BOT turns hawkish to deflate threat of growth bubble.

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EDITORIAL

BOT turns hawkish to deflate threat of growth bubble
By The Nation
2010-12-06

Risk of excessive growth in real estate sector prompted interest rate hike

The Bank of Thailand on Wednesday hiked its short-term interest rate by 25 basis points to 2 per cent. This is a welcome and prudent move, although most economists and analysts expected the BOT to stand pat given the benign inflation and a slower pace of economic growth going forward. The inflation rate for November was 2.8 per cent. But the Monetary Policy Committee has found it necessary to nip bubbles, particularly in the real estate sector, before they get out of control.

Indeed, the central bank needs to bring the interest rate back to its normal level. This means that on the inflation adjusted basis, the interest rate must pose positive rather than negative, as is now the case. At least the policy rate of the central bank should hover around 3 per cent to match the expected rate of 3 per cent in interest rates this year.

The Bank of Thailand under Dr Prasarn Trairatvorakul must stick to its mandate of safeguarding price stability. In the previous Monetary Policy Committee's meeting, the central bank bowed to pressure by keeping the interest rate unchanged at 1.75 per cent. The prevailing mood then was that the rate must be maintained or even slashed to discourage institutional investors from pouring their hot money into the Thai bond and equity market. Higher interest rates would entice the institutional investors to bring even more funds into the Thai market to speculate on the interest rate differentials. Yields of Thai bonds are at least two percentage points higher than yields of US bonds of similar maturity. Since the beginning of this year, capital inflow has driven the baht value by 10-11 per cent, turning the baht into one of the world's best performing currencies.

By keeping its rate unchanged at the Monetary Policy Committee's meeting, the central bank showed its hesitancy over its mandate. For if capital inflow were the real problem that added to price pressure and financial bubbles, the central bank should have dealt with it with separate administrative measures. This means the central bank could impose higher withholding tax or currency controls to stem the tide of the hot money inflow.

Now the central bank has become more hawkish. In monetary policy, it is always prudent to stay hawkish rather than dovish. Thai interest rates have been kept too low for an extended period to stimulate the economy. This has resulted in bubbles in both the stock market and real estate. The situation has been accentuated with capital inflow, driven by quantitative easing measures by the major world's central banks.

Naturally, businesses and investors love the low interest rate environment, which spurs growth and prosperity. But we have to take note from the dear lessons from many countries, which are now facing severe financial crisis. Low interest rate environment is the source of economic and financial bubbles.
Greece, Ireland, the United States enjoyed the low interest rate environment, over-spending, easy loans and a boom in real estate before the bubbles went burst. Many other European countries are about to follow suit.

In spite of the slowing down Thai economy, the central bank should be determined with its monetary policy. The interest rate normalisation process must continue so that interest rates must at least match or beat the inflation rate.

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Are Thai banks' interest rate spreads too high?

Hefty profits chalked up by Thai banks this year have again given rise to criticism about the high cost of financial intermediation in Thailand.
At the centre of the controversy are the allegedly high interest rate spreads - the issue of bank spread here has often been blown out of proportion - and the excessive fees charged by Thai banks.

The concept of "spread" has been subject to different interpretations. In its crudest form, it is measured as the minimum lending rate minus savings rate. It could also be viewed as the difference between the weighted average of deposit and loan rates.

However, an alternative concept of net interest margin - defined as the ratio of net interest income to interest-bearing assets - is often more prevalent as it is probably the best measure of bank profitability.

Since the economic cataclysm of 1997 Thai banks' net interest margins have increased steadily from minus 0.7% in 1998 - massive borrower defaults in the aftermath of the banking crisis caused Thai banks to report negative net interest margins (NIM) - to 2.8% in 2005, before stabilising at around 3% during 2006-2010.

Are Thai banks' net interest margins of 3 percentage points really too high? Are they more profitable than their peers in the region?

Empirical evidence shows that banks' net interest margins vary across countries and among regions of the world, as well as between developed and less developed countries. Historically, less developed countries with financial imperfections are typically characterised by higher NIMs, thanks to high operating costs, lack of competition, the burden of non-performing loans and other factors.

Among Latin American countries, NIMs in Brazil, Peru and El Salvador reached a high of 14%, 8.1% and 7.5%, respectively, in 2009. Similarly, countries in Africa, notably Zimbabwe, Zambia, Sudan and South Africa recorded net interest margins of 34%, 9%, 8.4% and 7.2% respectively, over the same period.

For countries in Asia, Sri Lanka, Indonesia and the Philippines stand out with NIMs of about 5.2%, 5% and 4.1% respectively, compared with 2.7% for South Korea, 2.4% for Hong Kong, 1.5% for Taiwan and 1.4% for Singapore.

There are many forces at work which explain the wide discrepancies in banks' net interest margins across countries.

First, operational costs: there is generally a positive correlation between operational inefficiencies, as reflected in the cost-to-income ratio, and net interest margins. Thus, banks with higher costs will need to work with higher margins to cover their operating expenses.

Second, loan quality: empirical evidence shows a negative relationship between loan quality, proxied by loan loss provisions to total loans ratio, and net interest margins. Hence, banks with lower loan quality tend to have higher net interest margins.

However, empirical results for Thailand and certain countries in Latin America appear to contradict the above findings.

Bank capitalisation also plays an important part in determining net interest margins. Empirical studies show a positive relationship between bank performance and capitalisation.

Well-capitalised banks tend to set wider margins in order to offset profitability losses caused by higher capital ratios. Besides, banks with high levels of capitalisation can pay less on deposits or charge more for credit, thanks to lower insolvency risks.

Market concentration is another determinant of a bank's net interest margin. Banks in highly concentrated markets tend to collude and, as a result, thwart competition. They will thus be able to extract monopoly rents through higher rates being levied on loans and less interest rates being paid on deposits. Hence, we could expect to see high concentration rates being associated with high bank margins.

Among other explanations for the variation in net interest margins across countries are exogenous factors, such as differences in macroeconomic environment - GDP growth, inflation rates, interest rate volatility, taxation, etc - in which banks operate.

Other factors such as reserve requirements, deposit insurance regulations, collateral, judicial efficiency and foreign bank entry - all play an important role in determining bank margins.

In addition, there are other endogenous factors at play such as the clientele of a bank, accounting practices and business or product mix. For instance, banks that focus on retail and SME clients will have wider margins than those whose businesses are concentrated on wholesale corporate loans.

Empirical evidence should put to rest the notion that Thai banks' interest rate spreads are too high. Be that as it may, although high NIMs are considered as a negative feature for financial intermediation - high interest rate spreads are generally thought to reflect the inefficiencies of a banking system - they may also lead to safer banks if high profits earned from high spreads are ploughed back by banks into their capital bases, thereby helping to contribute to the strengthening of a country's financial system.

http://www.bangkokpost.com/opinion/opinion/202063/are-thai-banks-interest-rate-spreads-too-high

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