Capital Market in Thailand: Issues and Opportunities...Inefficiencies are by definition welfare-reducing. As this study will show, the Thai capital market needs much improvement. But

Capital Market in Thailand:Issues and Opportunities

Richard A. Werner

Richard A. Werner is Lecturer, Sophia University, Tokyo; Chief Economist, Profit Research CenterLtd., Tokyo; and formerly Chief Economist (1994–1998), Jardine Fleming Securities Ltd., Tokyo.

106 A STUDY OF FINANCIAL MARKETS

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Scope of Study andIssues to be AddressedThe capital market in Thailand has been severelyaffected by the recent financial crisis. In the localbond market, trading as well as new issue activityhas come to a virtual standstill as interest rates havesoared and liquidity has dried up. The stock market,at its recent low, reached 1988 levels, wiping out 10years of investors’ gains and significantly loweringcompanies’ market capitalization. The foreign ex-change market has been volatile and interest rates inthe money market have spiraled upward due to li-quidity constraints.

Given the current crisis and deep recession, policydebate has focused on the deficiencies of the Thaicapital market, especially compared to other capi-tal markets, such as those of the UK or US. As thestudy on macroeconomic management in Thailandshows, however, the crisis was not caused by struc-tural issues, but rather by misguided macroeconomicpolicies. Inefficiencies are by definition welfare-reducing. As this study will show, the Thai capitalmarket needs much improvement. But it is alsoclear that the primary blame for the vast economicdislocation and misallocation of economic resourcesthat took place in the 1990s cannot be laid on thestate of the Thai capital market and its insufficientregulation.

An analysis of the efficiency of capital marketsrequires an understanding of their fundamental rolewithin the general macroeconomic environment.

1

A purely microeconomic focus may be misleading.In particular, many studies have started with thesimplistic premise that, almost per definitionem,more markets with more liquidity and more trans-actions and with as few regulations as possible arealways superior to fewer markets with less liquid-ity and more regulations. However, the recent lit-erature on market imperfections now recognizesthat even perfectly deregulated and highly liquidmarkets are characterized by market failure, which

is due to the pervasive problem of imperfect orasymmetric information. The literature (see espe-cially the work of Stanford Professor Joseph E.Stiglitz, such as Stiglitz and Weiss, 1981) has dem-onstrated that asymmetric information leads to quan-tity rationing, which renders first-best policies, suchas complete deregulation, inappropriate. With themore realistic premise that we live in a second-bestworld, it becomes clear that suitable governmentintervention in the economy and in capital marketsis likely to be welfare-enhancing.

Bank-centered vs. Capital-market-funded Economic Systemsand Corporate GovernanceIn a world of perfect information and no market fail-ure, banks and capital markets are perfect substi-tutes. But in the real world, the distinction betweenexternal corporate fundraising from capital marketsand fundraising from banks becomes important forthe following reasons:

• The incentive structure of bank-centered cor-porate governance favors high economic growth,as the influence of individual shareholders whoare interested in high dividend pay-outs is re-placed by cross-shareholdings or bank-sharehold-ings, giving managerial objectives toward scalemaximization the upper hand.

• Banks may provide a more effective form ofmonitoring than diffuse share ownership (Sheard1989).

• Since with imperfect information financial mar-kets are characterized by rationing, allocation ofscarce resources to priority sectors via the bank-ing system may be beneficial and is likely to maxi-mize economic growth. However, such a regimerequires “restrained” capital markets in order notto undermine the rationing effect via the bankingsystem. Moreover, in such a bank-centered sys-tem, corporate governance is necessarily verydifferent from that in the UK or US, wherecross-shareholdings were set up in order to re-

107CAPITAL MARKET IN THAILAND: ISSUES AND OPPORTUNITIES

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duce the influence of individual shareholders andthus maximize reinvestments and minimize divi-dend pay-outs. Within the logic of its own sys-tem, this is not necessarily bad; it demonstrablycontributed to raising economic growth rates.

• Even with perfect information, the two forms offundraising would not be equivalent, as is oftenclaimed, because of the credit-creation process:while fundraising from banks on a net basis in-creases purchasing power in the economy (netcredit creation occurs), fundraising via capitalmarkets does not create new purchasing power,but merely diverts already existing purchasingpower. Table 1 compares the magnitude of fundsraised in the capital markets with the loans out-standing from both banks and finance compa-nies before the crisis.

Policies that place greater emphasis onfundraising via banking systems, therefore, may bewelfare-superior to policies that place equal em-phasis on banking and capital markets. Many coun-tries, such as Germany, Japan, and most SoutheastAsian countries, including Thailand, have opted fora bank-centered financial system, while purposelyproviding disincentives for or restrictive regulationson fundraising in capital markets. An issue-orienteddiscussion of the capital market in Thailand, there-fore, must not neglect to situate the underdevel-oped state of the capital market within the contextof the country’s macroeconomic structural design.Compared to those of the UK or the US, the Thai

capital market certainly appear underdeveloped ortoo restricted. However, the UK and US economicsystems are fundamentally different from the bank-centered economic systems of which Thailand is aprime example. In Thailand, the capital market hasbeen deliberately restricted in a successful attemptto maximize macroeconomic growth via bank-cen-tered credit allocation. As a result, the country’spostwar economic performance has generally beenexemplary.

There is no strong causal relationship between thecrisis that started in 1997 and the fact that the Thaicapital market has been restricted and, by UK or USstandards, underdeveloped. Notwithstanding this,there are many areas where the Thai capital marketcan be rendered more efficient and its role enhancedeven within the general structure of a bank-centeredeconomy. Whether to maintain the bank-centeredeconomic system or to shift to a capital market-cen-tered one is ultimately a political decision. However,the recent crisis appears to have strengthened thecall for the introduction of UK- or US-style capitalmarkets. As macroeconomic management issues arecovered in the first part of this volume, this study,which is of limited scope, assumes that the transitiontoward capital markets as the main source of exter-nal financing has begun. It analyzes the current stateof the Thai capital market and its regulatory and su-pervisory environment. It also discusses the devel-opment potential of this market and focuses on policyrecommendations that will enhance its role and effi-ciency. In particular, it highlights the necessary stepsto further improve transparency and liquidity and topromote deepening of the capital market.

This study divides the Thai capital market into fivemain sectors: (i) bond market, (ii) stock market,(iii) mutual funds, (iv) contractual savings schemessuch as pension funds, and (v) foreign exchange andderivative markets.

This study is strictly issue-oriented. It focuses onidentifying issues for the formulation of a reformagenda. It discusses the structure, conduct, and per-

Table 1: Loans and Capital Market Funds, as of31 December 1996

Sources: Bank of Thailand, Thai Bond Dealing Centre.

AmountItem (B billion)

Outstanding Credits of Commercial Banks 4,911Outstanding Loans of Finance Companies 1,488Outstanding Value of Domestic Bonds 513Market Capitalization of the Stock Exchange 2,559Mutual Fund Assets 217Pension Fund Assets 89


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formance of these five sectors in sequence. For eachsector, the current state of the market and its partici-pants, the supervisory and regulatory structure, andthe market infrastructure are presented, including themarket performance during the crisis. The strengthsand weaknesses of the market and its institutionsare then analyzed and market-specific policy rec-ommendations drawn. The study concludes with adiscussion on the capital market outlook.

For additional background information, severalAppendixes are included in the study. Appendix 1discusses the Thai bond and repo markets in greaterdetail, including their settlement system. Appendix 2covers the money market and its microstructure. Ap-pendix 3 touches issues of dispute among scholars,where further research is required. Appendix 4 re-views recent developments in securitization.

Key Issues in theCapital Market andPolicy RecommendationsThe Bond Market:Difficult Years AheadDEVELOPING THE BOND MARKET TO COVERLONG-TERM FUNDING NEEDSThe corporate sector has traditionally relied on inter-nally generated cash and bank loans as primarysources of capital. The commercial banking sector,dominated by domestic banks, accounts for about 75percent of total financial assets. However, banks’capacity to carry out term transformation is limited,as the economy’s capital needs have ballooned andthe banks’ liabilities structure continues to be domi-nated by short-term deposits. Thus, prudent asset-liability management limits the banks’ capabilities toprovide long-term financing. In the infrastructuresector, however, long-term funding is required. De-veloping the local bond market has therefore becomea top priority for financial sector development.

Absence of an Active GovernmentBond MarketIn 1990, the Government ceased issuing new bonds

as it started running consecutive budget surpluses.As a result, the Government’s outstanding baht li-abilities dropped from almost B200 billion in 1990 toonly B14 billion by the end of 1997. Thus, govern-ment bonds as of end-1997 accounted for a mere 3percent of all outstanding bonds. Simultaneously, li-quidity in the secondary markets fell, as reflected inincreased bid-offer spreads. The absence of an ac-tive government bond market has constituted a ma-jor barrier to developing a yield curve.

Increased Issue Activity of other State EntitiesWhile the Government ceased to issue bonds di-

rectly, State enterprises increased their share of out-standing bonds to 55 percent by end-1997, account-ing for B288 billion. In 1995, the Government alsostarted issuing bonds through the Financial Institu-tions Development Fund (FIDF) and the PropertyLoan Management Organization (PLMO), financ-ing vehicles aimed at providing liquidity to ailing banksand finance companies. Many State bonds are ex-plicitly guaranteed by the Ministry of Finance andthus could be technically viewed as quasi-sovereignrisk, which could be employed as a risk-free asset toconstruct a benchmark yield curve. The ElectricityGenerating Authority of Thailand (EGAT), TelephoneOrganization of Thailand, Expressway and RapidTransit Authority, and National Housing Authorityhave all issued State bonds.

Significant Rise in Private Sector Bond IssuesHistorically, private sector corporations have not

been active borrowers in the bond market, prefer-ring bank loans or equity finance to satisfy their ex-ternal long-term borrowing requirements. Hamperedby poor disclosure standards, absence of a centralclearing system, the lack of a sovereign benchmarkfor reference purposes, and a less than fully trans-parent tax and regulatory environment, there was


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little corporate bond issuance until 1992. However,the corporate bond market started to take off in 1992when the Securities and Exchange Act (SEA) waspassed. The SEA gives limited companies the rightto offer debentures to the general public, whetherthey are listed on the Stock Exchange of Thailand(SET) or not. Spurred by these developments, issueactivity has risen quickly and corporate debenturesaccounted for 36 percent of all outstanding bonds byend-1997. In particular, structured financing, such ascorporate debentures and bonds with warrants (or,in the offshore market, convertible debentures) in-creased after 1992. There has been a substantial shiftfrom a largely Government-dominated sector to amore competitive market able to attract commer-cially oriented investors and where issues are pricedaccording to investors’ requirements.

Figure 1 indicates the growth of the Thai bondmarket by type of issuer from 1994 to 1997. Figure 2shows the significant increase in outstanding corpo-rate bonds for the same period. Unlike other South-east Asian countries, Thailand managed to establisha thriving corporate bond market over a relativelyshort time.

Crowding Out by Government BondsIn 1996–1997, however, while issue activity in

the bond market increased, corporate bonds were“crowded out” by public sector bonds in the formof FIDF and PLMO bonds, which rose dramati-

cally. As the financial sector experienced signifi-cant liquidity constraints, funds raised through theissue of FIDF and PLMO bonds accounted for morethan 70 percent of all bond issues in 1997. Mosthave short-term maturities and thus do little to de-velop a yield curve.

INTERNATIONAL ISSUES HAVECROWDED OUT DOMESTIC BONDSFigure 3 compares the development of domestic andoffshore offerings of bonds. Offshore offerings out-weighed domestic offerings in 1996–1997, perhaps asa result of an increasing interest rate differential be-tween domestic yields and those available to Thai bor-rowers in the offshore market before the currencycrisis, as shown in Figure 4. Foreign investors had a

Figure 1: Issuance of Domestic Bonds, 1994–1997

BoT = Bank of Thailand, FIDF = Financial Institutions Development Fund,PLMO = Property Loan Management Organization.Sources: Bank of Thailand, Thai Bond Dealing Centre.

Figure 2: Outstanding Value of Domestic Bonds,1994–1997

BoT = Bank of Thailand, FIDF = Financial Institutions Development Fund,PLMO = Property Loan Management Organization.Sources: Bank of Thailand, Thai Bond Dealing Centre.

Figure 3: Domestic vs. Offshore Offerings ofThai Bonds, 1992–1997

Source: Securities and Exchange Commission.

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B billion

1992 1993 1994 1995 1996 1997

DomesticOffshore


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large appetite for the higher yields of Thai bonds. Sov-ereign or quasi-sovereign issuers enjoyed investment-grade status until July 1997 and were able to borrowat 150–200 basis points over comparable US Trea-sury Yields. Exchange-rate risk seemed negligible, asthe nominal exchange rate had been virtually un-changed for more than 12 years. With the onset of thefinancial crisis and the loss of investment-grade statusof the country, these yields shot up to 600 basis pointsat the height of the crisis, before dropping again to350–400 basis points as of mid-1998.

From Figure 3 it is also apparent that bond offer-ings, both local and international, dropped significantlyin 1997, especially in the second half, when issueactivity came to a virtual standstill, except in theGovernment sector.

BOND ISSUES TOO CONCENTRATED INFINANCIAL AND PROPERTY SECTORSBond issuers come primarily from the financial andproperty sectors (Table 2). Almost half of existingcorporate bonds are issued by banks and financecompanies, while another 22 percent is accountedfor by the real estate and construction industries.While this concentration of bond issuers in only twosectors reflects the asset bubble, it also underscoresthe need to broaden the issuer base and to make thebond market a more attractive funding route for thereal sector of the economy.

2

RETAIL PARTICIPATION IN THE BOND MARKETSTILL LIMITEDDomestic investors in the bond market are primarilyinstitutional rather than retail investors. Apart fromcommercial banks and finance companies, which arerequired to hold at least 2.5 and 5.5 percent, respec-tively, of deposits in Government or State enterprisebonds, investors include mutual funds and providentfunds. Mutual funds can invest up to 35 percent oftheir assets in securities and debt instruments. Provi-dent funds are also required to invest at least 60 per-cent in lower-risk assets such as debt securities.These provisions have helped boost the investor basefor debt instruments. However, to further broadenthe investor base for bonds, the massive retail sav-ings pool in Thailand has to be tapped.

CREDIT-RATING SECTOR NEEDS TO BESTRENGTHENEDThe development of the bond market was boostedby the creation of a domestic credit-rating agencyin 1993, the Thai Rating and Information Services(TRIS), with a registered share capital of B100 mil-lion. TRIS is licensed by the Securities and Ex-change Commission (SEC) and owned by majorThai banks, brokers, SET, and Industrial FinanceCorporation. All corporate debentures sold to thegeneral public need a credit rating by TRIS. Thecredit-rating agency, so far the only one in the coun-

Figure 4: Onshore vs. Offshore Interest Rates,1992–1997

Source: Securities and Exchange Commission.

Table 2: Bond Issuers by Sector

Source: Thai Bond Dealing Centre.

Outstanding Share inValue, as of Corporate31 Dec 1997 Bonds

Sector (B million) (percent)

Banking 33,510 25.3Finance companies 30,532 23.1Property development 21,972 16.6Energy 11,406 8.6Holding company 8,541 6.4Construction 6,748 5.1Others 19,791 14.9Total 132,500 100.0


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try, successfully built up a core business. At its peak,it maintained ratings of more than 80 bond issuers.However, as the financial crisis has affected thepayment capabilities of issuers, a number of bondissuers have decided to discontinue their ratings withTRIS. This is a loophole in the current regulatoryenvironment, as it is allowed for pre-1995 issuesand for privately placed instruments that are de-fined as being sold to less than 36 investors. As aresult, most of TRIS clients withdrew their ratings.As of March 1998, only around 30 continued theirratings. Often, issuers opt to withdraw their ratingsrather than face a credit downgrade. This behavioreliminates the whole rationale for having a credit-rating agency in the first place.

When credit ratings are compulsory for public is-sues, significant power is vested with the credit-rat-ing agencies. When there is only one rating agencyin the country, as in Thailand, it effectively exercisesmonopoly power over issuers and there is a consid-erable risk of abuse. Thus, making credit ratings com-pulsory, but assigning responsibility to a monopolyinstitution, is undesirable.

TRADING SYSTEMS NEED TO BE FURTHERIMPROVED TO ENHANCE LIQUIDITYThe establishment in 1994 of the Thai Bond Deal-ers’ Club, now renamed the Thai Bond Dealing Cen-tre (TBDC), improved liquidity in the bond market.TBDC provides a computerized trading system forbonds and has more than 80 members, primarily banksand finance companies. Mutual funds and providentfunds are currently not admitted to TBDC. By end-1997, TBDC covered 131 bond issues, comprisingB133 billion of corporate issues (or 71 percent of thetotal corporate market) and B36 billion of Govern-ment bonds (or 18 percent of the Government mar-ket). However, out of the more than 131 bonds reg-istered with TBDC, the top five issues account foralmost 60 percent of trading activity. This impliesthat there is only a small number of liquid bonds forwhich market makers offer two-way bids.

TBDC uses a “blind” computerized system fortrading bonds. This system does not allow tradersto observe market conditions, as no other marketbids and offers are present on the monitor. Instead,traders have to negotiate with each other anony-mously. This practice may have limited the appealof using the trading system and instead encour-aged direct dealings between interested parties.While trading via the phone system is an estab-lished practice even in some developed economies,in an emerging bond market with relatively lowliquidity, it would be preferable to have a moretransparent system to facilitate market partici-pants’ receipt of up-to-the-minute information ontrading activities and bid-offer rates.

SECONDARY TRADING OF BONDS AT AVIRTUAL STANDSTILLFigure 5 shows secondary bond trading, both withinTBDC and among TBDC members in the phone mar-ket. Trading volume slumped dramatically from June1997 onward with the onset of the currency crisisand transactions within the TBDC system have fallento zero. The only trades taking place are carried outvia direct transactions between intermediaries. ByFebruary 1998, trading volume had fallen to a his-toric low.

Figure 5: Secondary Bond Trading,January 1996–February 1998

Source: Thai Bond Dealing Centre.


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WEAK BOND MARKET HAS PARTLY HAMPEREDMONETARY POLICY IMPLEMENTATIONThe lack of a deep and liquid Government bond mar-ket has partly impeded the implementation of mon-etary policy. As a result, the Bank of Thailand (BoT)had to rely to a great extent on three avenues toregulate credit creation in the economy: (i) the Ex-change Equalization Fund (EEF), which is part ofBoT; (ii) the discount window; and (iii) the issuanceof BoT, FIDF, and PLMO bonds. If only BoT had amuch more liquid and deep bond market available toconduct its money market and open market opera-tions, its intervention would likely have been smoother.While the economic impact of, for example, the issu-ance of a BoT bond is equivalent to a purchase op-eration of a Kingdom of Thailand bond, the formerbonds are fairly thinly traded. Without benchmarksand an established yield curve, investor interest islikely to be below optimal levels.

STRUCTURAL REFORMS CAN IMPROVEMARKET INEFFICIENCYTrading activity will pick up only if the macroeco-nomic situation improves and uncertainty over fu-ture inflation and interest rate developments is re-duced. Macroeconomic development and capitalmarkets interact closely: even the most efficient bondmarkets will not function in an uncertain macroeco-nomic environment. The following reform agendaassumes that structural reforms are important forpreparing the ground for a more efficient bond mar-ket. Indeed, the crisis can be considered as an op-portunity to implement measures to improve the fu-ture efficiency of the bond market. The key mea-sures are the following:

Establish a yield curve. Perhaps the most im-portant impediment to the development of a deepand liquid bond market has been the lack of a risk-free benchmark yield curve to facilitate bond pric-ing. The Government, by law, is not allowed to issuebonds, as long as it maintained a budget surplus. Inthe post-crisis environment, the Government is ex-

pected to run budget deficits, at least temporarily.Historically, Government bond issues have not fol-lowed market conditions, as bonds are placed with“captive” investors that are required to hold suchinstruments under statutory reserve requirements. Ifthe Government continues this practice, it will wastea chance to establish a benchmark yield curve. Thus,it is recommended that a Government borrowing pro-gram be established in coordination with the contin-ued issuance of Government-guaranteed State en-terprise bonds. Terms should be market-oriented andthe borrowing program should aim at establishing ayield curve by offering a range of maturities on aregular and consistent basis. Indeed, under the Fi-nancial Sector Reform Program Loan of the AsianDevelopment Bank (ADB), the Government com-mitted to establish a program and timetable for theissuance of long-term Government bonds to developa market for long-term securities. Such bond is-sues should be priced strictly according to marketcriteria.

Improve trading systems.As mentioned above, theefficiency of the trading system for bonds can be en-hanced by introducing a more transparent computersystem that allows all market participants to get real-time access to bid and offer quotes by the marketmakers. Such a system is preferable to the currentsystem, which does not promote transparency.

Broaden membership of the Thai Bond Deal-ing Centre. Mutual and provident funds should haveaccess to the TBDC system in order to broaden themarket base for trading activities. In general, liquid-ity and secondary market trading improves as moreplayers enter the market.

Enhance efficiency of the credit-rating sector.Other firms should be allowed to enter the ratingagency industry and break TRIS’ monopoly. Inves-tors will then go to rating agencies that provide thebest predictions of issuer-default probability. Com-petition will also improve rating transparency, as in-vestors can compare ratings by different agencies.Ratings should then be made compulsory and exist-


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ing loopholes for private placements and older issuesclosed.

Expand the investor base. Domestic institutionalinvestors can be attracted by the complete removalof any restrictions on the asset allocation of life in-surers, pension and provident funds, and investmentfunds. International investors will likely be encour-aged as soon as the currency markets stabilize. Lock-ing in the current relatively high yields may be anattractive proposition to investors and is likely to ex-pand the institutional investor base.

A major challenge is to draw retail investors tothe bond market. While investors have preferredstock market investments due to higher return ex-pectations, the recent volatility in the stock market,which led to significant losses for investors, makeslow-risk assets, such as bonds, attractive. Govern-ment bonds are likely to attract retail investors if thereis enough liquidity and if they yield a return compa-rable at least to bank deposits. Selling Governmentbonds to the general public, rather than just the tradi-tional captive investors, will require a well-targetedpublic education campaign. The expansion of themutual fund industry will also be critical for broaden-ing and diversifying share and bond ownership.

Enlarge the issuer base. Issuers in the bond mar-ket have been largely limited to State entities and thefinance and property sectors. It is desirable tobroaden the issuer base to the real sector of theeconomy. As banks ration credit due to their largeexposure to problem loans, it can be expected that awell-targeted campaign to attract industrial and ex-port-oriented companies will broaden the issuer base.

Provide tax incentives. There are no tax incen-tives to hold bonds compared to equities. On the con-trary, investors must pay a 15 percent withholdingtax when they purchase fixed-income securities, whilecapital gains on equities are tax-exempt and dividendsare subject to 10 percent tax.

3A lower withholding

tax will make bonds more attractive.Set up an enabling environment for asset sec-

uritization. The first quasi-securitization in Thailand

took place in 1993, but the Securitization Act wasintroduced only in June 1997. Yet, crucial legal ruleson trusts and special-purpose vehicles are still miss-ing. The Secondary Mortgage Corporation, whichwas established in 1997 under public ownership,should gradually be transferred to the private sector.Asset-backed securities are likely to be in demandas banks come under increasing pressure to restoretheir balance sheets and sell off nonperforming loans.These securities can be used to facilitate the dis-posal of assets or the collateral linked to the assetsof banks such as mortgages, credit card receivables,or other types of loans. For investors, they can pro-vide an opportunity to gain exposure to these mar-kets without having to directly purchase the underly-ing asset. A master plan is recommended in order tosystematically analyze current impediments to assetsecuritization and to establish an enabling frameworkfor this new type of asset class. The master planmust do the following:

• Assess the market demand and supply for dif-ferent types of assets that can be subjected toasset securitization.

• Propose amendments to the law and new lawson trusts and special-purpose vehicles in order toenable an efficient asset securitization process.

• Suggest tax treatment that will encourage assetsecuritization.

• Recommend a system of regulatory oversight.

The Stock Market: RecentTightening of RegulationPrevented Systemic FailuresThe Thai stock market has become a major sourceof capital for Thai companies. While the financialcrisis has affected issue activity in the stock market,it has not led to any major crisis in the regulatory andsupervisory system. The Thai equity market has beenmuch better regulated and supervised than the bank-ing sector. There have been no major bankruptciesor irregularities, for example, among brokers or se-curities companies. Issues such as margin trading


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and lack of adequate capitalization of brokers wererecognized and addressed even before the financialcrisis started in June 1997. While 56 finance and se-curities companies were permanently closed downin December 1997, the reasons for their closure layin their exposure to bad loans rather than their secu-rities business.

4 A recent regulation, approved by SEC

in December 1997, no longer allows the forming ofjoint finance and securities companies. By Decem-ber 1999, all finance-cum-securities companies mustseparate their lending from their securities business.The following sections detail some of the recent re-form measures in progress and point out remainingissues and policy recommendations.

CAPITAL MOBILIZATION SEVERELY AFFECTEDBY CRISISFigure 6 shows issue activity in 1982–1997, whileFigure 7 indicates the level of the stock market indexat year-end for the same period. Capital mobilizationdropped significantly in 1997, as the stock market hita new low. Not surprisingly, as stock valuationstumbled (Figure 8), companies were reluctant to raisecapital in the public market unless absolutely neces-sary. As of December 1997, 431 companies werelisted on the stock exchange.

The recent crisis followed a strong period ofgrowth in the 1990s, when market capitalization in-creased significantly in tandem with new listings onthe exchange as well as increased valuations. Bythe end of 1993, total market value had reached B3.3trillion (Figure 8), for the first time exceeding GDP.As stock market participants became more bearishand price-earnings (P/E) ratios declined, market capi-talization fell substantially in 1996–1997.

LIQUIDITY DROPPED SIGNIFICANTLYWITH FINANCIAL CRISISAnnual turnover rose from B10 billion in 1984 to B627billion in 1990, peaking at B2,201 billion in 1993, whenthe stock market index was at its highest level. Dailyturnover also increased tremendously and peaked in

Figure 7: Stock Market Index, 1982–1997

Source: Stock Exchange of Thailand.

Figure 6: Capital Mobilization of the StockExchange of Thailand, 1982–1997

Source: Bank of Thailand.

1993 (Figure 10). It has been declining substantiallysince then, as stock market valuations dwindled. Trad-ing activities are heavily focused on a small numberof stocks, with the top 20 most active stocks ac-counting for 70 percent of the trading volume.

Figure 8: Market Capitalization of theStock Exchange of Thailand, 1982-1997



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Figure 10: Daily Turnover on the Stock Exchangeof Thailand, 1982–1997


Figure 9: P/E Ratios of the Stock Exchange ofThailand, 1982–1997

P/E = price/earnings.Source: Stock Exchange of Thailand.

Table 3: Market Capitalization of the Stock Exchangeof Thailand by Sector, as of December 1996

Market Capitalization PercentSector (B billion) of Total

Banking and finance 894.8 34.9

Property and construction 369.3 14.4

Communication 308.2 12.0

Energy 225.7 8.8

Entertainment 89.9 3.5

Transportation 83.9 3.3

Chemicals and plastics 78.0 3.0

Commerce 63.2 2.5

Food and beverage 40.3 1.6Others 409.9 16.0Total 2,563.2 100.0


STOCK MARKET TOO CONCENTRATEDIN PROPERTY AND FINANCIAL SECTORSAbout half of SET’s market capitalization is concen-trated in the finance and property sectors, as shownin Table 3. While this concentration is less than thatof the bond market, a broader representation of othersectors of the economy would reduce market de-pendence on just two sectors and thus lower overallmarket volatility.

FOREIGN INVESTORS NOT RESPONSIBLEFOR SELL-OFF IN STOCK MARKETSForeign participation in the Thai stock market hasnot been as important as in some other SoutheastAsian countries. In particular, the hypothesis thatforeign investors contributed to the meltdown in the

stock market at the height of the financial crisis inthe summer of 1997 is not confirmed by data. Datafrom SET on the net turnover of foreign investorsshowed that foreign investors were net buyers ofdomestic securities on all but nine trading days fromearly July to late September 1997. This is in markedcontrast to local mutual funds, which were net sell-ers of domestic securities on all but seven tradingdays during the same period.

5

ORDER-DRIVEN SYSTEM LIMITS LIQUIDITYAn order-driven system is implemented in SET. Itallows all market participants to put competitive pricesinto the system for automatching, so its main advan-tage is market clearance at fair prices. However, itsmain drawback is the lack of liquidity. A quote-drivensystem, on the other hand, is operated by marketmakers who stand ready to execute transactions andbuy on their own accounts if necessary. While aquote-driven system improves liquidity, its perfor-mance depends on the integrity of market makersand the transparency of the market-making system.In addition, market makers have to be solidly capital-ized in order to survive when prices turn against them.Moreover, the system needs to be equipped withmarket infrastructure, such as securities lending and


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repo transactions, to enable market makers to func-tion efficiently. SET has implemented its order-drivensystem with market-making features. However, theso-called “market makers” are required to send someorders into the system to initiate a certain minimumamount of trades, so they do not stand ready on theother side of transactions all the time like the fullyfunctioning market makers. Thus, although the liquid-ity problem in SET has been somewhat alleviated, itstill remains.

FURTHER REFORMS CAN DEEPEN THE MARKETThe stock market has grown fast but has been veryvolatile over the past years. Several studies find botha high degree of volatility and a high frequency ofvariation (e.g., Rhee 1990; Dayananda and Fagg1995). Reasons for high volatility are the insufficientdegree of liquidity, which results from the small num-ber of stocks listed and traded, and domination of themarket by the financial and property sectors.

More reforms are needed in order to deepen themarket and render it more attractive to both inves-tors and issuers. The Government may do the fol-lowing:

Promote privatization. Some of the biggest andmost profitable companies are still owned by the State.Privatization could broaden share ownership andlessen the market’s dependence on finance and prop-erty stocks. Large-scale privatization programs haveexpanded share ownership and induced a “share-holder culture” in a number of countries. In additionto deepening the stock market, privatization also re-duces the scope for political interference in the com-mercial management of firms. Although it also en-tails political decisions, and however important thestock market is, privatization should be carried outfor the above reasons and not merely to supply newstocks to trade.

In the third letter of intent signed by the Interna-tional Monetary Fund (IMF) and the Government ofThailand in February 1998, the Government prom-ised to accelerate privatization. It established the

Privatization Committee in June 1998 and proposedlegislative reform (including the Corporatization Law)to expedite the process. However, privatization is nota panacea. Unless a proper regulatory framework isset up and competition introduced, privatization willnot lead to economically optimal resource allocationif it only serves to raise funds for the Government.

State-owned transportation companies slated forprivatization include Thai Airways, initially through astrategic partnership with a foreign investor, withremaining shares to be offered to domestic investorsand employees. EGAT initiated sales of its stakes inElectricity Generating (Public) Limited and PowerGen 2 in 1998. Ultimately, EGAT will be split intogeneration and transmission companies and sold offto domestic investors. Petroleum Authority of Thai-land (PTT), the large State-owned oil company, isscheduled for privatization by end-1999. The Tele-phone Organization of Thailand will be prepared forcorporatization and eventual privatization throughamendments of laws and regulations. Privatizationshould also include the water supply sector, follow-ing successfully completed transactions in Jakartaand Manila.

Privatization proceeds could amount to B81 bil-lion (Table 4). If successful, these could cover abouthalf of the estimated cost of the financial bailout ofthe banking sector in 1998.

Improve regulation and supervision of brokers.SEC has done remarkably well in preventing the trad-

Table 4: Privatizations Planned for 1998

Share Stake to Expected CashPrice be Sold to be Raised

Enterprise (B) (percent) (B billion)

PTTEP 556.0 20.0 34

Electricity GeneratingAuthority 76.5 14.9 5

Bangchak Petroleum 9.4 31.0 2

Telephone Organizationof Thailand na 25.0 25

Thai Airways 53.5 20.0 15

Total 81

na = not available.Source: Jardine Fleming.


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some hearings and reviews have been eliminated andreplaced by a simpler process that requires compa-nies to make fairly simple filings that meet clear andstandardized requirements.

8 Finally, a takeover code

was established to guide friendly or hostile takeoverbids. It is expected to be important as mergers andacquisitions become more significant and corporaterestructuring intensifies.

Other reforms needed include granting a fully in-dependent and self-regulatory status to SET, whichwill foster peer reviews and discipline in the brokeringcommunity. Granting more autonomy to SEC willstrengthen its credibility and reduce the possibility ofpolitical interference. At the same time, both bodiesmust be monitored by independent panels and audi-tors in order to maintain their maximum efficiency.

Improve market transparency and informationdisclosure. Clear disclosure requirements based onGenerally Accepted Accounting Principles (GAAP)and strict compliance mechanisms for listed compa-nies are the bases for transparency and improvedallocation of resources in the capital market. In De-cember 1997, SEC approved SET’s rules requiringan audit as a condition for listing new applicants be-ginning January 1998, and for keeping listed the com-panies already in existence by December 1999.

9 The

Government has also committed itself to reform bank-ruptcy and foreclosure laws to enable creditors toexert more pressure in case of default. Amendmentsto the bankruptcy laws will allow corporate reorga-nization (rather than outright bankruptcy) and ensurefair treatment of creditors.

10 Foreclosure laws were

amended in October 1998.Although all business enterprises are required by

the Institute of Certified Accountants and Auditors tocomplete and submit financial statements in line withGAAP, the supervisory and compliance mechanismcan be further strengthened to weed out any loop-holes or lax implementation. In addition, the owner-ship structure of companies and banks should be pub-lished to improve transparency and to facilitate corpo-rate restructuring through mergers and acquisitions.

ing defaults, insolvencies, and settlement irregulari-ties that have characterized the less-well-supervisedbanking sector. It has actively steered capital mar-ket development since its establishment in 1992. Itssuccess stories include gearing down a nearly $6 bil-lion bubble of margin lending over a period of 18months ending in late 1996, without compromisingthe integrity of the brokerage industry. In addition, aprogram to boost capital of securities firms wasstarted even before the occurrence of the financialcrisis. Brokerage firms must maintain a net capitalbase (i.e., liquid assets less liabilities) of 3 percentover total liabilities. This ratio rose to 5 percent byJanuary 1999 and will have to rise to 7 percent bythe year 2001, as per SEC requirements.

To reduce systemic risk arising from potential de-faults of brokers, SEC recommends that the ThaiSecurities Depository Co., Ltd. (TSD) establish aclearing fund to cover possible defaults.

6 With the

collapse of many brokerage firms attached to financecompanies, barriers to entry were reduced for for-eign investors. The Government now allows foreign-ers to buy local brokerage firms. However, no new“four-basic” securities licenses (covering brokering,dealing, underwriting, and investment advisory ser-vices) have been granted to new entrants. After theclosure of 56 finance companies, there remain 23securities companies and 22 finance and securitiescompanies with brokering licenses. A policy reviewshould allow more market entrants that cover all fourareas. The underwriting capabilities of domestic bro-kers have to be expanded in anticipation of the ex-pected large-scale privatization. A system of under-writing syndicates should be established, as individualbrokers do not have the underwriting capacity forlarge issues.

Since January 1998, short-selling has been allowed,regulated and supervised by SEC.

7 The initial public

offering process has been significantly streamlinedand made more transparent. Policies that previouslyencouraged companies to make exaggerated busi-ness projections or forced them to undergo burden-


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Improve corporate governance. The corporategovernance structure can be changed from the bank-centered system, where shareholders have relativelylimited direct influence on management and wheremanagement is relatively insensitive to shareholderconcerns, such as absolute dividends, P/E, return onequity (ROE), or return on assets (ROA), to the morestock-market-oriented UK- or US-style system,where shareholders have much larger influence.Making stock options a key component of the man-agement compensation package can help realign theincentive structure of management and render it co-incidental with the objective function of sharehold-ers. The commercial code, regulations, and the taxstructure can be changed to facilitate and encouragethe use of stock options. Their use in other countrieshas made management more sensitive to share-pricemovements and investor concerns. However, a mainadvantage of the bank-centered, diffuse corporategovernance structure—the long-term orientation ofmanagement policies—will be sacrificed, and man-agement goals are likely to become much more ori-ented toward short-term profit maximization. It is notobvious that the aggregate outcome for the economywill be welfare-enhancing.

Enhanced disclosure, increased transparency, theneed for further direct equity issuance for recapital-ization purposes, and the greater role of foreign anddomestic institutional investors are likely to dilute tra-ditional cross-shareholding patterns and tend to breakup family-dominated Thai business groups. The re-quirement to disclose ownership, particularly in thebanking system, will promote transparency and in-crease the credibility of markets and business deci-sions. A small number of families secretly own sub-stantial stakes in banks and business groups throughholding companies. An increased role for externalauditors and outside directors, whose compensationis tied to stock performance, would limit these fami-lies’ excessive influence. Clearly, however, the prob-lem of concentration of ownership or de facto con-

trol in the hands of a few families is not exclusive toThailand, but is pervasive in Southeast Asia, and evenin Europe and the US, albeit more indirectly and lessapparently.

Encourage primary-market deepening. If Thai-land’s bank-centered system shifts to a market-basedfunding structure, a number of measures can enhancethe attractiveness of the stock market, including taxincentives. In bank-centered economies, the tax struc-ture is designed to make debt financing more attrac-tive than equity financing. The incentive structurecan be reversed by abolishing any tax deductibilityof borrowing and introducing tax breaks for equityfinancing. However, small and medium-size firms willnot be able to access capital markets directly andwill remain dependent on bank loans. Since they areimportant employers and crucial for the labor mar-ket and consumption, the enhancement of equity fi-nancing should not take place at their cost. Selectivetax breaks on debt financing for them are thereforelikely to remain welfare-enhancing. The removal offoreign ownership restrictions would also encouragemarket deepening. Under the Alien Business Law,the limit on foreign shareholdings is 49 percent. Whilethis is under review for specific industries, it shouldbe completely abolished to promote overall economicefficiency and competition.

Reduce secondary market transaction costs.Transaction costs are kept above free-market levelsby a system of fixed brokerage commissions. Thebrokerage commission fee schedule has been revisedfrom 0.3 percent for mutual fund companies and 0.5percent for others, to 0.3 percent for mutual funds,0.5 percent for retail investors, and negotiable feesfor domestic subbrokers now that their commissionfloors have been abolished. While floors still existfor foreign institutional investors, the fee structure ismoving toward a free-negotiation system, whichshould reduce barriers to entry and allow discountbrokers, including foreigners, to operate in the Thaimarket.


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Improve market microstructure. A number ofreforms can be implemented to improve the effi-ciency and attractiveness of SET. In a world ofgreater international integration, simply increasingtrading hours is one such measure. Chang, Rhee,and Tawarangkoon (1997) showed that an increasefrom three to four trading hours at SET in July 1992,when an afternoon session was introduced from 2:30to 4:00, resulted in substantially higher trading vol-ume and value, and in speedier price adjustment, whilemarket volatility rose only modestly. A further length-ening of the trading hours is likely to provide furtherbenefits to market participants and also facilitate for-eign participation.

Meanwhile, SET has increased permissible mar-ket volatility in individual stocks before trading issuspended, from a 10 to 30 percent ceiling-and-floorlimit from the previous day’s closing price. Whilethis may potentially increase volatility, it is also be-lieved that a wider band of individual stock move-ments may enhance confidence, especially if com-bined with circuit breakers that limit overall indexvolatility.

Since April 1998, SET has implemented a newcircuit breaker system. As in the New York StockExchange, if the SET index falls by 10 percent fromthe previous day’s close, all trading of listed securi-ties is halted for 30 minutes; if it falls by more than20 percent, trading stops for one hour. However, cir-cuit breakers can often only delay rather than pre-vent severe corrections in asset prices, and their ef-fectiveness is disputed both in the theoretical andempirical literature. Some researchers even warn thatthey may increase market volatility.

11

Moreover, when weighing costs and benefits ofcapital market reforms against demands on otherpolicy areas, it must be kept in mind that even themost efficient market microstructure will be power-less to prevent market crashes if the latter are ren-dered inevitable by macroeconomic management.Hence, recommendations on macroeconomic man-agement reforms must receive first priority.

Mutual Funds: Significant GrowthAttracts Retail InvestorsCollective investment vehicles, such as mutual funds,play an important role in raising resources from thegeneral public. They allow even small investors topurchase units in a well-diversified fund, managedby a professional fund manager. Thus, mutual fundsreduce entry barriers for retail investors to capitalmarkets and substantially broaden the investor basefor debt and equity markets.

The first mutual fund in Thailand was introducedin 1977. Until 1992, the mutual fund industry wascontrolled by a single company, the Mutual FundCompany, an affiliate of the Government-owned In-dustrial Finance Corporation of Thailand. In 1992,the sector was liberalized, resulting in the entry of 15new asset managers and a rapid increase in numberof funds from 37 to over 200 by early 1998. Totalassets under management also rose rapidly from B58billion to B167 billion by June 1997, just before thefinancial crisis. With the fall of the stock market inthe second half of 1997, assets under managementdecreased to B102 billion by December 1997 (Fig-ure 11).

The majority of investors in mutual funds are pri-vate individuals who have about 65 percent share ofmutual fund assets; institutional investors constitutethe remaining 35 percent. As of 1995, an estimated800,000 investors—almost 1.5 percent of the popula-

Figure 11: Mutual Fund Assets, 1992–1997

Sources: Association of Investment Management Companies, Securities andExchange Commission.


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tion—had acquired shares in mutual fund companies.Mutual funds have widened share ownership by al-lowing even small-scale investors to have a well-di-versified and less risky exposure to the stock market.

All mutual fund companies are associated eitherwith banks or finance companies. Distribution of mu-tual funds is effected primarily through banks, whichaccount for more than three quarters of funds sold.Both closed-end and open-ended funds are available,with open-ended funds outnumbering closed-end fundsby about two to one. Naturally, open-ended funds werethe first to suffer capital outflows as the stock marketexperienced a rapid downturn.

Mutual funds have contributed positively to im-proving liquidity on the stock exchange. They ac-count for about 7 percent of total market turnover onany given trading day.

In 1996–1997, 6 new mutual fund and 19 privatefund management licenses were granted. They wereall separately capitalized at a minimum of B100 mil-lion, and their shareholders had to include at leastone bank or insurance company holding a minimumof 25 percent of the company’s shares. Some of theworld’s largest asset managers had teamed up withlocal banks and insurers to form these joint ventureasset management companies. As of December1997, there were 13 mutual fund management com-panies in Thailand.

Asset managers are regulated and supervised bySEC under the 1992 SEC Act. Fund managers mustappoint a fund supervisor (trustee) and custodian toensure that prudential requirements are met. Invest-ment guidelines are also adopted to ensure sufficientdiversification of assets under management.

Taxation policies aim to encourage investments inthese asset classes. Individuals are exempted fromcapital gains tax, while there is a 10 percent with-holding tax on dividend income. Brokerage commis-sions on mutual funds are 0.3 percent, instead of theusual 0.5 percent.

Mutual fund companies used to invest heavily inthe equity markets. Recently, however, they have

increasingly targeted the fixed-income market, as thenumber of issuers has increased and liquidity im-proved in this sector. Figure 12 shows the composi-tion of different mutual funds in the country as ofDecember 1997. Almost half of the mutual fundswere invested in fixed-income instruments, while 43percent was focused exclusively on equities. The restwere invested in both fixed-income as well as equitysecurities.

REFORM POTENTIAL AND OUTLOOKThe following reforms are recommended to enhancethe development of the mutual funds industry:

Improve regulation and supervision. Mutualfund managers established the Association of Invest-ment Management Companies in May 1994, an ob-jective of which is to evolve into a self-regulatoryorganization. Its members subscribe to a code of eth-ics. The future credibility of the fund managementindustry depends on how rigorously the code is en-forced. Independent auditors can enhance regula-tion and supervision.

Increase retail availability. The mutual fund in-dustry will benefit from further deregulation of re-strictions on sales and marketing of domestic andforeign fund products. Given a liberal environment,more companies and financial institutions that hadnever engaged in fund sales are likely to expand themarket by directly offering fund products through

Figure 12: Types of Mutual Funds, December 1997

Sources: Association of Investment Management Companies, Securities andExchange Commission.

Fixed Income Equity Others

47%43%

10%


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their branch networks. Competition can be stimu-lated by free and easy entry of foreign mutual fundsinto the retail market. As familiarity with mutual fundsand awareness of likely risk-return relationships in-crease, the entire market could grow, benefiting purelydomestic funds.

Provide tax incentives. Profits derived frommanaging mutual funds are already tax-exempt.However, incentives to retail investors could be ex-panded.

Help the mutual fund industry recover. Thefurther development of the mutual fund industry de-pends to some extent on how fast it can recoverfrom the significant losses incurred during the down-turn in equity and debt markets. Nevertheless, asinterest rates are at historic highs, there are oppor-tunities for money market and current income funds.In addition, as the stock market has rebounded inthe first quarter of 1998, investors may not want tomiss out on the upturn in financial markets, andmutual funds may start receiving net capital inflowsagain. From a structural perspective and againstthe background of an international trend of indi-vidual savings veering away from bank deposits tomutual funds, increased and sustained growth in thissector is likely.

Pension and Provident Funds:Building the Future Backbone ofthe Capital MarketThe provident fund industry started in 1983 with theobjective of establishing a welfare system for em-ployees who had hitherto relied on family support oraccumulated savings in their old age. In 1987, theProvident Fund Act was passed, establishing the le-gal framework for the expansion of the sector.

Private provident funds are established volun-tarily by companies that aim to provide social secu-rity and pension benefits to their employees. Thenumber of provident fund schemes has expandedrapidly from 159 in 1984 to more than 950 by 1997.There were 1.04 million members of these funds in

1997, accounting for approximately 13 percent ofthe work force employed in the private sector andState enterprises. This implied that a significant pro-portion of the working population, almost 90 per-cent, remained uncovered by a formal pension ar-rangement.

Provident funds are required to invest at least 60percent of their assets in (i) cash or deposits withbanks, (ii) debt instruments issued or guaranteed bybanks, (iii) bonds issued or guaranteed by Govern-ment, or (iv) corporate debentures rated by a credit-rating agency. However, investment in corporatedebentures may not exceed 10 percent.

By August 1997, provident funds had B123 bil-lion under management. Figure 13 shows the rapidincrease of the size of provident fund investment in1993–1997. Figure 14 illustrates the actual distribu-tion of funds according to asset class and highlightsthe significance of debt instruments in the portfoliosof provident funds.

REFORM POTENTIAL AND OUTLOOKDespite the rapid growth of provident funds, fewerthan 1.5 percent of Thai companies offer providentfund schemes to their employees. More than 85 per-cent of Thai employees are not covered by any formof formal pension scheme. Total assets of pensionfunds account for a mere 2 percent of GDP.

In more developed economies, pension fund as-sets provide a stable source of long-term capital. InThailand, however, up to 80 percent of total savingsare invested in short-term instruments, contributingto the volatility in financial markets. Thus, the fur-ther development of provident funds should providea major boost to establishing a stable pool of long-term investable assets. The following reform mea-sures are recommended to accelerate the develop-ment of the provident fund sector:

Centralize regulation and supervision. Regula-tion and supervision of pension and provident fundsare currently fragmented among several differentGovernment authorities, including the Ministry of La-


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bor and Social Welfare, which handles mandatorypension funds; the Comptroller General’s Department,which takes charge of Government pensions; and theFiscal Policy Office of the Ministry of Finance, whichsupervises private provident funds. Centralizing theirfunctions in a single government authority can achievesignificant scale effects, including joint training of staff,supervision, and monitoring technology.

Establish a consistent regulatory framework.Regulations concerning asset management, account-ing rules, and contributions and benefits differ acrossvarious kinds of pension and provident funds. Har-monizing regulations will improve comparability andsupervisory oversight of provident funds, transpar-ency, and compatibility between different schemes,allowing employees to transfer their benefits whenthey change jobs.

Introduce mark-to-market valuation. Fund man-agers of pension fund schemes report asset valuesbased on historical costs rather than on market prices.This may lead to severe distortions in reporting ifasset prices fall below historical costs. Asset-liabil-ity management can also be negatively affected asfuture pay-outs cannot be planned properly and fund-ing gaps may suddenly arise if asset prices fall rap-idly, as happened recently. For example, many em-ployers recently found out that provident funds donot adequately cover current and future liabilities,since assets are overvalued. In January 1997, regu-lations required mark-to-market valuation but onlyfor new provident funds. Mark-to-market reportingshould be instituted for all existing provident fundschemes to improve transparency and avoid un-pleasant surprises for policyholders during marketdownturns.

Strengthen supervision skills. A central unitshould be established that has the skills and authorityto supervise, regulate, and audit provident fund man-agers. The Association of Provident Fund Manag-ers should be turned into a self-regulatory organiza-tion with the authority to penalize members who vio-late its code of ethics. This approach would be con-sistent with SEC’s general policy to promote self-regulation among different capital market institutionssuch as SET and the Association of Mutual FundManagers.

Provide tax incentives. Deducting contributionsto the pension scheme from employers’ corporate oremployees’ income taxes is a common practice inmany countries to promote pension fund develop-ment. The possibility of introducing such an incen-tive program should be studied.

Foreign Exchange andDerivatives MarketsForeign exchange and capital controls were abol-ished in 1990 when Thailand subscribed to Article 8of the IMF Statutes. As a result, trading in the for-eign exchange market increased substantially from

Figure 13: Asset Growth of Provident Funds,1993–1997

Source: Savings and Investment Policy Section, Ministry of Finance.

Figure 14: Portfolio Composition of ProvidentFunds, as of August 1997

Source: Savings and Investment Policy Section, Ministry of Finance.


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a daily turnover of $550 million in 1992 to $8.9 billionin 1996. Foreign exchange activities consist of spotand forward transactions. The forward market hasexpanded rapidly and its trading volume recently sur-passed that of the spot market due to the growth ofswap transactions.

The main players in the foreign exchange mar-ket are the commercial banks and Exchange Equal-ization Fund (EEF), which was set up by BoT in1984 to serve as a vehicle to implement the precri-sis basket-peg exchange rate policy. The baht waspegged to a basket of currencies of Thailand’s ma-jor trading partners, dominated by the US dollar.EEF daily announced the mid-rate for the dollar-baht exchange rate and stood ready to purchase orsell dollars to banks if a differential of B0.02 fromthe announced mid-rate was exceeded. The ex-change rate peg served as the nominal anchor ofmonetary policy. However, the relative stability andpredictability of the exchange rate, which remainedunchanged since 1984, attracted arbitrage andspeculation, as investors exploited the differentialbetween onshore and offshore interest rates. Thecorporate sector also borrowed heavily in the off-shore markets without sufficiently hedging the ex-change rate exposure.

As the baht became increasingly overvalued andthe country’s current account deficit started to widensignificantly in 1996, the baht came under attack inthe foreign exchange market. BoT responded by di-rectly intervening in the market by selling dollars tosterilize capital outflows and by raising short-terminterest rates, resulting in overnight interbank ratessoaring up to 30 percent. The defense was success-ful but short-lived. In May 1997, the final attack onthe baht started when BoT imposed informal capitalcontrols limiting foreign exchange transactions withnonresidents only to those with genuine commercialor investment activities in the country. This createda two-tier foreign exchange market with baht supplylimited in the offshore market. Consequently, offshoreinterest rates rose to over 1,000 percent overnight,

forcing unwinding of short-term baht positions. Con-fidence returned temporarily until the resignation ofthe finance minister in mid-June caused a run on thebaht by domestic residents. As BoT saw its foreignexchange reserves rapidly drain away, it floated thebaht on 2 July 1997.

Under the new managed float system, the ex-change rate is competitively determined by the mar-ket, but BoT may intervene, at its discretion, to main-tain foreign exchange rate stability.

The market for financial derivatives has also beendeveloping rapidly. In December 1994, commercialbanks had outstanding derivative contracts of $4.6billion, accounting for 2.7 percent of their total as-sets. By March 1996, their exposure had increasedto $20 billion or around 11 percent of total bank sys-tem assets. The majority of derivative transactionsare in the form of foreign exchange swaps, with anaverage daily turnover of around $2 billion in 1996,the latest year for which data are available. Thesecontracts are characterized by exchanges of foreigncurrency via the spot market and re-exchanges viathe forward market. The swaps are undertaken ei-ther to convert offshore foreign currency borrow-ings into baht or to hedge against exchange rate riskfor importers or exporters. Forward swaps were alsoemployed by BoT in its failed attempts to maintainthe pegged baht exchange rate. On 19 August 1997,the Government announced that its forward swapobligations during the following 12 months amountedto $23.4 billion, of which $14.8 billion were offshoreobligations.

Other derivative products available in Thailandinclude interest rate swaps and other option prod-ucts. Options are typically issued by commercialbanks to hedge against foreign currency or interestrate risk.

REFORM POTENTIAL AND OUTLOOKThe following measures are recommended to ad-dress the deficiencies in the foreign exchange andderivatives markets:


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Introduce a legal framework. No proper legalframework for options and other derivative transac-tions currently exists. It is therefore necessary tointroduce the Derivatives Markets Act, which clearlydefines the legal rights and obligations of differentparties in derivative transactions.

12

Improve regulation and supervision. BoT super-vises and regulates derivatives transactions. Since1996, banks have been required to report derivativeexposure and transactions to BoT on a quarterly ba-sis. Further improvements in risk monitoring and su-pervision technology are required. Institutional strength-ening within the regulatory authorities will assist thedevelopment of supervisory skills. In such an environ-ment, an increased number of formal market indicesand derivatives based on these indices can be intro-duced to provide the full spectrum of choices for in-vestors to diversify and hedge their portfolios.

Introduce a formal futures and options ex-change. Current trading activities take place in anunorganized and informal market as banks and otherfinancial intermediaries buy and sell options and fu-tures through direct transactions rather than a for-mal exchange. This makes regulation and supervi-sion difficult. A more transparent market systemwould culminate in the establishment of a formalFutures and Options Exchange, which would be en-dowed with rights and duties, including a self-regula-tory function.

Outlook: What Roles Mustthe Capital Market Play?The capital market in Thailand is going through adifficult period. Before the crisis, its role had beenstrictly limited due to the bank-centered design ofThailand’s corporate governance and financing struc-ture. Now, however, many observers and economistscompare Thailand’s economic and financial struc-ture, including its capital market, with that of the US,and conclude that the Thai capital market is inferiorand need to be brought closer to the US model. In-

deed, on the micro-level, capital market reform islikely to increase efficiency and raise the productiv-ity of the financial sector. However, it must not beforgotten that, while there have been clear ineffi-ciencies and problems, the type of financing and cor-porate governance structure has not been the pri-mary cause of Thailand’s crisis and recession. Thecause is to be found in a specific set of macroeco-nomic policies, and so it is not valid to conclude thatthe capital market itself must change. Nevertheless,once the political decision has been made to changeThailand’s financial market and structure and to movetoward the US system, the policy recommendationsin this report may be undertaken.

The fundamental question is what roles the capi-tal market should play in the emerging financial mar-ket system. In general, the capital market may serveseveral functions during the adjustment process. Itprovides a signaling function to policy makers, whoget immediate feedback on their policy reform pack-age. Equipped with transparent and timely informa-tion, the capital market may quickly reward a suc-cessful economic reform program. However, it is alsolikely to penalize inactivity or lack of policy reform.This has been evident in the behavior of the capitalmarket since July 1997. While the stock marketdropped substantially, it rebounded in the first quar-ter of 1998, rewarding the swift policy response ofthe Government and its strict implementation of theIMF reform program.

The capital market also constitutes a source ofcapital for companies that need to recapitalize quicklyand may be unable to raise funds through other meanssuch as banks or private sources. Low valuationsattract investors and may lead to a significant infu-sion of new capital. This makes companies betterable to address the challenges arising from the eco-nomic adjustment. The banking sector was the firstto use the equity market to raise badly needed capi-tal, with Bangkok Bank and Thai Farmers Bank eachraising $1 billion. However, these issues were placedprimarily with foreign investors and through private


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placements rather than purely through the stockmarket.

Finally, the capital market can provide a channelto restructure corporates through mergers and ac-quisitions. While hostile takeovers are unknown inThailand, friendly mergers or acquisitions provide ameans to eliminate overcapacity in certain industriesor to achieve scale and scope economies by creatinglarger and more competitive companies. Again, thebanking sector is actively taking this route by seek-ing alliances with foreign institutions, such as the tie-up between ABN-AMRO Bank with Bank of Asia,

and Development Bank of Singapore with Thai DanuBank.

Capital market reform is supported by a $300-million loan from ADB, approved in December 1997.This policy loan aims to (i) strengthen market regu-lation and supervision, (ii) improve risk management,(iii) diversify the means of intermediating funds withinthe economy, and (iv) develop long-term institutionalsources of funds by promoting the development ofpension and provident funds. The loan is expected toprovide a significant impetus to promote capital mar-ket development in Thailand.


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Notes1The Nukul Commission Report focuses primarily on whoshould be held responsible for the crisis, but it also pro-vides an interesting analysis of the crisis from a Thaiinsider’s point of view.2More research is needed to know why the real sector ofthe economy has been reluctant to access the capital mar-ket. Part of the explanation could be that banks have sec-tor exposure limits to real estate and financial institutions,while no such exposure limits exist for the manufacturingsector. Thus, real estate and financial companies have agreater need to access the capital market than the manu-facturing sector, as they exhaust their traditional sourceof funding—the banking sector.3All listed securities (both debt and equity) traded at SETare exempt from net income tax assessment. However, thisregulation does not include debt instruments traded atthe Thai Bond Dealing Centre and therefore constitutesan inherent disadvantage for debt instruments vis-a-visequity investments.4Of the 56 closed-down financial institutions, 39 were fi-nance and securities companies of which 22 were brokers(SET members), 16 subbrokers (non-SET members), andone nonbroker firm. Nevertheless, none of the stand-alonesecurities companies were closed down and there has notbeen any default in the delivery and settlement system.However, because of declining business, two stand-alonesecurities companies and two finance and securities com-panies announced the voluntary closure of their businessas of 10 June 1998.5Of course, domestic mutual funds may include foreigninvestors. It is therefore statistically impossible to clearlydistinguish foreign and domestic selling activity.6 TSD is a wholly owned subsidiary of SET. It is the cen-tral clearing house and depository for Thai securities. Ithas a registered capital of B200 million. For the clearingfund, contributions were made by both SEC and clearingmembers to be used in the event of default by a clearingmember. In addition, TSD can also draw funds from thecredit line made available from commercial banks or fromthe fund set aside by SET for this purpose.7The following requirements apply:

(i) A securities company may sell short for its ownaccount or for customers only in one of the follow-ing instances: (a) short-selling of equity securitieslisted on SET or a licensed trading center, accordingto SET’s or the trading center’s rules approved bySEC; (b) short-selling of debt securities as regu-lated by SEC; (c) short-selling to satisfy an obliga-tion of the nature specified by SEC.

(ii) Noninstitutional customers have to be fully informedof all risks and the sale must be executed from amargin account.

(iii) Before the short sale is executed, the securities com-pany must arrange to have in place a facility to bor-row securities to meet the delivery deadline.

(iv) The securities company must keep records and pro-duce reports as required by SEC.

8Companies intending to mobilize funds from the publicby issuing and offering securities both for their initial andother public offerings must first obtain approval from SEC.The common qualifications for application are the follow-ing:

(i) The applicant must have definite objectives for theuse of proceeds raised.

(ii) The business of the applicant must be “economi-cally or socially beneficial” for the country.

(iii) The management must be “ethical and competent”as well as not having any adverse track record, andthe company’s auditors must be recognized by SEC.

(iv) The applicant must have good financial standingand performance record.

The approval procedure takes no more than 45 days fromthe date SEC receives accurate and complete statementsand draft prospectus. The issuer and its financial advisor(who is compulsory and must be recognized by SEC) areliable if information in the documents is inaccurate, mate-rially incomplete, or misleading.9To further foster good governance by listed compa-nies, SET published The SET’s Code of Best Practicesfor the Directors of Listed Companies and The Roles,Duties and Responsibilities of the Directors of ListedCompanies. It also released Audit Committee and GoodPractice Guidelines and provided guidelines on howlisted companies should prepare sections in their annualreports on “Management Discussion and Analysis,” “Di-rectors’ Responsibilities,” and “A Statement on Corpo-rate Governance.”10One key rationale behind the draft Bankruptcy Actpassed by Parliament on 27 February 1998 is to amendSection 94 (2) of the Bankruptcy Act, which provides that“the creditor who agrees to the debtor creating a debtwhile he is fully aware that the debtor is insolvent, shallnot be entitled to receive payment of debt in the bank-ruptcy case, thereby causing no financial institution orprivate party willing to give financial assistance to thedebtor who is confronting temporary liquidity problems,in consequence of which the debtor becomes bankruptwhile its business may be capable of being rehabilitated ifthere is financial assistance. Therefore it is expedient tohave provisions which protect the giving of financial as-sistance to the debtor who is confronting a temporaryliquidity problem so that the debtor may have the oppor-


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tunity to rehabilitate its business that would, in turn, en-able unsecured creditors to have an opportunity to re-ceive payment fairly, which would promote the prosperityof the nation’s economy and trade.”11Since the 1987 New York stock market crash and theBrady Commission report, which recommended the intro-duction of circuit breakers, trading controls or circuit break-ers have been introduced in many developed and devel-oping countries. However, the effectiveness of circuitbreakers on the operation of stock markets is disputed.Some researchers argue that circuit breakers curb the ef-fects of overreaction in markets and restore confidence,as they provide market participants with a cooling-off pe-riod while facilitating the price resolution process and pre-venting disintegration of cash, futures, and option mar-kets during periods of frantic trading. Others argue thatthese trading interruptions only postpone price move-ments or move them into other markets. Moreover, it issometimes argued that circuit breakers may amplify mar-ket volatility or produce enhanced ex ante volatility, forexample, when a price limit has a magnet or gravitationaleffect. Unfortunately, the empirical evidence for either viewis far from conclusive.

The literature on circuit breakers includes the followingrecent contributions: Bruce C. Greenwald and Jeremy C.Stein (1991), “Transactional risk, market crashes and therole of circuit breakers,” Journal of Business, vol. 64, no. 4(theoretical finding: circuit breakers may help overcomeinformational problems and thereby improve the market’sability to absorb large shocks); Avanidhar Subrahmanyam(1994), “Circuit breakers and market volatility: A theoreti-cal perspective,” Journal of Finance, vol. 49, no. 1, March(theoretical finding: by causing agents to suboptimallyadvance trades in time, circuit breakers may have the per-verse effect of increasing price variability and exacerbat-ing price movements); Lucy F. Ackert, Jonathan Hao, andWilliam C. Hunter (1997), “The effect of circuit breakers onexpected volatility: Tests using implied volatilities,” At-lantic Economic Journal, vol. 25, no. 2, June (finding:circuit breakers do not affect the market’s expectation offuture volatility); Christopher Ma, Ramesh Rao, andStephen Sears (1989), “Limit moves and price resolution:The case of the treasury bond futures market,” Journal ofFutures Markets, vol. 9, no. 4, August (finding: volatilitymay be reduced by circuit breakers); G. J. Santoni andTung Liu (1993), “Circuit breakers and stock market vola-tility,” Journal of Futures Markets, vol. 13, no. 3, May(finding: circuit breakers do not reduce the volatility ofstock returns); Beni Lauterbach and Uri Ben-Zion (1993),“Stock market crashes and the performance of circuit break-

ers: Empirical evidence,” Journal of Finance, vol. 48, no.5, December (finding: no evidence that circuit breakerswere effective in reducing order imbalance and price swingsin the long run); Betsey A. Kuhn, Gregory J. Kuserk, andPeter Locke (1990), “Do circuit breakers moderate volatil-ity? Evidence from October 1989,” Working paper, Wash-ington, DC: United States Department of Agriculture (find-ing: no calming influence in cash or stock index futuremarkets and possibly heightened volatility in other mar-kets where prices remain unconstrained). For a survey onthe literature on financial market volatility and its relatedissues, see Louis O. Scott (1991), “Financial Market Vola-tility,” IMF Staff Papers, vol. 38, no. 3, September.12The Draft Derivatives Market Act proposed by SECwas approved by the Cabinet on 5 March 1998. See SEC’shomepage on www.sec.or.th.

References

Chang, Rosita, S. Ghon Rhee, and Wuttipan Tawarangkoon.1997. “Extended Trading Hours and Market Microstruc-ture: Evidence from the Thai Stock Market.” In Ad-vances in Pacific-Basin Financial Markets, vol. 3.Edited by Theodore Bos and Thomas Fetherston.Greenwood, CT: JAI Press, Inc.

Dayananda, Don and Kevin Fagg. 1995. “Equity Price Varia-tion in Pacific-Basin Countries: Thai Stock Market Vola-tility.” In Advances in Pacific-Basin Financial Mar-kets, vol. 1. Edited by Theodore Bos and ThomasFetherston. Greenwood, CT: JAI Press, Inc.

Rhee, S. Ghon. 1990. “An Overview of Asian SecuritiesMarkets.” In Pacific Basin Capital Markets Research.Edited by S. Ghon Rhee and Rosita P. Chang. NorthHolland: Elsevier Science Publishers.

Rozeff, Michael. 1990. “Stock Market Regulation in thePacific Basin: Lessons from US Experience.” In Pacific-Basin Capital Markets Research. Edited by S. GhonRhee and Rosita P. Chang. North Holland: Elsevier Sci-ence Publishers.

Sheard, Paul. 1989. “The Main Bank System and Corpo-rate Monitoring and Control in Japan,” Journal of Eco-nomic Behavior and Organisation 11: 399-422.

Stiglitz, Joseph and Andrew Weiss. 1981. “Credit Ration-ing in Markets with Imperfect Information.” AmericanEconomic Review, 71( 3): 393-410.


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Appendix 1

Overview of the Bondand Repo Markets andtheir Settlement System

The first Government bond in Thailand was issuedas early as 1933. In the postwar era, bonds wereissued on a minor scale during the First National Eco-nomic Development Plan (1961–1966). The bondmarket saw little activity until the late 1970s and early1980s, when the Government issued bonds regularly.Before the early 1980s, the bond market was domi-nated by the Government sector, which raised fundsfrom the public in order to finance its budget deficit.Borrowing was usually carried out at below marketrates and issues were purchased by commercialbanks, which were required to hold Government se-curities under statutory reserve requirements. In thelate 1980s, up to 16 percent of bank funds had to beheld in the form of Government securities. Althoughthis requirement was lowered to 6.5 percent in Oc-tober 1992, the rapid rise in bank assets neverthe-less resulted in increased demand for Governmentbonds by banks. Not surprisingly, commercial bankshave always been the single largest holders of Gov-ernment bonds. Banks and finance companies es-sentially followed a buy-and-hold strategy for Gov-ernment bonds and no trading took place amongdifferent institutions. Consequently, a commercialbond market was slow to develop. Liquidity wasnegligible and no yield curve could be established.Neither was a direct sovereign benchmark readilyavailable.

From the early 1980s onward, however, the Gov-ernment attempted to develop the bond market inorder to promote an alternative source of long-termcapital. The Bank of Thailand (BoT) offered repur-chase transactions and encouraged wider distribu-tion of Government bonds. In addition, State enter-prises increasingly used the bond market to raisecapital. The main instruments of the sovereign capi-tal market were medium-term and long-term bonds

issued by the Kingdom of Thailand, as well as Statebonds issued by Government agencies and quasi-sov-ereign institutions (often explicitly backed by Minis-try of Finance guarantees). Bonds (with maturitiesranging from 5 to 10 years) as well as sovereignnotes (with maturities of up to five years), are cou-pon-bearing securities underwritten by BoT via a syn-dicate of selling agents, and are not auctioned.

The repo market in Thailand can be categorizedinto two: the BoT’s repo market and the private sec-tor repo market. The BoT‘s repo market was estab-lished in 1979 and trades Government bonds, Gov-ernment-guaranteed bonds, State enterprise bonds,BoT bonds, nonguaranteed State enterprise bondswhich are triple-A rated, and Financial InstitutionsDevelopment Fund (FIDF) bonds. The daily trans-actions volume in the BoT’s repo market increasedfrom an average of B32.2 billion in October 1996 toB40.1 billion in January 1997. In the private sectorrepo market, any securities mutually agreed upon withthe counterparty are accepted. No volume recordsare available for the private sector market, as theyare traded over the counter.

Corporate debt securities traded through theBONDNET (a blind dealing and quote-driven com-puterized system) run by the Thai Bonds DealingCentre (TBDC) are settled in the net clearing andbook entry system serviced by the Thailand Securi-ties Depository Co. Ltd. (TSD), a subsidiary of SET.Clearing and settlement occur on T+2, i.e., two busi-ness days after the transaction has been executed.On the trading day (day T) at 4.30 p.m., TSD sendsa net clearing report and a money balance reporton-line to members. The next day (T+1), sellersdeposit bonds with TSD before 4:30 p.m. On T+2,buyers deliver checks payable to TSD and sellersreceive checks from TSD from 8:00 a.m. to 9:00a.m. However, there are some corporate debt se-curities traded over the counter and not put throughthe organized exchange. In such cases, counter-parties normally handle the exchange of ownershipand pay by check.


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To ensure efficient settlement, TBDC introducedthe concept of credit line into the trading system. Adealer gives a credit line to each counterparty to limittrade and credit risks.

Government bonds and State enterprise debt se-curities guaranteed by the Ministry of Finance (MOF)qualify as collateral for the BoT’s Loan Window.Thus, financial institutions usually maintain them intheir securities account at BoT, which acts as theregistrar for the securities. Both kinds of securitiesare immobilized and held in a book-entry system atthe Deposit and Bonds Department. Like Govern-ment bonds, BoT bonds can be used as legal reservesas well as collateral for liquidity operations. Theyare thus maintained in financial institutions’ securi-ties accounts at BoT for securities and liquidity pur-poses. All BoT bonds are dematerialized and heldscripless in a book entry system. Being the registraras well as the bookkeeper for the bonds, BoT ef-fects settlement through the book-entry system. Fortrading in the BONDNET system, TSD transmitstransaction information to BoT, where the transferof ownership subsequently occurs.

In the interbank market, the standard settlementdate is T+2. Payment is usually made through thedelivery of cashier checks, unless agreed otherwise(e.g., BoT check or real-time gross settlement trans-fer [RTGS] or via BAHTNET).

To improve the settlement system for BoT bondsas well as Government and State enterprise bonds,BoT is conducting a feasibility study on a real-timeelectronic delivery-versus-payment system (DVP)for settlement. This will enable market participantsto use on-line facilities directly linked to the BoT se-curities and current account system to settle theirtrades. BoT is also considering the provision of li-quidity to the DVP system since the cash portion ofDVP transactions will be settled on a gross basis. Itwill release such information when the final decisionon the credit issue is made. It is believed that this willreduce systemic risk and equip the securities marketwith a new facility conducive to the enhancement of

market activities and the development of Govern-ment securities trading in general.

Margin trading is allowed for all securities listedon SET and those registered with the Bangkok StockDealing Center. However, margin trading commonlytakes place only for equities.

ChronologyThe following chronology provides an overview

of the development of the Thai bond market.1933. MOF issues the first domestic Government

bond.1942. The role of managing the issuing process

of bond is transferred to BoT after its establishment.1961. Since Thailand’s first National Economic and

Social Development Plan, substantial progress has beenmade in restructuring its economy from an agricul-tural base to a relatively high level of industrialization.Demand for capital from private and governmentprojects has exploded while financing with equity can-not continue indefinitely. Since financial institutionscould not mobilize sufficient international or domesticfunding to support such projects, a bond market be-came critical to the development of Thailand.

1979–1982. BoT tries to stimulate the bond mar-ket by encouraging bond trading.

1983–1986. Exchange bonds are offered to thepublic.

1990. The last series of Government bonds areissued.

1991. The value of State enterprise bonds quin-tuples.

May 1992. In synchronization with the liberaliza-tion of the money and financial markets, the Securi-ties and Exchange Commission is established by RoyalDecree in 1992, with all companies now able to mo-bilize funds through debt instruments. Firms thusturned to both domestic and foreign debt markets forfunding to lower costs of debt compared to borrow-ing from financial institutions.

July 1993. Thailand’s first credit-rating agency,Thai Rating and Information Services (TRIS) is es-


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tablished with support from BoT to facilitate the de-velopment of debt instruments as a channel for fundraising by providing credit-rating services for busi-ness and specific bonds. TRIS’s credit ratings pro-vide important information for investors in the formof fair and objective assessments of the quality of abond and the capability of a company to fulfill debtobligations.

Oct 1993. First credit ratings are assigned toDhana Siam Securities PLC for a company and abond rating.

Nov 1993. ASEAN Forum of Credit RatingAgencies (AFCRA), a regional association of credit-rating agencies was set up with members from four

countries: Indonesia, Malaysia, Philippines, and Thai-land. The AFCRA aims to discuss and share con-cerns common to credit-rating agencies in theASEAN region.

Nov 1994. The Thai Bond Dealers’ Club(TBDC) is established as the country’s first sec-ondary bond market, poised to widen and strengthenits mandate in the rapidly growing bond market. Theclub intends to develop the secondary bond marketin terms of standardization, regulations, and dealerefficiency. In addition, it encourages fair trade forboth sellers and buyers which will lead to highervolume and liquidity in the market and narrow in-terest spreads.

Appendix 2

The Money Market

The money market consists of the repurchase mar-ket, Bank of Thailand (BoT) loan window, interbankmarket, certificate of deposit (CD) market, and com-mercial bill market. It is differentiated from the bondmarket in that maturities of money market instru-ments do not exceed one year.

The commercial money market is operated pri-marily by commercial banks and finance compa-nies. The oldest formal money market is the rela-tively well-developed interbank market. It refers toshort-term, typically uncollateralized loans betweenfinancial institutions with maturities ranging fromovernight to two weeks. The market has been domi-nated by a few large commercial banks due to theirabundant sources of deposits tapped via a largebranch network. In March 1985, the Bangkok in-terbank offered rate (BIBOR), the average rate atwhich prime banks lend to each other, was intro-duced. Interbank rates have been volatile, especiallyin comparison to Eurodollar rates. This partly re-flects the limited volume of daily interventions by

BoT in the repurchase market. Market efficiencyhas also been hampered by the small number ofparticipants and oligopolistic bank behavior. (Banksoften ascertain the borrowers’ positions first andthen price discriminate, often giving rise to multipleinterest rates). In 1996, the average daily volumeof interbank loans amounted to B45 billion, com-pared to B24 billion in the repo market.

The repurchase market for Government and Stateenterprise bonds has been in operation since April1979. Its four main objectives were to (i) increasethe liquidity of Government bonds held by commer-cial banks, (ii) introduce an impersonal money mar-ket which would not reveal identity or liquidity posi-tions of lenders and borrowers, (iii) reduce theoligopolistic advantage of large commercial banks inthe interbank market, and (iv) open a new avenuefor central bank monetary policy implementation.Participants include financial institutions and certainState enterprises that can place their bid and offerorders with BoT. Maturities range from overnight to6 months (namely 1, 7, 15, 30, 60, 90, or 180 days),with over 90 percent of orders having maturities of 2weeks or less. Until October 1996, BoT employed


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the “Dutch” auction system, matching supply anddemand and announcing a single market repo ratefor each maturity. Since then, this system has beenreplaced with an “American” or “continuous match-ing” system in which prevailing best bidding and bestoffer rates are matched continuously throughout thetrading day. BoT may intervene in the market byeither absorbing or injecting liquidity. Since it func-tions as the principal match broker for all transac-tions, BoT can intervene in the market through open-market operations. It is also able to monitor liquidityby observing the bid/offer rates and can smoothenout market volatility. The repo rate acts as an impor-tant signal to the interbank market as well as othermoney market instruments, such as commercial billsand CDs.

The BoT loan window is the lender of last resort.Loans are extended against the collateral of eligiblesecurities comprising low-risk Government-guaran-teed bonds. Eligible borrowers include commercialbanks and, since November 1994, also finance com-panies. The interest rate charged under this facilityis termed the “bank rate” and is used as a primeindicator of interest rate movements engineered bythe central bank.

Thailand had a small Treasury bill market. Billswere auctioned on a weekly basis and bought by

financial institutions or the central bank. The sec-ondary market has remained modest. The Treasurybill market virtually disappeared during times of fis-cal surplus. It is therefore likely to stage a majorcomeback with the current widening of the fiscaldeficit.

In May 1987, the market for BoT bonds wascreated as BoT issued bonds to absorb excess li-quidity from the financial system. Maturity was 180days. However, the very infrequent issuance of BoTbonds hampered the establishment of its secondarymarket.

The commercial bill market rose steadily in Thai-land, as companies have found it easier to issue suchshort-term instruments, which are typically uncollate-ralized, than to secure short-term financing frombanks. Companies have raised funds not only to coverworking capital, but also to finance medium-termprojects by rolling over short-term financing instru-ments. This practice is sound only if creditors arewilling to roll over short-term debt. In times of a fi-nancial crisis, however, short-term creditors are thefirst to call in their loans, and borrowers could haveserious liquidity problems as they did during the re-cent financial crisis.


Appendix 3

Issues for Further Research

Several issues were not covered in the study due to itslimited scope. It is therefore suggested that furtherresearch be made on these issues, which include(i) operational and practical details of implementingspecific reform measures, (ii) the debate about thetheory of regulation and its implications for reform,(iii) the debate about the merits and demerits of thetwo “alternative” financial systems, usually referred

to as “stock-market-based” and “bank-based,” and(iv) the merits and demerits of portfolio capital inflows.

Much more detailed research is required on theseimportant topics than even state-of-the-art researchand literature can currently offer. It thus suffices hereto mention some of the fundamental issues concern-ing points (ii), (iii), and (iv).

Economics of regulation is insufficientThe economics of regulation is a discipline that

is still in its infancy. In implementing reforms, espe-


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cially during times of crisis, the decision makers andelected representatives of the people involved inthe process should strike a healthy balance betweenthe demands that are based on microeconomic con-siderations and those that are based on a macro-economic assessment of general welfare. However,general welfare considerations are often neglectedin micro-based economic models. Approachesbased on public choice theory that employ the prin-cipal-agent concept as utilized in modern financetheory, remind us that many principals (the elector-ate, stock exchanges and their members, brokers,auditors, banks, groups of foreign investors, etc.)vie for influence in order to shape the activities ofthe agents, namely the regulators. Since, for thepublic, the costs of monitoring the agents are high,there is scope for agents to be “captured” by spe-cial, vested interest groups. The enforcement ofregulations is in the hands of monitors that are them-selves not sufficiently monitored.

Finally, in the words of Rozeff (1990), “We do nothave substantial evidence to test alternative theoriesof regulation. Given the present state of knowledge,one cannot assume that specific US regulations haveaccomplished specific goals and hence are appealingcandidates for adoption in other countries.... Never-theless, quite a strong case can be made that privateinterest groups influence regulations to the detrimentof the general welfare.” He suggests that the Gov-ernment implement incentive structures that renderthe objectives of civil servants and regulators near-identical with general welfare goals and that the coststo private groups of influencing rule making be raised.

The debate on capital marketsvs. banks is inconclusiveA large body of recent work on the stock market

and long-term economic growth, based on endog-enous growth models, argues that stock markets sup-port economic development by raising the rate andproductivity of investment and via increased techni-cal progress. However, both the precise transmis-

sion channel and the empirical evidence are disputed.The evidence concerning both the pricing channeland the takeover mechanism channel for increasedefficiency in a “fundamental valuation” sense is farfrom conclusive. A body of literature finds that evenin the fully developed stock markets of London andNew York, share prices can deviate significantly fromfundamentals for considerable periods of time. More-over, the takeover mechanism can be shown to bebiased toward size, thus often allowing large, unprof-itable firms a greater chance of survival than small,more profitable firms. Finally, in economic modelsthat realistically acknowledge informational asym-metries and other market failures, to which financialmarkets are particularly prone, most standard neo-classical conclusions do not easily follow.

At the same time, recent work applying the prin-cipal-agent concept has found considerable macro-economic efficiency in bank-based fundraising andmonitoring relationships, such as the Japanese mainbank system. While the Southeast Asian and EastAsian bank-based financial systems appear to havebeen discredited by recent bad-debt problems andeconomic crises, there is a need to distinguish simplemacroeconomic business cycles from fundamentaland structural issues. Consequently, the debate con-cerning equity versus debt, or stock markets versusbank borrowing, cannot be said to have been un-equivocally settled in favor of stock markets. Thereis, therefore, a clear need for further research.

Merits and demerits ofportfolio capital inflowsIn many emerging markets, including Thailand, in-

ternational portfolio investment in equity has becomea major factor. Indeed, during the Latin Americandebt crisis of the 1980s, portfolio equity flows wererecommended to many developing or emergingeconomies, because (i) a huge potential supply offunds from international institutional investors couldbe tapped, (ii) equity was seen as more immune frominterest rate shocks, and (iii) the dividend burden was


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perceived as less onerous than interest payments ondebt, allowing foreign equity owners to share risk.

While there is merit in such arguments, the dan-ger must not be overlooked that capital flows canand often do fuel speculative bubbles that are de-tached from economic fundamentals. It happened inMexico in the early 1990s, and can be argued to alsohave happened in Thailand. Some researchers haveasserted that external financial liberalization and in-

creased reliance on capital inflows link two marketsthat can be prone to volatility: the stock market andthe foreign exchange market. Negative feedback canexacerbate any instability. Policies that encouragelong-term inflows, such as foreign direct investment,but discourage short-term equity flows may there-fore be advisable. They should be based on prudentsupervision of financial markets, as discussed in ourreform proposals.

Appendix 4

Recent Developmentsin Securitization

The major development in mortgage-backed securi-ties is the enactment of the Emergency Decree onSpecial-Purpose Vehicles (SPV) for SecuritizationB.E. 2540 (1997).

The decree covers three main topics.(i) The regulatory body responsible for enforc-

ing the decree. The minister of finance is incharge of the decree, which also empowersthe Securities and Exchange Commission(SEC) to set forth policy measures regardingsecuritization and issue-related notificationneeded for the securitization process.

(ii) The establishment of the SPV and its privi-leges. The SPV can be in the form of a lim-ited company, public company, or mutual fund.In order for the SPV to benefit from the privi-leges outlined by the decree, the securitizationprogram has to be approved by SEC and theSPV registered with SEC.

Among the SPV’s privileges is its exemp-tion from certain legal requirements:– It does not require a finance business or

credit foncier business license.– In the process of assigning of receivables

from the originator to the SPV, the decree

waives the requirement under the Civil andCommercial Code that the creditor must no-tify all the debtors of the assignment. How-ever, this exemption applies only when theoriginator is appointed as the servicing agent.

– The SPV is exempted from payment of thefee for the re-registration of collateral fromthe originator.

– It is exempted from the interest rate ceilingof 15 percent set by the Civil and Commer-cial Code.

– When the assignment of receivables con-stitutes a true sale transaction, the SPV’srights over the transferred debts will be fullyprotected even in the case of the originator’sbankruptcy.

(iii) Supervision over the SPV. When the SPVmanagement cannot perform its duties or thereis no authorized representative to act on itsbehalf, SEC may appoint a temporary man-agement so that the SPV can continue oper-ating under the approved securitization pro-gram in order to protect the interests of in-vestors.

To ensure that the SPV carries out its duties, thedecree also empowers competent officers to inves-tigate the SPV and its management.

To expedite the securitization process in accord-ance with Government policy, SEC issued the “Noti-


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fication on Criteria, Conditions and Procedures forSecuritization.” Its main provisions are the following:

• Persons eligible to propose securitization schemefor approval. Financial institutions (commercialbanks, finance, credit foncier, and securities com-panies), juristic persons established by a specificlaw, and public and private companies are al-lowed to become originators for securitization.

• Type of assets approved for securitization. Thereis no limitation, but the assets must be those ofthe originator.

• Type and characteristic of securities offered forsale. These are secured or unsecured deben-tures, excluding convertible debentures.

• Criteria for approval of securitization scheme andoffering of securities for sale:– The SPV must be a limited company or public

limited company whose objective is to under-take securitization.

– It must demonstrate that its purpose is to usemoney for securitization.

– It must clearly identify guidelines and meth-ods for investment of income flow arising fromdebt claims.

– In case of an offering of subordinated deben-tures for sale, its right to debt payment must

be subordinated to ordinary creditors, at leastin terms of receivership or liquidation for busi-ness dissolution, so as to enhance credit in asenior-subordinate structure.

– In case of domestic private placement, the de-bentures must be in registered form. Transferrestriction is required.

• Consideration of securitization scheme and ap-plication for approval. Within 10 business daysof obtaining the accurate and completed securiti-zation scheme, application for approval, and re-lated documents, SEC will inform the applicantof the result.

• Conditions for approval. An example of a con-dition for approval is that the SPV must offersecurities for sale and accept transfer of as-sets at the minimum value as specified in thesecuritization scheme within six months fromthe date SEC grants approval. The SPV mustsubmit all requirements to SEC within the speci-fied period.

SEC is drafting stringent regulations governingpublic offerings of securitized securities in order toprotect retail investors.


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