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

(2.16%), 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 714.19 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 130.63 billion Baht consisting of 75.35 billion Baht from nonbanks, 55.14 billion Baht from banks and 0.14 billion Baht from finance companies. Outstanding credit card loans serviced by non-banks and banks were 143.56 billion Baht consisting of 67.05 billion Baht from nonbanks, 48.56 billion Baht from Thai banks and 27.95 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 hirePersonal loan, credit card, and purchase loans of 250 billion Baht.

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

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. 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. This hampers the public sector when trying to plan suitable and effective

Moreover, appropriate policy will bring stability to financial institutions as well as support and facilitate the growth of Thailands 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

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 Thailands household debt in the 2nd quarter of 2004 was, on average, 103,940 Baht/household, up from 21,000 Baht in 2002. The proportion of household debt to income was 59%, up from 51% in 2002. concern. It was concluded that Thailands household debt was at a low level and not of

Figure 1 Household Debt against Household Income

160.00

% of Household Debt against Household Income

140.00 120.00 100.00 80.00 60.00 40.00 20.00 0.00

Year

1998

1999

2000

2001

2002

2003

2004

Japan USA South Korea Australia Thailand

Figure 2 Household Debt against GDP Ratio of Household Debt to GDP (%) (For D% Each Country) G P ()
S g p re in a o UA S A s lia u tra U K M la s a y ia S o a .K re Hnkk o go Ta hi In o e ia d ns in ia d 0 6 1 0 2 0 3 0 4 0 5 0 6 0 7 0 8 0 9 0 1 0 3 3 6 0 6 3 6 2 7 7 8 5 8 4 8 4

Ratio of Household Debt to G P GDP (%) D%

2. Income structure of personal loan users

Data collated for the 3rd quarter of 2004 by the National Statistical Office of Thailand showed that, countrywide, approximately 35 million people were employed*, of which about 15.64 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

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. 15.64 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

111.172 1 1 Million .7 2
2.34 2 4Million .3 1.21 1 1Million .2 0.25 Million 0 5 .2

Survey of 13 commercial banks and 9 NBFIs, Bank of Thailand

Figure 4 Income Structures of Personal Loan Users - Commercial Banks and NBFIs
Less than 7,000 Baht/month
23%

Approx. 3.85 million persons in total

More than 25,000 Baht/month 17%

15,000 - 25,000 Baht/month

19% 22% 7,000 10,000 Baht/month

19% 10,000 - 15,000 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-

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

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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

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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 (%) Cost of fund Operation Cost Default rate Margin AVG 2.5 13.2 5.9 1.4 Bank Max 3.8 19.1 9 12.5 Min 1.7 2 3.2 -9.2 AVG 3 11.8 9.1 1.5 Non-Bank Max 4.0 19.0 19.5 6.6 Min 2.5 3.6 3 -7.5

Remark: Average personal loan interest rate is 28.37% for (9) commercial banks and 31.06 % 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

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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.

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Figure 6 Distribution of Income Levels of Legitimate Personal Loan Users

900,000 800,000 700,000 600,000 Persons 500,000 400,000 300,000 200,000 100,000 Over 25,000 20,00125,000 15,00120,000 10,00115,000 7,00110,000 4,0017,000 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

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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.

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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

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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.

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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

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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

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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.

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Guidelines for Development and Regulation of Personal Loan Companies

Method 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. Expected Results 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). 5. Facilitate people towards financial discipline by paying importance to good credit.

Operation cost of business providers is reduced, which is advantageous to customers. Low incomers have chance to ask for unsecured loans.

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.

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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

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1.1 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 dont 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.

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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).

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Figure 9 Outstanding Loans in Thailand, 2004

Outstanding Loans in 2 4 2004 Thailand,() 5 7

3% 1

31% (175,000 million Baht) was unsecured loans (total personal loans was 621,000 million Baht).

5% 2 6 % 1% 1
purchase Car Hire-

Housing Loan

Card

Credit

Personal Loan

Personal Loans

Secured Loans (445,000 million Baht)

Source: Bank of Thailand

Unsecured Loans (175,000 million Baht)

The income structure of Thailands 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.

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Figure 10 Income Structure of Permanent Income Population, 2004 (Total 15.64 Million)

1.21 million 2.35 million

0.245 million

8 %

2 %

1% 5

11.72 million

7% 5

Less than 7,500 7 0 Baht ,5 0 15,000 -30,000 1 ,0 0- 3 ,0Baht 5 0 0 0 0

7,500 1 ,0 Baht 7 0 -15,000 0 ,5 0 5 0 More than 30,000 Baht 3 ,0 0 0 0

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.

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Market Share of Personal Loans for Commercial Banks and NBFIs Classified by Income Level of Consumers 30th June, 2004

Outstanding Personal Loans (million Baht) 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 Total Bank 6,191 6,866 9,914 18,077 98,483 139,531
Non-Bank

Number of Personal Loans Customers (capita) Bank 424,329 345,416 360,205 386,464 393,278
Non-Bank

Total 10,363 12,680 17,302 26,823 108,785

Total 839,719 836,718 720,095 705,695 632,322

4,172 5,814 7,383 8,746 10,302 36,417

415,390 491,302 359,890 319,231 239,044

175,953 1,909,692 1,824,857 3,734,549

Figure 11 Outstanding Personal Loans (Million Baht)

120,000 10,302 100,000 80,000 60,000 98,483 40,000 20,000 0 4,172 6,866 7,383 18,077 5,814 6,191 < 7,000 10,000- 15,000 15,000- >25,000 7,000 10,000 7,000 7,000-10,000 15,000 25,000 10,000 15,000 25,000 25,000 B ank N ank on-B 9,914 8,746

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NPL of Personal Loans for Commercial Banks and NBFIs Classified by Income Level of Consumers 30th June, 2004
Number of NPL customers 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 Total Bank 32,405 21,853 15,582 10,466 17,041 97,347 Non-Bank 24,653 28,450 20,728 13,487 8,262 95,580 Total 57,058 50,303 36,310 23,953 25,303 192,927 Bank 853 607 616 629 10,830 13,535 Outstanding NPL Non-Bank 1,027 223 360 299 260 2,169 Total 1,880 830 976 928 11,090 15,704

Figure 12 Number of NPL Customers of Personal Loan Consumers (Capita)

6 ,0 0 00 5 ,0 0 00 2 ,6 3 45 4 ,0 0 00 3 ,0 0 00 2 ,0 0 00 1 ,0 0 00 0
7,0007 7,000 ,0 0 0 0 0 0 010,000- 5 015,00050 50 <,0 0 7 0 - 1 ,0 0 1 ,0 0- 1 ,0 0 1 ,0 0- 2 ,0 0 10,000 15,000 25,000 Baht/month >25,000 50 2 ,0 0

2 ,4 0 85 2 ,7 8 02 86 ,2 2 3 ,4 5 20 2 ,8 3 15 1 ,5 2 58 1 ,4 7 38 1 ,0 1 74 1 ,4 6 06

B ank

N ank on-B

28

Figure 13 Outstanding NPL of Personal Loan Consumers Classified by Income

4,614 Million 4,614 Baht (29%)

, 29%

11,090 11,090 Million Baht (71%) , 71% < 25,000 Baht 25,000 > 25,000 Baht 25,000

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

Typical Unsecured Personal Loan Interest Rates in Foreign Countries

Country Hong Kong Korea Japan Interest Ceiling 60.00% 66.00% Financial cost is lower than for 29.20% loan providers in Thailand 3.04.0% USA Italy Taiwan 36.0% 37.5% 20% Interest Ceiling set According to Credit Limit Interest Ceiling set According to Credit Limit For NBFI providers, interest rate Remarks

(only commercial banks) 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

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)

C ial C o B M rim ases n lack arket L anP vid o ro ers N.o C o f ases 400,000.00 300,000.00 200,000.00 100,000.00 0.00 1998 1999 2000 2001 2002 2003

C V e(M nY ) ase alu illio en

40,000.00 30,000.00 20,000.00 10,000.00 0.00

Y ear C V e(M nY ) ase alu illio en

N.o C o f ases

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

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 Rate (%) Cost of funds Operation Cost Default rate Margin Interest Rate Suggested AVG 2.5 13.2 5.9 1.4 23.0 Bank Max 3.8 19.1 9 12.5 39.0 Min 1.7 2 3.2 -9.2 12.6 AVG 3 11.8 9.1 1.5 25.3 Non-Bank Max 4.0 19.0 19.5 6.6 35.0 Min 2.5 3.6 3 -7.5 14.0

32

Figure 15 Cost Structures of Unsecured Personal Loan Providers

100% 80% 60% 40% 20% 0% AG V B k an 1.4 5.9 13.2 2.5 AG V N -B k on an 1.5 9.1
M argin

11.8 3

D lt ra efau te O eratio C st p n o C st o fu d o f n

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

3.1 Competitivess of Personal Loan Providers

Foreign Commercial Banks
Strong Points Have good image as service providers. Service Have service know-how as the leaders of the market. Product Have diverse innovations and new product designs to meet customers demands.
Credit Have high interest rates and charges. Have limited channels to attract customers. Target low-risk customers - narrow market.

Brand

Price

Weak Points

Thai Commercial Banks

Strong Points Have low interest rates due to low cost of Service funds. Product Have many branches and channels to customers.
Credit

Brand

Price

Weak Points Only take low-risk customers due to the lack of unsecured personal loan knowhow.

Black Market
Strong Points Take unlimited risk. Service Easy, convenient, no hampering Product regulations. Weak Points Very high interest rates. No service. Bad image with consumers.

Brand

Price

Credit

34

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.

Service Product Brand

Price

Credit

SFI
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. 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.

Service Brand Product

Price

Credit

Source: Krung Thai Credit Company

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

Figure 16 Providers Classified by Customer Income and Demands Consumers Consumers Demands
Service High

Service Providers Foreign Commercial Banks Thai Commercial Banks

300,000
Brand

Product

> 60,000 Baht/month Price Middle 4 million 15,000 60,000 Baht/month Price Credit Service Mass Credit Service Brand Product

Non-Banks

6 million
7,500 15,000 Baht/month

Brand

Product

Price

Credit Service

SFIs

Low

24 million
Brand

Product

< 7,500 Baht/month Price Credit

Black Market

Source: National Statistical Office The employed population as of January 2005 was 33.63 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

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

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% 21.80% 20.00% 15.00% 10.12% 10.00% 5.00% 2.93% 0.00% -5.00% -10.00% -3.81% -4.55% 2000 8.81% 1.80% 0.29% -4.61% 2001 Year 2002 2004 44.7% 55.3% 12.38%

Growth Rate

Source: National Statistical Office

Average Income

Average Debt

Average Expense

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

0% Inco > 15K7.5K< 7.5K

5% 6.49 7.75 11.7

10%

15%

20%

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.

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Figure 19 Effect of Supply and Demand after Determining Interest Rate Ceiling on Legitimate Loan Businesses

Interest rate charge Legitimate Loans Supply

E I 0= X % I1= 28 % Unsatisfied Demand Demand Quantity of Loans

Q1

Q0

Q2

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 I0 and the number of loans at Q0. With variable interest rate supply and demand alters. When setting up an interest rate ceiling at I1, providers (supply) want to release loans only at Q1. However, the demand of consumers come rises to Q2, which creates an unsatisfied demand at Q2 - Q1. 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 15.642 million people from an

41

employed population of 33.63 million), it is found that those who have an income of less than 7,500 Baht/month account for 11.712 million or 78.59% of all employees (Fig. 21). These consumers thus turn to the black market for loans. The black market is positively boosted (Fig. 20) since the demands for loans from consumers increases from the former rate at D1. When there is control by determination of interest rate ceiling, the demand for black market loans will increase and shift towards D2. The interest rate that black market providers charge to consumers will also rise from I1 to I2. This shift in loan demands can be explained in Fig. 20.

Figure 20 Effect of Supply and Demand after Determining Interest Rate Ceiling on Loan Businesses in the Black Market
Black Market Loans Loan Interest

Supply

I2 I1 D2

D1

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Figure 21 Population Structure Classified by Income

1.21, 8% 0.245, 2% 2.3503, 15%

11.712, 75%

Lessthan 7,500 Baht 7,500 15,000- 30,000 Baht 15,000 30,000

7,500- 15,000 Baht 7,500 15,000 30,00030,000 Baht More than

Source: National Statistical Office Unit: Million persons

Figure 22 Effects of Regulatory Rules Prescribed to Control Credit Card and Personal Loan Companies
Credit Card Loan Personal Loan

Black Market Loan

Employed persons having incomes lower than 7,500 Baht/month are approx. 24 million. (This is 70% of 33.5 million employed persons in Thailand in 2004)

Bureau of Financial System Policy, Fiscal Policy Office Source: National Statistical Office

43

However, when considering the percentage of household debt to GDP as classified by country (Fig. 23), Thailand still has a lower household debt to GDP than neighbouring countries such as Malaysia, Hong Kong, Singapore, and South Korea. This can be looked at from several Their figures for viewpoints. An interesting issue is that these countries have developed a system of loan businesses that are truly legitimate. household debt therefore truly reflect the issue. In contrast, countries that have little financial development, such as Indonesia and India, have very few legitimate loan businesses here the reported figure for household debt to GDP is very low. One of the main reasons for this is probably due to large numbers of unreported black market loans. When considering the economic structure of Thailand, the figure for household debt to GDP should be close to that of Malaysia. Since it isnt, it is possible that some of the household debt has not been reported and is supposedly black market loans. This type of debt not only causes consumers to pay high interest rates, but the government also loses several billions of Baht per year through lost taxes.

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Figure 23 Ratio of Household Debt to GDP (%)

Ratio of Household Debt to GDP % (for Each Country)

Singapore USA Australia UK Malaysia S. Korea Hong Kong Thai Indonesia India 0 6 10 20 30 40 50 60 70 80 10 33 63 62 60 77

85 84 84

90

Ratio of Household Debt to GDP (%)

Source: National Statistical Office

5. Suggestions for Development and Regulation 5.1 Regulation

The study team makes the following suggestions.

Overall Guidelines for Development and

5.1.1 Determination of maximum credit limit not over 5 times that of income.

45

The study team suggests that, in principle, there should be a determination of maximum credit limit in ratio to the income of borrowers. In this respect, if the control of household debt is conducted efficiently so as to actually reduce the risk to the overall system, it is necessary to control the overall debt formation in all financial institutions of each borrower to a suitable level. This can be achieved by preventing the formation of debt exceeding 5 times the income of the borrower at all financial institutions together. Therefore, it is necessary to have an efficient credit data system in order to allow providers to check data equally and fairly, thereby eliminating problems asymmetric information. All personal loan service providers shall be required to become members of the credit data bureau, and collation of credit data for each customer shall be conducted according to the law. Information will be used to efficiently control the level of household debt of the nation. Moreover, any charges of the credit data bureau should be of an appropriate level in order to promote broad and wide-ranging usage of their information. Additional and necessary information that members must release to the credit data bureau should include information on debt formation behaviour, payment behaviour, and other debt burdens.

5.1.2 Determination of Interest Rate Ceiling

These guidelines may cause personal loan providers to avoid offering loans to low-incomers for 2 reasons. Firstly, to release loans to low-incomers has operational costs per credit limit higher than for highincomers, since low-incomers have the ability to ask for lower loans whereas operational costs for each case are fixed. As a result, the proportion of operational costs to credit limit of low-incomers is higher than that of high-incomers. Secondly, low-incomers have high default rates. This assumption comes from studies that indicate that the number of NPLs owed by those with an income of less than 15,000 Baht/month and using personal loan services total 143,000 cases or 74% of all NPLs.

46

Operational costs must therefore rise accordingly. From these reasons, the cost of granting loans to low-incomers is higher than that for highincomers. If the interest rate ceiling is determined by using the average cost of providers, without calculating the actual cost, service providers will then have to reduce costs by avoiding offering loans to low-incomers in order to fall within the determined interest rate ceiling. This will provide low-incomers with less opportunity to obtain legitimate loans, which runs counter to government guidelines that propose increasing the opportunities for low-incomers to benefit from the system. However, if it is necessary to control the release of personal loans in order to maintain overall financial stability, it may be possible to prescribe rules that control the interest rate ceiling for commercial banks only. This is to prevent financial institutions that receive deposits from people release excessively high risk loans and thereby possibly affect the overall stability and security of the financial system and become a burden to the government.

5.1.3 Consumer Protection

Rules related to the transparency of information for consumers should be stipulated to allow consumers to use the service without fear of hidden cost. For example, providers should indicate effective rates rather than flat rates, and any interest rate quoted to the customer should already include any other charges. Providers should also indicate the methods for calculating effective rate should the consumer fall behind in making repayments. Consumers should also be informed of the effective rate charged by providers in case of default of performance before using the service. This would provide a greater level of consumer protection and prevent providers taking advantage, especially in cases of default performance. To create equity for consumers, all personal loan providers should be required to abide by the rules and regulations of consumer protection as prescribed by the law.

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Moreover, there should be a determination of the maximum credit limit of consumers by stipulating that all personal loan providers shall become members of the central credit data bureau and pass on credit data of each customer in accordance with the law in order to more accurately control the level of household debt. A suitable level for charges by the credit data bureau should be considered. In addition, members should be required to submit other information to the credit data bureau such as other debt burdens (total credit limit, number of financial institutions, total outstanding liabilities, monthly instalment burdens, and type of debt owed by the customer), and debt creation behaviour (number of cancellations of loans by approvers, regularity of 90-day overdue notices, and percentage of debt repayment). Regulatory laws should be passed; however, guidelines for drafting these laws should focus upon these 4 important issues. 1) Promotion of credit scoring standards by personal loan providers in order to assist in future risk-based pricing determinations. 2) Fair and transparent consumer protection that is easily verifiable by consumers. Personal loan providers shall follow the rules and show equality to all. 3) All providers under ministerial regulations shall be members of the credit data bureau and shall pass on customer information to the system in order to increase the efficiency of the credit data bureau and reduce financial risk to all. The charge for using the credit data service is an important factor that must be considered. 4) Research and development of a more effective credit bureau must be supported.

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Form of Personal Loan Development Business Providers Development of Credit Scoring Transparency of Credit Data to Consumers Improvement of Credit Bureau Regulators

Development of Operational Investigation

Improvement of Credit Bureau

1) Merge credit bureaus for economy of scale and cost reduction of entrepreneurs. 2) Add data to the credit bureau so as to include public sectors such as payment of water, electricity, telephone, and tax etc. 3) Develop data collection by acquiring credit data of consumers every half-year in order to allow consumers to know their own credit status before asking for loans from financial institutions. This will increase the financial discipline of consumers. 4) Establish an auditing committee to maintain standards at the credit bureau by checking data that members send from their offices every month. This will promote the regular updating of data and prevent sending incorrect data to the bureau. 5) Establish efficient development of credit scoring to reduce the risk and cost incurred by providers of releasing loans. Consumers will be charged lower interest rates and receive better service due to free competition. 6) Ensure the credit bureau issues central credit ratings for each consumer in order to establish a benchmark for members - members

49

will therefore gain many advantages from being members of the credit bureau.

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