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an increase in other income (mainly earnings from securities business). 4 The increase in interest margins can largely be attributed to the liberalization of interest rates in 1992. A slowing of the economy along with a sharply increased off-shore borrowing by banks and new issues of bank capital filled the banks with liquidity. Meanwhile, the abolition of interest rate ceilings allowed banks to increase their lending rates and decouple them from the deposit rates. Nevertheless, as mentioned before, interest income may be overstated as a result of the lenient interest accrual norms. Moreover, despite the increase, net interest rate margins of banks during this period appear quite low compared to other countries. While net interest rate margins are a rough index of bank (in)efficiency, low margins do not necessarily imply that banks are operating efficiently. For example, low margins may reflect a higher loan to default ratio or may indicate that banks are mispricing credit risk by setting margins too low.<sup>46</sup> While (accounting) earnings and profits improved during the 1990s, banks never managed to reduce non-perforning loans (NPLs). As a ratio of total loans, NPLs remained around seven percent, despite the rapid loan growth during the same period indicating that portfolio problems continued to persist. From 1994 on, accrued interest receivables, often a leading indicator of problem loans, started to rise considerably to 25 percent in 1994 and 27 percent in 1995. This increase also suggests that the rapid credit growth did indeed strain assessment and monitoring skills at banks and made them vulnerable to an economic downturn.<sup>47</sup> Due to weak loan provisioning guidelines, banks also inadequately provisioned against specific and general loan losses.<sup>48</sup> Finance companies' profitability also improved during the early 1990s due to (i) an increase in net interest rate mrargins, (ii) a higher share of risk assets, and (iii) an increase in income from trading and brokerage activities. From 1993 to 1996, however, profitability of finance companies decreased quite markedly. Most of this decline was due to a fall in noninterest income from securities trading (which fell 77 percent during 1993-96) and brokerage fees (which decreased by 47 percent over the same period).<sup>4 9</sup>

- 45 ROE in the 90s are most probably overstated as financial institutions were subject to lenient interest accrual and loan loss provisioning guidelines. By the same token their capital is most likely overstated.

- 46 Compared to banks operating in more stable economies such as the UK and Germany (where banks recorded average net interest margins of 2.9 and 3.1 percent respectively over 1990-1997), Thai net interest rate margins (2.8 percent) appear out of line in terms of risk profile. Data Source: Worldscope.

- 47 However, the quality of the loan portfolio differed across banking institutions. Big banks still showed moderate levels of nonperforming loans and a smaller increase in accrued interest while smaller banks were more adversely affected by the slowdown in the economy and the collapse of the real estate sector.

- 48 The tax treatment of provisions also did not provide adequate incentives for commercial banks to provision. Thailand does not allow deductions from taxes that are greater than the lower of .25 percent of loans each year or 20 percent of interest income.

- 49 The stock market peaked in December 1993 and started to decline thereafter.