Thanong Khanthong and Vatchara Charoonsantikul look at the formation of the comprehensive bank-restructuring package.

SWEEPING banking reform was at the back of Tarrin Nimmanahaeminda's mind immediately after he made a comeback as finance minister in November last year. As a former top banker, Tarrin realised that if the health of the banking system was not restored it would be impossible to get the economy back on track.

Yet Tarrin's first order of business then was to shore up the plummeting baht. When Thailand sought a US$17.2-billion rescue package from the International Monetary Fund (IMF) in August 1997, its foreign-exchange reserves were almost depleted. In that month its net foreign-exchange reserves stood at $800 million, a far cry from $37.8 billion at the end of 1996. The baht suffered from a rout because panicky investors realised that Thailand no longer had reserves to back up its currency. The baht was trading at 42 to the dollar at year-end 1997 before bottoming out at 56 in January 1998.

As finance minister, he was managing the cash flow of the country, which was bleeding heavily from panic baht-selling and from fears of sharp economic contraction. The macro-economic framework attached to the IMF package, which essentially called for fiscal and monetary tightening, succeeded in restoring confidence to the baht to a certain extent in the first quarter of 1998.

The financial turmoil brought about widespread corporate bankruptcies and a collapse in the credit and billing system. The finance companies and the banks were awaiting judgement day, for the corporate bankruptcies would appear in their books. Sixteen finance companies were shut down in June 1997, and 42 finance companies went under two months afterwards. There was still a state of denial at most banks, which had made an error by not recapitalising sooner to cover their imprudent lending practices during the bubble economy. Most were too weak to recapitalise without the risk of losing ownership control. Thai banks were in the hands of the big-time families, which had dominated the economic landscape for the past four to five decades.

Indeed Tarrin did not favour the family banks. As a banker, he knew that the system was a big cartel. The monopoly had to end. In the financial-master plan during his tenure as finance minister in the Chuan I administration, Tarrin's financial liberalisation was aimed at creating a level playing field and limiting the participation of the family banks. He got carried away with the Bangkok International Banking Facility, but it was his intention to upgrade the Thai banking system to international standards.

By December 1997 it was clear something needed to be done with the insolvent banks. Bangkok Metropolitan Bank, a bad bank in good and bad times, was taken over. The stake of the Tejaphaibul family was written down to the bone. After nationalising Bangkok Metropolitan Bank, Tarrin had more confidence and gained experience on how to deal with deposit runs. He waited until February 1998 before having First Bangkok City Bank, Siam City Bank and Bangkok Bank of Commerce nationalised. Liquor tycoon Charoen Sirivadhanabhakdi's 30-per-cent stake in First Bangkok City Bank faced complete meltdown. The Mahadamrongkul family stake and other big-time family stakes in Siam City Bank were also gone. The Jalichandra family's controlling stake in scandal-plagued Bangkok Bank of Commerce had long been wiped out.

After permanently closing 56 finance companies -- two were allowed to resume operations -- and nationalising four banks, anything could happen to the rest in the finance and banking industry. The matter had to do with the timing. Then Tarrin believed that after closing the insolvent banks, the remaining financial institutions should move ahead to recapitalise, either through equity offerings or through foreign partnership. His role was to create a stable macro-economic framework for the recapitalisation process to succeed. The banks would have to look after their own interests.

A window of opportunity arose in late March 1998 when Thai Farmers Bank went to the international capital market to launch a 49-per-cent private placement. It raised $800-$900 million. He also helped Thai Farmers Bank out during its road show in New York by taking the time to meet the institutional investors. Tarrin told Banthoon Lamsam, the president of Thai Farmers Bank: ''Since I am helping you out, you've got to succeed.'' Thai Farmers Bank's private placement was oversubscribed, as was Bangkok Bank's.

Bangkok Bank also raised $1 billion by selling off 49 per cent in the following month. Much to Tarrin's relief, the two biggest banks were saved, at least in this round of financial turmoil.

Other foreign banks were circling the Thai banks. It was an opportunity to break into the Thai banking industry. The problem, however, had to do with pricing. ABN Amro Bank of the Netherlands decided to hook up with Bank of Asia, agreeing to pump Bt7.5 billion into the Thai bank for a 75-per-cent stake. The Development Bank of Singapore also bought 51 per cent of Thai Danu Bank.

Citibank would also like to buy First Bangkok City Bank at Bt1 a share, but the deal is going nowhere. The fundamental problem was the level of the NPLs. Most foreign banks would only buy Thai banks when the NPLs were carved out and looked after by somebody else, leaving them only the good assets. That was not going to be easy.

Then sentiment on Thailand appeared to have improved significantly, although fundamentally nothing had changed. However, external factors would make things worse. The yen began to wobble, and there were talks about another time bomb in Asia, the fall of Japan Inc. Nervousness over the health of the Japanese banking system and its economic recession led to a weakening yen and a capital outflow from the region. Asia was sealed from the rest of the world. Capital would not be flowing back.

By May it was clear to Tarrin that a state intervention in the banking system was inevitable. Later that month he flew over to Washington D C to consult Robert Rubin, the US Treasury Secretary, over the banking-reform agenda he had on his mind. Any of Thailand's big moves needed US support since the US has the largest say in the IMF. There were talks about the IMF providing an emergency stand-by credit to Thailand as a second line of defence should the baht suffer a run again.

Rubin would leave his mark in international finance by intervening to prop up the yen in June before flying over to Asia on a regional tour. President Bill Clinton was making a historic visit to China. Rubin accompanied him to China before visiting Southeast Asia, including Thailand.

In that month Chatri Sophonpanich, the executive chairman of Bangkok Bank, gave an interview saying that if the non-performing loans of his bank were to hit 30-40 per cent, Bangkok Bank would go bankrupt. Then he hinted at nationalisation. In a worst-case scenario the government might need to intervene in a selected group of Thai banks to shore up their operations, he suggested. This intervention could be done by the government's holding the stakes in the local banks, with a buy-back agreement once the economy recovered.

When the top banker of Southeast Asia's largest commercial bank said that his bank would need state intervention, it was clear that the Thai banking system was slipping into insolvency.

At the Chulalongkorn University Sasin School of Business Administration, Rubin was asked by a student to comment on a suggestion that the Thai banking system could be nationalised. Rubin sidestepped it directly but hinted that it was something Tarrin had been working on. By the end of June, the Thai banking system would be posting losses of Bt113 billion.

Fears of nationalisation had gripped the entire banking system. The stock prices of Thai Farmers Bank and Bangkok Bank began to fall. The foreign investors who had bought Thai Farmers Bank and Bangkok Bank at Bt85 and Bt93 a share would be facing heavy losses. There had been general comments that the banking system would face NPLs of 40 per cent of total loans and the government's intervention might punish the shareholders by writing down their capital to Bt0.01 each. All the bank stocks were dropping like stones. Siam Commercial Bank was pronounced dead while still breathing.

Tarrin had seven more finance companies nationalised, which included Nava Finance & Securities Plc, a subsidiary of the Thai Military Bank, and Union Asia Finance Plc, a subsidiary of Bangkok Bank. These finance companies failed to meet the 8.5-per-cent capital adequacy ratio, and they had been borrowing from the Financial Institution Development Fund more than twice their capital funds. Since the economy kept on deteriorating with the contraction at 6-8 per cent and the NPLs would rise in tandem, a complete nationalisation of the remaining banks looked inevitable.

If Tarrin was to take on the banking system, what would be the most appropriate model? Using the French way would change private ownership in the banks into government ownership. This did not fit the Thai way. Sitting on the sidelines and doing nothing would amount to turning the Thai banks over to the foreign banks, similar to the Mexican experience. Only one Mexican bank from more than 60 survived the peso crisis in 1994-95. Chile's nationalisation of the NPLs helped the banks recapitalise and retain some Chilean elements.

Obviously Tarrin would like to retain Thai ownership to a certain level. He would be devising a scheme that would amount to a do-or-die endeavour. The Thai banking system was an artery to the Thai economy. If the banks could not start relending, despite the fall of interest rates, the Thai corporate sector and the economy would not recover.

He discussed the components of the comprehensive banking-reform package with experts from the IMF, the World Bank, the Asian Development Bank and the private agencies. J P Morgan was also advising the Bank of Thailand on how to privatise Bangkok Metropolitan Bank, First Bangkok City Bank, Siam City Bank and Bangkok Bank of Commerce. He tried to get all the views to make sure that the package, once it was announced, worked. The experts from the Bank for International Settlements were also asked to take a look at the adjustment on the tier 1 or tier 2 capital to see whether it would conform to international standards.

The package would be his brainchild. After he had presided over surgery to reform the Bank of Thailand, he had the momentum to take on the banking system in a more daring way although Thais appeared to be losing their patience with the downturn of the economy. Tarrin bet his future on this package, which must restore the lending to the banking system, signal a bottoming out of the economy and create a level playing field for new investors.

Doing so would need at least Bt300 billion of public money to help the banks recapitalise. Standard & Poor's had estimated that the Thai banking system would need to recapitalise at least by Bt800 billion if the NPLs were to reach 35 per cent. Yet this number did not take into account the fact that the banking system had already set aside almost Bt400 billion in provisions for loan losses. Deducting the provisions, there would remain Bt400 billion in fresh capital that the banking system needed. Since Tarrin would provide Bt300 billion by issuing 10-year bonds, the system would only need to raise Bt100 billion.

How did the package work? There were two key elements. First, the government's money would provide the catalyst for recapitalisation since the Thai shareholders were too weak to raise funds by themselves. Foreign investors would not participate in the recapitalisation for fear of facing a dilution of their investments. The package ambitiously sets out to help the banks recapitalise tier 1 and tier 2 capital.

For tier 1, the government would make available bonds with a 10-year maturity carrying market interest rates. But the banks must write down their capital up front by bringing forward their loan classification and provisioning by year-end 2000. The cost would be born by the shareholders, who would take this hit first before qualifying. For tier 2, the government would make available subordinate debts, which are not tradeable. The injection would depend on the write-down of capital from corporate-debt restructuring and provisioning and the net increase in lending to the private sector.

In essence, the innovative scheme allows banks to work on debt restructuring while they make efforts to recapitalise with the government's helping hand. It would be a Thai-style solution, with protection that did not look nationalistic.

How would Tarrin convince the public or Parliament that state intervention was necessary to safeguard the banking system without being criticised for helping the rich or protecting the interests of the families who owned the banks? A lot of explaining would be needed.

Aug 14 would be the day to launch the comprehensive package, which was kept secret all along. However, a few days before the package was to be announced, there was a leak to help the public absorb the bad news. Otherwise the banking system could face a systemic run if the public were to be bombarded by the information in one day. Laem Thong Bank and Union Bank of Bangkok would be nationalised along with other five to six finance companies, including Dhana Siam Finance & Securities Plc. There would also be a shuffling around with the four nationalised banks. What the officials feared most was a run on these medium-scale banks, which would put more pressure on public money.