Recent development in the Thai financial sector: lessons

Abstract

Financial stability is an essential condition for conducting efficient economic transactions. When financial stability is threatened, the financial sector cannot perform its intermediation role which allocates available financial resources to the most productive users. In recent months the Thai financial system has undergone through various crises: currency speculative attacks, sharp currency depreciation, bank runs, stock market crashes, rising non-performing loans, and economic recession. In March 1997, the Bank of Thailand announced the names of 10 finance companies which were undercapitalized and order them to raise their capital subsequently. By late June, the Bank of Thailand suspended 16 financed companies which severely suffered from the liquidity shortage, due to the eroding confidence of depositors and creditors. The Bank of Thailand and the Ministry of Finance announced that there would be no further suspensions and all depositors would be fully protected. In August, another 42 finance companies and finance and securities companies were suspended. The announcement has started off the systemic crisis of confidence in the financial sector, leading to deposit runs to from small financial firms to large banks and foreign banks. The Bank of Thailand tried unsuccessfully to recycle funds from large commercial banks and foreign banks to those small banks and finance companies which suffer deposit losses because of the bank panics. It was estimated that the Financial Institution Development Fund (FIDF), an operating arm of the Bank of Thailand, has lent 430 billion baht to the suspended firms and 300 billion baht to the 33 finance companies still in operation. As can be seen from Figure 1, the rapid increase in the BOT's development credit has become more pronounced since the beginning of 1997, when liquidity problems were intensified. It is noted that the net claims of the BOT on financial institutions remained stable due to the issuance of the Bank of Thailand bonds. The total net claims of the Bank of Thailand on financial institutions in October 1997 amounted to only 139 billion--the small amount which does not allude any degree of excessive bailout. This paper analyzes the causes of Thailand's financial distress and examines the macroeocnomic impact of the financial crisis. In addition to providing anecdotal evidence on how and why Thai financial institutions are facing financial difficulties, the paper argues that macroeconomic instability, technical mismanagement, and the lack of prudent regulation and quality supervision are responsible for the financial crisis in Thailand. The financial crises could have been averted or mitigated had the authorities anticipated and realized the severity of the problem. The current policy applied in response to the financial crisis is evaluated. The paper also discusses the likely outcome of the new financial environment and suggests that the remaining financial institutions would emerge as an efficient firms, capable of withstanding tough international competition in the future. The study draws lessons that other countries can learn from Thailand's past mistakes when facing with huge capital inflows, in particular during a long decade of high economic growth with stability in prices and the foreign exchange rate.