thailand was required. Other businesses, requiring no prior approval from the Bank of Thailand, were agents for the sale of mutual funds, secured debentures holders representatives, mutual fund supervisors, and securities registrar. However, approval from the Securities and Exchange commission-sec was required for the last three businesses (the Bank of Thailand Annual Report 1992:106). For finance companies and finance and securities companies, new services offered to them to operate were leasing services, acting as selling agents for public debt instruments, arrangers, underwriters, and dealers for debt instruments and act as mutual fund supervisors (the Bank of Thailand Annual Report 1992: 51). 5. Weaknesses in the Thai Financial and Banking Systems Even though the Thai financial system has gone through various reforms within the last decade, there are underlying weaknesses which have still to be addressed. Some of the weaknesses are discussed below. 31

33 5.1 There are too many regulatory authorities in the Thai Financial Sector Figure 14 demonstrates that financial institutions in Thailand are subject to different laws and regulated by different agencies. For instance, the Bank of Thailand supervises three financial institutions: commercial banks, finance companies and credit foncier companies. The Fiscal Policy Office, under the Ministry of Finance, oversees SFIs. The Insurance companies are under the supervision of the Insurance Commission, the Ministry of Finance. SEC, an independent agency, supervises securities companies, the stock market, and derivative and future markets. Figure 14: of Thai Financial System Regulatory Authorities Structure 32