Public pays for banking gamble

August 13, 1999 -- BY the time Finance Minister Tarrin Nimmanahaeminda pushed out the Aug 14 Banking Restructuring Programme last year, it was inevitable that the state would have to underwrite the entire banking system.

Politically, it was a big gamble as, once again, Tarrin would have to justify a need for state funds to bail out the system while most hard-working Thais were left to struggle on their own.

The conditions were very precarious. The tight monetary and fiscal policy adopted by Thailand since it sought the International Monetary Fund support programme in August 1997 had failed to restore confidence and contributed to the further contraction of the economy.

The credit system had already collapsed. In fact, it was destroyed in the early part of 1997 during the period when Thai finance companies were suffering from a run on their deposits. Then banks slammed the brakes on their lending because they had run out of money and were afraid to lend into the slowing economy.

The informal credit market, the bloodline of small businesses and contractors, had also crashed. Before, contractors or local traders could buy their goods on two-month credit without having to pledge anything as collateral. Once they finished the project or were able to sell their goods, they collected the money and repaid their suppliers. This informal market was badly hit when all businesses suffered from liquidity problems due to both the financial sector and foreign exchange crises.

The permanent shut-down of 56 finance companies also dealt a big blow to the Thai economy. Together they held combined assets of more than Bt800 billion, equivalent to almost 20 per cent of the country's gross domestic product. All the credit and collateral got tied up in this big mess and jolted the economy. If they had not been closed down, but had been forced to merge, they would have kept the credit system from eroding too fast.

Then the defunct finance companies could have been allowed to run down their assets, while keeping what World Bank economist Joseph Stiglitz called the ''information capital'' intact. The problem with closing down the finance companies was that nobody knew what was going on with the lending portfolio and nobody would take responsibility. When the finance companies went bust, it was clear it would soon hit the banking sector.

At more than Bt6 trillion, the size of the credit market was even larger than the GDP. If the banking system went down, so would the economy.

Handling the banking sector was a much more delicate task than the finance sector. But the poorly run banks could not be allowed to continue to operate on their own because of a rise in their bad debts. They were facing a mismatch in their funds. The money that they had lent out was not repaid to match a need for customer withdrawals, resulting in a need for the Financial Institutions Development Fund to keep on pumping money into them. This situation could not last forever before the government went broke.

The word spread that Thailand would eventually have fewer than five banks left out of 15. For more than three decades, the banking sector had shut out foreign bank participation. It was the domain of Chinese-Thai families, who relied on their banks as a stronghold to branch out into other businesses and benefitted from a cartel-like operation. This would no longer last.

One of the conditions of the IMF programme was that Thailand would have to open up its banking industry to foreign bank participation. In the first letter of intent, signed in August 1997, rules were changed so that foreign ownership in Thai banks could go up to 100 per cent. After 10 years, however, foreign shareholders would not be allowed to subscribe to capital increases, hence gradually diluting their stakes over time. With this revision of the rules, and the depth of the crisis, the Thai banking landscape would be changed for good.

The IMF had also made it clear that bank shareholders would have to pay the price for their mistakes and their crony capitalism. Any financial injection by the state into Thai banks must come with preconditions that shareholders must be punished first, by the write-down of capital, and the management, run by the shareholder cronies, must be removed.

Bangkok Metropolitan Bank was the first bank in which the state intervened late in 1997, shortly after the Chuan government came to office. Other banks would also come into the government's hands in the following year. Bangkok Bank of Commerce, First Bangkok City Bank, Siam City Bank, Union Bank of Bangkok, and Laemthong Bank all went under in the severe financial storm. Thai Danu Bank was bought out by Development Bank of Singapore, and Bank of Asia by ABN-Amro Bank of the Netherlands. Nakornthon Bank was in big trouble, but its small size was not a cause of great concern.

The fate of other big banks -- Bangkok Bank, Thai Farmers Bank, Krung Thai Bank, Siam Commercial Bank, Bank of Ayudhya, and Thai Military Bank -- was also very uncertain.

Early in 1998, it appeared that the economic stabilisation programme was working. Tarrin preferred to let the Thai banks raise capital on their own -- a market-oriented economic policy having always been the bedrock of the Thai policy-makers. In March and April, respectively, Thai Farmers Bank and Bangkok Bank succeeded in raising capital through global offerings at US$1 billion each. But soon after, it became clear that the Thai economy had yet to sink to the bottom.

The international capital market was completely shut down as far as Thailand and other emerging markets were concerned. The only way out for Tarrin to save the Thai banking system was by using public money on a grand scale.

BY THANONG KHANTHONG