This Selected Issues report on Thailand discusses the rapid growth years of the country before and after the 1997 balance-of-payments crisis. The report discusses development of the crisis and the steps taken to normalize the situation; credit growth before and after the crisis; public debt dynamics in the aftermath of the crisis; export performance before and after the crisis; and an analysis of the role of fiscal policy that led to the 1997 crisis. The report also highlights weaknesses that were threatening the sustainability of Thailand's economic growth.

Abstract

This Selected Issues report on Thailand discusses the rapid growth years of the country before and after the 1997 balance-of-payments crisis. The report discusses development of the crisis and the steps taken to normalize the situation; credit growth before and after the crisis; public debt dynamics in the aftermath of the crisis; export performance before and after the crisis; and an analysis of the role of fiscal policy that led to the 1997 crisis. The report also highlights weaknesses that were threatening the sustainability of Thailand's economic growth.

III. Financial Sector Restructuring1

46. Thailand’s financial sector has experienced a deep crisis unprecedented in scope and magnitude. Several years of strong economic growth underwritten by rapid credit expansion and large capital inflows exposed underlying structural weaknesses in the conduct of banking and the regulatory framework. Growing confidence problems in the financial sector were brought to a head by the currency crisis in mid-1997, which exacerbated underlying solvency problems in finance companies and weaker banks. The adverse effects of the depreciation and subsequent economic contraction on corporate balance sheets led to a rapid build-up in non-performing loans and concomitant decapitalization throughout the whole financial system. This chapter discusses the development of the crisis in the financial sector and the steps taken to normalize the situation.

A. Prelude to the Crisis

Financial sector developments

47. The financial system grew rapidly in the 1990s, driven especially by expansion in the activities of finance companies and the offshore banking sector. The investment-led growth of the Thai economy was largely debt financed, which was reflected in the rapid growth of financial system assets. Simultaneously, easier licensing requirements for finance companies contributed to their expansion. Finance companies tended to focus more on consumer and real estate financing, while banks leaned more toward investment financing, particularly in the manufacturing sector. Meanwhile, Bangkok International Banking Facilities (BIBFs) were established in 1993 to promote Bangkok as a center of international finance, competing with Hong Kong and Singapore. The long-standing stability of the exchange rate, relatively high baht lending rates and substantial tax breaks led to a rapid growth in the activities of BIBFs. Contrary to initial hopes that these activities would focus on investments in South-East Asia, BIBFs rapidly became a major channel for foreign capital flows into the domestic Thai economy.

uA03fig01

Growth of Finacial System Assets, 1991-97

(y-o-y, percent)

Citation: IMF Staff Country Reports 2000, 021; 10.5089/9781451836813.002.A003

Source: Bank of Thailand.
uA03fig02

BIBF Activity, 1993-99

Citation: IMF Staff Country Reports 2000, 021; 10.5089/9781451836813.002.A003

Source: Bank of Thailand.

48. Banks appeared profitable and adequately capitalized throughout this period, while bank share prices quadrupled. Banks’ reported lending spreads averaged about 6.3 percent in the period 1993-97, as restrictions on new entry dampened competition, while rapid corporate income growth accommodated high bank lending spreads. These in turn supported bank profitability with returns on assets averaging 1.6 percent in this period. Simultaneously, the capital position of commercial banks appeared adequate, with reported capital adequacy ratios hovering around 9 percent through 1997. At the same time, bank share prices boomed in the pre-crisis period, quadrupling between 1992–96.

uA03fig03

Commercial Bank Profitability. 1990-98

(percent) 1/

Citation: IMF Staff Country Reports 2000, 021; 10.5089/9781451836813.002.A003

Source Credit Lyconais Securities Asia1/ Trade larger private commercial banks.
uA03fig04

Commercial Banks: Reported Capital Adequacy and Share Prices, 1990-98

Citation: IMF Staff Country Reports 2000, 021; 10.5089/9781451836813.002.A003

Source- Bank of Thailand

49. However belying this positive picture, indications of underlying weakness in the financial system continued to mount. Both banks and finance companies were heavily exposed to the property sector, but the exposure was most acute in the case of finance companies. This was particularly worrisome in light of the mounting evidence of overinvestment in the property sector, which accounted for a large share of the already rapid pace of overall investment. Available information on property values also suggests that these (while volatile) were also trending up before reaching a plateau in 1996. Additionally, substantial shares of finance company credit were being channeled into the stock market, leading to a rapid growth of risk.

uA03fig05

Credit Composition of Finance Companies and Banks, 1990-99

(percent of total credit)

Citation: IMF Staff Country Reports 2000, 021; 10.5089/9781451836813.002.A003

1/ Reel estate defined lo include credit to real estate and construction. In case of banks includes housing.Source: Bank of Thailand.
uA03fig06

Property Market Indicators, 1993-99

(December 1996=100)

Citation: IMF Staff Country Reports 2000, 021; 10.5089/9781451836813.002.A003

Sources: CEIC data base: Lones ant Lang

50. Meanwhile, the liquidity of finance companies was coming under increasing strain and accrued interest levels in weak commercial banks rose further. Spreads on finance company borrowing (relative to commercial bank deposits of the same maturity) began to climb from mid-1996 as the economy slowed and confidence in their prospects began to weaken. More severe liquidity problems emerged in early 1997 in response to which the authorities provided support to select finance companies. At the same time, while the reported level of overall nonperforming loans (NPLs) was relatively low (12 percent of total loans at end-1996) accrued interest levels in several banks were higher than average and growing, suggesting that true NPLs were actually higher and rising as well.

uA03fig07

Premium on Finance Company Notes over Commercial Bank Deposits, 1993-99

(percent)

Citation: IMF Staff Country Reports 2000, 021; 10.5089/9781451836813.002.A003

Source CEIC database
uA03fig08

Weak Commercial Banks: Accrued Interest, 1995-97

(percent of total assets)

Citation: IMF Staff Country Reports 2000, 021; 10.5089/9781451836813.002.A003

Source CEIC Database

Weaknesses in the banking and regulatory framework

51. Bank capital was substantially overstated, reflecting insufficient provisioning and reliance on collateral of uncertain value. Anecdotal evidence suggests that banking practices in Thailand focussed heavily on “name” based lending, relying on personal guarantees and collateral—frequently tracts of rural land and partially completed real estate projects—to secure loans. Extensive credit risk analysis was not often carried out, and collateral was mostly valued in-house (not by independent appraisers). Further, bank balance sheets were particularly opaque, given insufficient recognition of the extent of impairment of assets and resulting income. Indeed, while reported bank NPLs in May 1997 amounted to 11.6 percent of assets, this figure largely included loans that had been non-performing for one year and over, and thus did not capture the more recent deterioration in asset quality. Many private market analysts at the time conservatively estimated NPLs to be at least 15 percent of total loans for banks.

52. Problems in the regulatory framework arose particularly in the rules governing loan classification and interest accrual. Loan classification rules were too generous—secured loans had to be in a non-accrual state for 12 months before they were classified as nonperforming. The implied provisioning shortfall was exacerbated by the common overvaluation of collateral such that reported capital adequacy ratios were substantially misleading. In addition to the long period of time that banks could accrue interest on nonperforming loans—thereby effectively overstating the banks’ income—rules on reversal of accrued interest were also not sufficiently stringent.

B. Crisis and Initial Response

Finance companies

53. The finance companies were the first domino to fall in the Thai financial crisis. Excess exposure to sectors sensitive to the asset-price inflation of the 1990s, coupled with weak underlying capitalization had left them particularly vulnerable to the slow-down in economic activity and asset price decline that began in late 1996. Underlying solvency problems first manifested themselves at 10 finance companies early in 1997 (Box 1). During the spring of 1997 the broader finance company sector began to experience a large-scale withdrawal of deposits, prompting massive and secret support from the Financial Institutions Development Fund (FIDF),2 that peaked in August at about $10 billion, some 8 percent of 1997 GDP. The deposit withdrawal represented more a flight to quality, as households and businesses moved their savings out of finance companies and into the larger commercial banks.

uA03fig09

FIDF Support

(In millions of baht)

Citation: IMF Staff Country Reports 2000, 021; 10.5089/9781451836813.002.A003

Source: Bank of Thailand.
uA03fig10

Deposits, 1994-99

(millions of baht)

Citation: IMF Staff Country Reports 2000, 021; 10.5089/9781451836813.002.A003

Source: Bank of Thailand.

54. To contain the crisis, the authorities suspended insolvent finance companies and introduced a blanket deposit guarantee.3 In mid-1997, 58 out of 91 finance companies, accounting for about 14 percent of the total financial sector, were suspended and a due diligence process to assess their solvency was initiated. All of the suspended finance companies had received FIDF support far in excess of their capital, and their solvency was suspect. However, the due diligence process took substantially longer than planned, partly on account of political pressure, during which time the assets of the suspended companies deteriorated. Several announcements were made at various points in time to the effect that the government would guarantee the deposits of all operating financial institutions. However, a lack of coordination adversely affected public confidence in the credibility of the guarantee, compounded by concerns over the legal ability of the Bank of Thailand (BOT) to effectively honor the guarantee. These issues were laid to rest by the introduction in October of the first comprehensive financial sector reform package under the Fund-supported program. Under this, the state-owned Financial Restructuring Authority (FRA) was established to resolve the problems in finance companies. Simultaneously, a state-owned Asset Management Corporation (AMC) was also created to manage assets acquired by FIDF in the process of financial sector restructuring. In the second half of 1997, the due diligence of the suspended finance companies was conducted under the auspices of the FRA and 56 were ultimately determined to be insolvent and closed at the end of the year. From this point on, the FRA’s focus shifted to asset resolution including the liquidation of finance company assets through public auction in which the public AMC was to participate as the bidder of last resort. In 1998, twelve additional finance companies that were deemed insolvent were intervened and merged with a state-owned finance company into a new bank.4

Commercial banks

55. The confidence problems which had first affected finance companies, spread next to commercial banks, exacerbated by the exchange rate crisis in July. While rollover rates for external credit lines were reduced to banks in general, the weaker commercial banks began to experience deposit withdrawals thus squeezing their liquidity. As a result, the FIDF also started providing support to these banks as well, with FIDF credit outstanding to banks reaching $8 billion, about 6 percent of GDP, by the end of the year. At the same time, overall commercial bank asset quality began to deteriorate sharply in mid-1997, with reported NPLs rising from 11½ to 18½ percent of all loans between May and June. By the end of the year, NPLs exceeded 22½ percent of all loans (about $35 billion, some 27 percent of GDP).

Time-Line of Crisis in the Finance Companies

article image
uA03fig11

Share of Weak Banks in Total Commercial Bank Deposits, 1996-98

(percent)

Citation: IMF Staff Country Reports 2000, 021; 10.5089/9781451836813.002.A003

Source CEIC Database
uA03fig12

NPLs at Domestic Commercial Banks, 1995-99

(percent of all loans)

Citation: IMF Staff Country Reports 2000, 021; 10.5089/9781451836813.002.A003

Source: Bank of Thailand.

56. The authorities announced their strategy for dealing with commercial banks in October 1997. The key principles included:

  • Up-front recognition of existing losses, which were then to be written off against equity capital;

  • Preparation of recapitalization plans by individual banks to be completed by the first quarter of 1998;

  • In the event banks could not raise capital within the stipulated time frame, the BOT would have the right to demand a legally binding Memorandum of Understanding, extending the deadline for raising capital;

  • Banks were encouraged to seek foreign partners given the limited resources then available in Thailand. Shareholders in those banks ultimately unable to raise capital would lose their equity stakes, and the banks would then be recapitalized by FIDF as a prelude to subsequent merger or privatization.

57. While initially the BOT had been reluctant to intervene banks, three banks were finally taken over in January 1998 (Box 2). The BOT’s initial reluctance to intervene banks reflected uncertainties about the BOT’s legal authority to actually do so. In addition, there were concerns that intervention of commercial banks at that point might widen the crisis. The final decision to intervene was taken in light of analysis that showed the three banks were clearly insolvent. The recent amendments to the Commercial Banking Act provided the basis for the BOT to write down capital and change management in these troubled banks. Subsequently, the authorities hired a financial advisor for developing a strategy to deal with these banks, as well as with the Bangkok Bank of Commerce that had been recapitalized by the FIDF in 1996. Eventually, a number of other small banks were intervened such that by the summer of 1999, the authorities had taken over a total of six (of fifteen) commercial banks.

Time-Line of Crisis in the Commercial Banks

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C. Comprehensive Financial Sector Reform

58. After stemming the initial crisis, the authorities focussed on revamping the prudential and legal framework and introduced a scheme to support private bank recapitalization. In this context, the key principles underlying financial sector reform in Thailand have been:

  • No bailout of private share-holders or holders of subordinated debt;

  • Intervention of those institutions that were unable to raise sufficient capital and meet prudential norms;

  • A strong bias toward private-market based recapitalization and restructuring of the financial sector.

Initial changes to the regulatory framework

59. Revamping the prudential framework focussed on bringing capital adequacy, and loan classification and provisioning rules in line with international best practices. A decision was made that it would be better to implement the new rules at the outset, but allow banks some time to conform with the new and more stringent guidelines. New loan classification, loss provisioning and interest accrual rules were introduced in March 1998, after consultation with the banking industry, and took effect from July that year. Details of the new rules are presented in the following Table 1. The new rules require that all accounts, both on-balance sheet and off-balance sheet, be classified into five categories. The classification is to be done primarily using qualitative criteria such as the prospects of the business or borrower, cash flow, and payment capability. However, if such information is missing or insufficient for assessing a borrower’s repayment capacity, the time a loan has been overdue is used. Previously, secured loans had to be twelve months overdue to be classified as nonperforming (six months if unsecured). Simultaneously, interest continued to be accrued on secured loans for twelve months (six months if unsecured—though in January 1998, the interest accrual period was reduced to six months irrespective of collateral). More importantly, there was no requirement to reverse accumulated accrued interest once a loan moved to non-accrual status, as a result of which bank capital was grossly overstated. Under the new rules, banks must cease accruing interest after three months of missed payments. Further, from January 2000 onwards, banks will also have to immediately reverse interest accrued in the three months prior to loans being shifted to non-accrual status. Also, rules on collateral valuation were changed to require yearly appraisals by independent appraisers for collateral above a certain threshold so as to set appropriate safeguards. Under the new rules, up to 90 percent of the appraised value of collateral can be deducted from the loan principal prior to forming provisions (50 percent if the collateral has not been re-appraised within the year).5 To facilitate the process of debt restructuring, rules governing the classification and provisioning of restructured loans were also issued. Finally, capital adequacy ratios for finance companies were increased from 8 percent to 8.5 percent of risk assets, the same ratio which applies to commercial banks.

Table 1.

Loan Classification and Provisioning Requirements Introduced in July 1998

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The 1 percent general provision counts towards Tier-2 capital. The rules for computing general provisions were changed in late 1999. Previously general provisions had been formed on all outstanding performing loans. They are now to be formed on all performing loans, net of existing collateral.

60. In order to avoid a credit squeeze and substantial nationalization of the banking system, the authorities allowed banks to phase in these new rules. While the new norms took effect from July 1998, financial institutions were allowed to phase in the provisioning rules over a 2½-year period to be concluded by end-2000 (Table 1). Similarly, the new rules on accrual of interest were introduced in January 1999, to be completely phased in by January 2000. This was done to give banks time to raise capital reserves as these rules represented a substantial tightening compared to the previous regime. A crucial feature of the process was the very transparent fashion in which the forbearance was exercised with the announcement of an explicit timetable for raising additional provisions.

61. The authorities also effectively allowed foreigners to take control of existing Thai commercial banks. Previously, foreign ownership of Thai banks had been legally capped at 25 percent. The BOT relaxed this limit for a period of 10 years from 1998. During this time, foreigners may—subject to BOT approval—acquire more than a 50 percent stake in Thai commercial banks. After 10 years, the share of foreign ownership cannot be increased but can legally remain at the same level in excess of 49 percent, effectively grand-fathering foreign control of any banks acquired in this period.6 This change has proved particularly important in facilitating the sale of intervened banks, and will lead to increased competition in the Thai banking system over the medium term.

August 1998 financial sector restructuring package

62. In order to support bank recapitalization, given the rapid growth of NPLs, the authorities announced a new and more comprehensive financial sector restructuring package in August 1998. In the first half of 1998, as the economic slow-down intensified, NPLs continued to mount steeply going from 22½ percent of all bank loans at the end-1997 to more than 35 percent of all loans by the middle of 1998. While several banks, including the two largest, had been able to successfully raise private capital in early 1998, it was clear that bank’s would need to raise much more, while it remained uncertain as to whether they would be able to do so. As such, the new package announced included two state-funded schemes to facilitate the recapitalization of private banks (Box 3). The recapitalization schemes were tied into an overall strategy of advancing debt-restructuring to bring NPLs down and allow banks to restart lending. The schemes came with strong safeguards for the use of public funds, including, in the case of the Tier-1 scheme, full up-front recognition of losses by existing shareholders before the injection of state capital, and the right for the government to make changes to management and the board at the bank. To date, one commercial bank has accessed the Tier-1 scheme, and as such the schemes have fulfilled their minimum purpose of acting as a safety net to ensure the viability of the core banking system.

63. As part of the focus on debt restructuring, the August package also introduced rules governing the establishment of privately-owned Asset Management Companies (AMCs). Under these guidelines, private banks can set up AMCs which specialize in asset recovery and securitization, including as joint ventures with outside investors. This was expected to accelerate the clean up of bank balance sheets. The measures also included safeguards, including requiring consolidation of the bank’s and AMCs balance sheets when the exposure of the bank to the AMC is substantial. In October this year, the authorities issued additional tax measures applying to private AMCs that ensured that the transfer of NPLs to an AMC was tax-neutral from the banks’ point of view. Also, some regulations that limited the size of AMCs that banks could set up were modified to allow banks to transfer a critical mass of NPLs to AMCs.

Public Capital Support Facilities

Two public capital support schemes were introduced. The first was aimed at catalyzing new private Tier-1 capital to provide institutions with the resources necessary for adequate provisioning and new lending. The second provided resources to accelerate restructuring of NPLs and support new lending.

Tier-1 Capital Scheme: Here the government makes available Tier-1 capital in the form of tradable government bonds on a preferred basis, pari passu with private investors. Conditions and safeguards include that: (i) institutions advance and implement end-2000 loan classification and provisioning rules; (ii) existing share-holders bear associated losses; (iii) viable restructuring plans are approved by the BOT; and (iv) the government or new investor will have the right to change existing management. If needed, solely public resources could be used to bring the institutions CAR up to 2.5 percent. Thereafter, the government matches any new capital provided by new shareholders, at least up to the regulatory minimum.

Tier-2 Capital Scheme: Here the government subscribes to a bank’s subordinated debt, with payment in the form of non-tradable government bonds. The injection is based on the magnitude of: (i) the write-down resulting from corporate debt restructuring, net of previous provisioning; and (ii) the net increase in lending to the private sector. Resources made available by the government cannot exceed 2 percent of risk assets, of which 1 percent is the limit related to new lending. The government bonds issued in the Tier-2 scheme are nontradable as the transaction is reversible (subordinated debt that must ultimately be returned to the government). The benefit to the bank from the Tier-2 scheme is that its debenture pays a lower interest rate than the market rate, giving the bank additional income as well as counting towards the Tier-2 capital ratio.

64. The authorities also announced the intervention of two additional banks and five finance companies in August 1998. Subsequently, a number of intervened banks were merged with existing state banks, while 12 finance companies taken over by KTT were merged with another intervened bank to form a new state owned bank (see Box 2).

Changes to the legal framework

65. The authorities are in the process of preparing laws that will introduce a new regulatory framework for financial institutions. Three closely related laws are in an advanced stage of preparation and are expected to be presented to parliament in the first half of 2000. These include: (i) the Financial Institutions Law which will unify the existing Commercial Banking and Finance Company Laws; (ii) a Deposit Insurance Law that will eventually supersede the existing blanket guarantee of the financial system; and (iii) a new Central Bank Law which will aim to enhance the authority, independence and accountability of the BOT.

66. The new Financial Institutions Law aims to comprehensively modernize and strengthen the prudential framework for regulating and supervising deposit taking institutions. In particular, the law will (i) concentrate supervisory responsibilities with the BOT, including for specialized financial institutions (currently under MOF supervision) and limit the power of BOT to grant individual exceptions; (ii) codify prudential rules with respect to capital adequacy, large exposure and credit to insiders and related parties; (iv) provide the BOT with an adequate legal framework to regulate and undertake consolidated supervision of credit institutions and their subsidiaries; (iv) introduce clear exit policies, including with regard to (a) actions to be taken by BOT when a financial institution does not meet supervisory standards; (b) conditions that should trigger mandatory intervention by BOT; and (c) the legal regime applicable to the intervention of financial institutions (the provisions of the law in this area will be consistent with the provisions contained in the law establishing the deposit insurance agency which is currently also being drafted); (vi) review and rationalize penal provisions (penalties, fines, terms of imprisonment, etc.); (vii) introduce new provisions to permit the control of money laundering.

D. Progress on Financial Sector Restructuring

Financial sector consolidation

67. The restructuring of the financial sector has led to the consolidation of the system and a temporary increase in the role of the state (Table 2). There has been a shift from finance companies to banks, and the number of state-owned commercial banks has increased from one to four. Moreover, this has been reflected in a three-fold increase in financial system assets under state control, which rose from 10 percent in mid-1997, to over 23 percent by late 1999. This has also been mirrored in an increase in foreign equity participation in the Thai banking system, with the number of foreign owned commercial banks increasing sharply since mid-1997, from zero before the crisis (excluding foreign branches), to four today with the takeover of two small Thai banks by foreign banks in early 1998 and the sale of two of the intervened banks to foreign investors that was completed late this year.

Table 2.

Consolidation of the Financial Sector 1/

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Source: Bank of Thailand.

Dollar figures are at constant exchange rates of 37 baht per dollar. Other financial institutions (foreign bank branches and BIBFs) account for the residual 22-25 percent of total assets.

Figures on assets as of end-September, 1999.

This is projected to decline to 15 percent after the privatization of the two remaining intervened banks.

Further, the three largest private banks, with over 1/3 of total assets, have high foreign ownership (30-49 percent).

68. However, the increase in the role of the state is expected to be temporary with the core of the banking system expected to remain in private hands. Of the seven intervened banks, two have been privatized and another two are in the process of being privatized (with sales expected to be finalized by early 2000), one bank has been closed, and another two have been merged with existing state-owned institutions. In addition, two state banks (Krung Thai Bank and Bank Thai) have begun operational restructuring in preparation for their partial privatization over the medium term. The recapitalization and resolution of the bad assets of the state banks, and the loss protection for the banks which are to be privatized, will impose a large burden on public finances. The public injections of equity into state (and intervened) banks has thus far amounted to about $12 billion.

Bank recapitalization

69. The authorities’ objective of minimizing the state’s role in the financial system has been facilitated by the success of Thai banks in raise private equity capital (Table 3). Thai commercial banks have been able to raise substantial amounts of new equity capital from private markets. It is estimated that private banks will have raised about $7 billion in new Tier-1 capital from the market by end-1999 (about 50 percent of their June 1997 capital base). This includes common equity but also the more recent issuance’s of hybrid and other capital instruments (i.e., SLIPS and CAPS) that has amounted to some S3 billion (Box 4). One of the larger private banks raised over $1½ billion, half of which through the public Tier-1 support scheme. In any event, the success in raising private capital is encouraging given that it was achieved against the backdrop of falling stock prices, rising nonperforming loans, and large operating losses, and it is in stark contrast to the experience of other Asian crisis countries.

Table 3.

Progress in Bank Recapitalization

(Tier-1 capital raised since July 1997; in billions of US dollars 1/)

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Source: Bank of Thailand.

Calculated at a constant exchange rate of 37 baht per dollar.

70. The periodic signing of forward-looking memoranda of understanding (MOUs) with the Bank of Thailand has provided additional impetus to the recapitalization process of banks. After examining the capital needs of all financial institutions earlier in 1999, the Bank of Thailand signed MOUs with the seven banks and nine finance companies needing to raise capital during the first half of 1999. Of the seven banks, two are privately-owned and raised additional capital, including one in part through the Tier-1 scheme. The remaining five banks are state-owned and were recapitalized directly by FIDF in conjunction with their plans for operational restructuring (Krung Thai Bank and Bank Thai), or as part of the privatization process (Radanasin, Siam City, and Bangkok Metropolitan Bank).

71. The six other banks also made progress in raising capital in 1999. Among these banks (all privately owned and accounting for 54 percent of total banks deposits), three have raised some $2.8 billion in Tier-1 capital in 1999, which should allow at least two of them to advance the stricter end-2000 provisioning rules and still meet the minimum capital adequacy requirement. Another bank is majority foreign owned, and has adequate access to capital. The remaining two banks also raised capital earlier in 1999.

Hybrid Capital Instruments

Hybrid capital instruments consist of non-voting preferred stock and, inseparably stapled to it, a subordinated debt component. In Thailand these have been issued in the form of so-called SLIPS (Stapled Limited Preferred Securities) and CAPS (Capital Augmented Preferred Securities) comprising equity and debt in equal shares. For banks, the share component is attractive because it prevents dilution of ownership; for investors, the debt component provides a minimum return when losses preclude dividend payments. The share component of SLIPS/CAPS is recognized by the Basel Committee as core capital.

However, these instruments become very costly once profitability returns, because the bank pays out dividends and interest. The debt component of the instruments issued in Thailand pays an interest rate in most cases of over 20 percent. While currently banks pay no dividends—such that the effective funding cost of these instruments is about 10 percent—it is likely that well within the life of these instruments banks will be under pressure to declare dividends which will substantially push up their funding cost. As such, banks are likely to use these instruments only on a temporary basis, and replace them with common stock when profitability returns to normal levels.

72. Nevertheless, the recapitalization plans of the private banks remains subject to a number of risks. Market sentiment remains volatile following the decline in share prices in the second half of 1999. Additional risks arise from the possibility that a stagnation of the recovery may further raise the level of nonperforming loans, depress collateral values, and prolong corporate debt restructuring (and hence the exit from nonperforming loan status). Also, given the likely future costs associated with the hybrid instruments that have recently been issued by banks, their demand for more traditional equity instruments is likely to intensify again after a few years.

Asset resolution and debt restructuring

73. Asset resolution has focussed on the FRA process, debt restructuring through coordinated creditor activity (CDRAC), and the nascent decentralized AMCs. The process of liquidating the assets of the 56 closed finance companies is coming to an end, with the last FRA auction likely to be completed in early 2000, and the imminent distribution of the sale proceeds. Thus far, the FRA has auctioned 80 percent of the roughly $23 billion of assets seized from the closed finance companies, with an average recovery rate of 28 percent of the principal amount. About $5 billion (or 30 percent of the total assets on sale) have been acquired by the state-owned AMC. From the perspective of the financial system itself, the authorities have as far as possible favored a decentralized approach to asset resolution, and have encouraged the establishment of private bank owned AMCs. Supporting changes in tax regulations have accompanied this emphasis, and the BOT has introduced several regulations clarifying the process and treatment of debt restructuring, including how losses and write-offs should be accounted for, and how restructured loans should be classified for prudential purposes.

Table 4.

Progress in FRA Auctions (November 1999)

(Billions of baht)

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Source: FRA

74. In early 1999, the BOT relaxed the regulations on re-classification of restructured loans. Previously, BOT regulations had required receipt of payment for three consecutive payment periods (months) before reclassification of an NPL as performing. The amendment, in April 1999, allows a restructured loan that meets any one of five conditions to be immediately classified as a “pass” asset (thus requiring only 1 percent general provisions) regardless of whether the bank has actually received any new repayments on the loan.7 While early uncertainties regarding interpretation of some aspects of the regulation resulted in banks being slow to reclassify restructured NPLs, recent clarifications have given renewed impetus to this process of NPL reclassification.

E. Conclusion

75. The Thai authorities have made impressive progress toward resolving the problems in the financial sector. Banks have raised substantial amounts of new capital, the core banking system remains in private hands, and foreign entry should stimulate competition and improvements in technology and service. At the same time, the stubbornly high level of NPLs and slow progress in enforcing property rights highlight the risks that banks continue to face. While banks have created substantial provisions against loan losses, the full extent of likely losses remains hard to predict. The key challenges for the future include optimizing the conditions for debt restructuring so that private banks can return to focus on their core business, and ensuring the swift restructuring and early privatization of the remaining state-owned banks.

References

  • Bank of Thailand, 1996, Annual Economic Report.

  • Bank of Thailand, 1997, Annual Economic Report.

  • Bank of Thailand, 1998, Annual Economic Report.

  • International Monetary Fund, 1999, “Financial Sector Crisis and Restructuring—Lessons from Asia—Background Studies,” EBS/99/154.

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  • International Monetary Fund, 1999, “Thailand—Sixth Review Under the Stand-By Arrangement,” EBS/99/48.

  • International Monetary Fund, 1999, “Thailand—Seventh Review Under the Stand-By Arrangement,” EBS/99/86.

  • Moody’s Investor Service, 1999, “A Framework for Assessing Hybrid Securities.”

1

Prepared by Vikram Haksar, with input from Lorenzo Giorgianni (both APD).

2

The FIDF is a legally distinct agency established within the BOT to rehabilitate distressed financial institutions.

3

The guarantee covers deposits and credits (excluding subordinated credits) of Thai financial institutions (including banks, finance companies and foreign bank branches, but excluding BIBFs). It also covers interbank credits, but excludes creditors that did not act in good faith, credits held by directors and management of failed institutions, and credits provided by offshore head offices, in the case of foreign bank branches.

4

This was reflected in the switch in FIDF support from open finance companies to banks in early 1999 with the commencement of operations by Bank Thai.

5

The shortage of qualified appraisers combined with the illiquid and depressed property market, highlight the substantial risks and uncertainties associated with current collateral valuations. These risks have been heightened by the lengthening—in mid-1999—of the period before which collateral must be re-appraised, from six to twelve months.

6

In the event that foreign-owned banks require additional capital after the 10 year grace period is over, they must secure a substantial portion of this from Thai investors, which over time would lead to a dilution of foreign ownership.

7

The conditions include: (a) the restructuring is consistent with “normal restructuring practices” and at least two of the creditors agree to the terms of the restructuring; or (b) losses must equal 20% or more of the original book value of the loan and the financial institution has made full provisions for these losses. In addition, an analysis of the debtor’s business status and future cash flow, based upon realistic assumptions and supporting documents from creditors, must show that the debtor will be able to service the restructured debt; or (c) in the restructured loan contract, the loan interest rate is at least equal to the market interest rate and no grace period is granted for interest repayments; or (d) in cases where CDRAC or the BOT have approved the restructuring carried out by the financial institution; or (e) in cases where the financial institution has filed in court for collection and where the financial institution and debtor agree to undergo restructuring and obtain a court settlement or where the financial institution has filed a bankruptcy petition against the debtor and the court approves the restructuring or reorganization plan.

Thailand: Selected Issues
Author: International Monetary Fund