Relaxing the rules: Foreign direct investment in the sector is set to increase

As the Bank of Thailand (BOT) gradually reduces constraints on foreign direct investment (FDI) in the banking sector, Asian banks are proving the keenest to tap opportunities. A key plank of the regulator’s second Financial Sector Master Plan (FSMP) is to reduce costs and enhance the competitiveness of Thai banks by allowing more foreign entrants. While it plans to award five new foreign commercial bank subsidiary licences in 2014, more aggressive investors are seeking majority equity stakes in existing Thai lenders. As foreign banks’ share of commercial banking assets increased from 19% to 26% in 2013, according to BOT data, following the acquisition of Bank of Ayudhya (BAY) by Japan’s largest bank, Mitsubishi UFG Financial Group (MUFG), competitive pressures are only set to grow. “The BOT strategy has been clear: they will allow the entrance of new foreign banks if this leads to an increase in the efficiency and stability of the system,” Deepali Seth-Chhabria, a Mumbai-based analyst at Standard & Poor’s, told OBG.

Four Hybrids

While the 2007 Financial Institutions Act allows bank investors to exceed the 49% FDI cap with special permission from the finance minister, this permission has only been granted in the case of four banks sold by the Financial Institutions Development Fund (FIDF), the BOT fund empowered to resolve bad assets leftover from the 1997-98 financial crisis. These included the UK-based Standard Chartered’s acquisition of 75% of Nakornthon Bank in 1999, raised to a 99.87% stake in 2005; Singapore’s United Overseas Bank’s (UOB) purchase of a 99.66% stake in Bank of Asia in 2004 and its integration with UOB Radanasin Bank in 2005; Malaysia’s CIMB Group’s acquisition of 93% in Bank Thai in 2009; and the Industrial and Commercial Bank of China’s (ICBC)’s acquisition of 97.24% of ACL Bank in 2010. The four hybrid banks with a majority foreign ownership have remained largely focused on key urban markets in Bangkok and major secondary cities, targeting higher-income retail, small and medium-sized enterprises (SMEs) and larger corporate markets.

While the four banks have expanded their loan books since acquisition, all have struggled to mobilise deposits from Thai clients who traditionally deposit savings with Thai-owned lenders, however. While other foreign investors purchased equity stakes in Thai lenders, such as GE Capital in BAY (33%), ING in Thai Military Bank (TMB, 31%) and Bank of Nova Scotia in Thanachart Bank (49%), these remained minority positions. Meanwhile, 15 foreign banks maintain branches in Thailand (including five European, three Japanese and three from the US), accounting for roughly 13% of commercial bank assets, according to BOT data.

Branch To Subsidiary

While foreign branches were allowed to open a second branch from March 2010 onwards, the BOT unveiled plans under its four-year FSMP2 to 2014 to allow foreign banks with branches in Thailand to apply for a subsidiary licence. This new licence would allow foreign banks to open up to 20 branches and 20 off-site ATMs, although subsidiaries must comply with more onerous capital requirements: capital adequacy ratios of 12%, higher than the 8.5% required from domestic banks, paid-up capital of BT20bn ($654m) and a requirement to maintain non-performing loan (NPL) ratios below 3.5%. Eligible banks are those from countries with “significant business relations with Thailand”, those with free trade agreements with Thailand or those providing reciprocal access to their home markets for Thai banks.

Despite the regulatory change, no bank branch applied for a new licence until 2013. While 20 branches represents a tenfold increase in foreign banks’ reach, this remains too limited to roll out a convincing retail or SME strategy in the face of competition from more than 1000 branches operated by leading retail lenders such as Siam Commercial Bank, Bangkok Bank or KasikornBank. Yet as foreign bank branches including Deutsche Bank beef up their investment banking capacity to capture a growing share of cross-border merger and acquisition deals, a wider domestic footprint could yield fruit. “The cross-border transaction element is where we see the greatest potential for progress,” Frank Krings, chairman of the Association of International Banks (AIB), said. In early 2013 the BOT reported receiving applications for five foreign subsidiary licences on offer and expected to award licences by the end of first-half 2014.

A Landmark Deal

Aside from minority stakes in lenders such as TMB, BAY and Thanachart, the four foreign majority-owned lenders remain small. In a landmark deal announced in June 2013, MUFG announced its intention to acquire 75% control of BAY, the fifth-largest domestic bank by assets, acquiring GE Capital’s reduced 25.33% stake (after its sale of 7.6% to institutional investors in 2012) and tendering for up to the remaining 50% free float on the stock exchange. Beating a rival bid by Maybank, MUFG agreed to preserve the Ratanarak family’s minority shareholding (25%) and gained the finance minister’s approval in August 2013. Valuing BAY at 2.02 times book value, yielding GE Capital $2.41bn and up to $3.2bn for minority shareholders, the deal is more expensive than past acquisitions on the Thai market but forms part of MUFG’s regional strategy. As part of the deal, to comply with the BOT’s single presence policy, the acquired BAY will incorporate the existing Bank of Tokyo Mitsubishi UFG (BTMU) branch specialised in wholesale banking for Japanese corporates, with BT602bn ($19.7bn) in assets (55% of BAY’s) as of April 2013. While the 580-branch BAY has carved a strong niche in retail and SME lending, leading the used car financing market and second in the automotive credit market overall, MUFG’s competitive edge in corporate banking and access to wholesale funding will create significant synergies.

“MUFG’s acquisition of BAY could be a threat to the big four, particularly given its potential to raise the benchmark deposit rate for all lenders,” Peach Patharavanakul, research analyst at Deutsche TISCO Investment Advisory, told OBG. While competitive pressures may take time to materialise given the year-long integration process, MUFG plans to develop BAY’s regional reach in the Greater Mekong Sub-region.

TMB Sale

Having launched unsuccessful attempts at acquiring the finance ministry’s 25% stake in TMB, Dutch lender ING announced its intention to dispose of its 31% stake (acquired for €460m in 2007) in the Thai lender in 2012 to raise sufficient funds to repay the Dutch government’s bailout in 2008. The seventh-largest lender by assets in the first half of 2013, TMB is an attractive target for foreign banks seeking a sizable footprint, with 462 branches and a loan-book growing at 13.9% in 2012.

While TMB has historically had the highest NPL ratio of all privately held commercial banks, restructuring under new management since 2010 and NPL sales to the Thai Asset Management Corporation up to the fourth quarter of 2012 brought its NPL ratio down from 6.7% to 4.8% in the year to the second quarter of 2013. TMB also brought its provisioning for NPLs up to a similar level as its peers in 2012, with 3% coverage of NPLs. Given the finance ministry’s inability to sell its stake at a loss, below BT3.84 ($0.13) per share, any foreign institution bidding for majority control would need to tender for free-float shareholders’ stakes on the stock exchange or DBS’s 7.17% stake.

“A buy-out price of BT3.84 ($0.13) per share would represent a valuation of TMB at around three times book value, which would be high even compared to MUFG’s takeover of BAY,” Sasikorn Charoensuwan, the senior vice-president of research at Phillip Securities ( Thailand), told OBG. A bid at two times book value would prove more realistic, according to Bangkok-based bankers. Bidders having announced their interest in ING’s stake include Maybank, ICBC, Japan’s Mizuho Bank and the Korean Development Bank. The year 2013 proved a watershed for foreign banks’ participation in the Thai market. The finance minister’s approval of MUFG’s majority takeover of BAY reflected the government’s willingness to liberalise at a faster rate than envisaged in the FSMP2. Debate in mid-2013 focused on whether this signalled a new policy or a one-off approval – the former may encourage foreign investors like Bank of Nova Scotia to raise its 49% stake in Thanachart to a majority. New foreign subsidiary licences should meanwhile increase certain Asian banks’ participation. Awaiting full ASEAN-wide liberalisation of the banking sector by 2020, regional finance ministers were negotiating terms for Qualified ASEAN Banks which would be allowed to operate with more flexibility in ASEAN countries. More eager investors are not awaiting formal ASEAN liberalisation to bid for majority stakes in Thai lenders, however, with competition set to heat up on the domestic and regional markets in coming years.

“With the advent of the ASEAN Economic Community (AEC) from 2015 and beyond, we can expect continued economic development and prosperity across ASEAN, making it an even more attractive banking growth market in the future. As countries phase in further liberalisation plans over the coming years, we can expect to see the emergence of pan-ASEAN banking networks focused on serving the needs of clients across the region,” Darren Buckley, Citibank’s country head for Thailand, Myanmar, Cambodia and Laos, said.