Life after death for Thai banks as Basel II comes into sight
In the late 1990s Thailand's banks faced melt-down. Thanks to growth, and firm action, they are earning their way back to health. New Basel capital regime to be implemented at end-2008
Hard to imagine, as the Thai banking sector prepares to adopt the new Basel risk-based capital rules at the end of 2008, that less than a decade ago the country was struggling to overcome a devastating financial crisis. In the dark days of the late 1990s, more than half of all the banks' loans had gone bad. The value of the collateral backing many loans, mostly property, was plummeting, as the real estate bubble burst. Capital ratios of banks were often negative.
Bank regulation in Thailand before the crisis erupted in the summer of 1997, is now generally recognised to have been utterly inadequate. Regulators allowed reckless bank lending to continue unchecked. Indeed, high levels of lending were even encouraged in some government quarters to fuel economic growth.
Environment transformed
Since then, the banking and regulatory environment has been transformed. In February, Fitch Ratings raised the credit rating of six of the country's seven largest banks (other agencies have similarly raised ratings). Their profitability is up, impaired loans have dropped sharply, and the level of loan loss provisions has been raised significantly, while reported capital ratios are comfortably above minimum requirements. The Bank of Thailand, the bank regulator, has taken a lot of measures to strengthen financial institutions, says one Bangkok-based bank analyst.
The health of the banks has not been fully restored. Bad loan levels remain high by international standards, and there are fears that many restructured loans could very easily become non-performing again, for a second, or even third time. But "almost all of the Thai banking system is solvent now," says Deborah Schuler, a bank credit analyst at Moody's credit rating agency, in Singapore, who closely follows the sector in Thailand. "And the solvent banks genuinely meet minimum capital standards." Although analysts have not always believed the banks' reported capital figures, the gap between the true underlying situation and the reported figures is converging. At the rate the banks are now earning money, this gap could disappear altogether within a year, Schuler says.
That is, perhaps, why the Bank of Thailand (BoT) feels able to set end-2008 as the date for the adoption of the new international capital regime - Basel II - by the country's commercial and retail banks. From that date, the banks will have to apply either the simplest or intermediate approaches to measuring their credit and operational risks. The most advanced approaches to credit and operational risk measurement will be available one year later.
However, only foreign-owned banks in Thailand that are part of major international groups are expected to adopt these advanced approaches initially, says Paiboon Titisrikundwan, the director heading the Basel II team within the BoT's Financial Institutions Strategy Department. Even the largest domestic banks are unlikely to be ready to implement the advanced approaches this decade, although Bangkok Bank and Kasikornbank, the two largest private domestic banks, are said to be looking seriously at these options.
The central bank is planning to issue a series of consultative papers this year dealing with various aspects of Basel II. January saw the first paper, on the standardised (simplest) credit risk measurement approach. This was followed in February by a paper dealing with the simpler op risk approaches. Another consultative paper, looking at the advanced internal ratings based approach for credit risk, is promised for June. Other papers will deal with pillars 2 and 3 of the new capital regime (while pillar 1 sets minimum capital levels, pillar 2 deals with regulatory oversight of banks, and pillar 3 with market discipline and information disclosure by the banks).
The BoT has been moving towards a more risk-based system of bank regulation for some years, says Paiboon. So, the level of expertise demanded of supervisors under pillar 2 should not be difficult to meet. The "crucial issue," he says is the central bank's current lack of authority to impose additional capital requirements on banks above the regulatory minimum. Under pillar 2 of the new international rules, a bank may be obliged to hold additional capital, depending on the supervisory assessment of the riskiness of its activities. A bill currently before parliament includes provisions that would give the BoT the necessary powers.
Still to be decided, it seems, is whether the minimum capital requirement will be 8.5% of risk weighted assets, the ratio that Thai banks are currently obliged to meet. This is slightly higher than the 8% minimum level set under both the existing, Basel I accord, and Basel II. Neither is it clear whether the adoption of the simpler Basel II approaches to credit and operational risk measurement will lead to a rise or fall in the overall level of capital in the Thai banking system. It is too early to estimate the overall impact, says Paiboon. There are still too many uncertainties. It will depend on the risk profile of the banks' loan portfolios four years from now, he says.
Credit rating agencies, which have become increasingly laudatory in their assessment of Thailand's progress since the crisis, do not doubt the banks' ability to adopt at least the less sophisticated Basel II risk measurement approaches on the government's timetable. "Of all the countries caught up in the Asian crisis, Thailand stands out as the foremost model of external adjustment," Fitch Ratings said in a commentary last year. It had generated current account surpluses sufficient to repay $57 billion of public and private external debt since the end of 1997. A reduction of external debt of this order was "unprecedented" among the countries that the agency rated, it said. Certainly strong economic growth since 2002 of 5% to 6.5% has been a key factor in the rehabilitation of the banks.
And, strong leadership has played a big part in this economic recovery, according to Fitch. Much of the credit is being given to the populist government of prime minister Thaksin Shinawatra, whose Thai Rak Thai Party came to power in early 2001, and was re-elected again in February 2005. Hard-nosed Pridiyathorn Devakula, the former banker and politician appointed governor of the Bank of Thailand by Thaksin in 2001, is also credited by bank analysts with "getting things done."
In fact, restructuring of the finance industry was underway even before the Thaksin government came to power. Some 56 finance companies were closed in 1998, and banks and finance companies were ordered to merge. In a few cases, cases banks have subsequently been nationalised. The authorities have also injected some capital into the banking system. In 2000, the Thai Asset Management Company was set up to buy the bad loans of the banks, at a discount to face value.
But unlike Malaysia and South Korea, which were also hit by the east Asian crisis, Thailand "did not throw money at the problem," notes one local analyst. Some banks managed to raise capital from the market in the form both of common equity (where that proved possible), or hybrid capital in the form of SLIPS (stapled limited interest preferred shares) and CAPS (capital augmented preferred securities).
Although this hybrid capital involved a dubious combination of preference shares and subordinated debt, the authorities allowed it to be classed as Tier 1 capital, which is supposed to comprise the banks' purest form of capital. For a while, these SLIPS and CAPS constituted a significant portion of some banks' Tier 1 capital. But in most cases, they were redeemed last year, following pressure to do so from the BoT.
Regulatory forbearance
Limited in the amount of financial support that it could provide to the banking sector, the BoT's chief tactic has been what is referred to as "regulatory forbearance." In other words, it has not enforced its own prudential reporting requirements, particularly in relation to the classification of dubious assets or the extent of loan loss provisioning to cover impaired assets. Banks, instead, have been left to earn their way back to health - a tactic that seems largely to have paid off.
Only as banks have made sufficient profits to rebuild their balance sheets has the BoT started to apply the screws and more firmly enforce the rules - a move that analysts describe as "the withdrawal of forbearance."
Last year the state-owned Krung Thai Bank was required to reclassify a significant portion of its allegedly performing loans as impaired. Although this rekindled concerns about the bank's asset quality, because many of the restructured loans that were classified as performing appeared to be turning bad again, bank analysts in Bangkok viewed the move as positive.
"The increasing regulatory pressure now being exerted by the BoT is a positive development," says one, particularly in the light of the rapid lending growth of state-owned banks in the last two or three years. "It is a firm, precautionary move," he adds.
Since the crisis, the BoT has certainly changed, says Moody's Schuler. It is tougher, and more engaged. Enforcement of the rules is much better, too, she says. And, importantly, the central bank's more robust supervision has the backing of the Ministry of Finance, which has sometimes, in the past, put more emphasis on strong bank lending to stimulate the economy, than on prudential rules. The BoT has for some time been moving away from transaction-based supervision and towards more risk-based and consolidated supervision. New Bills now in parliament should help the central bank to monitor and oversee the banking sector still more effectively.
Banks, meanwhile, have been instrumental in their own rehabilitation. "They have taken big strides in cleaning up their balance sheets and improving their risk management," says Nancy Koh a bank credit analyst at ratings agency Standard and Poor's, in Singapore. Some have introduced systems for credit scoring and analysing borrowers' cashflows, and are starting to price products according to risk, she says.
In some cases, banks have raised their loan loss provisions significantly above the supervisory minimum levels. Dividends have been skipped to rebuild capital and additional capital has been raised even though this dilutes the equity of existing owners.
Bad loans understated
Today, the level of reported non-performing loans (NPLs) is on average around 16% of total loans for Thailand's big seven banks - Bangkok Bank, Krung Thai Bank, Kasikornbank, Siam Commercial Bank, Bank of Ayudhya, Thai Military Bank and Bank of Asia. Analysts reckon this NPL number probably understates the real position, even though the BoT has gradually tightened reporting standards. The trouble is another 15% of bank loans have been restructured and declared performing again. Yet many of these restructured loans are described as "fragile," because the weakened debtor companies are often vulnerable to any adverse business developments.
Loan loss reserves are now reckoned to cover around 65% of the big seven banks' NPLs on average, but in the case of some individual banks, such as state-owned Krung Thai bank, the "coverage" ratio is much lower. The reported capital ratio (capital to risk-weighted assets) is approaching 12% on average, and the Tier 1 capital ratio is around 8% - but, again, the precise numbers vary sharply between individual banks.
Financial masterplan
If the last few years have brought many changes to the Thai finance industry, still more is in the pipeline. As well as seeking new Acts of Parliament to tidy up the rather inchoate laws regulating banks, the government announced a Financial Sector Master Plan (FSMP) early last year. This plan is intended to ensure fair treatment for the customers of financial firms and promote a more streamlined industry through consolidation.
Under the FSMP, the central bank will only issue two types of banking licence. One type of licence will be granted to universal banks, able to produce a wide range of services, and well-capitalised with tier 1 capital of over 5 billion baht ($130 million). The second type will be granted to retail banks with a minimum capital requirement of 250 million baht ($7 million). In addition, a financial conglomerate will only be able to have one deposit-taking subsidiary.
Consolidation foreseen
The plan will also streamline rules and regulations by improving the basic infrastructure of the financial sector, resolving tax impediments to mergers, strengthening financial institutions' risk management and corporate governance, and enhancing market mechanisms.
Various non-bank finance companies can request a banking licence if they meet the requirements. The government believes all this will bring about a restructuring of the finance industry, perhaps halving today's roughly 80 banks and other financial firms. But no precise targets have been set, unlike Malaysia's master plan, which aimed to reduce that country's finance sector to ten anchor banking groups. The Thaksin government has decided to leave it to the market to determine which banks will merge, and which will eventually predominate.
