Chapter

5 Distressed Financial Institutions in Thailand: Structural Weaknesses, Support Operations, and Economic Consequences

Author(s):
International Monetary Fund
Published Date:
March 1991
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Author(s)
R. Barry Johnston1

This chapter is one in a series of examinations of experiences with financial crises in different countries. Although each of these experiences reflects country-specific factors, each also provides general background on the potential causes and consequences of financial crises. A recurring theme in this book is the interrelationship between the stability and soundness of the financial system, the role of regulation and supervision of the financial institutions, and macroeconomic conditions. This chapter reviews the background for the deterioration in the conditions of financial institutions in Thailand, the remedial actions and support arrangements that were subsequently taken, and the consequences for macroeconomic conditions.

The financial system in Thailand faced a crisis in the first half of the 1980s. Poor managerial practices, accompanied by inadequate regulations and supervision, led to a gradual deterioration in the quality of the balance sheets of Thailand’s financial institutions. The difficulties were exacerbated by a slowdown in economic activity in the early 1980s. Beginning in 1983, the Thai authorities had to intervene in the affairs of about 50 finance and security companies and 5 commercial banks, which together accounted for about one fourth of the total assets of Thailand’s institutions. Twenty-four finance and security companies were closed and 9 others merged into 2 new companies; 13 finance companies and 5 commercial banks continued to receive support, including financial subsidies in the form of “soft” loans. Remedial actions also continued; these included reductions in capital values, management restructuring, and the buildup of capital and reserves under financial programs set by the authorities. As a result of the crisis, the power of the authorities to supervise and restructure financial institutions was substantially strengthened. The macroeconomic impact of the crisis was probably procyclical, resulting in a more restrictive policy in 1984 and 1985 and a more expansionary policy in 1986 and 1987.

Section I reviews the structure of the financial system and the evolution of banks and finance companies; Section II discusses some indicators of the condition of financial institutions; Section III examines the reasons for the weakening position of financial institutions in Thailand, emphasizing structural and regulatory inadequacies; Section IV describes the arrangements to support the ailing financial institutions; Section V assesses the success of these support arrangements; Section VI examines the macroeconomic consequences of the financial crisis; and Section VII presents the conclusion and a summary of the main findings.

I. Structure of the Financial System and Evolution of Banks and Finance Companies

The financial system in Thailand appears relatively diversified. As of the end of 1987 it consisted of the Bank of Thailand (BOT), the central bank; 16 local commercial banks and 14 branches of foreign banks; a number of representative offices of foreign banks; nonmonetary financial institutions comprised 94 finance companies, 11 security companies, and 25 credit foncier companies; a number of government-owned or government-sponsored specialized financial institutions (the Government Savings Bank—GSB; the Bank for Agriculture and Agricultural Cooperatives—BAAC; the Government Housing Bank—GHB; the Industrial Finance Corporation of Thailand—IFCT; and the Small Industries Finance Office—SIFO); a large number of savings and agricultural cooperatives; 12 life insurance corporations; the Securities Exchange of Thailand (SET); short-term money markets; and a sizable unorganized financial system. Table 1 provides a summary of the main characteristics of the financial institutions. In practice, assets of the financial system are concentrated mainly among the commercial banks and the finance companies, which are predominantly private sector institutions, and the GSB. Because of the concentration of assets, a crisis among the banks and finance companies is tantamount to a financial sector crisis.

Table 1.Summary of Structure of Financial Intermediaries, End-December 1987
Commercial

banks
Finance

Companies
Credit

Fancier

Companies
Govemmert

Savings

Bank
Life

Insurance

Cooperalions
Savings

Cooperatives1
Agricultural

Cooperatives1
Bank of

Agriculture

and

Agricultural Cooperartives
Industrial

Finance

Corporalion

of

Thailand
Small-Scale

Industries

Financial

Office
Government

Housing

Bank
Pawn

shops
Total assets (in billions of baht)943.3163.23 8111.524.919.68.533.622.60.115.45.4
Total number of institutions3094211127321,1571111336
Foreign owned141......
In which the Government holds
50 percent or more of equity21111
With public quotations on the SET1212
Total number of branches22.00422452724703
Of which: In Bangkok557964683
Proportion of Stabilities that are
Demand deposits4.70.10.1
Savings deposits24.016.910.731.8
Time deposits47.345.410.718.8
Capital funds6.16.715.75.011.26.313.393.814.325.9
Other borrowing
Bank of Thailand4.55.88.90.26.5
Commercial banks2.519.152.60.236.661.1
Government2.52.00.91.8
Overseas3.91.422.339.816.9
Other private sector4.567.031.730.684.73.644 9
Proportion of assets held as claims on
Bank of Thailand2.70.20.50.6
Commercial banks2.42.85.213.112.011.63.650.41.93.7
Other financial institutions5.55.51.95.85.05.2
Central Government12312.476.916.52.30.1
Public enterprises1.60.61.90.1
Business and household sectors65.265.955.31.434.974.749.682.588.8
Overseas4.1
Regulatory framework
Governing legislation4,5,67789101011121314
Licensing body1515161716181817171719
Supervisory agencies
Primary161616152018181515211519
Secondary
Source: Bank of Thailand.

Estimates based cm 1985 data.

Excluding head office.

End of June 1987.

Commercial Bank Ad. 1962 and 1979 (revised).

Bank of Thailand Act.

Currency Act.

The Finance Securities and Credit Foncier Act of 1979, amended by emergency decree, 1983.

Government Savings Bank Act, 1946.

Life Insurance Act, 1967.

Cooperatives Act, 1968.

Bank for Agriculture and Agricultural Cooperatives Act, 1966.

Industrial Finance Corporation of Thailand Act, 1959.

Government Housing Bank Art, 1953.

Pawnshop Act, 1962.

Ministry of Finance.

Bank of Thailand.

Art of Parliament.

Ministry of Agriculture and Agricultural Cooperatives.

Ministry of Interior.

Ministry of Commerce.

Ministry of Industries.

Source: Bank of Thailand.

Estimates based cm 1985 data.

Excluding head office.

End of June 1987.

Commercial Bank Ad. 1962 and 1979 (revised).

Bank of Thailand Act.

Currency Act.

The Finance Securities and Credit Foncier Act of 1979, amended by emergency decree, 1983.

Government Savings Bank Act, 1946.

Life Insurance Act, 1967.

Cooperatives Act, 1968.

Bank for Agriculture and Agricultural Cooperatives Act, 1966.

Industrial Finance Corporation of Thailand Act, 1959.

Government Housing Bank Art, 1953.

Pawnshop Act, 1962.

Ministry of Finance.

Bank of Thailand.

Art of Parliament.

Ministry of Agriculture and Agricultural Cooperatives.

Ministry of Interior.

Ministry of Commerce.

Ministry of Industries.

The establishment of local and foreign banks had proceeded at a rapid pace up to 1955, when the Thai Cabinet passed a resolution to restrict the approval of new banks; a virtual moratorium on new banking licenses was imposed from the mid-1970s (see Table 2). At the end of 1987 there were 16 local and 14 foreign-owned banks, virtually the same number as in 1966.2 In addition to imposing a virtual moratorium on new banks, the Government restricted each foreign bank’s branching activities to a total of 20 local branches. The local commercial banks, by contrast, developed an extensive branch network and at the end of 1987 the 16 local commercial banks had 1,964 local branches, excluding head offices, compared with 352 in 1960.

Most local banks were established by Thai-Chinese business families and trading houses to help finance their operations. The Bangkok Bank, the Thai Farmers Bank, the Bank of Ayudhya, the Bangkok Metropolitan Bank, and the Bank of Asia have remained effectively family-controlled institutions. The Government has also become an important participant in bank ownership: the Krung Thai Bank, and more recently the Sayam Bank, are government owned and the Government has minority shareholdings in several other banks.3

The banking system in Thailand is highly concentrated. Local banks account for 95-97.5 percent of total commercial bank assets, advances, and deposits (see Table 2). Within the commercial banking sector, business is concentrated among a few banks. At the end of 1986 the largest bank, the Bank of Bangkok, accounted for about 30 percent of total commercial bank assets and deposit liabilities, and the three largest banks (the Bangkok Bank, the Thai Farmers Bank, and the Krung Thai Bank) together accounted for about 57 percent of commercial bank assets. The smallest five local banks accounted for only 5-6 percent of commercial bank deposits and assets. The two government-owned banks, the Krung Thai Bank and the Sayam Bank, which have been operationally merged, are the second-largest banking organization; together they account for about 15 percent of bank assets. The banks have operated an effective interest rate cartel organized around the Thai Bankers’ Association (TBA); in recent years the cartel arrangements have been breaking down under pressure from foreign competition for bank loans to domestic customers and official encouragement of a more competitive interest rate structure; by the end of 1988, the competitive setting of local deposit rates had begun to emerge. About 60 percent of the value of commercial bank deposits is accounted for by deposits larger than B 500,000 (US$20,000), and some 70 percent of credits outstanding are for loans exceeding B 1.0 million (US$40,000). Because of various family and corporate connections among bank customers, the effective degree of deposit and loan concentration is even higher.

Table 2.Date of Opening and Distribution of Private Sector Deposits for Commercial Banks
BankYear of

Opening
Deposits as a Percentage

of Total

(December 31, 1986)
Local commercial banks
Siam Commercial Bank19068.7
Nakornthon Bank119330.9
Bank of Asia19392.4
Siam City Bank19414.1
Bangkok Bank of Commerce19444.7
Bangkok Bank194426.6
Bank of Ayudhya19455.9
Thai Farmers Bank194514.1
Laem Thong Bank19480.5
Union Bank19491.9
Thai Danu Bank19491.2
Bangkok Metropolitan Bank19504.1
Thai Military Bank19575.1
First Bangkok City Bank19602.9
Sayam Bank219652.0
Krung Thai Bank196612.7
Subtotal97.8
Foreign commercial banks
Hongkong and Shanghai Banking18880.3
Corporation
Standard Chartered Bank18940.2
Banque Indosuez18970.1
Four Seas Communication1909
Bank of Canton1919
Citibank319230.1
International Commercial Bank of19470.1
China4
Bharat Overseas Bank519470.1
Bank of America19490.2
Mitsui Bank19520.3
Bank of Tokyo19620.4
Chase Manhattan Bank19640.2
United Malayan19640.1
Deutsche Bank (Asia)619780.1
Subtotal2.2
Total100.0
Source: Bank of Thailand.

Previously Wang Lee Bank Ltd.

Previously Asian Trust Bank Ltd.

Previously Mercantile Bank Ltd.

Previously Bank of China Ltd.

Previously Indian Overseas Bank Ltd.

Previously European Asian Bank Ltd.

Source: Bank of Thailand.

Previously Wang Lee Bank Ltd.

Previously Asian Trust Bank Ltd.

Previously Mercantile Bank Ltd.

Previously Bank of China Ltd.

Previously Indian Overseas Bank Ltd.

Previously European Asian Bank Ltd.

Finance and security companies make up the second major group of financial intermediaries. Finance companies—which, in contrast to commercial banks, are highly competitive institutions—first emerged in the early 1960s as the finance arm of retailers. Subsequently, finance companies expanded their activities into certain types of corporate finance; the first full-fledged finance company was established in 1969. The entry of new finance and security companies was first regulated by National Executive Council Announcement No. 58 issued in July 1972, but this order left the finance and security companies relatively free in their operations compared with commercial banks. Thus the effect of the Executive Council Order was largely to give official recognition to the companies, thereby significantly increasing their attractiveness to investors. Further controls were placed on the operations of finance companies by the Finance, Securities, and Credit Foncier Business Act, BE 2502, in 1979, when problems emerged with one finance company (Raja Finance). As described (in Section III), however, these controls were generally inadequate to regulate these companies.

The number of finance companies grew rapidly during the 1970s, when foreign and local banks set up such companies partly to avoid the moratorium on new banking licenses and on foreign bank branching, and partly to avoid the maximum interest rate and credit controls imposed on commercial banks. Initially, financial companies were not subject to interest rate ceilings, and when those ceilings were introduced, they were higher than the ceilings on commercial banks. The number of finance companies grew from 17 in 1971 to 78 in 1973 and 113 in 1979.

Chart 1 illustrates how finance company assets grew much faster than commercial bank assets up to 1979; Charts 2 and 3 show the positive relationship between the relative growth of finance company promissory notes and bank time deposits, and the differential in the interest rates paid by finance companies and banks up to 1979. The fluctuation in 1979 coincided with the emergence of problems with a finance company (already noted) which temporarily undermined general confidence in finance companies.

Chart 1.Growth of Finance Company and Commercial Bank Assets, 1972–86

(In percent)

Chart 2.Growth of Time and Saving Deposits with Finance Companies and Commercial Banks, 1972–86

(In percent)

Chart 3.Interest Differential Between Finance Company and Commercial Bank Deposit Rates, 1972–86

(In percent)

Thai finance companies engage in diverse activities. In December 1987, 22 were licensed only for finance company business (consumer installment lending, corporate advances, etc.); 11 only for securities business (essentially stockbroking); and 72 for both activities, performing functions not unlike those of merchant/investment banks. The largest finance company, with assets of B 8.4 billion, was about the same size as the third smallest commercial bank, and 6 finance and security companies had larger assets than the smallest commercial bank. The 10 largest companies accounted for about 30 percent of the total assets of finance companies. Finance companies can borrow through the issuance of fixed-term promissory notes but cannot accept deposits. Because promissory notes can be at call and withdrawn on demand, however, the practical effect of this restriction has been limited. Business and household holdings of promissory notes accounted for 52 percent of the liabilities of finance and security companies.

II. Financial Position of Banks and Finance Companies

The financial position of Thai commercial banks and finance companies weakened during the first half of the 1980s.

Commercial Banks

Between 1980 and 1986, average bank net profits fell from 25 percent to 7 percent of capital funds, and capital/assets ratios declined from 6.4 percent to 5.7 percent (Table 3). An examination of the components of “other assets” of banks (Table 4) indicates the substantial buildup in interest and income earned but not received in recent years, equivalent to about 2 percent of total assets. About 15 percent of the total assets of Thai banks were estimated to be delinquent in 1987.

It is difficult to assess the financial position of institutions simply by focusing on a few ratios. For example, historical net profit figures are misleading because they include accrual of income and interest earned but not received. Moreover, because banks did not make adequate provision for loan losses, the banks’ reported net profit was inflated. More recent net profit figures, which improved to about 11 percent of capital funds in the 12 months to June 1987, also are exaggerated because they have been boosted by the soft loan subsidy provided by the BOT (see Section IV). Similarly, the historical capital/assets ratios failed to give a true picture of bank solvency because little debt was provisioned or written off. More recently, capital values of banks have been written down against loan losses, and in 1986 and 1987 banks raised about B 15-20 billion in new capital funds. As a result, the more recent capital/assets ratios imply a sounder financial position than the same ratios one to two years previously.

Table 3.Indicators of Financial Position of Commercial Banks, End of Period, 1980—87
19801981198219831984198519861987
All banks
Total assets (in billions of baht)305.4358.3431.4540.1649.4713.6777.8943.3
Annual percentage change15.617.320.425.220.29.99.021.3
Annual growth of nonbank private sector
Deposits25.219.026.426.422.411.513.220.2
Loans13.015.018.533.117.69.84.822.6
As percent of assets
Capital accounts6.46.05.75.25.66.05.76.1
Reserves with Bank of Thailand3.43.33.02.82.33.02.82.7
Government securities112.914.015.412.514.613.816.212.3
Loans to nonbank private sector73.872.371.275.774.073.971.072.2
Foreign assets5.17.06.14.64.74.75.44.1
Nonbank private sector deposits67.368.371.672.473.474.777.676.4
Borrowing from Bank of Thailand5.55.64.94.33.73.74.32.5
Claims on nonmonetary financial institutions6.45.04.94.75.24.64.75.5
As percent of nonbank private sector deposits
Loans to nonbank private sector109.6106.099.4104.6100.599.091.694.5
Reserves with Bank of Thailand5.14.84.13.83.14.03.73.6
Reserves plus government securities119.220.521.517.319.818.420.919.6
Demand deposits12.210.57.86.06.14.85.66.2
Savings deposits13.215.019.423.821.320.826.131.4
Time deposits74.174.072.470.072.474.267.961.9
Local banks2
Total assets (in billions of baht)688.0753.0812.33
Capital and reserves (in billions of baht)39.140.644.83
As percent of assets5.75.45.53
Reserves for loan losses (in billions of baht)4.25.46.33
As percent of assets0.60.70.83
Source: Bank of Thailand. Some figures are partly estimated.

Includes Bank of Thailand bonds.

Excludes operations of foreign branches.

June 1987.

Source: Bank of Thailand. Some figures are partly estimated.

Includes Bank of Thailand bonds.

Excludes operations of foreign branches.

June 1987.

Table 4.Components of “Other Assets” of Commercial Banks, End of Period, 1983–86
1983198419851986
(In billions of baht)
Premises, furniture, and equipment11.212.414.516.4
Properties foreclosed1.51.71.82.6
Accrued interest receivable3.75.58.211.0
Prepaid expenses0.92.14.95.1
Income earned but not collected1.92.32.94.5
Interoffice expenses1.10.91.31.4
Sundry debtors1.01.42.10.6
Other4.34.94.95.7
Total25.731.240.647.3
(Percentage change)
Premises, furniture, and equipment10.716.913.1
Properties foreclosed13.35.944.4
Accrued interest receivable48.749.134.2
Prepaid expenses133.3133.34.1
Income earned but not collected21.126.155.2
Interoffice expenses-18.244.47.7
Sundry debtors40.050.0-71.4
Other14.016.3
Total21.430.116.5
Source: Bank of Thailand.
Source: Bank of Thailand.

Indicators of the performance of individual local commercial banks in 1985 and 1986 are shown in Table 5. The capital/assets ratios of most banks were relatively low by international standards,4 and the ratios for 8 banks declined in 1986. Seven banks, including the first-, third-, and fourth-largest banks, had capital/assets ratios below 5 percent. Eleven of the 16 local banks for which data are available recorded net profits in 1986; however, the net profitability of 10 of these banks declined relative to 1985. Two other banks slightly reduced their losses. Returns on equity fell by between 3 and 5 percentage points in 1986 to an average of about 7 percent. Most banks added to their provisions for loan losses in 1986, hut the typical provision amounted to much less than 1 percent of assets.

Table 5.Performance of Local Commercial Banks, 1985–86(Amounts in billions of baht unless otherwise stated)
AssetsLoansDepositsCapital/

Assets Ratio

percent
Loan Deposit

Ratio

percent
Net

Profit
Return on

Assets

(percent)
Return on

Equity

(percent)
Provision

for Loan

Losses
Bank19851986Percentage

change
19851966Percentage

change
19451986Percentage

change
198519861985198619851986198519861985198619851986
Bangkok Bank262.3263.02.2200.0203.81.5194.5199.72.74.64.6103.2102.11.430.930.550.3511.47.61.20
Thai Farmers’ Bank104.5116.211.276.979.33.285.996.712.65.95.489.582.00.600.470.580.419.87.60.20
Krung Thai
Bank Ltd.93.5105.612.964.969.77.477.985.19.23.94.283.381.90.060.150.060.141.63.40.010.08
Siam Commercial65.373.111.948.851.65.752.660.815.45.34.892.684.90.540.350.830.4815.610.11.601.29
Thai Military Bank17.74.818.827.031.516.727.834.323.46.85.797.191.80.230.230.670.519.88.90.11
Bank or Ayudhya38.841.67.227.028.97.130.635.315.45.85.589.181.90.190.160.490.378.36.90.66
Bangkok Metropolitan
Bank33.335.87.523.5246.04.722.425.212.54.54.7105.897.60.120.080.380.238.45.00.26
Bangkok Bank of
Commerce29.231.37.120.822.06.026.028.69.64.04.180.076.9
Siam City Bank27.828.62.519.220.46.422.724.89.25.75.684.682.30.020.061.020.01
First Bangkok City Bank27.527.5-19.716.6-15.616.116.41.85.45.8122.4101.2-0.10-3.6-6.3-0.13
Sayam Bank17.220.318.010.210.74.98.311.742.03.02.6122.991.4-0.70-0.45-4.07-2.22-136.66-82.61
Bank of Asia Lid.15.517.211.410.911.89.913.014.914.85.26.383.979.20.03-0.170.033.20.40.01
Union Bank of
Bangkok15.214.1-7.29.29.75.410.311.310.44.65.289.385.80.050.040.290.306.40.01
Thai Danu Bank7.98.912.76.26.66.76.27.520.38.17.3100.088.00.060.050.810.5510.107.50.020.04
Nakomthon Bank5.76.413.43.64.522.74.35.220.74.54.484.885.90.030.020.450.279.65.90.03
Lawn Thong Bank4.54.73.82.92.92.32.45.216.620.1126.1120.8-0.04-0.01-0.80-0.07-5.2-0.040.01
Source: Annual reports of commercial banks.

Accounts do not reflect B 4.9 billion in doubtful debts for which income is not available to make provision.

Source: Annual reports of commercial banks.

Accounts do not reflect B 4.9 billion in doubtful debts for which income is not available to make provision.

During 1987, 5 banks with assets amounting to about 25 percent of total commercial bank assets received official support, and 2 other banks were reported to be having financial difficulties (see Table 6).

Finance and Security Companies

The financial crisis among finance and security companies began in the autumn of 1983, when a finance company and two affiliates were closed as a result of large losses; between 1983 and 1986 a total of 20 finance companies and 4 security companies were closed. These closures were accompanied by a loss of confidence which resulted in a withdrawal of deposits. In the year to September 1984, finance and security company liabilities to businesses and households fell by 11 percent, but the growth in their liabilities to the banking system began to accelerate, as banks and the BOT moved to support ailing finance companies (Table 7). In 1985 business and household deposits recovered somewhat, but not enough to prevent a further increase in liabilities to the banking system, which rose to 25 percent of assets by the end of 1987. The capital/assets ratios of finance and security companies fell from 12 percent in 1980 to 6.7 percent in 1985. Reserves for loan losses rose to about 2 percent of assets, and delinquent debts were estimated at between 10 and 15 percent of assets.

Operating losses of finance and security companies were B 200 million in 1986, reduced from B 600 million in 1985 and B 400 million in 1984. However, as was true of the profit figures for the commercial banks, the underlying profit trends are difficult to discern because of the soft loan subsidy that has been provided by the BOT and the various provisions for loan losses. BOT loans to finance and security companies increased from B 3.7 billion at the end of 1984 to B 7.4 billion at the end of 1985 and B 9.1 billion by the end of 1987. Assuming that the interest subsidy on these loans averaged 7 percent, the BOT support arrangements might have increased finance and security company profits by B 300 million in 1984, B 600 million in 1985, and B 700 million in 1986. But companies increased their loan loss provisions by B 900 million in 1986. Similarly, the interpretation of the trends in the capital/assets ratios has been affected by the writing down of capital values against loan losses and the subsequent raising of new capital.

III. Reasons for Weakening Position of Banks and Finance Companies

A combination of factors contributed to the weakening financial position of banks and finance companies.

Table 6.Commercial Banks That Were Receiving Financial Support or Had Reported Financial Difficulties(Position at end-December 1986)
Total Assets
In

billions

of baht
As

percent

of total
Capital/

Assets

Ratio
Loan/

Deposit

Ratio
Reported

Difficulties
Recommendations

by Bank of

Thailand
Support

Arrangements
Bank of Asia17.22.16.379.2B 1.7 billion was provided as a soft loan by BOT in 1987.
Sayam Bank20.82.52.686.3Taken over by Government in August 1984 and operationally merged with Krung Thai Bank in February 1987. Monetary authorities provided B 3.5 billon in support in 1986: B 500 million to boost capital, B 1 billion to absorb bad debts, and remainder as a soft loan.
First Bangkok

City Bank
27.53.35.8101.2Atend-1985, bad debts were reported at B 2.8 billion; inclusion of doubtful debts would push figure to B 5 billion.Value of capital was ordered reduced from B 1.365 billion to B 68 million, and then raised to B 2 billion.Received a soft loan of B 3.8 billion with a 10-year maturity in May 1986 from BOT. RF stood ready to take up B 500 million of shares issued. BOT officials took over management of the bank.
Siam City Bank28.63.45.782.3Ordered to reduce capital from B 800 million to B 40 million, and to increase it subsequently to B 1.5 billion. BOT to approve management.Soft loans provided by BOT; raised B 1 billion of new shares in February 1987. RF was ready to lake up B 500 million of shares issued.
Knmg Thai

Bank
105.612.64.273.6Weak capital and reserve position. Also had experienced losses because of the overexposure of a financial subsidiary (IFCC).Recapitalization of bank with a capital subscription of B 2 billion in 1987.
Other Banks with Reported Financial Difficulties
Bangkok

Metropolitan

Bank
33.84.05.194.9Loan exposure to the liquor sector and low capital funds.Management structure to be revised to reduce family influence; exposure to liquor sector to be reduced; registered capital to be raised from B 500 million to B 1 billion.The Government has supported the Sura Thrip Group (liquor group) to protect banking system.
Laem Thong

Bank
4.60.619.9110.3Experienced loan losses and loss of confidence among depositors, leading to deposit withdrawals.
Table 7.Indicators of financial Position of Finance and Security Companies, End of Period, 1980—87
19801981198219831984198519861987
Total assets (in billions of baht)65.477.695.7106.3119.5132.8142.8163.2
Annual percentage increase14.918.723.311.112.411.17.514.3
Annual growth of business and household
Deposit22.328.825.45.2-5.416.04.07.6
Loans11.817.621.016.45.78.29.312.6
Net liabilities (in billions of baht) to
Banking system4.30.40.46.615.418.223.835.7
Bank of Thailand1.00.2-0.20.23.77.410.19.1
Commercial banks3.3030.66.411.810.713.726.6
Businesses and households-9.0-6.0-4.9-13.1-21.7-13.2-15.5-22.5
As percent of assets
Capital accounts12.010.49.29.77.66.76.86.7
Reserves for loan losses1.11.71.7
Borrowing from banking system9.65.66.510.115.917.319.324.9
Borrowing from households and businesses63.268.569.666.055.557.956.052.1
Advances to households and businesses57.358.856.660.060.758.258.856.9
Claims on Government4.64.55.75.07.911.111.712.4
Source: Bank of Thailand. Some figures are partly estimated.
Source: Bank of Thailand. Some figures are partly estimated.

Institutional Weaknesses

The oligopolistic structure of the banking system, which allowed banks to make profits for many years, also led the banking industry to be inefficient and encourage bank management and shareholders to pay little attention to safety and soundness. The structure of bank ownership and the high concentration of banking activity also led to weaknesses in the banking system. In 1981, the Governor of the BOT summarized several of the management problems of commercial banks as follows:5

  • Several managers were not professional bankers but were extensively involved in commercial enterprises and gave too little attention to running their banks;

  • Inadequate internal controls and operating procedures provided scope for malpractice, irregularities, and fraud;

  • Contrary to sound banking practices, the institutions extended credit and guarantees to businesses in which directors and shareholders of the banks were heavily involved;

  • Banks constructed lavish and unnecessarily large headquarters and bank offices, which raised banks’ operating costs excessively;

  • Banks failed to diversify their share ownership and to include more small shareholders—practices that might have imposed greater discipline on the activities of directors and managers;

  • Concentration of lending to a few large interrelated enterprises and industries magnified the risk exposure of the banks and reduced the supply of credit to smaller borrowers, thereby possibly impeding economic development;

  • Lack of competition between banks may have raised lending margins and reduced deposit rates thereby discouraging savings and reducing the attractiveness of the organized vis-à-vis the unorganized financial markets.

Management weaknesses were especially notable in many finance and security companies. In contrast to commercial banks, finance companies were highly competitive in bidding for deposits, but their main objective often was simply to mobilize funds for use by their own or related companies. The management weaknesses were compounded by the generally lax regulatory framework and controls that were imposed on these companies’ operations, and their faster rate of balance sheet expansion during the 1970s.

Inadequate Legislative Framework

The internal weaknesses among the banks and finance companies might not have threatened the stability of the financial system if the authorities had had adequate powers to regulate, supervise, and intervene to direct the financial institutions. But the legal, regulatory, and supervisory framework had to be developed after problems emerged among financial institutions, and it has taken time to implement the new regulations fully.

The central bank is normally placed at the apex of the financial system, and the bank’s powers over the financial system are clearly defined in its statutes. The Bank of Thailand Act, BE 2485 (1942), which established the BOT, however, restricted the BOT’s powers and meant that detailed regulations had to be developed through separate laws and directives. As a result, the regulatory system was less flexible and more political, and may have been slow to react. Moreover, it took several years before the BOT was vested with sufficient power to supervise and regulate financial institutions adequately.

The original laws and regulations for banks and finance companies also were inadequately drafted and had to be amended. The original version of the current Commercial Banking Act BE 2505 (1962) (denoted here as CBA1)6 was first amended in 1979 and was known as the Commercial Banking Act (No. 2), BE 2522 (denoted CBA2). This act was again amended in 1985 by the Emergency Decree Amending the Commercial Banking Act, BE 2505, BE 2528 (denoted EDCBA). The main statutory controls over finance and security companies were set out in the Act on the Undertaking of Finance Business, Securities Business, and Credit Foncier Business, BE 2522 (1979) (denoted ECA). The act was amended by Emergency Decrees in BE 2526 (1983) and BE 2528 (1985) (denoted EDFCA1 and EDFCA2, respectively). Table 8 shows the regulatory arrangements at the end of 1987.

Specific Regulatory Shortcomings and Amendments to Commercial Banking Act and Financial and Security Company Legislation

Concentration of Ownership and Portfolio

The original Commercial Banking Act (CBA1) provided insufficient safeguards against a high concentration of ownership. CBA2 set the maximum individual shareholding at 5 percent and the minimum number of shareholders per commercial bank to 250. Under CBA2 the registry of shareholders was to be made available to the Bank of Thailand before any payment of dividends.

CBA1 placed no limits on banks’ holdings of shares and debentures in companies as a percentage of the banks’ own capital, thus permitting an excessive concentration of assets. CBA2 limited banks’ holdings of shares and debentures to 20 percent of the banks’ capital and reduced the limit on banks’ holdings of another company’s issued shares from 20 percent to 10 percent of the total shares sold. CBA2 also prohibited a commercial bank from purchasing the shares of another commercial bank, except when explicitly authorized to do so by the BOT.

Conflicts of Interest

CBA1 did not regulate the selection of directors, managers, and advisors; CBA2 listed the qualifications and exclusions for bank employees. CBA1 prohibited loans to a director or to the spouse of a director, or to partnerships in which they were involved, but it did not restrict directors’ access to a number of channels through which directors could obtain finance. CBA2 imposed tighter restrictions on commercial banks’ business transactions with their own directors; the definition of loans to directors was widened to include companies in which they held 30 percent or more of the shares issued, and the banks’ boards were required to obtain approval for, and to notify the BOT about, certain transactions. EDCBA further tightened these restrictions by requiring that the BOT approve any transactions over a certain amount between a commercial bank and its directors. EDFCA2 introduced identical restrictions for finance companies. EDCBA also expanded the definition of loans to a director to include loans to subsidiaries of a company in which the director or the director’s family members or associates were holding shares. EDFCA2 prohibited finance companies from lending money and guaranteeing any debt to its directors. CBA2 increased the penalties on interlocking directorships in commercial banks.

Changes in Supervisory Responsibility

To improve the supervisory arrangements, CBA2 transferred a number of regulatory responsibilities from the Ministry of Finance (MOF) to the BOT. The MOF retained responsibility for licensing head offices of domestic banks, but the BOT gained the power to regulate changes in the location of bank offices and to authorize domestic representative offices of foreign banks and foreign representative offices of domestic banks. EDFCA2 made the BOT responsible for authorizing domestic representative offices of foreign finance companies, for approving bank auditors, for setting banking hours and bank holidays, and for prescribing the form and frequency of commercial banks’ summary statements.

Table 8.Summary of Main Statutory Requirements of Commercial Banks, Finance and Security Companies, and Credit Foncier Companies, End-1987
Commercial BanksFinance and Security CompaniesCredit Foncier Companies
Minimum paid-up capital (in millions of baht)6030
Restrictions on share ownership150 holding100 holding100 holding
Number of shareholders50 percent of shares50 percent of shares50 percent of shares
Foreign ownership25 percent of shares25 percent of shares25 percent of shares
Maximum held by a single person0.5 percent of total0.6 percent of total0.6 percent of total
Minimum ratio of holdings of capital (in percent) to
Risk assets866
Contingent liabilities2025
Exemptions of assets from the risk/asset ratios12
Maximum lending in relation to capital (in percent)
Loans to a single borrower253030
Other loan categories20 percent of aggregate share holdings5 percent for car hire purchase20 percent for unsecured call loans to an individual institution and 100 percent in aggregate
Other Sending restrictions
Loans to directorsProhibitedProhibitedProhibited
Overdraft lending to single borrowerMaximum B 50 million
Loan to deposit ratio
Minimum collateral requirementsCash or notes equal to 70 percent of value of loans for security purchases3
Open foreign exchange position (percent of capital funds)20
Reserve and liquidity requirements
Cash reserve ratio (in percent of deposits)7
Balances of Bank of Thailand(>2)(…)(…)
Cash in hand(<2.5)(…)(…)
Government securities(2.5)(…)(…)
Liquid asset ratio (percent of borrowing)75
Balances of Bank of Thailand(-)(>0.5)(>0.5)
Unobliged government securities(-)(>5.5)(>3.5)4
Deposits at call and loans to banks(—)(<1.0)(<1.0)
Other restrictions on liabilitiesMaximum interest ratesMaximum interest rates, minimum size of promissory notes;5 demand and savings deposits prohibitedMaximum interest rates, minimum one-year maturity and size of promissory notes;6 demand and savings deposits prohibited
Supervisory framework
Regular reports to BOTMonthlyMonthlyMonthly
BOT approval needed for
Payment of dividends
Appointment of auditorsYesYesYes
On-site inspections by BOT staffYesYesYes
Formal loan classificationsYesYesYes
Formal provisioning requirementsYesYesYes
Source: Bank of Thailand; Commercial Bank Acts; Finance and Security Company, and Credit Foncier Acts.

Some 28 items are excluded, including certain loans to priority sectors.

Exempt 14 items.

This figure is subject to the regulation of the SET but not less than 25 percent.

Including unobliged government-guaranteed securities.

B 10,000 in Bangkok metropolitan area, B 5,000 elsewhere.

B 1,000.

Source: Bank of Thailand; Commercial Bank Acts; Finance and Security Company, and Credit Foncier Acts.

Some 28 items are excluded, including certain loans to priority sectors.

Exempt 14 items.

This figure is subject to the regulation of the SET but not less than 25 percent.

Including unobliged government-guaranteed securities.

B 10,000 in Bangkok metropolitan area, B 5,000 elsewhere.

B 1,000.

Tighter Regulations and Penalties

Under CBA1, banks had been largely unrestricted in the types of activities they could undertake. Under CBA2, the banking business was defined in more detail, and any activity by banks that was unrelated to banking became either unlawful or subject to approval by the BOT. CBA2 also gave the BOT authority to set a capital requirement against contingent liabilities, to impose a liquid assets requirement, and to differentiate the cash requirement by type of deposit.

CBA2 specified more power for the MOF to revoke bank licenses and authorized the MOF to recommend that a commercial bank dismiss its directors or officers to avoid having its license revoked. EDFCA1 required finance companies to close their books at least every six months and specified that balance sheets and profit and loss accounts had to be approved by a general meeting of shareholders before being published and had to be submitted to the BOT within 21 days. EDCBA introduced the same regulations for commercial banks. EDFCA1 required that the BOT approve auditors for finance companies annually; EDCBA extended this requirement to commercial banks.

Stricter penalties were introduced for noncompliance with the law by CBA2 and EDFCA1. The most important changes in the penalties imposed on banks are given in Tables 9 and 10.

Expanded Supervisory Powers and Cease and Desist Arrangements

CBA1 provided for the appointment of bank inspectors but did not give inspectors the power necessary to conduct on-site examinations of commercial banks; moreover, the lack of BOT control over bank returns under CBA1 may have restricted off-site inspection. CBA2 gave inspectors more power, including the right to enter a bank’s premises when they had reason to suspect that an offense had been committed. Inspectors could demand cooperation not only from directors, officers, and employees of commercial banks, but also from the banks’ auditors. EDCBA and EDFCA2 gave inspectors (competent officers, in the case of finance companies) the right to enter the premises where data were analyzed or stored and to obtain information from, and to order cooperation by, persons responsible for collecting or analyzing data. With the approval of the Governor of the BOT or the MOF, bank inspectors also could enter the premises of and examine the operations of a commercial bank’s borrower, or otherwise require the borrower or other persons to provide information necessary for the inspection of the commercial bank.

Under CBA1 the Minister of Finance could order, in the public interest, a license to be revoked or a bank to be placed under control following the inspector’s report, but these broad powers were not used. CBA2 gave the BOT the power to demand that a commercial bank write off as worthless, assets that were found to be unrecoverable during the analysis of the summary statements—thereby allowing the BOT to impose some effective remedial measures. EDFCA1 established similar regulations for finance companies and gave the BOT the additional flexibility to require finance companies to provide special reserves to cover doubtful assets, EDCBA extended this additional power for the BOT to commercial banks.

Table 9.Main Changes in Penalties for Noncompliance with the Commercial Banking Law Enacted by CBA2
New Offenses

Subject to

Penalties Under CBA2
Penalties for

Bank
Penalties for

Responsible

Persons
Operating representative office domestically or abroad without obtaining authorization of BOTImprisonment of up to one year, maximum fine of B 100,000, or both
Failing to comply with regulations on concentration of ownership of sharesMaximum fine of B 100,000
Failing to comply with special cash reserve requirements when in effectMaximum fine of B 200,000Imprisonment
Increased penalties for existing offenses
Undertaking commercial banking without proper authorizationImprisonment of up to five years, maximum fine of B 500,000, or both
Serving as director or holding any other position in two or more commercial banks simultaneouslyImprisonment of up to one year, maximum fine of B 100,000, or both
Establishing branch without proper authorizationMaximum fine of B 300,000
Reducing bank’s equity capitalMaximum fine of B 300,000 and/or B 3,000 a dayImprisonment of up to one year, fine of B 300,000, or both
Source: Commercial Banking Act (No. 2), BE 2522.
Source: Commercial Banking Act (No. 2), BE 2522.
Table 10.Main Changes in Penalties for Noncompliance with the Commercial Banking Law Enacted by EDCBA
New Offenses Subject

to Penalties

Under EDCBA
Penalties

for Bank
Penalties for

Responsible

Persons
Dismissed bank employees still working for bank or not cooperating with new employees by providing informationImprisonment of up to one year and/or maximum fine of B 100,000
Prescriptions and conditions for noncompliance with following regulations:Maximum fine of B 100,000 per offense
Concentration of ownership of shares
Minimum 250 shareholders per bank
Bank purchase/ holding of shares in another bank
Cessation of bank operations
Transferral/dismissal of bank employees
Maximum credit per borrower
Liquid asset requirements
Increase/reduction of equity capital
Removal of directors
Source: Emerging Decree Amending the Commercial Banking Act, BE 2505, BE 2528.
Source: Emerging Decree Amending the Commercial Banking Act, BE 2505, BE 2528.

EDCBA and EDFCA2 allowed the MOF, with the advice of the BOT, to stop all or parts of a commercial bank’s or a finance company’s operations temporarily in order to rectify the financial position of the bank or to protect the stability of the financial system. The BOT obtained power to enforce compliance with regulations through direct intervention, to order a commercial bank or a finance company to increase or reduce its capital in order to prevent any damage to the public interest, to remove any director or person responsible for operating a commercial bank or a finance company that threatened damage to the public interest, and to approve new officials.

Lax Regulatory Standards

Even when the regulatory framework was adequate in Thailand, implementation was weak.

Capital/Assets Ratios

The deterioration in the overall capital/assets ratio of banks partly reflected an easing of regulatory standards for commercial banks. In May 1983, the overall capital/risk assets ratio fell from 8.5 percent to 8 percent largely because of a lack of capital rather than because of any reassessment of the riskiness of banks’ assets. This reduction in the overall capital/assets ratio was accompanied by a very rapid growth of bank loans to the private sector (34 percent in 1983, see Chart 4). Rapid balance sheet growth by itself can strain management resources and credit appraisal systems, and, combined with weak procedures for assessing the quality of loans, that growth in loans contributed to the banks’ subsequent loan losses.

The definition of banks’ risk assets also was weakened. First, a number of relatively high risk assets, such as lending to finance and security companies, were excluded from the definition; because these assets tended to grow rapidly, the quality of banks’ balance sheets deteriorated. Second, in August 1986, the BOT reduced from 100 percent to 80 percent the proportion of loans extended to certain priority sectors that were counted as risk assets; this action also tended to weaken banks’ balance sheets. Third, between October 1986 and April 1987, as a measure to reduce domestic currency liquidity in the financial system, the BOT temporarily increased the limits on banks’ open foreign exchange positions from 20 percent to 40 percent of capital funds. It subsequently redefined banks’ open foreign exchange positions to exclude positions in a bank’s branches abroad, thus providing scope for avoidance of the restriction on banks taking an overall open foreign exchange position. Fourth, until 1985 the assets of Thai banks’ foreign branches were excluded from their capital/ assets ratios; and capital requirements remained to be completely consolidated. As a result of the exclusions just mentioned, Thai banks’ on-balance-sheet risk assets amounted to only 51 percent of their total assets at the end of 1986, compared with 64 percent in 1984 (Table 11). In addition, off-balance-sheet risks were substantial.

Chart 4.Economic and Financial Indicators

(In percent)

Sources: Data provided by the That authorities and International Monetary Fund, International Financial Statistics.

Off-Balance-Sheet Risks

A 20 percent capital requirement was imposed against contingent liabilities, but because the definition of contingent liabilities used in calculating this capital requirement covered only 12 percent of banks’ off-balancesheet transactions (see Table 11),7 the capital requirement against total off-balance-sheet transactions averaged only 2-3 percent. Furthermore, this capital requirement has been imposed along with the 8 percent capital/risk assets ratio for on-balance-sheet risks using the same capital base. In other words, the balance sheet risk assets and contingencies have not been added together to arrive at a measure of total risk exposure in the portfolio for the purposes of determining capital adequacy.8 Hence, to the extent that the capital has been fully employed as a safeguard against on-balance-sheet risks, it has not been available as a safeguard against off-balance-sheet transactions. Such transactions exceeded 50 percent of banks’ total assets. The ratio of capital to gross total assets and off-balance-sheet transactions was approximately 3 percent (Table 11).

Table 11.Assets, Off-Balance-Sheet Items, and Capital of Commercial Banks, 1982-861(In billions of baht)
19821983198419851986
Total assets496.2614.7741.4806.8870.1
Risk assets2247.0326.7396.1450.5439.6
As percentage of total assets49.853.264.455.850.5
Off-balance-sheet transactions310.6348.4429.7411.2484.5
As percentage of total assets62.656.760.051.055.7
Contingencies343.454.761.057.5
As percentage
off-balance-sheet transactions12.412.714.811.9
Contingencies and risk assets370.0450.7511.4497.2
Total assets plus off-
balance-sheet transactions806.8963.11,171.11,218.01,354.6
Capital funds24.528.036.142.343.9
As percentage of
Total assets4.94.64.95.25.1
Risk assets9.98.69.19.410.0
Off-balance-sheet transactions7.98.08.410.39.1
Contingencies64.566.169.376.4
Contingencies and risk assets7.68.08.38.8
Total assets plus off-baiance-
sheet transactions3.03.63.13.53.2
Source: Bank of Thailand.

Including overseas branches.

Those assets subject to 8 percent capital requirements.

Off-balance-sheet items defined under Section 10(3) of the Commercial Bank Act that are subject to a 20 percent capital requirement.

Source: Bank of Thailand.

Including overseas branches.

Those assets subject to 8 percent capital requirements.

Off-balance-sheet items defined under Section 10(3) of the Commercial Bank Act that are subject to a 20 percent capital requirement.

Dividend Payments and Interest Accruals

Although the BOT had power under Section 21 of the CBA2 to prevent the distribution of dividends and banks were slow to increase provisions for bad and doubtful debts, the BOT never exercised its power. Similarly, the BOT imposed no restrictions on the accrual of interest and income earned but not received in the balance sheets of commercial banks. Restrictions on dividend payments and interest accruals have been imposed on finance companies. Interest accruals boost recorded earnings and book profits, and unwarranted dividend payments could give a misleading impression to new shareholders when banks are raising new capital.

Loan Provisioning

The BOT defined worthless and irrecoverable assets in a circular, BE 2529, on March 18, 1986. The criteria were defined mainly in terms of the nonrecoverabitity of the debt, evidenced, for example, by death, bankruptcy, lack of collateral, or legal proceedings rather than by delinquency in meeting scheduled payments. Because there were no clear criteria for defining doubtful debts, which required provisioning in advance of loss, the result was to delay provisioning until the debt was actually a loss.

Concentration of Ownership

Despite the regulations on share ownership, ownership appears to be highly concentrated, and this concentration has interfered with the professional management of some commercial banks. This problem was especially severe in banks where the regulations on lending to shareholders, directors, and management (or other affiliates) were being circumvented.

Economic Conditions

Although distinct structural and regulatory inadequacies were evident in the 1970s, the inherent institutional weaknesses were exacerbated by the downturn in economic activity in the first half of the 1980s (see Chart 4). In 1982 the Thai authorities substantially increased nominal and real interest rates. Real bank loan rates, which had averaged 4.2 percent between 1971 and 1981, averaged 12.4 percent between 1982 and 1986. Nominal bank loan rates rose above the growth of bank credit to the private sector in 1980 and 1981 and again in 1985 and 1986, resulting in a net transfer of resources from borrowers to commercial banks which acted to squeeze borrowers and caused loan delinquencies. As already noted, the rapid growth of bank lending in 1983 reflected the easing of the capital/ assets ratio requirement. By 1983 the growth of the monetary aggregates slowed significantly (see Chart 4). The difference in the growth rates of M2 and M3 (M2 plus the consolidated liabilities of finance companies) in 1984 is indicative of the serious loss of confidence in finance companies in that year, which resulted in a shift of deposits out of finance companies into commercial banks (see Section VI). The average rate of real GDP growth fell from 6.9 percent between 1971 and 1981 to 4.4 percent between 1982 and 1986.

Also during the 1980s, competition in the supply of bank credits increased for several reasons. First, after 1985 the authorities encouraged a more competitive determination of bank interest rates and placed less reliance on interest rate ceilings. Second, between 1983 and 1986 the emergence of positive differentials between Thai and Eurodollar interest rates encouraged increased borrowing abroad by prime corporations. Third, in 1986 and 1987, the financial sector showed a high level of liquidity—a reflection of the improved balance of payments and foreign exchange reserve accumulation by the BOT. Fourth, between 1984 and 1986 loan demand was relatively sluggish and loan/deposit ratios fell (see Table 3). As a result, banks cut their lending rates to prime borrowers to 3 percentage points or more below posted “minimum lending rates”; the effective spread between the average cost of funds to banks and the average return on lending to banks then declined from 2.8 percent in 1982 and 1983 to 2.2 percent in 1984, 2.05 percent in 1985, and 1.95 percent in 1986. In some cases, the spread between borrowing and lending rates failed to cover the risks acquired in the portfolio, and, as already noted, the overall profitability of the banking system was reduced. An increase in competition inevitably put pressure on weaker institutions and made their recovery even more difficult.

The combination of weak institutions and economic downturn caused a crisis in 1983 when one finance company failed and others experienced runs on deposits. Because finance companies accounted for a relatively small proportion of total financial institution liabilities, they might have been allowed to fail without threatening financial sector stability, but in view of the sharp economic downturn, there was concern that any loss of confidence could have had serious economic implications. Hence the BOT decided to intervene in these companies either to pay off depositors or to support and restructure them. A loss of confidence in commercial banks was potentially much more serious, but except for deposit runs on the Sayam Bank, there was no evidence of a general loss of public confidence in the banking system.

IV. Support Arrangements and Remedial Actions

The restructuring and the support of ailing financial institutions in Thailand reflect the extent to which the arrangements were put into effect as part of crisis management or made in advance of the crisis. EDFCA1 (1983) expanded the supervisory power of the Minister/BOT over financially troubled companies. Any finance company that suspended repayment of its due obligations had to notify the MOF and the BOT immediately, and was prohibited from transacting any business without special authorization from the Minister. Upon receiving such a notification, the Minister had the power to appoint a competent officer to investigate the company. The BOT gained the power to order a banker or finance company to reduce or increase its capital, to remove directors and managers, and to appoint new officers in the public interest only in 1985 under EDCBA and EDFCA2. Hence the BOT could not really intervene when the crisis emerged in 1983. After 1985, the restructuring of institutions through mergers continued to be inhibited by the merger law, which required 100 percent agreement of creditors before mergers could take place. As a result, the remedial measures have been pursued mainly through direct government takeovers and attempts to rehabilitate existing institutions, rather than through mergers. In addition, there have been legal difficulties in recovering delinquent debts.

Support for Finance and Security Companies

The main elements of support for finance and security companies have been injections of liquidity through a number of schemes (“liquidity fund,” “lifeboat” support, and credit from other financial institutions) and through capital and management restructuring.

Initial Liquidity Support

In late 1983, to provide general liquidity support to the ailing finance and security companies, the Government and members of the Thai Bankers Association (TBA) established a “liquidity fund” of B 5 billion, of which B 1 billion was provided by the Krung Thai Bank, acting on behalf of the Government, and the remainder by other commercial banks. The fund, which was used to support 18 companies, was managed jointly by representatives of the Krung Thai Bank (representing the TBA), the MOF, and the BOT. The TBA charged market-related interest rates on its loan to the fund (initially, 13 percent, equal to the BOT discount rate); rates on the loans provided by the fund to support institutions were also market related (set initially at 16—16.5 percent but subsequently reduced in line with the decline in market rates). Loans were initially granted for periods of up to three years but have subsequently been rolled over.

“Lifeboat” Support and Restructuring

In April 1984, after it became clear that a serious loss of confidence was developing in the finance companies, the MOF initiated a “lifeboat” scheme for the troubled companies, which provided additional support to the liquidity fund and gave the authorities a means to intervene in the finance companies (which the liquidity fund and the existing legal framework did not provide).

Under the lifeboat scheme, any troubled finance or credit foncier company that was not a bank affiliate could apply to join the lifeboat, which offered three types of financial assistance: credit lines at market rates, without a maturity date, to offset deposit withdrawals (the total amount available to be drawn was B 3.2 billion); capital injections through equity participation by the Krung Thai Bank9 (B 2.4 billion); and BOT soft loans to be invested in government bonds (up to B 6.4 million). The soft loans carried a five-year maturity and an interest rate of 0.1-2.5 percent, depending on the interest rate on government bonds purchased.

To join the scheme, the company had to reduce the value of its shares and existing management and major shareholders had to surrender additional collateral and to transfer to the MOF 25 percent of the shares plus another 50 percent of the voting rights; the latter 50 percent was to be transferred back to the original owners within five years at a price to be set by the MOF. As the authorities injected additional capital into the companies, their effective voting rights rose to about 90 percent of shares issued. The BOT and MOF were responsible for screening applicants; installing new management; and determining the amount, type, and terms of financial assistance. The BOT also had to monitor closely the performance of companies in the scheme.

Twenty-five companies joined the lifeboat scheme; 11 of these were viewed to be in a position that could be supported with soft loans, while the remaining 14 were judged to be in critical condition. Seven other companies refused to join the lifeboat scheme and were subjected to a detailed evaluation and restricted from accepting new deposits or granting new loans. Of these seven, 4 lost their licenses and were closed in October 1985; a fifth was closed in November 1986. The BOT has been paying off depositors in those 5 companies over a ten-year period without interest on the deposits. The controls on accepting new deposits and granting loans on the two others were lifted. In July 1986 4 security firms (which had not been in the lifeboat scheme) lost their licenses, reducing the number of security firms to 11.

In January 1987 a scheme was announced to resolve the problems of the finance companies in the lifeboat: (1) The Krung Thai Bank was to take over the management of the finance companies still in the lifeboat; staff from the Krung Thai Bank were appointed to join the management teams and to oversee the operation of these financial institutions; in addition, a task force consisting of analysts and examiners was set up at the BOT to follow activities of the firms and to provide management information and recommendations to policymakers; (2) The business of the companies was to be restructured to make them active in investment banking; (3) The cost of borrowing from the liquidity fund was to be cut to 8.85 percent (with a similar reduction in the return on placements with the fund); (4) The stronger companies in the scheme were to be reprivatized and the weaker companies were to be merged into new companies; (5) Foreign financial institutions were to be invited to join in the ownership and management of firms in the lifeboat and given incentives similar to those offered to encourage mergers (this proposal has faced difficulties); (6) Nonperforming assets of finance and security companies were to be rediscountable with the Fund for Rehabilitation and Development of Financial Institutions (RF), thus providing liquidity to these otherwise nonperforming assets. In addition to the funds it had provided to the liquidity fund, the Krung Thai Bank set aside a further credit line of B 4 billion to be extended to companies at market rates. This action brought the total credit lines provided under the support schemes to approximately B 19 billion. By the end of 1987 the net indebtedness of finance companies to the banking system had reached B 36 billion (see Table 7).

By the end of 1988, 5 of the 25 companies in the lifeboat had been resold to their previous shareholders and directors appointed by the authorities had been withdrawn, as originally envisaged when setting up the scheme, but the new management installed by the authorities was retained as part of the resale arrangement. The prices at which these companies were resold did not involve losses to the original shareholders, and additional soft loans were provided as incentives for the reprivatization of the companies. The authorities have encouraged other companies that have common shareholders or common debtors to merge and have provided incentive schemes such as the privileges to open branches and new lines of business (leasing). After two years of legal and administrative preparations, the first merger of 6 companies took place in late 1987; since then 3 other companies have merged too. The merged companies have remained in the lifeboat and continue to be supported by soft loans. At the end of 1988, 13 companies with assets of B 20 billion remained in the lifeboat.

Fund for the Rehabilitation and Development of Financial Institutions (RF)

The RF was set up within the BOT as a legally distinct entity with its own Board and management under the EDCBA to rehabilitate financial institutions. The RF’s activities consist of lending (with proper collateral) to, placing deposits in, acquiring assets from, and holding equity in financial institutions; and offering assistance to depositors in, or lenders to, financial institutions during crises. Financial institutions are required to contribute to the RF at a rate set by its Board, up to 0.5 percent of outstanding deposits; the rate in 1988 was 0.1 percent. However, in November 1988 the BOT contributed the majority of the resources of the RF through a capital subscription and loans equivalent to 84 percent of the RF’s total funds of B 12.2 billion. The RF has been active in underwriting and subscribing to capital issues by distressed financial institutions and has taken over the capital injections made earlier by the Krung Thai Bank under the lifeboat scheme. It has also provided liquidity support by rediscounting nonperforming assets of troubled financial institutions and providing soft loans. By November 1988, the RF had lent B 4.2 billion to commercial banks—the largest portion to the Krung Thai Bank—and invested B 4.3 billion and B 1.0 billion, respectively, in the equity of five banks and one finance company.

Support for Commercial Banks

The support and restructuring arrangements for commercial banks have also reflected the powers of the BOT to intervene and to order a restructuring of troubled financial institutions. The main arrangements used to support ailing commercial banks have been government takeover, soft loans from the BOT and the RF to be invested in government bonds by the institution (a de facto subsidy to banks’ profits), and equity participations by the RF combined with a restructuring of the banks’ managements under BOT guidance. Proposals to support ailing banks have been made by the Bank Supervision Department of the BOT. On the basis of these proposals the Board of the BOT can approve soft loans to the institution, and the Board of the RF can approve equity participations, rediscounts, and soft loans by the RF. As a condition of support, the BOT has set financial programs specifying paths for increases in capital and bad debt provisions of the banks. The purchase of shares by the BOT or the RF in supported institutions has meant that part of the gain in the net worth of the banks attributable to soft loan subsidies accrues to the BOT through an appreciation in share values.

Five banks have received financial assistance (see Table 6). The Sayam Bank, with about B 20 billion in assets (the eleventh-largest local bank), was judged insolvent in the early 1980s and, after suffering a run on deposits, it was taken over by the Government in August 1984. It has since received B 3.5 billion in support (equivalent to 20 percent of assets) from the monetary authorities and was operationally merged with the nationalized Krung Thai Bank in February 1987.

The Siam City Bank and the First Bangkok City Bank (the ninth- and tenth-largest banks, each with about B 28 billion in assets) were also judged to be insolvent but did not face deposit runs, and hence, emergency intervention and restructuring were not required. Because emergency measures were not called for, the BOT could more easily decide the timing and type of intervention and was able to utilize the new powers granted to it under EDCBA. After inspections of their books, the BOT ordered the value of the banks’ capital to be reduced and new capital to be raised to a level that could support their activities, thus involving losses for existing shareholders. In each case, the banks were supported by soft loans from the BOT, and the RF stood ready to underwrite a large part of the new capital issue.

Once the BOT’s powers of intervention had become established, it was easier for it to encourage further “voluntary” restructuring by certain commercial banks. In the case of the Bank of Asia (the twelfth-largest bank), the BOT provided soft loans when the bank agreed to a comprehensive restructuring package, and the shareholders and existing management were supported. However, the BOT retained the option of buying shares in the bank at below-market rates should the restructuring fail to advance as intended.

A package of support measures, including an equity participation of B 2 billion and loans by the RF, was announced in 1987 for the Krung Thai Bank, which had been active in supporting the ailing finance companies; consequently, the burden of financial institution support has come to rest even more heavily with the BOT.

V. Review of Support Arrangements

It seems important to distinguish between the support operations for the finance and security companies and the commercial banks. As already noted, the finance companies were financially less significant and substantially unregulated before the crisis and the insolvent companies had significant negative net worth, which has made their rehabilitation difficult. There would seem to be a prima facie case for closing these institutions rather than supporting them. On the other hand, the banks were quantitatively more important and were at least nominally subject to official regulation, and thus there would seem to be a better case for the support and restructuring operations. The restructuring operations for four of the five commercial banks were better planned, in that they were not undertaken in reaction to a crisis.

The success of the present support arrangements depends on the outlook for a recovery in profitability of the ailing financial institutions. The substantial recovery in the Thai economy in 1987 and 1988 to growth rates of 7-9 percent have improved loan performance, raised the value of collateral, and reversed the weak profit trends and declining bank lending margins noted during the 1980s, thus improving the prospects for success. On the other hand, competition between financial institutions has continued to intensify as the cartel arrangements between banks have continued to break down, keeping profit margins low. A competitive financial system may inevitably require that weaker firms disappear and new firms are permitted to enter, thus requiring a more fundamental restructuring of financial institutions and revisions to the present merger law.

The costs of keeping open the ailing institutions have turned out to be high. The direct annual cost of the support arrangements to the BOT, because of its soft loan subsidy, and indirectly to the central government budget, because of the lower BOT profits available for appropriation, is estimated to have amounted to about 1 percent of budgeted revenue in 1987/8810 (equivalent to an annual cost of about 0.2 percent of GDP, and 2 percent of reserve money). The profitability of the Krung Thai Bank has also been adversely affected and has required support. Scarce resources—both human and financial—were also tied up in keeping open the ailing finance companies which might have been better employed in other activities.

The initial decision to support rather than close the insolvent finance and security companies was taken on the basis of the estimated comparative costs of paying back the depositors of the companies over a ten-year period (estimated in present value terms to be equivalent to 50 percent of the value of deposits assuming that no interest was paid on deposits) and of keeping open the ailing institutions. The estimates indicated that a salvage operation would be less costly. However, the costs of keeping open the ailing institutions turned out to be much higher than anticipated mainly because the magnitude of companies’ bad debts was underestimated, the recovery of collateral was more difficult than anticipated, and also because the BOT staff, which took over the management of the companies, lacked commercial banking expertise. As a result the activities of the companies stagnated and their losses continued to increase. In these circumstances, new injections of capital were quickly wiped out and did not improve companies’ solvency, but simply went toward paying interest to depositors.

An alternative would have been to develop at an early stage a program which would have involved a larger number of closures or the sale or merger of nonviable institutions with sound institutions. Nonviability might mean that there was a limited probability that the institution would achieve solvency and profitability in a reasonable period of time (say, three to five years). The closure of an institution would have required an injection of public funds to repay depositors. In a case where it would have been possible to sell the institutions (or merge them), which may be preferable to outright closure, it may have been necessary to have an initial injection of public funds equivalent to the institutions’ negative net worth. The government budget has had to carry the cost of the support arrangements, albeit indirectly through reduced BOT (and Krung Thai Bank) profits, and the necessary one-time injection of public funds needed to restructure financial institutions might not have added to budgetary costs, taking a number of years together, while removing the burden of support from the authorities. Indeed, selling and merging the ailing companies could have placed them under more competent managements, and hence their operations might not have stagnated, resulting in lower recovery and budgetary costs. Moreover, depositors could have been expected to bear some of the losses of finance companies, since they had benefited from the previous higher interest rates on finance company deposits. The interest differential paid by finance companies may have included a margin to cover the risks that deposits with finance companies would not be fully repaid, and so depositors may have anticipated some loss.

Such a program would have had to address the impediments to the restructuring of the financial system such as the commercial and bankruptcy laws which have made the closure and merger of financial institutions highly cumbersome, requiring direct intervention by the authorities. An easing of the restriction on foreign participation in local commercial banks, which has been limited to 25 percent of equity, could also have provided an injection of capital funds and management skills that would have facilitated the restructuring of financial institutions.

The BOT was able to restructure financial institutions as part of its support arrangements and in many cases imposed sanctions on bank managements and shareholders. Nevertheless, the approach to supporting existing financial institutions carried risks for financial sector efficiency when it prevented or slowed down a necessary restructuring of the financial sector. In several cases shareholders were also insulated from the full losses incurred by their financial institutions, which could weaken shareholders’ incentives to require the highest standards from the managements of the institutions concerned. The capital of banks was ordered reduced in some cases, but in others the shareholders were not penalized or at least did not bear the full losses of their institutions. Moreover, depositors in supported finance companies were fully bailed out by the authorities, even though the interest rates paid by these companies were at a premium to those offered by commercial banks. Intervention by the authorities may have raised problems for “moral hazard” and weakened self-regulatory systems.

VI. Macroeconomic Consequences

As regards the broader economic implications of the support arrangements, there are a number of possible channels by which the financial crisis could have influenced the macroeconomy. Since the BOT soft loans had to be invested in government securities sold from the BOT’s portfolio, it is probable that a substantial part of the loans was automatically sterilized and therefore did not have direct effects on economic activity. However, the requirement that soft loans be invested in government bonds might not prevent some leakage of these loans into other activities; for example, government bond purchases by these institutions might have taken place anyway. The higher budget deficit resulting from the lower profits of the BOT available for appropriation by the Government could contribute to monetary expansion if it were financed through the banking system.

A potentially more serious concern was that the stance of monetary policy was relaxed by the need to improve bank profitability rather than by macroeconomic considerations during 1986 and 1987. During these years the authorities permitted a high level of financial sector liquidity and the growth of reserve money increased sharply, reaching 20 percent in 1987. The increase in liquidity largely reflected balance of payments surpluses. The authorities had at their disposal the instruments—government bond repurchases and issues of central bank bonds—to restrict the liquidity expansion, and indeed the BOT became more active in its money market intervention in 1986 and 1987, but limited the amounts to certain nominal ceilings. As a result, interbank rates fell to very low levels and it has been suggested that this was partly to help weaker financial institutions by reducing borrowing costs; however, as noted above, the increase in liquidity also intensified competition for bank loans and therefore may have reduced bank lending spreads. During 1986 and the first half of 1987 the economy was in the early phases of recovery, inflation was low, and the balance of payments was in substantial surplus; therefore a looser financial policy may have been justified by macroeconomic conditions. Hence, there was no great conflict between supporting financial institutions and the macroeconomic policy stance during this period. Circumstances could have been otherwise, and there may be concern that the need for a future tightening of policy on macroeconomic grounds could be delayed by the need to support ailing financial institutions.

As is evident from Chart 4, there was a shift in the behavior of the M2 and M3 monetary aggregates in 1983 and 1984, associated with a movement of deposits out of finance companies into commercial banks following the financial crisis which distorted the monetary aggregates. Our estimated demand equation shows a significant increase in the demand for M2—currency and deposit liabilities of commercial banks—following the emergence of the crisis among finance companies in 1983.11 The Thai authorities have used multiple monetary targets as a guide to policy including the M2 monetary aggregate. The more rapid growth of this aggregate in 1983 and 1984 as a result of the portfolio shift out of finance company accounts into bank deposits could have contributed to the significantly tighter monetary policy during these years. But there would have been no necessary reason to tighten monetary policy simply because of a portfolio shift which would not have had expenditure implications.

Even if policy had not been tightened deliberately, an unanticipated tightening of policy could have occurred through two channels. First, since the cash ratio requirement was higher on bank deposits than on finance company promissory notes (see Table 8), the shift of deposits to banks from finance companies would have raised the demand for cash reserves. The authorities would have had to supply additional cash reserves to avoid an unanticipated tightening of policy, but there is no evidence of this. Second, in 1984 commercial banks were requested to restrict overall credit growth to the private sector and to restrict the opening of import letters of credit. The portfolio shift in deposits out of finance companies into banks meant that finance companies were less able to meet their credit demands and there was a sharp decline in the growth of their loans to the nonbank private sector (see Table 7); hence, there may also have been a portfolio shift which increased the demand for bank loans. Moreover, banks were increasing their lending to the finance companies which may have been caught under the restrictions on credit to the private sector, and which may have further crowded out other private sector borrowers. Thus the effect of the restrictions on commercial bank credit growth could have been tighter than anticipated because of the failure to allow for credit reintermediation and the increased demand for loans by finance companies as a result of the crisis. The precise impact of the financial crisis on real economic activity, inflation, and the balance of payments is very difficult to gauge. During 1983-85, economic policy had been tightened to correct domestic and external imbalances and economic activity slowed sharply. It is precisely during this period that any disruption to credit availability and a misinterpretation of monetary aggregates because of emergence of the financial crisis could have resulted in a more restrictive policy and hence slower economic activity. Real GDP growth slowed to a very low level by Thai standards in 1984 and 1985 (see Chart 4). As noted, the subsequent recovery in activity was associated with the substantial growth of liquidity support by the BOT and economic activity recovered sharply in 1987 and 1988. Hence the crisis and the subsequent support may have influenced economic activity in a procyclical manner.

VII. Conclusion and Main Findings

The emergence of distressed financial institutions in Thailand had its origins mainly in weak managerial practices and an inadequate legal, regulatory, and supervisory framework for financial institutions. The indigenous private sector financial institutions were established by trading families and other powerful economic groupings and had a high concentration of ownership and, in several cases, of loan exposure to interrelated entities. Such institutions were not “self-regulatory” in the sense that there was a lack of normal checks and balances between shareholders, directors, and management, and this resulted in inherent management weakness. Moreover the regulation of interest rates and restrictions on branching and new bank offices encouraged the rapid growth of substantially unregulated finance companies.

Against this background, a high standard of external supervision and regulation was necessary if institutions were to develop sound and professional practices. However, the initial legislative framework establishing the BOT and covering the operations of financial institutions was very weak and did not give the authorities the powers to regulate or supervise the financial system. Finance companies were officially recognized—which acted to increase public confidence in these companies—but they were not regulated. Hence poor banking practices went on largely unchecked, leading to a problem of delinquent debts and erosion of the capital bases of the banks and finance companies. These problems were brought to the fore with the slowdown in economic activity in the early 1980s.

Initially, intervention occurred in a crisis environment and the authorities did not have flexible powers to intervene in and to restructure the ailing financial institutions. Only in 1985 were the legislative frameworks amended to give the BOT adequate powers to supervise and intervene in the financial institutions. The subsequent intervention in commercial banks using these powers was undertaken before a crisis was allowed to develop. This intervention could have been more systematic, involving financial programs that would return banks to solvency. However, cumbersome merger laws have continued to restrict the speed and scope for more fundamental restructuring of the financial system. It is difficult to avoid the conclusion that the crisis first could have been prevented, and second, could have been dealt with more expeditiously if the initial legislative system had been adequate and effectively implemented. That is, the central bank should have been given the appropriate powers to supervise and regulate the financial system and to intervene when the first signs of difficulties emerged.

The Thai authorities took a variety of remedial actions as the problems with financial institutions emerged, including a substantial strengthening of the legal, regulatory, and supervisory arrangements; the takeover of institutions by the Government; financial support through credit lines at market rates; soft loans and equity participation; direct intervention to order changes in management and capital restructuring; and mergers and closures with deposit payoffs by the BOT. The support arrangements maintained confidence in the financial system, but have been costly in terms of the use of public funds and scarce human and financial resources, and undermined efficiency in the financial system. In several cases, shareholders have been insulated from the full losses of their financial institutions, and depositors who invested with finance companies and earned higher interest rates have had their deposits underwritten by the authorities. Alternative arrangements might have been less costly and more effective, such as a more active policy of closures and mergers including legislative reform and the involvement of foreign financial institutions. The finance companies were relatively small and unregulated with significant negative net worth, and there would seem to be a good case for closing more of these institutions. More generally, the increased competitive structure of the Thai financial system may require a more fundamental restructuring of financial institutions.

The broader economic consequences of the financial crisis are difficult to gauge. A portfolio shift by depositors and borrowers out of finance companies into commercial banks could have led to an unanticipated tightening of policy because of an increased demand for reserve money and because the restraints on credit expansion by commercial banks may have been more restrictive than expected, since they did not allow for the reintermediation of credit to the banking system. The faster growth of the demand for M2 monetary aggregates could also have added to the monetary policy tightening, and to the already deflationary policies being followed by the authorities in 1983–85. The subsequent expansion in BOT liquidity support for financial institutions occurred during the recovery phase (1986–87). Hence, to the extent that the financial crisis had real economic effects, these were probably procyclical, leading to a deeper recession (1983-85) and stimulating the recovery (1986–87).

An earlier version of this paper was discussed at the IMF Seminar on Central Banking, November 28-Dccember 9, 1988. I am grateful to V, Sundararajan and Tarisa Watanagase for their comments on an earlier draft of the paper, and to Anne Johannesseri for her help in compiling the information in Section III.

The only new bank opening after 1966 was the German-based European Asian Dank, which reflected both the lack of a previous German representation and the desire by the Thai Farmers Bank to open a branch in the western part of Germany. Of the 16 local hanks, the Sayam Bank stopped accepting deposits and extending credits in April 1987, when its performing assets and deposit liabilities were transferred to the Krung Thai Bank (discussed later in this section and in Sections II and V).

The Siam Commercial Bank, the Bangkok Bank, the First Bangkok City Bank, the Bank of Ayudhya, the Thai Military Bank, and the Union Bank of Bangkok all have some government ownership.

The Basle Committee of Banking Supervisors has recently recommended a minimum capital-to-risk assets ratio of 8 percent. See Bank for International Settlements, Committee on Banking Regulations and Supervisory Practices. International Convergence of Capital Measurement and Standards (Basle, July l988).

Speech by Nukul Prachuabmnoh, Governor. Bank of Thailand, to Thai Bankers Association, February 18, 1981.

This act replaced the Commercial Banking Act, BE 2488 (l945).

Excluded from the definition were undrawn facilities, interest rate and currency swaps, options, and forward exchange rate and interest rate agreements. Such transactions were relatively new for Thai banks but have been growing rapidly, particularly because banks have been seeking to improve their profit positions by increasing their fee incomes and to avoid the capital/risk asset restrictions on their balance sheet activities. The BOT has been conducting a review of its treatment of off-balance-sheet transactions. Tejasinit and others. “Central Bank Policy on Off-Balance-Sheet Operations,” Thailand Country Paper, presented to SEACEN Seminar. July 22-24, 1987, Bangkok, Thailand.

This type of procedure is suggested by Bank for International Settlements, Committee on Banking Regulations and Supervisory Practices, International Convergence of Capital Measurement and Standards (Basle, July 1988).

These were later taken over by the Fund for Rehabilitation and Development of financial Institutions (see below).

The contribution of BOT profits to budget revenues declined from B 2.3 billion (1.6 percent of total revenue) in 1984/85 to a budget estimate of B 1.2 billion (0.6 percent of total revenue) in 1987/88. Over this period there was a doubling of the BOT’s net foreign assets, which might have been expected to increase profits, although this may have been offset by a drop in interest rates which would have acted to reduce revenue. The cost to the BOT of its loans to commercial banks and finance and security companies, which amounted to B 28 billion at end-June 1987, might be estimated at B 2 billion annually, assuming an average soft loan rate of I percent and an average government bond yield of 8 percent.

The estimated demand equation for M2 is

R2 = 0.52; DW = 2.09; estimated period 1971-86; t-ratios in parentheses;

where GDP = nominal GDP

GDPA = nominal GDP in agricultural sector

rcb = savings defjosit rare at commercial banks

rfc = deposit rate at finance companies

π = rate of consumer price inflation

D = dummy variable for the crisis among finance and security companies, taking value zero 1971—82 and one thereafter. (-1) is the lag operator, in the log operator, and ΔX= X - X(- 1) is the first difference.

This equation imposes the restriction that the long-run income elasticity uf money demand is unity, which is an acceptable statistical restriction. Other eqoalions estimated for M3 did not exhibit a significant shift dummy as would be expected then the shift was mainly between components within M3. The coefficient on the dummy implies that the crisis would cause the M2 aggregate to increase by 18 percent in the long run. Evaluated using end-1982 data, this implies an increase of B 67 billion, equal to the stock of business and household holdings of promissory notes with finance companies at end-1982, prior to the crisis.

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