Bailout of bad debt is a bad idea

June 16, 2000

ONE of the most contentious questions now is whether a new government - if it is to be headed by Thaksin Shinawatra of the Thai Rak Thai Party - will continue to pursue the economic and financial reform programme as laid down jointly by the Chuan government and the International Monetary Fund. When asked this question yesterday, Ranjit Teja, the head of the IMF delegation, said: "I don't have a crystal ball. But that is a possibility."

But Teja and his colleagues did not show their concern over any drastic reversal of the economic and financial reform programme. Any newcomers to the scene will be facing the same figures or the same problems, chiefly a need to continue to reform the banking sector and to address corporate-debt restructuring. Teja did admit, however, that the IMF team has had a very good relationship with the Chuan government. In short, they have been on the same wavelength over the broad strategy with which to deal with the Thai financial and economic crises.

As an institution, the IMF will have to deal with any governments which are its members, Teja added.

In its political platform, the Thai Rak Thai Party has sharply criticised the IMF support programme for Thailand. Earlier, Thaksin had floated a proposal to nationalise the bad debts in the banking system. He did not specify the scope by which the nationalisation of the bad debts would take place. But he believes that it is the quickest way to clean up the balance sheets of the Thai banks. The second main point of the Thai Rak Thai Party's platform is a relaxation of banking standards so that Thai banks have more breathing room to lend money to the cash-strapped corporate sector, particularly to small- and medium-scale industries.

Carl Johan Lindgren, a banking expert of the IMF, has disputed any temptations to carve off the bad debts from the banking system by using taxpayers' money. From his experience in studying banking crises in different countries, Lindgren argues that it is better to resort to a market approach by keeping the problem loans at the banks and encouraging the bankers to tackle their own problems. If the problem loans are transferred to the government-owned asset-management corporation without due consideration, it will create a moral hazard. The bankers will then try to push all of their burdens on to the government. Debtors with good connections will get away from their responsibility of having to service their debts. The result is a more costly bailout programme for the banking system.

Both Teja and Lindgren understand that there is pressure for the Thai government to accelerate banking-sector reform and bring down the high level of problem loans. But they said it is a complex process that will take time, perhaps five to 10 years, based on the experience of other countries facing a banking crisis.

So far the Thai government has pursued a three-pronged strategy in dealing with the banking system crisis.

First, it has closed down the nonviable finance companies and banks and auctioned off their assets. The Financial Sector Restructuring Authority has handled the liquidation of 56 defunct finance companies.

Second, it has intervened in weak finance companies and banks and forced them into mergers. Some of them have been privatised and others are awaiting further privatisation.

Third, it set up the August 14 Banking Restructuring Programme to help the remaining private banks or finance companies to re-capitalise. Tough conditions, earlier put in place, have been relaxed to encourage the banks to take government money to re-capitalise. Simultaneously, legal and tax regulations have been improved to facilitate the process of establishment of privately-owned asset management corporations to deal with the bad debts.

At the time when the Chuan government took power in November 1997, half of the assets of the Thai financial system had already turned sour. Since the deposits and senior debts of the banks have been fully guaranteed to prevent a systemic shock, the cost of bailing out the ailing financial institutions has now risen to between Bt800 billion to Bt1.2 trillion. This does not include Bt500 billion in bailout money approved in 1998 to compensate the debt of the Financial Institution Development Fund.

Given the improvements in the economy by a growth rate of four to five per cent a year, Lindgren said there is no need for the government to intervene to buy out the bad debts. The figures speak for themselves. The economy can continue to grow despite structural problems in the banking sector.

But that does not mean that the government or the Thai people can be complacent with banking sector reform and corporate debt restructuring.