II. Financial Sector Developments and Prospects1
1. The Thai economy boomed in the decade prior to 1997, concealing growing financial fragilities. With growth averaging almost 10 percent per year, resulting large current account deficits were financed by short-term capital inflows in the context of the fixed exchange rate regime and positive interest differential. An asset bubble ensued, with surging real estate investment and stock market prices. These factors combined to conceal growing financial fragilities as investment flowed into increasingly marginal enterprises, culminating in the exchange rate crisis in mid-1997.
2. The crisis exposed underlying fragilities in the financial sector.2 Years of lax lending and provisioning standards masked underlying weaknesses in many finance companies and some banks. The slumping economy compounded these weaknesses and led to a massive increase in non-performing loans (NPLs) throughout the financial system (Text Figure). As part of the policy response, unviable institutions were closed or taken over by the state, while a comprehensive deposit guarantee was put in place to preserve confidence. To prevent financial sector problems from recurring, an enhanced prudential framework was phased in, bringing loan classification and provisioning rules gradually in line with international best practice. Capital support schemes were also put in place to assist financial institutions’ efforts to raise equity. In addition, the government took steps to promote the restructuring of corporate debt, through a reform of bankruptcy and foreclosure procedures, and the encouragement of voluntary debt restructuring. These actions have facilitated Thailand’s emergence from the crisis with more than two-thirds of the core banking system still in private hands.
Thailand: NPLs and Real GDP, 1997-99
3. There has been significant consolidation amongst Thai banks and finance companies following the crisis. The finance company sector has been substantially reduced, with the share of financial system assets made up by finance companies declining from some 25 percent of all assets before the crisis to under 5 percent at end-2000. Meanwhile, there has been significant consolidation and ownership change in the banking system, with seven banks (accounting for 16 percent of banking system assets before the crisis) having been closed, intervened and/or merged. Moreover, the large amount of new capital raised by private banks has resulted in a significant dilution of existing ownership stakes and also an increase in the level of foreign ownership. Four small commercial banks are now foreign-owned, and the largest private banks have substantial (30-49 percent) minority foreign holdings (Text Table).
|Finance companies||Commercial banks|
|Total assets of $163 billion||State share negligible||State share 10 percent of total assets|
|Foreign-owned: 0 percent of total assets|
|Total assets of $133 billion||State share negligible||State share 28 percent of assets|
|Foreign-owned: 6 percent of assets 3/|
4. Nonetheless, the corporate sector remains highly leveraged, with the large volume of distressed assets continuing to pose risks to the financial system. Domestic corporate debt has fallen little since 1997, and debt-equity ratios remain high. Thus the corporate sector remains exposed to new shocks to the global economic outlook and the slowing recovery, and is a source of vulnerability for the financial system.
5. This chapter takes stock of the current performance of the Thai financial sector and discusses the future outlook. Section B provides an overview of the current status of the financial system, Section C discusses developments in the corporate sector, while Section D focuses on debt restructuring. Section E then discusses the outlook for the financial system, including an assessment of various sources and types of risk. This includes sensitivity analysis with respect to bank profitability and vulnerability to credit risk, as well as a discussion of portfolio risk. Some final conclusions are presented in Section F.
B. Banking Sector Developments and Status
NPLs and Distressed Assets
6. Distressed assets remain high despite the sharp fall in headline NPLs.
Reported NPLs at both private and state banks have dropped substantially from a record high ratio of over 50 percent of loans during the crisis (over 70 percent for state banks), to about 20 percent for the system as a whole (Text Figure).
However, distressed assets remain high, at over 40 percent of all loans. This is because the largest part of the reduction in headline NPLs reflects write-offs and transfers to AMCs (which are included in distressed assets but excluded from NPLs). The reduction in NPLs as a result of debt restructuring has been almost fully offset by new and re-entry NPLs (Text Figure).
Writing-off losses that have in effect already been taken by the bank is essentially an accounting transaction that has no substantive impact on a banks’ balance sheet or performance.3 Meanwhile, large transfers of NPLs to effectively off-balance sheet asset recovery vehicles are positive steps towards ultimate resolution of distressed assets. However, establishing a dedicated AMC does not by itself have an immediate and direct impact on a bank’s underlying performance and prospects.
Commercial Bank NPLs, 1998-2001
Contributions Cumulative Change in NPLs since 1999q3
7. NPL levels have crept upwards in recent months. The reduction in NPLs has come to a halt this year, in part reflecting a sharp slow down of debt restructuring in the run up to the establishment of the new TAMC. Banks and borrowers alike have been waiting to see the nature of the post-TAMC landscape for debt restructuring and asset pricing before proceeding further with their own private efforts. Meanwhile, first time NPLs continue to arise, albeit at a slowing pace (Text Figure). A sizeable proportion of previously restructured NPLs also continue to fail and revert to NPL status.4 This could reflect in part the weakening economy, but also some unwinding of deals concluded from late 1999 onwards whose initial easy repayment periods have expired. Given that system-wide debt restructuring took off only towards the end of 1999, there is a risk that reentry NPLs could pick up towards the end of 2001.
New NPL Entry, 1999-2001
8. Distressed assets remain particularly high in state banks. State banks’ distressed assets account for almost 50 percent of their loans and about half of system-wide distressed assets. This reflects the higher starting levels of NPLs in these banks, especially given that they include a large number of intervened and merged financial institutions. But the problem also reflects state banks’ slower progress in debt restructuring as compared with private banks (Text Figure). By April 2001, private banks had restructured about 45 percent of base period NPLs, compared with about 30 percent by state banks.5
Debt Restructuring by Private and State Commercial Banks, 1999-2001
Bank Capital and Provisions
9. Private bank regulatory capital is currently well in excess of statutory minimum requirements (Table II. 1). Headline CARs for private banks have remained in the 12-14 percent range throughout the post-crisis period (Text Figure). However, CARs adjusted to reflect the phasing-in of the new provisioning requirements under the revised prudential framework (introduced in June 1998) have been lower. Currently, underlying capital is higher than reported capital (reflecting provisions from restructured debt that have yet to be reversed into capital). This explains why the adjusted CAR had risen above the headline CAR by end-2000. Private banks have raised over $10 billion in new capital since the crisis, amounting to a cumulative total of about 16 percent of their average risk weighted assets. Of this about $2 billion is in the form of hybrid capital instruments (the so-called SLIPS and CAPS), while about another $2 billion is in the form of public capital support through the Tier-1 scheme.6 The hybrid capital instruments are part of Tier-1 capital and maybe used to reserve against losses. However, they cost on average 12 percent per year, rising to about 24 percent per year when the bank declares a dividend. Given this potential expense, banks are likely to issue new capital to refinance these hybrid instruments at the earliest possible opportunity.
Private Bank Capital Adequacy, 1998–2000
10. State banks’ capital adequacy has been boosted by public capital injections, as well as by the guaranteeing of NPLs transferred to asset resolution vehicles. CARs for KTB and Bank Thai are now almost 20 percent, reflecting public recapitalization, and the takeover of their NPLs by state-owned AMCs/covered asset pools. The remaining intervened banks continue to have a negative capital position, despite some public capital injections, reflecting the large level of losses remaining to be recognized in these banks. The authorities currently plan to split off the bad assets of these banks and then have the government pension fund directly recapitalize the remaining good bank.
11. The large capital raising effort by private banks is reflected in the substantial coverage against potential losses accumulated by Thai banks in the post-crisis period. Private Thai banks built loan loss reserves of almost 40 percent of peak-classified assets. Further, collateral accounts for another 43 percent of peak classified assets. But the concern remains (as discussed below) that while reserves are high, losses may continue to rise, necessitating further capital increases by banks.
12. Banks are also dependent on real estate collateral for a large portion of their loss coverage. Loan loss provisions in Thailand are computed net of collateral which comprises mostly real estate with the bulk held in the form of undeveloped “raw” land (Text Figure). There remains a large glut of supply in the real estate sector, and prices have fallen substantially in very thin trading.7 This raises concerns about the valuation of collateral pledged as security to banks. While appraised values of banks’ collateral have reportedly fallen, the concern remains as to whether they have adequately adjusted to current market conditions. BOT regulations have been strengthened in this regard, requiring annual independent appraisals. However, appraisal methods in Thailand are not in line with international standards.8 For example, reviews of practice have revealed that appraisers often use the cost approach (even for unfinished projects) as opposed to a direct sales comparison.
Structure of Commercial Bank Collateral
13. Commercial bank earnings have improved, with private banks breaking even by end-2000 for the first time in three years (Text Figure). The improvement in operating performance reflects a recovery of net interest income in the context of stable operating expenses. While interest margins have improved, they have been driven more by a reduction in funding costs to historically low levels. Meanwhile, there has been little progress towards a sustained reduction in operating expenses, though the impact of recent staff-shedding exercises by a number of banks may help profitability in the future.
Bank Profitability: Private Banks, 1997–2001
14. The state-owned and intervened banks continued to make losses at the end-2000, including on an operating basis, with overall operating losses of about 1½ percent of assets. This includes income accrued by the largest state bank KTB on the note from its subsidiary AMC whose payments are guaranteed by the FIDF. Excluding such accrued income, cash operating losses at the state banks were ½ percentage point higher at end-2000. Moreover, net losses after provisioning amounted to about 2 percent of assets, with the situation at the intervened banks particularly acute (as they made net losses of 3 percent of their assets at end-2000).
15. Overall, income generation in the banking system remains weak. Profitability could be easily eroded if margins were squeezed, including by further reversion of restructured NPLs and new entry, which could pick up given the weakening macro-economy.
C. Corporate Sector Performance
16. Continuing high corporate sector leverage, four years after the onset of the crisis, mirrors the high level of distressed assets in the financial system. Aggregate debt of the corporate sector, at some 150 percent of GDP, remains at pre-crisis levels, and both listed company and SME debt-equity levels are high (Box II.1). As such, all measures of indebtedness, while having fallen from peaks during the crisis, remain close to if not higher than pre-crisis levels, which in any event were arguably too high. Moreover, listed company debt-equity ratios in Thailand are among the highest in the Asia region, notwithstanding the reductions since peak levels during the crisis (Text Charts).
Corporate Debt, 1994–2000
Debt - Equity Rations, 1997-vs-2000
17. The data suggest that small and medium size enterprises (SMEs) are also heavily indebted. While recent information for this sector are not available, manufacturing sector survey data during the period through the first half of 1998, indicate that debt-equity levels were, and are likely still high. SMEs do not borrow extensively from abroad or in foreign currencies, but their indebtedness to domestic banks remains high.
Box II.1.Measuring Corporate Sector Debt
All measures of corporate capital structure point to continued high levels of debt and relatively low levels of equity in the Thai corporate sector. However, reflecting the difficulties in obtaining comprehensive, consistent and up to date corporate sector data in the Thai context, it is useful to consider information from a number of different sources.
Listed company debt levels remain high. Listed company data are most frequently used to illustrate the problems in the Thai corporate sector given the relative ease of obtaining consistent and up to date financial information for these companies. However, in contrast to other Asian countries with more concentrated industrial structures (such as Korea), listed companies provide a less complete view of the situation in the Thai corporate sector given that they reportedly account for a relatively lower share of total manufacturing output and employment. Therefore, it is important to look at other sources as well. That said, it remains useful to monitor listed company performance, especially given that the sample considered here accounts for about Vi of borrowing from the banking system and should thus be fairly representative of at least larger Thai corporations which continue to have high debt-equity ratios.
Aggregate data on corporate debt show that the overall level of debt has not fallen below pre-crisis levels. These aggregate figures were compiled from: (i) monetary survey data on credit to the corporate sector adjusted for lending by BIBF’s, transfers to AMC’s, and write-offs; (ii) balance of payments data on external borrowing by the corporate sector; and (iii) data on domestic bond issuances by Thai corporates. As such, these provide a comprehensive measure of corporate sector debt, and indicate that total corporate debt remains high at some 150 percent of GDP by end-2000. The overall debt level jumped in 1997 reflecting the effect of the baht depreciation on external debt. The composition of the debt has since changed with the U.S. dollar level of external debt falling (though remaining unchanged as a share of baht GDP given the more depreciated post-crisis level of the baht). The domestic component of corporate debt has remained broadly unchanged and it is this latter which contains the counterpart to the high level of distressed assets of the domestic banking system.
Estimated Private Non-household Debt, 1994–2000
Source: Bank of Thailand, stat Testimates.
Firm level survey data, including of SME’s, confirms that debt-equity levels were high, both before and after the crisis. The Ministry of Industry and the World Bank organized surveys of Thailand’s manufacturing sector during 1997–99 with a sample covering about 3 percent of manufacturing sector employment. Of the surveyed firms, 2/3 were small, with less than 150 employees. The survey illustrated the continued high corporate debt equity ratios, including for SME’s. These ratios had risen slightly in 1997, driven by the baht depreciation, but less so than for listed companies reflecting SMEs’ lower levels of foreign currency borrowing.
SME Debt Equity Ratios, 1996–98
Source: Office of Industrial Economies, World Bank
18. Debt equity ratios, while high in aggregate, vary widely across sectors. In particular, listed companies in the traded sector appear to have lower levels of debt as compared with those in the non-traded sector (Text Chart). Thus for example, corporates in the traditionally export oriented food processing and electronics sectors have very low debt-equity ratios. Companies with main activities in areas such as real estate development have substantially higher degrees of leverage. This may reflect the debt financing of the asset bubble that has yet to be completely unwound off corporate balance sheets.
Sectoral Debt-Equky Ration, 1994–2000
19. Corporate sector profitability has improved with the economic recovery, but remains fragile. Real earnings before interest, tax, and depreciation allowance (EBITDA) fell sharply during the crisis, but have since picked up as overall output has recovered from the depths of the crisis (Text Figure). Meanwhile, corporate interest expenses have fallen with the reduction in lending rates and favorable interest rates in the initial phase of debt restructuring agreements. Reflecting the continued low levels of interest expenses and the pickup in earnings, listed company coverage ratios (EBITDA/interest expense, a basic cash flow ratio) have recovered to pre-crisis levels (Text Figure). However, analysis by Merrill Lynch illustrates that a large fraction of listed companies are currently servicing their debts at rates below the prime rate. Thus any increase in interest rates would jeopardize corporate profitability. Addressing this risk adequately will require supportive macroeconomic policies, coupled with steps to deleverage Thai corporates.
Real Corporate Earnings and CDF, 1997–2000
Interest Coverage of Listed Companies, 1994–2000
D. Corporate Debt Restructuring
20. The CDRAC process to facilitate debt restructuring has largely been completed. The Corporate Debt Restructuring Advisory Committee was established under the aegis of the Bank of Thailand to facilitate debt restructuring, especially in large multi-creditor cases. At its peak, CDRAC was overseeing debt restructuring cases with a value approaching 50 percent of GDP. Of this, over half of the cases have been successfully restructured, though as noted earlier, the sustainability of these restructurings is yet to be borne out. Further, just under half of the cases, worth some 25 percent of GDP, remain to be resolved, and risk devolving on to the already burdened civil court system. Moreover, some of the successfully restructured debt was held by non-resident creditors and thus would have no impact on the measures of NPLs and distressed assets that pertain to the domestic banking system.
21. Debt restructuring by commercial banks appears to have largely involved rescheduling with little deleveraging of borrowers. Comprehensive data on the nature and quality of debt restructuring conducted by banks are not available. This in part reflects the inherent complexity and variety of methods used in debt restructuring deals. Nonetheless, information put together by the BOT on the nature of debt restructuring conducted in a sample of cases indicates that rescheduling, grace periods on debt service, and some interest rate reduction are the most commonly found components of debt restructuring deals (Text Table). The first two methods have in practice typically been crafted in such a fashion as to not imply much net present value (NPV) reduction in the value of the debtor’s obligations. While interest rate reductions could in principle imply some reduction in the effective debt burden, anecdotal evidence suggests that here also, many deals involve a reduced interest rate for the first 2-3 years of the revised agreement, with above prime rates for the remaining loan period such that there is no NPV loss to the bank. This is corroborated by the fact that banks have in general reported very low NPV losses on restructured debt (Text Figure). In particular, reported NPV losses on debt restructured by commercial banks during 1998q3–2000q3, averaged only 1.8 percent of the face value of debt restructured by private banks and 0.9 percent on restructuring by state-owned banks.
22. BOT guidelines require banks to fully reserve against losses from debt restructuring, but implementation may be uneven. Under troubled debt restructuring (TDR) guidelines, the loss on TDR should preferably be based on the NPV reduction in projected cash flows. In most cases banks do appear to use cash flow models to determine the actual NPV loss from TDR (which given the factors discussed in the previous paragraph, is typically low). However, in line with international practice (FAS 114), the regulations allow banks to also take into account the collateral value supporting the restructured loan (subject to BOT appraisal requirements). Given concerns with collateral valuation (discussed above), this could result in understated losses on TDR.
|Grace period on debt repayment||20||21|
|Interest rate reduction||22||20|
|Principal or accrued interest reduction||6||6|
Average Write-offs on Debt Restructured, 1998q3–2000q3
23. BOT guidelines also allow restructured loans meeting certain criteria to be immediately reclassified as pass. This is generous by international standards—typically at least 3–6 months of conformity with the revised debt service agreement is required before reclassification. Even though the specified criteria allowing immediate reclassification aim to ensure that the underlying restructuring is of good quality, this clause opens the possibility for banks to prematurely reverse provisions on these loans (some weaker banks have already reversed such provisions into income). In an environment where re-entry of previously restructured NPLs is rising, this could be of particular concern.
24. Slow progress in debt restructuring reflects the large scale of the problem and weaknesses in the legal framework. Importantly, creditors’ power to enforce their claims is undermined by the weak legal framework for bankruptcy and foreclosure (these issues are discussed further in Chapter IV). This creates disincentives for banks to make concessions to deleverage borrowers. For example, it is difficult for creditors to force recalcitrant borrowers to cede some control of their companies in the context of debt for equity swaps. Often, standoffs arise with neither side making the concessions necessary for equitable and sustainable debt restructuring to arise. Also, banks concerned about their capital position and faced with a difficult legal environment, attempt to minimize their upfront losses and the concomitant impact on capital. This can result in a protracted period of negotiation, and may not lead to sufficient deleveraging of the corporates, which in turn could further prolong the debt restructuring process.
E. Outlook and Key Risks for the Banking System
Near term outlook
Headline Bank ISPLs and System Distressed Assets, 1999–2001
1/ Headline NPLs plus loans transferred 10 AMCs/CAPs and write-offs of fully provided (or of collateral) portions of NPLS from bank balance about.
2/ Projected level of NPLs following introduction of TAMC, among an other net change in the level of NPLs.
25. Responding to the slow progress in deleveraging of the corporate sector, the authorities have decided to establish a national AMC.9 The Thai Asset Management Corporation (TAMC) is expected to take on about ½ of system-wide distressed assets, mostly from the state banks. As such, the headline NPL figure for the overall banking system should fall substantially (Text Figure), to around 10 percent of all loans once the TAMC has completed the process of acquiring NPLs, provided there is no new net entry of NPLs. However, the level of distressed assets that will still have to be addressed will remain large, at nearly 40 percent of loans. The TAMC is not expected to have a substantial upfront impact on the private banking sector, though the state banks are expected to have most of their distressed assets removed.
26. Bank profits are likely to remain weak in the near term, and are sensitive to risks of lower margins and the re-entry of previously restructured NPLs. Even with the introduction of the TAMC, the return on assets for private banks is likely not to exceed around 1 percent in the near term, assuming flat loan growth, no erosion of margins, and stable NPL levels. Some sensitivity analysis of bank profits over a 12-month horizon is presented in Table II.2 and highlights the fragility of bank earnings.10 The shocks considered are a reduction in lending spreads and a reversion in NPLs. Either of these shocks would reduce returns on assets by almost 1 percentage point. Indeed, if both shocks were to occur together, interest margins would be halved, banks would again make significant losses, and capital adequacy ratios would be reduced by 2-3 percent over the 12-month horizon considered. The impact on profitability is most acute for the small private Thai banks, though the effect on capital adequacy is more uniform (reflecting that larger banks have lower risk weighted assets relative to total assets than the smaller banks).
Fundamental Credit Risk
27. Banks remain exposed to the risk that losses on their loan portfolios could be higher than currently provisioned. While NPLs have been reduced, much debt restructuring is of uncertain quality, and other NPLs written off and transferred to AMCs remain exposed to the risk of lower collateral values. The sensitivity analysis of bank profitability discussed in the previous section provides a sense of the short-term prospects for bank capital and is also relevant from a cash-flow perspective. However, another perspective on risk can be gleaned by examining the sensitivity of bank net worth to shocks to the value of assets. These exercises can be somewhat arbitrary as ex ante loss rates on banks’ asset bases are not possible to estimate accurately. However, some sensitivity analysis in this regard can at least provide a sense of the banks’ exposure.
28. Sensitivity analysis with regards to credit losses is indicative of the likely range of additional recapitalization needs that private banks could face in the period ahead. The simple analysis illustrated in the following Text Figures is based on peak levels of classified assets for individual banks. A range of loss rates is then applied to these peak distressed asset levels, with resulting losses offset against available loan loss reserves (current reserves plus write-offs) and capital in excess of the minimum requirement. If the value of losses exceeds the level of total reserves, additional capital will need to be raised. These loss rates can be interpreted as the needed reduction in the NPV of the debt required to conduct sustainable debt restructuring, or alternatively as the discount that would ultimately be achieved on sale of foreclosed collateral.
Private Bank Additional Capital Need: Different Loss Rate Scenarios
Private Bank Additional Capital Heed: Different Loss Rate Scenarios
29. The scenarios suggest that it is not implausible for banks to face additional losses in the future. Loss rates between 40 to 70 percent of peak distressed asset levels generate additional capital needs of between 1-14 percent of risk-weighted assets. These peak losses would only be marginally tempered by the gain-loss sharing arrangements affecting assets transferred to TAMC.11 A “medium” case of 55 percent loss, would imply that private banks as a whole would need to raise additional capital of 6 percent of risk weighted assets.12 As expected, there is considerable variation across banks generated by differences in levels of peak impairment, as well as loss coverage. Small domestically owned Thai banks are exposed to the most significant risk. Meanwhile, the larger private banks are comparatively less exposed, but could still face the need for additional capital of between $1-3 billion. While these amounts are not so large compared to the capital raised by the banks already, the current depressed state of the capital markets would pose a challenge to any efforts to raise additional capital.
Portfolio and Foreign Exchange Risk
30. Since the crisis, banks have substituted out of loans and into government and money market securities, raising questions about portfolio risk. With a stable deposit base, the counterpart to the large decline in loan deposit ratios (from about 120 percent in early 1997 to the current level of 80 percent) has been the build-up in domestic commercial bank holdings of government securities and money market lending (Text Figures). In particular, this raises questions about banks’ exposure to an increase in bond yields from the current low levels, particularly given the recent upward shift in the yield curve.
Commercial Bank Investment In Government Securities, 1997–2001
Source. SET; bank statements
Net Commercial Bank Investment in Money Market, 1997–2001
Source: SET; bank statements
1/ Excludes KTB AMC Dole
31. However, commercial banks do not currently appear likely to realize substantial losses on their government bond portfolios. Commercial banks hold about 12 percent of their assets in the form of government bonds. However, banks are unlikely to realize large losses as only about 10 percent of private banks’ bond portfolios are held in their trading book (just over 1 percent of assets), and thus subject to an upfront charge. It would require substantial increases in interest rates to generate significant losses on this portfolio. Of the remaining bond portfolio, 30 percent are held-to-maturity with another 60 percent classified as available-for-sale, and thus not immediately exposed to interest rate risk. Banks would realize losses on the available-for-sale portfolio only in the event they were constrained to sell in the current market, but with weak loan demand and stable deposit bases, this is unlikely.
32. Commercial bank exposure to foreign exchange risk is closely regulated by the BOT, leaving little scope for losses. Banks have gradually developed a positive open foreign exchange position on their balance sheets, especially driven by the unwinding of lending activities through their BIBFs (which largely sourced foreign currency funding for onshore baht lending). However, the BOT requires banks to match any on-balance sheet open foreign currency position with offsetting off-balance sheet positions such that the total net open foreign exchange position does not exceed 15 percent of banks’ Tier 1 capital. As such, banks’ net open position is well within the regulatory limit (Text Figure). Within this limit, it would take substantial exchange rate movements to generate significant losses for banks.
Commercial Bank Net Open F/X Position, end-May, 2001
Note: Excludes two intervened banks.
33. Thai banks have made substantial strides towards reducing their vulnerability, but risks remain to their capital and profitability. The main source of uncertainty in the near-term outlook is the scope for re-entry of restructured NPLs of questionable quality, as well as a rise in new NPLs because of the weakening recovery. Banks’ margins also remain fragile and any rise in policy rates that puts upward pressure on the structure of banks’ interest rates would also jeopardize profitability. The introduction of the TAMC will have a positive, but only marginal impact on the private banks’ income; however, state banks’ performance and capitalization will be boosted more substantially.
34. Slow progress with corporate restructuring is the main source of risk to the Thai financial system. The continued high level of financial system distressed assets is the mirror image of the still very high level of corporate debt. A more pronounced weakening of domestic growth could lead to a vicious circle of deteriorating corporate performance and rising NPLs. Slow growth and increases in the fiscal cost of financial sector restructuring could also add to concerns about the sustainability of public debt. These risks underline the importance of structural reforms to accelerate corporate debt restructuring, particularly in the state bank sector where progress has been slower. In this regard, the TAMC could play an important role but weaknesses in the legal framework also need to be addressed.
35. Finally, although other sources of portfolio risk do not appear significant, private banks may need additional capital if collateral values fall or profitability drops. Banks’ exposure to foreign exchange risk is tightly regulated, and their exposure to losses on government bonds is limited. However, the sensitivity analysis presented above suggests that private banks may well need to raise further capital in the future if collateral valuations fall or underlying profitability deteriorates. This risk is heightened by the weakening recovery and any rise in NPLs. However, the need for additional capital is unlikely to be either large, relative to the amounts already raised by private banks, or immediate, as banks currently have excess provisioning and capital.
|A. Classified assets 2/|
|(billions of baht)||1,100||616||384||163||68||484|
|(Percent of total loans)||30||25||23||28||25||38|
|(percent of total assets)||20||16||14||21||18||28|
|B Non-performing loans|
|(billions of baht)||927||588||352||121||115||339|
|(percent of total loans)||25||24||21||21||42||27|
|C. Peak classified assets 2/|
|(billions of baht)||2,689||1,369||978||227||209||1,320|
|(percent of total loans)||56||45||48||33||61||75|
|D. Tier-1 capital|
|(bilions of baht)||266||202||129||49||27||64|
|E. Provisions needed per end-2000 rules|
|(billions of baht)||252||33||26||6||1||218|
|F. Existing Provisions|
|(billions of baht)||388||160||124||23||13||228|
|(percent of current classified assets)||35||26||32||14||20||47|
|Losses written-off (billions of baht)||431||391||291||65||35||40|
|Provisions and writeoffs (percent of peak classified assets)||30||40||42||39||23||20|
|Provisions and writeoffs (percent of current classified assets)||60||56||65||47||32||71|
|J. Collateral 3/|
|(billions of baht)||1,218||559||342||148||69||660|
|(percent of current classified assets)||111||91||89||90||100||136|
|(percent of peak classified assets)||45||41||35||65||33||60|
|K. CAR, percent||11.4||12.0||11.5||12.7||13.7||9.3|
|L. Number of employees||95,745||64,470||41,768||17,004||6,927||31,275|
|M. Number of branches||3,817||2,648||1,598||790||324||1,169|
|N. Total assets (in billions of baht)||5,841||3,930||2,818||786||380||1,911|
|in percent banking system’s assets||100||67||48||13||7||33|
|O. Total loans (in billions of baht)||4,071||2,603||1770||594||283||1,468|
|in percent banking system’s loans||100||64||43||15||7||36|
|Risk weighted assets (billions of baht)||3,516||2,719||1,862||629||240||797|
|Net interest to income (quarterly)||4,351||14,953||2,283||1,444||5,075|
|Net profit (quarterly)||1,814||6,811||−150||354||1,842|
|Net interest yield (annualized)||2.1%||2.4%||1.2%||2.5%||2.1%|
|Return on assets (annualized)||0.8%||1.0%||−0.1%||0.6%||0.7%|
|Scenario (i)||(1 percent lower lending spreads)|
|Net interest income (quarterly)||2,685||9,534||990||1,008||2,963|
|Net profit (quarterly)||147||1,392||−1,442||−81||−270|
|Net interest yield (annualized)||1.3%||1.5%||0.5%||1.7%||1.2%|
|Return on assets (annualized)||0.0%||0.2%||−0.8%||−0.1%||−0.1%|
|Scenario (ii)||(33 percent NPL reversion)|
|Net interest income (quarterly)||4,140||14,287||2,019||1,345||4,874|
|Net profit (quarterly)||−155||598||−2,613||−564||−38|
|Net interest yield (annualized)||2.0%||2.3%||1.1%||2.3%||2.0%|
|Return on assets (annualized)||−0.2%||0.1%||−1.4%||−0.9%||0.0%|
|Scenario (iii)||(lower lending spreads and NPL reversion)|
|Net interest income (quarterly)||2,474||8,868||726||910||2,761|
|Net profit (quarterly)||−1,822||−4,821||−3,906||−1,000||−2,150|
|Net interest yield (annulized)||1.2%||1.4%||0.4%||1.6%||1.2%|
|Return on assets (annualized)||−1.0%||−0.7%||−2.0%||−1.6%||−0.9%|
|Tier-1 Capital Adequacy Ratio|
|(changes from base case)|
Prepared by Vikram Haksar.
Further details of developments during the crisis and the ensuing reforms can be found in, Financial Sector Restructuring, Chapter III of the Selected Issues paper for the 1999 Article IV Consultation discussion (SM/99/304).
Under BOT regulations, banks are required to write-off from their balance sheets the provisioned portion of NPLs that have been classified as loss for 12 months. The write-off represents the very low likelihood that the bank will recover the loan, and is thus a fuller recognition of the loss that had been provisioned. The bank continues to maintain its full legal claim on the debtor, and will continue to calculate accrued interest and other penalties that may be included as part of any ultimate debt restructuring deal.
The monthly flows might appear small, and there should in any event be some entry and exit of NPLs in the financial system under a normal steady state situation. However, monthly new and reversion NPLs combined have been averaging about 0.8 percent of loans outstanding in recent months. This would imply that over the course of one year, NPLs could rise by a sizeable 10 percent of loans, all else being equal.
October 1999 is chosen as the base period as data giving a break-down of debt restructuring by private and state banks is available only from then onwards.
See Financial Sector Restructuring, Chapter III, SM/99/304 for a discussion of hybrid capital instruments as well as a description of the Tier-1 capital support scheme.
The pre-crisis asset bubble was particularly severe in the real estate sector with a substantial increase in construction activity reflecting rapid credit growth to the construction and property sectors, particularly from the finance companies. While overall asset prices have fallen substantially since the crisis, real estate valuations remain difficult to ascertain given the extremely low level of actual transactions currently taking place.
This issue is discussed further in Developing the Valuation Profession in Thailand (1999), a White Paper commissioned by the Securities Exchange Commission of Thailand and undertaken by the Royal Institution of Chartered Surveyors Thailand Group.
Chapter III provides a detailed description and assessment of the structure of the TAMC, including details on the impact of the TAMC on private banks.
Net interest income (and implied yields/spreads) in the base case is derived from financial statements as of 2000Q4. Net operating non-interest income in the base case is assumed to be the average in 2000. In Scenario (i) the spread on performing assets (excluding restructured loans which are assumed to yield 3 percent across the board) is lowered by 100 basis points. In Scenario (ii) 1/3 of restructured NPLs are assumed to revert in a 12-month period through end-2001. These NPLs are assumed to have 50 percent collateral cover, and to require 50 percent provisions net of collateral. Accordingly, provisioning charges arise. Scenario (iii) combines scenarios (i) and (ii). In all scenarios, baht figures for quarterly net interest income and net profit are provided. These baht figures are also scaled by the appropriate lending/asset measure to provide ratios in all cases. Finally, the implications of these scenarios for the Tier-1 capital ratio are derived for a 12-month period. The analysis here takes into account the TAMC’s impact on the banks.
For example, at an assumed loss rate of 60 percent, private bank unassisted capital need would amount to baht 240 billion, while the gain-loss sharing with TAMC would reduce this only by about baht 37 billion. Further details are presented in Chapter III.
The total capital raised by private banks since the crisis amounts to about 16 percent of their average risk weighted assets.