Comparative Study of Domestic and Foreign Bank Performance in Thailand: The Regression Analysis

Saovanee Chantapong* September 2003

Abstract This paper studies the performance of domestic and foreign banks in Thailand in terms of profitability and other characteristics after the East Asian financial crisis. The study is based on a micro bank-level panel data on financial statements by pooling cross-bank time-series data with the major balance sheet and income statement ratios for domestic and foreign banks in Thailand for 1995-2000. The estimation results of this study indicate that foreign bank profitability is higher than the average profitability of the domestic banks. All banks gradually improved their profitability during the post-crisis period after the shock. As for the commitment to domestic economy, both domestic and foreign banks reduced their credit exposure during the hard times. Importantly, the study finds that in the post-crisis period, the gap between foreign and domestic profitability become closer. This shows some positive results of the financial restructuring program.

JEL Classification: G15 G21 G32 G34 Keywords: International Financial Markets, Banks, Ownership Structure, Restructuring,
_____________________________
*

Saovanee Chantapong, Analyst, Financial Institutions Policy Group (FIPG), Bank of Thailand, 273 Bangkhunprom, Bangkok 10200, Thailand: saovanec@bot.or.th and currently, Ph.D. student at Department of Economics, Kiel University, Olshausenstrae 40, D-24118 Kiel, Germany : chantapong@bwl.uni-kiel.de

The author thanks Prof. Dr. Eno L. Inanga, Maastricht School of Management and participants at the International West-East Conference 2003: Accounting and Finance in Transition: European and Asian Experiences and Public Policy Considerations, the Greenwich Business School, London, 10-12 July 2003 for helpful comments on the earlier drafts of this paper. The author is greatly indebted to Dr. Ralph P. Heinrich and Dr. Claudia M. Buch for their valuable comments. The author thanks Somchai Lertlarpwasin, Bussaracum Petchclai and Augsupalee Watcharakiet, her colleagues at the Bank of Thailand for their great help. The paper has benefited from very helpful comments from Felix Hammermann, Om Prakash Mall, Paula Jaramillo and Marie-Helene Manchec, her colleagues at the Advanced Studies Programme (ASP), the Kiel Institute for World Economics, Germany. The author acknowledges financial support from the Ph.D. Programme, Department of Economics, Kiel University. The views expressed in this paper are entirely those of the author only and do not necessarily reflect those of the Bank of Thailand. Remaining errors are under the authors responsibilities.

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Contents I. Introduction II. Previous Works 2.1 Foreign Bank Entry and its Impacts 2.1.1 Foreign Bank Entry and its Positive Impacts 2.1.2 Foreign Bank Entry and its Negative Impacts 2.2 Bank Profitability Bank Profitability in Thailand III. Data and Methodology IV. Empirical Results V. Concluding Remarks Text Tables Table 1: Profitability of Major Banks in 1999 and 2000 Table 2: The Comparison of Domestic and Foreign Bank Performance: Between Regression Table 3: The Comparison of Domestic and Foreign Bank Performance: Fixed Effects Regression Text Figures Graph 1: Bank Profitability in Thailand between 1997-2001 Graph 2: Provisioning Expenses in Thailand between 1997-2001 Graph 3: Net Interest Margin in Thailand between 1997-2001 Graph 4: Operating Costs in Thailand between 1997-2001 Appendix Tables Table 4: Macro and Financial and Banking Data for Thailand, 1995-2000 Table 5: Synopses of the Four Market Crises Table 6: Summary of Coverage and Features of Bank Level Data Table 7: Correlation Matrix Appendix 1: Definition of Bank Level Data Variables Endnotes References

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-3..Banks were the happiest engines that ever were invented for spurring economic growth.. Alexander Hamilton (1781) ..Banks harm the morality, tranquillity and even wealth of nations.. President John Adams (1819)

I. Introduction
Thailands acceptance of the International Monetary Funds (IMF) Article VIII in May 1990, which lifted foreign exchange controls on current account transactions, marked the starting point of a series of financial liberalisation measures. The second round of liberalisation abandoned most restrictions on capital account transactions in April 1991. The third round gave more freedom to outward direct investment, travel expenditures and additional channels of crossborder payments in February 1994. In March 1993, the Bangkok International Banking Facilities (BIBF)1 were established with an aim to develop to be an international financial centre (Allison and Suwanraks:1999). The above measures were under the presumption that that the Thai financial market would be better off if liberalisation was pursued Commercial banks were permitted to undertake new business, such as debt underwriting and dealing, acting as securities registrars and custodians, selling public sector debt instruments, mutual fund management, financial consulting and feasibility studies. Finance and securities companies had new lines of operations, which include leasing, management of provident/private/mutual funds, custodian services and foreign exchange businesses. In 1996, the Thai economy faced a number of difficulties. Export growth slowed down due to weak world demand while imports remained buoyant, resulting in surging current account deficits. Domestic inflation was rising which led to a decrease in the countrys competitiveness in the world market. Traders and speculators had doubts about Thailands debt servicing capacity or creditworthiness. In addition, an increase in non-performing Loans (NPLs) in Thai financial institutions further weakened foreign investors confidence. Capital outflows, both in the forms of (p)repayments of external debts and exchange rate speculation occurred in the first half of 1997. The Baht was, therefore, floated on July 2, 1997. After that, capital outflows continued to such an extent that the U.S. dollar reached a peak at 53.7 baht in January 1998 from 25.7 baht in the first half of 1997. Referring to financial institutions, speculative and imprudent lending during inflated many bubbles sectors; for example, real estate, services (private hospitals), steel and

-4petrochemical industry. Before the crisis funds seemed to be properly allocated to the productive sectors and direct lending to the real estate businesses or property sector was consistently below 5% of the total lending. However, after the crisis it was apparent that these productive sectors such as exporting sector had misused their BIBF borrowing to invest heavily in the property or real estate sectors. This turned the entire business group lending into NPLs overnight as the baht depreciated (Watanagase: 2001). It is stated that the crises of the 1990s in many countries were due to a combination of unsustainable current account deficits, excessive short-term foreign debts, and weak domestic banking systems. This was so called Twin crisis which was the interrelationship between two phenomena: banking crisis and currency crisis. However, the experience in each crisis country was unique one or more of these conditions might be present differently (Feldstein, 2002). Lamfalussys study (2000) shows the synopses of four market crises; Latin American 1982-83, Mexico 1994-95, East Asia 1997-98 and Russia 1998, principally linked to the banking sector (table 5). In the case of Thailand, economic crisis in mid-1997 can largely be attributed to three policy errors: 1) liberalisation of foreign capital flows while having rigidity in the exchange rate system. 2) pre-mature liberalisation of financial institutions 3) failure to prudently supervise financial institutions (Allison and Suwanraks:1999). The liberalisation of financial institutions in Thailand was controversial issue as question were there whether they should be liberalised in the light of their lack of maturity because liberalisation could bring more risks. During the past, the financial system in Thailand was often characterised as one of no entry, no exit which meant that it is difficult to get in as well as difficult to allow a financial institution fail (BOT: 1998). Before the 1997 financial crisis, the domestic banks dominated the retail market and had close relationship with local customers whereas foreign banks concentrated their businesses on wholesale customers. The effects of the crisis left most domestic banks to seek for large amounts of new capital, which could not be raised from local investors as they were also affected from the crisis. At the same time, one of the measures of the financial sector reform was the relaxation of restrictions of foreign ownership. The result of these is that four out of a total 13 local banks turned to be majority-owned by foreign institutions as of September 2001(table 6). This gave these foreign banks an access to retail customers. These foreign banks offer diversified financial services to their retail customers. Consequently, their shares in retail

-5market are expected to increase. Strong foreign bank participation will affect Thai banking industries in many aspects. For example, family banking and conventional connected lending may gradually disappear2 and the introduction of professional management by foreign banks will give momentum to technological adjustment of domestic banks (Allison and Suwanraks: 1999). The Asian crisis demonstrated the deficiencies in domestic financial system and called for financial reform in accounting and disclosure practices, bank corporate governance, domestic regulation and supervision. An increase in foreign participation in domestic financial sector can accelerate improvements in those areas (Goldberg, Degas and Kinney, 1999). Critics argued that industrialised country banks are unstable lenders who undermine local financial markets. The issue of openness of foreign participation in domestic financial system are still arguable. This paper attempts to compare the domestic and foreign bank performance after the financial crisis. If the foreign banks with professional management perform better during the hard time, it will contribute to policy implications for the openness of the banking sector. The purpose of this paper is to provide a comparative study of the performance of domestic and foreign banks in Thailand in terms of profitability and other characteristics after the financial crisis. The paper includes five sections. Section 2 briefly presents the related previous works in this area. Section 3 contains the coverage and data sources and methodology. Section 4 presents the empirical results and analysis. Section 5 draws some conclusions from the empirical results.

II. Previous Work

2.1 Foreign Bank Entry and its Impacts 2.1.1 Foreign Bank Entry and its Positive Impacts Feldstein (2002) pointed out that the countries with strong banking systems and good bank supervision like Singapore prevented the difficulties that occurred in the crisis countries. Argentina had an early crisis in which many banks failed but now has shifted the ownership of most of its banking industry to foreign banks, primarily from the United States and Spain that provide a much greater professionalism of management. Mexico recently changed its banking law to allow majority foreign ownership of its bank. Despite the fact that many countries oppose foreign ownership, it seems to be one way of improving banking practice faster. However, one

-6can argue that as evidenced in the experience of banking crises in the industrialised countries over the last 200 to 300 years, the industrialised countries still do not deal with these crises very well. The G10 jointly spent large amounts of money bailing out their own financial systems (Feldstein: 2002). Many emerging market and transition economies are more volatile than industrialised countries and consequently, greater foreign participation in the banking sector seems to be valuable because it helps insulate the banking system from domestic shocks (Claessens, Demirguc-Kunt and Huizinga (2000), Mishkin : 2002). The summary of the benefits of greater foreign bank entry in home countrys banking system can be illustrated into four main aspects as follows; 1) it seems likely to lead to a banking and financial system that is substantially less fragile and far less prone domestic to crisis; 2) it can encourage adoption of best practice in the banking industry because foreign banks come with expertise in areas, particularly, risk management; 3) it increases competition in the banking industry in the home country and it can lead to improved management techniques and a more efficient banking system; and 4) it seems likely that uninsured deposits and other creditors of banks will not be bailed out since it will not be political popular. In addition, Goldberg, Deges and Kinney (1999) found that in Argentina and Mexico, foreign banks exhibited stronger loan growth that is sensitive to economic signals compared to domestic-owned banks. Foreign bank credit activities were associated with a bolstering of overall banking sector loan growth and a lower volatility of this growth. In short, foreign ownership of domestic financial institutions contributes positively to the overall level and stability of domestic credit. Using bank-specific data on U.S. bank claims on individual foreign countries since mid 1980s-2000 (Goldburg :2001), foreign claims are highly correlated with U.S. GDP growth, but uncorrelated with foreign demand condition and correlated with real U.S. interest rate, but uncorrelated with foreign real interest rates. In sum, U.S. banks have not been volatile lenders internationally, even during the financial crises period. The findings indicate that foreign banks in emerging markets play an important role in stabilising the overall lending while local banks are sensitive to local condition. These findings concurred by Feldsteins study (2002) links to the currency crisis prevention in emerging market.

-72.1.2 Foreign Bank Entry and its Negative Impacts Sabi (1996) compared the performance of foreign and domestic banks in the process of transition into a market-oriented economy in Hungary. This study shows that foreign banks are more profitable than domestic banks and did not expose to a greater liquidity or credit risk. Foreign banks provided less money for consumer loans and were reluctant to give long-term loans, only 8.4% of foreign banks loans are long-term. It is also mentioned that the entry of foreign banks did not help to improve the performance of domestic banks. Weller (1999) found that under the asymmetric information assumptions, multivariate regression results indicate that more multinational banks entry resulted in a decline of credit supply by Polish banks during the early transition phase. The overall impact of increased international financial competition on credit supply of Polish banks resulted in lower total credit supply in the Polish economy, which led to adverse effects on business investment. Park3 (cited in Feldstein: 2000) pointed that in Korea, foreigners own 70 percent of one bank; however, they are not interested in management control. He also mentioned that foreign owners are not interested in sharing their risk management techniques with Koreans. One reason for this is that foreign banks are competing with domestic banks. On credit risk management stance, domestic banks actually have an advantage from better local knowledge. Roubini4 (cited in Feldstein: 2000) stated some concerns about foreign banks as follows; firstly, foreign banks seem to cherry pick the best credits and leave the worst for domestic banks. Secondly, foreign banks tend to incline to lending in good times but less incline in bad times. Thirdly, it seems likely that home country regulations force foreign banks to retrench more than is desirable. Fourthly, in reality, there is political pressure on the local authority to provide the bailout for foreign banks. 2.2 Bank Profitability Liberalisation has arguably increased the scope for pronounced financial cycles which in turn can lead to the amplification of cycles in the macro economy and often ending up with banking crisis. The damage caused by financial instability has been serious for emerging market countries (BIS:2001) The decline in profitability in downturns may lead to a lower tolerance for risk, and, some cases, to a strong reduction in the supply of credits. Banks will rearrange their portfolio towards relatively safe assets or charge higher lending margins.

-8The main contribution to the cyclical pattern in bank profitability is the cyclical nature of aggregate loan losses and that of provisioning for these losses. Over the second half of the 1990, the return on equity for commercial banks in the United States persistently exceeded returns earned over the previous 20 years. The provisioning expenses incurred by US banks declined significantly5. From the table, it can be seen that bank profitability increased whereas provisioning expenses declined in Germany, United Kingdom, Australia, Sweden and Thailand. However, it can be noted that even during the contraction period, foreign banks in Thailand experienced higher level of profitability, compared to those of banks in industrialising countries.

Table 1: Profitability of Major Banks in 1999 and 2000

as a percentage of total average assets

Number of banks

Pre-tax profits 1999 2000 1.79 0.37 0.55 0.83 1.53 1.85 1.09 0.96 -1.92 3.29

Provisioning expenses 1999 0.44 0.90 0.28 0.20 0.33 0.24 0.01 0.12 5.54 1.72 2000 0.63 0.52 0.18 0.18 0.21 0.20 0.07 0.04 1.99 0.63

Net interest margin 1999 3.34 1.14 0.95 1.14 2.30 2.72 1.27 0.70 0.64 3.75 2000 3.22 1.07 0.82 0.94 2.21 2.43 1.39 0.73 1.40 4.21

Operating costs 1999 3.84 0.89 1.65 1.85 2.40 2.55 1.50 2.55 2.46 3.54 2000 4.10 1.01 1.74 1.91 2.39 2.39 1.66 2.90 2.25 3.76

United States Japan 1/ Germany France United Kingdom Australia Sweden Switzerland Thailand Domestic Banks Foreign Banks

12 16 4 4 4 4 3 2 9 10

2.17 0.42 0.43 0.69 1.43 1.72 0.84 0.82 -6.49 1.79

1/ 1999 figures refer to the fiscal year ending 31 March 2000; figures for 2000 are annualised first half data for the fiscal year 2000. Sources: BIS 71st Annual Report and Chantapong (2001)

-9Bank Profitability in Thailand between 1997-2001

( % of average total assets) Graph 1
Bank Profitability
0.035
0.015 0.005 0.000 -0.005 -0.010 -0.015 -0.020 -0.025 -0.030 -0.035 -0.040 1997- 1997- 1998- 1998- 1999- 1999- 2000- 2000- 2001- 2001H1 H2 H1 H2 H1 H2 H1 H2 H1 H2 Year Foreign Banks Domestic Banks All banks 0.010 % of total avg assets

Graph 2
Provisioning Expenses

0.030 % of total avg asse ts 0.025 0.020 0.015 0.010 0.005 0.000 1997- 1997- 1998- 1998- 1999- 1999- 2000- 2000- 2001- 2001H1 H2 H1 H2 H1 H2 H1 H2 H1 H2 year Foreign Banks Domestic Banks All banks

Graph 3
Net Interest Margin
0.025

Graph 4
Operation costs
0.016 0.014 % of total avg assets

0.020 % of total avg assets 0.015 0.010 0.005 0.000 -0.005 1997- 1997- 1998- 1998- 1999- 1999- 2000- 2000- 2001- 2001H1 H2 H1 H2 H1 H2 H1 H2 H1 H2 Year Foreign Banks Domestic Banks All banks

0.012 0.010 0.008 0.006 0.004 0.002 0.000 1997- 1997- 1998- 1998- 1999- 1999- 2000- 2000- 2001- 2001H1 H2 H1 H2 H1 H2 H1 H2 H1 H2 Year Foreign Banks Domestic Banks All banks

Bank Profitability in Thailand From graphs 1-4, commercial bank earnings slightly improved, with a smaller loss between 1997-2001. Domestic banks recorded the significant decline in losses because of reduction in provisioning expenses6. The improvement in operating performance after the financial crisis reflected a recovery of net interest margin and a sustained reduction in operating costs. Net interest margin of foreign banks was higher than those of domestic banks whereas foreign banks had a lower level of loan provisioning expenses, consequently, foreign banks experienced relatively higher profits than domestic banks. However, the provisioning expenses

- 10 of foreign banks gradually increased since the second half of 2000. It seems likely that foreign banks expedited debt restructuring, compared to that of domestic banks. After the financial restructuring, domestic banks tended to adjust themselves; as a result, operating costs of both came to be closer in the subsequent period. Nevertheless, bank profits are likely to remain weak in the near future and are sensitive to the risks of lower margins and the reversion of restructured NPLs and new entry which may rise given the fact that the macroeconomy continue to be weak (IMF:2001).

III. Data and Methodology

This study uses a micro-bank level panel data on financial statements both income statements and balance sheets of domestic and foreign banks in Thailand covering 6 years for 1995-20007. The data set covers 23 out of the total of 31 commercial banks as in September 2001. It excludes Japanese banks and some banks whose annual reports are released in March and November respectively and foreign bank branches that do not play active roles. The banks included in the study can be classified into three groups; 9 domestic banks (representing both local private and state-owned banks), 4 joint venture banks (representing banks with more than 50 per cent of foreign ownership since 1999 and 10 branches of foreign banks (representing banks with 100 per cent of foreign ownership). Total assets of these 23 commercial banks amounted to almost 90 per cent of banking systems assets between 1995-2000 (table 6). From the banks income statement, accounting identity can be identified as follows (Claessens, Dimirguc-Kunt and Huizinga, 2000)8:
netmargin/ta + noninterestincome/ta = beforetaxprofits/ta + overhead/ta + loanlossprovisioning/ta (1)

Financial management theories offer many indicators for accessing a banks performance. The best indicator of bank performance is the behaviour of the banks stock price since it reflects the markets evaluation of the banks performance (Sabi: 1996). From the micro bank-level panel data, I compute seven measures for a comparative study of the performance of

- 11 domestic and foreign banks in Thailand. These variables can be grouped into two main categories as follows: 1) Profitability: These variables consist of Return on Assets (ROA: profit after tax/total assets) which is an indicator of managerial efficiency and indicates the competence of management of the bank to convert the bank assets into net earnings. Other ratios include net interest margin/total assets, non-interest income/total assets, overhead/total assets, and loan loss provisioning/total assets9. 2) Commitment to Domestic Economy: The variable for this aspect is loan ratio (LR: loans to clients/total assets) which presents consumer lending activities and bank commitment to the domestic economy. I apply the methodologies followed in some earlier studies (Claessens, Dimirguc-Kunt and Huizinga: 2000, Weller: 1999 and Sabi: 1995) to my empirical estimation. I estimate the reduced form equation that relates endogenous banking variables, such as profitability to banking, inputs such as loan loss reserve/total assets and non-interest income/total assets and a set of dummy variables such as ownership dummy (foreign, domestic) and crisis dummy (period before and after the financial crisis) variables.

I it = 0 + i Bit + it

(2)

where I it is the endogenous variables (e.g. net margin/average total assets or before tax profits/average total assets) for domestic and foreign banks i at time t ;

Bit is bank variables for domestic and foreign banks i at time t and dummy variables;

0 is a constant and i are coefficient while it is an error term

I use the Generalised Least Squares Method (GLS) to estimate the equation (2). I use the between estimator which is consistent (through not efficient) when GLS on the pooled sample is consistent10 . The fixed effects model11 is also applied. This method has the advantage of controlling for incidence of time-invariant omitted variables, which may be correlated with the other explanatory variables.

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IV. Empirical Results

Table 2 (between estimators) presents the performance measures in terms of financial ratios. The ratio analysis compensates for the disparity generated by the differences in bank size. The results indicate that foreign bank profitability (equation 1-4) is significantly higher than the average profitability or higher than those of domestic banks. In fact, return on assets of foreign banks is 2.3 percent higher than an average profitability. It should be noted that domestic bank profitability is not significantly different from the average profitability, possibly because of the multicolinearity problems between ownership dummy variables (see table 7). Average profitability tends to be close to domestic bank profitability because of a slight change of market share during the post-crisis period (1998-2000). Domestic banks still hold a large market share or about 86.9 percent of total assets. Foreign banks increased their market share from 5.5 percent of total assets in pre-crisis period (1995 1996) to 13.1 percent in the post-crisis period (when including merged banks as foreign banks)12 (Chantapong: 2001). Not surprisingly, noninterest income is significantly positvely related to bank profitability while loan loss reserve is negatively related to bank profitability. As for expense side, both domestic and foreign banks significantly reduced overhead expenses. Loan loss provisioning expenses of both domestic and foreign banks reduced although the coefficients of ownership dummy variables are not significantly different. One explanation is that loan loss provisioning expenses strongly link with the regulation in line with the International Loans Classification and Provisioning (LCP) rules, which was fully implemented by the year 2000. With reference to the commitment to domestic economy (from equation 7) although none of coefficients of independent variables is statistically significant, it indicates that both domestic and foreign banks reduced their credit exposure during the hard times and foreign banks responded more strongly. The reason for this may come from the uncertainty in the weakening recovery and the possibility of re-entry of restructured NPLs. As a result, banks were reluctant to provide loans to the customers during the bad times.

- 13 Table 2 : The Comparison of Domestic and Foreign Bank Performance: Between Regression Dependent Variables
(1) (2) Non-int income/ta (3) Before tax profits/ta 1.350** (0.490) -0.0003 (0.032) 0.613*** (0.194) 0.003 (0.002) 0.018*** (0.005) 0.005 (0.003) -0.010 (0.007) 0.5830 23 -0.265*** (0.088) -0.950 (0.681) 0.0005 (0.003) 0.026** (0.009) 0.005 (0.009) 0.0006 (0.016) 0.8177 23 (4) ROA 1.186** (0.418) -0.270*** (0.079) -0.875 (0.582) 0.001 (0.002) 0.023** (0.009) 0.006 (0.008) -0.0007 (0.014) 0.8110 23 -0.001 (0.001) -0.010* (0.006) -0.007* (0.003) 0.025*** (0.004) 0.3504 23 (5) Overhead/ta 0.470* (0.245) 0.020 (0.035) (6) Loan loss pro/ta 0.245 (0.154) 0.169*** (0.035) -0.257 (0.263) -0.005*** (0.001) -0.007 (0.009) -0.0001 (0.010) 0.019* (0.011) 0.5859 23 -0.571 (0.446) -0.108 (0.152) 0.140 (0.377) 0.1103 23 (7) Loan/ta 13.137 (9.325) 0.490 (0.754) -9.316 (14.389)

Independent Variables Non-Int Income/ta Loan Loss Reserve/ta Overhead/ta LR (avloan/ta) Foreign Domestic 1/ constant R2 No. of Obs.

(1)Net margin/ta 0.572 (0.404) -0.091 (0.067) -0.158 (0.564) -0.002** (0.005) 0.019** (0.008) 0.005 (0.008) 0.019 (0.013) 0.6378 23

Note: 1) The regression is estimated using Generalised Least Squared pooling cross-bank time-series data. Detailed variable definitions and data sources are given in the appendix. 2) * denotes 10% level of significance, ** denotes 5% level of significane, and *** denotes 1% level of significance.

Table 3 (fixed effects estimators) presents the domestic and foreign bank performance with respect to time difference. From equation 1 and 3, coefficients of dc (crisis dummy variable) are statistically significant. It indicates that all banks gradually improved their profitability during the post-crisis period. However, coefficients of dfdc (combination of crisis and ownership variable: foreign bank after the crisis year) for equation 1-4 are significantly negative. It means that in the post-crisis period there has been a smaller gap in profitability of foreign and domestic banks. This shows a positive sign of domestic bank performance resulting from financial restructuring program, which embarked after the financial crisis. It should be noted that none of coefficients of dddc (combination of crisis and ownership variable: domestic bank after the crisis year) are significant, because of the multicolinearity problems between dummy variables (see table 7). Also, there has been slight progress in a sustained reduction in operating expenses across all the banks as shown in significant negative coefficient of dc in equation 5 (overhead over total assets).

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Table 3 : The Comparison of Domestic and Foreign Bank Performance: Fixed Effects

Dependent Variables
(1)
Independent Variables Net margin/ta 0.148 (0.137) -0.043** (0.016) 0.046 (0.192) 0.001*** (0.001) 0.025*** (0.005) -0.027*** (0.005) -0.0006 (0.005) 0.022*** (0.006) 0.5985 0.004 (0.008) 0.090 (0.071) -0.003*** (0.0006) 0.003 (0.002) -0.008** (0.004) 0.002 (0.002) 0.012*** (0.003) 0.2425

(2)
Non-int income/ta

(3)
Before tax profits/ta 0.703* (0.396) -0.265** (0.117) -1.162 (0.835) -0.003 (0.002) 0.045* (0.026) -0.049* (0.027) -0.017 (0.031) 0.021 (0.023) 0.3655

(4)
ROA 0.596 (0.387) -0.286** (0.120) -1.219 (0.845) -0.003 (0.002) 0.038 (0.026) -0.048* (0.026) -0.021 (0.031) 0.026 (0.024) 0.3414

(5)
Overhead/ta 0.078 (0.052) -0.005 (0.016)

(6)
Loan loss pro/ta 0.416 (0.367) 0.226** (0.106) 0.235 (0.697)

(7)
Loan/ta -66.339 (44.856) -0.164 (1.230) 13.521 (11.564)

Non-Int Income/ta Loan Loss Reserve/ta Overhead/ta LR (avloan/ta) dc dfdc dddc constant R2

0.001*** (0.0002) -0.010** (0.004) 0.004 (0.004) 0.003 (0.005) 0.029*** (0.003) 0.1856

0.004** (0.002) -0.019 (0.026) 0.022 (0.026) 0.016 (0.029) -0.0002 (0.020) 0.1807 0.313 (0.237) -1.067 (0.729) -0.018 (0.220) 0.611 (0.580) 0.2245

No. of Obs.

136

136

136

136

136

136

136

Note: 1) The regression is estimated using Generalised Least Squared pooling cross-bank time-series data. Detailed variable definitions and data sources are given in the appendix. 2) * denotes 10% level of significance, ** denotes 5% level of significane, and *** denotes 1% level of significance.

Taking results from table 2 and 3 into account, it can be seen that in both cases between and fixed effects estimators, loan loss reserve over total assets has significant negative relationship to bank profitability. It seems likely that the deterioration of bank asset quality during cyclical downturns requires higher loan loss provisions and reserves. This leads to decline in bank profitability and capital shortages faced by banks, which provide a large share of total lending to the economy. Consequently, credit contraction may prolong and the impact of capital shortages on the real economy will be magnified. This is very crucial for policy implications for balancing between the risk management policy and negative impact of loan loss reserve policy.

- 15 Loan over total assets is negatively related to bank profitability in between regression methodology whereas it has significantly positive relationship with bank profitability when applied fixed effects methodology. However, results from between estimators indicate that all banks faced the problem of deterioration of asset quality and re-entry of restructured loans whereas results from fixed effects estimators show that the quality of bank asset in the slightly improved during the post-crisis period. Similar evidence can be found in the relationship between loan and loan loss provisioning. These inconsistencies may result from complexity of loan loss provisioning methodology by itself and problem of time differences. However, in this case results from fixed effects methodology seem to be useful for understanding the development of bank performance. From equation 1, table 3, the relationship between loan over total assets and bank profitability is significantly positive. The more loan banks provide the customers, the more profits banks get. However, from equation 6, table 3, some credit risk and problems of re-entry NPLs resulting from continued weak domestic economy, a decline growth in world economy after the crisis and complete implementation in line with International Loans Classification and Provisioning (LCP) rules by the year 2000 made an increase in loan loss provisioning when banks provided more loan. Consequently, banks were cautious to extend credits to the corporate companies during the bad times. This also affected the business operations of good companies afterwards. It seems likely that this is one of the explanations why it takes long time for Thai economy to get back in the same track again.

V. Concluding Remarks
It is generally mentioned that banking sector is becoming increasing global resulting from financial liberalisation and economic integration. Some positive impacts of greater foreign bank entry in home countrys banking system are as follows; it makes banking and financial system less fragile and less prone of crisis, it encourages adoption of best practice in the banking industry, particularly in risk management and foreign banks in emerging markets play an important role in stability overall lending while domestic banks are highly sensitive to local condition. On the other hand, it brings some negative impacts, for example, foreign banks seems to cherry pick the best credits and foreign banks tend to incline to lending in the good time and provide less lending in the bad time. Increasing liberalisation in the economy and mergers and acquisitions by foreign banks after the 1997 financial crisis, domestic financial institutions in

- 16 Thailand would no longer be protected like one mentioned in the past that no entry, no exit and would be challenged by foreign banks more than ever before. This paper provides a comprehensive study of the performance of domestic and foreign banks in Thailand in terms of profitability and other characteristics after the 1997 financial crisis. The results of this study indicate that foreign bank profitability is higher than the average profitability of the domestic banks. All banks gradually improved their profitability during the post-crisis period. Importantly, the study finds that in the post-crisis period, the gap between foreign and domestic profitability becomes closer. This shows some positive sign of domestic bank performance improvement resulting from financial restructuring program, which implemented seriously after the financial crisis. It seems likely that domestic banks, which are under the process of restructuring try can gradually improve their performance in order to catch up with the foreign banks if we use them as a benchmark. It can be concluded that increase in competition by greater foreign participation in banking systems in Thailand gave momentum to technological and managerial adjustment of domestic banks. Our finding is also consistent to Dziobek and Pazarbasioglus study (1998), which is stated that a return to profitability requires more difficult and longer time operated restructuring. One of the policy implications is that national authorities should anticipate the need for reforms and carry them on in times of relative financial calm.
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Table 4 : Macro and Financial and Banking Data for Thailand, 1995-2000
Before crisis year 1995 1. Macro Data 1.1. GDP growth (%) 1.2 Inflation 1.3 Current account balance 1.4 International reserve (bil of US$) 1.5 External debt (bil of US$) 2. Financial Data 2.1 M2 2.2 Domestic Credit Credit to public sector Credit to private sector 2.3 Capital Adequacy Ratio (%) 2.4 Liquidity Ratio (% of total assets) 3. Banking Data 3.1 Net profit (% of avg assets) 3.2 NPLs (% of total loan) 3.3 Total loans (%of tatal deposits) 3.4 Inter liabilities from banks (mil of US$) Source: Bank of Thailand 1.00 n.a. 131.23 0.42 n.a. 131.76 -2.05 n.a. 140.62 -3.35 43.43 115.04 5,817.3 -1.80 39.86 110.08 1,152.4 -0.12 18.07 93.70 425.2 79.0 108.2 1.7 103.7 9.59 5.13 80.6 111.6 1.2 107.6 10.26 5.26 91.5 141.6 1.0 137.0 9.33 6.31 102.7 140.2 7.0 129.2 10.80 10.93 105.2 135.0 8.4 122.2 12.30 10.89 102.7 117.4 8.5 105.4 11.71 17.79 9.3 5.8 -7.9 37.0 100.8 5.9 5.9 -8.1 38.7 108.7 -1.4 5.6 -0.9 27.0 109.3 -10.8 8.1 12.8 29.5 105.0 4.2 0.3 10.2 34.8 95.2 4.4 1.6 7.5 32.7 79.2 1996 Crisis year 1997 After crisis year 1998 1999 2000

Unit : % of GDP, otherwise as stated

16,474.7 14,396.9 11,530.0

- 18 -

Table 5 Synopses of the Four Market Crises

Latin America, 1982-83 Banks Mexico, 1994-95 Investment funds; Institutional investors; Corporations (FDI; Banks Corporations; banks; in final stage, government Bonds; equity; treasury bills; FDI Moderate until early 1994, then substantial Fast Boom Liberalisation and deregulation in full swing East Asia, 1997-98 Banks; investment funds; institutional investors; corporation (FDI) Corporations; banks Russia,1998 Banks; investment funds; institutional investment Government; banks, stock purchases in markets and privatisation Treasury bills and bonds; inter bank deposits; bonds; equity Very substantial and persistent No significant domestic credit Boom but reaching peak before outbreak of crisis No genuine financial intermediation; anarchical liberalisation Asia Latin American (Brazil) and financial market in developed countries Strong but dismal record of enforcing Unilateral moratorium and rescheduling

1. Who were the foreign lenders or investors? 2. Who were the domestic borrowers or users of funds? 3. What were the vehicles of capital inflows? 4. Capital outflows 5. Domestic credit expansion 6. Equity and real asset price development 7. Regulatory framework for domestic financial system 8. Contagion 8.1 Where form? 8.2 Where to?

Government or other public authorities Rollover loans (mostly syndicated) Substantial and persistent Fast underdevelopment Strong regulation

Inter bank deposits; loans; banks; equity; FDI Non until few months before the crisis, then strong Fast Boom but reaching peak before outbreak of crisis Liberalisation and deregulation in full swing

Eastern Europe All Latin American countries, plus developing countries Strong Bailing in

No source Other Latin American countries: tequila effect

Thailand Other Southeast and East Asia countries

9. Crisis management 9.1 Macro policy conditionality 9.2 Private sector contribution to crisis handling: bailing in or bailing out

Strong Bailing out

Strong Initially bailing out; soon after, bailing in

Source: Summarised only items related to banks from Lamfalussy, Alexander (2000)

- 19 -

Table 6: Summary of Coverage and Features of bank Level Data as of September 2001
Share of total assets (%) 22.29 15.89 12.92 11.66 8.05 6.22 4.60 3.22 2.24 87.08 2.61 2.03 1.24 0.78 6.66 1.54 1.08 0.75 0.74 0.59 0.50 0.48 0.43 0.12 0.03 6.26 100.00 Share of Foreign Ownership (%) < 50 < 50 < 50 < 50 < 50 < 50 < 50 < 50 < 50 79 52 75 75 100 100 100 100 100 100 100 100 100 100

Listing of Commercial Banks 1. Domestic Bank Banks 1.1 Bangkok Bank 1.2 Krung Thai Bank 1.3 Thai Farmer Bank 1.4 Siam Commercial Bank 1.5 Bank of Ayudhaya 1.6 Thai Military Bank 1.7 Siam City Bank 1.8 Bangkok Methopolitan Bank 1.9 BankThai Bank Sub-total 2. Joint Venture Bank 2.1 Bank of Asia 2.2 DBS Thai Dhanu Bank 2.3 Standard Chartered NakornThon Bank 2.4 UOB Radhanasin Bank Sub-total 3. Branches of Foreign Banks 3.1 Citibank, N.V.
3.2 The HongKong and Shanghai Banking Corp.

Short name

Some Features

BBL KTB TFB SCB BAY TMB SCIB BMB BT

Private owed Bank Staed owned Bank Private owed Bank Private owed Bank Private owed Bank Private owed Bank Staed owned Bank (FIDF hold 100%) 1/ Staed owned Bank (FIDF hold 100%) Staed owned Bank (FIDF hold 96%)

BOA DBS TDB SCNB UOBR

Acquired by ABN-AMRO Bank in 1999 2/ Acquired by DBS, Singapore in 1999 3/ Acquired by SC, U.S.A. in 1999 4/ Acquired by UOB, Singapore in 1999 5/ Bank Nationality : U.S.A. Bank Nationality : U.K. Bank Nationality : U.S.A. Bank Nationality : Germany Bank Nationality : U.S.A. Bank Nationality : The Netherlands Bank Nationality : U.S.A. Bank Nationality : France Bank Nationality : China Bank Nationality : Malaysia

3.3 Standard Chartered Bank 3.4 Deutche Bank 3.5 The Chase Manhattan Bank 3.6 ABN-AMRO Bank, N.V. 3.7 Bank of America 3.8 Credit Agricole Indosuez Bank 3.9 Overseas Chinease Banking Corp. 3.10 RHB Bank Berhad Sub-total Grand total

CITIBANK HSBC SC DEUTSCHE CHASE ABN AMRO BANKAMERICA INDOZUEZ OCBC RHB

Source: Our calculation is based on data from Bank of Thailand 1/ The dataset consists of 23 commercial banks from totalling 31 commercial banks as of September 2001. It comprises 9 domestic banks (representing local private and state-owed banks), 4 joint venture banks (representing banks with foreign participation more than 50 % of ownership) and 10 branches of foreign banks (representing foreign-owned banks). Total assets of 23 commercial banks accounted for almost 90 per cent of banking systems assets between 1995-2000 2/ Foreign banks in this study can be defined as banks which have a percentage share of foreign ownership more than 50 percent. Notes: 1/ FIDF : Financial Institutions Development Fund 2/ ABN AMRO Holding (Thailand) hold about 79 percent of ownership in Bank of Asia (BOA). 3/ Development Bank of Singapore (DBS) hold about 52 percent of ownership in DBS Thai Dhanu Bank (DBS TDB) 4/ Standard Chartered Bank and FIDF hold about 75 percent and 25 percent repectively of ownership in Standard Chartered NakornThon Bank (SCNB). 5/ United Overseas Bank (UOB), Singapore and FIDF hold about 75 percent and 25 percent respectively of ownership in UOB Radhanasin Bank.

- 20 Table 7: Correlation Matrix

non_int loan loss overhead_ income_ta reserve_ta ta non_int income ta loan loss reserve ta overhead_ta LR_ta foreign domestic dc dfdc dddc LR_ta foreign domestic dc dfdc dddc

1.0000 -0.0339 0.2752 -0.2556 0.4939 -0.3343 0.0206 0.3053 -0.1996 1.0000 0.1363 0.0347 -0.1345 0.2031 0.3074 0.0592 0.3857 1.0000 0.0435 0.0725 -0.1583 0.1730 0.1634 -0.081 1.0000 -0.1081 0.0740 0.0621 0.0307 0.0433 1.0000 -0.7100 -0.0092 0.4673 -0.3470 1.0000 0.0023 -0.3318 0.4888 1.0000 0.5808 0.5463 1.0000 -0.1622 1.0000

Note: The correlation matrix computes the correlation coefficients of the columns of a matrix. That is, row i and column j of the correlation matrix is the correlation between column i and column j of the original matrix. The diagonal elements of the correlation matrix will be 1 since they are the correlation of a column with itself. The correlation matrix is also symmetric since the correlation of column i with column j is the same as the correlation of column j with column i. (from: www.itl.nist.gov)

Apendix 1 Definition of Bank Level Data Variables No. Variable Name Definition 1 After-tax profits/ta (ROA) Ratio of after tax profits and extraordinasry items to total assets 2 Before-tax profits/ta 3 Net Margin/ta 4 Non-interest income/ta 5 Overhead/ta 6 Loan Loss Pro/ta 7 Loan Loss Reserve/ta 8 LR (Laon/ta) 9 dc 10 dfdc 11 dddc 11 foreign 12 domestic Ratio of gross profit (profit before income tax and extraordinary items) to total assets. Ratio of net interest income (interest income and dividend - interest expenses) to total assets. Ratio of non-interest income to total assets Ratio of operating expenses (salaries and employee benefits and other non interest expenses) to total assets. Ratio of Loan Loss Provisions to total assets. Ratio of Loan Loss Reserves to total assets. Ratio of loans (commercial loans, public sector loans, consumer loans, secured loans and other loans, net of LLR) to total assets. Crisis dummy variable. Combination of ownership and crisis dummy variable (foreign banks after the crisis) Combination of ownership and crisis dummy variable (domestic banks after the crisis) Ownership dummy variable for foreign banks Ownership dummy variable for domestic banks

- 21 -

Endnotes
1

Since BIBFs are not allowed to take domestic deposits, they are subject to fewer regulations than commercial banks. BIBF transactions are granted some tax privileges (e.g. reduction of corporate income tax, exemption from special business tax and withholding tax on interest income). BIBFs gain a lower tax rate of 10%, compared to 30% in the case of commercial bank operations.

Also Matheison and Schinasi (2001) stated that in most emerging markets, local banks began as family-owned institutions that in many cases became parts of industrial conglomerates. It is generally believed that family businesses tend to be bigger and last longer in economies with less developed primary and secondary capital markets. Yung Chul Park, Professor of Economics, Korea University Nouriel Roubini, Associate Professor of Economics and International Business at the Stern School of Business, New York University The rate of return on bank equity in the Euro area, lower than in the United States, steadily increased during the 1990s with a simultaneous decline in provisioning expenses. The government assumed some losses of intervened banks when their NPLs were transferred to the AMC (Asset Management Corporations) and allowed previously made provisions to be reversed and treated as part of income. The data are based on the databank of financial institution data compiled by Data Management Group, Bank of Thailand. The first two ratios show the accounting value of a banks net interest income over total assets (net margin/ta) and net non-interest income over total assets, non-interest income over total assets (non-interest income/ta). The noninterest income/ta shows that many banks engage in non-lending activities, such as investment banking and brokerage services. In order to reflect bank profitability, I consider the banks before tax profit over total assets (beforetaxprofit/ta). The overhead/ta variable shows the banks entire overhead whereas loan loss provisioning/ta measures actual provisioning for bad loans. Each of the above mentioned variables give us a slight different aspect of bank profitability.

3 4

10

This estimator is sometimes called a Wald estimator because if T is large enough, such an estimator is robust to classical measurement error in the X variables. One of the charateristics of between estimator is that it convert all the data into individual specific averages and perform GLS on the following equation :

y i = xi +

11

With panel data, it is possible to obtain consistent estimates of parameters of interest even in the face of correlated omitted effects when OLS on individuals cross sections would not obtain those. Foreign bank presence may be greater if taking into account of foreign investors participation in large domestic banks when they increased their capital after the outbreak of the crisis.

12

References
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- 22 Bank of Thailand (2001) Supervision Report 2000 Chantapong, Saovanee (2001), What happened to the Banking Sector in the Aftermath of Financial Crisis: The case of Thailand, Kiel Institute of World Economics, Working Paper No. 378, November Claessens, Stijn, Demirguc-Kunt, Asli,and Huizinga Harry (2000), The Role of Foreign Banks in Domestic Banking Systems, Claessens, S. and Jansen, M. (eds), The Internationalization of Financial Services, p. 117-137, Kluwer Law International, Great Britain Dziobek, Claudia and Pazarbasioglu, Ceyla, (1998) Lessons from Systemic Bank Restructuring, Economic Issue 14, International Monetary Fund Feldstein, Martin, (ed) (2000), Discussion Summary Version of May 17, 2001, Financial Policies, Economic and Financial Crises in Emerging Markets Economies, NBER Conference, Woodstock, Vermont, October 19-21, 2000 Feldstein, Martin (2002), Economic and Financial Crises in Emerging Markets Economies: Overview of Prevention and Management, NBER Working Paper No. 8837 (March) Goldberg, Linda, Dages, Gerard and Kinney, Daniel (1999), Lending in Emerging Markets: Foreign and Domestic Banks Compared, Working paper (November), Federal Reserve Bank of New York Goldberg, Linda (2001), When is U.S. Bank Lending to Emerging Markets Volatile?, Prepared for the NBER Currency Crises Prevention Project headed by Sebastien Edwards and Jeffrey Frankel (March) IMF, (2001) IMF Country Report No. 01/147, Thailand: Selected Issues Johnston, Jack and DiNardo, John (1997), Econometric Methods, Fourth edition: MacGraw-Hill Internationals Lamfalussy, Alexander (2000), Financial Crises in Emerging Markets: An Essay on Financial Globalisation and Fragility, Yale University press, New Haven & London Mashkin, Frederic, S. (2000), Financial Policies and the Prevention of Financial Crises in Emerging Market Countries, prepared for NBER Conference, Economic and Financial Crises in Emerging Markets Countries, Woodstock, Vermont, October 19-21, 2000 Mathieson, Donald .J. and Schinasi, Garry J. (2001), International Capital Market: Developments, Prospects and Key Policy Issues, World Economic and Financial Surveys, August, International Monetary Fund Sabi, Manijeh (1996), Comparative Analysis of Foreign and Domestic Bank Operations in Hungary, Journal of Comparative Economics 22, p. 179-188 Watanagase, Tarisa (2001), The Banking Industry in Thailand: Competition, Consolidation and Systemic stability, BIS Paper No. 4, The Banking Industry in the Emerging Market Economics : Competition, Consolidation and Systemic Stability, August 2001 Weller, Christian (1999), Financial Liberalisation, Multinational Banks and Credit Supply: The Case of Poland, Working Paper B10, Centre for European Integration Studies, Rheinische Friedrich-Wilhelms-Universitat Bonn