May 22, 1999 -- THE war on interest rates is brewing up again, this time it is at fever pitch. Banthoon Lamsam, the chairman of the Thai Bankers' Association, has lost his cool, hitting out at Tarrin Nimmanahaeminda, the finance minister. Fed up with the portrayal of the banks as the bad boys, he asked Tarrin sarcastically to spell out clearly what kind of interest rate directive the minister would like the banks to follow.

This comes after widespread criticism that the banks are taking advantage of the system by acting too quickly to cut deposit rates but moving too slowly to slash lending rates. By doing so, the banks have managed to keep the wide nominal interest rate spread -- the differential between the lending and deposit rates -- at 4 to 6 per cent, a wide margin to help them ride out of the bad-debt problems at the expense of depositors and model borrowers.

On Thursday, a day after Thai Danu Bank took the lead by cutting its savings rate by 0.50 percentage points to 4 per cent and the prime rate by only 0.25 percentage points to 9.50, Tarrin immediately came under pressure. He had to explain to the public why their hard-earned savings were getting a meagre return when they were already suffering from the economic crisis.

However, Tarrin buried himself in vague terms, saying the authorities had been signalling a downward trend in interest rates which should be allowed to move according to the market mechanism. In other words, the savings and deposit rates that have been brought down must be matched by a slash in the lending rates.

The Law Society of Thailand, led by Sak Kosaengrueng, fuelled the emotional debate by issuing a statement of condemnation against the commercial banks. It charged that the banks' interest rate manoeuvre amounted to their ''farming on the back of the Thai people''. It called for the banks to effectively narrow their nominal spread to 3 per cent.

After talking it over with fellow bankers late Thursday, Banthoon waited until yesterday morning to launch a counter-attack. Even with this wide nominal spread of 4 to 6 per cent, Banthoon said most banks are still losing money every day due to the burden of non-performing loans. Based on the assumption of NPLs running at 40 per cent, the banks will on the average be mustering a net margin of only 0.2 per cent. For the banks which have an NPL rate of more than 40 percent, they are running on a negative spread.

''Is it right that the minister would like the nominal interest rate spread to fall to 3 per cent? If not, what is the appropriate spread for the Thai system? Please don't say it ambiguously that interest rates have to be set according to the market mechanism. If the government makes a clear announcement, we'll know that it is the policy of the country -- not a flip-flop between the Finance Ministry and the Bank of Thailand. And if the banks are to lose money, what will be the government's action?. Where will Thailand end up?'' Banthoon said.

Banthoon's suggestion was that the banks are already doing their best (by keeping the wide nominal spread) to stay afloat and not to become a burden on society. If they fail the result will eventually land on the head of the tax-payers. Tarrin yesterday declined to trade words with Banthoon, saying the banker could say anything he wanted to because it was merely his opinion.

This further added to the confusion. To put things into perspective, the radically distorted interest rate structure arises out of the impaired banking system. Although the short-term interest rates have been brought down to their historic lows -- with the interbank rate falling to 1.25 to 2 per cent and repurchase rate to 0.8125 per cent -- the banks are not bringing down their rates fast enough. The prime rates are still high at 9 per cent or more, not to mention the more expensive rates, or the minimum retail rate (MRR) plus, for the small-time borrowers because the banks need this wide spread to offset losses from the NPLs.

This problem can be dealt with only if the banks raise enough capital to cover 100 per cent of their loan-loss provisions. By doing so, the banks' shareholders will assume full responsibility for the NPLs. Then they won't have to worry about past mistakes and the interest rate system will be fully repaired.

In fact, bankers can no longer claim the right to ownership or management when the NPLs of their banks run up to 40 to 50 per cent. Under normal conditions, running an NPL at a level of 15 per cent or more warrants official intervention. The same applies if the bank faces a 2 per cent loss from its shareholders' equity, which must be officially maintained at 8 per cent at all times.

This leads to the conclusion that the government lacks the political will to deal with the undercapitalised banks, which have managed to avoid the hard choice of raising equity for fears of a dilution effect on their holdings and losing management control.

As the banks have failed to capitalise sufficiently, the interest rate structure will continue to be distorted. The weak banking system will continue to hold the economy hostage. The banks should take this window of opportunity of bouyant sentiment in the stock market to issue equity. That would be responsible action, if not for their own sake then for the sake of the country.