Thailand’s experience with financial services liberalisation

1. Thailand’s experience with financial services liberalisation WBI Trade in Services Course in Hanoi, Vietnam, May 23-27 2005. Jutamas Arunanondchai* Fiscal Policy Research Institute (FPRI), Bangkok, Thailand *The content is drawn from various sources: Mullineux, Murinde & Pinijkulviwat (200-); FTA Monitoring (2005); TDRI (2005); Sathirathai (2004); and Euromonitor (2004).

2. 3 types of financial service liberalisation • Financial service openings => market access by foreigners • Financial deregulation, e.g. lifting controls on interest rates and on activities of FSP • Capital account liberalisation => allow freer flows of capital

3. Thailand’s financial services • Divided into 4 groups • Banking • Securities and asset management • Insurance • Non-bank

4. Thailand’s financial liberalisation • 2 Phases • Between 1990-1997 (focused on banking) • Post-1997 financial crisis • Scope of liberalisation in the early 1990s • Scope of liberalisation post-1997

5. Scope of liberalisation in the early 1990s

6. Capital account liberalisation • Exchange control deregulation (IMF Art. 9) • 1990, Phase I: commercial banks can trade in foreign currencies for trade-related transactions • 1991, Phase II: • All exchange controls abolished and new ones introduced for reporting purposes only; • USD 10 m limit per annum for investment by individuals • Foreign funds can move in and out freely • 1992, Phase III: • Exporters can receive and make payment in Baht in addition to foreign currencies • Exporters can transfer foreign currency deposits for overseas debt payment

7. Financial service opening - BIBFs • In 1993, BIBFs were introduced to encourage capital inflows to finance domestic investment and throughout Indo-China region • 46 BIBF licenses granted • Income tax reduced from 30% to 10% • Permitted activities of BIBFs: • licensed banks use foreign funds raised overseas to lend locally (out-in) or to lend overseas (out-out) • Cross currency trading • Trade finacing on out-out • Loan syndication arrangements • Arranging issue of debt instruments • Engage in underwriting in foreign currencies

8. Financial service opening – BIBFs cont. • Prudential regulations relaxed, e.g. capital adequacy ratio, single lending limit (in view that BIBFs were supervised by authorities of the home countries). • ST debts increased markedly, most are rolled over for long term use

9. Financial deregulation - Interest rate • Until 1990, all deposit rates were capped • In 1989, deposit ceiling for >12 m increased from 9.5% to 10.5-11.0% to mobilise savings • 3-yr interest rate liberalisation plan (1990-93) • 1992, Ceilings on all bank deposits were abolished • Competition for deposits • 1992, Ceiling on lending rates for banks, finance etc. removed • Lower interest rates by BIBF led to stiff competition and borrowers can acquire cheaper loans.

10. Exchange rate system reforms • 1963-1977, Baht fixed to gold • 1978, Basket peg ($ weight = 0.85) • 1981-1984, Fixed to USD 1:23. • 1984, Basket peg

11. Further deregulations for banks • FDI abroad • Local banks were encouraged to open branches or form JVs (Mode 3) • In Indochina to channel BIBF funds towards • In financial centres to tap funds into BIBFs • 1992-1998, increased scope of activities • Allowed to establish mutual fund management companies with foreign analysts; • Arranging, selling and trading debt instruments • Etc.

12. 1997 Financial crisis • 1997-1998, Baht floated => volatile exchange rate • Huge capital outflows (non-renewal and repayment of ST loans) • Net outflows in 1997 USD 8.4 bill and on 1998 USD 16.0 bill • Mostly from the banking sector • 1999-present, net foreign exchange position limits imposed (15% limit for commercial banks) • due to surging volume of foreign exchange activities and derivatives trading

13. 1997 Financial crisis cont • In 1997, 12-14% deposit ceiling imposed to maintain stability. • 1997-1999, High interest rate policy to support Baht and FIDF. • Since 1998, restrictions on deposit rates reduced.

14. What went wrong? • Various factors are thought to have contributed to the crisis • Inappropriate government policies • Inherently unstable financial market • Herd behaviour of private agents => manias, panics and crashes (Kindleberger)

15. Inappropriate government policies • BIBF operations • Entry of foreign BIBF branches intensified competition => banks took excessive risks in borrowings and lending. • Moral hazard induced by fixed exchange rate (no hedging) • No restrictions from lending to domestic borrowers in USD • Mismatch in loan durations • Poor supervision of commercial banks and finance companies • Collaterals not properly valued

16. Perceived need to strengthen financial supervision and regulation in Thailand before further liberalisation. • “Crisis prevention” measures

17. Two-prong: ex ante discipline and ex post safety net • Ex ante discipline: emphasis on compliance to pre-set standards and codes + surveillance/monitoring mechanisms  Ex post safety net: emphasis on creating new safety net scheme • Trade-offs: moral hazard • Complementary

18. Current initiatives • International: emphasis on the first type (ROSCs, FSAP, Basle II, etc.) • Domestic: reforms to strengthen market discipline (new deposit insurance system, credit bureau, new asset classifications, new banking regulations, etc.) • Regional: surveillance (ASP, ASEAN+3 ERPD), regional safety net scheme (AMF/ CMI), and other types (ABMI).

19. Post-1997 • Further banking service opening • Allow 100% foreign ownership for 10 years • Foreign equity participation <49% in all financial sectors • Financial Master Plan (2004) • One full branch limit (minimum capital of Bt 3 billion) • Foreign bank subsidiaries allowed to open 4 branches (Bt 4 billion minimum capital) • IBFs (out-out; out-in) – no tax benefits for out-in transactions post-crisis (linked to mode 1)

20. Impact on banking industry so far • Increased foreign share ownership in top 4 banks (foreign ownership >40% for 3 of 4) • DBS, ABN AMRO, Standard Chartered and UOB became majority shareholders of 4 domestic banks • DBS divested in 2004

21. Commercial bank industry:Top 5 firms (2002)

22. Other impacts on banking industry … • Foreign banks and branches focus on: • retail banking, e.g. credit card services (decline in income threshold) • Institutional clients • Individuals with high net worth • Brought in technology and know-how ... • Personnel from various foreign banks have been head hunted by Thai banks (tech transfer);

23. Post-1997 policies and existing situation for credit cards • Credit cards • In 2002, minimum income restriction reduced to Bt 7,500 from Bt 15,000 • Rapid expansion of credit cards (before 2002, only 10% of population owned credit cards) • Strong growth amongst lower income consumers • Heavy competition => a move towards lower to middle income group to sustain growth • Deteriorating credit quality and higher risk of credit delinquencies • BOT raised concern over credit risk

24. Existing policies and situation for credit cards • New regulatory measures • 3% interest on cash advance fee • Minimum monthly income requirement at Bt 15,000 • 18% interest limit on revolving credit (some foreign FSPs were charging 27%) • Next? • Voluntary consolidation to strengthen portfolio? • Increased market segmentation; focus on niche market, e.g. young generation

25. Insurance service opening • Post-crisis, • DOI eased restrictions on joint-ventures, <49% • 25 additional licenses issued • Increased quota to 25 for life; 76 for non-life • Following restrictions remain • Cross-border service allowed for re-insurance, not direct insurance. • One branch limit

26. Highly regulated non-life insurance market • Non-life insurance activities are heavily regulated through: • Prescribed range of insurance premium for most policies, e.g. for auto insurance • Investment eligibility conditions • Applications for new insurance products etc. • Lots of market distortions • Lots of competition (76 firms – most with <1% of market share and less than Bt 300 mill capital) • Direct price competition and product differentiation not possible

27. Impact on insurance industry • Post-crisis, increased participation of foreign entities in the form of JV led to greater product variety, e.g. bank assurances. • Foreign providers have not entered auto-insurance industry in general because the complexity of local market and require network of garages. • AIA entered in 1950s before foreign ownership restriction came into place. First mover advantage => AIA enjoys 50% market share in life insurance industry

28. Life insurance industry: Top 5 firms (Sept, 2004)

29. Non-life insurance industry: top 5 firms (Sept, 2004)

30. Securities and asset management services opening • Market access • License is required • Need commercial presence • Investment banking • De facto liberalised in mode 4, e.g. Morgan Stanley in HK fly their agents into Thailand to prepare deals (need to comply with local regulations wherever securities are sold)

31. Securities and asset management – cross border regulations • Cross listing of Thai securities not yet possible (although talks with Singapore etc.) • Sales of foreign financial assets in Thailand is heavily restricted (in-out) • Retail Thai investors can invest in mutual fund units (FIF) managed by AMCOs • Institutions may • invest in securities issued by Thai residents up to USD 50 mill, else seek approval from BOT • Foreign investors may invest in Thai securities under relatively free environment (out-in) • Ownership per company < 49% • NVDR sidesteps 49% restriction

32. Other regulations on securities… • AMCOs face limited scope of investment due to • Thai SEC’s restrictions (not helped by lack of product variety in Thai financial market) • Cap on investment abroad (not helped by lack of experience in global market and lack of demand by Thais) • Minimum brokerage fee of 0.25% • Deregulation in 1999-2000 led to price war • Thai retail and institutional investors ratio is 70:7 • New product offering must be approved by SEC Thailand

33. Securities and asset management: top 5 firms (2002)

34. Impact on securities and asset management industry so far • Foreign investors account for 23% of SET • More competition in business for • Institutional clients • High net worth individuals • FIF allows greater portfolio diversity for Thai residents; familiarise Thai service providers with global markets • Local AMCOs do not use up all their annual FIF quota, but foreign ones do.

35. Summary of the lessons • Highlighted the importance of policy flexibility • For macro management • In capital account • etc. • At the minimum, comprehensive and effective safeguard measures must be included in trade agreements. • Safeguard measures could be revised as new information becomes available?

36. Lessons … • Local market environment or condition dictates the outcome of liberalisation • E.g. deregulation of brokerage fees led to price war due to very elastic demand. • Educating retail investors to look long term and encouraging consolidation of service providers are important as first steps.

37. Lessons … • Benefits of market opening and capital account liberalisation so far • Increased choice, lower prices • Technology transfers (but to what degree?) • Greater competition (particularly for high income group) • Increased market access to finance by lower to middle income group • Costs • Financial crisis (if do not sequence properly) => recession, burden on tax payers • Increased competition leads to more risky behaviour which must be contained. • Increased debt level for lower to middle income group • Many lack the knowledge of financial planning

38. Thank you