I recently did a study on bank lending and found distinct differences between Thailand and developed markets, with collateral-based lending more pronounced in the Kingdom. Moreover, the way in which collateral-based lending is conducted seems to reflect Thai market imperfections. Thai banks demand collateral more often and to a higher degree than do their counterparts in developed markets.

Several Thai banks were found to operate like pawnshops. The valuation of collateral is undertaken to support the amount of credit that can be given to the client as the bank's lending officer tries to convince the management that the loan should be given for a certain amount because the collateral offered is worth that amount.

This is contrary to good lending concepts in which the valuation of collateral should be carried out to find out how much the bank can recover in a bad case when the borrower cannot pay.

Legal restrictions have inhibited the development of good lending practices, in which the decision to lend should have been based on the cash flow of the projects or the business, instead of the value of collateral.

One of the Bank of Thailand's past directives stated that banks had to extend credit on the basis of sufficient collateral. This implied to the banks that they had to consider collateral first. As a result, they would hesitate to grant loans to borrowers without collateral, despite the fact that borrowers may have a very viable project or business with sufficient cash flow. Because of this regulatory condition, the banks were essentially encouraged to emphasise collateral-based lending rather than cash-flow-based lending.

Thai banks were guilty of not disciplining or governing their borrowers. They spoiled them by not strictly demanding that certain performance targets or criteria be met.

Moreover, by not following up on borrowers' projects and not threatening to penalise the borrowers, the banks then fostered a lack of discipline among debtors.

Many used covenants as conditions in loan contracts, but they never acted seriously on them.

Therefore, many borrowers did not pay attention to the loan contract.

Or if they did, they would not worry too much when they breached the covenants.

In the lead-up to the last financial crisis, in 1997, the Thai economy experienced high growth and received large and deceptively cheap capital inflows. Industries and businesses enjoyed very high growth and expanded investment. Speculation on land made real-estate prices double, or even triple in some cases.

During this period, Thai banks had surplus funds. Therefore, they tried to expand their assets so much that they pursued lending practices that considered quantity more than quality. The market for bank lending became very competitive. Borrowers had more bargaining power and could talk with many banks at the same time. Banks were afraid to lose customers if they demanded a lot from them or if they asked too many questions or took too much time in analysing the credit risk.

At the time of the crisis, Thai banks were largely family-owned and managed by the members, who maintained power in the credit-decision committee. They influenced credit decisions that were based on personal experience and relationships. This cultivated lending practices whereby credit officers paid less attention to credit analysis and risk consideration than to relationships. This was also reflected in the fact that if borrowers received a reference from the owners of the bank or had previous contact with the management, they would be treated with special attention by the lending officers.

I caution that these opinions reflect the leading view or mainstream comment at that time. Based on the above views being put forth so regularly at that time, it is possible that people just accepted it without analysing it. In other words, the impression of banking experts in Thailand could very well reflect the prevailing view from that period.

We also have to caution or take into account the fact that before the financial crisis, the World Bank, the International Monetary Fund and many leading economists continued to state that everything was going well with Thailand's economy and banking sector.

However, these same people quickly changed their views after the crisis in 1997.

This is the first part of a series by the director of the Financial Policy Section at the Finance Ministry's Fiscal Policy Office. He can be contacted at chodechai@fpo.co.th.

Chodechai Suwanaporn