Tarisa Watanagase: Thai financial sector and the challenges ahead
Speech by Dr Tarisa Watanagase, Deputy Governor of the Bank of Thailand, at the conference on
Asian Finance & Capital Markets 2004, Bangkok, 8 July 2004.
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Good morning,
Let me first begin by thanking Euro Events for inviting me to address this distinguished audience. I am
delighted to be here to share with you some of my thoughts on the Thai financial sector and where it is
heading, especially since a lot is happening at this juncture, with the Financial Sector Master Plan
being implemented. I trust therefore that we will have much to learn from each other, given the diverse
background of participants in this conference, ranging from banking and government officials to
investment managers and business leaders.
Since you will engage in absorbing debates on practical issues on finance and capital markets, my
presentation will deal with the broader issue of prospects and challenges for the financial market in the
Thai perspective. While the discussion will be based on the experience of Thailand, some of the
challenges will be commonly faced by other emerging economies. Thus, it is my sincere hope that the
implication drawn from this presentation will also be applicable and useful for participants from other
countries.
I will first touch on the structure of the Thai financial sector and the assessment of where the banking
sector currently stands. This is then followed by a discussion on the authorities' major policies to
further strengthen financial institutions' positions in view of more intensified competition and changing
financial environment, including the implications of these policies. Finally, I will conclude this morning's
talk by highlighting some challenges and benefits of capital market development for the banking
sector.
The Thai financial system consists of four main institutional categories, in the order of their
importance: the banking sector, the capital market, specialized financial institutions and non-bank
financial intermediaries. The first two categories are the backbone of the Thai financial system, while
the third provides funding for specific developmental purposes in accordance with the government
policy, and the last supplements the others. Despite the stock exchange boom last year and the pick
up of the bond market in recent years, the banking sector remains the primacy of our financial system
in every sense. Not only does it provide the bulk of lending that amounted to about 5.5 trillion baht as
of end-2003, or equivalent to 93 percent of GDP, the banking sector also mobilizes savings from the
public and provides means of payment and settlements that sustain the well-functioning economy.
With the recapitalization effort and commendable operational improvement, the banking sector has
emerged much stronger after the 1997 crisis, with all performance indicators pointing to the direction
of resiliency. The banking sector's net profit has turned positive for the past three years; this figure
more than doubled in 2003 from the previous year. Operating profit also rose at a higher rate in 2003,
helped by both increasing interest- and non-interest incomes, and falling operating expense.
Meanwhile, the growth of loan* portfolio maintained its momentum well at the rate of 5.6 percent at the
end of 2003 compared with 4.9 percent a year earlier, in tandem with the robust economic recovery.
On the stability front, the banking sector's average provisioning was well above the required provision
by about 35 percent, and capital to risk-weighted asset ratio remained comfortably above regulatory
requirement in 2003, with a ratio of 13.7 percent for Thai banks and 20.5 percent for foreign banks.
Moreover, the non-performing loans continued a declining trend with the ratio of 12.8 percent to total
loans in 2003, compared to 15.7 percent in the previous year. The number is still high, admittedly; but
one only needs to recall that we started with an NPL ratio of nearly 50 percent right after the crisis to
realize that we have come a long way. The remaining NPLs do not pose a significant downside risk
because of the over-provisioning and the continued robust performance of the economy. However, we
will not be complacent. Regulations will be forthcoming to further expedite the resolution of the
remaining NPLs - an issue that will be revisited later.
At the same time, banks have made substantial progress on productivity, with improvements on
many fronts. Operating costs have been drastically cut by means of organizational restructuring and
work process re-engineering. Moreover, capitalizing on their extensive network of over
3,000 branches, banks have widened the arrays of services to include distribution of corporate bonds
or debentures, unit trusts, IPO shares and other debt instruments. Such efforts pay off with tangible
result. Within four years, banks' ratio of net interest- and non-interest income to average number of
employees rose from 0.8 to 2.6 million baht per person per year in 2003.
We also witness improvement in the area of customer access. Crowded customers at micro-branches
speak volumes for the success of banks' strategy to approach customers outside their office hours. In
response to more sophisticated demand, banks introduced new channels of services such as internet
banking and tele-banking to satisfy the technology savvy demands of emerging new generation of
customers.
These efficiency gains have been achieved without forsaking comprehensive risk management. On
the contrary, banks have begun to move away from collateral-based lending to risk-based approach.
At the same time, financial literate Board of Directors has bolstered its oversight function to ensure
that banks are managed in a sound manner. In the area of credit risk management, credit scoring has
been widely applied in the retail loan originating process, whereas internal credit rating models have
been used for significant corporate loan portfolios. Moreover, banks also have in place security
measures, contingency plans and auditing standards within their system of internal control to monitor
reputational risk, strategic risk and other risks.
The logical question to ask here is how do we ensure that these positive developments will maintain
their momentum and that the banking sector will remain strong and sound amidst a more liberalized
environment, fierce domestic and external competition, and the advent of more advanced technology
and financial innovation? We can wait passively for external forces to inflict changes on us, or we can
chart our own path of development in anticipation of any change. The Asian crisis brought it to the fore
that complacency when met with abrupt and radical reforms as a result of external forces could entail
enormous output loss and social cost. Thus, we must do what we can to ensure that the banking
system is up to meeting any challenge. This brings us to the second point I want to make - what the
authorities intend to do to enhance the financial system's competitiveness and its capability to
withstand forces of change in this age of globalization.
The authorities are quick to grasp the opportunity of healthy economic and banking conditions
conducive to embarking on a structural reform, with the announcement of the Financial Sector
Master Plan. Thorough discussion on the Master Plan will require a separate session of its own. So,
let me just pick some of its key features that will have the most significant impacts on the structure and
efficiency of the banking industry.
First and foremost, under the "One Presence" principle, existing financial institutions must choose one
form of deposit-taking financial institutions; be it a commercial bank, retail bank, foreign bank
subsidiary or foreign bank full branch. This principle will foster a new structure that is clear, competitive
and efficient. Specifically, the structure whereby many types of financial institutions offer essentially
the same services to the same pools of customers and whereby a financial group has more than one
type of deposit-taking institutions must go. Financial institutions will therefore have to address the
issue of redundancy resulting from this principle.
Moreover, the Master Plan has introduced additional competitive pressure to the banking industry.
Qualified foreign banks that opt to upgrade to subsidiaries will be able to open some branches, adding
healthy competitive pressure to the market.
On the part of regulators, we will streamline regulations to ensure a smooth transition process and to
provide adequate flexibility for banks to conduct their businesses. For instance, the authorities are
working to resolve tax impediments to mergers. Moreover, banks have been allowed to outsource their
administrative works and cut cost on redundant operations by back-office sharing.
While the structural reform is under way, we continue to forge ahead with our prudential supervision
to maintain banking system soundness. In this regard, there are a few key regulations in the pipeline,
some aiming at expediting the NPL resolution and others at strengthening the risk-based supervision.
The Bank of Thailand is rolling out a new measure in the second half of this year with a view to giving
banks a nudge to deal with NPLs head on. For NPLs that have long been pending without proper
restructuring or legal actions, financial institutions will be required to set aside provisions for the
collateral at an increasing rate, depending on the overdue period. Essentially, banks will be required to
make provision in full, regardless of the collateral value, for loans that have been non-performing for
over four years. Also, the Asset Management Corporation, set up exclusively to buy NPLs from the
finance companies that were closed down during the crisis, will be enabled to buy NPLs of banks. We
are now in the process of amending the Corporation's charter.
On risk-based supervision, the Bank of Thailand has issued a Market Risk Supervision Policy
framework at the end of last year - a timely move given a possible upward trend of interest rates. This
measure will ensure that financial institutions instill mechanism to manage market risk commensurate
with their risk-taking activities, especially in the trading book. Recognizing the need for financial
institutions to adjust, the Bank of Thailand will implement the measure in transitional phases. By June
2005, banks will be required, for the first time, to maintain capital fund against market risk. Prior to
that, they will have to comply with guidelines on internal control and trading book policy, as well as
submit call reports on the calculation of the volume of trading book transactions and the calculation of
the capital charge against market risk.
Ladies and Gentlemen,
Another factor which will have crucial implications for the banking sector is the Basel II
implementation. With the recent release of the Basel II framework, it is inevitable that we get ourselves
ready for this international standard of capital adequacy. We all would agree that the New Capital
Accord is for the betterment of banking system soundness for it signifies a move away from the
one-size-fits-all approach to credit risk assessment in accommodation of evolving more sophisticated
risk management of modern banking. Specifically, under the New Accord, it provides more
comprehensive and risk sensitive approach to calculate regulatory capital, augmented by supervisory
review process of Pillar II and market discipline enforcement of Pillar III.
Despite the novel complexity of capital calculation under Pillar I, if a bank adopts the standardized
approach, its calculated regulatory capital is only a proxy of the actual risks. I suspect that
standardized approach is the one that most banks in emerging markets will adopt before they can
meet the preconditions of IRB, or the internal-rating-based approach, especially in the areas of data
quality and risk management practices. Therefore, only through proper Pillar II supervisory review can
we understand the true risk profile of banks, so that capital requirement is set in line with the risks
assumed by banks. To carry out this task, the authorities need to have the right prudential rules in
place, as well as the supervisory capability and capacity. At the Bank of Thailand, we are
developing prudential standards and risk-focused on- and off-site examination practices and manuals
so that each supervisor can work on a common structured approach to risk analysis. Moreover, a lot of
resources have gone into supervisory training to equip our supervisors with the necessary tools and
build up their sound judgment for the implementation.
In parallel, the Bank of Thailand has proposed the New Financial Institutions Businesses Law to the
Parliament to give us the necessary legal basis to implement both effective banking supervision and
Basel II. To foster Pillar III market discipline enforcement, the authorities are working on an
appropriate safety net to replace the blanket guarantee that undermines the functioning of the Pillar III.
It's obvious that without lifting the blanket guarantee, market discipline will not work no matter how
much disclosure is required. At present, the Ministry of Finance is in the process of reviewing the draft
legislation on Deposit Insurance Agency before submitting it to the Parliament.
Ladies and Gentlemen,
Now let me turn to the issues that directly impact the banking industry: what might be the implications
for financial institutions as a result of the measures discussed earlier, and what are the challenges
ahead for the banking sector? I would like to point out a few:
First, in the new financial landscape following the implementation of the Master Plan, we anticipate a
structural change in the banking sector with more industry consolidation and emergence of financial
conglomerates, embraced by the "One Presence" principle. Such processes should lead to larger
size and falling number of financial institutions. Although not a sure ticket to success, size will allow
the working of economies of scale and scope - to eliminate redundancies in administrative and
operational functions, reduce costs from more diversified portfolio of clients and enhance income from
provision of wider range of services. For the first time ever in the Thai banking history, banks will have
the opportunity to do all these and grow through consolidation and/or forming a financial group. Up
until now cost cutting and income enhancement, for example, were possible only through
reorganization and re-engineering within the same organization. Of course, there were cases of
mergers in the history, but they were mainly out of necessity to solve the problem of some weak
banks, not as a calculated move for growth. Therefore, in my opinion, the first major challenge in the
next couple of years for banks is to reap the benefits from such an opportunity offered by the Master
Plan. In doing so, a bank's Board and senior management must give its full attention and be fully
committed to articulating a strategic plan, successfully integrating their operations, streamlining
various business processes, as well as finding their niche markets or areas of comparative advantage.
Second, banks must prepare themselves for the new Basel Accord. Most banks in Thailand will start
with the standardized approach in the calculation of their regulatory capital, because of the reasons I
talked about earlier. Adopting the standardized approach does not require much preparation, since it
is quite similar to the existing Accord, with only some differences in the risk weights of some assets.
However, if banks stay on the standardized approach for too long, they will not be as risk sensitive as
those which adopt the IRB approach, resulting in higher risk and higher need for capital, which means
that they will not be able to compete well as internationally active banks. Therefore, the ultimate goal
for those who wish to compete internationally would be to move to the IRB approach, after some
extensive preparations. These preparations, in particular those on improving data quality and risk
management, are in fact something that banks would like to do any way to be safe and sound, with or
without moving to the IRB approach. Hence, the second major challenge for banks is to put in place a
good data base and systems to identify, measure and manage all banking risks to optimize their use of
capital and price their products according to risks. In addition, when taking into account the risk
associated with business cycle, banks must be prepared to beef up financial strength during
favorable economic conditions so that they could weather vulnerability during the downturns. These
are daunting tasks and again require the full attention and commitment of the Board.
Banking is all about customer relation; this is particularly true for personal banking segment. The
needs for financial institutions to properly take care of customer complaints are occasionally
highlighted by a few high profile cases in the media. This type of issue will gain more importance,
given the growing retail banking sector. To remain competitive and maintain customers' trust, banks
must be fair and transparent about their provision of financial services, a challenge which is very
much in line with the Basel II's Pillar 3.
Ladies and Gentlemen,
I have not forgotten the capital market, another integral part of the financial market, which makes it
vibrant and offers diversification in terms of channels of financial intermediation. Deeper and broader
capital market can avert or at the very least lessen the liquidity crunch effect on corporations in the
event of a banking crisis. Efforts, therefore, have been made to develop the capital market to curtail
dependence on the banking sector. In the past years, the private sector has raised financing more and
more from the capital market. In particular, the bond market's outstanding corporate debt instruments
more than doubled in five years, surging from 180 billion baht or 4 percent of GDP at the end of 1998
to 556 billion baht or 9.4 percent of GDP at the end of 2003. When combining the market capitalization
of the equity market to the bond market, the capital market's outstanding financial instruments stood at
5.4 trillion baht or 91 percent of GDP at the end of 2003, nearly equal lending from the banking sector.
With its growing share in the financial market, the capital market offers both opportunities and
challenges to the banking sector. Through their extensive branch networks, banks can further
enhance fee-based income by increasing their roles as arranger, underwriter, facilitator and custodian.
In direct competition with the capital market for corporate clients, banks must sharpen their competitive
edge by being cost efficient without compromising quality of services, so that they can offer corporate
loans at competitive pricing at par with the capital market. This again underscores the critical
importance of risk management-banks with more advanced tools in risk management are likely to
have an edge over those without, since the former can better price risk and use their capital more
efficiently. Moreover, instead of competing for corporate loans at fine margin, banks can also explore
other niche sectors that may have been somewhat neglected such as SMEs.
In summary, I would like to conclude that so far, the Thai financial system has shown signs of
resilience with promising prospects for the future. But we will continue to press on with the structural
reforms to achieve sustainable growth and soundness of the banking industry. The Master Plan
provides us with a road map to a more balanced and efficient financial system. While the Bank of
Thailand will continue to strengthen risk-based supervision and foster observance of corporate
governance for financial system stability, financial institutions will need to continuously and vigorously
improve their risk management capacity for the upcoming formidable challenges in order to thrive in
the new financial landscape.