Growth of bank credit in Thailand has been robust in recent years, and generally healthy balance sheets have helped buffer Thai banks against the gradual deleveraging by European banks that has occurred so far.

Nevertheless, I think Thai banks remain potentially vulnerable to a large shock to foreign funding of the kind that occurred during the 2008 crisis.

How could Thai banks be affected by the euro-zone crisis? With some of the major financial institutions in Europe in deep trouble, these European banks could pare back their foreign assets. This sharp deleveraging arising from an intensification of the euro crisis could potentially cause a shock to credit supply in Thailand.

Such a credit crunch could arise from a withdrawal of wholesale funding to the domestic banking sector ― and associated derivatives markets ― or through a direct reduction in credit supply to the non-bank private sector. Now, it all depends on how Thai banks and the non-bank private sector are exposed to and dependent on European finances.

The Bank for International Settlements (BIS) recently released data that show European banks have already started deleveraging from Asia, although this has been partially offset by regional banks stepping in, particularly from Japan and Australia.

So far, the deleveraging has been orderly, and much of it has occurred through asset sales rather than lower credit provision. Moreover, the European Central Bank’s three-year, long-term refinancing operations have alleviated funding difficulties for euro-zone banks. But if the euro crisis escalates and the banking conditions in Spain and Greece deteriorate further, there is a high risk that the deleveraging process could gather momentum and become a disorderly rush for the exit.

Thailand’s liabilities to foreign banks may be substantial at 23 percent of gross dometic product as of the third quarter of 2011. This figure can be broken down into 5 percent of GDP for Thai banks; 10 percent of GDP for the non-bank private sector; and 8 percent for the Thai public sector. However, Thailand has less exposure to foreign banks than most other countries in Asia.

Hong Kong, New Zealand and Singapore are among the most exposed, averaging 120-230 percent of GDP. China, Japan and Indonesia are among the least exposed at 5-15 percent of GDP. Therefore, the Thai economy would be relatively less affected in the event of disorderly deleveraging by euro-zone banks.

What are the implications of a future shock? Looking ahead, I think Thailand’s policymakers still have ample room to respond aggressively to a sharp deleveraging of foreign banks arising from a euro-area shock. Of course, the space for a macro-policy response is smaller than before the 2008 global financial crisis. But compared to other regions of the world, Thailand is still well placed to respond to shocks with a counter-cyclical fiscal policy given our relatively low public debt to GDP level.

However, on the monetary policy side, our real policy rate is now considerably below historical averages (the real rate is now close to zero), thus the room to ease the monetary policy may be less than before the 2008 crisis.

But Thai policymakers still have a large menu of measures at their disposal to stabilize financial markets, and ample domestic liquidity in the banking systems to withstand the eurozone deleveraging.

Moreover, we now have a large stock of international reserves at over $180 billion, which is more than 10 months worth of imports and three times the short-term external debt, as well as functioning regional pooling arrangements (such as the swap arrangement under the Chiang Mai Initiatives). In the worst-case scenario, time-bound deposit guarantees and programmes to support trade finance and lending to small and medium enterprises could also play a role again.

At the same time, a relatively healthy local banking system should provide a buffer as it did after the 2008 financial crisis. Thai bank balance sheets remain strong in general, owing to good economic growth and conservative bank regulators. Overall capital adequacy ratio (Tier 1 CAR) is 15 percent, which is well above the regulatory standard of 8.5 percent, while the non-performing loan ratio is very low at 3 percent.

The IMF has recently done a sensitivity simulation that if eurozone banks deleveraged by 25-50 percent, Tier 1 CAR in Thai banks would decline to 14.5-14.8 percent. Of course, European deleveraging scenarios are highly uncertain and will have differing severity. Thai policymakers must ensure that local banks are able to compensate in terms of local credit supply to the domestic economy in order to mitigate the impact from financial shocks from Europe.

Overall, it seems that Thailand’s financial sector is well positioned to cope with the coming financial turmoil.

By Chodechai Suwanaporn

Chodechai Suwanaporn is executive vice president for economics and energy policy at PTT Public Co. Ltd. ― Ed.

(The Nation/Asia News Network)