As Thailand's banking industry emerges from the clouds of the economic crisis of 1997, two major changes are apparent. One is a structural change from family-owned banks to three types of majority ownership: Thai private banks, majority foreign-owned banks, known as hybrids, and state-owned banks, which are majority owned by the Financial Institutions Development Fund (FIDF). The other is a business shift from traditional to modern banking practices.

These changes have brought fierce competition to the industry, and have caused difficulties for banks trying to increase interest-based income due to price competition. To survive amid intensified competition, banks will need to remain focused on business and organisational reform, which will bring in cost efficiency. However, deteriorating asset quality is still a major concern, because it puts pressure on banks' provisioning requirements and capital adequacy status. Several economic stimulus packages of the Thaksin government are expected to help banks improve performance and rebuild confidence in the country's long-term financial and economic outlook.

The government had to bear some post-crisis burdens, mainly by increasing its ownership in banks. The number of state-owned banks has increased from one before the crisis to four after. The government's burdens also include obligations under the Financial Sector Restructuring Package (The 14 August 1998 Measure) and the Sale Agreements the FIDF signed with buyers of the companies that would become the two hybrid banks.

Towards modern banking
The entry of hybrid banks has intensified competition in the industry, particularly by spurring a change from traditional to modern bank practices. Competition has been particularly fierce in retail banking through the innovation of new financial products and services. Various e-banking services, and the promotion of plastic products, especially debit and credit cards, ATM, and other e-cards, have shown the Thai banking industry new strategies and opportunities to expand its retail customer bases. In the wholesale market, big corporate firms have responded positively to new services, for example, a so-called Cash Management Scheme.

Shifting to modern banking practices also has allowed banks to place greater emphasis on non-interest income. One result is that for the banking system as a whole, the contribution of non-interest income to total income has doubled from 10% in 1997-1998 to nearly 20% in 1999-2000. Banks' fee and service income grew 9% on a yearly average during 1999-2000, compared to a negative growth of 17.4% in 1998.

The figure for the first half year of 2001, showing 18% year-on-year growth, is a strong indication of a rising trend. New income sources have been particularly welcome at this time when banks have found expanding interest-based income difficult because of non-performing loan problems, limited demand for new credit, and narrower interest margins because of price competition. Though its proportion has shrunk, interest-based income remains banks' major income source.

To strengthen banks' capital fund status in line with international standards, the Bank of Thailand (BOT) introduced new regulations on loan classification and provisioning in March 1998. With their assets eroded by the economic downturn, nearly all the banks had to increase their capital to follow the new rules. Recapitalisation of Thai commercial banks during 1998-2000 totalled more than Bt897bn (about $20bn), or about 18% of banks' asset size before the crisis. As a consequence the capital adequacy ratio of Thai commercial banks as a whole stood at almost 11% at the end of 2000, above an 8.5% minimum requirement set by the BOT. Meanwhile, loan loss provision covered about 35% of NPLs at their peak of $58.7bn in May 1999.

To speed the reduction of NPLs, the BOT released criteria for troubled debt restructuring (TDR) in June 1998. As of June 2001, Bt2.25trn in NPLs had been restructured. The rest are considered hardcore NPLs and are in court procedures. The Thai Asset Management Corporation (TAMC), established in July and expected to begin taking over bad loans soon, is considered crucial to handling the bad loan problem. It is thought that pooling a large number of NPLs and making the TAMC a single large creditor will speed up the TDR process. After an expected Bt1.35trn in bad loans is transferred to the TAMC, the government expects the NPL ratio will fall from 20% of all loans as of the end of 2000 to 7%. However, the TAMC will have limited impact on private banks, because Bt1.1trn will come from state-owned banks, and only Bt250bn or less is expected to come from private banks.

Hopes that the ratio of NPLs to total loans would fall to 7% by the end of 2001 are unlikely to be realised, however. Several factors - including the global economic slowdown, an expected drop in exports and recent interest policy changes at the BOT (a 100 basis point increase in 14-day repo rate) that has created market uncertainty about monetary policy – have contributed to a deteriorating economic environment that has seen a rise in new and re-entry NPLs. On average over the first six months of the year, banks registered Bt14bn in new NPLs monthly, while the relapsed rate averaged 5.3% of total TDR during the same period, with monthly average re-entry NPLs of Bt20bn.

If NPLs start to emerge again, banks are likely to face provisioning pressure, and consequently capital fund intolerance, and some private banks might need a new round of recapitalisation in 2002.

As the deteriorating asset situation points out, Thai banks need a strong recovery in the general economy to ensure their recovery plans stay on track. To boost the domestic economy, the Thaksin government has introduced several stimulus packages, particularly its Village Development Fund project, economic stimulus packages, and certain tax incentive measures. These programmes are in place and expected to support improved performance among banks.

In early June, the BOT decided to increase key policy interest rates, raising 14-day repo rate from 1.5% to 2.5%, and said at the end of August it would maintain that level for the rest of the year. The BOT believes it has set an appropriate interest rate level to fulfil its macroeconomic targets to simultaneously balance effects on capital flows, domestic spending and investment stimulation, public debt management, and exchange rate stability.

While some analysts have questioned the interest rate increase, the more important issue for the government is to put priority on policy implementation to strengthen economic fundamentals. This would help rebuild confidence in the country's long-term financial and economic outlook.

Future challenges
New regulations of the Bank for International Settlements (BIS), scheduled to be applied worldwide in 2004, will push the banking industry to higher standards of asset quality improvement and supervisory process, particularly methodologies for risk measurement and good governance. Currently, the BOT has set the minimum capital adequacy ratio at 8.5%, higher than the 8.0% minimum requirement of the BIS standards.

A new Financial Institution Act, now being considered by the Thaksin government, maintains the current capital requirement ratio, while its major principles are consistent with international standards. If no major changes are made, the law should be in place in 2002.

Going forward, Thai commercial banks face a number of challenges. Competition from hybrid banks and foreign banks with full branches will intensify. To be competitive, Thai banks will need to continue moving toward modern banking services and reorganisation.

Upgrading the sector's technology will be crucial. E-banking provides customers with fast, efficient services via electronic channels, while allowing banks to expand customer bases and build-up fee-based businesses through computerised services for various financial transactions. Organisationally, the structures of Thai banks will change to conform to modern banking services.

Furthermore, efficiency gained in management and operations will result in cost efficiencies. Uses of new technology and electronic channels have already led to staff downsizing.

More downsizing is expected. Industry wide during 1997-2000, more than 22,000 staff were either laid off or took early retirement.

Early retirement schemes are scheduled to continue for the next three to five years, and an additional 20,000 staff are expected to leave the industry.

The crisis then has not only changed the structure and business of the Thai banking sector, but it has also changed the sector from one with high job security into one with competitive employment conditions.