FOCUSED AND QUICK (FAQ) Issue 17
Competition in the Banking Sector: Any Gain over the Past Decade?
Tientip Subhanij & Wanvimol Sawangngoenyuang
Over the last decade, the banking sector in Thailand has undergone transformation as a result of the Financial Sector Master Plan (FSMP) and more prudent regulations. These changes have created a new financial landscape where banks are expected to operate in a more competitive environment. Although there are some evidence that the banking sector has become more competitive over time, the market is not yet contestable. In comparison with neighboring countries, Thailand's banking sector is also considered less competitive.
Since the banking crisis in 1997, the banking sector in Thailand has undergone significant transformation through the implementation of the Financial Sector Master Plan (FSMP), more prudent regulation and supervision standards such as Basel II and IAS39, and advancing information technology such as ATM and internet banking. Given these changes, the question is whether or not the banking sector has become more competitive along the way.
Let us look first at the new financial landscape after the transformation. Although the number of commercial banks remains almost the same as in the pre-1997 financial crisis period, the number of financial institutions has dropped drastically from nearly 180 to merely 38 financial institutions, as many weak financial institutions were closed down, merged or acquired by other financial institutions after the crisis.
One significant push for mass consolidation is the implementation of FSMP I in 2004. With the aim to enhance efficiency and reduce regulatory arbitrage, FSMP I introduced a licensing rationalization scheme and one-presence policy. In essence, there would be only two types of Thai financial institutions, namely commercial bank and retail bank, and two types of foreign financial institutions, namely foreign bank branch and subsidiary. Finance companies and credit foncier companies were meanwhile allowed to upgrade to become retail banks, or merge and upgrade to become commercial banks. Stand-alone international banking facilities (IBFs) could choose to upgrade and become a full branch, or merge with finance and credit foncier companies and upgrade to become a subsidiary.
There has also been a change in the shareholding structure of financial institutions, from private ownership to state ownership and subsequently to foreign ownership. Following the crisis, many banks were required to raise capital, some with the assistance from the government. These banks that were bailed out by the government were later sold to qualified foreign investors who had been allowed to hold more than 49% ownership for a period up to 10 years. These banks*(1) are now called "hybrid banks".
Moreover, banks have been faced with more competition from non-banks. As the government worked to avoid a credit crunch while many banks were curtailing their lending, several policies were implemented to promote access to funding and a deeper financial market. For example, the government granted tax benefits to firms for listing in Market for Alternative Investment (MAI), liberalized the stock brokerage fee, and upgraded Bank for Agriculture and Agricultural Cooperatives (BAAC) to a development bank. As a result, firms' reliance on bank loans declined to less than 50%, while their reliance on bond issuance and loans from Special Financial Institutions (SFIs) increased to 9% and 14%, respectively. Does the new financial landscape bring about more competition among banks?
Based on casual observation, many people would notice foreign banks starting to compete more aggressively with domestic banks over the years. For instance, HSBC and Citibank, though restricted by having just one branch, have firmly established their presence in the retail market, such as the credit card business.
In this FAQ, we would like to look at more quantitative measures of competition in the banking sector, namely Boone indicator and H-statistic. Boone indicator assumes that perfect market competition would reward the most efficient players with larger market shares. Thus, there should be a negative correlation between marginal cost and market share. The more negative Boone indicator is, the tighter is that negative relationship and hence an indication of more market competition. H-Statistic measures the elasticity of bank's revenue with respect to input price. Under perfect competition, banks earn zero economic profit and thus have to pass on all the change in cost to customers. On the other hand, under a not-soperfectly-competitive environment, banks have excess profit and may pass on only some portion of cost to clients and still remain profitable. A higher value of H-statistic means that the banking sector is more competitive. For the case of Thailand, we can see that both Boone indicator and H-statistic suggest that the Thai banking sector has become more competitive when compared with a decade ago.
Due to data limitation, it is difficult to compare Boone indicator and Hstatistic cross nations. Hence, we employ net interest margin (NIM) and return on assets (ROA) as measures of competition. NIM is calculated by dividing net interest income by total asset, and ROA is determined by dividing net profit by total asset. Among the selected Asian countries, ROA in Thailand is almost the lowest in the region, reflecting relatively high operating costs. At the same time, NIM in Thailand is the third highest, staying above that of Korea, Malaysia and Singapore. Higher NIM means that banks charge higher interest on loans while offering lower interest rate on deposits. The wide interest rate gap is necessary to compensate for high costs, suggesting that the Thai banking sector is not yet competitive, especially in the loan market, compared with regional peers.
From various indicators mentioned above, we conclude that the degree of competition in the Thai banking sector has increased over the last decade but the market is still a long way from being competitive and efficient. There are several reasons for this. First, the threat from foreign bank branches (FCBs) continues to be modest though it is on the rise. Despite the aim of FSMP I to create a level playing field, FCBs still feel that they are competing in an unfair market. In principle, FCBs can conduct the same businesses as Thai commercial banks (TCBs) but are crippled by the limit of one branch. While FSMP I allows FCBs to upgrade to subsidiaries which can open 5 more branches, only Mega International Commercial Bank Plc (Mega) has applied for the subsidiary license but has not fully expanded its operations. What this probably means is that Mega does not think that it can compete with TCBs with just 5 branches. Hence, the impact of FCBs in terms of being an effective force to promote competition in the Thai banking sector remains limited.
Second, the market is very much segmented. Each financial institution has its own business model. SFIs target low income clients and are utilized by the government. Retail banks and some newly open commercial banks focus on the leasing, auto loan and personal loan businesses as they carry on the clientele base from their former entity as finance companies. FCBs focus their business on non-interest income, while big Thai banks focus their business on corporate lending. Hence, the overlap in the clientele bases, which is necessary for competition, is also limited.
Third, there is a large disparity in the size of banks. While the largest 5 banks hold more than 65% of the banking sector's assets, hybrid banks and retail banks as well as FCBs are relatively very small, limiting their ability to compete with TCBs.
Lastly, there is fairly little threat from alternative sources of funding due to the under-developed capital market. Most of the time, only blue chip companies are able to raise funds in the stock or bond market.
Despite some evidence of increased competitive pressure from a decade ago, the Thai banking sector appears to remain concentrated, and existing banks can still enjoy market power in a relatively closed environment. In order to make banks behave in a more competitive manner and thus customers would hopefully get to enjoy better services, we need to deal with the issue of contestability.*(2) If banks feel no threat from competition, they have no incentive to improve their operation. Luckily, this issue has been partly addressed in FSMP II and Capital Market Development Master Plan (CMDM). FSMP II will allow subsidiaries to have up to 20 branches and 20 ATMs. Applicants for new licenses will also be considered in the future. Meanwhile, CMDM which is being implemented in 2010-2014 aims to help promote the depth and efficiency of the country's financial system.
*(1) They are Standard Chartered Bank (Thai) Plc., United Overseas Bank (Thai) Plc., CIMB Thai Bank Plc., and Industrial and Commercial Bank of China (Thai) Plc.
*(2) William Baumol defined contestable markets as existing where “an entrant has access to all production techniques available to the incumbents, is not prohibited from wooing the incumbent’s customers, and entry decisions can be reversed without cost.”
Herberholz, C., Subhanij, T., and Sawangngoenyuang, W. (2010) "The Impact of Changing Financial Landscape on Thai Banks", The Sixth National Conference of Economists Conference Proceeding, Bangkok, October, 29.
--------------. (2010) "Competition in The Thai Banking Sector". Mimeo Wesaratchakit, W., Subhanij, T., Roengpitya, R.,
Sawangngoenyuang, W., and Serrevoravitgul, C. (2010) "Financing Thailand for Balanced and Sustainable Growth", BOT Symposium 2010.
Contact authors:
Ms. Tientip Subhanij Chief researcher [email protected]
Economic Research Dept. Monetary Policy Group
Ms. Wanvimol
Sawangngoenyuang
Researcher
Source: Bank of Thailand