Windfall foreign exchange profits for Thai banks:
Slow adjustment to two-tiered exchange rate system
By Jon Fernquest[Introduction|Vocabulary|Article]
[Reading Questions|Answers]
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Thai Banks just posted a surprising jump in profits on foreign exchange transactions for the first quarter.
The windfall profits are a little bit of a fluke and definitely a one-off phenomenon since the credit card company rules that created these profits by using the offshore rate (32 baht/dollar) to settle transactions rather than the onshore rate (34 baht/dollar) have already been changed.
Reading Questions
Here are some questions to guide your reading (See answers at end):1. In what part of their businesses did Thai banks make greater than expected profits recently?
2. What recent market conditions led to these profits? (Explain how)
3. Over what period were these profits accumulated?
4. Were these profits expected?
5. How did credit card transactions contribute to these above normal profits? (Describe the process)
6. What losses partially offset these profits?
7. What conditions were necessary for a Thai bank to capture these profits?
8. Which Thai banks were affected the most? Why? (Ranks the banks in a list, make sure to choose the right criteria for ranking to answer this question)
9. Will these profits be repeated again in the future?
Bangkok Post article: May 14, 2007
Global InsightsBANKING FIRST-QUARTER PERFORMANCE
Two-tier baht market leads to windfall for local banks DARANA CHUDASRILocal banks enjoyed strong windfall profits from their treasury operations in the first quarter owing to continued volatility in the foreign exchange market. Bangkok Bank, Kasikornbank, Siam Commercial Bank and Bank of Ayudhya all posted double-digit growth in their foreign-exchange profits for the first quarter.
Traders said profit opportunities were plentiful in the first quarter, thanks to market volatility and arbitrage opportunities created after the Bank of Thailand imposed its 30% reserve rule on foreign inflows in mid-December.
Credit-card receivables were a healthy source of profits, thanks in part to the two-tier currency market created by the 30% reserve rule.
"It's unique, but it's credit cards that were driving exchange gains in the first quarter. It's just a windfall from the market distortions created under the foreign-exchange controls," one banker said.
Every dollar spent by foreign travellers through credit cards in Thailand essentially represents a foreign-exchange gain for the banks managing the acquisition terminals at the point of sale.
"It's a profit that really was unanticipated. None of the banks did anything to actually receive these profits - it just happened as a result of the way payments are settled internationally among the banks within syndicates such as Visa and MasterCard," the banker said.
In a credit-card transaction, the intermediary, whether it be Visa, MasterCard, JCB or American Express, records a debt for the issuing bank and credits the bank controlling the acquisition terminal, which in turn processes the payment for the retailer.
But since the 30% reserve rule was imposed in December, the baht market has been split into two - an onshore market rate used for domestic transactions and an offshore market based on transactions outside of Thailand.
The result has been a discrepancy - and profit opportunities - for banks due to the different rates.
MasterCard, for instance, uses forex rates from New York at midnight to calculate payment charges.
Currently, the onshore baht is quoted at 34 to the dollar, compared with around 32 in the offshore market.
As a result, a foreign tourist making a charge locally will result in an automatic profit for the domestic bank controlling the acquisition terminal at the point of sale, thanks to the higher rate quoted for the baht in the onshore market.
On the other hand, a domestic bank would suffer an equivalent loss if a Thai cardholder used a card offshore, as the transaction would be in the opposite direction.
In general, however, Thai banks have posted gains from the distortions, as the inbound tourist market is substantially larger than that for Thais travelling abroad.
According to the Bank of Thailand, in the first quarter of the year foreign credit-card customers made 36.39 billion baht worth of transactions in the local market, compared with 6.45 billion baht by Thais overseas.
"Basically, any bank with a large network of acquisition terminals and heavy volume of overseas buyers is going to post a profit," one banker said.
Market leader Bangkok Bank controls around 40% of all card terminals in Thailand, followed by Kasikornbank at 28%, Siam Commercial Bank and Bank of Ayudhya at another 20% to 25% each.
According to information released to the Stock Exchange of Thailand, Bangkok Bank posted first-quarter foreign-exchange gains of 1.1 billion baht, 45.1% higher than the same period last year. Kasikornbank posted a 45.4% increase in profits to 610 million baht, while SCB had a 14.5% increase to 771 million and BAY 91.9% to 325 million.
"While the profits were an important contributor to the quarterly earnings, it's basically a short-term phenomenon. MasterCard has already shifted to using the onshore rate since the end of March for settling transactions," a banker said.
Vocabulary (in discussion above)
foreign exchange - foreign currencies
foreign exchange markets - markets where currencies are exchanged for other currencies (See Wikipedia on foreign exchange markets)
a windfall - money received unexpectedly
windfall profits - unexpected profits
a fluke - accidental (not planned or arranged)
one-off - happens only one time (will not be repeated in the future)
onshore - in the country, domestic
offshore - outside of the country, foreign
a tier - one level among many levels in a system
two-tier currency market - a currency market with two prices for the currency (usually in two different places, inside and outside the country)
two-tier baht market - teh currrent system where there are two baht exchange rates, one inside Thailand and one outside Thailand
treasury - the center of financial operations within a company or government, responsible for such things as issuing new securities (a company) or issuing money (a government) (the older meaning is a place where wealth and valuable objects are kept, ibn the old days Thai and Burmese kings had such a treasury) (See Wikipedia)
* treasury operations
volatility - the tendency to change suddenly and unexpectedly (See glossary)
posted - report, make information available publicly
double-digit growth - growth that is 10% or greater (1% to 9% have one digit, 56% has two digits, and 119% has three digits; note: "figure" is used much the same way for incomes, for example, he has a six-figure income: $140,000)
* posted double-digit growth
arbitrage - buy in one market and sell in another for a profit (taking advantage of differences in prices between markets) (See Wikipedia)
receivables - money owed to a company from the sale of goods and services on credit (called Accounts Receivable in accounting and listed as a current asset on the company's balance sheet; See Wikipedia on accounts receivable and factoring)
credit-card receivable - money owed to company from people who made purchases with a credit card (there is a delay between the transaction and receiving payment)
a healthy source of profits - a profitable part of the business
distort x, a distortion of x - a change making x not true or not clear
market distortions - a market failure from government regulation that prevents markets from establishing a price balancing supply with demand (See Wikipedia)
a market failure - when a market does allocate goods and services efficiently (for example because there is not enough information, unequal access to information, a powerful company can force others out of the market with pricing strategies, when there are costs on people outside the market (e.g. pollution), or when it is an important good that requires cooperation (e.g. national defense; See Economist's Glossary and Wikipedia)
foreign-exchange controls - government regulations that restrict the free operation of foreign exchange markets (markets for foreign currencies)
the point of sale (POS) - the place in a store where a sales transaction takes place (See Wikipedia on point of sale and point of sale displays)
POS terminal - in a store the computer device for processing credit card transactions
POS equipment - equipment used for retail transactions such as cash registers, card readers, bar-code scanners, etc.
acquisition terminals -
* a large network of acquisition terminals
unanticipated - was not expected or predicted in advance
settle payments, payment settlement - payment of money agreed upon in a transaction (cash can change hands or money transferred between accounts (See Wikipedia list of payment systems)
syndicates - groups formed for business purposes or to do a project
Visa and Mastercard - two of the largest credit card companies in the world (See Wikipedia and Wikipedia)
* the way payments are settled internationally among the banks within syndicates such as Visa and MasterCard
intermediary - financial intermediary, a company which channels funds berween borrower and lender (in this case a credit card company, the borrower is a customer purchasing by credit card and the lender; See Economist's Glossary and Wikipedia)
onshore market - within country market
offshore market - outside of country market
discrepancy - a noticeable difference between two things that should be the same
forex rates - foreign exchange rates, exchange rates (See Wikipedia)
a phenomenon - something observed to happened (usually lacks a complete explanation of why it happened)
* a short-term phenomenon
credit card float - When a cardholder makes a purchase or obtains an advance, the transactions may not post for a few days. The charge amount is not added to the balance of the account until the transaction does post. The time between purchase and posting is referred to as the float.
Answer Key:
1. In what part of their businesses did Thai banks make greater than expected profits recently?
In treasury operations, more specifically in foreign exchange operations.
2. What recent market conditions led to these profits? (Explain how)
a. Volatility in exchange rates.
b. Opportunities for arbitrage from foreign exchange controls (the 30% reserve rule).
3. Over what period were these profits accumulated?
These profits were accumulated over the first quarter of the year, a three month period.
4. Were these profits expected?
No, the windfall profits were "unanticipated."
5. How did credit card transactions contribute to these above normal profits? (Describe the process)
Foreign travellers used credit cards in Thailand.
This created foreign exchange gains for the banks operating credit card terminals in Thai stores.
The rules for settling credit card payments internationally among banks were responsible for these profits. The process ran as follows:
a. The credit card company recorded a debt for the bank that issued the credit card and a credit for the bank with the POS terminal that handled the transaction.
b. The offshore (New York) exchange rate was used (about 32 baht/dollar), not the onshore rate (about 34 baht/dollar).
c. The offshore rate provided more dollars per baht to the credit card company than the onshore rate.
("In a credit-card transaction, the intermediary, whether it be Visa, MasterCard, JCB or American Express, records a debt for the issuing bank and credits the bank controlling the acquisition terminal, which in turn processes the payment for the retailer.MasterCard, for instance, uses forex rates from New York at midnight to calculate payment charges.Currently, the onshore baht is quoted at 34 to the dollar, compared with around 32 in the offshore market. As a result, a foreign tourist making a charge locally will result in an automatic profit for the domestic bank controlling the acquisition terminal at the point of sale, thanks to the higher rate quoted for the baht in the onshore market.")
6. What losses partially offset these profits?
Thai credit card transactions in foreign countries led to losses by the Thai banks issuing the credit card and offset these gains a little bit, but "the inbound tourist market is substantially larger than that for Thais travelling abroad."
("On the other hand, a domestic bank would suffer an equivalent loss if a Thai cardholder used a card offshore, as the transaction would be in the opposite direction. In general, however, Thai banks have posted gains from the distortions, as the inbound tourist market is substantially larger than that for Thais travelling abroad.")
7. What conditions were necessary for a Thai bank to capture these profits?
The bank needed two things:
a. A large network of credit card POS terminals (acquisition terminals)
b. A heavy volume of overseas buyers using these terminals
8. Which Thai banks were affected the most? Why? (Ranks the banks in a list, make sure to choose the right criteria for ranking to answer this question)
Percentage increase in profits should be used to create the list.
1. Bank of Ayutthaya (91.9%)
2. Kasikorn Bank (45.4%)
3. Bangkok Bank (45.1%)
4. Siam Commercial Bank (14.5%)
9. Will these profits be repeated again in the future?
No, they were a short-term once-off phenomenon. Credit card companies have already shifted to using the onshore rate.
This raises the question of what will will happen if the Bank of Thailand ends exchange controls and the difference between onshore and offshore exchange rates falls to zero again.
