Banks work with borrowers beyond just granting loans, often acting also as a kind of in-house consulting unit.

Apart from collateral such as land and buildings, banks always ask for a personal guarantee from the owners or the top management of the firm.

When lending to limited-liability companies, they try to solve the moral-hazard problem by asking the major owners or directors of the firm to pledge a personal guarantee.

Several bank auditors said bank lending in Thailand was based more on personal feelings and relationship factors than on credit-risk assessment. However, bank executives in Thailand do not seem to agree with this claim.

They argue that although they use personal feelings or relationships to judge the creditworthiness of borrowers, they only use it to a certain extent and always rely more on economic principles of credit-risk evaluation. In other words, apart from the consideration of credit risk, relationship factors like personal impressions, trust and reputation play an important role in the credit decision.

The banks firmly believe their lending decision is systematic, taking into account risk and other appropriate factors in line with international standards.

Some have argued that Thai banks were weak prior to 1997 at analysing their customers, the customers' businesses, and the projects that the loans would be used to finance. Many economists, especially the financial or banking experts from the International Monetary Fund and World Bank, generally accused Thai banks of not measuring the risk from lending and that lending decisions were based on collateral.

According to these accusations, the value of collateral - not the cost of the project or the needs of the business - determined how much banks were willing to lend to their customers. If this were true, then it is possible that Thai banks did not place enough importance on cash-flow projections, the viability of the project, profitability of the business, or even consider a thorough industry analysis.

However, experts from the auditing firms that I interviewed said it is often not easy to know the financial details and project the cash flows of the borrowing firms. The prime reason is that financial statements, profit and loss and balance sheets, cannot be blindly trusted and have to be reconciled.

Small-and medium-sized firms are believed to prepare, provide and keep three sets of books. One is to show to the bank, another to the tax authorities, and the third to the owners or their business partners. Banks often have to rearrange and make their own version of a customer's financial statements.

I have also analysed the credit-risk management process of several Thai banks from their credit-policy handbooks. I have to admit that it looks very good on paper, but to what extent Thai banks actually enforce or practise what they preach is still a major question for many banking experts. A few years ago I did a survey and found some doubts or negative comments generalised on Thai banks' lending practices and credit risk management as follows:

l Thai banks were said to have a staff problem. They lacked skills to analyse the risk from lending to customers, businesses or projects. Credit officers of Thai banks spent very little time trying to understand the business of the borrowers and analyse the potential of that business, such as what factors mattered to failure or success of the business. On the other hand, they spent a lot of time making sure they received all the documents needed to support their claim and then turning the decision over to management to approve or disapprove the loans. After the loan was approved, the credit officers just spent time trying to collect other documents and financial statements, not for the purpose of analysing them but for the purpose of having a complete file on record.

l Thai banks were said to be lacking a good credit-monitoring system. Credit officers failed to perform reviews of credit that had been given. Borrowers often misused the borrowed money. For example, the clients borrowed money for business expansion or for short-term working capital but instead used the money to buy real estate, trying to make profit from speculation. Sometimes the banks let the borrowers draw down money too easily and the amount of borrowed money was more than should have been given compared to the progress of work that had been done. Often, credit officers did not keep track of the performance of the business of the borrowers, and as a result they were unaware of any deterioration in the borrower's business.

l Thai banks were criticised for not placing sufficient emphasis on auditing their credit extension. The audit department was not given due respect or enough power or internal recognition. It lacked support from the management and failed to receive full cooperation from the credit department. It did not have enforcement powers or incentive ability to motivate other departments to recognise them as important in the organisation. Because of this lack of power, the audit department tended to compromise with the credit department and did not seriously attempt to find fault or misconduct in its credit audits.

l An efficient risk-management system was said to be lacking in the banks' credit operation. Thai banks did not have an appropriate risk control process. They did not have a measure to deal with or to avoid excessive risk taking in the portfolios of their lending. Because of the poor information and reporting system, banks could not act to mitigate risk due to size, geography and industry. That was why some banks had too much risk exposure to certain industries or certain groups of customers. Some also had overexposure on big loans or projects. After the financial crisis of 1997, many Thai banks set up a new division called risk management to perform thorough risk analysis of the overall loan portfolio and also of individual loan projects to support the credit department.

l The structure of the credit analysis and approval process was criticised for not fostering serious and strict independent thinking on the basic question of "why should we lend to this business or project". In the case of Thai banks, the credit department was truly in charge of the credit decision. It had a strong say in every step of the credit granting process. Credit officers also were the persons to contact customers and help customers to prepare their "story" and documents for loan consideration by the credit committee.

Because of this dual role, the credit department could possibly have a conflict of interest. For example, many credit officers may have acted on the borrowers' side by helping to build a good story or to be overly optimistic with forecasts of financial performance of the projects or businesses.

Several Thai banks are now separating the function of credit analysis or credit approval from customer relations. The Thai banks acquired by foreign institutions after the financial crisis have now changed the credit-approval process to consist of a relationship manager for contacting customers and a credit-risk analyst group - or risk-management group in some banks - to handle in-depth risk analysis on which to base their lending decision.

The writer is director of the Financial Policy Section of the Finance Ministry's Fiscal Policy Office. He can be contacted at chodechai@fpo.go.th.

Chodechai Suwanaporn