Tuesday, January 17, 2012

Thailand: from financial crisis to financial resilience

The development of Thailand’s financial sector has been a story of restructuring, adjustment and renewal, following the devastating effects of the Asian financial crisis in the late 1990s.

The crisis was very costly to the Thai financial system, with an estimated gross fiscal loss equivalent to about 33 per cent of 2006 GDP. At the peak of the crisis, the Thai banking sector had large net losses, a declining net interest margin, low capital levels and a non-performing loan ratio that peaked at 43 per cent of total loans in 1998.

But the manner in which the Thai banking problem was tackled, beginning in 1998, shows how authorities might successfully overcome a systemic banking crisis. The government embarked on a comprehensive restructuring of the financial sector, intervening in weak banks and focusing on recapitalisation, debt restructuring, reform of the regulatory and supervisory framework, strengthening corporate governance of banks, and introducing initiatives to deepen and broaden the capital market.

Thai authorities then proceeded aggressively with regulatory and supervisory reforms aimed at moving Thailand’s financial regulation and supervision towards a risk-based framework on par with international best practice. Key elements of the reforms centred on risk-based supervision under Basel II (an accord on banking regulations), consolidated supervision and the phased implementation of IAS 39 (a more rigorous method of measuring financial transactions). Financial institutions were also restructured to rationalise and consolidate the financial system under a ‘One Presence’ policy. These reform efforts were coordinated under the broad agenda of the Financial Sector Master Plan Phase I (2004–08) which aimed to improve the financial system’s efficiency, broaden access to finance, and improve consumer protection.

By mid-2007, when the global financial crisis erupted, many weaknesses in Thailand’s regulatory and supervisory framework had been reduced. Consolidation in the financial system brought the number of deposit-taking institutions down to 45 from 124 before the 1997/98 crisis, while the process of deleveraging in the private sector was more or less complete, with the debt-to-equity ratio declining from 1.2 in 1998 to 0.7. The domestic capital market also grew rapidly in response to the funding needs of Thailand’s government and firms, further strengthening the system’s resilience. Importantly, these improvements resulted in much stronger balance sheets for firms and banks.

The immediate impact of the global financial crisis on the Thai economy and the financial sector was limited, due to the funding structure of Thai banks and the low exposure of the Thai banking sector to subprime assets. This structure was based on domestic deposits that helped insulate Thai banks from the tight liquidity conditions abroad. The second-round effects from the decline in economic activity and deleveraging were slightly more pronounced, and a policy response was required at the macroeconomic- and finance-sector levels. The key challenge for Thailand has been to help small and medium enterprises adjust to the impact of the global slowdown while maintaining confidence and ensuring a normally functioning financial sector.

By 2010 the Thai economy was on a firm path to recovery, supported by fiscal stimulus, low interest rates and a fully functioning banking sector. Lessons from the global financial crisis point clearly to the importance of having a sound and resilient financial system to prevent the risk of crisis and help the economy adjust to shocks. Reflecting this, reforms to strengthen the financial sector continue under the broad agenda of the Financial Sector Master Plan Phase II. The plan focuses on improving the financial system’s efficiency through greater competition, reducing the financial system costs, expanding access to financial services, and strengthening banks’ risk-management capacities by developing better and more complex financial markets and infrastructure.

In parallel with domestic reform, the landscape for the global regulatory and supervisory framework is also changing rapidly in the wake of the global financial crisis. The most important item here is the introduction of the Basel III standards, to be implemented in 2013. The aim of Basel III is to make banks resilient to stress through stronger capital bases, better liquidity positions and more comprehensive risk management. Although the capital position of Thai banks is robust, the industry’s longer-term strength will benefit from a continued improvement in capital, liquidity, governance and risk management.

The key future regulatory issue for Thailand, therefore, is how to adapt to the new global regulatory process without harming economic recovery. This must happen while also ensuring the finance industry is contributing to the economy’s efforts to address post-crisis challenges, which are expected to be different and more complex.

Important in this context is the role the financial system must play to promote domestic demand as a key engine for growth, and the task of more successfully transforming the country’s high rate of savings into productive investment.

By Bandid Nijathaworn former Deputy Governor of the Bank of Thailand and is Chairman of the Thai Bond Market Association and President and CEO of the Thai Institute of Directors, Bangkok. This article appeared in the most recent edition of the East Asia Forum Quarterly, ‘Where is Thailand Headed?‘

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