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PolicyFebruary 1 2010

Government effects reform despite recent turmoil

Build up: reinforcement of the Thai financial sector is planned to pave the way for increased international tradingUnfazed by continued political and economic turmoil, Thailand is embarking on major deregulation to strengthen its banking and finance sector and, in the grander scheme, to diversify the country's economic base. Writer Michelle Price
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Government effects reform despite recent turmoil

The New Year is a critical period in Thailand's economic calendar as wealthy Western tourists pour into the south-east Asian country making for a vibrant, if often over-crowded, atmosphere in the country's urban hotspots. But the hubbub found in Bangkok or Chiang Mai belies the underlying political turmoil and economic malaise that has resulted in a testing two years throughout the country. Nevertheless, Thailand's government has not been deterred from advancing with major financial sector restructuring: indeed, 2010 marks the beginning of a five-year period of ambitious banking and capital market reform that the government hopes will form the basis of future economic growth.

Since the bloodless military coup of 2006, Thailand's economic performance has been frustrated by severe political discord and civil unrest. While Thailand's south-east Asian neighbours enjoyed boom-time economic expansion upwards of 7% for the years 2006 and 2007, Thailand experienced solid but unremarkable gross domestic product (GDP) growth of 4.5% and 4.8%, respectively. The situation has not been helped by the global economic slowdown. Dependent on exports for some 70% of its economic output, the south-east Asian nation has been assaulted by the collapse in global trade, which caused a 3.5% decline in GDP growth for 2009, according to the International Monetary Fund (IMF).

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Tarisa Watanagase, governor of the Bank of Thailand

Disaster averted

Led by finance minister Korn Chatikavanij, the Thai Ministry of Finance (MoF) has succeeded in averting economic disaster, however, through an aggressive and extensive stimulus package comprising social welfare and infrastructure spending married with a range of tax cuts and cash credits. "The first six months of 2010 will be quite upbeat due to the stimulus measures," says Ekniti Nitithanprapas, executive director of the macroeconomic policy bureau at the MoF. The IMF forecasts GDP growth of an encouraging 3.7% for the year.

Amid the political and economic instability, the Thai banking sector has stood strong, boasting a Bank for International Settlements (BIS) ratio of 16%. Since the country's febrile political atmosphere has weakened investment and consumer confidence in Thailand, the country has not experienced an asset bubble. This has allowed for a benign credit environment, in spite of the macroeconomic slowdown, as illustrated by the banking system's gross non-performing loan (NPL) ratio, which has remained steady, hovering at about 5.4% for 2009.

Although lending growth has been flat in recent quarters, it is forecast to return to about 6% to 7% for 2010. "The banking sector has been resilient, which I attribute to the efforts that the regulators and the banks have taken to reform the sector after the Asian crisis," says Tarisa Watanagase, governor of the Bank of Thailand (BOT). "Many years of hard work have started to bear fruit. The banks have focused on risk management, stress testing, and the increased supervisory role of the board of directors. These things don't show up in the numbers, but they are even more important than the quantitative measure," she says.

The BOT's Financial Sector Master Plan I (FSMPI), implemented between 2003 and 2008, proved one such important reform programme for the sector, setting strict minimum capital levels, sharpening the definition of commercial and retail banks, and encouraging banks to either expand nationally or transform into smaller credit providers. Most notably, the programme brought about much-needed consolidation, halving the number of second-tier banks and finance companies. As a result, the country's top four lenders now account for some 60% of sector assets, according to Moody's. "Now, in a sense, we have cleaned up our own home and the banking sector is ready for the next step," says Ms Tarisa.

Stepping out

Thailand's next step is a big one, comprising a bold period of liberalisation that will see not merely the banking sector but the financial services industry at large thrown open to increased competition and foreign investment. Underpinned by two major pieces of regulatory reform, the Financial Sector Master Plan II (FSMPII) and the Capital Markets Development Master Plan (CMDMP), this process of liberalisation, it is hoped, will provide a springboard for broader economic growth through the diversification of the country's economic base.

The FSMPII, devised and overseen by the BOT, aims to further strengthen the fundamentals of the Thai banking sector and prepare it for a raft of new players. These goals will be achieved through three phases, or so-called 'pillars': the first aims to reduce system-wide operating costs principally through the harmonisation of regulatory rules, the divestment of non-performing assets and the system-wide reduction of non-performing loans; the second will increase competition through the granting of new licences to domestic and foreign institutions, as well as promoting greater financial access to the 9% to 15% of the country's population that remains unbanked; the third pillar will see the sector's infrastructure reinforced with a specific focus on upgrading risk-management controls and IT.

"Each stage further raises the standard of Thai banks in preparation for the eventual entry of Thai banks into the international arena," says Tan Kong Khoon, the outgoing president and CEO of Bank of Ayudhya, the country's fifth largest commercial bank.

Both foreign and local bankers are broadly positive toward the FSMPII, which they regard as a necessary means by which to both strengthen and expand the sector. "But there are threats too," says Apisak Tantivorawong, president of Krung Thai Bank, the country's second largest lender by assets. "There will be more competition, especially from foreign banks, so we have to prepare ourselves," says Mr Apisak, whose bank is working hard on the retail side of the business to enhance the stickiness of its customer base in anticipation of more foreign competition.

Wider benefits

Indeed, for foreign players, which currently account for just 13% of system assets, according to Moody's, the benefits of the plan are clear-cut. "The FSMPII has a number of elements that are of interest to us," says Peter Eliot, CEO of Citi Thailand, the largest foreign bank in Thailand, principally the potential for Citi and other existing foreign players to locally expand their existing branch networks and product ranges. "We are delighted that the Bank of Thailand is going to allow us to apply for additional branches," says Mr Eliot.

Prior to 2008, the government imposed a 25% cap on foreign stakeholdings in local banks which was raised in 2008 to 49%. Speaking to The Banker in October 2009, Mr Korn said that the government is keen to attract new foreign entrants as only foreign banks are large enough to challenge the expansive network and franchises of the country's top five local lenders. In order to entice new players, foreign banks will be allowed to bid for the government's stakes in local banks that were recapitalised during the Asian financial crisis. "They are moving in the right direction, slowly and cautiously, but in the right direction," says Mr Eliot.

In search of clarity

But some local bankers believe that the FSMPII's vision of increased competition remains ambiguous. According to Prasarn Trairatvorakul, president of Kasikorn Bank, the country's third largest lender by assets, the government's desire for more players and the resulting fragmentation this will create seems to conflict with the consolidation achieved by the FSMPI.

"I have mixed feelings towards the announced FSMPII: it is drawn up with good intention, but I think that there are still some points, from the angle of practitioners, that we are seeking some clarification on," says Mr Prasarn. Reducing system-wide operating costs may also prove a challenge in the current global regulatory environment, he adds. "After the global financial crisis, there is talk of increasing capital requirements and becoming more stringent and, on the other hand, [the BOT] wants to lower operating costs," he says. "One can't avoid thinking: how can they achieve this goal?"

At the BOT, however, this is less a concern than the issue of financial inclusion. According to Ms Tarisa, expanding financial access will likely prove the most challenging aspect of the plan. "It is difficult because when we talk about increasing financial access, these are mainly people in the rural areas and the low-income segment. For the traditional banking model, these are people that are difficult to reach." Traditionally, the work of enfranchising the rural poor has been performed by specialist financial institutions, but this sector is very small, says Ms Tarisa. "If you really want to expand the region, you really have to try to get the commercial banking sector to play a bigger role. This is something that both the regulators and the banking system have to work together on to see if there are some business models that might be applicable to our conditions," she says.

There is encouraging evidence, however, that some local banks are already making efforts in this respect. Krung Thai Bank, which is 54% state-owned, regards the microfinance sector as a potential area of expansion, says Mr Apisak. "We need to expand and those are areas that we are looking to expand into, but it has to be the right model that is commercially viable." The bank has sent a team to Indonesia to study what Mr Apisak describes as the "success factor" found at major microfinance players such as Bank Danamon and Bank Rakyat Indonesia. "It may be that the environment is different in Thailand to Indonesia, but the countries must have something in common - but it is still in its very early stages," he says.

The economic slowdown combined with Thailand's volatile political atmosphere may, however, prove the biggest obstacle to realising the government's ambitions for the sector. "With the recent economic slowdown, there will be increased resistance to market liberalisation," says Mr Tan Kong Khoon, who left Bank of Ayudhya at the end of 2009. "Moreover, with political tension continuing, albeit with lower intensity, there might be delays to the actual implementation of each stage of the plan," he says, "but I believe that there is determination to successfully complete this well-crafted plan."

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Veerathai Santiprabhob, executive vice-president and chief strategy officer of the Stock Exchange of Thailand

Preventing stagnation

But the FSMPII is not the biggest step confronting the Thai financial services sector. The most dramatic reforms will take place in the country's capital markets under the five-year CMDMP, which was approved by the Economic Cabinet of Thailand in November 2009. The Thai capital market has historically played a limited role in the wider Thai economy, with its capitalisation accounting for just 80% of GDP and the country's top five banks acting as the principal source of project funding and liquidity.

"Everyone in the Thai capital market realises that it might enter a phase of stagnation and marginalisation," says Veerathai Santiprabhob, executive vice-president and chief strategy officer of the Stock Exchange of Thailand (SET). The CMDMP, the ultimate goal of which is to boost Thailand's capital market capitalisation to 130% of GDP by 2015, aims to avert stagnation through a range of 'big bang'-style reforms designed to address both demand and supply-side weaknesses.

These weaknesses include too few institutional investors, a small retail investor base, a limited range of financial products, high transaction costs, obstructive tax laws and poor enforcement. "The objective of the plan is clear," says Thirachai Phuvanatnaranubala, secretary general of the Thai Securities and Exchange Commission (SEC), which is overseeing the implementation of the CMDMP. "People who need capital should be able to raise it conveniently, competitively and at low cost, and people who save must have venues to make their investment also at competitive rates and low costs."

Among the various measures outlined by the plan, the key reforms include: the demutualisation of the SET and the opening up to new trading venues; the liberalisation of the securities business, including a new structure for brokerage fees and the granting of new licences to securities firms based, as Mr Thirachai explains, on a "fit and proper" criteria with no cap on the number of securities firms allowed to operate; critical reforms in the country's legal framework, including changes to promote merger and acquisition activity, reforms to streamline the country's tax system and to improve the SEC's enforcement capability; the creation of a range of new products to encourage capital-raising activity, including the promotion of the domestic bond market and venture capital, as well as the divestiture of the MoF's shareholdings in publicly traded companies; and the establishment of a National Savings Fund to cover the 70% of Thais who have no formal retirement fund, thereby expanding the domestic institutional investor base.

Initially, however, the SET will bear the brunt of these reforms. As of June 2009, the market capitalisation of the SET has accounted for just 51% of Thailand's GDP. Compare this with the Singapore Stock Exchange, south-east Asia's biggest market, the capitalisation of which accounts for 202% of the country's GDP and a good chunk of which has been gained at the expense of other regional exchanges including the SET.

Ever-increasing competition from such neighbouring exchanges, not only for regional listings but for foreign investor inflows from elsewhere in the world, is a growing concern for the SET, says Mr Veerathai. "Exchanges in the region will become much more aggressive, with competition growing during the next few years. Exchanges that are most efficient and have the largest investor base will be able to attract good companies," he adds.

In order to achieve this efficiency, the exchange will follow the majority of its Asian peers and be demutualised and listed on its own market by the third quarter of 2011. According to Mr Thirachai, the corporatisation of the SET is a critical first step due to the institution's stranglehold on product supply. "I have been in this role for six years and it took me a few years to realise that the only people who are capable of creating new products in Thailand is the exchange," says Mr Thirachai. "They have been very, very slow because they had not been concentrating on making profit, and living and dying by having new business [lines] and new products. That will have to change and it will change with the new mandate," he says.

The SET's Mr Veerathai agrees that the SET has suffered from a "lack of focus" due to its dual role as both an exchange and as an agent of capital market development, which requires the SET to undertake a broad range of educational and general developmental work. This semi-mutual, semi-public structure, as Mr Veerathai describes it, will not support the SET's competitiveness over the long term, he says. For this reason, the corporate structure of the exchange will also be overhauled under the demutualisation plan, with the SET's capital market development activities transferred into a new entity called the Capital Market Development Fund, with a broader remit dedicated not only to the equity markets but to the capital markets at large, says Mr Veerathai.

Perhaps more striking, however, is the government's move to open up the domestic equity market to competition from the types of alternative electronic trading venues that have transformed the cash equities markets in both the US and Europe. While Asia's equity markets have seen pockets of competition emerge during the past year, few, if any, Asian regulators have so explicitly thrown open the market to alternative players. The SEC has not yet received advances from the likes of rising star Chi-X Global or any other alternative trading venues, says Mr Thirachai, "but we are open to anyone coming along and offering an electronic platform - after we have amended the law."

Different this time

The government's grand ambitions for the financial services sector have provoked scepticism among some local practitioners. This is not the first occasion on which a Thai government has outlined capital market reforms, they observe, while the political atmosphere is hardly conducive to the legislative changes that the CMDMP demands. Brokerage fees, for example, have been unsuccessfully restructured by previous governments, who were forced to retrench amid strong market dissent. Kasikorn Bank's Mr Prasarn, who was formerly the secretary-general of the SEC, says his own agenda some 10 years ago was not much different to the current plan.

In particular, some local bankers believe that stimulating the supply side of the equation will prove extremely challenging. "The problem with our stock market is that there are too few players. Those who would be listed have already been listed. If the economy doesn't pick up then the chance of having new players is limited," says Vichit Suraphongchai, CEO of Siam Commercial Bank, the country's fourth largest lender. Citi's Mr Eliot also says that extremely low interest rates continue to make bank lending a more attractive source of funding. "Companies have to question whether they want to sell their companies versus borrow at very low rates," he says.

The government is attempting to directly address this issue, however. The MoF holds considerable stakes in some listed entities which it plans to sell onto the market. It seems unlikely, however, that other state-owned companies will be privatised any time soon, says Mr Veerathai. "We have to accept that in the current political environment, the privatisation of state-owned companies is not well-received." However, as the government will need to raise funds to support public investment programmes, the MoF is looking to create a list of potential subsidiaries of state-owned companies that may be listed on the SET.

Early signs

To a large extent, the success of the CMDMP will be determined by the broader performance of the Thai economy, but some local bankers already see encouraging signs of capital markets growth. "Achieving the five-year masterplan's overall objective won't be easy," said Chartsiri Sophonpanich, president of Bangkok Bank, the country's largest lender, in a written note. However, he adds that bonds currently make up about one-fifth of corporate funding and this figure has been steadily rising in recent years: "We expect this to continue, possibly eventually reaching the 30% to 50% level, which is more usual in developed countries." The retail investor appetite for corporate bonds is also growing, according to Bangkok Bank.

But at the heart of the issue, says Mr Prasarn, is the political commitment that such a transformative plan requires. Even within the SET, there has been some resistance to the plan, says Mr Thirachai. But he is heartened by the political leadership provided by Mr Korn, whose background as a JPMorgan investment banker brings with it a unique level of both understanding and commitment to capital market development. "On the whole, I think we are still on track. We are going round to various organisations like think tanks in Thailand to try to explain the rationale and the process. We still have to work hard, but I think we are winning."

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