Over the past ten years, Thailand’s financial system has progressed tremendously in terms of size and efficiency. The financial sector has grown by an average of 19.2 percent a year in real terms, compared with 8.9 percent a year for the whole economy. Competition among financial institutions has also risen markedly. Consequently, the financial system’s ability to mobilize domestic savings and to finance economic development has accelerated. Much of Thailand’s financial success can be attributed to the sustainable economic boom and the authorities’ program of financial liberalization and development. This paper describes and evaluates that program, with an emphasis on interest rate liberalization and money market development.

Over the past ten years, Thailand’s financial system has progressed tremendously in terms of size and efficiency. The financial sector has grown by an average of 19.2 percent a year in real terms, compared with 8.9 percent a year for the whole economy. Competition among financial institutions has also risen markedly. Consequently, the financial system’s ability to mobilize domestic savings and to finance economic development has accelerated. Much of Thailand’s financial success can be attributed to the sustainable economic boom and the authorities’ program of financial liberalization and development. This paper describes and evaluates that program, with an emphasis on interest rate liberalization and money market development.

Structure of Thailand’s Financial System

Thailand has a wide array of financial institutions, most of which are privately owned. Over the years, commercial banks and finance companies have dominated the Thai financial market in terms of the amount of their assets, their geographical coverage, and their role in mobilizing savings and financing the country’s economic development. The major difference between commercial banks and finance companies is in the method of mobilizing funds and the type of financing. While commercial banks obtain about 70 percent of their funds by taking deposits from the public, finance companies are prohibited by law from doing so, and they must rely on issuing promissory notes in the domestic market and overseas to obtain funds. Furthermore, branch regulations on the establishment of branches are more restrictive for finance companies than for commercial banks, thus forcing finance companies to concentrate their business only in Bangkok and the nearby provinces. As a result, the total size of finance companies amounts to only one fourth that of commercial banks. In competing with commercial banks for funds from the public, finance companies usually offer higher interest rates on their promissory notes than commercial banks offer on deposits. When commercial banks reduce deposit rates, it is common for large depositors to shift part of their deposits to invest in finance companies’ promissory notes. Because of lower international interest rates and insufficient domestic savings to finance growing investment demand, commercial banks and finance companies in Thailand have increasingly turned to borrowing from overseas. On the lending side, commercial banks specialize in manufacturing and trade financing, while finance companies opt for personal consumption and real estate financing (see Table 1). At the end of 1994, there were 15 Thai commercial banks (with 2,823 branches) and 14 foreign bank branches in Thailand, compared with 91 finance companies (with 59 branches).

Table 1.

Distribution of Credits Extended by Commercial Banks and Finance Companies, End-1994

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Source: Bank of Thailand.

The offshore banking business has been formalized in Thailand with the establishment of the Bangkok International Banking Facilities (BIBFs) in March 1993. The main business of the BIBFs is mobilizing foreign funds to finance domestic and foreign businesses in foreign currencies. So far, 48 BIBF licenses have been issued to 15 domestic banks, 12 foreign banks that already had branches in Thailand, and 21 new financial institutions from overseas. At the end of 1994, BIBF credits to domestic businesses amounted to B 457 billion, accounting for 13.4 percent of total domestic credits extended by the banking system. In early 1995, the authorities expanded the offshore banking business further by granting 37 licenses for Provincial International Banking Facilities (PIBFs) to operate in areas outside Bangkok. The PIBFs’ funding must be from overseas as in the case of the BIBFs. However, the PIBFs can extend credits both in baht and in foreign currencies, while the BIBFs can extend credits only in foreign currencies.

Besides commercial banks and finance companies, Thailand also has a variety of other financial institutions, namely, credit foncier companies, life insurance companies, and a number of specialized financial institutions established by the government for development purposes. (Of all types of financial institutions, only commercial banks, finance companies, and credit foncier companies are under direct supervision and examination by the Bank of Thailand.) Table 2 summarizes the special characteristics of these financial institutions.

In addition to the above financial institutions, savings and agricultural cooperatives have also played an important part in mobilizing household savings and extending credits to their members. Savings cooperatives are organized mostly on an occupational basis. (Teachers’ savings cooperatives are the most numerous of all) Agricultural cooperatives obtain most of their funds by collecting members’ monthly subscription to capital and by borrowing from commercial banks and the Bank for Agriculture and Agricultural Cooperatives (BAAC). Savings cooperatives, on the other hand, rely almost exclusively on members’ monthly subscription to capital. At the end of 1994, there were 2,474 agricultural cooperatives and 1,045 savings cooperatives in Thailand.

Table 3 summarizes the key statistics of financial institutions in Thailand.

During the past few years, private provident funds and mutual funds have also become increasingly important in mobilizing domestic savings. At the end of 1994, there were 768 private provident funds with a net asset value of B 31.8 billion, and 101 mutual funds with a net asset value of B 226.5 billion.

Table 2.

Characteristics of Financial Institutions Other Than Commercial Banks and Finance Companies

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Table 3.

Key Statistics of Financial Institutions, End-1994

(In millions of baht unless otherwise indicated)

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Source: Bank of Thailand.

Although commercial banks’ and finance companies’ credits are still the most prevalent sources of financing, more businesses have turned to direct financing through equities, bonds, and debentures (with or without convertibility features), both in the domestic market and overseas. In 1994, private businesses in Thailand issued debt instruments worth B 112.5 billion, compared with B 80.8 billion in 1993. The Stock Exchange of Thailand, established since 1974, is currently one of the fastest-growing markets in Asia. Stock Exchange of Thailand market capitalization reached B 3.3 trillion at the end of 1994—a tremendous success considering that the market capitalization in 1985 was only B 49.5 billion, which translates into an effective growth rate of 59 percent a year. Derivatives such as futures and options are still limited in Thailand, except for options on foreign exchange, which are growing very fast in both volume and complexity.

Money Market Development

Current Structure of Thai Money Market

The money market in Thailand involves interbank lending (unsecured call loans), overdrafts, state enterprise and government bond repurchases (where the Bank of Thailand acts as auctioneer in a Dutch auction), negotiable certificates of deposit, commercial bills, and short-term promissory notes. Commercial banks and finance companies are by far the most active participants in the money market. During the first five months of 1995, the average daily volume of interbank and bond repurchase transactions amounted to B 55.5 and B 2.8 billion, respectively. Currently, there are no treasury bills in Thailand, and the amount of government bonds outstanding has been declining steadily because the fiscal balance has been in surplus for the past seven years. Some government bonds have even been redeemed before maturity. Outright trading in government bonds is very thin as commercial banks and finance companies need to hold them as part of their legal reserves, officially called the “liquid asset requirement,” imposed by the Bank of Thailand. In November 1994, a number of financial institutions took the initiative in establishing the Bond Dealers’ Club, which aims to increase the liquidity of domestic bonds and debentures. Membership in the Bond Dealers’ Club increased from 62 initial members to 87 by the end of March 1995 (comprising 59 finance and securities companies, 10 securities companies, 1 finance company, 10 domestic commercial banks, and 7 foreign bank branches in Thailand). An on-screen quoting system has been set up to facilitate trading. So far, the volume of trading through the Bond Dealers’ Club has been small, averaging only B 128.4 million a day during the first four months of 1995.

Large commercial banks and finance companies also have access to international financial markets (mainly Singapore and Hong Kong), providing them with more flexibility in adjusting liquidity. For this reason, linkage between the domestic money market and the foreign exchange market has become closer, and development in one market may create an immediate impact on the other market. Currently, foreign exchange business is exclusively conducted by commercial banks. They, in turn, are subject to net foreign exchange position limit on a daily basis.1 However, the authorities are considering allowing qualified finance companies to engage in foreign exchange business in the near future. Figure 1 illustrates the current structure of Thailand’s financial markets, while Table 4 provides recent statistics on major financial instruments in Thailand.

Bank of Thailand’s Role in the Money Market

Currently, there is no primary dealer system in Thailand. Outright sale or purchase of securities is also limited because the secondary market is small and illiquid. Therefore, the Bank of Thailand (BOT) must rely mainly on the repurchase market to conduct day-to-day open market operations. The operation of the repurchase market has been the responsibility of the BOT since 1979. Participants (including commercial banks, all other financial institutions, and some state enterprises) could telephone the BOT’s banking department during the morning and afternoon trading rounds (9:00–10:30 a.m., and 2:00–3:30 p.m.) to place their buy or sell orders of eligible securities (at full face value) in the following fashion.2

Figure 1.
Figure 1.

Financial Markets in Thailand

Table 4.

Major Financial Instruments

(In billions of baht)

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If commercial bank A needs cash, it places an order to borrow B 20 million (against eligible securities) for one day, at the maximum interest rate of 7 percent a year (to be paid at maturity). Commercial bank B, which has excess cash, places an order to lend B 15 million (against eligible securities) for one day, at a minimum interest rate of 5 percent a year. Maturities allowed in the repurchase market are one day, one week, two weeks, one month, two months, three months, and six months—although over 90 percent of all orders are for within two weeks. Once all orders have been received in each round, the BOT selects a single repurchase rate that would match demand for and supply of cash for each maturity date. The example in Figure 2 demonstrates the BOT’s determination of the one-day repurchase rate in each trading round.

Aside from allowing financial institutions to adjust day-to-day liquidity, operation of the repurchase market also provides the BOT with reliable information on financial system liquidity in real time, which is essential to the BOT’s formulation of intervention strategy in each trading round. Thus, the BOT has been able to smooth out money market volatility to a certain extent. However, it does not allow the BOT to conduct dynamic monetary policy because its intervention policy is bound by the nature of buy and sell orders in each trading round, and the BOT can only respond to market orders without ability to initiate transactions on its own. Figure demonstrates movement of the repurchase rate and the interbank rate.

Figure 2.
Figure 2.

BOT’S Determination of the Repurchase Rate

Figure 3.
Figure 3.

Money Market Rates in Thailand

(July 1994-June 1995)

The magnitude and direction of the BOT’s intervention in the repurchase market varies from one period to another. In normal circumstances, the BOT tends to inject more liquidity than it absorbs for two reasons. First, the BOT’s ability to absorb excess liquidity is limited by the small amount of eligible securities in its portfolio relative to the total volume of money market transactions. Second, excess cash demand that persists for a period of time, if not accommodated in some way, may jeopardize small financial institutions’ solvency.

In addition to the repurchase market, the loan window embodies the traditional “lender-of-last-resort” function of the BOT. Originally, it was made available only to commercial banks but, since November 1994, it has been extended to finance companies, as the demarcation line between their activities and those of banks has blurred. Loans are extended against the pledge of government and eligible state enterprise securities at 90 percent of face value for a maximum term of seven days. Each institution is given a quota based on the size of its deposits or (in the case of finance companies) borrowing from the public in the form of promissory note issues. Borrowing from the loan window is subject to close scrutiny and questions from the BOT and is therefore resorted to only sparingly, when money is exceptionally tight.

Another operation of the BOT that has some influence on money market conditions is the buying and selling by the Exchange Equalization Fund (EEF) of U.S. dollars with commercial banks in Thailand. The EEF, which is a part of the BOT’s operation, announces the official U.S. dollar/baht exchange rates and stands ready between 8:30 a.m. and noon to buy and sell U.S. dollars in unlimited amount with banks. (The usual spread between buying and selling rates is B 0.04.) Regarding spot foreign exchange transactions between commercial banks and customers (in U.S. dollars and nine other currencies), maximum selling rates and minimum buying rates are also set daily by the EEF. The official rates are fixed daily with a basket of major currencies, resulting in the dollar/baht exchange rate being quite stable amid an increasingly volatile international foreign exchange market. Since transactions between the EEF and banks are for same-day value, banks have used this open-ended facility as a means to adjust their baht liquidity. At other times, the direction and magnitude of international capital movement will determine commercial banks’ need to buy or sell U.S. dollars with the EEF, which results in the EEF’s absorption or injection of baht liquidity. In these cases, the BOT may have to intervene in the money market in the opposite direction of the EEF’s operations to prevent sharp swings in baht liquidity in the money market. Because of increasing linkage between the money market and the foreign exchange market, it is important that both markets be monitored closely to determine day-to-day open market intervention.

Commercial banks are required to hold specified liquid assets, averaged over a fortnight period, of no less than 7 percent of their deposit base. Of this 7 percent, the liquid assets comprise at least 2 percent in non-interest-bearing deposits at the BOT, a maximum of 2.5 percent in vault cash, and—making up the remainder—bonds issued by the government, approved state enterprises, specialized financial institutions, or the BOT. Although this regulation is potentially a powerful monetary management tool, it has so far been used purely for prudential control purposes, and no change has been made to any of these ratios since 1979. However, the range of eligible securities was widened recently because of a declining supply of government bonds in the market. The maintenance period was also lengthened (from one week to two weeks) in order to give banks more room to adjust their reserves and thus help somewhat to limit fluctuations in the money market.

Appendix I describes the liquid asset requirements in Thailand in detail.

Official Plan to Reform Open Market Operations

The current open market operations conducted by the BOT have two weaknesses. First, they do not allow the BOT to conduct dynamic open market operations to achieve monetary policy objectives, as they can only respond to market demand. Second, the increasing magnitude and volatility of international capital movement require that the BOT increase the magnitude of open market operations to offset the EEF’s injection or absorption of baht liquidity (against U.S. dollars).3 Currently, the BOT is employing the following two strategies to improve the effectiveness of open market operations.

First, more instruments are being explored to increase the BOT’s ability to intervene in both the money market and the foreign exchange market. For example, since August 2, 1995, the BOT has begun to issue (on tender) its own short-term bonds every Friday. The list of eligible securities in the repurchase market will also be broadened to include state enterprise securities not guaranteed by the Ministry of Finance. Swap operations are also being considered as another means of injecting or absorbing baht liquidity against U.S. dollars.

Second, the BOT is considering setting up a primary dealer system as an additional channel for conducting money market operations. According to the plan (which is not yet finalized at this writing), the BOT would initially select a number of commercial banks, finance companies, and securities companies as unofficial trading counterparties. Securities to be traded between the BOT and primary dealers would be limited to government securities, BOT bonds, and state enterprise securities. At this stage, no obligations would be imposed on these financial institutions. However, their performance regarding market-making and trading activities would be evaluated in the subsequent process of selecting official primary dealers. Once officially designated, primary dealers would have to accept certain obligations, such as participating regularly in the weekly auction of BOT bonds, making markets for government securities and BOT bonds by standing ready to provide reasonable two-way quotations to the BOT and other parties (including financial institutions and private investors), and providing market information to the BOT upon request. In return, primary dealers would receive exclusive privileges from the BOT, such as automatic end-of-day repurchase facilities at preset interest rates (within quota), and short-selling of eligible securities (to facilitate their market-making function). All primary dealers would also have to maintain demand deposit accounts at the BOT. They would also become members of the BOT’s electronic payment system. It is the BOT’s policy that all types of primary dealers (bank or nonbank) would receive similar obligations and privileges. In the more distant future, the BOT may consider direct intervention in the foreign exchange market to gain information and to ensure that market exchange rates do not deviate too much from the EEF’s official rates.

Interest Rate Policy After World War II to the Late 1980s

Deposit Rates of Commercial Banks and Borrowing Rates of Finance Companies

The Ministry of Finance and the BOT had imposed ceilings on commercial bank deposit rates since 1945, as empowered by the first Commercial Banking Act, which took effect that year. The rationale was to prevent excessive interest rate competition to mobilize the already limited domestic savings. If excessive interest rate competition were allowed, smaller and less experienced banks would lose out to the larger and more powerful banks, which might ultimately result in the loss of public confidence in the young and fragile financial system as a whole. (There were only 13 commercial banks in Thailand in 1945, and other types of financial institutions had not yet been developed.) Moreover, high deposit rates would lead to higher lending rates, which the authorities believed would slow down the pace of economic development. A deposit rate ceiling was also used for coping with the high inflation resulting from the Second World War.

From 1945 to 1961, the ceiling on commercial bank deposit rates was fixed with the BOT’s discount rate and refinancing rates. In 1962, the BOT started to impose ceilings on commercial bank deposit rates separately from the discount and refinancing rates to gain more policy flexibility.

From 1945 to 1982, the deposit rate ceiling was changed only a few times and seemed to be lower than the market level, as suggested by the fact that the actual interest rates offered by commercial banks had always been the same as the ceilings, and that there had been widespread use of nonprice strategies by commercial banks to attract deposits—for example, advertising and customer relations.

Empowered by the Act on the Undertaking of Finance Business, Securities Business, and Credit Foncier Business of 1979, the Ministry of Finance and the BOT started to impose interest rate ceilings on finance companies’ promissory notes and bills of exchange in 1981. Reasons for the ceiling were similar to those for commercial bank deposit rates. Because of the branching limitations described earlier in this chapter, the ceilings on finance companies’ promissory notes and bills of exchange were always set 3–4 percent higher than that on commercial bank deposit rates.

Commercial Bank and Finance Company Lending Rates

From 1923 to 1961, interest rates on all types of lending, including lending by financial institutions, were subject to a 15 percent ceiling set by Section 654 of the Civil and Commercial Code. When the Commercial Banking Act of 1962 took effect, the Ministry of Finance and the BOT were empowered to set a ceiling on commercial bank lending rates separately. However, Section 654 of the Civil and Commercial Code still applied, and the ceiling set by the Ministry of Finance and the BOT could not exceed 15 percent a year. The 15 percent ceiling was not practical during the second oil shock in the late 1970s, when international interest rates were much higher. Deposit rates that were too low resulted in capital flight, while lending rates that were too low resulted in excessive demand for credits. Extremely tight liquidity prompted the authorities to pass the Financial Institution Lending Rates Act of 1980, which allowed the Ministry of Finance and the BOT to impose ceilings over 15 percent on lending rates by commercial banks and finance companies. When the Act took effect in 1980, ceilings on commercial bank deposit rates and lending rates were raised by 3 percent. The following year, the authorities started to impose ceilings on finance companies’ borrowing and lending rates that were 3–4 percent above those imposed on commercial banks. It was not that the authorities wanted to have more control on domestic interest rates, but rather that they wanted to prevent the unfair advantage that finance companies might otherwise have over commercial banks.

Since 1982, interest rate ceilings imposed on commercial banks and finance companies had been adjusted more often to coincide with market conditions, cost structures, and the income of financial institutions. The ceilings also became less binding, reflecting the authorities’ desire to move away from direct controls.

Interest Rate Liberalization as Part of Overall Financial Reform

Interest rate liberalization in Thailand is a part of the overall financial reform that has been implemented on a gradual basis since the early 1980s. The early stage of the reform had been rather selective, in response to specific problems in each period, starting with the enactment of the Financial Institutions Lending Rate Act of 1980, which provided more flexibility for the BOT to set interest rate ceilings above the 15 percent level previously fixed by the Civil and Commercial Code.

The financial liberalization program would have been pursued more aggressively in the first half of the 1980s, if it had not been for the serious macroeconomic problems as well as the financial system crisis facing Thailand and other developing countries during that period. On the external front, Thailand’s current account deficits exceeded 7 percent of GDP in 1981 and 1983, and the debt-service ratio had risen to a peak of 22.7 percent of export earnings in 1985 (see Table 5). Several financial institutions also faced severe liquidity shortages and fundamental insolvency. The Thai authorities’ main concern in the first half of the 1980s was to restore macroeconomic and financial stability.

In order to cope with the external imbalance, the following stabilization and structural adjustment measures were taken:

  • reduction of price distortions;

  • drastic restraint on government expenditure;

  • a series of tax increases;

  • self-imposed ceiling on foreign borrowings;

  • liberalization of imports;

  • shift of emphasis from import-substitution industries to export industries; and

  • devaluation of the baht by 15 percent (in November 1984), coupled with the introduction of a more flexible exchange rate arrangement whereby the value of the baht is fixed to a basket of currencies, instead of only to the U.S. dollar.

Table 5.

Key Economic Indicators

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These stabilization and structural adjustment measures proved to be effective in reversing external imbalance and stimulating growth. Current account deficits declined from an average of 5.3 percent of GDP during 1981–85 to only 1.6 percent of GDP during 1986–89. Real economic growth also increased from an average of 5.5 percent a year during 1981–85 to 10.1 percent a year during 1986–89.

A number of financial institutions faced a solvency problem in the early 1980s, brought about by a sharp economic downturn as well as fraud and mismanagement, such as granting credits to friends or business associates with substandard collateral. To prevent further damage, the BOT did provide “soft loans” and, in some cases, managerial assistance to financial institutions in distress. In return, those institutions were required to follow strictly the BOT’s guidelines on conducting business and reporting information.

However, as Thailand’s industrialization and economic growth strengthened in the latter half of the 1980s, it became clear that a comprehensive program of financial reform was needed so that the financial sector could satisfy growing demand for financing and other financial services. The financial reform program, which formally began in 1989, has the following main objectives: to raise efficiency in the financial system; to mobilize domestic savings more effectively; and to internationalize the domestic financial system.

Deregulation and Liberalization

Interest Rates

The first step of formal interest rate liberalization was the removal of the ceiling on interest rates on time deposits with a maturity of more than one year in June 1989. In addition to easing banks into a more flexible interest rate regime, the measure was also intended to encourage longer-term savings.

In March 1990, interest rate ceilings on all time deposits were abolished. This resulted in the flexible adjustment of time deposit rates and, on the whole, interest rates have become more responsive to market developments.

In January 1992, ceilings on savings deposits were lifted. It was not until June 1992 that ceilings on commercial bank lending rates, as well as ceilings on finance companies’ borrowing and lending rates, were abolished, thus completing interest rate liberalization in Thailand. Since June 1992, commercial banks and finance companies have been able to determine their own rate structure (see Table 6).

Foreign Exchange Control

The first phase of financial exchange control liberalization was carried out in response to Thailand’s acceptance of obligations under Article VIII of the IMF’s Articles of Agreement in May 1990. The primary objective of the first phase of exchange control liberalization was to free all current account transactions. The second phase of deregulation was carried out in April 1991, freeing most capital account transactions, especially on the outflow side. Individuals were allowed to open foreign exchange accounts of up to $500,000 at commercial banks, while the limit for corporations was $5 million.

Residents in Thailand could transfer up to $5 million abroad for direct foreign investment. (The limit was raised to $10 million in 1993.) Repatriation of investment funds, dividends, and loan repayments is no longer restricted. Only resident purchases of property and securities abroad still require approval.

Portfolio Management

Several restrictions on the holding of assets by commercial banks—for example, the government bond holding requirement, the rural credit requirement, and the liquid asset requirement—have been relaxed to allow greater flexibility and induce higher efficiency in the commercial banks’ operations.

Entry of New Foreign Banks

This area has been liberalized through the BIBF offshore banking facility and the plan to open new foreign bank branches as described earlier in this paper.

Expanding Financial Institutions’ Operations

Commercial banks have been permitted to undertake certain securities businesses such as dealing, arranging, and underwriting debt instruments, while finance companies have been permitted to issue negotiable certificates of deposit. These measures were aimed at enhancing competition among various types of institutions and increasing the overall efficiency in resource mobilization and allocation.

Table 6.

Liberalization of Commercial Banks’ Interest Rate Ceilings

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Note: Figures in parentheses are actual interest rates quoted by the four largest commercial banks in Thailand.

Ceiling removed January 1992.

Ceiling removed March 1990.

Ceiling removed June 1989.

Ceiling removed June 1992.

Strengthening Prudential Supervision

During the same period that financial liberalization and deregulation were carried out, prudential supervision was also upgraded to ensure the soundness of financial institutions. Following financial liberalization and deregulation, financial institutions had to be more competitive in all areas of business. They were compelled to engage in more risky businesses (which, on average, yield higher returns) to maintain profitability. The BOT upgraded its internal standard of bank supervision and examination to ensure that the solvency problem experienced in the early 1980s would not repeat itself. The guideline on capital adequacy and asset quality of the Basle Committee on Banking Supervision was applied to both commercial banks and finance companies.

Developing Financial Instruments and Markets

A wider variety of financial instruments than before was necessary to support long-term economic growth in Thailand. The Securities and Exchange Commission Act was enacted in 1992 to correct several weaknesses in the regulatory settings regarding the issuing of debt instruments and trading in the secondary market. The Securities and Exchange Commission was established to supervise all aspects of securities business, as well as public offerings of all types of securities. The Act specifies that the mobilization of funds from the public by issuing stocks or equity instruments is limited to public companies, but debt instruments can be issued by both public companies and limited companies. On the initiative of the BOT and the Ministry of Finance, the Thai Rating and Information System was established in 1993 as a limited company in order to support investment decisions.

Improving the Payment System

As the financial system becomes more developed, a more efficient payment system is needed to facilitate a growing volume of transactions. The BOT has developed electronic systems for fund transfers and check clearing, namely, the Bahtnet for large-value transfers and the Thaiclear for small-value transfers and check clearing. The Bahtnet has already started operation, while the Thaiclear is expected to operate soon.

In June 1995, the first Financial Master Plan, drafted by the Ministry of Finance, the BOT, and the Security and Exchange Commission of Thailand, was approved by the cabinet as a comprehensive blueprint for further development of the Thai financial system. All the agencies concerned will coordinate efforts to reform regulations, taxation, and other elements of the financial infrastructure in order to accomplish the task as quickly and efficiently as possible. Appendix II lists all the major financial reform measures taken since the second oil shock.

Table 7.

Financial Deepening

(In percent)

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Impact of Financial Liberalization

Overall, the various objectives of the financial liberalization program have been realized. The success of the program rests on three factors. First, the liberalization program was implemented in a stable economic and financial environment. Second, it was accompanied by a fundamental reordering of the regulatory structure to ensure public confidence (domestic and international) in the Thai financial system. Third, the liberalization was carried out gradually to allow domestic business and financial institutions to adjust smoothly to the new environment.

Since a number of financial liberalization measures were carried out simultaneously (and, in most cases, gradually), it is difficult to attribute the success of the program to any particular area. However, the impact of the financial liberalization program on the Thai financial sector and on monetary policy management in Thailand is clear.

Impact on the Financial Sector

Increased Depth and Breadth to Financial Sector

M2 has risen as a percentage of GDP from 62.2 in 1987 to 75.3 in 1992 and 80 in 1994, reflecting deepening of the financial system (see Table 7). This is comparable to the M2/GDP ratios in Australia, Singapore, and the Netherlands of 60.1, 84.4, and 101, respectively, in 1992. During the same period, the M3/GDP ratio in Thailand also increased, from 73.2 in 1987 to 105.5 in 1994.

Broadening of the financial system can be observed through the faster expansion of commercial banks’ branches, the establishment of new types of financial institutions (as described earlier), and the emergence of new financial instruments such as straight debt and hybrid instruments.

Domestic Interest Rates Following International Rates More Closely

Interest rate and exchange control liberalization have facilitated the internationalization of the Thai financial system. On the positive side, less restriction on capital flows and increasing investment opportunities in Thailand have attracted foreign funds, both short-term and long-term, to finance growing domestic investment demand. Foreign funds have also boosted liquidity in the financial market to a great extent. As a result, domestic interest rates have been following international interest rates more closely (although with some lag period). Foreign funds have also become alternative financing means for prime customers, thus forcing down the spread between commercial bank deposit rates and maximum lending rates from 7.25 percent in June 1992 to 6 percent in June 1994. However, the effective spread between commercial banks’ cost of funds and lending rates increased from 2.87 percent in the second half of 1989 to 3.74 percent in the second half of 1994, owing to the lower cost of funds tapped from foreign sources (see Table 8).

Table 8.

Effective Interest Rate Spread

(As percentage of total assets)

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The reduction of interest rates has tended to favor prime customers over nonprime customers because of the differences in their bargaining power. During 1990–mid–1993, lending rates for prime customers were reduced by 6 percent, compared with 4.5 percent for nonprime customers. In response to this development, the BOT required each commercial bank to announce the Minimum Retail Rate as a reference lending rate for small but good-quality borrowers since October 1993. This rate is calculated from the cost of deposits and operating costs, and is changed as these costs change. Because of the Minimum Retail Rate policy, lending rate determination was not left entirely to commercial banks. Figure 4 describes the Minimum Retail Rate formula in detail.

Impact on Conduct of Monetary Policy

The increasing volatility of private capital flows spurred by financial liberalization has made it more difficult for the BOT to control (or rather, influence) domestic liquidity and interest rate structure. Furthermore, as capital flows directly affect the expansion of bank deposits (see Figure 5), money supply has become a less reliable indicator of economic activities. In 1994, Thailand experienced net outflows of non-bank private capital in the first quarter and sluggish net inflows for the rest of the year. This contributed to a slowdown in the growth rate of M2 from 18.4 percent at end-1993 to 13.6 percent at end-1994. Given that pressure on inflation and the current account in Thailand had been increasing slowly since the beginning of 1994, reflecting the pickup in economic activity, M2 would not have been a good choice as a monetary target. The behavior of Ml in 1994 also fluctuated too much to be a meaningful policy indicator. To complicate matters even more, the disintermediation of the banking system weakened the relationship between the money supply and economic activity. Financial liberalization also meant the abandonment of direct control instruments. Thus, the BOT had to devise new channels of indirect monetary policy implementation, or risk losing control over monetary developments altogether.

Preferential Rates and Subsidies

In Thailand, direct subsidies have rarely been used. However, preferential interest rates charged on loans to priority sectors, as well as infrastructure development, have been accepted as part of the economic development program. Priority sectors as defined by the BOT are the agricultural sector, the export sector, the rural sector, and the small-industry sector.

Figure 4.
Figure 4.

Minimum Retail Rate1

1 Lending rate for prime retail borrowers.
Figure 5.
Figure 5.

Relationship Between Commercial Bank Deposits and Nonbank Private Capital Inflows

Priority Sectors

There are two main channels through which the BOT’s funds have been directed to priority sectors. The first is the refinancing facility, whereby commercial banks can refinance part of qualified commercial bills or promissory notes with the BOT at preferential rates. The second channel is long-term credits from the BOT to specialized financial institutions, such as the Bank for Agriculture and Agricultural Cooperatives, the Industrial Finance Corporation of Thailand, and the Export and Import Bank of Thailand. The refinancing facility has gradually been phased out of the BOT’s operations as the priority sectors have strengthened. The refinancing facilities that remain are the following.

The crop-financing scheme is in effect from November to June each year. The refinancing ratio is 50 percent with the BOT, at 4 percent; commercial banks are allowed to charge up to 10 percent on the total amount of the credit. A second scheme extends credits to businesses located in designated areas that have received investment privileges. The BOT refinances 40 percent of the credit at 3 percent, while commercial banks are allowed to charge up to 11.25 percent on the total amount of the credit. Finally, under the small industries scheme, the BOT refinances 50 percent of the credit at 3 percent and commercial banks are allowed to charge up to 10 percent on the total amount of the credit.

Infrastructure Development

Since infrastructure development projects require large investment funds, Thailand has financed a great many such projects through the government budget. The government budget deficit before 1987 had constrained the overall development of infrastructure in Thailand. In recent years, the official policy has changed to encourage the private sector’s participation in infrastructure development. However, the government still extends financial support to infrastructure development projects in some ways. For example, the government may provide guarantees for bonds issued by state enterprises involved in infrastructure development. Guaranteed state enterprise bonds are eligible securities for liquid asset maintenance, which allows interest rates on these securities to be lower than otherwise. And finally, the redemption of state enterprise bonds issued for purchasing lands for infrastructure development is paid for by the government from the budget.


Thailand, like many other developing countries, has had long experience with administered interest rate determination. Before the late 1980s, the BOT was empowered by law to set ceilings on commercial banks and finance company interest rate structures. The wave of financial market globalization and the booming economy in the late 1980s led the Thai authorities to gradually liberalize the domestic financial system, including the abolishment of interest rate ceilings, which was completed in June 1992. Interest rate liberalization, together with other liberalization measures, has helped to deepen and broaden the financial sector to accommodate growing demand for financial services, in terms of both volume and complexity. Overall, the various objectives of the financial liberalization program have been realized. Specifically, the program has enhanced the efficiency and internationalization of the domestic financial system. On the negative side, the Thai financial system has become more sensitive to external developments, which makes it more difficult for the BOT to exercise monetary control.


Appendix I Reserve Requirement as Monetary Policy Instrument in Thailand

Current Reserve Requirement

Commercial banks, finance companies, and credit foncier companies in Thailand are subject to a liquid asset ratio. Commercial banks must maintain no less than 7 percent of their total deposits as liquid assets, including at least 2 percent of that 7 percent in the form of nonremunerated deposits at the BOT; no more than 2.5 percent of total deposits as vault cash; and the remainder in the form of eligible securities. Eligible securities include Thai government securities, bonds issued by the BOT, debentures and bonds guaranteed by the Ministry of Finance, debentures and bonds issued by state organizations or state enterprises as approved by the BOT, or debentures and bonds issued by the Industrial Finance Corporation of Thailand. Maintenance of liquid assets is based on a daily averaged standard, with a fortnightly lag basis. Each period is set by specific dates: from the 8th to the 22nd of each month, and from the 23rd to the 7th of the following month. The daily averaged holding of liquid assets in one period must comply with the prescribed ratio, using the daily averaged amount of deposits in the previous period as the base.

Finance companies are required to maintain at least 7 percent of their total borrowing from the public (that is, promissory notes) issued as liquid assets, including at least 0.5 of that 7 percent in the form of nonremunerated deposits at the BOT. At least 5.5 percent of that 7 percent must be in the form of eligible securities, which comprise Thai government securities, debentures, bonds, and other debt instruments guaranteed by the Ministry of Finance, debentures and bonds issued by the Industrial Finance Corporation of Thailand or bonds issued by state enterprises established by special laws, negotiable certificates of deposits issued by commercial banks; and the remainder in the form of deposits or loans at banks located in Thailand. Maintenance of liquid assets is based on a daily averaged standard, with a weekly lag basis. Each period starts on Friday and ends on Thursday of the following week.

Credit foncier companies must maintain as liquid assets no less than 5 percent of total borrowing. The liquid assets required are as follows: nonrenumerated deposits at the BOT making up at least 0.5 percent of total borrowing; deposits at banks located in Thailand; lending on demand to banks located in Thailand; and no less than 3.5 percent of total borrowing from the public in the form of eligible securities, as defined above for finance companies. The maintenance of liquid assets is based on a daily averaged standard, with a weekly lag basis. Each period starts on Friday and ends on Thursday of the following week.

Objectives of the Liquid Asset Requirement

The liquid asset requirement in Thailand was imposed primarily for prudential purposes and not as a monetary tool for influencing money supply or credits. Over the past two decades, only a few modifications have been made for practical purposes, without changing the overall ratio. In 1979, vault cash was allowed to be counted toward legal reserves for commercial banks, without changing the total reserve ratio of 7 percent. The purpose was to reduce the BOT’s workload in counting and verifying banknotes deposited by commercial banks. In 1991 and 1992, securities other than government securities were added to the list of eligible assets, primarily to make up for the depleting stock of government securities resulting from the government budget surplus and to help promote the debt instrument market. In 1991, the liquid asset maintenance period for commercial banks was increased from one week to two weeks to achieve a smoother path of liquidity adjustment, in light of increasing money market volatility caused by international capital movements.

Reserve Requirement as Policy Tool to Discourage Capital Inflows

In theory, the central bank may impose a reserve requirement on foreign liabilities of financial institutions (deposits and/or borrowing) to discourage them from relying too much on foreign savings. However, a couple of issues must be thoroughly considered before such a measure is imposed.

First, in a developing country with a negative savings-investment gap, foreign financing is still essential to the country’s economic development (as long as it is really for financing investment and not for financing domestic consumption)4 If this is the case, reserve requirements should only be imposed on the short-term foreign liabilities of financial institutions, for prudential purposes.5

Second, in many cases, short-term nonbank private capital inflows are the source of financial system volatility and risk. In such cases, targeting the non-bank inflow may be more relevant than targeting the foreign liabilities of financial institutions through reserve requirements.

Appendix II

Chronology of Major Financial Reform Measures Since the Second Oil Shock

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Commercial banks are subject to an end-of-day net foreign exchange position limit (including forward transaction) of 20 percent of capital on net overbought or 15 percent on net oversold. The limit applied to finance companies is 25 percent on net overbought or 20 percent on net oversold.


Eligible securities for trading in the repurchase market are: all government securities; BOT bonds; and state enterprise securities guaranteed by the Ministry of Finance and with the BOT as registrar. Since the BOT is the sole registrar of these securities, it has up-to-date records of actual ownership, thus doing away with credit risk altogether.


As capital account transactions become larger, the volatility and elasticity of the supply and demand functions of baht (against U.S. dollars) with respect to the exchange rate will increase. As a consequence, only a slight deviation of the EEF’s official rates from the market rates will result in larger volume of the EEF’s net purchase or sale of U.S. dollars within a given day.


Whether or not this is the case can be answered by examining the composition of imports and determining whether it is made up of consumption goods or capital goods and raw materials.


Starting August 8, 1995, nonresident baht deposits at commercial banks in Thailand with terms of less than one year will be subject to a 7 percent reserve requirement in the form of nonrenumerated deposits at the BOT. The previous regulation required only 2 percent minimum deposits at the BOT, with the remaining 5 percent in the form of vault cash and eligible securities.