Aggressive lending by state-owned banks has helped the country's economy start to hum. Has the government solved its growth problem or just sown the seeds of a new banking crisis?
By Nick Cumming-Bruce
February 2003
Institutional Investor Magazine
"If you have nonperforming loans and want to solve your problems, come to us." So declares a soothing voice in a television ad campaign touting the services of Thailand's second-biggest commercial lender, Krung Thai Bank.
Aimed at debt-choked borrowers, the commercial features a knight in shining armor atop a white horse galloping to the rescue of a businessman overwhelmed by unpaid bills. It's a striking promotion, and one made even more so by the fact that Krung Thai is a state-owned institution that until two years ago was so mired in its bad loans that it could barely function.
The ad hasn't just resonated with cash-strapped businesses and individuals who have flocked to Krung Thai. It has grabbed the attention of rival lenders, too.
"We were aghast," says the head of a private bank competitor. "They are ruining the credit culture. The ad says it's basically okay not to pay up. It's a totally casual dismissal of moral hazard."
Since the Asian financial crisis started here in 1997, Thai banks have struggled to unburden themselves of bad debt. At the peak of local banking woes in 1999, 2.6 trillion baht (about $56 billion at the time), or an astronomical 46.8 percent of all Thai bank loans, were nonperforming. Even today, following massive write-downs and government bailouts, nonperforming loans amount to B840 billion (about $19.6 billion at recent exchange rates), representing more than 10 percent of all outstanding loans. Worse, debt already restructured by the banks is lapsing back into nonperforming status at an alarming rate of about B30 billion a month.
To exasperated competitors the underlying message of Krung Thai's commercial is clear, as the rival private banker bitterly puts it: "The crisis is over. Let's go back to doing what we did so badly before."
Krung Thai is hardly repentant. Just after it launched the campaign in October, it followed up by slicing its minimum lending rate to 6.5 percent, or 25 basis points below that offered by other major Thai commercial lenders and nearly a full percentage point beneath that of smaller banks. And the moves are paying off. In the first half of 2002, when net new lending by all Thai banks grew just 1 percent, Krung Thai, under its new president, Viroj Nualkhair, expanded its loan book a hefty 20 percent. (Viroj declined to be interviewed for this article.)
"We are in a strong position to grow our books," says Ithinant Punyanitya, executive vice president for finance. "We are expanding all segments of our business."
The aggressive lending is more than a case of an aspiring bank trying to win market share. The government, under populist billionaire Prime Minister Thaksin Shinawatra, aims to rev up the country's recession-battered economy by pushing its state-affiliated lenders to make money available. (In addition to Krung Thai, the primary vehicles for this campaign are three specialized state lenders -- the Government Housing Bank, the Government Savings Bank and the Bank for Agriculture and Agricultural Cooperatives. In all, Thailand has ten private banks, two state commercial banks and five of these specialized lenders.) Doing so, it figures, will push the risk-averse private banks -- still mindful of their painful late 1990s experience and worried about future economic growth -- to open the spigots to local companies. With freer bank credit and heftier public spending, the government, which plans to pare its controlling interest in Krung Thai through an equity offering later this year, hopes to craft a more resilient domestic economy with a thriving small and medium-size business sector and less dependence on exports (Institutional Investor, September 2001).
"The ministry has a firm policy to encourage state banks to lend, not force them to lend," says Thanin Cheunsochit, head of the Ministry of Finance's macroeconomic policy division, who terms the slow growth of private bank lending "a bottleneck in the economy now."
By some measures, the government plan is already succeeding. Heavy government spending in late 2001 and early 2002 jump-started consumer demand, particularly for housing, autos and other consumer durables, which in turn has helped to revive investment, up an estimated 11.5 percent in 2002. All told, Thailand's GDP growth, which languished at 1.8 percent in 2001, rose to 4.8 percent in 2002, exceeding expectations and giving the country the third-highest rate in Asia.
"The story of the recovery last year is a classic," says Bank of Thailand governor Pridiyathorn Devakula, who has sharp words for private sector banks that are griping about the state banks' aggressiveness. "It's about time you stop complaining and work. If people are more industrious and take your clients, it's your fault. Don't complain, okay?"
He may have a point. The government's moves are helping Thailand win admirers abroad. "Korea is our favorite, but Thailand is possibly our No. 2," says Stewart Aldcroft, managing director of Investec Asset Management Asia, the Hong Kong unit of Investec Group, with $24 billion under management globally. "We have bought the recovery story; we have been increasing our holdings in Thailand for about three or four months. It's been through five and a half years of recession, and it really does look as if it's coming out the other side."
But not everyone shares this optimism. Some skeptical market watchers worry that Thailand, ground zero for the Asian financial crisis, is buying growth at the expense of its still wobbly banking sector. Future economic growth will be a key determinant of whether the government -- which contends it is simply trying to coax overly reluctant bankers to make sensible, much-needed loans -- or its critics are proved right.
"There's no question that the economy is doing well right now," agrees Ammar Siamwalla, a prominent economist at the Thailand Development Research Institute who has occasionally clashed with government policymakers over their populist tendencies. But, Ammar asks, "is it sustainable?" A war in the Middle East and continued weakness in the U.S. economy are the two main threats, he says. Both uncertainties will negatively affect growth in 2003. "We have to see what will push the economy forward now," he concludes.
"It's a gamble," says a Western bank analyst who did not want to be identified. "If the global economy doesn't melt down, Iraq proves a temporary blip and the Thai economy continues to grow, the gamble could pay off. If it falters, this could really blow up in their face."
In the meantime, the government will continue to rely on Krung Thai and the specialized lenders to nudge the economy along. That doesn't inspire widespread confidence. Krung Thai, for instance, had a crushing 69 percent nonperforming loan ratio after the Asian crisis and has used a government bailout to clean up its balance sheet. With its finances vastly improved in the past year or two and access to lower-priced funding, Krung Thai and the other state lenders are in a position to crowd out the private banks, hurting their profitability and slowing both their own and the economy's revival.
"We can't have a strong and sustainable recovery if we don't have strong banks," a senior Thai banker warns. (Like many private sector bankers interviewed, he declined to speak for attribution out of concern about upsetting government officials.)
DISPUTES OVER THE PROPER ROLE OF BANK lending are nothing new in Thailand. Foolhardy lending policies based on personal relations and guarantees or government influence rather than systematic credit analysis left commercial banks highly vulnerable when the Asian crisis struck in 1997. Once the smoke began to clear, seven crippled Thai banks came under government control (one was closed; two were sold to foreign banks; two were merged; and one, BankThai, was partially privatized in October) and 58 other finance houses, mostly mortgage lenders and securities brokerages, disappeared. Thai banks, handicapped by weak bankruptcy and foreclosure laws and a stagnating economy, made little progress resolving their most intractable bad loans. They also sharply curtailed lending.
The resulting economic gridlock helped candidate Thaksin, founder of Shin Corp., which controls a group of successful local telecommunications companies, win a landslide victory for prime minister in 2001. He pledged to pump money into Thailand's moribund economy by providing B1 million for each of Thailand's 70,000 villages (which he's done through the Government Savings Bank), offer debt relief to farmers (accomplished by suspending interest charges on loans from the Bank for Agriculture and Agricultural Cooperatives) and supply health care for all at a cost of less than $1 for any treatment. To avoid busting its budget, the Thaksin government has made clear that it wants the state-owned banks and private financial institutions to lend more money.
The effort is still a work in progress. Total lending at the end of September 2002 was down 25 percent from year-end 1997. Despite the recent GDP growth, manufacturing industries today operate at just over half their capacity and have little appetite for new loans. But there has been improvement. In 2001 most banks reported a return to operating profit, and the slow but steady gains continued last year. Bank lending in the third quarter of 2002 showed the first year-on-year growth since the crisis.
The state-owned commercial banks (aside from Krung Thai and the now partially privatized BankThai, this group includes Siam City Bank) have had the speediest recovery, thanks to the transfer of most of their nonperforming loans to the Thai Asset Management Corp., a government entity set up in 2001 to buy the banks' troubled debt and then dispose of it. Krung Thai, for example, has off-loaded bad loans totaling B535 billion -- more than two thirds of its loan portfolio -- to the TAMC. The private Thai banks, despite making 60 percent of all loans, have transferred a relatively small volume of nonperforming loans -- less than B100 billion in all -- to the TAMC.
Why the disparity? The government agreed to take any loan its state banks (which make 29 percent of all Thai loans; the remainder come from foreign institutions) wanted to get rid of but limited private bank access to only those loans that had more than one bank creditor. Because of the number of participants, these multicreditor loans were deemed the most difficult to resolve and so the government believed it could speed the cleanup by rolling them into the TAMC. Some private banks also resisted selling loans at a deep discount to the TAMC, thinking they could recover more money by handling collection themselves.
Krung Thai's aggressive use of the TAMC has made it one of the best-capitalized banks. At the end of the third quarter, it claimed total assets of B1 trillion, with a very robust tier-1 capital ratio of 12.5 percent and a total capital ratio of 13.56 percent. These are extremely high levels that would subject a U.S. bank, for example, to criticism for being grossly overcapitalized (an 8 percent tier-1 figure would be considered strongly capitalized).
Because Thai banks are awash in liquidity, they have been able to fund themselves at extremely low rates. And, at least until Krung Thai's recent campaign, lending rates have remained fairly stable. As a result, banks like Krung Thai with revitalized balance sheets operate on gross spreads of 5 percent or more. "Historically, we have the highest interest rate spread; the key is utilizing it, " says finance chief Ithinant. "You have to grow your loan book when you have this spread."
Sums up Fitch Ratings (Thailand) managing director Vincent Milton, "They are not competing from a level playing field" with the more constrained private banks.
Pushing Krung Thai's expansion is Viroj, recruited by Thaksin in late 2001 to oversee the bank. The securities industry veteran set up Phatra Thanakit Securities in the 1970s and, as chief executive, presided over its growth into one of the biggest and most respected Thai financial firms. He also is a member of the country's Securities and Exchange Commission, overseeing and regulating the industry. In 1997 Phatra was devastated by the Asian crisis and taken over by Merrill Lynch & Co. Viroj became chairman of Merrill Lynch Phatra Securities Co. As a onetime director and executive board chairman of the state-owned Government Savings Bank and former director of the Petroleum Authority of Thailand, Krung Thai's head is an experienced hand at running public sector entities.
Viroj has close ties to the Thaksin government. Before his Krung Thai appointment he served as an adviser to Finance Minister Somkid Jatusripitak. Viroj also gave evidence on behalf of Thaksin when, early in his administration, the prime minister faced charges in Thailand's Constitutional Court that he had deliberately concealed the extent of his wealth in official statements he was required to submit as a minister in a previous cabinet. Thaksin was acquitted.
Since the arrival of Viroj -- described by one Western finance executive as a "superlative manager" -- Krung Thai has not only cleaned up its balance sheet, it has also begun to shed its reputation as a hugely inefficient state bureaucracy. He has hired bankers from the private sector, assembled a new risk management division from departments previously scattered throughout the bank's operations and invested in a costly new core computer system. The early results are promising: The bank's cost-to-income ratio, greatly aided by selling off its bad loans to the TAMC, fell to a respectable 59.8 percent in the third quarter of 2002, down from 77.9 percent a year earlier. And after running a loss of B4.4 billion in 2001, Krung Thai recorded operating profits in each of the first three quarters of 2002, for a total of B7.5 billion.
As impressive as these numbers are, Krung Thai's history as a government-controlled entity raises questions about its intentions. Originally created from the state-mandated merger of two banks in 1966, Krung Thai absorbed insolvent government-run Sayam Bank in the early 1980s. In the midst of the Asian crisis, it took over First Bangkok City Bank, which was forced into government ownership, as well as the performing assets of scandal-tinged Bangkok Bank of Commerce, which had collapsed in 1996. With Thailand's biggest branch network -- 611 outlets spread around the country -- Krung Thai also provides excellent access for the government to areas outside Bangkok, where lending by private commercial banks is heavily concentrated.
The bank does not give a detailed breakdown but acknowledges that more than half of its loans are to government institutions and big projects like those undertaken by state utilities. Not surprisingly, critics charge that Krung Thai's lending supports government aims and its terms are so generous that other banks couldn't compete even if they wanted to. In their view, the bank may build another portfolio of poor-quality loans that will eventually need to be assumed by the government.
Certainly, Krung Thai's recent lending has done nothing to dispel concerns about its government ties. Last year, for instance, debt-riddled Bangchak Petroleum asked the government for a B6 billion bailout. The Ministry of Finance, which already owns nearly half of Bangchak's equity, declined and instructed the company to seek bank loans instead. In October the government announced it had approved a proposal by Bangchak to seek up to B3 billion from Krung Thai. Last month the bank provided B1.5 billion to Bangchak to refinance a World Bank loan about to come due.
Also in January Vivat Viniccayakul, director of the Office of SME Promotion, a state agency charged with furthering the interests of small and medium-size enterprises, said Finance Minister Somkid had directed that B120 billion in new credit should be made available to SMEs by July. He added that Krung Thai would kick in B28 billion of that. Such statements reinforce the perception that Krung Thai operates as a financial arm of the government, rather than as a strictly commercial bank.
Bank of Thailand governor Pridiyathorn says he personally looked into the Bangchak Petroleum loan. Krung Thai, he explains, provided the credit only after it had received appropriate collateral. The loan to the refinery, he says, "was more or less fully secured." He was satisfied.
Whatever the credit merits of these loans, the aggressive growth policy appears to have caused deterioration in Krung Thai's asset quality. Despite the large transfers of bad debt off its books, the bank's nonperforming loans increased from B65 billion, or 16 percent of its total lending, at the end of 2001, to B116 billion, or 23 percent of its portfolio, at the end of the third quarter of 2002. "Very aggressive lending in this environment, without fully assessing the risk, can come back to bite you," says Kenneth Ng, head of research at ING Barings in Bangkok.
COMPETITORS, OF COURSE, ARE MORE concerned about their own financial health than Krung Thai's. Analysts say Bangkok Bank, Thailand's biggest private bank and one that often vies with Krung Thai for major loans to big companies, is already feeling the heat. Its net interest margin fell from 2 percent at the end of 2001 to roughly 1.6 percent -- a full percentage point below its major competitors -- in the third quarter of 2002, says Fitch's Milton.
Thai Farmers Bank, the country's second-largest private bank, is under similar pressure. Krung Thai seems "to be able to book assets at ridiculous prices, and I don't think they are as cautious as they might be," says David Hendrix, executive vice president and head of the bank's retail business group. "Customers come to us who say, 'With this collateral, Krung Thai is prepared to give us 10, 20 percent more in credit lines.'"
Bankers in TFB's wholesale corporate operation have had the same experience. "They are head-hunting our customers. They provide very sizable funds at very attractive prices," says Boonthuck Wungcharoen, head of the corporate business group, which targets mostly small and medium-size enterprises. Krung Thai is offering loans at rates 50 basis points below what Thai Farmers is prepared to offer, the executives say. "They take anything they can get," says Boonthuck.
A number of prominent private sector bankers contend that such aggressive lending is imprudent because Thailand's economic recovery is still narrow and its duration uncertain. Recent gains in manufacturing output, for instance, have been concentrated in areas like autos, electronics and consumer items. Corporate debt, they note, still equals about 95 percent of Thai GDP, a level that tends to retard growth and make new lending more risky. "To achieve sustainable growth in the long term, the recovery should be more evenly spread throughout all sectors," warns Kosit Panpiemras, Bangkok Bank's executive chairman.
Central bank head Pridiyathorn offers a characteristically blunt response to complaints about government-directed lending or a lack of state bank credit standards: "Not true." To him it's nothing more than "losers' talk."
Pridiyathorn argues that many of the shifts in lending by the state-affiliated banks don't affect private banks. For instance, the Bank for Agriculture and Agricultural Cooperatives' suspension of farmers' interest payments doesn't hurt private banks' balance sheets because they aren't big agricultural lenders, he notes.
Not that Pridiyathorn is oblivious to the plight of the private sector lenders. In November he introduced a new regulatory mandate that he says will largely clear up the private banks' problem loans within a year. Starting in January central bank officials began mediating the most contentious debt disputes between lenders and borrowers. The central bank will not coddle debtors, Pridiyathorn stresses. Creditors will be encouraged to take borrowers who reject the government-mediated compromises to court. To give this threat teeth, the government is also drafting a new law that will tighten foreclosure procedures and give banks additional powers to pursue deadbeats and resolve nonperforming loans. "We have to clear these up fast. Then the banks' profitability will increase right away, and they will be in better shape to perform their functions," he says.
Of the B840 billion of bad debt still stuck in commercial banks, Pridiyathorn says B150 billion is covered by agreements whose repayment terms are nearly finalized and a further B300 billion is in earlier stages of negotiation. The biggest problem now lies with about B390 billion of nonperforming loans that are the subject of legal actions. The government's planned bankruptcy law revisions will help to accelerate the execution of court rulings on about B200 billion of these remaining loans, and its recent mediation initiative should resolve the remaining B190 billion, the central bank chief says. Critics concede progress is being made. "There is some substance to these proposals; it's not just PR," says a senior Thai banker who often disagrees with the government.
Even these lingering problems aren't as serious as the bankers insist, Pridiyathorn suggests. Overall, private bank lending is rising more briskly than the 2 percent figure indicates, he says. The total is being held down by a healthy decline in some of the older outstanding loans, including haircuts the banks have taken on problem credits. And any weakness at the banks doesn't have the kind of ramifications for the Thai economy that it did at the time of the Asian crisis, he says. Thailand's bond market grew from B500 billion in 1998 to about B1.8 trillion last year, giving companies an alternative source of funds, notes the central banker.
THE PROGRESS OF THE THAI BANKING SYSTEM and Krung Thai's activity will get an important outside evaluation later this year. Viroj plans to privatize much of the bank by selling 3 billion Krung Thai shares to local and foreign investors on the Stock Exchange of Thailand. At recent prices the deal would raise roughly B20.1 billion and cut the government's ownership from 93 percent to 49 percent. Krung Thai has already recruited ten underwriters to assist -- four international firms, led by Merrill Lynch International, along with six local outfits coordinated by Merrill Lynch Phatra Securities.
Supachai Watcharasupara, head of investment banking at Merrill Lynch Phatra, says surveys of international investors in December and January found "quite positive" interest in Krung Thai shares, but investors and analysts contend it will be a difficult sale -- depending on how flexible management is on price. Already, Viroj has had to announce two postponements -- the first in November and the other early last month -- citing the weak global economy and the U.S.-Iraqi standoff for the delay. There are other worries closer to home.
"The perception is, rightly or wrongly, that you really wouldn't want to be involved in a bank that is being leaned on politically," says the head of sales at a major foreign investment bank. Moreover, Krung Thai's semiprivatization will leave the government as its largest single shareholder -- hardly a comforting thought to fellow investors worried about government-influenced lending decisions and minority stockholder rights.
And even investors inclined to accept management's descriptions of Krung Thai remember last October's partial privatization of B223 billion-in-assets commercial lender BankThai. After the sale, which raised B7.28 billion, the bank's shares fell about 10 percent below the original price because of weaker global markets and concerns about the government's continued stake.
Krung Thai also faces tough regional competition for investor interest from banks in countries that have gone much further in reforming their financial systems. "Why am I going to bother with [Krung Thai Bank] when I have Kookmin [Bank in South Korea]," asks Ray Jovanovich, head of portfolio management at Crédit Agricole Asset Management in Hong Kong. "Korean banks are clean, they have new, invigorated management, they are very focused, and they're trading at a little bit above book value." At present, Krung Thai -- despite its importance to the Thaksin government's economic revival plan -- doesn't meet all of these basic investment criteria.
