Part I Non-Bank Financial Institutions

Transcription

1 Development of Non-Bank Consumer Financial Business in Thailand and Policy Recommendation: The Case Study of Personal Loan Companies Chodechai Suwanaporn Fiscal Policy Office, Ministry of Finance Part I Non-Bank Financial Institutions Non-Bank Financial Institutions (NBFIs) or non-bank businesses are internationally recognised as financial institutions or intermediaries that provide several forms of financial services within the economic system, and which require specialised expertise in those areas. On the whole, NBFIs provide financial services that differ from those provided by banks, and create a variety of financial services as well as increase competition between different financial institutions. As a result, customers and consumers receive more effective services. Generally, non-bank businesses refer to non-deposit taking financial intermediaries. However, some countries define non-bank businesses as non-deposit taking financial intermediaries only for current accounts; in other countries, nonbank businesses include differing characteristics, including taking deposits but not providing credit services, such as postal saving entities in the USA, Japan, and Italy. Thailand has long been a bank-based economy. Most business sectors and people obtain funds and support from commercial banks, which function as financial intermediaries and provide loans in response to the demand of working capital. The total overall business value of all financial institutions, calculated from the amount of credit at the end of 2005, was 7.50 trillion Baht. Of this, banks accounted for 6.89 trillion Baht (91.86%), financial companies or securities firms for 0.16 trillion Baht

2 2 (2.16%), life insurance companies for 0.05 trillion Baht (0.67%), credit foncier companies for 0.95 billion Baht (0.01%), and other general nonbank companies for 0.40 trillion Baht (5.29%). However, when combining traditionally so-called non-bank businesses operated by financial companies as well as banks, the total credit of these non-bank businesses was billion Baht, equating to 9.5% of the total value of the whole credits in the financial system. This indicates that non-bank businesses have a rather limited role as a source of funds in supporting the economic development of the country when compared to commercial banks but still have a lot of room to grow. Therefore, Non-bank businesses should be given greater support and encouraged to play a bigger role as sources of funds for the economy. In the last decade, NBFIs have expanded their role as sources of funds for business sectors and everyday people. At the end of first quarter of 2006, Outstanding personal loans serviced by non-banks and banks were billion Baht consisting of billion Baht from nonbanks, billion Baht from banks and 0.14 billion Baht from finance companies. Outstanding credit card loans serviced by non-banks and banks were billion Baht consisting of billion Baht from nonbanks, billion Baht from Thai banks and billion Baht from foreign banks. Factoring companies, which provide working capital loans, had outstanding loans of 80 billion Baht. Leasing companies had leasing loans of 60 billion Baht. Finally, hire-purchase companies had hirepurchase loans of 250 billion Baht. Personal loan, credit card, and factoring companies are short-term sources of funds; whereas, leasing and hire-purchase companies are medium-term (3-5 years). NBFIs still have a small role compared to commercial banks in the financial system. This is partly due to unclear supervision, related laws, and the implementation of rules and regulations. In other words, the level

3 3 of regulation varies between different types of enterprise or is sometimes completely lacking, meaning that each operates under different regulatory standards. This may also bring unfair advantages or disadvantages to entrepreneurs with the same type of business. Moreover, with no specific laws relating to non-bank businesses, financial institutions must depend on other related laws. Conflicts within these laws, such as conditions for terminating a hire-purchase contract as stated in the Civil and Commercial Code, differ from those stated in the Laws of Consumer Protection Board. In Thailand, these problems particularly affect developing non-bank businesses. Moreover, data regarding NBFIs is randomly distributed amongst several organisations such as the Non-bank Entrepreneur Association, the Ministry of Commerce, the Bank of Thailand, and several other research centres; there is no systematic/central database. This hampers the public sector when trying to plan suitable and effective developmental and regulatory policies. This study of the development and regulation of NBFIs gathers and analyses details, facts, and statistical data in order to provide guidelines for uniform development and administration. For this investigation, I chose to analyze personal loan companies since developmental guidelines and supervisory systems are still unclear and more importantly, these companies are growing very quickly, and have high value and high potential as useful sources of funding within the economic system. They also have an important role to play in the determination of policy with regard to controlling the distribution of credit appropriately and the impacts on the economy. If non-bank businesses can be developed and regulated appropriately, they will provide an important source of funds to compliment the commercial bank system; this alternative source of funds will mean the economy does not have to rely entirely upon commercial banks.

4 4 Moreover, appropriate policy will bring stability to financial institutions as well as support and facilitate the growth of Thailand s economy. Part II The case study of personal loan companies Summary of findings and recommendation The rapid expansion of the system of personal loan businesses, especially non-bank providers, has caused the financial regulators to worry about the financial stability of the country, and call for suggested regulatory guidelines for this type of business. The guidelines for control are similar to those of the credit card business as proposed by the Bank of Thailand. For this reason, I have studied and researched the aforementioned business by gathering data from different organisations such as the Bank of Thailand and the National Statistical Office. Interviews with entrepreneurs to elicit known problems and general information about their operations were also conducted. Data was also gathered from foreign personal loan entrepreneurs, foreign research, and by consultation with the Office of Consumer Protection Commission. This has led to perceive facts, problems and obstacles for use as guidelines in proposing systematic and appropriate regulations that meet the actual needs and operations of the business. This will be to the advantage of consumers, entrepreneurs, and the national economic system. The results of the study on personal loan companies can be summarised as follows. The personal loan business is divided into 2 types; unsecured loans and secured loans. The type of personal loan investigated was unsecured, providers of which fell into 3 categories; commercial banks, non-bank financial institutions (NBFIs), and specific financial institutions (SFIs). Data from the Bank of Thailand indicates that outstanding unsecured loans account for approximately 376,000 million Baht or about 3% of GDP. The

5 5 number of clients is about 3.86 million. However, at present there are no rules or clear regulations for this type of business. 1. Household debt is lower than other countries When considering household debt in Thailand compared to other countries such as Japan, South Korea, Singapore, Malaysia, USA, and Australia and by using household debt against household income as a percentage (Fig. 1) and household debt against GDP as a percentage (Fig. 2), it is found that Thailand comes out quite low, which is consistent with reports from the World Bank. The Bank of Thailand also reported that Thailand s household debt in the 2 nd quarter of 2004 was, on average, 103,940 Baht/household, up from 21,000 Baht in The proportion of household debt to income was 59%, up from 51% in It was concluded that Thailand s household debt was at a low level and not of concern. Figure 1 Household Debt against Household Income % of Household Debt against Household ร อยละหน ต อรายได ภาคคร วเร อน Income Year ป Japan ญ ป นAustralia ออสเตรเร ย USA สหร ฐอเมร กา South เกาหล ใต Korea ไทย Thailand

6 6 Figure 2 Household Debt against GDP Ratio of Household Debt to GDP (%) (For Each ส ดส วนหน ภาคคร วเร อนต อ Country) GDP%(รายประเทศ) Singapore USA Australia UK 77 Malaysia S.Korea Hongkok 60 Thai 33 Indonesia 10 india ส ดส วนหน ภาคคร วเร อนต อGDP% Ratio of Household Debt to GDP (%) 2. Income structure of personal loan users Data collated for the 3 rd quarter of 2004 by the National Statistical Office of Thailand showed that, countrywide, approximately 35 million people were employed *, of which about million or 44.68% had permanent incomes. Of those who were employed and had permanent incomes, about 14 million persons had incomes of less than 15,000 Baht per month (Fig. 3). According to information supplied by the Bank of Thailand on the number of personal loan users within the entire system, there were a total of about 3.85 million unsecured loan users or 13% of all employed persons in Thailand. Of these personal loan users, 2.4 million * Summary of Condition of Employed Population in September 2004, National Statistical Office

7 7 had incomes of less than 15,000 Baht per month equating to 62% of all unsecured loan users (Fig. 4) or 16% of all those in Thailand with permanent incomes. Figure 3 Income Structure of Permanent Income Population in Thailand Approx million persons in total 15,000-30,000 Baht/month More than 30,000 Baht/month 7,000 15,000 Baht/month Less than 7,500 Baht/month ล านคน 2.34 ล านคน 1.21 ล านคน 0.25 ล านคน Million 2.34 Million 1.21 Million 0.25 Million Survey of 13 commercial banks and 9 NBFIs, Bank of Thailand

8 8 Figure 4 Income Structures of Personal Loan Users - Commercial Banks and NBFIs Approx million persons in total More than 25,000 Baht/month 17% Less than 7,000 Baht/month 23% 15,000-25,000 Baht/month 19% 19% 10,000-15,000 Baht/month 22% 7,000 10,000 Baht/month However, when considering the overall picture of personal loan services within the entire system, it was found that the target customers of NBFI personal loan providers were customers who had incomes of less than 15,000 Baht/month. This was consistent with survey data that indicated that of the 1.82 million NBFI personal loan users, there were up to 1.26 million users who had incomes of less than 15,000 Baht/month or about 70% of all NBFI personal loan users. By looking at the income structures presented above, it is clear that the majority of personal loan users are those with low incomes, and that most use services provided by NBFIs. Therefore, controlling the minimum income of borrowers or fixing the interest rate ceiling may cause entrepreneurs, especially NBFIs, to cancel providing loans to low incomers. This will seriously affect low incomers and force them to turn to black-market services. According to a report by the Bank of Thailand (BOT), after developing their personal loan business, the number of black-

9 9 market loans decreased. At present 36% of low incomers are debtors of black-market providers. 3. Effects Which may Occur if Setting Restrictive Measures on Personal Loan Companies 3.1 Controlling Interest Rates (Fixing Interest Rate Ceiling) Setting the interest rate ceiling may cause Non-bank loan providers to change their target group from low incomers to high incomers. There are 2 main reasons. Firstly, to operate this kind of business, there is an important cost used to calculate interest, the operation cost, most of which is fixed. Therefore, when taking into account the operation cost, a small releasing loan is more expensive to the institution than a large-sized loan. Compared to high incomers, most of the services provided to low incomers are of smaller loans due to limited income. Secondly, low incomers have a high default rate. Information indicates that the number of non-performing loans (NPLs) owed by clients with personal loans and incomes lower than 15,000 Baht/month totalled 143,000 cases or 74% of the total NPL. From all these reasons, the cost of providing loans to lowincome users is higher than to high incomers this means that providers have to reduce the burden of default risk costs by refusing to release loans to low incomers. If the interest rate ceiling is determined by the regulatory sector without appropriate cost reflection, it will force low-income users to use black-market services (Fig. 6). These assumptions are consistent with studies conducted in many countries including the UK and Japan. It also creates intense competition within the business due to the change in target group of NBFI personal loan providers from low incomers to high incomers, presently being serviced by commercial banks. As a result this consumer group will have an excessive debt burden due to the over-expansion of credit limit to them. This will increase the amount of household debt as

10 10 well as the proportion of NPL from personal loans. Meanwhile, low-income customers will be forced by market forces to utilise black-market loans, which brings negative impacts to society and the national economy. Many social problems will arise, as has occurred in Japan where the number of criminal cases involving black market debt recovery have increased since the government passed laws controlling the interest rate ceiling. Some consumers may turn to the services of Specialized Financial Institutions (SFIs) instead. However, SFIs may not be able to provide comprehensive services to low incomers since they already deal extensively with large numbers of low-income and non-permanent-income customers. Therefore, precise countermeasures to help low-income users should be prepared before determining or controlling the interest rate ceiling. However, information acquired from interviews with entrepreneurs and from Kasikorn Research Centre shows that the cost structures used to determine the interest rates of bank and non-bank personal loan providers (Table 1) were highly variable, implying that the data should be considered carefully. This can be seen in the disparity of operation costs, where the difference between the highest and lowest operation costs provided by banks was 17%; for NBFIs the difference was 15%. Therefore, if the BOT used average cost structures when determining the interest rate ceiling, mistakes could be incorporated. If it is necessary to determine an interest rate ceiling, it is suggested that the regulatory sector should conduct further studies in order to more accurately gauge determining factors before assigning appropriate levels. In the USA and Italy, for example, the interest rate ceiling is determined according to the size of the total loan. In other words it is not determined from the averaged predicted costs provided by all providers. The determination of interest rate ceiling should be calculated in order to allow every provider to operate its business capably and to provide a service to every type of borrower. This will be consistent with government policy that encourages people to make greater use of legitimate loans. This should

11 11 start with a detailed study of the structure of costs and funding of loans by entrepreneurs. It is probably best to invite entrepreneurs to consult on the appropriateness of any proposed interest rate ceiling. Table 1 Structure for Determining Interest Rate of Personal Loans Structure for Determining Interest Rate of Personal Loans Structure of interest rate Bank Non-Bank (%) AVG Max Min AVG Max Min Cost of fund Operation Cost Default rate Margin Remark: Average personal loan interest rate is 28.37% for (9) commercial banks and % for NBFIs (Source: Kasikorn Research Centre) Figure 5 Effect of Determining Interest Rate Ceiling on Consumers Number of customers Low Risk Consumers Number of customers High Risk Consumers Ceiling Rate P %

12 12 Fig. 5 shows the distribution of population as classified by income, and indicates the effect of determining an interest rate ceiling on consumers at each level of income. It hypothesises that low-income customers will have a higher default risk than high-income customers due to the determination of interest rate as calculated from burrowers. Providers determine the risk based pricing of each customer in order to cover any costs they may incur from the risk. In Figure 5, high default-risk low-income customers are on the right whereas low default-risk highincome customers are on the left. The area below the graph shows the number of consumers. If determining the interest rate at P, it will mean that providers are able to provide loans to low risk consumers, i.e. those consumers to the left of P, and unable to provide loans to high risk consumers, i.e. those consumers to the right of P. Alternatively, loans could be provided to high risk consumers under special conditions such as loan sureties or co-burrowers. Therefore, if the public sector determines the interest rate ceiling, providers will avoid granting loans to high risk consumers or will stipulate rules to reduce risk, thereby decreasing the chance of a loan. Therefore, the determination of an interest rate ceiling will have two negative effects on low incomers; 1. It will reduce the opportunity of applying for and being granted a loan; 2. Customers will find other sources of loans to meet their requirements such as the black-market.

13 13 Figure 6 Distribution of Income Levels of Legitimate Personal Loan Users Persons 900, , , , , , , , ,000 - Over 25,000 20,001-25,000 15,001-20,000 10,001-15,000 7,001-10,000 4,001-7,000 Below 4,000 Income Levels No. of Population Fig. 6 shows the distribution of personal loan users within the overall market and shows a normal distribution similar to that of NPLs arising from personal loans and classified by income level. It is consistent with the aforementioned hypothesis that providers have a tendency to avoid providing loans to low-incomers (which are on the right of the figure 6) since, from the viewpoint of providers, low incomers have a higher defaultrisk than high incomers. Therefore, as previously seen, low incomers will be most affected by the changes. However, the remaining customers with a low enough risk for providers to provide them with a loan may be affected by changing strategies employed by providers to increase the potential income available from them. This may include strategies such as increasing the size of the loan available for each account by providing higher credit limits than consumer demand or extending due dates for payments. This will

14 14 cause excessive loans within just one group of consumers and an overly long instalment basis. Determination of an interest rate ceiling will inhibit an important aspect of loan business operations, namely risk based pricing, which will bring with it an unfair calculation of interest rate, meaning that those who have good credit and good financial discipline will be charged interest at the same rate as those who have bad credit or poor financial discipline, due to a blanket rate of interest for every account. Moreover, there will be an excessive effort to increase credit limit, which will benefit only one group of consumers, those with the power to spend money excessively. As a result, the determination of an interest rate ceiling may solve one problem, but it will also create many others. Studies on the effects of interest rate ceilings in the USA, UK, and Japan have shown many induced problems including social and criminal injustice. The correct balance should be reached by allowing responsible and complete competition within the business. This will bring efficiency of service as well as cause the interest rate to decrease naturally due to competition. A similar situation can be seen in the leasing business in which interest rates were initially very high but have now decreased to a very low level due to competition. It also protects consumers and increases the opportunities for new providers to enter the market. Not least, it increases the opportunity for low incomers to access a source of low cost funds.

15 15 Figure 7 The Relationship between Credit Card Loans, Personal Loans, and Black Market Loans Under Regulatory Control Credit Card Loans Personal Loans Black Market Loans Employed persons with an income of less than 5,000 Baht/month are approx. 20 million. (This is 62% of 33.5 million employed persons in Thailand in 2004) 3.2 Setting Maximum Credit Limit at Not Over 5 Times Income Level The determination of maximum credit limit per person per provider does not decrease household debt because practically all consumers, especially whose who have financial problems, seek for liquidity by asking for loans from more than one provider. Therefore this method needs more detailed and better control; the determination of maximum credit limit should be borrower-based rather than institutionbased. For example, a user may be granted loans not exceeding a multiplier of their income (sometimes may be more than 5 times) for all loan providers together. This is not a maximum credit limit of up to 5 times the level of income from each provider, since this could still lead to borrowing from several providers at the same time. Therefore, the central credit bureau should, by law, be required to hold data and inform members or providers of the current loans held by each burrower prior to any new

16 16 application for credit approval. This information should be updated continuously so that providers have access to real-time data. 3.3 Setting Required Capital The decision to allow private individuals to register and operate a personal loan business is one way to help increase and legalise opportunities for those currently in the black market who might want to enter the legitimate market. However, to operate this kind of business involves risk management by which credit (of a fairly substantial amount) is distributed to several groups of users. This will greatly affect small entrepreneurs, so much so that they may not be able to operate due to limitations on interest. It could easily lead to private businesses avoiding registration. 3.4 Regulatory Scope Since bank and non-bank entrepreneurs provide services to different groups of customers, i.e. bank providers deal with high-income customers whereas non-bank providers deal with low-income or high risk customers, regulatory guidelines may have to vary according to situation. Using the same rules and regulations for all may bring about more bad results than good. 4. Effects of Lack of Regulation during Non-bank Insolvency Below are three reasons why the insolvency of non-bank business providers has little effect on the economic system and general population during periods when they are unable to operate. 1) Non-bank providers have relatively low bank loans so when financial problems occur the knock-on effects on the financial system are small. However, if these non-bank providers were to come under the control of the Securities and Exchange Commission, Thailand (SEC), they would need reserve capital that meets the strict regulations of the SEC.

17 17 2) For some of the loans which are debentures or other derivatives, such as securitisation, non-bank providers under the supervision of SEC cannot sell directly but must sell through institutional investors. Therefore, there is no direct impact on the people. 3) Other sources of capital. Since many personal loan companies use capital from foreign parent companies, insolvency will not affect the financial system of the host country. However, if considering the differences in rules and regulations for business operation, non-bank companies listed under the Stock Exchange of Thailand have to establish capital reserve in accordance with the regulations stipulated by the SET, which are much stricter than those of the Bank of Thailand. For example, debt without payment of interest over 3 months shall lead to 100% provision (cease revenue receipts, loss recognition), debt with no performance over 6 months shall be adjusted to bad debt, general provision shall follow the historical default rate (general banks determine the fixed rate at 1%), and loan collateral securities shall not be calculated for the reserve. These limitations make banks superior in terms of capital of operation cost; they are also entitled to receive deposits. 5. Suggestions for Regulation and Development 5.1 Development of Credit Bureau Increase data, such as payment of water bills, electricity bills, telephone bills, and basic public utilities, to help estimate risk. Adjust credit bureau charges appropriately in order not to burden members. Promote the usage of data held by the credit bureau. Develop real-time data access for members that the credit bureau will update continuously. Amend current laws and stipulate that all loan providers must be members of the credit bureau. This will mitigate the effect of large

18 18 providers not wanting to share data. In this respect, there should be precise guidelines to create equity to all providers. The credit bureau should issue central credit scoring for all customers to be used as a benchmark for personal loan business members. Since the credit bureau holds the largest source of data, their benchmarks will be the most precise and reliable; this will be an incentive to join the credit bureau. 5.2 Development of Credit Scoring When the credit bureau has been developed, credit scoring will be better managed since increased data will help precisely estimate the risk of each consumer and reduce the cost to business providers; due to free competition, this will be reflected in decreased interest rates for consumers. It will also help support the issue of central benchmarked credit scoring for members when considering the risk of each customer, decreasing operational costs. 5.3 Determination of Interest Rate Ceiling If the interest rate ceiling has to be stipulated, a detailed study of how to determine an appropriate level should first be conducted. In order to prevent the negative impacts on low incomers brought about by providers refusing to give credit, the average cost to providers should not be used to calculate the ceiling. Different interest ceilings should be determined that reflect the true risk of burrowers - data from the credit bureau such as default performance, total received loans, default rate, and number of financial institutions used by the debtor should be taken into account. As in the USA, the interest rate ceiling can also be determined according to the size of loan in each account. 5.4 Promotion of Free Competition under Transparency of Data to Consumers. In order for consumers to make clear cut decisions when choosing a service, laws should be passed that force business providers to

19 19 clearly display their effective interest rate, including other charges, to consumers. This will promote free competition and consumer protection. 5.5 In order to systematically and appropriately regulate and develop personal loan businesses in Thailand, detailed studies should be conducted. This must involve supporting officers on study trips to investigate this type of business (as well as the operation of credit bureaus) overseas in countries such as Japan and the USA that already have a proven track record.

20 20 Guidelines for Development and Regulation of Personal Loan Companies Method Expected Results 1 Create regulations that recognise the importance of credit scoring and the transparency of business data to customers. 2. Develop the credit bureau to make it more effective than present. 3. Develop regular investigations by regulatory body. The business is developed and grows systematically; consumers are protected and entrepreneurs are able to operate their business. Financial discipline of customers is facilitated (adapt financial discipline to financial cost) Investigation of entrepreneurs is conducted effectively and regularly. 4. Financial institutions use data from credit card to consider loans (Risk-based Pricing). Operation cost of business providers is reduced, which is advantageous to customers. Low incomers have chance to ask for unsecured loans. 5. Facilitate people towards financial discipline by paying importance to good credit. People can borrow money on good terms so they can better manage debt burden and decrease NPL. Government can raise more income from specific business tax.

21 21 Part III Full Study on Personal Loan Companies 1. Background In this case, personal loan companies refer to unsecured loans, which have developed alongside credit card companies. Financial institutions that operate a credit card business usually operate a simultaneous personal loan business. In 2005, personal loan companies were not under precise rules or regulations, so the Bank of Thailand and Ministry of Finance was trying to pass laws that will standardise their business operation, protect consumers against exploitation by entrepreneurs, and prevent the excessive expansion of household debt, which could, if uncontrolled, become so acute as to cause serious impacts upon the economy. Similarities between Credit Cards & Unsecured Personal Loans Both are loans without collateral or personal securities. Both can facilitate immediate liquidity to service users in emergencies. Differences between Credit Cards & Unsecured Personal Loans Target different groups of customers. (Credit cards are for those who have minimum income of 15,000 Baht/month; whereas, most unsecured personal loans are for customers with incomes of less than 15,000 Baht/month. Main utilisation is different. (Credit cards are for buying goods from shops that accept the card and are mainly used instead of cash; whereas, an unsecured personal loan is a lump sum or credit limit for customers daily life or as an emergency source of cash.) Source: Kasikorn Research Centr,2005

22 Types of Personal Loan Personal loans can be divided into 2 types; secured loans such as housing loans and leasing loans, and unsecured loans. Since the end of 2002, many providers have paid more interest to unsecured loans due to the passing of stricter laws controlling the credit of credit card companies. This has made business providers look for alternative ways not to affect their customer base. Unsecured loans don t need collateral or personal securities, thereby increasing liquidity and facilitating consumers when necessary or during emergencies. In this respect, unsecured personal loans can be divided into 2 types, term loans and overdrafts. 1) Term Loans are lump sums or cash released to customers at one time with a predetermined period and fixed value of instalments to pay off the debt. Each provider will determine the maximum time to pay off the debt, such as 3 years or 5 years, and the minimum period of time to close the account of the loan payment; for example, it may be prohibited to close the account within 6 months otherwise the customer may have to pay a fine or cover all designated charges. Most term loans are granted for specific purposes that are necessary in customers daily lives, such as house repairs, education, or travel. 2) Overdrafts are current account credit limits granted to customers in an emergency. They are suitable for businesses or people requiring immediate reserve credit limits when withdrawing cash, within the credit limit, through ATM machines or cheques. The repayment term is not fixed as with term loans. In this respect, the interest rate for this type of loan is usually higher since they are loans that increase customer convenience for whatever reason the borrower determines. Likewise, the credit limit is lower than term loans since it is supplementary credit that injects temporary liquidity; term loans have higher credit limits because they are deemed to be more necessary they incur charges from the beginning of the loan.

23 23 Figure 8 Categories of Personal Loans Personal Loan Secured Loan Unsecured Loan Term Loans Overdrafts 2. Roles and Size of the Industry The amount of outstanding household debt in Thailand in 2004 totalled 2 billion Baht, which equated to 33% of GDP. The total value of personal loans was 621,000 million Baht or 31% of all outstanding loans (Fig. 9), of which 67% was secured loans (approximately 445,000 million Baht) and 33% unsecured loans (175,000 million Baht). The market size of credit card businesses was 118,000 million Baht. Within the unsecured personal loan market, NBFI providers account for only 20% of the market or 36,422 million Baht, whereas banking providers hold 80% of the market or 139,531 million Baht. The total number of customers using unsecured loan services (both bank and non-bank) was 3.85 million, of which 2 million or 52% were commercial bank customers, and 1.85 million or 48% were NBFI customers. This is because NBFIs tend to deal with customers with incomes of less than 15,000 Baht/month (1.26 million or 70% of all customers).

24 24 Figure 9 Outstanding Loans in Thailand, 2004 ปร มาณส นเช อคงค างในประเทศไทย Outstanding Loans in Thailand, ป 2547 (พ นล านบาท) % 31% (175,000 million Baht) was unsecured loans (total personal loans was 621,000 million Baht). 6% 11% 52% Housing Loan Credit Card Personal Loan Car Hire- ส นเช อท อย อาศ ย ส นเช อเช าซ อรถ purchase บ ตรเครด ต ส นเช อบ คคล Personal Loans Secured Loans (445,000 million Baht) Unsecured Loans (175,000 million Baht) Source: Bank of Thailand The income structure of Thailand s population (Fig. 10) shows that those having an income lower than 7,500 Baht/month accounted for 11.7 million people (excluding self-employed business - 24 million if included). It is this portion of the population who may be influenced if there is stricter control of the personal loan business (determining interest rate ceiling or minimum income). Therefore, before designating policies or regulations consideration should be given to the effect they may have on low incomers since they form the majority of the working population.

25 25 Figure 10 Income Structure of Permanent Income Population, 2004 (Total Million) 2.35 million 15% 1.21 million million 8% 2% million 75% น อยกว า Less than 7,500 Baht บาท 7,500-15,000 Baht บาท 15,000-30,000 Baht - บาท มากกว า More than 30,000 Baht บาท Source: National Statistical Office The development of personal loan companies will decrease blackmarket loan businesses since people will turn to borrowing money from the legitimate market. People will thereby benefit from lower interest rates as well as being consumer protected this will decrease the problems of exploitation. Personal loan companies also help increase domestic consumption and may help as a source of capital loans for housing purchases and educational investment for the low-income population. However, there should be controls to manage suitable consumption and investment. For example, if consumers purchase luxury goods above the necessity of personal loans, this will mean an ultimate reduction in future income and may cause negative effects on the national economy. The ratio of bad debt to GDP will increase and many economic problems will follow.

26 26 Market Share of Personal Loans for Commercial Banks and NBFIs Classified by Income Level of Consumers 30 th June, 2004 Outstanding Personal Loans (million Baht) Number of Personal Loans Customers (capita) Income per month Bank Non-Bank Total Bank Non-Bank Total Less than 7,000 Baht 6,191 4,172 10, , , ,719 7,000-10,000 Baht 6,866 5,814 12, , , ,718 10,000-15,000 Baht 9,914 7,383 17, , , ,095 15,000-25,000 Baht 18,077 8,746 26, , , ,695 More than 25,000 Baht 98,483 10, , , , ,322 Total 139,531 36, ,953 1,909,692 1,824,857 3,734,549 Figure 11 Outstanding Personal Loans (Million Baht) 120, ,000 10,302 80,000 8,746 18,077 98,483 60,000 40,000 20,000 4,172 6,866 7, ,191 5,814 9,914 น อยกว า < 7,000 7,000 7, , ,000 15,000 บาท 10,000 บาท 15,000 บาท 15,000 15, มากกว า >25,000 25,000 25,000 บาท 25,000 บาท ต อเด อน Bank Non-Bank

27 27 NPL of Personal Loans for Commercial Banks and NBFIs Classified by Income Level of Consumers 30 th June, 2004 Income per month Less than 7,000 Baht 7,000-10,000 Baht 10,000-15,000 Baht 15,000-25,000 Baht More than 25,000 Baht Number of NPL customers Outstanding NPL Bank Non-Bank Total Bank Non-Bank Total 32,405 24,653 57, ,027 1,880 21,853 28,450 50, ,582 20,728 36, ,466 13,487 23, ,041 8,262 25,303 10, ,090 Total 97,347 95, ,927 13,535 2,169 15,704 Figure 12 Number of NPL Customers of Personal Loan Consumers (Capita) 60,000 50,000 24,653 40,000 28,450 30,000 20,000 32,405 20,728 13,487 8,262 10,000 21,853 15,582 10,466 17,041 0 น อยกว า < 7,000 7,000 บาท 7,000-10,000 7,000- บาท 10,000 10, ,000 15,00015, ,000 10,000 15,000 25,000 Baht/month บาท บาท มากกว า >25,000 บาท ต อเด อน Bank Non-Bank

28 28 Figure 13 Outstanding NPL of Personal Loan Consumers Classified by Income 4,614 Million 4,614 Baht ล านบาท (29%), 29% 11,090 11,090 ล าน Million บาท, 71% Baht (71%) < 25,000 Baht > 25,000 Baht น อยกว า 25,000 บาท มากกว า 25,000 บาท Figure 13 shows that most outstanding NPLs come from borrowers who have an income of more than 25,000 Baht per month, numbering just 25,303 cases. If calculating NPL per case, this equates to 470,000 Baht/capita. However, the number of borrowers with an income of less than 25,000 Baht per month with bad debts accounted for 148,908 cases, equating to 31,000 Baht per head. If looking at the ratio of bad-debt customers to personal loan customers, it is found that the percentage of bad-debt customers who have incomes of less than 25,000 Baht per month (approximately 3.58 million) is 3.8%. In comparison, the proportion of baddebt customers who have incomes of more than 25,000 Baht per month is 0.65%. Therefore, if when looking at bad debt per capita, it is those who have higher incomes that are the worst offenders; however, if looking at the overall picture of who is most likely to have bad debt, it is those who have a lower income who come out worse.

29 29 Typical Unsecured Personal Loan Interest Rates in Foreign Countries Country Interest Ceiling Remarks Hong Kong 60.00% Korea 66.00% Japan 29.20% USA 36.0% Italy 37.5% Taiwan 20% (only commercial banks) Financial cost is lower than for loan providers in Thailand % Interest Ceiling set According to Credit Limit Interest Ceiling set According to Credit Limit For NBFI providers, interest rate ceiling is set at 30% Interest rates of personal loan providers for each country, as shown in the table above, show that rates (including other charges) are similar to that in Thailand; however the ratio of household debt to income for each country is, on average, higher than in Thailand. Thailand has a ratio of household debt to income of 60% whereas Japan stands at 138%. Korea has a ratio of household debt to income twice that found in Thailand. The USA has a ratio of household debt to income of 120% whereas Australia stands at 135%. Most of these countries have no rules or regulations to control personal loans. However, Japan started controlling unsecured personal loans in 2000 by determining the interest rate at 29% (formerly 40%) which caused low-incomers to no longer be able to acquire loans from personal loan providers; they instead turned the services of the black market. This caused an increase in criminal actions and violence related to the demands of debt repayment to loaners in the black market, and with

30 30 it many social problems. The increasing rate of criminal cases is clearly illustrated in Figure 14. Figure 14 Criminal Cases - Black Market Loan Providers (Japan) Crimial Cases on Black Market Loan Providers Case Value (Million Yen) 40, , , , No. of Cases 400, , , , Year Case Value (Million Yen) No. of Cases Source: Consumer and Environmental Protection Division, Community Safety Bureau of Metropolitan Police, Japan 3. Weak Points, Strong Points and Structural Characteristic of Market Players The market structure of the personal loan business consists of 5 main players, non-bank financial institutions (NBFIs), commercial bank institutions - including foreign commercial banks, Thai commercial banks, and a few specific financial institutions (SFI), and finally black-market providers. Business performance and operation of each market player vary. They have different strong and weak points which influence various target areas according to the performance of each financial institution.

31 31 Providers in the Market Thai Commercial Banks Foreign Commercial Banks Non-Bank SFI Black Market?????? Structure for Determining Interest Rate of Personal Loans Structure of Interest Bank Non-Bank Rate (%) AVG Max Min AVG Max Min Cost of funds Operation Cost Default rate Margin Interest Rate Suggested

32 32 Figure 15 Cost Structures of Unsecured Personal Loan Providers 100% 80% 60% 40% 20% 0% AVG AVG Margin Default rate Operation Cost Cost of fund Bank Non-Bank Personal loan providers have differing operational costs. The cost of funds for banks is a little bit lower than it is for NBFIs. This may be because banks can secure deposits that at a lower cost than NBFIs so banks can show a higher competitive performance. However, the operational costs for banks are higher than for NBFIs. The default rate for banks is almost 3% of the total cost lower than that of non-banks, which means NBFIs have an average cost of operation 2% higher than banks.

33 Competitivess of Personal Loan Providers Foreign Commercial Banks Brand Service Product Strong Points Have good image as service providers. Have service know-how as the leaders of the market. Have diverse innovations and new product designs to meet customers demands. Price Credit Weak Points Have high interest rates and charges. Have limited channels to attract customers. Target low-risk customers - narrow market. Brand Service Thai Commercial Banks Strong Points Have low interest rates due to low cost of funds. Product Have many branches and channels to customers. Brand Price Price Service Credit Credit Product Weak Points Only take low-risk customers due to the lack of unsecured personal loan knowhow. Black Market Strong Points Take unlimited risk. Easy, convenient, no hampering regulations. Weak Points Very high interest rates. No service. Bad image with consumers.

34 34 Brand Price Service Credit Product Non-Bank Strong Points Can take high risks due to in-depth knowledge of the business. Can service low-income customers with diverse products. Weak Points Financial cost is higher than others, lack of competitive performance in terms of cost. Have limited channels to attract consumers. So-so image with consumers, limited operating performance may be greatly affected if interest rate ceiling is established. SFI Brand Service Product Strong Points Direct support from government, can take high risks, and have low cost of funds. Have many branches, especially in different provinces, can reach to lowincome customers easily. Price Credit Weak Points Have limited risk management which may cause problems with low-income consumer risk evaluation, and high chance of bad debt. Non professional image. Consumers do not know details of products due to bad marketing. Source: Krung Thai Credit Company

35 35 From the figures illustrating competitive performance for each player in the personal loan business, it can be seen that 3 service providers can take high risks, NBFIs, SFIs, and the black market. Therefore, these providers have customers of medium to low-income. Those who have incomes lower than the standard will tend to use black market loans - apart from a lack of consumer protection, these people will have to pay very high interest with a corresponding lack of opportunity to acquire funds for necessary expenses.

36 36 Figure 16 Providers Classified by Customer Income and Demands Consumers Consumers Demands Service Providers High Middle 300,000 > 60,000 Baht/month 4 million 15,000 60,000 Baht/month Brand Brand Price Service Product Credit Service Product Foreign Commercial Banks Thai Commercial Banks Price Credit Non-Banks Service Mass 6 million Brand Product 7,500 15,000 Baht/month Price Credit SFIs Low 24 million Brand Service Product < 7,500 Baht/month Black Market Price Credit Source: National Statistical Office The employed population as of January 2005 was million. (National Statistical Office) It is a common business policy of unsecured personal loan companies to pay attention to risk evaluation of consumers who ask for loan. Each consumer has different risks. The reason for strict checks is because providers have to reduce the chance of bad debt after releasing the loan. This can be achieved by credit scoring since each provider has

37 37 already had to evaluate borrower risk. Therefore, new regulations should place more emphasis on controlling the evaluation standards for releasing loans rather than on controlling the interest rate ceiling. 3.2 Key competitive factors To create competitive performance within the personal loan business, key success factors are as follows: 1) Appropriate risk management including interest rate pricing according to borrower risk. 2) Managing funding cost so as not to pay excessive interests by considering fund raising abilities and opportunities that are appropriate to current interest rates and inflation. 3) Controlling operation cost - especially that of personnel cost, verification of clients risks, finding new customers, marketing, and pursuit of debt payment - which are all rather high. 4) Interest rate and charges collected have to cover the risk and operational costs. If an interest rate ceiling is inappropriately defined, companies will be reluctant to take risks with low-income customers; therefore they will change their target customer group to higher-income customers only. 4. Effects on the Economy People are turning to black market loans more than they ever did in the past due to the high number of providers - this creates competition among them both on price and service. Clients receive many more advantages when there is high competition. However, there should be controls in place to prevent providers taking advantage of consumers and to prevent them from releasing loans that could lead to more NPL in the economy. From 2002 to June 2004, average expense per household

38 38 increased from about 5.5%, whereas income increased by 4.4%. Household debt increased by 11.7%. If looking at the overall picture, it shows that the amount of income increased less than expense. However, if this is further broken down according to social and economic status, it is found that the income of agricultural households increased by 7.8% but expense increased by only 7.2% with average debt increasing by 5.5%. For labourers, the average income increased 1.8%, expense increased 6.8%, but average debt increased at the highest rate of 47.5%. This shows that the low-income population had average debt increases at a much higher rate than average income increases. Since these households have low incomes, they cannot easily access legitimate loan services. This is reflected in the NPL of commercial banks, which stood at 11.57% of all loans. In other words most of the debt owed by low-income households was debt in the black market. Figure 17 Growth of Average Income, Average Debt, and Average Expense per Household 25.00% 20.00% 21.80% Growth Rate 15.00% 10.00% 5.00% 0.00% -5.00% 2.93% -3.81% -4.55% 1.80% 0.29% -4.61% 10.12% 8.81% 12.38% 44.7% 55.3% % Source: National Statistical Office Year Average Income Average Debt Average Expense

39 39 Increasing household debt, which is reflected in the conflict in NPL figures, can be explained by the fact that before releasing loans personal loan providers consider the salary base and interest rates as important factors since, statistically, low-incomers have higher default rates than high-incomers. Figure 18 Default Rates of Personal Loan Customers Classified by Income Inco > 15K- 7.5K- 0% 5% 10% 15% 20% < 7.5K 23.1 Average Source: Krung Thai Credit Since low-incomers have higher default rates, low-income borrowers of unsecured personal loans caused higher costs to providers than highincome borrowers. Therefore, if there is a determination of interest rate ceiling, it will cause providers to turn to higher incomers, who have lower costs and risks. The determination of an interest rate ceiling is therefore similar to determining a minimum income of consumers.

40 40 Figure 19 Effect of Supply and Demand after Determining Interest Rate Ceiling on Legitimate Loan Businesses Interest rate charge Legitimate Loans Supply I 0 = X % E I 1 = 28 % Unsatisfied Demand Demand Q1 Q0 Q2 Quantity of Loans Figure 19 shows the relationships between number of consumer loans (demand) and number of loans provided (supply). E is the equilibrium of demand and supply, with the interest rate at I 0 and the number of loans at Q 0. With variable interest rate supply and demand alters. When setting up an interest rate ceiling at I 1, providers (supply) want to release loans only at Q 1. However, the demand of consumers come rises to Q 2, which creates an unsatisfied demand at Q 2 - Q 1. The reason why providers do not want to release loans is because when the interest rate ceiling is determined, it will make providers unwilling to release high cost loans, in other words, to low-incomers. This is because the chance of loans granted to low-incomers becoming bad debt is higher than for those granted to high-incomers. Therefore, low-incomers cannot get the services they require. According to figures on the income of government, private and state enterprise employees (totalling million people from an