IV. Financial Reform
- David Robinson, Ranjit Teja, Yangho Byeon, and Wanda Tseng
- Published Date:
- September 1991
Over the past two decades, Thailand’s financial system has more than tripled, with the ratio of financial assets to GDP increasing from 40 percent to 120 percent. But while the financial sector is now quite deep,14 it still has a long way to develop. In common with many other developing countries, it is dominated by a relatively small group of domestic banks; the variety of financial instruments available to both users and providers of funds is limited; and, with the important exception of the stock market, the capital markets remain quite thin. To address these shortcomings, the authorities are currently preparing a wide-ranging program of financial reforms, with the threefold aim of boosting savings to support future growth; enhancing the capability of the financial sector to compete in international markets; and ultimately promoting Thailand as a regional financial center.
The Financial System
The financial system consists of the Bank of Thailand; 32 banks, including 29 commercial banks and 3 specialized banks owned by the Government; 94 finance and securities companies; several government-owned or sponsored specialized institutions; and a large number of small private and publicly owned institutions (Table 7).
|Assets (in billions of baht)|
|Bank of Thailand||1942||1||30.31||56.23||142.72||223.93||478.37|
|Government Savings Bank||1946||1||6.82||12.6||14.15||8.0||27.97||6.1||54.89||5.4||134.62||5.3|
|Bank for Agriculture and|
|Nonbank financial institutions||2,667||2.94||5.4||34.50||19.6||93.07||20.4||196.50||19.5||502.86||20.0|
|Finance and securities companies||1969||94||…||…||23.00||13.0||64.79||14.2||130.96||13.0||343.14||13.6|
|Credit foncier companies||1969||18||…||…||1.29||0.7||4.10||0.9||4.46||0.4||4.26||0.2|
|Small Finance Corporation of Thailand||1964||1||0.05||0.1||0.06||…||0.06||…||0.06||—||0.08||—|
|Industrial Finance Corporation of Thailand||1959||1||0.44||0.8||1.48||0.8||4.15||0.9||14.96||1.5||36.57||1.5|
|Life insurance companies||1929||12||0.97||1.88||2.22||1.3||6.45||1.4||17.64||1.7||44.97||1.8|
Excludes the Bank of Thailand.
Excludes the Bank of Thailand.
The commercial banking sector, which accounts for 71 percent of total financial assets, dominates the financial system. Most domestic banks were originally established by business groups and trading houses to help finance their operations, and they maintain close links today. The 15 local commercial banks, with their extensive branch networks, account for more than 95 percent of bank assets; the 14 foreign banks, which are subject to a number of restrictions,15 account for only 5 percent. The banking system itself is highly concentrated, with the 5 largest domestic banks accounting for some two thirds of total bank assets; new entry is highly restricted, with only 1 new bank established in the last twenty-five years.
The second largest group of financial institutions are the 94 finance and securities companies, which account for some 14 percent of total financial assets. They emerged originally in the early 1960s as affiliates of commercial banks either to provide services that the parent bank could not undertake directly or to engage in higher-margin but higher-risk consumer finance, and subsequently expanded into certain types of corporate finance. After a period of dramatic expansion in the 1970s, partly reflecting efforts to evade controls imposed on commercial banks, their growth slowed during the 1980s, following financial crises in both 1979 and 1983 (see Box 6 for a description of the latter). Finance and securities companies are forbidden from offering checking accounts and derive their funding from sales of promissory notes, which can be withdrawn on demand. Their activities cover short-term finance, hire purchase, underwriting and security trade, and other investment and advisory services, most of which commercial banks are not permitted to undertake; they are not yet allowed to undertake foreign exchange business, which is reserved to the commercial banks.
The remaining financial institutions account for about 15 percent of financial assets. Chief among these are the various government-owned financial institutions, particularly the Government Savings Bank, which aims to mobilize primarily household savings through an extensive branch network; the Bank for Agriculture and Agricultural Cooperatives (BAAC), which makes loans to the agricultural sector; and the Government Housing Bank, which helps persons of moderate income to purchase houses. The other financial institutions include the Industrial Finance Corporation of Thailand (IFCT), a privately owned development bank financed primarily through foreign borrowing (with government guarantee);16 a large number of savings and agricultural cooperatives; credit foncier companies (which finance the purchase of immovable assets); life insurance companies; and pawnshops.
The main financial instruments available to individuals are bank deposits, promissory notes issued by the finance and securities companies, and shares. On the borrowing side, the primary sources of finance are loans from the banking system or from the finance and securities companies, share issues, and, for larger companies, foreign borrowing. Government bonds and Treasury bills, the other main financial instruments available, have recently been in short supply owing to the Government’s sizable fiscal surplus, and are mainly held by the banks to satisfy various portfolio requirements. While other financial instruments do exist-—for instance, commercial paper, transferable certificates of deposit, short-term notes, debentures, and floating rate notes—they have in practice played only a limited role. Overall, the primary market for debt instruments has shrunk steadily since 1985 to a level of 5.6 percent of M2 at end-1990 (Table 8). In part, this contraction is due to the absence of an active market in government paper, which typically precedes the development of a market in corporate paper because individual corporate issues are too small to develop a secondary market of sufficient size to support the necessary institutional infrastructure; but it also reflects legal restrictions on the issuance of long-term debt17 by corporations.
|Transferable certificates of deposit||—||18.9||1.9||1.0||0.3||0.2||0.11|
|State enterprise bonds||1.5||1.9||3.6||2.5||2.2||1.8||6.7|
|Bank of Thailand bonds||—||—||—||—||2.0||—||13.4|
|Floating rate notes||—||0.6||1.4||1.9||7.1||7.1||7.0|
|Equity market (market value)||25.3||49.4||75.1||137.3||221.9||656.7||609.8|
|As percentage of GDP||3.5||7.1||5.4||4.8||4.1||2.6||4.1|
|As percentage of M2||9.1||12.1||8.8||7.5||6.4||3.8||5.6|
|As percentage of GDP||3.8||4.9||6.9||11.0||14.7||36.7||29.3|
|As percentage of M2||10.0||8.3||11.2||17.0||23.2||54.4||39.9|
As of September 1990.
Issued by Citibank, Chase Manhattan Bank, and the Industrial Finance Corporation of Thailand (IFCT).
As of September 1990.
Issued by Citibank, Chase Manhattan Bank, and the Industrial Finance Corporation of Thailand (IFCT).
The two main short-term markets are the interbank market, through which the larger retail banks supply funds to smaller banks and finance companies, and the repurchase market for government bonds operated by the central bank. Beyond this, money markets and long-term debt securities markets are very shallow, and secondary markets are almost nonexistent, the latter owing partly to double taxation of transactions. On the other hand, the stock market, founded in 1975, has grown steadily since recovering from a crash in 1979, with the ratio of market capitalization with respect to GDP rising from less than 4 percent in 1980 to 29 percent in 1990. The unregulated money market also played an important role in the past, but shrank during the 1980s as higher real deposit rates and improved financial services began to be offered in the formal market. Difficulties in the financial sector also increased public awareness of risk and prompted savers to turn to the larger formal institutions.18
Box 6.The 1983 Financial Crisis
In October 1983, Thailand experienced a financial crisis, triggered initially by large losses in a finance company and its affiliates. This was eventually to spread to one third of its financial institutions, accounting for about one fourth of total financial assets. In the following three years 24 financial institutions had their licenses revoked, and the Bank of Thailand was forced to intervene in some 30 more. The crisis, which was aggravated by a slowdown in growth and a tightening of monetary policy, brought to the fore widespread pressures in the banking system and particularly among the more loosely controlled finance companies. At the same time, the injection of liquidity that was necessary to support failing institutions complicated the conduct of monetary policy and the achievement of macroeconomic stabilization objectives. These pressures included weak management practices (notably the extension of credit and guarantees to businesses with which bank directors and shareholders were involved, and an overconcentration of lending to a few large-scale and interrelated industries) together with weaknesses in the supervisory and regulatory framework. In a successful attempt to maintain confidence in the financial system, the Thai authorities took a variety of measures to support these ailing financial institutions, while at the same time moving to strengthen the legal, regulatory, and supervisory framework. The Bank of Thailand was empowered to enforce compliance with regulations through direct intervention, to order an increase in bank capital, and to remove bank directors and officers when deemed necessary in the public interest; restrictions on transactions between financial institutions and their directors were tightened; and the Bank’s powers to conduct on-site examinations were strengthened. Finally, the Fund for the Rehabilitation and Development of Financial Institutions (RF), subsequently renamed the Financial Institutions Development Fund, was established under the aegis of the Bank of Thailand, with the main purpose of rehabilitating financial institutions.
The main elements of support for finance and securities companies were liquidity injections through several schemes, the most important of which was the “lifeboat scheme,” set up in April 1984. To join the lifeboat, participating institutions had to agree to write off their losses, provide reserves for doubtful accounts, strengthen credit and collection procedures, suspend dividends, and submit a financial plan for returning the institution to health. In addition, the value of their shares was reduced, and 25 percent of the shares plus 50 percent of the voting rights were to be transferred to the Ministry of Finance. The voting rights were later to be returned to the original owners, at a price to be determined by the Ministry of Finance. Thus, although the ownership of existing shareholders was diluted, they retained the hope of recovering the value of their shares later on. In return, they were eligible for credits at market rates to offset deposit withdrawals; capital injections through equity participation by the Krung Thai Bank; and direct subsidies from the Bank of Thailand in the form of soft loans that had to be invested in government paper. Twenty-five companies joined the lifeboat scheme: as of early 1991, seven still remained in the lifeboat.
The main support arrangements for commercial banks have been government takeover, subsidized loans from the Bank of Thailand and the RF to be invested in government bonds, and equity participation by the RF, combined with a restructuring of the bank’s management under Bank of Thailand guidance. As a condition of support, the Bank set financial programs for banks, specifying a path for increases in capital and writing off bad loans; the Bank and the RF also purchased shares in supported institutions so that they would receive part of the benefits of the subsidies provided through increased share values. Overall, 5 banks received financial assistance under these schemes.
Conduct of Monetary Policy
Monetary policy is guided by targets for a range of monetary aggregates, determined on the basis of the authorities’ objectives for inflation, growth, and the balance of payments. The chief monetary policy instruments are open market operations in the repurchase market and lending by the Bank of Thailand. The Bank of Thailand also influences monetary conditions through ceilings on lending interest rates (until recently, on deposit interest rates as well), and through intervention in the exchange market. Reserve requirements exist for prudential purposes, but are not actively used as an instrument of monetary policy.
The primary instrument of monetary policy is open market operations in the repurchase market. Since the central bank acts not only as a participant but also as the sole dealer, it can easily obtain firsthand information and inject or absorb liquidity whenever it judges it appropriate to do so. The eligible securities in this market are government bonds and the form of operation resembles short-term lending and borrowing, with securities functioning as collateral. Until 1986, the central bank’s operations in the repurchase market largely involved matching the demand and supply of repurchases, with limited intervention on its own account for monetary control purposes. But, following the substantial improvements in the external position in 1986 and the emergence of a high level of liquidity in the banking system, the central bank actively drained liquidity through government bond repurchases. These operations were supplemented by the introduction of sales of the central bank’s own bonds from 1987.19 Reflecting the growing importance of open market operations, the volume of transactions in the repurchase market increased sixfold between 1980 and 1990 (to B 600 billion).
The Bank of Thailand lends to financial institutions through a general loan window and a refinancing facility. The former provides short-term liquidity with government securities as collateral, and banks must show that they have no alternative source of funds. Reflecting the “last-resort” nature of this window, the outstanding amount was B 2.4 billion at the end of 1990, far lower than the ceiling of B 13.8 billion (1 percent of deposits for each bank) imposed by the Bank of Thailand for monetary control purposes. In 1986, the authorities simplified the scheme by moving from a dual to a unified interest rate. Recently, the Bank of Thailand has begun to change the loan window interest rate more frequently to signal changes in its policy stance.
The Bank of Thailand’s refinancing facility is designed to allocate more financial resources to priority sectors,20 at preferential interest rates by providing credits to commercial banks against their promissory notes. In 1989. this scheme was changed to improve the distribution of financial assistance (which was heavily skewed toward large exporters whose share in total exports was declining) and to lower the direct subsidy provided. The amount that commercial banks could borrow from the Bank of Thailand out of the amount of commercial banks’ loans extended under this scheme was lowered from 60–100 percent to 50 percent. At the same time, the preferential interest rate charged by commercial banks to customers was raised from not more than 7 percent to not more than 10 percent a year, while refinancing interest rates remained at 3–5 percent depending on the sector. Additional funds were made available for small-scale industries and rural development. As a result of these measures, the amount of refinancing outstanding declined from B 37 billion at the end of 1988 to B 22 billion at the end of 1990. A global ceiling for the facility, as well as ceilings for individual banks, is set by the Bank of Thailand and reviewed every six months.
Banks are subject to a basic reserve requirement of 7 percent of deposit liabilities, of which at least 2 percent must be held in the form of deposits in the Bank of Thailand, up to 2.5 percent as vault cash, and the remainder can be held as government securities,21 The reserve requirement has not been actively used as an instrument of monetary policy, and has remained unchanged for the past 20 years. In addition to the basic reserve requirement, commercial banks must hold 7.5 percent of their deposit liabilities (reduced in stages from 16 percent in 1988) in the form of government securities if they wish to be eligible to open new branches.
Over the past decade, financial reform measures have been implemented primarily in response to specific problems, rather than as part of an overall reform strategy. The measures included a first step toward interest rate liberalization in 1979/80 with the introduction of taws empowering the Minister of Finance to vary the ceilings on interest rates offered by commercial banks and finance companies; the introduction in 1979 of the repurchase market for government paper; and the amendment of the Commercial Banking Act to broaden the ownership of commercial banks.22 During the remainder of the 1980s, reform efforts concentrated on providing support for financial institutions experiencing difficulties, and particularly on strengthening the supervisory and regulatory framework (see Box 6), and, in 1984, some reforms of the capital market were instituted.23
By the end of the 1980s, however, as Thailand’s growth and industrialization accelerated, it became increasingly clear that the time had come for a more comprehensive approach. The initial reform effort focused on interest rate liberalization. In June 1989, the interest rate ceiling on time deposits with a maturity of more than one year was lifted to encourage long-term deposit-taking and to enable commercial banks to adjust themselves to a more flexible interest rate system. Subsequently, in March 1990, interest rate ceilings on time deposits with a maturity of one year or less were abolished; currently ceilings remain only on savings deposits and lending rates.
Foreign exchange transactions were also liberalized. In May 1990, the authorities accepted the obligations of Article VIII of the Fund’s Articles of Agreement; simultaneously, the scope for commercial banks to approve foreign exchange transactions without seeking prior approval from the Bank of Thailand was increased. A further package of liberalization measures, concentrating on capital account transactions, followed in April 1991. Specifically, foreign exchange earners were allowed to open foreign exchange accounts with commercial banks in Thailand up to $500,000 for individuals and $5 million for corporations. Thai investors could freely transfer up to $5 million abroad for direct investment. The package also permitted free repatriation of investment funds, including dividends and loan repayments, without the prior approval of the Bank of Thailand. The remaining restrictions are limited to resident purchases of property, financial instruments, and equity abroad, which are subject to prior approval by the Bank of Thailand.
The authorities are now preparing a three-year plan that encompasses a broad range of liberalization measures. They view comprehensive reform as urgently needed not only to strengthen the efficiency of the financial system to cope with future challenges and international competition, which could intensify along with an agreement in the Uruguay Round of the General Agreement on Tariffs and Trade (GATT), but also to support the fast-growing real sector without creating bottlenecks. At the same time, the authorities consider that the ability of financial intermediaries to absorb reforms has greatly increased in recent years; the old managerial style of family control has been replaced by professional management teams; most banks and a number of finance and securities companies have increased their capital adequacy, and their portfolio quality has improved; and the profitability of financial institutions has risen sharply. While a detailed blueprint for further financial reforms has not been issued, some elements have been referred to in official pronouncements, and these arc described below.
Restructuring Commercial Banks and Finance and Securities Companies
The authorities’ strategy entails (i) a widening of the scope of business of these institutions in line with the international trend toward a universal type of banking system to promote domestic institutions’ competitiveness vis-à-vis foreign banks; and (ii) a reduction of entry barriers to promote fair competition among financial institutions. As regards the former, the Bank of Thailand has forwarded recommendations to the Government to expand the activities of commercial banks and finance and securities companies, whereby commercial banks would be allowed to underwrite debt instruments—both private debt and government and state enterprise securities—and undertake leasing and provident fund management and provide investment advice. Finance companies would be allowed to expand into areas previously reserved for the commercial banks. Foreign exchange business would be permitted for some finance companies that demonstrate sound management with an adequate capital base. As a result, the top-tier finance companies would, in actuality, become commercial banks. For securities companies, additional business such as custodial services and registrant and agent for dividend payments would be authorized. As to the latter, the Bank of Thailand proposes to introduce more competition in the banking sector by allowing new foreign banks to operate in Thailand, although implementation of measures in this area will be linked to a successful conclusion of the Uruguay Round.
The Bank of Thailand also intends to introduce measures to improve the quality of securities and finance companies partly by encouraging mergers between those companies that are not sufficiently competitive. Since mergers appear to be difficult under the current merger law—which requires the 100 percent agreement of creditors before mergers can take place—the authorities are considering introducing a new legal framework that would regulate mergers and acquisitions. They believe that merger incentives for small and medium-sized finance companies will be considerable, since amount of capital would be the most important criterion in selecting financial companies allowed to undertake foreign exchange transactions. In addition to encouraging mergers among finance companies, permission to establish joint ventures with foreign partners is also being considered as a long-term measure.
In the relatively near term, the authorities plan to abolish the remaining interest rate restrictions on both banks and finance companies. (The limit on the savings interest rate will entail modification of existing legislation.) They arc also considering eliminating the remaining portfolio constraints on banks, namely, the requirements of government bond holding for branch opening and on the share of lending to the rural sector.24
Strengthening Prudential Supervision
The authorities intend to continue strengthening prudential supervision to ensure the stability of the financial system in the context of liberalization. In particular, they intend to emphasize the importance of capital adequacy, which would be brought into line with levels recommended by the Bank for International Settlements, Asset quality would also be stressed, with the requirement that risk-based capital be property disclosed.
As regards the equity market, legislation is being prepared to set up a separate and independent institution along the lines of the U.S. Securities and Exchange Commission (SEC) to supervise the stock exchange. At present, the supervisory power is vested in a number of government departments: the Ministry of Finance has the power to approve stocks to be listed on the SET; the Bank of Thailand supervises finance and securities companies; and the SET Board regulates the operations of the stock exchange. The establishment of an independent body would facilitate the supervision of both primary and secondary trading.
Developing Financial Instruments and Markets
As previously noted, the debt instrument market—short-term money markets and long-term bond (nonequity) markets—is not well developed. The Bank of Thai and plans to promote the development of new financial instruments through measures in four main areas. First, the legal barrier to the issuance of debt instruments and the transaction tax on secondary trading of financial instruments would be eliminated. Second, the planned elimination of the government bond holding requirement for branch openings also will help develop secondary markets for government bonds. Third, private companies would be encouraged to issue debt instruments to the public directly, after instituting appropriate prudential safeguards. Finally, to improve the financial infrastructure, the telecommunications system is to be expanded, and the establishment of a credit rating agency is being considered.
Improving Payments and Information Management System
As a measure to improve the efficiency of the payments and financial information system, the authorities plan to introduce a system of electronic transfers to facilitate payments in both wholesale and retail transactions. The system, which will be centralized at the Bank of Thailand, will enable commercial banks to review their financial positions on a real-time basis. Further, the authorities will encourage greater use of checks and credit cards to reduce the dependence on cash.