Bouncing back: Despite the aftermath of the floods, the sector is posting solid numbers

In many ways Thailand’s banking sector looks much like those of its neighbours: tightly regulated, well capitalised and highly risk-averse. Just as in other countries in the region, including Malaysia and Indonesia, the 1997-98 Asian financial crisis had a formative effect on bankers. Risk management has improved since the crisis, and central bankers are focused on system-wide stability.

But banking in Thailand is also a notably Thai affair. Just 14.5% of assets are held by foreign banks. Outsiders are subject to restrictions on branches and services. Among those foreign players who have chosen to buy a domestic bank instead of waiting for laws to be liberalised so they can build their own network, there are few success stories so far. Further, the local preference for domestic banks comes not just from the laws and regulations but from the people themselves, who have demonstrated a lower comfort level with foreign lenders.

COMING COMPETITION: The market is set to open up to more foreign competition in 2015, but for now the Bank of Thailand (BOT), the central bank and regulator, is not issuing new licences. With 2015 approaching, Bangkok’s financial-services community has been pondering the possibilities. Most conclude that few foreign banks will challenge local banks’ dominance in the retail market. Buying in by acquiring a domestic bank is also harder now than in the past, as most big lenders are well capitalised and do not need outside funding. Likewise, incorporating several smaller players into one organisation would be complicated and costly.

Sector fundamentals were stable and improving as of early 2012, with an overall expectation for significant returns in the early part of the year, based on flood-recovery activity and pent-up demand. This should be followed by a more muted pace of expansion in the second half of 2012. At the end of the first quarter of 2012 loan growth was up 14.2%. Net interest margins are expected to contract, but were little changed from the end of March 2011 to the end of March 2012, moving from 3.01% to 3.02%.

FLOOD IMPACT: In response to flooding during the third quarter of 2011 the BOT encouraged lenders to close threatened branches but to keep payments systems functioning, and banks themselves were not profoundly impacted. Indeed, according to the BOT, in early November 2011 there were 710 branches closed due to damages; just two weeks later that number had shrunk to 346.

The central bank issued several directives and non-mandatory reforms for the nation’s banks, to minimise disruptions in the system. It suspended a rule capping loans to retail customers at 5% of their salary, so that consumers can take on additional debt to recover their losses faster. It also allowed banks to restructure debt, so as to extend payback periods by up to 12 months.

These and other measures to allow affected debtors more flexibility for repayment are meant to limit the system-wide increase in non-performing loans (NPLs) to a blip instead of a spike. As of September 2011, the ratio of net NPLs in the system was 1.63%, according to the BOT.

PREDICTIONS: At the country’s major banks, few expected a worst-case scenario to emerge. Instead of the double-digit NPLs many predicted elsewhere, banks assumed a bump of a few percentage points at most. At Bangkok Bank, the country’s largest, the prediction was for a 0.5% increase. Kasikorn Bank, a market leader in lending to small and medium-sized enterprises (SMEs), said in late 2011 that some 240,000 SMEs in 32 provinces had been impacted. It offered clients several mitigation measures, such as a principal-free grace period of six months for credit lines and flood-relief loans at low rates.

A CHALLENGING TASK: Year-on-year comparisons of Thai banks are difficult to make, but not just because of the flooding. The year 2011 was not going to be a normal one, due to the political crisis in 2010 leaving a degree of pent-up demand. Likewise, only recently has the central bank mandated the adoption of 38 accounting rules set out in the International Financial Reporting Standards. The harmonisation should help make comparisons of Thai banks to foreign ones easier. The new accounting methods are being implemented from 2011 to 2013, and lenders shifting their balance sheets means comparisons will be less telling than normal. Of the rules, 29 were scheduled for adoption in 2011, with the rest becoming mandatory in 2013. Therefore, a true picture of Thai banks’ performance may not be available until 2014.

It is clear, though, that Thai banks have proven resilient after prospering through a number of shocks to the economic system over the past 15 years. “Thai banks are very healthy,’’ Kasem Prunratanamala, the head of securities at CIMB Securities (Thailand), told OBG. “We learned our lesson in the Asian financial crisis. This time around we may see NPLs go up for a quarter or two, but that’s it.’’ SIZE & SCOPE: As of late 2011 there were 15 commercial banks in Thailand, with no expectations that new licences would be issued over the next few years. The BOT divides the 131 entities it regulates into 13 categories. Beyond lenders such as the commercial banks, foreign branches, non-bank financials and finance or leasing companies, the list includes asset-management companies, specialised financial institutions (see analysis), the National Credit Bureau and fonciers.

While rankings are somewhat fluid, four of those commercial lenders control approximately 75% of total assets: Bangkok Bank, Siam Commercial Bank, Kasikorn Bank and Krung Thai Bank, which is the only state-owned lender among the four. Siam Commercial Bank is the largest lender, while Kasikorn is known for its focus on SMEs. Bangkok Bank was a pioneer in the 1940s in competing with foreign interests, heralding the eventual return to local control of the financial services market.

FOREIGN INSTITUTIONS: The small foreign presence includes HSBC and Citibank, as well as some non-bank firms such as GE Capital, the financial-services arm of US-based conglomerate General Electric. (GE Capital previously had a credit-card business it sold to Bank of Ayudhya in exchange for a 32.9% stake in the local lender, making it effectively the controlling shareholder.) The US firm is in the same position as other foreign owners of local banks, such as the Bank of Nova Scotia, Malaysia’s CIMB, Singapore’s United Overseas Bank and the Netherlands’ ING. Each of these ownership arrangements was finalised in just the last few years, so the success of buying in through a local bank is still to be determined.

However, it appears unlikely that the model can be replicated – there were few other major banks offering a nationwide retail network and a universal model that were candidates to be bought until March 2012, when an opportunity became available. ING Group said it would put its stake in TMB Bank, worth about $775m, up for sale, saying it needed the money to repay the Dutch government for a 2008 bailout. Interested buyers reportedly included the Korean Development Bank and Malaysia’s Maybank, which also owns Kim Eng.

Other international banks that have branches in Thailand include BNP Paribas and Deutsche Bank. Another way foreign banks are looking to enter the market is through securities and investment banking, as Thai banks are not allowed to offer investment-banking services on their own (though they can own subsidiaries offering them).

FOCUS ON FEES: One major trend in recent years, in line with banking sectors worldwide, is an increasing reliance on fee-based income. Charges for services are a reliable earnings stream, because they are not subject to changing interest rates.

According to research by Goldman Sachs, among the banks reporting the biggest profit increases in the third quarter of 2011 were those with the largest jump in their fee-based income. Such fees have drawn attention from non-bank financial companies, as well as large retailers.

“Competition is quite fierce on fee-based income and non-banks are coming into this space,” Kasem told OBG. “Companies like [hypermarket chain] Tesco have launched Visa cards, so banks are also competing with non-banks in certain segments.’’ MASTER PLAN: The sector has grown in line with the BOT’s Financial Sector Master Plan, which began implementation in 2004. Phase one, which ended in 2010, featured an evolution of banks from specialist lenders to universal providers.

The second phase extends from 2010 to 2014. The idea for this stage is to cut costs, streamline operations, gain efficiencies and promote further consolidation. This has included reviewing regulations that encourage efficiency, promote competition and expand available services. Banks with limited licences are encouraged to apply for less-restrictive ones, so long as they meet established capital requirements.

Another key feature of the second phase is the shedding of NPLs and assets. Among the country’s five largest banks, the NPL ratio was between 2.1% and 3.8% as of late 2011, the majority of it in foreclosed real estate. According to the master plan, banks should write off these properties and partner with agents to sell them.

The second phase also comes with a loosening of restrictions on foreign banks, which were previously limited to a single branch. Now foreign banks can have up to three branches, and both Citibank and HSBC have already begun expansion.

By the end of the second phase of the plan in 2014, foreign banks can apply to make their Thai operations subsidiaries and be allowed to open up to 20 branches and have as many as 20 ATMs in locations outside branches. The central bank will also consider new licence applications and allow foreign banks to compete on an even footing.

INTERNATIONAL INTEREST: Some of the world’s biggest banks have been keen to expand in Asia, believing it as good source of capital through deposits. Many see the region’s inhabitants as savers instead of spenders, and find attractive the stability these economies had following the global financial crisis. However, as of late 2011, few in Bangkok expected more than one or two banks to contemplate entering the market in force. Conventional wisdom is that competing for retail customers would require at least 500 branches, and there are not commonly acquisition opportunities at that level.

Further arguments against new branches include a tax incentive for them that recently expired. There was a wave of branch building timed to get the incentive before it ended, so foreign banks choosing to chase the retail market would be competing with banks that financed their expansions at a lower cost, already enjoy a first-to-market advantage and have brands, reputations and the extra favourability coming from domestic ownership. The investment also lacks immediate payback. Mark Arnold, the Bank of Ayudhya’s CEO, told OBG it generally takes three years for an investment in a new branch to add to earnings. “We are seeing some repositioning of certain foreign banks such as HSBC and we expect more expansion from ASEAN banks and possibly new market entrants over the medium term,” Darren Buckley, the country head of Citibank Thailand, told OBG. “But we also expect to see Thai firms move to invest more in international markets, and continued liberalisation in Thailand will allow foreign banks to play an increasingly important role in this market.”

HIGH HOPES: Nonetheless, the BOT hopes the master plan’s approach to sector liberalisation will bring to Thailand the benefits of having the world’s largest lenders. They are generally valued in developing and middle-income countries for their ability to push innovation and efficiency in the local market and to increase global interconnectivity.

“The increased competition is consistent with the policy to enhance the competitiveness of Thai economy in the environment of increased globalisation and regional integration,” Prasarn Trairatvorakul, the governor of the BOT, told OBG. “This is where the Thai businesses will need to enhance their regional trade and investment strategy, with both out-in and in-out direct investment as well intra-ASEAN trade.”

The intent is to have the master plan and its effects – a liberalised sector in which foreign and local banks compete on an even footing – in place before the next major reform, scheduled for 2020. That is when the banking sector will be subject to the rules of the ASEAN Economic Community, the regional economic bloc. Most areas of the economy will be subject to a free-trade pact by 2015, but the impact on the banking sector was delayed until 2020.

MEDIUM-TERM SOLUTIONS: Until then, a halfway solution called Qualified ASEAN Banks may affect the market. The standards for acquiring this designation have not yet been set, and negotiations about it are ongoing, but those who meet the criteria will get licences to operate in participating countries.

Bank fees, which have been another area of concern, are also in the spotlight. However, some argue that while bank fees in Thailand appear high, the numbers actually make sense in context. “Commentators who say that Thai bank fees are too expensive only look at one side of the issue,” Kannikar Chalitaporn, the president of Siam Commercial Bank, told OBG. “High costs mean that operating margins in Thailand are some of the lowest. It costs roughly BT1000 ($31.90) to refill one ATM, while rents in prime locations (like next to a 7-Eleven in central Bangkok) can reach BT20,000 ($638) a month.”

CAPITAL MARKETS DEMAND: Another smaller upcoming reform – the curtailing of deposit insurance – looks set to change the composition of banks’ balance sheets by cutting the size of current and savings accounts. While that may further erode the attractiveness of retail banking for international entrants, it should service another goal – broadening the depth of offerings in the capital markets.

In concert with a series of reforms to the Stock Exchange of Thailand (SET) and other capital markets organisations, the BOT will reform deposit insurance in 2012 by capping it. Currently bank deposits can be fully insured up to BT50m ($1.6m), and that cap will change to BT1m ($31,900) in August 2012. The BOT’s intent is to encourage savers to take on more risk, in the process funnelling their money towards the stock market, bonds and other investment opportunities in the capital markets.

By creating more demand for securitised investment the sector authorities hope that large-scale commercial clients will get past their current reliance on banks for financing and explore other channels. The Ministry of Finance, for instance, has floated the idea of an infrastructure fund. Consumers could buy units in such a fund and their money would go toward infrastructure projects. The immediate impact on the banking sector may, however, be an even greater concentration of deposits amongst the country’s largest banks, with customers migrating because of their lower risk of failure.

LENDING: The high loan growth reported by the BOT for the first three quarters of 2011 (17.3%) is an anomaly. That pace, more commonly associated with less-developed markets in which banking penetration rate is lower, was due to pent-up demand left over from 2010. Consumers and businesses that pushed off decision making and spending for the most part ended up completing those plans in 2011.

For 2012 several banks are predicting loan growth in the high single digits – Bangkok Bank in December 2011 forecast credit expansion for the coming year at around 6-8%. The bank’s loan-to-deposit ratio was at 100% at the end of the first quarter. Among the largest banks, the top end of the range was Bank of Ayudhya, at 124%. Bangkok Bank had the lowest ratio, at about 87%.

The NPL ratio is not likely to increase by more than a few percentage points, however. Bangkok Bank forecasts a 0.5% increase for its loan portfolio, while Kasikorn Bank executives told local media they expected no uptick in defaults because of mitigation strategies the lender is offering its debtors.

SMES A SPECIALITY: Kasikorn had been expected to suffer a greater impact than most because, in comparison to the sector as a whole, a larger portion of its credit has been extended to SMEs, who were disproportionately hit by the flooding.

Thailand’s lending market is traditionally one in which the fourth quarter is the most active. Because of the flooding in 2011, many expected that the first half of 2012 would be a busy time for commercial loan departments, as companies would be in need of capital to rebuild facilities.

Commercial loans comprise about three-quarters of the total, according to the Ministry of Finance, and while the long-term plan is to coax borrowers into securitised financing, a short-term impact on the lending mix does not appear likely.

Lending to SMEs is a sector dominated by Kasikorn Bank, with about a quarter of the market. Kasikorn uses a scorecard approach to evaluate SMEs, and provides tailored services such as specialised accounts and training sessions. The government has used incentive and guarantee schemes to help boost loans to SMEs, currently around 4%.

RETAIL: Two measures are likely to increase retail lending in 2012, both involving tax credits. First-time car buyers can take advantage of a scheme established in September 2011 and set to expire in December 2012 that provides a tax rebate of up to 16% of the value of the vehicle.

To qualify for the tax credit, buyers must be at least 21 years old and spend no more than BT1m ($31,900) on the car. For saloon cars, engine size cannot exceed 1500 cc. Transfers of ownership are prohibited for the first five years of ownership.

A study by the Thai research department of Citibank projected a 20% increase in sales due to the rebate, on top of an existing 20% year-on-year increase in car sales as of August 2011. This, again, can be partially attributed to pent-up demand from 2010.

This incentive’s structure will likely encourage people to buy saloon cars and large pick-up trucks instead of small vehicles – Citibank’s study calculates that, depending on the price of the car, saloon or double-cab pick-up buyers will end up with a tax rebate of 12-16%, whereas those buying two-seat trucks will see a savings of only around 3%.

Citibank’s research forecast less impact for the other retail scheme, a tax deduction for first-time home buyers in 2012. They will be allowed to deduct 10% of the home’s value from taxable income over the next five years, to a maximum of BT500,000 ($15,950). This incentive would make a significant impact only for those that are paying tax at a 20% rate or higher, which rules out all but a “minimal number of income earners’’, according to Citibank’s research. For those earning under BT500,000 ($15,950), the tax credit as a percentage of the home’s value would be 1% or less.

Unlike most of the rest of the banking sector, credit cards are an industry in which foreign players have so far set the stage for further development. Citibank, GE Capital and others were early leaders, but the market has now broadened. As of late 2010 there were more than 14m cards in circulation and 15 providers, including banks and 11 companies licensed specifically for this service. Companies are now focusing less on new accounts (the amount of take-up is less than 1m a year) and more on getting additional usage from current customers.

OUTLOOK: The impact of flooding in the fourth quarter of 2011 was generally modest. If banks continue to show solid earnings, or at least minimal impact from the floods, that episode seems likely to serve as another reminder of the stability and resiliency of the country’s banking sector. Having been the victim of a series of crises, capital flight and hot money in the past, the basic principles of prudence and risk management seem well respected across Thailand’s banking scene. In the short term, reconstruction work may give the sector an added boost.