Publication Code: Y87D
The major function of financial institutions is to intermediate between those who have an excess supply of funds and those who have an excess demand for funds. In performing this role, financial institutions have to attract savers by offering more attractive financial claims in terms of returns and security than those that savers themselves can obtain. On the other hand, financial institutions have to attract borrowers by offering more attractive terms than borrowers can arrange themselves.
If such activities are efficient, which can be achieved through specialization, economies of scale in financial transactions, and the like, financial intermediaries can conceivably increase net returns to savers and, simultaneously, lower costs to borrowers. The increase in returns to savers and the decline in borrowing costs to investors may, in turn, lead to increases in both savings and investment, thereby raising the overall rate of economic growth.
However, it is often argued that financial intermediaries are not operating efficiently due to various rules and regulations designed to ensure the maintenance of financial stability and discipline. Nevertheless, these rules and regulations, which include reserve requirements, selective credit policies, interest rate ceilings, do affect the behavior of the intermediaries.
Reserve requirements raise the resource cost to financial intermediaries, and widen the spread between financial intermediaries' lending and borrowing rates. Selective credit policies typically involve credit rationing at a relatively low rate of interest. While the policies are aimed at allocating financial resources to "desired" sectors, they, in effect, constitute a cost to intermediaries. Interest rate ceilings can also affect the operational efficiency of the financial sector. On the deposit side, the ceiling may reduce the volume of resources available to intermediaries. The ceilings may also, on the allocation side, reduce productive risk-taking by intermediaries, thereby reducing the quantity of investment.
This study is, therefore, aimed at examining the question of efficiency in the Thai financial sector. The objective is to shed some light on the relative efficiency of Thai financial intermediaries. The study is based upon the aggregate data of commercial banks and finance companies as a group, and must be interpreted in that light.
Section II of this study defines the methodology upon which the study was based and discusses the environment within which financial institutions operate. Section III analyzes-the profitability of financial intermediaries. Section IV examines the financialization of savings and efficiency of resource allocation. Results of an analysis of the spread between lending and borrowing interest rates are discussed in Section V. Concluding remarks are made in Section VI.
November 1987