Thai Commercial Banks One Decade After the Crisis

8/12/2019 Thai Commercial Banks One Decade After the Crisis

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B NK OF TH IL NDThai Commercial Banks One Decade after the Crisis:

Assessment of Risk to Financial Stability

Don Nakornthab

July 2007

DP/03/2007

(English Version)

DISCUSSION P PER

E-Mail Address: [email protected]

By

The opinions expressed in this discussion paper are those of the author(s)

and should not be attributed to the Bank of Thailand.


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Thai Commercial Banks One Decade after the Crisis:

Assessment of Risk to Financial Stability

Don Nakornthab*

July 2007

1. Introduction

The Thai commercial banking sector was at a center stage of the financial

crisis that hit the Thai economy in July 1997. Beyond inconsistent macroeconomic

policies, aggressive lending by commercial banks was a major factor that fueled the

economic bubble and massive currency mismatch in the real sector. With the collapse

of the exchange rate peg, defaults skyrocketed and banks balance sheets were subject

to severe distress. When the banking sector was on a verge of bankruptcy, what had

started as seemingly containable exchange rate depreciation quickly became a full-

blown twin crisis.

A decade after Thailands worst economic calamity, Thai commercial banks

have seen significant improvements in profitability, asset quality, and risk

management. This paper however is not about how the public and the private sectors

have together helped put the troubled sector back on track. Thailands experience

with banking-sector restructuring and subsequent structural reforms has been well

documented. See, for example, Santiprabhob (2003) and Vichyanond (2007).

This paper is more like an input for central banks macro-prudential analysis.

Its main objective is to assess Thai commercial banks current financial conditions

and short-term outlook which may impact financial systems stability.

The analysis in this paper draws on a number of sources. The main source of

aggregate bank data is the Bank of Thailands website. The sources of individual

bank data are a large database maintained by the Stock Exchange of Thailand (the

SETSMART database) and banks 2006 annual reports. All Thai commercial banks

except one are listed companies and therefore required to disclose to the public a

wealth of financial information.

*Senior Researcher, Economic Research Department, Bank of Thailand. The views expressed in this paper are my

own and not necessary those of the Bank of Thailand. Paper presented at ADB-TDRI-MOF, Thailand JointConference, Integrating Asian Economies: Ten Yeas after the Crisis, Bangkok, 18 July, 2007. I thank ThanawatPruksananont for able research assistant. All errors are the mine.


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The rest of the paper is organized as follows. Section 2 takes stock of the state

of the Thai commercial banking sector as at the end of 2006. Significant content of

the section is devoted to analysis of post-crisis changes and their implications for Thai

commercial banks going forward. Section 3 presents an assessment of Thai banks

short-term outlook, with a focus on their credit risk exposure. Section 4 concludes.

Implications for regional integration are described in Appendix A.

2. The landscape at the end of 2006

This section provides a high-level overview of Thailands commercial banking

sector landscape, dividing into the players and the environment in which they operate.

Where relevant, attempts are made to compare the current landscape to the one right

before the 1997 crisis to highlight important changes that have taken place over the

past ten years.

2.1 The players

a. Industry structure

Figure 1 shows the breakdown of total assets of Thailands commercial

banking sector at the end of June 1997 and December 2006, respectively. In several

aspects, the structure of the industry does not appear to have changed much. There

are about the same number of both Thai and foreign commercial banks today as there

were ten years ago (14 versus 15 and 18 versus 19, respectively). The six largest

banks are the same ones (two have changed their English names). The number one

foreign bank was similarly about the same size as the smallest of the medium-sized

Thai banks. Taken as a whole, foreign commercial banks accounted for about 13% of

the sectors total assets at the end of 2006, dropping slightly from around 15% as ofthe end of June 1997.

Using gross loans and deposits (data not shown) in place of total assets, the

corresponding shares of foreign banks at the end of 2006 were much smaller at 8.3%

and 10.1%, respectively.1 Making up the differences with the total asset share is the

disproportionate shares of foreign banks in interbank and money market items (on

1It is noteworthy that foreign banks share of gross loans has not changed much from June 1997. In contrast, thedeposit share of foreign banks has tripled over the period.


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both the assets and the liabilities sides of the balance sheet), investments in securities

(on the assets side) and borrowings (on the liabilities side). This partly reflects legal

restrictions on foreign commercial banks and hence their different business models

Within the group of Thai commercial banks, the industry has become slightly

more concentrated, with the Herfindahl index increasing from 0.118 to 0.123 and the

combined asset shares of the six largest banks increasing from 74.7% to 80.5%. This

reflects post-crisis industry consolidation and a quest for scale economies by the large

players. In the latter regards, it is noteworthy that large foreign players have also

become larger relative to their foreign peers. The top five foreign banks now control

75% (two-thirds of which belong to Japanese banks) of foreign banks total assets, up

from 42% a decade ago.

Figure 1.Total assets of commercial banks and finance companies in Thailand

1,646

4056

83

87

134

954

46

71

72

129

138

162

203

255

275

350

432

564

704

729

1,216

91 finance companies

Bank of AmericaHSBC

Citibank

Sakura Bank

Bank of Tokyo

All 19 foreign banks

Laem Thong Bank

First Bangkok City Bank

Nakornthon Bank

Thai Danu Bank

Bank of As ia

Bangkok Bank of Comm erce

Bangkok Metropolitan Bank

Siam City Bank

Union Bank

Thai Military BanK (TMB)

Bank of Ayudhya

Siam Commercial Bank

Thai Farmer Bank (Kasikorn)

Krungthai Bank

Bangkok Bank

40

81118

140

178

181

233

1,139

40

80

81

186

189

219

257

412

665

751

942

989

1,206

1,496

2 retail banks

6 finance companiesHSBC

Mizuho

Sumitomo Mitsui

Citibank

Bank of Tokyo Mits ubishi

All 18 foreign banks

ACL Bank

Kiatnakin Bank

Tisco Bank

Standard Chartered (Thai)

UOB (Thai)

Bank Thai

Thanachart Bank

Siam City Bank

Bank of Ayudhya

TMB Bank

Siam Commercial Bank

Kasikorn Bank

Krungthai Bank

Bangkok Bank 17.3%

13.9%

11.4%

10.9%

8.7%

7.7%

4.8%

3.0%

2.5%

2.2%

2.2%

0.9%

0.5%

0.5%

13.2%

2.7%

2.1%

2.1%

1.6%

1.4%

19.3%

11.6%

11.2%

9.0%

6.9%

5.6%

4.4%

4.0%

3.2%

2.6%

2.2%

2.0%

1.1%

1.1%

0.7%

15.1%

2.1%

1.4%

1.3%

0.9%0.6%

Total assets

(Bt m)

Share of banking

sectors assets

Total assets

(Bt m)

Share of banking

sectors assetsJun 1997 Dec 2006

Source: C.B. 1.1 and C.B. 1.2 reports for bank data; BOT website for finance company data

The bottom of Figure 1 shows the number and the total assets of finance

companies at the end of the two respective periods. Finance companies were an

important fixture of the Thai financial sector and had many overlapping businesses

with commercial banks. The distinguishing feature is that these companies were not

allowed to raise fund in the form of deposits, but only in the form of higher-interest-

rate promissory notes. In return, they were given exclusive rights to operate leasing


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and hire purchase businesses on top of almost everything that commercial banks could

do.2 In 2004, the Bank of Thailand decided to phase out these companies, requiring

them to return their license or upgrade to retail banks which can serve only

individuals and SMEs or to commercial banks which now can operate leasing and hire

purchase business as well (more detail in Section 2.2c).

What is remarkable from Figure 1 is the dramatic decline in the number and

the total assets of finance companies after the crisis. Right before Thailand was hit by

its worst post-war economic fallout, there had been ninety-one finance companies

whose combined assets exceeded one-fourth of the banking sectors total assets. By

the end of 2006, there were six of these companies left, with combined assets of less

than one percent of that of the banking sector. Thus, to the extent that thesecompanies competed with commercial banks in several market segments, the playing

field has now become much less crowded.3

One important change that is masked by Figure 1 is the change in

shareholding structures of Thai commercial banks. Although not as badly hit by the

crisis as finance companies, the banking sector did suffer significant damage. From

1998 to 2000, Thai commercial banks were forced to raise around 800,000 million

baht in additional capital, a substantial sum considering that the combined capital baseof all Thai commercial banks at the end of June 1996 was slightly below 500,000

million baht (about 20 billion USD at the pre-crisis exchange rate). Several banks

were closed down, intervened, sold, or merged into other entities. Of todays fourteen

Thai commercial banks, only nine banks remain Thai privately-owned, compared to

fourteen out of fifteen before the crisis. Three are majority-owned by Financial

Institutions Development Fund (FIDF): Krungthai, Bank Thai, and Siam City. Two

are wholly-owned by foreigners: UOB (Thai) and Standard Chartered (Thai). Buteven among the remaining Thai private banks, foreign ownership has also increased

significantly. Most notably, Singapore-based DBS and U.S.-based GE Capital have a

sizable stake in TMB Bank (18%) and Bank of Ayudhya (29%), respectively. Table 1

shows percent foreign ownership in the nine private banks at the end of 2006.

2A notable exception is foreign exchange business.3It is interesting to note that five commercial banks in operation today (Thanachart Bank, Bank Thai, Tisco Bank,Kiatnakin Bank, and ACL Bank) are reincarnation or upgrades of finance companies.


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Table 1.Foreign ownership of Thai private banks as of December 29, 2006.

Foreign ownership (%)

Bangkok Bank 48.8%

Kasikorn Bank 49.0%

Siam Commercial Bank 34.7%

TMB Bank 37.9%

Bank of Ayudhya 48.6%

Thanachart Bank 0.0%

Tisco Bank 49.0%

Kiatnakin Bank 44.0%

ACL Bank 20.0%Note: (1) Foreign ownership calculated as percent foreign limit less percent foreign availability.

(2) Pre-crisis foreign limit was 25.0%.Source: SETSMART

Finally, it should be noted that while the total assets of the Thai banking sector

grew 37% over the period (41% counting only Thai banks), the ratio of the banking

sectors total assets to GDP declined from 133% to 111%. The fall in banking-sector

assets relative to GDP indicates the reduced significance of the banking sector in the

Thai economy.

b. Thai banks performance in 2006

On many accounts, 2006 was a solid year for Thai commercial banks as a

group. Improved profitability and solvency both contributed to further strengtheningof the sectors financial position.

A look at Thai banks net profit in 2006 alone distorts the picture. All together,

Thai commercial banks 2006 net profit dropped 40% from 2005, bringing down the

sectors return on assets to 0.75, the lowest level in three years. The drop in Thai

banks net profit was largely a result of IAS39-compliant loan loss provision burden.

(See Section 2.2c for more detail of IAS39.) The other major factor that contributed

to the reduced net profit was the expiration of crisis-related tax shield for some

commercial banks. In terms of pre-provision operating profit (PPP) margin, however,

2006 was a post-crisis record-breaking year. The growth in PPP was supported by a

strong increase in net interest and dividend income, which in turn benefited from

improvement in net interest margin (NIM) and continued loan growth.

Figure 2 traces out the evolution of Thai commercial banks net profit and the

amount of loan loss provisioning expenses along with ROA and the ratio of PPP to


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averaged total assets from 1990 to 2006.4 For our purpose, we use 1992-1996 as the

pre-crisis base for performance comparison. 1992 was the first year that commercial

bank interest rates in Thailand were fully liberalized. It was also the year that

commercial banks were allowed to set up Bangkok International Banking Facility

(BIBF) operation which enabled them to channel low-cost foreign funds to domestic

borrowers and started the subsequent lending boom. There, we see vividly the extent

of the 1997 crisis and the turnaround that followed. Provisions for massive loan

losses turned an industry that had previously registered on average higher than 50,000

million baht of net profit a year into an industry with net profit losses of more than

300,000 million baht in 1998 and 1999. It took nearly five years from the beginning

of the crisis to put the industry back on a stable growth path. Note that if we were to

plot also retained earnings of Thai commercial banks in Figure 2, we would find that

it only turned positive in 2004.

Figure 2. Provisioning expenses, net profit, ROA, and PPP of commercial banks

registered in Thailand, 1990-2006

-400000

-300000

-200000

-100000

0

100000

200000

300000

400000

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

-8.0%

-6.0%

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

Million baht Percent

ROA (RHS)

Loan loss provisionsNet profit

PPP (RHS)ROA (RHS)

Loan loss provisionsNet profit

PPP (RHS)

Avg. PPP (92-96) = 2.76% 2006 PPP

= 1.98%

Source: BOT website; Krungthai Bank (1997); authors calculation

While Thai banks 2006 PPP in baht amount exceeded the pre-crisis high,

expressed as a percent of averaged total assets, it was still below the pre-crisis

average. This is due partly to the fact that the cost-to-income ratio of Thai

commercial banks after the crisis has become higher and partly to the fact that most

4To be precise, the data shown in Figure 2 to Figure 6 are for commercial banks registered in Thailand which from

2005 include retail banks and subsidiary of foreign banks in addition to Thai commercial banks. However,because of their small sizes, their inclusion makes virtually no difference with respect to the aggregate financialratios.


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Thai commercial banks still carry a sizable amount of non-income generating assets

(non-performing loans plus foreclosed properties) on their balance sheets.

Figure 3 plots the aggregate NIM and the aggregate cost-to-income ratio of

Thai commercial banks during the same time span as Figure 2. At 3.2%, Thai banks

2006 NIM was a post-crisis high. For the second consecutive year, the increase in

NIM in 2006 was propelled by a stronger increase in interest income relative to

interest expenses. This stood in sharp contrast with previous years where the

primarily culprit for NIM improvement was a relative decline in interest expenses.

Looking in a context of a contemporaneous interest rate cycle, this is consistent with

the observation that during an interest rate downtrend, banks adjust the deposit rates

first, but during an interest uptrend, banks adjust the lending rates first.

Figure 3. NIM and cost-to-income ratio of commercial banks registered in Thailand,

1990-2006

0.5%0.6%

1.0%

1.7%

2.1%

3.0%

3.2%

2.5%

1.8%

182%174%

96%85%

53%57%54%59%66%

0.0%

1.0%

2.0%

3.0%

4.0%

1990 1992 1994 1996 1998 2000 2002 2004 2006

0%

40%

80%

120%

160%

200%

Net interest income/averaged total assets Cost-to-income ratio (RHS)

Average 92-96 = 3.7%

Average 92-96 = 42% 0.5%

0.6%

1.0%

1.7%

2.1%

3.0%

3.2%

2.5%

1.8%

182%174%

96%85%

53%57%54%59%66%

0.0%

1.0%

2.0%

3.0%

4.0%

1990 1992 1994 1996 1998 2000 2002 2004 2006

0%

40%

80%

120%

160%

200%

Net interest income/averaged total assets Cost-to-income ratio (RHS)

Average 92-96 = 3.7%

Average 92-96 = 42%

Source: BOT website; Krungthai Bank (1997); authors calculation

It should be noted that while the 2006 NIM is materially lower than the pre-

crisis average, it is highly respectable by international standards, particularly when

compared to those in developed economies. For example, the average NIM of large

EU banks in 2006 was a little over one percent (ECB, 2006). Pro-market activists

may argue that the high NIM reflects a low degree of competition among Thai banks.

Under the same interpretation, however, the fact that the NIM is below the pre-crisis

average suggests that there is more competition now than before.

One negative development in 2006 was a deterioration of Thai banks cost-to-

income ratio. For the first time since 1998, Thai banks cost-to-income ratio increase


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over the previous year, propelled by a rise in operating expenses over operating

income. The upturn suggests that the cost-to-income ratio may never go back to its

pre-crisis level, i.e., there may have been a structural shift in the cost structure of Thai

commercial banks. Nevertheless, the 2006 cost-to-income ratio was in line with

international norm and hence not yet a cause for concern.

In terms of asset quality, the ratio of non-performing loans (NPLs) to total

loans of Thai commercial banks dropped further to 8.0%, the lowest level since 1997

(Figure 4). The continued improvement in the NPL ratio reflected banks effort to

clean up their loan books in response to the Bank of Thailand (BOT)s more stringent

provisioning rules that took effect in August 2004 as well as to meet the BOT target to

bring down the ratio of net NPLs which do not count NPLs that have been fullyprovisioned to 2% by the end of 2007.5

Figure 4. NPL ratio of commercial banks registered in Thailand, 1997Q4-2006Q4

0

10

20

30

40

50

60

70

1997Q4

Entire Banking system

Thai banks only

Percent of total loans

1998 1999 2000 2001 2002 2003 2004 2005 2006

2006 Q4= 8.0%

Source: BOT website (98Q2-06Q4); CEIC (97Q4 and 98Q1)

0

10

20

30

40

50

60

70

1997Q4


Thai banks only


1998 1999 2000 2001 2002 2003 2004 2005 2006

2006 Q4= 8.0%


Thai banks only


1998 1999 2000 2001 2002 2003 2004 2005 2006

2006 Q4= 8.0%

Source: BOT website (98Q2-06Q4); CEIC (97Q4 and 98Q1)

In 2006, the solvency position of Thai commercial banks improved further

(Figure 5). Although one banks capital adequacy ratio fell below the regulatory

minimum of 8.5%, the Tier 1 and the total capital adequacy ratios of Thai commercial

banks as a whole rose from 10.0 and 13.2 at the end of 2005 to 10.9 and 13.8 at the

end of 2006, respectively.

5The ratio of net NPLs to total loans of Thai banks at the end of 2006 was 4.5%. No historical figure is

available. For prudential purpose, the relevant NPLs are the net ones. This is because there is no furtherimpairment on banks' capital from the portion of NPLs that have been fully provisioned. From a profitability pointof view, however, keeping NPLs that are fully provisioned on its balance sheet entails a carrying cost for a bank.


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Figure 5. Total and Tier 1 capital as percent of risk-weighted assets of commercial

banks registered in Thailand, 1997-2006

7.928.48

7.5

8.91 8.939.57

9.019.98

10.9210.46

11.97 11.39

13.28 12.9613.43

12.36

13.2513.85

7.34

9.23

0

2

4

6

8

10

12

14

16

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

Tier 1 capital Total capital

Source: BOT website

A look at aggregate data alone often does not give a complete picture of

industry-wide performance, for they are to a large extent driven by the performance of

large banks. Table 2 looks at key financial ratios of Thai commercial banks by five

subgroups: large private banks, medium-sized private banks, small private banks,

state-owned banks, and foreign-owned Thai banks. All ratios in the table are taken or

calculated from individual banks 2006 audited financial statements which are

available to the general public.

Table 2.2006 key financial ratios of Thai banks by subgroup

Largeprivate

banks

Mediumprivate

banks

Smallprivate

banks

State-owned

banks

Foreign-owned

banks

Number of banks 3 3 3 3 2

Share of total assets (Thai banks only) 46% 22% 3% 24% 5%

ProfitabilityROA 1.4% -0.4% 2.2% 0.1% 1.1%PPP 2.5% 0.9% 2.5% 1.6% 2.8%ROE 14.0% -6.5% 10.2% -13.7% 10.8%

NIM 3.5% 2.5% 3.9% 3.1% 4.3%Yields on interest earning assets 5.9% 6.1% 7.6% 6.5% 7.7%Funding costs 2.5% 3.5% 4.7% 3.0% 3.0%Net interest spread 3.5% 2.6% 2.9% 3.6% 4.7%

EfficiencyCost to income 52.8% 78.1% 59.0% 62.1% 58.6%Operating expenses to average assets 2.8% 2.6% 3.3% 2.4% 3.4%Non-interest income to total income 24.7% 14.4% 20.5% 14.3% 21.0%

Asset quality and solvencyNPL ratio 7.5% 7.1% 11.6% 6.1% 7.0%Net NPL ratio 3.6% 4.3% 6.0% 4.3% 2.9%CAR 14.5% 11.1% 25.8% 10.8% 15.2%

Note: (1) Simple average(2) Data from consolidated financial statements except for SCBT and TBANK(3) NPL ratios are of solo (company) basis.


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(4) Large private banks: BBL, KBANK, SCBMedium private banks: BAY, TMB, TBANK

Small private banks: TISCO, KK, ACLState-owned banks: KTB, SCIB, BT

Foreign-owned banks: UOBT, SCBTSource: Thai banks 2006 annual reports; authors calculation

In terms of ROA, small private banks came ahead of the other four subgroups.

In terms of ROE, their performance was less impressive. This is because small

private banks have on their books an enormous amount of capital relative to their total

assets. Their capital adequacy ratio at the end of 2006 was three times above the

regulatory minimum. This raises a question whether they use their capital funds

efficiently. Nevertheless, to the extent that they had the highest NPL ratios in the

table, the high capital adequacy ratio may not be too overwhelming.

Perhaps the most unpleasant thing for small private banks is that they had the

highest funding costs (interest paid on average interest-bearing liabilities). This

reflects their small sizes and limited branch networks. The main reason that they

managed to do well in 2006 were higher yields from hire purchase and leasing

businesses, their traditional strength from the time they were finance companies. To

the extent that other banks can now also engage in these businesses, there is a

downside risk to future profitability of small private banks.

Overall, the large private banks appeared to perform best in 2006 relative to

the other subgroups, followed not-too-distantly by foreign-owned Thai banks. Large

private banks have the lowest funding costs which reflect their market dominance.

Had they not carried substantial NPLs on their books (which depressed their asset

yield), their performance would have been even more impressive. Foreign-owned

banks had higher NIM and net interest spread (the difference between yields on

interest-earning assets and the funding costs) than large private banks, but had higher

operating costs and provisioning expenses which brought down their profitability.

This indicates that economies of scale may play some roles here. Recall from Figure

1 that foreign-owned banks are much smaller than the large private banks.

Medium-sized private banks and state-owned private banks did not do as well

as the other three subgroups in 2006. Not only did they have the lowest return on

assets, but because they also had low NIM and high operating cost to income relative

to the rest of the industry. One bank in each subgroup made net profit losses in 2006

which turned the average ROE of both groups into negative territory. But the others


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also did not fare much better. Moreover, their net NPL ratios indicate that both

medium-sized private banks and state-own banks may still have a lot more to do in

terms of extra provisioning under IAS39. The question of interest then is whether

these banks will be able to improve their performance going forward.

c. The changing business model6

The 1997 crisis made it necessary for Thai commercial banks to adapt and

develop in nearly every dimension of their operation. This subsection looks at

changes in Thai banks business structure, sales and services, distribution channels,

and risk management.

Before the crisis, Thai banks earned most of their income from lendingbusiness. Interest income accounted for nearly 90% of banks total income on

average between 1992 and 1996. Within the loan portfolios, the focus of most banks

was on large corporations. Such dependency made banks profit sensitive to an

economic downturn. Defaults by a few large borrowers meant huge damages to

income and capital base.

To achieve greater portfolio diversification, Thai banks have given more

importance to consumer loans and loans to small and medium enterprises (SMEs).

The proportion of consumer loans in Thai banks loan portfolio in particular rose from

13% in 1998 to 21% at the end of 2006. To reduce dependence on interest income,

non-interest income, especially fees and commissions, has been emphasized. Non-

interest income to total income of Thai banks averaged 22% during 2002-2006, up

from 10% during 1992-1996.

In terms of sales and services, cross-selling and customer segmentation was

generally rare before the crisis. The need to increase the bottom line amidst increased

competition after the crisis motivated Thai banks to cross-sell and move to a

customer-centric architecture where customer needs come first. Several banks have

adopted a customer relation management (CRM) platform to serve specific needs of

different customer segments.

With regards to distribution channels, the most visible change is probably

branch rationalization. Even the state-owned banks have fewer people in their

branches before the crisis. At the same time, Thai banks have aggressively used

6Most of the materials in this subsection are from Triratvorakul and Vacharachaisurapol, 2006


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ATMs and sub-branches to increase points of service and lower cost-to-serve. Use of

mobile and internet banking also has an impressive growth albeit still small in total

volume.

Last but perhaps most important is the change in Thai banks risk

management. A good example is in the area of credit and credit risk management

processes which have become more systematic. Before the crisis, Thai banks

customer acquisition and lending approval was largely decentralized with branch

managers and regional managers making most of the decisions for loans of less than

ten million baht. While large loans were subject to board approval, there was

typically little time to perform comprehensive credit analysis at the headquarters. The

discretionary power of branch managers extended to pricing where relationship with

branch managers often determined the final pricing.

Figure 6. Comparison of Thai banks credit and credit risk management processes

before and after the crisis

- Analyze and

review credit by

themselves

- Relationship-

based pricing

Credit review

and approval

Operation

after credit

authorization

Headquarters

Board Board

Risk Management

Committee

Credit PolicyRoles and Responsibilities Roles and Responsibilities

- Analyze credit usingtools such as credit ratingand credit scoring

- Credit reviewingcommittee decides onlarge loans

- Formula-based pricing

with RAROC

Customer

information

Credit Policy

Credit review

and approval

Operation

after credit

authorization

Branches Headquarters

Sales team/branches

Relationship managers

Headquarters/

Regional centers

Customer

acquisition

Customer

acquisition

Before crisisBefore crisis TodayToday

Source: Triratvorakul and Vacharachaisurapol, 2006

After the crisis, most banks adopted a system where the main role of branches

is to find and maintain customers, leaving credit review and approval to the

headquarters. This creates transparency in the credit process as well as the system of

check and balance and specialization among different departments. In all banks, there

is now a risk management committee that sets credit risk policy and monitor banks


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own risks. In several private banks, modern risk management tools such as credit

scoring, internal rating systems, and credit portfolio models have been adopted.

There is also an attempt to move towards risk-based pricing using RAROC (Risk-

Adjusted Return on Capital) or similar tools although success in this area has been

quite limited. These changes in Thai banks credit and credit risk management

processes are summarized in Figure 6.

An important caveat is that while the right panel of Figure 6 looks very much

like what one would have found in the case of any international best-practice bank,

the devil lies in the detail. For example, internal rating models of the large private

banks currently cover only a portion of their corporate loan portfolios. Nevertheless

this does not present as much a problem as the fact that certain banks lag significantly

behind in the adoption of modern credit risk management tools. The difference

between the good and the bad risk management will be most apparent during the

downturn of the business cycle.

2.2 The environment

As with the Thai commercial banking players, the environment in which they

operate continues to evolve. This subsection divides Thai banks operating

environment into macroeconomic environment, industry or competitive environment,

and regulatory environment. In contrast to the preceding subsection which for the

most part was backward looking, this subsection focuses on the changing environment

over the next 2-3 years along with their implications for Thai commercial banks.

a. Macroeconomic environment

After registering robust growth from 2002 to 2004, the Thai economy slowed

down moderately in 2005 and 2006. 2006, in particular, was a challenging year for

the Thai economy as it was buffeted by a number of negative shocks. These included

political uncertainties, high oil prices, and severe flooding in many provinces. As a

result, domestic demand softened markedly. The economy however managed a

respectable growth rate of 5% for the year with the help of robust exports on the back

of a strong global economy.


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Figure 7.Thailands GDP real growth forecast

Source: Bank of Thailand Inflation Report, April 2007

Figure 7 shows the medium-term forecast of real GDP growth of the Thai

economy published by the Bank of Thailand in April 2007. The figure suggests an

economy on a moderate growth path. The growth is expected to come mainly from

exports, given healthy global conditions, additional government spending, and lower

oil prices.

Meanwhile, both internal and external stability appears well under control.Low unemployment and inflation rates are expected to continue in the medium term.

On the external front, the current account is expected to be in surplus at least till 2008,

which is a sharp contrast with the pre-1997 situation. International reserves have

risen to over 70 billion US dollars, keeping the ratio of reserve to short-term debt in a

highly comfortable position.

Thus, the economy looks to be in a sustainable expansion, albeit not as fast as

those recorded during 2002-2004. There is virtually no sign of a recurrence of the

crisis of 1997 type. Of course, there are downside risks to growth, most notably if the

world economy tanks. Although unlikely, this could easily happen if the US dollar

collapses or the Chinese economy goes into a hard landing. The Thai economy is

particularly vulnerable to these adverse events because of its heavy reliance on

exports as driver of growth.

But even if the Thai economy does proceed along the projected trajectory in

Figure 7, things will likely be less rosy for the commercial banks. This is because

private consumption and private investment, the major drivers of commercial banks


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15

revenues, are not expected to show a significant pickup until the second half of 2008.

In fact, there is a possibility that 2006 could be a short-term peak in Thai banks

performance. Against this backdrop, effective credit risk management will be

essential for banks to maintain a healthy bottom line going forward.

b. Industry environment

Jittamai, Nakornthab, and Poshyananda (2005) describe in detail four major

changes in Thai commercial banks industry environment that have taken place after

1997. The four changes are disintermediation by the capital markets, the increased

role of specialized financial institutions (SFIs), the rise of non-bank financial

institutions, and heightened competition from foreign banks. This subsection reviews

each of the changes briefly along with their implications for Thai commercial banks

going forward.

Figure 8. Composition of Thai financial system

1996 2006

Financial institution loans Corporate bonds

Public-sector bonds Stock market

69%

3%

26%

2%

44%

19%

31%

6%

1996 2006

Financial institution loans Corporate bonds

Public-sector bonds Stock market

69%

3%

26%

2%

44%

19%

31%

6%

Note: (1) Financial institution loans = loans extended by commercial banks, finance and credit fonciercompanies, and specialized financial institutions

(2) Outstanding domestic bond value at par

(3) Stock market capitalizationSource: BOT website; Thai Bond Market Association

The first and perhaps also the most important element of Thai banks industry

environment is the structure of the financial system. Like those in most other Asian

economies, Thailands financial system is bank-based, with commercial banks being

the major providers of funds for the domestic economy. Nevertheless, since the 1997

crisis there has been a gradual shift towards greater capital market financing. Figure 8

shows the structure of the Thai financial system at the end of 1996 and 2006,


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respectively. Although not a perfect proxy7, it is quite obvious that the Thai financial

structure today is becoming more balanced. This trend is expected to continue in the

immediate future.

The decline in the significance of financial institutions in the Thai economy

seen in Figure 8 is due partly to the problems facing these institutions in the aftermath

of the 1997 crisis and partly to the authorities effort to promote the development of

capital markets. In the case of commercial banks, a huge pile of NPLs and balance

sheet weakness had led to a contraction in bank loan supply, making capital market an

attractive financing alternative, or in some cases the only choice, for certain firms.

One important lesson Thailand has learned a hard way from the 1997 crisis is

the need to have a developed capital market that can act as a spare tire when the

banking sector fails to perform its intermediary function. It is therefore no surprise

that capital market has received a high priority in the Thai authorities effort on

financial system reform. Three capital market development plans were launched in

2000, 2003 and 2006. The latest, Thailands Capital Market Development Master

Plan 2006-2010, targets the corporate bond market as well as equity. Perhaps one of

the most aggressive measures in this plan is a liberalization of brokerage commission

fees in 2010 as a preparation for the full liberalization of the entire securities industry.

Several observers see the growth of the equity and bond market as a major

threat for Thai commercial banks. This paper takes a different view and argues that

the net effect of capital market growth is positive for Thai commercial banks. While

disintermediation inevitably hurts lending, capital market development provides

banks with several income-generating opportunities. The most obvious is the bond

market where Thai banks are the major players. League tables published by the Thai

Bond Market Association shows Thai banks consistently dominate the lists of top

dealers, underwriters, and registrars of domestic bonds. In addition, Thai banks are

also occasional issuers of corporate bonds. All of these mean that Thai banks stand to

gain handsomely as the bond market grows.

7Though often used to describe financial structure, market capitalization may overstate the importance

of the stock market in the economy. A notable example is Thailand in 1993 where stock marketcapitalization exceeded bank loans and led Demirguc-Kunt and Levine (1999). to wrongly concludethat Thailand had a market-based financial structure.


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Although Thai banks are prohibited to directly participate in equity securities

business, many own securities and asset management companies. As a matter of fact,

securities and asset management company subsidiaries of the large private banks are

among leaders in their respective industries. Thus, on a consolidated perspective,

disintermediation is more like a shift in revenues from interest income to fees and

services income. Of course, such capital market benefits depend on how universal

a particular bank is.

Additionally, because all but one Thai banks are listed companies, equity

market growth offers them a number of indirect financial benefits. First, as the Thai

stock market grows, the cost of equity for listed firms is likely to fall. Second, a

healthy stock market enables them to raise more capital easily. And third, they couldin principle use their market capitalization in merger and acquisition activities.

One promising area that cannot be overlooked is wealth management.

Globally, wealth management for high-net worth customers is the fastest growing

business segment for banks. We have not seen this happening in Thailand yet. But it

is conceivable that it is just a matter of time for the wealth management industry to

take off if the Thai capital market continues to deepen.

Lastly, a developed capital market offers two important indirect benefits for

Thai commercial banks. First, a deep capital markets promotes overall financial

system development which is good for economic growth. See, among others,

Demirguc-Kunt and Levine (2001). Second, capital market development contributes

towards a more stable financial system and an economy which is more resilient in the

presence of shocks.

Figure 9 breaks down financial institution loans at the end of 1996 and 2006

into loans from commercial banks, loans from finance companies and credit foncier

companies, and loans from special financial institutions (SFIs). Credit foncier

companies are finance companies that specialize in property lending. SFIs are

government-owned development financial institutions that provide financial

assistance to specific sectors of the economy. Five major SFIs are Government

Housing Bank, Government Savings Bank, the Bank for Agriculture and Agricultural

Cooperative, the Export-Import Bank of Thailand, and SME Bank.


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Figure 9.Breakdown of financial institution loans

1996 2006

Commercial banks Finance and credit foncier cos SFIs

70%

22%

8%

78%

1%

21%

1996 2006

Commercial banks Finance and credit foncier cos SFIs

70%

22%

8%

78%

1%

21%

Source: BOT website

After the 1997 crisis, the role of SFIs in the Thai financial system increased

significantly. The government has used SFIs to fill the gap voided by troubled banks

and finance companies as well as to stimulate the battered economy, especially at the

grass root level. Compared to commercial banks, SFIs are more lax in lending

discipline. Part of this is due to the so-called policy-directed lending, but primitive

credit risk management capabilities also play a major role. For the most part,

however, this does not present a problem to commercial banks as many of SFIs

customers (mostly the poor and farmers) do not belong to their target groups. A

major exception is SMEs. Weak lending discipline by SFIs effectively distorts the

market and represents one barrier for commercial banks to implement credit risk

management for their SME customers.

Not included in Figure 9 is the amount of loans extended by non-banks or

more precisely non-deposit-taking consumer finance specialists. These players

include global names such as Aeon, American Express, Cetelem, and Citiloans, as

well as local ones. Non-banks operations cover primarily three businesses: hire-

purchase, credit cards, and personal loans. An average customer of non-banks has

lower income than that of commercial banks, but there exists a material overlap

between their customer portfolios.

Before 2002, non-banks were not regulated. The Bank of Thailand viewed

regulation of these companies unnecessary as they do not pose systematic risk to

depositors. As the Thai economy recovered however, the influence of non-banks in

the Thai consumer finance market grew significantly. Concerning that their explosive


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growth might have led to financial instability (in the case of the credit card business)

and excessive buildup of household debt, the BOT issued a series of prudential

guidelines on credit card loans in 2002, 2004, and 2006 and took personal loan

business under its supervision in July 2005 on the ground of consumer protection.

Among the regulations which apply to banks as well as non-banks are minimum

income of cardholders, ceiling on interest and other charges, and a maximum credit

limit for a particular borrower.

Despite the increased regulatory burden, non-banks continue to expand their

influence. Figure 10 shows outstanding amounts of credit card loans and personal

loans extended by banks and non-banks from the first quarters that non-bank data in

respective markets are available. As of 2007Q1, non-banks accounted for 46% ofcredit card loans outstanding (up from 40% in 2002Q4) and 53% in personal loans

outstanding (up from 51% in 2005Q2).

Figure 10. Outstanding values of credit card and personal loans under BOT

supervision

0

20

40

60

80

100

05 Q2 05 Q3 05 Q4 06 Q1 06 Q2 06 Q3 06 Q4 07 Q1

Banks Non-banks

0

20

40

60

80

100

02Q4

03Q1

03Q2

03Q3

03Q4

04Q1

04Q2

04Q3

04Q4

05Q1

05Q2

05Q3

05Q4

06Q1

06Q2

06Q3

06Q4

07Q1

Banks Non-banks

Credit card loans Personal loansBillion baht Billion baht

0

20

40

60

80

100

05 Q2 05 Q3 05 Q4 06 Q1 06 Q2 06 Q3 06 Q4 07 Q1

Banks Non-banks

0

20

40

60

80

100

02Q4

03Q1

03Q2

03Q3

03Q4

04Q1

04Q2

04Q3

04Q4

05Q1

05Q2

05Q3

05Q4

06Q1

06Q2

06Q3

06Q4

07Q1

Banks Non-banks

Credit card loans Personal loansBillion baht Billion baht

Source: BOT website (credit card loans); BOT internal data base (personal loans)

The BOT internal data shows that, in addition to faster growth, non-banks as a

group has a lower NPL rate in personal loans than commercial banks. The difference

in NPL rates also hold in the case of credit card loans (Vanikkul, 2006). This is an

interesting statistics in itself because low-income customers are the most sensitive to

deteriorating economic condition. While faster growth and a lower NPL rate do not

necessary correspond to superiority, there are reasons to believe that non-banks can

take on more risks than commercial banks. After all, several of these firms are global

players who have honed their skills and winning strategies in other markets. The

incumbent Thai banks, on the other hand, are relatively new to this market. It wasnon-banks that first found opportunities in this market segment and sparked the


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subsequent lending boom. Perhaps the best example of non-banks differing strategy

is their treatment of loans that miss payments. While non-banks have a higher

proportion of delinquency loans than commercial banks which reflects the greater

riskiness of their portfolios, they do not allow these loans to lapse more than three

months to be counted as NPLs. Their aggressive write-off and debt collection policies

along with high interest rates and fees allow them to go for high-risk customers.

Going forward, competition in the consumer finance market is expected to

become fiercer as the softened economy slows down the now crowded market. Some

banks, however, have managed to avoid direct competition with non-banks in this

market by launching their own non-banks or by forming strategic alliances with non-

banks themselves. Others will have to find ways to respond to increased competition.

The final element of Thai banks industry environment is heightened

competition from foreign banks. Although it was a foreign bank which jumpstarted

commercial banking in Thailand in 1888, foreign banks have played limited roles in

Thailands modern banking era. This is in sharp contrast to the life insurance industry

where American International Assurance controls roughly 45% of the markets total

premium. The main reason for the limited presence of foreign banks in Thailand has

to do with the Bank of Thailands regulations on foreign bank entry and branching.Today, with exceptions of Standard Chartered (Thai) and UOB (Thai) and a small

foreign bank registered as a foreign subsidiary, all other foreign banks are confined to

having one branch only.

But even foreign wholly-owned Thai banks are a relatively new phenomenon.

In an effort to stabilize the Thai banking system after the 1997 crisis, the Bank of

Thailand relaxed the 25%-ceiling on foreign ownership in Thai banks. In this

process, four commercial banks were sold during 1998 and 1999 to Standard

Chartered, UOB, DBS (merged their acquisition into TMB bank in 2004), and ABN

Amro (sold their acquisition to UOB in 2005). More recently, the Bank of Thailandallowed GE Capital to take a majority stake in Bank of Ayudhya in 2006 and sold its

FIDF holding in Bank Thai to TPG Newbridge in 2007. Another FIDF deal is also

said to be forthcoming.

Meanwhile, a few foreign bank branches have opted for organic growth during

the past ten years. Most notable are Citibank and HSBC which have also built an


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21

impressive retail operation, particularly in credit cards, despite having only one

branch each.

Although business models of foreign bank branches are diverse, most of them

focus on corporate banking. Lending to large and medium-sized firms, structured

products, and foreign exchange and money market activities are typical businesses of

foreign bank branches.

Figure 11 illustrates the different compositions of Thai banks and foreign

bank branches loan portfolios. It is clear from the figure that the loan portfolio of

foreign bank branches heavily tilts towards corporate lending. The composition

becomes even more skewed if we exclude the two foreign retail giants, Citibank and

HSBC, from the picture.

Figure 11.Loan portfolio compositions of Thai bank and foreign bank branches as of

2007Q1

Thai banks Foreign bank branches

78%

9%

13%

89%

0.2%

10%Corporate loans

Credit card and personal loans

Housing loans (mortgages)

Thai banks Foreign bank branches

78%

9%

13%

89%

0.2%

10%Corporate loans



Corporate loans



Source: BOT website

Increased activities of foreign wholly-owned banks and foreign bank branches

are among the major factors that have catalyzed Thai banks changing business model

described in Section 2.1c. Nevertheless, because of their small sizes, foreign banks

are still marginal competitors of many Thai banks, except in certain products such as

credit cards and cash management. This competitive balance could change in the

future however if there is a change in regulatory regime that allows them to grow at a

faster rate than the current one, for which we turn to the next subsection.


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c. Regulatory environment

The 1997 crisis would not have inflicted such a deep wound on the Thai

commercial banking sector if the regulatory environment that will prevail in the next

two years had been in place then.8

This subsection describes the core elements of the

new regulatory environment, namely, the regulatory and the supervisory frameworks

that have already been or will be put in place by the end of 2008 along with the

supporting infrastructure.

An important milestone in Thailands post-crisis banking regulatory reform

was the initiation of the first phase of the Financial Sector Master Plan (FSMP) in

January 2004. Bank of Thailand (2006) provides background, rationales, and details

of the plan. The FSMP is a 10-year, medium-term development plan for financial

institution under the supervision of the Bank of Thailand.

The most visible outcome under the first phase (2004-2007) of the FSMP is

the rationalization of the structure and roles of financial institutions. A major

structural weakness of the Thai financial institutions system before the 1997 crisis had

been the presence of many high-risk finance (and credit foncier) companies. In some

way, finance companies risks were forced on them by the regulatory system that did

not allow them to raise funds in the form of deposits. Faced with higher costs, these

companies naturally resorted to high risk activities in order to generate higher returns.

One of the strategic objectives of the FSMP is to correct this structural weakness.

This has been accomplished by the removal of the regulatory boundary line between

commercial banks and finance companies businesses. Finance companies were then

asked to merge with their parent bands, merge with other finance companies to

become commercial banks or retail banks, or return their licenses.

Another major structural weakness of the pre-crisis regime was the

International Banking Facilities (IBFs), mentioned in Section 2.1a. It was IBFs that

fueled the pre-crisis lending boom in Thailand. IBFs attached to commercial bank

were asked to merge with their parents while stand-alone IBFs had to upgrade to

foreign full branch or subsidiary or to return their license. By March 2006, there are

no IBFs left in Thailand.

8It would probably not be able to prevent the crisis from happening, for there were also other root

causes in play.


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The establishment of foreign subsidiary is a new concept in Thailand and

represents the Bank of Thailands response to pressures for further financial

liberalization. Under the FSMP, foreign banks can operate as a full branch or a

subsidiary. Both full branch and subsidiary enjoy the same scope of business as Thai

commercial banks, but the latter can have four branches in addition to one head office

as opposed to the former which (by definition) has only one branch.

The Bank of Thailand initially hoped that major foreign players such as

Citibank and HSBC might have chosen to become a subsidiary. In the end, however,

only Taiwans Mega International Commercial Bank (formerly ICBC) did so.

Interviews with Citibank and HSBC conducted by Jittamai, Nakornthab, and

Poshyananda (2005) revealed that the two banks would instead like to have 20-40branches to be cost effective.

The Bank of Thailand has now moved to work on the second phase of the

FSMP which will further step up the pace of reform. The FSMP Phase II will aim at

increasing efficiency of the financial institution system so as to strengthen its

competitiveness and resiliency. An important element of the FSMP Phase II will be

the orderly but meaningful introduction of more competition into the system

between existing institutions and new entrants, domestic and/or foreign. The detailsof Phase II are expected to be finalized in the first quarter of 2008.

Another notable development on the regulatory front is the adoption of new

regulatory framework in line with the changing international standards. These

include, IAS39 (2006-2007), consolidated supervision (2007) and the Basel II Capital

Accord (yearend 2008).

IAS39 (International Accounting Standard 39, Financial Instruments:

Recognition and Measurement) concerns several accounting areas, but the one that

has affected Thai banks the most is the provisioning of NPLs. The required

provisioning amount under IAS39 is based on the difference between the outstanding

loans and the present value of their collaterals as opposed to the difference between

the outstanding loans and the appraisal value of their collaterals under the old BOT

rule.

To ensure a smooth adoption of IAS39, the Bank of Thailand has phased

IAS39 compliance in three periods according to the age of the NPLs: doubtful of loss


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loans (loans overdue more than 12 months) by December 2006, doubtful loans (loans

overdue 6-12 months) by June 2007, and substandard loans (loan overdue 3-6

months) by December 1995). Nevertheless, the impact of IAS39 on banks net profit

was still quite substantial in 2006, as seen in Section 2.1b. It is expected that the

banking sector as a whole has to set aside 40-50 billion baht of additional provisions

in 2007 compared to 62 billion last year (Kasikorn Research Center, 2007a). After

2007 however, IAS 39 will improve the transparency and provision buffer against

impaired assets, significantly strengthening the banking sector.

With consolidated provision, the Bank of Thailand will be able to supervise

financial institutions on a consolidated basis, which has become increasingly

necessary in the era of financial conglomerates. Consolidated supervision will allowthe Bank of Thailand to better assess risks of banks more effectively.

The adoption of Basel II slated for end-2008 will raise the standard of risk

management of commercial banks. At the minimum, banks will have to hold

regulatory capital that better reflects the underlying risks of their business. The end

goal is however for banks to develop risk management culture and capability that

together allow them to manage their risks effectively. The Bank of Thailand has been

working with the banking sector on the implementation of Basel II in Thailand forseveral years. It is expected that the transition to the new capital regime will be

relatively smooth.

On the supervisory front, the Bank of Thailand has significantly strengthened

its supervisory capacity and monitoring practices. Risk-based supervision has been

adopted in place of rule-based supervision. A range of database and risk-management

system has been developed along with training programs for supervisors. This

includes the use of scenario analysis, an early warning system, and the publication of

quarterly macro-prudential indicators.

Finally, the Financial Institution Business Act (FIBA), expected to be passed

this year, will strengthen the Bank of Thailands supervisory power by unifying the

supervision of all types of financial institutions under its purview. The FIBA will also

give the Bank legal power to enforce consolidated supervision, Basel II, and prompt

corrective actions to address weakness in troubled banks.


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In terms of supporting infrastructure, three are particularly noteworthy. The

first is the legal process with regards to bankruptcy cases. The Bankruptcy Act has

been amended several times since 1998 to deal with NPL cases. The Central

Bankruptcy Court was established in 1999. The overall process from initial document

to the end of foreclosure sale has been shortened from 42-60 months to 26-35 months

(Kasikorn Research Center, 2007c).

The second important supporting infrastructure is the Deposit Protection

Agency (DPA) Act, expected to be passed this year, will replace the current blanket

deposit guarantee in place since 1997. The new system of limited-coverage deposit

insurance will be phased in over four years to allow banks and depositors to adjust to

the new framework. The establishment of the DPA should reduce banks moralhazard and introduce more market discipline to the banking sector by putting pressure

on banks to improve financial strengths if they want to attract and retain depositors.

The third is the National Credit Bureau (NCB), formed from a merger of two

credit bureaus in 2005. The NCB collects and warehouses debt and debt service

records provided by its member financial institutions. The NCBs database now

covers more than 10 million customers. Thus, the problem of the lack of information

about loans granting to one borrower by several institutions has been significantlyreduced. For example, in the area of housing loans, banks now routinely use

information from the NCB to ensure that a prospective customer does not have

excessive debt burden and also to prevent occurrences of double or triple mortgages.

3. Short-term risks and outlook

The Basel II Capital Accord specifies three major risk buckets of financial

institutions: credit risk, market risk, and operational risk. This section focuses

primarily on credit risk, by far the largest risk exposure of all Thai commercial banks.

Market risk in particular is small, as suggested by the ratio of market risk assets to

total risk assets. Excluding one bank with a sizable market risk exposure, the average

proportion of market risk assets to total risk assets for all other Thai commercial

banks at the end of 2006 was a mere one percent.

Before jumping to the credit risk issues of Thai commercial banks, it is worth

noting about Thai banks foreign exchange risks, however. One of the major

misconceptions by Thailands outsiders is that the 1997 crisis resulted partly from


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currency mismatches on banks balance sheets. For example, McKinsey & Company

(2002) forcefully argues that Thai banks were vulnerable because they onlent foreign

funds to their domestic borrowers without proper hedging of foreign exchange rate

risks. The truth is, then as well as now, Thai banks were required by the Bank of

Thailand to keep their net foreign exposure in check. Instead, what the Bank of

Thailand and the banks themselves overlooked and is now a classic case study, is that

the mismatches in the real sector could feed back to the banks in the form of increased

credit risks.

In the short-term, i.e., this year and the next, the most important factor

affecting Thai banks risks and outlook is likely to be the not-so-favorable economic

environment. As mentioned in Section 2.2a, the Thai economy into the end of 2008 is

forecasted to be driven mainly by exports, with domestic demand particularly private

investment below trend growth. In such an environment, the pressure for

shareholders value creation will lead to intensifying competition among market

players. The combination of the not-so-robust economy and increased competition

presents an important challenge for all Thai commercial banks.

Week domestic demand affects banks in two major ways. First, it exerts a

downward pressure on loan growth. Second, it is likely to lead to more default

occurrences. Figure 12 plots year-on-year growth rates of total loans, corporate loans,

and consumer loans of Thai commercial banks against nominal GDP growth from

2004Q4 to 2007Q1. Over the period shown, Thai banks loan growth moved roughly

in tandem with nominal GDP growth, falling as the economy softened since 2006Q1.

Corporate loan growth, in particular, has slowed down markedly. As a matter fact, the

last time that corporate loans of Thai banks registered a negative growth was in 2003.9

On the other hand, consumer loan growth appeared little affected by the economic

slowdown. The robust growth in consumer loans partially offset the fall in total loan

growth resulting from corporate loans.

9Discontinuity in sectoral loan data in 2003Q4 prevents Figure 4 to goes back beyond the period shown.Nevertheless, that the last time corporate loan registered a negative growth was in 2003 can be inferred from theavailable data.


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27

Figure 12. Loan growth of commercial banks registered in Thailand versus nominal

GDP growth, 2004Q4-2007Q1

-5%

0%

5%

10%

15%

20%

25%

30%

04Q4 05Q1 05Q2 05Q3 05Q4 06Q1 06Q2 06Q3 06Q4 07Q1

All loans Corporate loans Consumer loans Nominal GDP growth

Source: BOT website

Given the economic outlook and the contemporaneous movement between

nominal GDP and total loans observed in Figure 12, Thai banks overall loan growth

in 2007 will likely be lower than that in 2006 and may not pick up much in 2008. The

implication from this is a downward pressure on banks interest income going

forward.

It should be noted that movements in bank loan growth are not entirely

demand driven. Banks also watch over their credit risks. As economic uncertainty

mounts, the probability that potential borrowers may not be able to repay their debt

increases. So banks may keep tap on new lending when their perceived risks of

borrowers increase.

An important indicator of the quality of banks loan books is NPLs. After

reaching a low of 8.0% at the end of 2006, Thai banks NPLs rose slightly to 8.1% in

2007Q1. Net NPLs also rose from 4.5% to 4.6%.

While banks NPL rates capture their overall loan portfolio quality, they are

generally not a good indicator of credit risks facing banks. In theory, one would like

to use the expected default rate of new loans for that purpose. In the absence of

public data, one rough proxy of bank credit risks would be the ratio of new NPLs to

total loans.10,11

10In a forthcoming study, Chantapant, Kritayakirana, and Nakornthab (2007) use a database available only to

supervisors to construct historical default rates of bank corporate borrowers.11One may be tempted to use the change in total loans outstanding in the denominator. There are at least twoproblems with this. First, the amount of new loans in a given period is the change in loan outstanding plus the sumof loan repayments, write-offs, and transfers. In a period when total loans outstanding is declining (the case of


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Figure 13 plots the ratios of new NPLs and reentry NPLs (NPLs of loans that

have been previously restructured) to total loans of Thai commercial banks going

back to 1999Q4 when the data became available. The sum of the two ratios captures

roughly the default rates of Thai banks loan portfolios.

Figure 13.Ratios of new NPLs and reentry NPLs to total loans of commercial banks

registered in Thailand, 1999Q4-2007Q1

0.0%

0.3%

0.6%

0.9%

1.2%

1.5%

99Q4 00Q4 01Q4 02Q4 03Q4 04Q4 05Q4 06Q4

New NPLs Reentry NPLs

Source: BOT website

Excluding the temporary increase in reentry NPLs in the first half of 2003, the

credit environment facing banks appeared benign throughout the period shown.

Nevertheless, since the end of 2005, there seems to be an upward shift in the level

new NPL rates compared to the earlier period.

The upward drift in the new NPL rate is in line with Figure 14 which shows

the absolute and the relative amounts of special-mention loans of a subset of Thai

commercial banks at the end of 2004, 2005, 2006, and 2007Q1. Special-mention

loans are loans that are past due for more than one month, but less than three months.

So they are not counted as NPLs, which by the BOTs aging criteria refers to loans

that have been past due for more than three months.

Thai banks between 1998 and 2001), using changes in total loans instead of total loans as the denominator wouldresult in negative NPL rates. Second, NPLs in the respective period may have come from loans that have beenoriginated several periods ago.


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Figure 14.Special mention loans of Thai commercial banks

0

30,000

60,000

90,000

120,000

150,000

2004 2005 2006 2007Q1

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%Special mention loans Percent of total loans

Million baht

Source: Kasikorn Research Center (2007)

Changes in special mention loans are generally indicative of future changes in

new and reentry NPLs. Thus, together with the softened economic condition, Figure

13 suggests that more new and reentry NPLs are in the pipeline this year.

Despite potential increases in new and reentry NPLs, the overall NPL ratio of

Thai banks is expected to fall significantly this year. As mentioned in Section 2.2c,

Thai banks are required to set aside additional provisions in compliant with IAS39

this year. To reduce provisioning burden, banks are expected to transfer a substantial

amount of their NPLs to asset management companies (AMCs). Estimates by

Kasikorn Research Center (2007b) put the ratios of NPLs and net NPLs to total loans

between 4.0-5.5% and around 2% at the end of this year, respectively.

A major caveat is that, for banks with their own AMCs (five largest private

banks do), such NPL transfers merely represent a shift from a direct exposure on their

loan books to an indirect exposure through their subsidiaries. To the extent that their

AMCs make losses from the transferred loans, they will have to realize these losses

too. An efficiency issue aside, a bank with 20 billion baht of NPLs is no different

from a clean bank that owns an AMC (99.99% or 100%-owned) with 20 billion baht

of NPLs. Good analysts usually look at consolidated NPL figures when assessing a

banks capital vulnerabilities.

To gain a little deeper understanding of Thai banks credit risk, we look

separately at Thai banks corporate sector exposure and household sector exposure.

Figure 15 shows time series plots of selected financial ratios of non-financial listed

companies, often taken as a proxy of banks top-tier corporate customers. The figurereveals a very comfortable picture. Although the gross profit margin of non-financial


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listed companies has been somewhat depressed recently, the other three ratios point

out to exceptional financial strengths, particularly in debt service capacity. Moreover,

since the crisis, many Thai private companies, including listed ones, have shied away

from foreign currency funding. Accordingly, the risk of currency mismatches turning

these firms into defaults like what happened during 1997-8 is remote. All these

backdrops suggest minimal credit risk coming from large corporate borrowers, at least

in the immediate horizon.

Figure 15.Selected financial ratios of non-financial listed companies

0

5

10

15

20

25

30

1999

2000

2001

2002

2003

2004

Q12005

Q2

Q3

Q4

Q12006

Q2

Q3

Q4

Q12007

0

1

2

3

4

5

1999

2000

2001

2002

2003

2004

Q12005

Q2

Q3

Q4

Q12006

Q2

Q3

Q4

Q12007

0

2

4

6

8

10

1999

2000

2001

2002

2003

2004

Q12005

Q2

Q3

Q4

Q12006

Q2

Q3

Q4

Q12007

Time Interest coverage ratio

Debt to Equity RatioTime

Gross Profit Margin

18.4

-6

-4

-2

0

2

4

6

8

10

12

1999

2000

2001

2002

2003

2004

Q12005

Q2

Q3

Q4

Q12006

Q2

Q3

Q4

Q12007

Percent Return on Assets

7.1

7.0

1.0

Average 1994-1996Average 1994-1996

Average 1994-1996

Percent

Average 1994-1996

0

5

10

15

20

25

30

1999

2000

2001

2002

2003

2004

Q12005

Q2

Q3

Q4

Q12006

Q2

Q3

Q4

Q12007

0

1

2

3

4

5

1999

2000

2001

2002

2003

2004

Q12005

Q2

Q3

Q4

Q12006

Q2

Q3

Q4

Q12007

0

2

4

6

8

10

1999

2000

2001

2002

2003

2004

Q12005

Q2

Q3

Q4

Q12006

Q2

Q3

Q4

Q12007

Time Interest coverage ratio

Debt to Equity RatioTime

Gross Profit Margin

18.4

-6

-4

-2

0

2

4

6

8

10

12

1999

2000

2001

2002

2003

2004

Q12005

Q2

Q3

Q4

Q12006

Q2

Q3

Q4

Q12007

Percent Return on Assets

7.1

7.0

1.0

Average 1994-1996Average 1994-1996

Average 1994-1996

Percent

Average 1994-1996

Source: SET; compiled by BOTs Monetary Policy Group

The lack of data on non-listed firms makes it difficult to draw similar

inferences in the case of smaller-sized corporate borrowers. Nevertheless, we know

that these firms, particularly the SMEs, are in general more sensitive to adverse

economic condition than their larger peers. This, together with the fact that SMEs

have been a focus of Thai banks loan expansion in recent years, makes middle-

market borrowers a potential source of corporate-sector credit risks for Thai banks.

At the same time, there are indications that household sector credit risks have

increased. The pace of growth in consumer loans during the past four to five years

has led to an increasing exposure of Thai banks to the household sector. While the

strength of household lending has been a boon for banks, a spate of defaults by

households would turn the situation around.


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Figure 16 traces the evolution of NPL ratios of Thai banks consumer loans

and their subcategories over the past four years. From 2003Q4 to 2006Q4, NPL ratio

of consumer loans came down significantly, reflecting an improving of banks

consumer loan portfolios. The situation is different in 2007Q1 when it went up

slightly on the back of increases in NPLs in the area of credit cards and housing loans.

Figure 16. NPLs of consumer loans, 2003Q4-2007Q1

0

4

8

12

16

20

2003Q4 2004Q4 2005Q4 2006Q4

Consumer loans Housing loans Credit card loans Personal loans

% of total loans

Consumer loans


Loans for personal

consumption

Credit card loans

Personal loans

Consumer loans


Loans for personal

consumption

Credit card loans

Personal loans

0

4

8

12

16

20

2003Q4 2004Q4 2005Q4 2006Q4

Consumer loans Housing loans Credit card loans Personal loans

% of total loans

Consumer loans


Loans for personal

consumption

Credit card loans

Personal loans

Consumer loans


Loans for personal

consumption

Credit card loans

Personal loans

Source: BOT internal database

Although it is too early to tell that this is a start of a new trend, given the state

of the economy, NPL ratios of consumer loans could rise further as the year

progresses. Nevertheless, because consumer loans are among the sectors with the

lowest NPL ratios, it is still a long way for their increases to pose threat to banks

stability. In addition, due to the Bank of Thailands prudential regulative on loans to

value (LTV) of mortgage loans, banks are more or less covered in the event of

borrower default. In fact, it would require a significant financial distress in the

household sector before banks potential losses from their consumer loan exposures

would pose a concern for financial stability.

Karnchanasai, Nakornthab, and Piamchol (2004) highlighted net properties

foreclosed on banks balance sheets as a potential source of additional risks for Thai

banks in the event of a property price collapse. Figure 17 plots the amount of net

foreclosed assets on Thai bank balance sheets and their percent of total assets from

1997:1 to 2007:4. Since mid 1999, Thai banks properties foreclosed have ballooned.

Most of these properties foreclosed were previously collateral of loans that had turned

sour. While their ratio to total assets has been trending since the beginning of 2006, it


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remains well above 2%. For comparison, the corresponding figure for foreign bank

branches is 0.02%. Although a sharp decline in property prices look unlikely in the

immediate horizon, having such sizeable non-income-generating and highly illiquid

assets on balance sheets does entail hidden financial costs for Thai banks.

Figure 17. Net properties foreclosed of commercial banks registered in Thailand,

1997:1-2007:4

0

20,000

40,000

60,000

80,000

100,000

120,000

140,000

160,000

180,000

200,000

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

0.00%

0.50%

1.00%

1.50%

2.00%

2.50%

3.00%

Outstanding value Percent of total assets Source: BOT website

In addition to slower loan growth, increased credit risks, and carrying costs of

net properties foreclosed, continued strengths in deposit growth of most Thai

commercial banks is another factor weighing down banks operating performance this

year. With low loan growth prospect, banks have parked their excess liquidity in the

money markets. Coupled with a series of policy rate reduction in the first half of this

year, this exerts a further downward pressure on both NIM and asset yields. We have

seen this already happened in 2007Q1. Adding IAS39 provision burden on top of that

and Thai banks net profitability in 2007 does not look very good.

Consistent with this outlook are analysts expectations of banks profitabilitythis year and the next. Table 3 shows that analysts expect earnings per share of half

of the Thai commercial banks in the table to fall against their 2006 values. All

commercial banks are however expected to do better in 2008 when IAS39 provision is

no longer an issue.


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Table 3.Averaged EPS forecasts of selected Thai banks as of July 6, 2007

2006A 2007F 2008F

Bangkok Bank 9.35 10.20 11.25

Kasikorn Bank 5.74 5.73 6.45

Siam Commercial Bank 4.64 5.10 6.01

TMB Bank -0.86 -0.17 0.21Bank of Ayudhya 0.58 0.59 1.45

Thanachart Bank 0.15 0.19 0.22

Tisco Bank 1.88 2.17 2.52

Kiatnakin Bank 3.98 3.36 3.66

ACL Bank 0.94 0.44 0.48

Krungthai Bank 1.26 1.20 1.51

Siam City Bank 2.02 1.45 2.18

Bank Thai -3.32 0.40 0.62

Note: Excludes UOB (Thai) which was delisted in August 2006 and Standard Chartered (Thai) whichis no longer traded.

Source: SAA Consensus (www.settrade.com)

4. Conclusions

Thai commercial banks have come a long way since 1997. Aided by strong

economic growth, consolidation and recapitalization efforts, improved risk

management, operational restructuring, and regulatory reforms, the sector has more or

less returned to stability by the end of 2006.

On the surface, the Thai banking sector does not appear to be much different

from its pre-crisis years. A deeper look at the players and their operating environment

reveals a very different industry dynamics, however. Among other things, this

implies that the risks facing Thai commercial banks have also changed from what

they were facing in 1996-1997.

After enjoying a smooth journey for the past several years, Thai banks have hit

a bump in the road in 2007. Most important from the financial stability perspective is

the thinner bottom line and increased credit risks. Nevertheless, there is no sign of

sector-wide distress. All banks are also expected to do better in 2008. Of course, theoutlook for Thai banks could change if the future macroeconomic and financial

environment significantly diverges from its expected course.

Looking forward, the major test for Thai banks will the introduction of greater

competition under the second phase of the Financial Sector Master Plan. While the

timing, the extent, and the speed of the planned liberalization will not be finalized

until 2008, it is not difficult to see from the assessment in this paper that some banks

are far more vulnerable than the others to the increased competitive pressure. These


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banks will have to work harder than the rest to find ways to ensure their long-term

place in the Thai economy.

References

Bank of Thailand (2006). Thailands Financial Master Plan Handbook, August.

Bank of Thailand (2007). Inflation Report, April.

Chantapant, Sukonpat, Kritayakirana, Krongkaeo, and Don Nakornthab (2007). How

Vulnerable Are Thai Banks: A Structural Analysis of Bank Corporate Portfolios

and Implications, forthcoming.

Demirguc-Kunt, Asli and Ross E. Levine (1999). "Bank-Based and Market-Based

Financial Systems: Cross-Country Comparisons," World Bank Policy Working

Paper No. 2143, July.

European Central Bank (2006). EU Banking Sector Stability, November.

Jittamai, Pajongjit, Nakornthab, Don, and Roong Poshyananda (2005). Changing

Macroeconomic Environment and Financial Landscape: Challenged for the

Banking Sector, Bank of Thailands Discussion Paper No. 10/2005, November

(in Thai).

Karnchanasai, Chatsurang, Nakornthab, Don, and Suchot Piamchol (2004). Bank

Lending, the Housing Market, and Risks: A Test for Financial Fragility, Bank of

Thailands Discussion Paper No. 05/2004, November.

Kasikorn Research Center (2007a). Commercial Banking Business in 2007: Facing

Several Negative Factors, Current Issues, Vol. 13, No. 1943, January (in Thai).

Kasikorn Research Center (2007b). Bank Loan and NPL Trends during the Rest of

2007, Current Issues, Vol. 13, No. 1974, May (in Thai).

Kasikorn Research Center (2007c). Thai Economy 10 Years after Crisis: Lessons for

Thai Financial Institutions, Current Issues, Vol. 13, No. 1981, July (in Thai).

Krungthai Bank (1997). Key Financial Data of Thai Commercial Bank, 1988-1996.

McKinsey&Company (2002). Dangerous Markets: Managing in Financial Crisis,

Wiley Finance.

Santiprabhob, Veerathai (2003). Lessons Learned from Thailands Experience with

Financial Sector Restructuring, Thailand Development Research Institute,

November.


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Vanikkul, Krirk (2006). Bank of Thailands Policies towards Development of the

Financial Institution System, paper presented at TDRI 2006 Yearend Conference,

December (in Thai).

Vichyanond, Pakorn (2007). Crucial Transition in Thailands Financial System,

paper presented at the Brookings Institutes Asian Economic Panel, April.

Appendix A. Implications for regional integration

This appendix looks at integration in banking services in Asia from a financial

stability perspective. In particular, it argues that policymakers should follow proper

sequencing of first ensuring the stability of the domestic banking sector and the

integrity of the regulatory and supervision framework before moving to full regional

(or international) integration. Where relevant, the findings in this paper are as cases

in point.

Integration in banking services generally takes two primary forms. The first is

cross-border provision of services, be internet banking or cross-border borrowing and

lending. The second is commercial presence, either through local subsidiaries or

equity stakes.

Different regions follow different approaches to integration. In Latin America,

the proliferation of foreign banks is the hallmark of the regions internationalized

banking sector. In contrast, intraregional cross-border bank flows are the main mode

of integration within the European Union. As a matter of fact, looking only at

percentage of total bank assets held by foreign banks would find little integration of

the EU banking sector. With some exceptions1, national banks overwhelmingly

dominate the markets in EU economies.

In Asia, integration in banking services

Documents

Thai Commercial Banks One Decade After the Crisis