KRUNG Thai Bank plans to bring down its lending rate by 1.5 per cent this month. Siam Commercial Bank is to cut its lending rate by one full percentage point, effective on Nov 30, while Thai Farmers Bank will slash its rate by 1.5 per cent, effective next week.

It appears that the commercial banks have got the warning message, albeit only after they had stretched public tolerance to the full over the past months, during which banks ripped off the depositors and their good customers in order to subsidise their non-performing loans.

On Thursday Prime Minister Chuan Leekpai tried to calm public outcry over the outrageous profits banks were making through widening the spread between deposit and the lending rates to 7 per cent. He said banks still had certain carry-over funding costs to account for and that the rates should be coming down soon, otherwise the banks would receive social punishment. Do the banks deserve only social punishment?

Structurally, the banking system is insolvent. Finance Minister Tarrin Nimmanahaeminda is facing a dilemma: when he turns left, he faces a tiger; when he turns right, he encounters a crocodile. The tiger is the crumbling banking system that is literally stuffing everything down its throat to stay alive. The crocodile is the real sector, which increasingly agrees that the best way to deal with the banks is to stop repaying the loans.

The banks had their reason to keep lending rates high at 15-16 per cent while pushing down the savings rate to 4.5 per cent and the fixed-deposit rate to 6-7 per cent.

A simple calculation suffices to understand the banks' behaviour. With the non-performing loans at 40 per cent, the banks could only make money from the remaining 60 per cent of their lending portfolio. Multiplying 0.6 per cent (the performing-loan portion) by the lending rate of 16 per cent, the banks arrived at a break-even spread of 9 per cent. So theoretically the banks could not offer deposit rates of 9 per cent because they had to pay the staff salaries, electricity and other operating costs. That was why the savings rates were pushed down to 4.5 per cent and the fixed rate to 6 per cent, so that banks could muster the spread at 4 to 5 per cent.

But the point is that by keeping the lending rates exhorbitantly high the banks are punishing the real sector, the 60-per-cent performing portion of their lendings. If the real sector is hammered, economic recovery is out of the question. Further recession will add to the non-performing loans on the banks' books, hence the vicious circle which brings down the entire country, rich and poor alike.

One way to punish the local banks is to create more competition by giving free licences to foreign banks, which will certainly put an end to domestic price collusion. The taxpayers have been repeatedly asked to help shoulder the burden in bailing out the banking system, but ironically they continue to be squeezed by the banks every time the banks see an opportunity.

Breaking the impasse will involve bank recapitalisation. However, banks' shareholders do not have the money; neither do they want to participate in the bank restructuring programme, announced by the the government on Aug 14, for fear of losing their shirts and their management control. Bangkok Bank and Thai Farmers Bank, which have raised Bt40 billion each, appear to be safe at this point, but the other big banks are struggling to keep their heads above water.

Siam Commercial Bank, Thai Military Bank and Bank of Ayudhya have devised a live-today-die-tomorrow scheme to recapitalise. They have issued subordinated debt amounting to Bt14.65 billion, Bt4 billion and Bt4 billion respectively. Bank of Ayudha's subordinated debt was twice overscribed, leading the bank to increase the size of its issue to Bt8 billion.

But these debt issues can only be counted in tier-2 capital, which will help the three banks buy more time. Stability of the banks lies in the core capital or tier 1. When the non-performing loans of the banks are written off, they will eat into the tier-1 capital and not tier 2.

If the banks are to apply for recapitalisation under tier-1 capital, they will have to write down their net worth and hand over management control to the government. The conditions of the tier-2 recapitalisation programme are less tough, but applying for this programme will be a big loss of face. Siam Commercial Bank is the only bank to have applied for government assistance in the tier-2 programme.

By offering more attractive rates than deposit rates, the three banks in effect are trying to rely on public deposits to help them recapitalise. Siam Commercial Bank has offered about 1.5 per cent over its fixed rate and Bank of Ayudhaya 3 to 4 per cent over the fixed rate. Looking down the road, Bank of Ayudhaya will have to make sure that it has enough earnings to repay its debt.

Clearly the cost of issuing the subordinated debt is higher than the funding cost in the government's tier-2 recapitalisation programme, which is about 1 per cent, but by getting one baht from the government's tier-2 programme, the bank can take Bt12 in additional public deposits, translating into an overall cost of 0.1 per cent.

Why are Siam Commercial Bank, Thai Military Bank and Bank of Ayudhya willing to pay a higher cost of funding by issuing subordinated debt rather than directly applying for funding in the tier-2 recapitalisation programme? The answer lies in face-saving: the three banks, which are struggling to maintain adequate capital-adequacy ratio, may need to have more bargaining power when they hold talks with foreign partners for joint ventures at this juncture.

As they say, it's better for the banks to live today and die tomorrow. But can the government afford to let the whole country or the economy die with the banks?