Inadequate supervision of financial institutions has given rise to the current financial sector distress. A recent move by the Bank of Thailand to tighten its supervision of finance companies amounts to an admission that it had not been tough enough. For Rerngchai Marakanond, the BOT governor, there is still plenty of work to do to demolish the legacy of his predecessor.

Earlier this month, Michel Camdessus, the managing director of the International Monetary Fund, told The South China Morning Post of Hong Kong that part of Thailand's financial system crisis could be attributed to inadequate supervision of financial institutions.

This has dealt a credibility blow to the central bank at a time when it is trying to restore confidence in its macro-economic management. In the meantime, Rerngchai is busily picking up the pieces after years of BOT complacency gave rise to the present financial mess.

Last week Amnuay Viravan, the finance minister, followed up with a blistering order that the central bank overhaul the examination and supervisory systems it uses for financial institutions. This shake-up will take place in parallel with the momentous BOT task to clean up the mess in the finance sector.

If the BOT is successful in forging a merger between Finance One Plc and Thai Danu Bank, it will gain momentum for spearheading further mergers and acquisitions amongst the 91 finance companies, half of which are too ill-equipped to compete.

A former bank executive who asked not to be named, said although BOT people are good at examining the balance sheets of financial institutions, they are not efficient when it comes to supervising the financial institutions.

BOT supervision of the failed Bangkok Bank of Commerce was horrendous, bordering on malfeasance. BBC was allowed to continue plundering public deposits until it racked up Bt90 billion in financial damages by 1995, although it should have been declared technically bankrupt in 1992.

BOT supervision of the finance companies, several of whom will be running out of steam sooner or later, has also raised eyebrows. In 1978, the BOT limited the auto hire-purchase business of finance companies to 5 per cent of their shareholders' equity. It failed to follow up the spectacular growth of the risky hire-purchase business closely enough.

Between 1992 and 1994, the finance companies' total exposure to hire-purchase sky-rocketed. In 1992, exposure totalled Bt1.6 billion, before soaring sharply to Bt3 billion in 1993 and Bt8.7 billion in 1994. By 1995, the BOT put the brakes on the hire-purchase business by placing its growth limit at 15 per cent. As a result, finance companies' exposure to hire-purchase loans levelled off in 1995 at about Bt8.7 billion.

However, hire-purchase loans jumped again to Bt300 billion in 1996. The BOT did not realise that hire-purchase loans, considered non-productive credit, would create big problems later as they amounted to only 0.76 per cent of the total of Bt1.49 trillion in credit extended in the finance sector system.

On a case-by-case basis, however, hire-purchase is creating big problems for some finance companies. Finance One, for instance, extended 25 per cent of its Bt90 billion in loans to the hire-purchase sector, most of which went sour with the slump of the Thai economy.

BOT supervision of real estate credit was also dismal. Before 1990, finance companies' exposure to the real estate business was minimal. Now, real estate amounts to about 25 per cent of their total loans. With the collapse of the real estate market, these finance companies are being brought to their knees, dragging the Thai economy down with them.

A build-up of the finance companies' real estate exposure could be attributed to the BOT's tightening of its supervision of commercial banks in 1989-1990. Then, the BOT was telling banks to resist the temptation to make loans to non-productive projects, such as high-rise buildings or golf courses. Since speculative real estate developers could no longer get easy credit from the banks, they turned to the finance companies.

There was a yawning gap in supervision between banks and finance companies. A look at the statistics shows that finance companies' exposure to the real estate market jumped quickly as a result of this flawed supervision. In 1992, the exposure amounted to Bt120.7 billion, before rising to Bt163.8 billion in 1993, Bt239.7 billion in 1994, Bt325.9 billion in 1995 and Bt362.8 billion in 1996. Most of these loans are now non-performing.

By 1995, the BOT tried to control the damage by requiring 17 finance companies with assets below Bt20 billion to submit their credit plans for supervision. Again, although the BOT was trying to curb the ceiling of credit growth to shareholders' equity, it was not regulating the growth of the portfolios, which had been expanding in tandem with the Thai economy.

Nobody was questioning whether the spectacular growth in hire-purchase and real estate loans would be sustainable in the face of the economic slowdown. When the economy began to show signs of trouble last year, the asset quality of finance companies and banks almost immediately became a subject of prime concern.

Finance companies suffering from the current distress can also blame the government's murky policies. They are considered second-class banks. Since the scope of their financial services is limited, they are forced to venture into risky, non-productive sectors to muster expected returns to justify their higher costs of funds.

As finance companies become larger, they are obliged to increase their risky portfolios. Half of Finance One's lending portfolio went to hire-purchase and real estate loans, sectors that are most vulnerable to the economic slowdown. Fin-One's plight is symptomatic of the finance sector as a whole.