Fitch Ratings on the strength of Thailand's banking sector
By Jon Fernquest |
A Fitch Ratings report for Thailand released this week highlighted some reasons why the country may be financially stronger than other countries and better able to weather the current global financial crisis:
Thai banks are still funded predominantly by domestic deposits so funding is...less of a concern. Thai banks have limited exposure to complex offshore instruments such as CDOs or other foreign securities. Leverage ratios in Thailand's corporate and bank sectors are relatively low, reflecting in part, a more modest recovery and risk aversion since the 1997 crisis, as well as slower growth over the past three years due to the domestic political turmoil.
To summarize:
1. Bank funding mostly from domestic deposits.
2. Less exposure to offshore structured finance (CDOs, CDSs).
3. Low leverage.
4. Risk version recovering from the 1997 Asian Crisis.
5. No economic bubble due to domestic political turmoil.
The advantage of funding loans with domestic deposits
The last two decades of "financial innovation" in the US increased the complexity of bank operations and funding. In traditional banking, deposits and the ratio of loans to deposits measured a bank's health and strength:
Once upon a time, bankers and examiners leaned on the core-deposit- to-total-loan ratio to assess liquidity. The logic was simple: Core deposits — such as checking accounts, passbook savings accounts and small time deposits (under $100,000) — stay put, exhibiting little sensitivity to changes in market rates or bank condition. Other things equal, the higher a bank's stock of core deposits — or, put another way, the lower its loan-to-core-deposit ratio — the lower the liquidity risk.
Loans by Thai banks are funded mostly by domestic deposits. This lowers the liquidity risk of Thai banks and makes them stronger in the face of the global financial crisis:
One benchmark used to track bank liquidity is the ratio of loans to deposits. As of September, the ratio for the country's six largest banks was a relatively low 86%, with KBank the highest of the six at 107%.
In contrast, over the last two decades the US banking system has moved away from funding loans with deposits. From 1992 to 2002, the average loan to deposit ratio increased from 92.9 to 121.2 in the US compared with the current average of 86% in Thailand. As loans grew in the US, deposits shrunk:
Over the past 10 years, the aggregate loan-to-core-deposit ratio has "deteriorated" markedly. At year-end 1992, the ratio for U.S. banks stood at 92.9 percent, meaning that there was 92.9 cents in loans for every $1 in core deposits. By year-end 2002, the ratio was up to 121.2, meaning there was $1.21 in loans for every $1 in core deposits. Both cyclical and structural factors account for this trend. On the cyclical side, between 1992 and 1999 annual loan growth at U.S. commercial banks averaged 7.9 percent, compared with average annual growth of 5.4 percent between 1984 and 1990. The pickup reflected the record length and strength of the 1990s economic expansion. On the structural side, between 1992 and 1999 core deposits grew at an average annual rate of 3.1 percent, down sharply from the average annual growth of 6.5 percent between 1984 and 1990. The slowdown reflected heightened consumer interest in non-deposit investment alternatives. For example, stock and bond mutual funds grew at an average annual rate of 10.7 percent between 1992 and 1999—even after adjusting for the run-up in the stock market. Over the same interval, money-market mutual funds grew at a 15.2 percent annual clip.
As the financial crisis has progressed this year in the US, deposits regained their importance as a stable base for bank operations.
As a safety measure, for instance, investment banks were given permission last month to become regular deposit taking banks.
Bank liquidity in traditional banking
So what exactly is liquidity risk for a traditional deposit-taking bank?
A "bank run" is when large numbers of a bank's depositors suddenly start withdrawing their money from the bank.
Since banks use their deposits to make loans, if all their depositors suddenly withdraw their deposits the bank has a big problem.
The bank probably could not get cash fast enough to pay the depositors.
In this "liquidity crisis" the bank would have to ask help from the larger government-run central bank, the "lender of last resort".
The possibility that such a liquidity crisis or bank run could happen is called "liquidity risk".
This is because bank deposits (liabilities) are short-term and loans (assets) are long-term. The maturity or length of life of assets is longer than the life of liabilities. There is a "maturity mismatch" between assets and the liabilities that fund these assets. This mismatch is one important source of liquidity risk.
Another source of liquidity risk is "currency mismatch." A bank might also fund baht loans (assets) with dollar loans from foreign banks (liabilities).
If the baht suddenly loses its value then the bank's loan assets become worth a lot less than the loan liabilities funding these assets. When this happens, as it has recently in Iceland and Korea or during the 1997 Asian Crisis, banks face a liquidity crisis. In the past, the IMF has stepped in as a lender of last resort to help such banks.
IMF involvement with financial sector policymaking
Although IMF policies were heavily criticised, most notably by Nobel Laureate Joseph Stiglitz in his Globalization and its Discontents, IMF involvement in financial sector policy has made Thailand's financial sector stronger in the face of the current crisis:
Directors commended the authorities for the significant strides made to strengthen the financial and corporate sectors. They welcomed the completion of the Financial Sector Stability Assessment (FSSA), and called on the authorities to build on the progress already achieved by implementing rapidly the FSSA's recommendations. The strong profitability and sound balance sheets of private banks and corporates have limited their vulnerability to the ongoing turmoil in global financial markets. Directors praised the progress made in upgrading the regulatory and supervisory frameworks, and welcomed the recent passage of key financial sector legislation, including that granting operational independence to the BOT. The financial sector would be further strengthened by addressing the remaining nonperforming loans from the Asian financial crisis and implementing tighter supervision of the state-owned specialized financial institutions. Scaling back government ownership in financial institutions remains an appropriate longer-term goal (Source: IMF 2008 Consultation Report, also see academic paper on the first generation of the IMF's Financial Sector Stability Assessment (FSSA)).
(Sources: Bangkok Post, Washington Post, St Louis Fed, and Thai PR Net)
Vocabulary:
liquid - having cash or assets that can be reduced to cash quickly
a liquidity crisis - running short of the cash (cash is needed to continue doing business, so this endangers the life of the business)
insolvency - not being able to pay debts when they are due (at the required time)
liquidity risk - the risk of a liquidity crisis, the risk of running short of cash (so that you cannot borrow short-term with commercial paper the funds necessary for the day-to-day operation of the business, so that you cannot repay your debt (insolvent) (Source: www.vedpuriswar.org also see recent Fed guidebook)
a bank run - when the depositors suddenly all try to withdraw their deposits from the bank at the same time (See Wikipedia)
a central bank - a bank run by the government of a country that: 1. issues currency, 2. regulating the supply of credit in the economy, and 3. carries out the country's monetary policy, 4. oversees and regulates banks operating in the country (See Wikipedia)
lender of last resort - a bank that can loan money in an emergency if no one else can (See Wikipedia)
maturity - the length of time of a loan or a bond, when this time ends Fitch Ratings - an international credit rating agency dual-headquartered in New York City and London. It was one of the three Nationally Recognized Statistical Rating Organizations (NRSRO) designated by the U.S. Securities and Exchange Commission in 1975, together with Moody's and Standard & Poor's. predominantly - mainly, mostly Collateralised Debt Obligation (CDO) - "an unregulated type of asset-backed security and structured credit product. CDOs are constructed from a portfolio of fixed-income assets. These assets are divided by the ratings firms that assess their value into different tranches: senior tranches (rated AAA), mezzanine tranches (AA to BB), and equity tranches (unrated). Losses are applied in reverse order of seniority and so junior tranches offer higher coupons (interest rates) to compensate for the added default risk. Since 1987, CDOs have become an important funding vehicle for fixed-income assets." (See Wikipedia) Credit Default Swaps (CDS) - a transfer of credit risk through a derivative instrument, insurance against loan default (See Wikipedia) a benchmark - a known standard that can be used for comparison and measurement an economic expansion - a period of time with a lot of economic activity and growth
maturity mismatch - when the maturities of assets and the liabilities used to fund them are different, as they typically are in a bank
currency mismatch - when the currencies of assets and the liabilities used to fund them are different, as they typically are in a bank
(See Wikipedia and website)
a credit rating agency - a company that estimates how likely a borrower is to deafault and not pay back the money it has borrowed (default) and assigns a numerical score to measure this (credit rating) (See Wikipedia)
highlight - emphasize important points and make you think about them
weather the crisis - survive the crisis and are able to continue normally after it has passed
limited exposure - limited risk
offshore - not in this country, in another foreign country
instruments, financial instruments - an investment can be bought and sold for cash (liquidated) such as stocks, bonds, and derivatives
offshore instruments - financial instruments sold in foreign countries
core deposits - the standard kinds of deposits that traditional banking is based upon: checking accounts, passbook savings accounts and small time deposits (under $100,000)
stay put - stay in one place, do not move around or travel to other places
X exhibits little sensitivity to Y - changing Y causes little change in X
loan-to-core-deposit ratio - the ratio of loans made by a bank to the deposits of the bank, a measure of liquidity risk
the leverage ratio - the ratio of debt to equity, shows how much assets are being funded with money borrowed (debt) versus stock (equity)
low leverage - less borrowing, more long-term equity ownership investments in businesses
risk aversion - risk avoiding, not wanting to take risks
an economic bubble - when asset prices increase far above their actual worth (long-run trend value), eventually the "bubble bursts" and asset prices return to normal, and people lose a lot of money
structured finance - a sector of finance that was created to help transfer risk using complex legal and corporate entities (See Wikipedia and list)
offshore structured finance - structured finance products from outside of the country
political turmoil - political disorder and uncertainty
track bank liquidity - follow and check on bank liquidity
deteriorated - the situation got worse
markedly - significantly, was big and easy to notice, not small and meaningless
deteriorated markedly - the situation got a lot worse
a pickup - an increase in activity
non-deposit investment alternatives - investments such as money market funds, bonds, or the stock market (that compete with bank deposits, less safe but higher return)
mutual funds - a professionally managed investment funds that collects together money from many investors and invests it in stocks, bonds, short-term money market instruments, and/or other securities (See Wikipedia)
money-market mutual funds - are mutual funds that invest in short-term debt instruments (See Wikipedia)
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