An Analysis of the Quality of

the financial institutions in Thailand

Present at the Bank of Thailand,
29 May 2015
The views expressed in this presentation are the views of the author and do not necessarily
reflect the views or policies of the Asian Development Bank Institute (ADBI), the Asian
Development Bank (ADB), its Board of Directors, or the governments they represent. ADBI
does not guarantee the accuracy of the data included in this paper and accepts no
responsibility for any consequences of their use. Terminology used may not necessarily be
consistent with ADB official terms.
1

Background of the financial institutions in

Thailand

Cause of 97 crisis:

FX overvaluation, weakness in the financial system

Measures after crisis:

1. Restore stability to the financial system

(e.g. closure, recap, debt restructure, consolidation)
2. Dramatic internal reforms to realign with new risk based supervisory framework

Key improvement of financial landscape over the decade:

1. Financial Sector Master plan I (2005-2008) and II (2010-2014)

(promote competency driven, modification of prudential guideline, improve financial
service & competition, universal banking, improve financial access)
2. Reform to improve surveillance procedure for specialized financial institutions
(SFIs) in 2015
2

Deposit taking institutions in Thailand

and supervision structure
Supervision

Supervised by
Bank of
Thailand1/

Supervised by
MOF (examined
by
BOT) 2/
Note:

Type of deposit
taking
institutions4/

Scope

1.Commercial
bank
1.1 local
1.2 subsidiaries
1.3 retail banks
1.4 foreign bank
branches

-Commercial
banking business
- Capital market, FX,
derivative (for 1.1
and 1.2 only)

2. Finance
companies
3. Credit foncier
companies

4. Specialized
Financial
institutions (SFI)

Objective

Profit max.

Deposit
insurance
premium
Pay 0.47%
of deposit
base

Stability

NPL

Market
share

Good

Low

Large

-Accept deposit and

grant credit only

Good

Low

Small

-Accept deposit and

grant mortgage
loan, purchase
immovable property

Good

Low

Small

High for Ibank and

SME bank

Medium,
Growing
rapidly

Support
No
Good but subject
financial
contributi
to Government
access
on3/.
intervention
1/
Non deposit taking institutions under BOT supervision are foreign financial
institution
representative
office,
+Profit max.

asset management companies, non-bank (credit card company, personal loan company), e-payment.
2/
Non deposit taking institutions under MOF supervision are Thai asset management company, national credit bureau.
BOT will supervise this group in early 2016.
3/
Under the new Act for specialized financial institution development fund (on 20 Mar 2015), SFI will need to contribute the deposit insurance
premium
to the SFI fund to reduce an unfair competition. The MOF is considering the method of collection and the premium rate.
4/
Other types of deposit taking institutions are savings cooperative and credit union, supervised by Ministry of Agriculture and Cooperatives, with the
scope of managing funds contributed by members and grant loan to members who need credits. The objective is to provide financial service among

The Thai financial market is mainly bank based.

% of total assets of financial institutions, end 2013

Bank of Thailand; 15.3

Non-depository corporation; 25.9
Money market mutual fund; 0.8
Saving cooperative and credit union; 4.9
SFIs; 12.3

Commercial bank; 40.8

Source: Bank of Thailand

The commercial bank and the specialized government credit institution (SFIs) are
the two most important depository institutions for Thailand.

Details of reform to improve surveillance procedure

for specialized financial institutions (SFIs)
The State Enterprises Policy Commission (super board) allowed the Bank
of Thailand (in October 2014) to take over the supervision and inspection
of specialized financial institutions (SFIs) beginning in early 2016.
MOF keeps its role in setting SFI policy and direction, and appointing
executive (that must meet BOT criteria).
Specialized Banks includes:
- Deposit taking institution:
1. Government Savings Bank (GSB)
2. Government Housing Banks (GHB)
3. Bank for Agriculture and Agricultural Cooperatives (BAAC)
4. Islamic Bank of Thailand (IBANK)
- Non-deposit taking institution:
5. Export-Import Bank of Thailand (EXIM bank)
5. Small and Medium Enterprise Development Bank of Thailand (SME bank)
5

Problem of SFIs
The objective of organizing the SFIs:
To play a key role in providing financial services to
sectors not adequately served by commercial banks such as small and medium enterprises (SMEs),
agricultural and rural enterprises - and also contributed
to the government's social and development policies.
Comments from public:
The regulatory framework is weak, occasionally
subjected to government intervention, the major role is
not fully achieved.
High NPL ratio for SME bank (36.24%of total loan),
and IBANK
6

Are they ready for the new regulation under

the BOT?

Regulatory standards for SFIs in terms of capital adequacy ratio and loan loss provision
reserves could be looser than for commercial banks because SFIs are required to run business
that comply with government schemes, FPO director general-Krisada Chinavicharana, 9 Feb
2015

Government saving bank should not be affected by the measure, as it complies with the rule
and are examined by BOT regularly, Director-Mr. Tachapol Kanjanakul, GSB, 1-3 Jan 2015

BOT has examined the Bank for Agriculture and Agricultural Cooperatives twice a year using
the same standard as the commercial bank, the bank stability remain intact, the liquidity
management is better than the requirement, credit quality is good, loan growth increase steadily,
NPL is under control. The measure helps enhance efficiency in the monitoring system and shore
up credibility.., BAAC president- Luck Vajananawat, 31 Jan 2015

SFIs are development banks, applying universal regulatory standard (like commercial bank)
could conflict with their mission. The new regulation under he BOT should be deferred until the
economy improve and get approval from stakeholders, SME Bank chairwoman- Salinee
Wangtal, 24 Mar 2015.
7

Research Question?
Questions:
1. How is the financial condition of depository taking institutions in
Thailand? What indicator should we use?
2. Does the difference in business model and supervision associate
with the difference in the financial condition?
3. Can we infer the risk from the financial condition?
Data: annual data (2006-2013) from Bankscope.
26 observations: 2 finance companies, 4 deposit taking SFIs, 3
foreign bank branch, 2 subsidiaries, and 15 local commercial
bank
8

Research Outline and Methodology

1. Assess the financial condition of the deposit taking
institutions (banks) in Thailand and identify key
financial ratios (using PCA)
2. Classify banks according to their financial
condition (using Cluster analysis)
3. Associate the risk aspect to the financial profile &
peer group assessment (using regression)

Key financial ratios

Profitability and earning
-Return on average equity (ROAE)
-Net interest margin (NIM)

Operational Efficiency
income to cost ratio (ICR)

Asset quality/ risk provision

gross loan to loan loss reserve ratio (LLOSR)

Liquidity
-liquid asset to deposit and
borrowing ratio (LADBR)
-Asset to net loan ratio (ATNL)

Capital adequacy (solvency)

equity to asset ratio (ETA)

Note: this method is similar to CAMELS approach which was developed by bank regulators in USA to measure
financial condition of financial institutions. (ie. Capital adequacy, Asset quality, Management, Earnings (profitability),
Liquidity and funding, sensitivity to market risk (loses arising from changes in market prices)
10

Principal component analysis

Principal component
Aspects

Variables

ROAE

0.12

0.35

0.64

NIM

-0.44

0.39

-0.08

LADBR

0.51

0.07

-0.06

Liquidity

ATNL

0.44

0.34

-0.42

Efficiency

ICR

0.18

0.43

0.48

Asset Quality
Capital

LLOSR

-0.04

0.62

-0.41

adequacy

ETA

0.55

-0.20

0.00

Profitability

Note: data is period average (2006-2013),

consisting of 26 deposit taking institutions

Principal component 1:
Tradeoff between higher capital adequacy + liquidity
and lower profitability
Principal component 2:
Asset quality and efficiency
Principal component 3:
Tradeoff between higher profitability + efficiency,
and lower liquidity and asset quality

11

Financial conditions of 26 banks

Component loading plot

Score plot

pink dot represent= finance company

orange dot=specialized government credit institution
brown dot = subsidiaries
yellow dot=local commercial bank
green dot= foreign bank branch

Specialized government credit institutions (SFIs) have relatively higher dispersion of

component values. (1. IBANK is weak, 2. BAAC have strong financial condition, 3.financial
condition of GSB and GHB is quite close to local commercial bank)
- Foreign bank branch and subsidiary have strong capital adequacy and liquidity
- Financial condition among the local commercial bank is quite similar
The cluster analysis in the next section will help discriminating the group of financial institutions
according to their financial condition.
12
-

More components

13

Research Outline and Methodology

1. Assess the financial condition of the deposit taking
institutions (banks) in Thailand and identify key
financial ratios (using PCA)
2. Classify banks according to their financial
condition (using Cluster analysis)
3. Associate the risk aspect to the financial profile &
peer group assessment (using regression)

14

Custer analysis
- Principal Components 1-3 are used to classify groups
financial institutions (banks)
- This helps us identify the banks that have similar
financial conditions
- We assume that there is no prior knowledge about
which banks belong to which type or group.
- The grouping will be defined through a cluster analysis
of the data
- This allows us to maximize the similarity of banks
within each cluster, while also maximizing the
dissimilarity between groups that are initially
unknown
15

Identifying group of financial institutions

Dendogram from hierarchical (average linkage) cluster analysis

- The four largest banks have very similar financial condition

- Financial condition of the two SFIs (GHB and GSB) are quite close to the four largest bank
16

The cluster analysis yields 9 groups of banks

Financial ratios, 2006-2013

Group of bank

1
2
3
4
5
6
7
8
9
ETA

LLOSR

NIM

ROAE

ICR

Profitability: ROAE, NIM

Liquidity: LADBR, ATNL
Efficiency: ICR

ATNL

LADBR

Asset quality: LLOSR

Capital adequacy: ETA

The difference in bank business model

and regulatory framework does not
necessary implies difference in the
17
financial conditions

Research Outline and Methodology

1. Assess the financial condition of the deposit taking
institutions (banks) in Thailand and identify key
financial ratios (using PCA)
2. Classify banks according to their financial
condition (using Cluster analysis)
3. Associate the risk aspect to the financial profile &
peer group assessment (using regression)

18

Can financial ratio infer to risk?

There are 2 main types of risk:

Systemic risk- general risk such as economic slowdown

Specific risk- balance sheet weakness/ mismanagement

Financially weak and risky institutions are generally the first

group that suffer in the stressed condition and crisis (as seen
in recent crisis)

19

Link between financial condition and risk

The strong key financial conditions are protection
against risk
Financial conditions
Profitability
& earning
Operational
Efficiency

Asset quality
& risk provision

Liquidity

RISK
- Funding
- Business
- Regulatory
- Reputation
- Asset composition
and quality

Capital adequacy
&solvency

20

Associating the risk aspect to our analysis of

the financial profile.

The two major indicators that define the risk of the financial institutions are
the non-performing loan to gross loan (NPL) and the z-score (ZSCORE).

Instead of performing regression of the risk variable on the financial ratios

directly, the first three principal components of these financial ratios are
used as regressors, which helps:

1. solving muticollinearity problem (financial ratios can be collinear with each

other)
2. the dimension reduction property of the PCA helps lowering the effective
number of parameter characterizing the financial conditions.

We are assessing whether each of the three principal components are an

important determinant of the financial institutions risk.
21

2 main indicators to identify risk

ZSCORE measures the financial institutions overall risk taking, which

covers credit risk, liquidity risk and market risk that can occur from
non-lending activities. It captures the distance to distress or the
probability of default. The larger value suggests the lower overall risk
and is more stable.

NPL is an alternative measure of risk which is more specific to the

institutions that participate in the lending activities. It is calculated as
NPL/Total loan. It reflects the financial stability of the financial
institutions.

22

There is significant statistical relationship

between financial condition and the risk
OLS regression for each indicator of risk

Variables
Component 1
Component 2
Component 3
Constant
Observations
Adjusted R-square

Ln(Z-score)
0.48(4.17)***
0.23(1.80)*
0.64(4.08)***
3.46(20.74)***
26
0.58

NPL/gross loan
-1.08(-1.39)
-1.06(-1.02)
-3.49(-3.19)***
4.72(4.16)***
25
0.33

Note: t-statistics in parentheses *p<0.1, ** p<0.05, *** p<0.001

The regression results confirm significant relationship between financial condition

and risk.

The stronger the financial condition (profitability, liquidity, solvency, credit quality,
efficiency), the lower overall risk and the more stability measured by Z-Score

The stronger the financial condition, the lower the risk (measured by NPL ratio) of
the banks that participate in the lending activities

23

The peer group assessment

Panel regression for Zscore and NPL ratio
using random effect estimation.
Variables
ln(ROAE)
ln(LADBR)
ln(ATNL)
ln(NIM)
ln(ICR)
ln(LLOSR)
ln(ETA)
Dumg1
dumg2
dumg3
dumg4
dumg5
dumg6
dumg8
dumg9
_cons
Obs.
Overall R2

ln(ZSCORE)

ln(NPL to gross loan)

0.03(10.95) ***
0.00(-0.19)
0.04(2.51) ***
0.01(1.52)
0.03(3.19)* **
0.01(1.59)
0.98(123.63) ***
-0.43(-0.76)
-0.53(-0.85)
-2.84(-2.86) ***
-1.24(-2.20) **
-1.40(-1.41)
-2.92(-2.95) ***
-0.11(-0.15)
-0.12(-0.12)
1.72(5.79) ***
173
0.64

-0.03(-0.35)
-0.12(-1.22)
0.40(0.81)
0.49(2.27) **
-0.62(-2.31) **
-0.84(-5.93) ***
0.37(1.83)*
-1.48(-2.97)***
-0.45(-0.94)
1.40(2.34)**
0.36(1.05)
-0.24(-0.41)
-0.23(-0.37)
0.09(0.20)
1.35(2.15)**
-1.62(-0.63)
160
0.71

Note: Data is annually observed from 2006-2013.

Dummy for the group is held constant over the period.

Main findings:
1. The sign of the coefficient for the
financial ratio is correct.
2. Group 7 is employed as base group.
After controlling for the financial ratios,
the base group is relatively more stable
than the other groups.

where group 7 consists of the big 5

commercial banks and government
housing bank, and other 3 new
commercial banks.

24

Conclusion
This paper investigates the effects of bank financial performance on the
risk-taking.
The balance sheet items of the 26 financial institutions are carefully
examined. Five main aspects that commonly explain their financial
position are explored, such as profitability, liquidity performance, asset
credit quality, efficiency and capital adequacy.
The research also identifies the group of these financial institutions
according to their balance sheet characteristics.
The implications on the financial risk aspects are analyzed. We found
that the strong financial position significantly associate with the higher
stability, longer distance to distress and lower risk.
25

Suggestion for future work

Due to the limitation of the data, an analysis
cannot well capture 2 aspects
1. An analysis cannot capture the risk adjusted
financial condition (i.e. data on the risk weighted
asset, risk weighted equity in Bankscope is not
completed).
2. An analysis of the risk of the financial institutions
can be more comprehensive with the data on
concentration risk (risk from type of customers),
foreign exchange exposure, maturity mismatch of
asset and liability, etc.
26