Thanong Khanthong and Vatchara Charoonsantikul say the Thai-style banking-reform package is a half-hearted bail-out whose success depends on a host of domestic and external factors.

Instead of using the Chilean model to carve out the non-performing loans (NPLs) in the banking system, the Thai-style banking-reform package goes the other way round by keeping the NPLs intact but providing government finance up to at least Bt300 billion to facilitate loan-loss provisions and recapitalisation.

In the early 1980s, Chile was successful in dealing with the systematic crisis of its banking industry by nationalising the NPLs, which were carved out and replaced with a 10-year government bond. By doing so, the banks could almost overnight clean up their balance sheets, although they had obligations later to buy back their bad assets. Without the NPL burden on their books, the Chilean banks could embark on a course of recapitalisation and rehabilitation.

After thorough consideration, Finance Minister Tarrin Nimmanahaeminda found that a systematic carve-out of the NPLs, expected to hit 40 per cent of the total Bt5.6-trillion loans, might not prove effective in the traditional Thai and regulatory practices. Had the systematic carve-out been undertaken, the NPLs would have been placed in a special-purpose vehicle, generally known as an asset-management corporation (AMC). Tarrin explained that questions would have been raised over who would actually own the AMC, how the AMC could raise its funding or how it would consolidate its accounting book with the parent banks.

''It would be very complicated in practice. For example, how could the prices of the NPL transfer be determined? Would the transfer be based on the book value or on market prices? On what basis would the banking regulators supervise the transactions to make sure that they were up to date? Banks of course would like to get the book value, but that is out of the question. Still, how would the market prices of the NPLs be determined?'' he asked.

''But the most important problem with this approach is that if the NPLs were to be carved out and placed in the AMC, at whatever transfer prices, they would be denied access to relending for restructuring and would still be recognised as bad loans. In effect, it would force banks' customers to repay their debts. An NPL customer can become a good customer again if his debts are restructured and get new loans. Once the NPLs go into the government-controlled AMC, they are no different from the NPLs managed by the Financial Sector Restructuring Authority. Weak customers will then become bad customers.''

But if the parent banks are to manage their NPLs by setting up the AMC by themselves, they can transfer the NPLs at the level they consider appropriate, seek funding for the AMC, establish ownership and form a management to recover the assets, Tarrin said. Asset foreclosures can be conducted within the AMC, which need to be backed up by a new set of regulatory guidelines, he added.

Both Dr Vichit Surapongchai, the chairman of Radhanasin Bank, and Phirasilp Supapholsri, the president of of the Krung Thai Thanakit Plc, said last week that they would set up special teams within their banks to recover the bad assets of the nationalised Laem Thong Bank and Union Bank of Bangkok respectively.

So instead of taking on the NPLs directly, the Thai banking-reform package goes the other way to address the loan-loss provisionings of the banks, which will stand to receive government finance made available through a Bt300-billion bond with a 10-year maturity to help them recaptialise. It is a flexible package aimed at restoring solvency to the banking system and protecting the Thai banks from a complete wipe-out. Tarrin has been trying to avoid the Mexican model, where the non-intervention policy in the end has witnessed the survival of only one bank compared to 60 before the peso crisis.

The Thai banks are now on the brink of insolvency due to expectations that their NPLs are on the way to hit 40 per cent or even 50 per cent of total loans. They are obliged to maintain a capital-adequacy ratio of 8.50 per cent -- 6.00 per cent in tier-1 capital and 2.50 per cent in tier-2 capital -- of their risk assets. If they have the NPLs -- loans that do not make interest payments after three months -- on their books, they have to make provisions to cover the NPLs. By doing so, they will run down their capital and need to recapitalise further. But the banks cannot recapitalise because the capital markets have been shut to them.

The Tarrin scheme comes into play by allowing the banks to address their NPLs directly by adopting full provisions in return for government finance. It sets out to adjust the adequacy-ratio structure of the banks, changing it to 4.25 per cent in their tier-1 capital and 4.25 per cent in tier-2 capital, which still meets the Bank for International Settlements standard of 8.50 per cent. To qualify for the rescue programme, the banks need to adopt full provisionings for the NPLs instead of gradually meeting this regulatory requirement by the year 2000, when the Thai banking system must conform 100 per cent to international accounting and banking standards. Adopting full provisioning for loan losses means that the shareholders will take a hit up front.

Then the banks, with possible foreign participation, can start to increase their capital in tier 1, which is core capital that consists mainly of common stocks and retained earnings. If the shareholders of the bank agree to put in, say, Bt10 billion, in the tier-1 recapitalisation, the FIDF will match this effort by pitching in Bt10 billion in tradeable bonds drawn from the Bt300- billion bond issue. The limit of the FIDF's participation in tier-1 capital adequacy is 2.50 per cent.

In tier-2 recapitalisation, the banks will only get the non-tradeable government bond in proportion to their write-down resulting from corporate-debt restructuring and net of previous provisioning and the net increase in lending to their customers. This tactic will force the banks to work hard with their customers to clean up the NPLs and to resume lending as quickly as possible. The participation of the government finance in tier-2 recapitalisation is capped at 2 per cent of these weighted assets.

In effect, the shareholders stand to get half-hearted help, not a complete bail-out, because they will see an erosion of their wealth through the provisionings first. The scheme is designed to pre-empt as much as possible criticism that the government is bailing out the rich at the expense of the poor. But it still cannot be denied that the rich will get the carrot, although they will have to be caned with the stick first.

''The scheme carries several characteristics not found in any models in other countries which have tackled the banking system. You could say that it has a lot of Thai elements,'' said an official of the International Monetary Fund, who considers the banking-reform package and the debt-restructuring scheme the core of the fifth letter of intent between the Thai government and the IMF.

As of June 1998, the remaining Thai banks and finance companies have not yet breached that 8.50-per-cent capital-adequacy ratio, at least in the eyes of the Bank of Thailand's supervisors and examiners who have scrutinised their books. Technically, the Thai banks are still sound, breaching no regulatory requirements. M R Chatu Mongol Sonakul, the Bank of Thailand governor, said that at least until December 1998 the remaining Thai banks and finance companies would not have to raise new capital to meet the capital-adequacy requirements.

''The Bank of Thailand's supervisors and examiners won't go after their books until June 1999, so the Thai financial institutions are technically safe at least until then,'' Chatu Mongol said. Laem Thong Bank, Union Bank of Bankok, Dhana Siam Finance & Securities Plc and four other finance companies faced a write-down of their capital last week because they failed to meet the capital-adequacy requirements and had borrowed liquidity from the Financial Institution Development Fund at twice the amount of their shareholders' equity, he explained.

Yet fundamentally speaking, the Thai banks are insolvent based on the expectations of the rising NPLs amid a sharp contraction of the economy by 6-8 per cent this year. This is the only one reason why the foreign banks and investors are not buying into the Thai banks, even though it is a once-in-a-five-decade opportunity to do so. It is not the question of foreign-ownership restriction or pricing; it is the question of insolvency down the road. By insolvency is meant that even after the Thai banks have completely written down their capital to address the NPLs, their total assets will not cover their total liabilities.