9.1 Various excuses were quoted for FIDF extension of liquidity aids, e.g. bank runs as a result of political instability, closure of some finance companies, and flotation of exchange rate. In essence, the BOT offered liquidity funds to problem banks and finance companies in order to avoid panic and maintain confidence as well as stability in the financial system, because in Thailand there was no deposit insurance corporation. Consequently, before the mandate of the IMF, the BOT tried its best to restore ailing private financial institutions.
9.2 Even though preserving stability of financial institutions facilitates development of the financial system, the rescue operations undertaken by FIDF as mentioned above should not belong to a central bank’s territory, as they could easily interfere with appropriate monetary policy. In the case of Thailand, such interference is immediately evident. Chart 2 shows that before the financial crisis in 1997, when looming current account deficits and inflation needed to be corrected by deceleration of money supply growth, credit extension from FIDF did the opposite for the sake of healing problem banks and finance firms. In other words, amid the dilemma of stability at the micro-or macro-level, the BOT opted for the former at the expense of the latter. This represents the second incident of BOT’s policy inconsistency. Worse yet, rescuing those financial patients at the near final stage tended to be futile in various respects and generate numerous adverse repercussions subsequently.
9.3 Problems of commercial banks and finance companies in 1994-96 stemmed from mismanagement spurred by untimely financial liberalization. New practices, newcomers (BIBF), and enormous capital inflows gave rise to strong competition, Such pressures, together with domestic financial institutions’ inadequate experience, led to excessive and improper credit extension (e.g. in property sectors) without careful screening of project viability and likely risks versus returns. The economy was therefore overheated and finally reached the bubble status, similar to the Japanese economy. Over-investment was fueled by imprudent banks and finance companies which eventually encountered record high levels of non-performing loans, 35% of commercial banks’ and 60 % of finance companies’ outstanding credits.
9.4 If more efficient and forceful supervision had been done by bank regulators, the crisis may not have occurred, or if so, must have been less severe. In the midst of high-tech financial era, bank examiners and regulators need to thoroughly understand banking plus business risks and move as quickly as possible to deal with bad loans and financial mismanagement. In contrast, the examiners and supervisors took up to a year to detect and notify the suspected or guilty banks or finance firms. Problems thus became too difficult or too late to solve. In most cases, aids from FIDF did not help rectify roots of the problems. They only palliated symptoms at the final stage, while exacerbating macroeconomic imbalances. That was why the IMF demanded a termination of continual aids from BOT to ailing financial institutions.
9.5 Maturity mismatching by FIDF created strong distortions in local money markets. As a large portion of assistance from FIDF came in the form of equity holding in ailing financial institutions, It should have been funded by long-term borrowing such as government bonds or securities. Instead, FIDF resorted to short-term borrowing, engendering pressure upon domestic liquidity. Such maturity mismatching aggravated the high interest rate environment as prescribed by the IMF.
9.6 Given that policy discretion of FIDF was not transparent, various sources claimed that BOT provided preferential treatments to particular banks and finance companies due to close connections or acquaintance with the involved executives. In addition, political influences played some roles in the determination of which finance firms should or should not be entitled to receive assistance from FIDF. In any case, one distinct defect of rescuing private financial institutions was the moral hazard among executives in the financial circle. Once those executives learned that the central authorities could hardly let any financial institution go under, they were inclined to take more risks and be less cautious. This generated a vicious circle for the BOT, i.e. the more it helped remedy ailing finance companies, the more risks others will take, and the larger number of sickening firms will come in the future.
9.7 As formally recommended by a special commission scrutinizing the BOT, the responsibility of regulating and supervising private financial institutions should be under a separate organization from the BOT such as a deposit insurance corporation (FDIC) which acts as a risk evaluator and (partial) guarantor for deposits. Segregating FDIC from BOT will resolve the policy dilemma at BOT. Meanwhile, the process of supervision at FDIC should be quick and transparent, which will stimulate the market force to compel problem banks and finance firms to rectify themselves. Otherwise, they will receive lower rating and less guarantee from FDIC, unlike FIDF and BOT which revealed nothing but guarantee everything (including principal plus interest). The above suggestions correspond with the two lessons mentioned in (8.5), i.e. policy consistency and timely or immediate actions.