Financial Sector Reform and Corporate Debt Restructuring:
Thailand's Experience

Kiatchai Sophastienphong
Director, Financial Institutions Policy Department
Bank of Thailand

Conference on Crisis & Credit: Restructuring Asia's Financial Sector
Asia Society, 1 October 1999
New York City

Good Morning, Distinguished Guests, Ladies and Gentlemen,

We have seen significant progress in the economic recovery and the resolution of problems in the financial system. These include consolidation of financial institutions, recapitalization, corporate debt restructuring, and improvement of the supervisory and regulatory framework.

I will briefly walk you through each of the five issues. Please feel free to ask any questions that you may have during the Q&A session

1. Financial Institutions Closure/Consolidation & Asset Sale through FRA

The initial stages of Thailand's financial system reform consisted of the suspension of 58 of 91 finance companies: 16 in June 1997 and another 42 in August that year. These suspensions and eventual closures were intended to clearly separate weak financial institutions from strong ones, in order to strengthen public confidence in the financial system. The Financial Sector Restructuring Authority (FRA) was set up to take care of the asset sale of these finance companies, while the FIDF has provided deposit guarantee. In December 1997, the FRA allowed two of the 58 suspended companies to resume their businesses and formally shut down the rest. In the case of banks, the Bank of Thailand had intervened in 5 commercial banks, cutting the number of banks in the system to 13. Three banks are now majority owned by foreign strategic partners and three others are to follow suit by the end of the year, with a combined 16% market share in loans, two will remain state-owned with 27 % market share, and only five in private hands with 57 % market share. Thai bankers are now wondering whether they should conduct business in English or in Thai at Thai Bankers' Association luncheons and meetings!

The FRA and the Public Asset Management Corporation (PAMC) were charged with managing and disposing of the assets of the closed finance companies, totaling 860 billion baht (about USD 23 billion). As the previous speaker - Mr. Amaret Sila-On - mentioned, the FRA has played a crucial role in disposing off assets of these defunct finance companies.

In addition to closing down weak financial institutions, the government has initiated several major consolidations among other banks and finance companies to strengthen their operations. Krung Thai Bank was merged with First Bangkok City Bank (FBCB) and Bangkok Bank of Commerce (BBC) in 1998. All the assets and liabilities of FBCB, and 'good' assets of BBC, were transferred to Krung Thai Bank, where the Financial Institutions Development Fund will compensate for the loss against impaired assets of FBCB using yield maintenance and gain/loss sharing scheme.

Twelve finance companies, Union Bank, and Krung Thai Thanakit were merged together in February this year. This new financial institution, named 'Bank Thai', is now operating in a commercial bank capacity.

2. Recapitalization

As of end-June 1999 loan loss reserves (LLR) of the Thai financial system amounted to 780 billion or 60% of the total provisioning requirements of 1.304 trillion baht. Because of regulatory forebearance, financial institutions are permitted to phase in building up provisioning up to the year 2000. As against the required provisioning of 40% as of June 1999 and 60% as of December 1999, it is interesting to note that as of 30 June 1999, the actual figures were 77% for the five private banks, 47% for government banks, and 59% for the six privatized banks. Thai banks and finance companies will have until the end of the year 2000 to raise fresh equity to meet this 524 billion baht shortfall. Please note that of this LLR shortfall of 524 billion baht (US$ 13.1 billion), only 94 billion baht or 18% was accounted for by the five private banks which, if they were to make provisions upfront, would still be operating with CAR over the 8.5% minimum as opposed to 14.8% currently. Given that pre-provision loss of Thai banks showed a substantial drop in the first half of 1999, 25 billion baht as against 55 billion baht in the second half of 1998, we expect Thai banks to start making pre-provision profit in the second half of 1999, thus slowly being able to earn their way out of their problems.

When Thai financial institutions meet accepted international standards on capital adequacy, I believe they will gain confidence from the international community and will be able to actively expand their businesses. Thai commercial banks have successfully raised capital themselves through the issuance of innovative capital instruments, such as SLIPS and CAPS, which combine features of subordinated debt and preferred shares. The Bank of Thailand has accepted that these instruments have some loss absorption characteristics, hence they are allowed to be included as tier 1 capital, but the amount to be included cannot exceed one fourth of total tier 1 capital - in compliance with international standards. Since January 1999, 5 Thai commercial banks have successfully issued SLIPS and CAPS, yielding fresh tier 1 capital of almost 90 billion baht.
To help Thai financial institutions in their recapitalization efforts, the Thai Government has introduced two state-funded schemes to facilitate the recapitalization of financial institutions in August 1998. These include tier 1 and tier 2 schemes. The government has pledged a total of 300 billion baht or 75 billion US dollars for both schemes, however, until now only 39.4 billion baht or just over 10% has been approved and paid out, with approximately 41.4 billion baht of aggregate requests under consideration in the pipeline. The Thai authorities, like you Americans, do not believe in giving 'free lunch' and so the money comes with sticks, many of which existing bank shareholders find unpalatable.

The tier 1 capital support scheme is based on a simple concept. The Ministry of Finance stands ready to inject capital into undercapitalized financial institutions up to 2.5% of their capital requirements. Above that percentage, the MOF will purchase the financial institution's preferred shares to match with every share purchased by strategic investors (1:1 ratio). By doing so, the MOF intends to encourage strategic investors to take part in running Thai financial institutions with professionalism and superior technological network, as well as introducing good corporate governance into the system.

On the other hand, under the tier 2 capital support scheme, institutions that show commitment to debt restructuring and promote new lending can apply for the fund. The MOF will provide tier 2 capital for the amount equal to 100% of losses incurred through debt restructuring, plus up to 20% of total new lending. The allowable percentage would gradually decline, until the final deadline to join the tier 2 scheme, which is November 1st, 2000. As one can see, the underlying objective of this scheme is three-fold: the first is to encourage the resolution of NPL problems through debt restructuring, the second is to stimulate economic activities through new lending, and the third is, of course, to increase capital.

3. NPL resolution (Debt Restructuring)

The mounting NPL problem is one of the most important issue that we are trying to resolve. No question about that. As you may already know, Thailand currently has approximately 2.645 trillion baht of NPL or 6.6 billion US dollars, representing 47.1% of the total loans in the system of 5.615 trillion baht. This high NPL level was primarily caused by the non-productive use of short term foreign funds, and the lending process which concentrated on collateral value rather then the cash flows of the projects. These two factors, coupled with the devaluation of the baht and the downturn of the property sector, have resulted in the growing NPL level that we are facing at the moment.

A detailed analysis shows a divergent trend among local private banks, state-owned banks and foreign banks in their handling of NPLs. NPLs of Thai private banks have peaked since May at 1.302 trillion baht and have steadily decreased to 1.215 trillion baht in July. In percentage terms, NPLs peaked in May at 42.82% and since then have declined to 40.86% by end-July. NPLs at state-owned banks have also peaked, though in June, a month later, with over-due loans of 1.177 trillion baht or 70.39%. The figures for July were 1.170 trillion and 69.69% respectively. Unfortunately NPLs at foreign banks and finance companies show no clear indications of stabilizing. Foreign banks' NPLs at 86.2 billion appeared to be steady in May and June but suddenly jumped in July to a new record of 89.8 billion or 12.58%

Thailand's NPLs stood out in the region for being the highest both in absolute terms and in percentage terms partly because of an archaic Revenue Department ruling which prescribed that no loans could be charged off until creditors have resorted to all legal means of recovery, even though full loan loss reserve has been provided. In June the BOT succeeded in persuading the Revenue Department to do away with this rule. Henceforth, all loans classified by financial institutions as "loss" can be written off the books of financial institutions, provided that full provision has been made.

If all financial institutions with current loan loss reserve at least 60% of the required year 2000 provisionings were to avail of this new charge off provision, NPLs could be reduced by a total of 265 billion baht. The NPLs ratio would have dropped by 2.5% to 44.6% from 47.1% based on these numbers. The BOT on September 21st issued a regulation requiring all financial institutions that have met our required Year 2000 provision requirements to charge off all loans classified as "loss". Accordingly, in September NPLs are expected to drop by 42 billion on account of this new charge off regulation.

Another factor accounting for the high NPLs ratio of Thailand's financial system that I would like to draw attention to is the fact that until June this year, total loans showed a continuously declining trend, decreasing from 6.393 trillion baht in June 1998, one month before the baht was devalued, to 5.615 trillion baht in June 1999, a sharp drop of 778 billion baht or 12% over this 12-month period. Had the loan portfolio been kept unchanged at the June 1998 level, Thailand's NPLs would have been 41% rather than 47%, a difference of almost 6%.

Corporate debt restructuring is an integral part of the restructuring of the NPLs, which necessarily requires supportive legal and regulatory infrastructure, as well as the willingness on the part of both creditors and debtors. As a first step, the authorities have successfully attained a low interest rate environment, which is a crucial setting to stimulate new lending and induce an early economic recovery. Building on this favorable environment, the authorities are guiding out-of-court debt restructuring negotiations. The Corporate Debt Restructuring Advisory Committee (CDRAC) was set up to provide framework for negotiation between creditors and debtors, especially in the case of the large corporate debtors with multi-creditors, was premised on the basis of the general accepted practice and voluntary workouts with an aim to maximize benefits of creditors, debtors, shareholders, and employees.

Since June 1st 1999, the BOT has taken a new initiative to sharply reduce the level of NPLs within 9 to 12 months. A new out-of-court NPL resolution framework involves the signing of the Inter-Creditor Agreement (ICA) and Debtor-Creditor Agreement (DCA). The ICA is a contractual accord among creditors. It compels the signatories to follow the procedures and decisions taken within the CDRAC resolution process. The DCA is an agreement signed by the debtors and the creditors, expressing an intent to execute a restructuring agreement within a legally binding timeframe. The debtor is required to provide a full list of creditors and credits, a key proviso that ensures a complete picture of the debtor's obligation. Until now, individual workouts have been hampered by this lack of transparency, leading to unproductive dead-ends in many cases as restructuring agreements were invalidated in the unearthing of previously undeclared cross claims and liens on collateral.

Under this bold new plan, creditors and debtors have a maximum of five months to prepare the restructuring plan. Votes are then taken on the plan, with a limit of two rounds imposed. 50% of creditors by number, and 75% by credit amount must vote in favor to secure plan approval. If the required vote is not achieved, the BOT will appoint mediators to iron out the issues needed to secure sufficient plan approval before proceeding to the second vote. Failure to gain a simple majority (50% of the creditors and/or credit amount) will result in creditors taking legal actions against debtors. Failure to gain a super majority (75% or more of the credit amount) triggers an arbitration procedure. Arbitration is carried out by a three-member panel, the so-called Executive Decision Panel, which must deliver unanimous decision for the plan to be upheld. The whole resolution can take up to eight months including a three-month plan evaluation/adoption process.

In order to press for maximum participation/minimum disruption, CDRAC stipulates heavy penalties for non-compliance. Debtors that refuse to sign the DCAs are required to be sued for bankruptcy by creditors within two months from the CDRAC mandated agreement date: June 1st 1999 for the first group of 351 debtors with a total debt of 676 billion baht and June 21st 1999 for a second group of 316 debtors with a combined debt of 805 billion baht. Creditors that have signed the ICA can be fined up to 10% of their credit amount if they fail to vote in the DCA plan voting process. If the case is protracted and goes to arbitration, failure to abide by the EDP decision could lead to a fine of up to 50% of the credit amount.

Given an appropriate 9-12 month workout timeframe (8 months for out-of-court process and 1-4 months for Bankruptcy Court approval), the BOT expects substantial progress on the two target groups of debtors with a total debt value of 1.48 trillion by March-June 2000. The two tranches combined amount to about 55% of total NPLs outstanding. Even if 25-50% of this debt were to be restructured, it would reduce both the required provision requirements and the NPL figures by a few hundred billion baht.

Another factor that will help accelerate the process is the establishment of the credit bureau in September this year. With the benefit of the enhanced CDRAC database on progress of NPL resolution the credit bureau will make it more difficult for strategic debtors to access credit. As of August 1999, financial institutions have reported the progress of their debt restructuring efforts as follows: Completed debt restructuring of 680 billion baht or 17 billion USD, and Debt restructuring in progress of 1,205 million baht or 30 billion USD.

Alternatively, we have encouraged banks to set up their own asset management companies as a vehicle for speeding up debt restructuring and reducing NPLs, so the banks can focus on other areas of bank management instead. In this process, we are also trying to reduce the remaining legal and tax obstacles to the AMCs and to their operations - by allowing them to fairly receive tax privileges currently enjoyed by other financial institutions. We expect that the Cabinet will soon approve a package of tax measures to encourage banks to set up AMCs.

4. Privatization of Nationalized Banks

Next, let me touch on the subject of bank privatizations. As you are probably aware, the Thai Government has nationalized five Thai banks, namely First Bangkok City Bank (FBCB) which was merged with KTB, Siam City Bank (SCIB), Bangkok Metropolitan Bank (BMB), Laem Thong Bank (LTB) taken over by Radanasin Bank, and Nakornthon Bank (NTB). On September 10th, we decided to sell a 75% equity stake in NTB to Standard Chartered Bank after a competitive price matching process. NTB was taken over by the authorities during the first week of July 1999. Its share capital was written down from 2,016 million baht to 2.0 million baht, and the Financial Institutions Development Fund (FIDF) has assumed a 99% ownership by injecting fresh equity of 7,000 million baht to the bank. In order to ensure fair treatment and transparency, the authorities invited interested investors to match the purchase price offered by Standard Chartered Bank during a 60-day price-matching period. Since no bidder has offered a price higher than Standard Chartered Bank with all other terms being the same, Standard Chartered Bank emerged as the winner under this competitive and fair process.

The second bank to be privatized is Radanasin Bank (RSB). The selection and negotiation process is almost completed and the new strategic partner is expected to take over the day-to-day running of RSB after meeting all the legal closing conditions.

In the case of SCIB and BMB, we expect to receive the final bids from prospective investors in the second week of October 1999. After all the competitive bids have been considered and ranked by the Selection Committee - chaired by the BOT Governor - in that same week, the authorities will work out the detailed terms and conditions and finalize legal documentation with the strategic investors that have submitted the most favorable proposals. Signing of legal documents is expected in the middle of November, and the sale consummated by the end of November.

We expect all the four banks to be privatized by the end of this year. We believe that the Thai banking system will be much stronger as a result of these bank privatizations through a more competitive banking environment, transfer of IT technology and bank management skills, and infusion of fresh capital.

5. Improving Supervisory and Regulatory Framework

The authorities are closely reviewing the overall supervisory framework of financial institutions with a view to enhance supervision efficiency and standards. A new Financial Institutions Law will replace the current commercial bank and financial company laws. Under this new framework, supervisory functions will be consolidated - with powers and responsibilities clearly defined. A school for examiners has also been set up at the BOT to upgrade examiners.
A new Central Bank Act (which would strengthen the BOT and enhance its accountability) and amendments to the Currency Act (which would allow more flexible management of foreign exchange reserves while preserving foreign exchange backing of the currency) will also be submitted to Parliament in the last quarter of this year.

The bill on default judgment is expected to be approved by Parliament and will be enacted shortly. Also, the new Secured Lending Law will be submitted to the Cabinet by the end of this year, with an intent to facilitate new credit flows by widening the scope of securitizable assets.

Thailand has implemented significant financial sector reforms and provided legal framework as well as tax and other incentives for corporate debt restructuring by adopting market-based approaches rather than the easy route of public bailouts. We believe that we have applied the right level of forcefulness and fiscal resources given the severity of the NPLs problem. We plan to follow through with critically needed reforms as in the case of the amended foreclosure Law and the Bankruptcy Law. We have gone a long way in laying a firm foundation for the three most politically difficult tasks, recapitalization of the surviving financial institutions, carve-out of NPL and creating the legal framework needed for restructuring. In the case of resolution of failed financial institutions, we are committed to closing down unviable financial institutions or absorbing these into other banks. The 300 billion baht government-funded capital support scheme is available to assist the remaining financial institutions in raising the needed fresh equity by providing a catalyst for private capital flows. Foreign banks or strategic partners will be sought in our plan to privatize the remaining state-owned banks.

We have provided comprehensive tax and other incentives for corporate restructuring, and are now working closely with the MOF and other government agencies to extend similar tax and other benefits to the AMCs to be set up by banks seeking to carve out NPLs for professional and more focused management. We plan to revamp the regulatory and legal framework for bank supervision by strengthening prudential norms through introduction of more efficient foreign exchange risk controls and regulation of maturity mismatching. We will continue to strengthen further bank management, bank credit culture, borrower financial management and repayment culture through instituting international best practices.

Lastly, with regard to corporate governance, we shall issue new rules on public disclosure, insider lending, conflicts of interest, business ethics, and corporate governance. Recently, we have required bank directors and senior management not to sit on the board of directors of debtor companies in cases of loans and advances extended exceeding certain thresholds.