system reform 2009

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COLLEGE OF ECONOMICS VIETNAM NATIONAL UNIVERSITY, HANOI

BANKING SYSTEM OF VIETNAM:

REFORM STRATEGIES AND TRANSITION ASSESSMENT

Research paper written under the grant of Thai Research Fund.

(Draft)

By: Nguyen Hong Son . Ph.D, Assoc. Professor of Economics

Hanoi, May 2009.


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Abstract

The banking system of Vietnam has not been seriously hit by the current global financialcrisis as it was able to escape from the Asian financial crisis safely. Yet, just as the Asian

financial crisis pressed for a new round of banking reforms in Vietnam, it is expected that the

current global crisis will be a condition for Vietnam to accelerate the reform speed of its banking

system.

This research examines the reform of Vietnamese commercial banking system from two

angles: banking reform strategy and transitioning structure of the banking system. It argues that

there is inconsistent direction in the reforms of Vietnamese commercial banking system,especially in time of economic and financial turbulence. This has resulted in the imbalance of the

structure and slow reform speed of the banking system. Slow reforms may protect Vietnamese

commercial banking sector from short-term external impacts by chance, but it will cause major

longer-term weaknesses of Vietnamese commercial banking sector by consequence.


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Table of Content

Introduction 3

1. Overviews of the Commercial Banking System of Vietnam 5

1.1. The Development of the Banking System 5

1.2. Main Characteristics of the Commercial Banking System 9

1.3. Risky Issues 12

1.4. The Impact of the Current Global Financial Crisis 16

2. Banking Reform Strategies and Transition Assessment 18

2.1. Two Reform Approaches 19

2.2. Assessing the Reforms of the Commercial Banking Sector 25

3. Policy Implications 28

Conclusion 31

Appendices

References 38


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Introduction

Since 1986, together with Doi Moi (reforms), the banking system of Vietnam hasundergone through a reform process. From 1988 to 1990, the mono-tier banking system in the

pre-reform period was dissolved. A two-tier banking system was set up with the separation of

commercial banking from central banking. In 1997, the National Assembly passed the Law on

Credit Organizations which provided a legal framework for the development of the commercial

banking sector. In parallel with the decentralization of the banking system, the government has

gradually introduced a number of liberalization measures, including rationalization of the

interest-rate structure, cessation of concessionary refinancing for the state-owned commercial

banks, unification of refinancing rates, creation of the money markets, and establishment of a

more flexible exchange rate mechanism etc.

Since the early 1990s, one can distinguish two reform strategies which have been carried

out by the government. The new entry strategy supports a rapid liberalization process by

allowing the quick emergence of a new private banking system. The rehabilitation strategy

calls for a re-structure of the old state-owned commercial banks and a limited entry of new

banks. Banking reforms in Vietnam has swung between these two approaches, especially in time

of economic and financial turbulence such as present when major weaknesses of the banking

system are unraveled. This inconsistency has resulted in the imbalance of the structure and slow

reform speed of the banking system.

There are a number of studies on the reforms of the commercial banking sector in

Vietnam (see e.g. Barr, 2006; Du, 2007; Hoan and Son, 2008; Hao, 2008; Oh, 2000; SBV,

2006; Son, 2008; Thomas, 2003; Unteroberdoerster, 2004; WB, 2002). However, few studies

look at the reforms via the telescope of the two mentioned strategies which are popular

experiences of other transitional economies. Most previous studies also prefer to describe the

transitional process of the banking system rather than assessing it with concrete indicators as the

result of the banking reform progress. In addition, they lack adequate analyses on the impact of

the current global financial crisis on the reform strategy of the commercial banking sector.

Although in 2006 the Prime Minister issued Decision 112/2006/QD-TTg approving the

Development Plan of the Vietnamese Banking Sector till 2010 and Development Guidelines till

2020, both the former and latter only lays out some broad objectives without concrete


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implementation measures, and moreover, within their broad objectives, they fail to identify a

reforming philosophy of the banking system.

This research is to understand the reforms of Vietnamese commercial banking system in

the context of the current global economic and financial crisis. Specifically, it aims to: i) Analyze

the reform strategies that have been implemented in the commercial banking system; ii) Assess

the transitioning structure of the commercial banking system as the result of the reform

strategies; iii) Examine the impact of the current global financial crisis on the commercial

banking sector in comparison with the one of the 1997-1998 Asian financial crisis; and iv)

Explore a policy implications for the development of the commercial banking system.

This research paper is divided into three parts. Part one will present major characteristics

of the banking system of Vietnam before and after Doi Moi . It also examines the impact of and

policy responses to the current global financial crisis with respect to the commercial banking

sector and comparing these with the impact of and policy response to the 1997-1998 Asian

financial crisis. Part two will analyze the reform framework and two banking reform strategies

that have been carried out by the Vietnamese government. It also constructs and reports the

indices to assess the transition structure of the commercial banking sector. Part three will draw

policy implications for the reform strategy and development of the commercial banking sector.

1. Overviews of the Vietnamese Commercial Banking System

1.1. The Development of the Banking System

Before Doi Moi, Vietnam had a mono-banking system in which there was an

enmeshment between central banking and commercial banking activities. The whole banking

system served purely as a planning and administrative instrument of the government in a

commanded economy.

Looking at the structure of the banking system, the State Bank of Vietnam or the Central

Bank was founded on May 6 th 1951 during the war time. In the following years, the government

established a few functional state-owned banks which served mainly as the facilitators of capital

transaction in some areas of economic activities: the Vietnam Reconstruction Bank was created

in 1957, re-named as the Bank of Investment and Construction in 1981, and since 1990 has

become the Bank for Investment and Development of Vietnam (BIDV); Foreign Trade Bank of


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Vietnam (Vietcombank, VCB) was created in 1963; and after Doi Moi began, Vietnam Bank for

Agriculture and Rural Development (Agribank) and Industrial and Commercial Bank of Vietnam

(Incombank, ICB) were both created in 1988. In April 2008, Industrial and Commercial Bank of

Vietnam was re-named Vietnam Bank for Industry and Trade (Vietinbank). The current

commercial banking system of Vietnam emerged from four functional state-owned banks

established in the planned economy: BIDV, Vietcombank, Agribank and Vietinbank.

In 1986, the Sixth National Congress of the Communist Party of Vietnam (CPV)

announced Doi Moi policy to transform the centralized economic mechanism toward market

economy. Comparing with the reforms in other economic sectors such as state-owned enterprises

(SOEs), the reforms of the banking sector began in a more difficult and turbulent context. In

1986, Vietnam experienced a profound socio-economic crisis, where inflation rate reached three-

digit number, and the entire financial system was on the brink of collapse. In 1988, the Second

session of the Party Central Committee (Sixth Congress) issued Resolution 02-NQ/HNTW to

provide the guidelines to address the urgent problems relating distribution and circulation of the

economy. Later, on March 9 th 1988, the Chairman of the Minister Council issued Decision 53,

allowing all types of economic organization, including private enterprises, to mobilize and

borrow money from the public. This bold yet imprudent Decision created a credit pyramid whichcollapsed a year later as its huge bad loans were discovered and left behind devastating impact

on the lenders. Thus the early reforms of the commercial banking system had gone too far and

too fast without corresponding reforms in other sectors such as SOEs, foreign trade and

industrial production and without minimum safeguard measures such as capital adequacy ratio

and risk monitor mechanism.

The reforms in the 1986-1990 can be seen as a preliminary experiment in which the

government tried to separate the state management function from monetary and credit activities

of the banking system. In May 1990, the State Council passed two banking ordinances 1 to

officially transform the old mono-banking system to a new two-tier banking system. In the latter,

at the first level State Bank of Vietnam (SBV) serves as the Central Bank, and at the second level

there is a system of commercial banks. In December 1997, these two banking ordinances were

replaced by the Law on State Bank and Credit Organizations.

1 Ordinance on State Bank of Vietnam, and Ordinance on Banks, Credit Cooperative and Financial Enterprises


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Since 1990, a number of join-stock commercial banks (JSCBs) have been established.

Foreign banks are also allowed to open branches in Vietnam or to form a joint-venture with

domestic banks. Besides, the government established a few other state-owned commercial and

policy banks such as Bank for the Poor in 1995 (re-named as Social Policy Bank in 2002); and

Mekong Housing Bank (MHB) in 1997. 2 In 2006, Vietnam Development Bank (VDB), another

policy bank, was created from Vietnam Development Fund. During the 1990s, together with a

high economic growth rate, the number of private commercial banks in Vietnam increased

dramatically.

After experiencing a rapid development, the commercial banking system of Vietnam

however started to encounter some serious problems especially the inefficiency and non-

performing loans. Thus, the government decided to launch an ambitious re-structure program of

the commercial banking system. In 2000, it established the asset management companies (AMC)

of four SOCBs to address their non-performing loan issues. In 2003, it created Debt and Asset

Trading Company (DATC) to address the debt problem of the non-performing SOEs. In 2004,

SBV was assigned to design the equitization plans for state-owned commercial banks (SOCBs).

At the same time, a number of inefficient JSCBs had been closed, merged and consolidated and

this reduced the number of private banks significantly. On January 11th

, 2007, Vietnam officially became the 150th member of the World Trade Organization (WTO). According to its

commitments with the WTO which became effective on the same day, Vietnam will have to

open its banking sector within 7 years since its admission. In the early 2008, among five major

SOCBs (Vietcombank, Vietinbank, Agribank, MHB and BIDV), after a long delay,

Vietcombank began the equitization process. By May 2008, Vietnam has 7 state-owned banks,

including 5 SOCBs and 2 policy banks, 36 joint-stock commercial banks, 44 branches of foreign

banks, 6 joint-venture banks, 6 financial enterprises, 10 leasing companies, 998 peoples credit

organizations a sort of credit cooperative, 46 representative offices of foreign banks. 3 By the

2 Due to the failure of the housing development program in the Mekong River Delta, the bank now operates purelyas a commercial bank. http://www.mhb.com.vn/?p=gioi_thieu_mhb.asp&r=0 accessed on February 20 th, 2009.3 http://www.saga.vn/view.aspx?id=9662 ; accessed on February 18 th, 2009

http://vneconomy.vn/20080810112958943P0C6/quanh-chuyen-tam-ngung-cap-phep-lap-ngan-hang.htm ; accessedon January 10 th, 2009


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early 2009, 5 one hundred percent foreign-owned banks have been issued license as to fulfill the

WTO commitment to opening the banking sector. 4

Box 1: Key Events in the Development of the Commercial Banking System of Vietnam

Key Events Time

Mono-banking system

(State Bank of Vietnam and other functional State-owned

Banks)

1951-1990

Experiment with peoples credit organizations

(Decision 53 of Chairman of the Minister Council)

1988-1990

Two-tier banking system officially introduced (Ordinance on State Bank of Vietnam, and

Ordinance on Banks, Credit Cooperative and Financial

Enterprises)

Law on State Bank and Credit Organizations

19881990

1997

Growth of commercial banks 1990s

Re-structure of commercial banking system

- Establishment of AMC, DATC

- Equitisation of state-owned commercial bank

2000-now

2008Vietnam became 150 th member of the WTO 2007

Permission of 100 percent foreign-owned banks 2008

After two decades of reforms, Vietnamese banking sector has recorded major development

achievements. Banks have increased in both number and forms of ownership. Banking services

become more diversified. Within the state-owned system, social and management functions were

separated from profit activities of the state-owned banks and the autonomy of the SOCBs has

increased significantly during the preparatory phase of equitization. In addition to thedevelopment of banking system, two stock exchanges have been created in Ho Chi Minh city and

Hanoi in 2000 and 2005 respectively and become important part of the financial market. T he

government has also introduced a number of liberalization measures to the financial system,

including rationalization of the interest-rate structure, cessation of concessionary refinancing for

4 http://vneconomy.vn/2008122904446332P0C6/them-hai-ngan-hang-100-von-ngoai-duoc-cap-phep.htm ; accessedon January 11 th, 2009


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the SOCBs, unification of refinancing rates, creation of the money markets, and establishment of

a more flexible exchange rate mechanism etc. Nonetheless, the reforms have also exposed the

commercial banking system of Vietnam to major weakness and risks especially in time of

economic and financial distress and this shows that the current reform efforts are still

insufficient.

1.2. Main Characteristics of the Commercial Banking Sector

* Bank-based financial system :

The financial system of Vietnam is bank-based. This is the result of a transition from a

centrally-planned economy where state-owned banks dominated the financial system. Capitalsare provided by the banking sector account for more than 50% of the total investment in the

economy, equivalent 16-18% GDP. 5

Recent period has experienced a rapid development of Vietnamese banking sector.

Although the total asset base of the banking sector is still small, equivalent to only $US 75.43

billion as the end 2006, 6 it has been growing rapidly, reaching 48.2% in 2007 (Table 1). Banking

asset/GDP ratio grew from 16.2% in 1993 to merely 18.1% in 1997 but 131.2% in 2007, whereas

M2/GDP ratio also increased from 20.1% in 1993 to merely 22.6% in 1997 but 109.6% in 2007

(Table 2, Table 3). These figures are much higher than in other Southeast Asian countries and

China. In a broader picture, they point to an increased financial deepening in Vietnam as the

result of significant increase in financial mobilization and investment.

A high degree of dollarization and cash economy are other two prominent features of

Vietnamese banking sector. The degree of dollarization in Vietnam is always above 20% in

comparison with 7-10% in other countries in Southeast Asia such as Thailand, Malaysia and

Indonesia due to massive flow of remittance and foreign investment and increased export

earnings over the past years. 7 It is expected that dollarization may rise further in the recent

context of high inflation and volatility of the VND. The cash/GDP ratio of the Vietnamese

banking is also much higher than in other Southeast Asian countries and China, at the level of

5 Hao, Nguyen Thi Thanh. 2008. Vietnamese Banking System: Reality and Solutions . Presentation paper in the proceeding of the Conference Vietnamese Banking System and the WTO Commitments: Assessment andProspect. Hanoi, May 2008. pp. 3.6 Hoan, Pham Xuan and Nguyen Hong Son. 2008. Vietnams Financial Challenges. Vietnam Socio-Economic

Development . No 56. December 2008. pp. 3-21.7 http://www.saga.vn/Cohoigiaothuong/Thitruong1/forex/9470.saga ; accessed on December 10 th, 2008


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* Small Equity Capital

Vietnamese banks, including the largest SOCBs, have small equity capital. Equity capital

of four largest banks, which are Agribank, Vietcombank, BIDV and Vietinbank, were around

$US 400 million, $US 270 million, $US 260 million and $US 215 respectively as of 2006. 13 The

averaged equity capital of SOCBs is around $US 260 million in 2008. 14 The averaged equity

capital of Thai banks is $US 813 million whereas the one of Singaporean banks is more than

$US 1 billion. Equity capital of major banks in the world such as HSBC and City Bank reached

$US 25.78 billion and $US 21 billion as of 2003 (IMF, 2003; see Table 5).

* Traditional and Monotonous Banking Services Despite recent improvement, banking services in Vietnam are still poor in terms of

quality and quantity (Table 6). Most banks prefer to provide the traditional services such as

foreign currency exchange, accepting deposits, lending and conducting checking accounts for

business customers. While modern services such as pension, securities broking, and venture-

capital investment become more attractive, their coverage is still very low. Profit earnings from

non-credit business account for only 20-25% of total profit of the banking system. This ratio is

52% in Thailand, 60% in Japan and 66-70% in the US. 15

1.3. Risky Issues

The above characteristics of Vietnamese commercial banking system has contained serious

risks of which inefficiency, non-performing loans and mismatches are the most prominent

especially in time of financial distress.

Inefficiency: Inefficiency is one of the urging problems that the Vietnamese commercial

banking system has to deal with. It is evidenced by a low return on equity (ROE), and a low

return on assets (ROA) of the banks. The averaged ROA of commercial banks in Vietnam is0.38%, whereas the averaged ROA of commercial banks in the Asia-pacific region and Southeast

13 SBV. 2006. Annual Report . Hanoi.14 http://www.ffb.edu.vn/index.php?view=article&catid=44%3Atai-liu-tham-kho-nh-2008-2009&id=135%3Anhng-im-yu-ca-h-thng-ngan-hang-&tmpl=component&print=1&page=&option=com_content&Itemid=80 ; accessed onJanuary 10 th, 200915 UNDP and MPI. 2006. General Framework for National Development Strategy of Service Sector in Vietnam upto2020. Project VIE/02/09. Hanoi. pp 56.


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Asian economies (Thailand, Indonesia, Malaysia, and Phillipines) is 0.94 and 0.77 respectively. 16

The problem of performance is even more serious with the SOCBs. In 2006, among five largest

SOCBs, only Vietcombank meets the international standards which require ROE of 15% and

ROA of 1% (Table 7). Because the SOCBs account for major share of the market and banking

activities, their poor performance is an important indicator for the performance of the entire

banking system.

Non-performing loans (NPLs): Non-performing loan ratio of the banking sector has

fallen from 20% in the 1990s to approximately 3.1% according to Vietnam Accounting Standard

(VAS). However, there is little concurrence on the measurement method. According to

International Accounting Standard (IAS), non-performing ratio of Vietnamese banking sector is

around 7%. 17 Some major factors may increase future NPLs. The large SOEs and public

investments inefficiency could result in the loss of repayment capability of those borrowers.

Moreover, the risks associated with real estate and securities -collateralized loans, which were

substantial in several JSCBs, are quite high in the context of high inflation and an asset bubble.

So far real estates have been the main collaterals for banks loan. By early 2008, the real estate-

backed loans accounted for up to 50% of the total asset of the banking system. Apart from this,

loans to the real estates, itself, mounts to about $8 billion or 11% of the total banks loan.18

Thereal estates market of Vietnam has experienced a recession recently with very limited liquidity,

and this poses a great risk to the banking system. Another risk comes from a low capital

adequacy ratio (CAR) of the banking sector. As the end of 2005, CAR of the commercial

banking system was only 4.5%, far below the international norm (8%). The risk is multiplied by

a high credit growth which is over 20% per annum. In contrast, after the 1997-1998 financial

crisis, averaged CAR in the Asia-pacific region has increased significantly, reaching 13.1% and

12.3% in the Southeast Asian region. 19 None of 28 economies qualified by EBRD as transition

has CAR below 8 percent. 20

16 Tai, Nguyen Trong. 2008.Competitiveness of Commercial Banks in Vietnam from Theoretical View andPractice. Banking Journal No.3/2008 .17 Hoan and Son. 2008. Ibid. 1718 Hoan and Son. 2008. Ibid. 1719 Tai. 2008. Ibid.20 http://www.ebrd.com/country/sector/econo/stats/index.htm ; accessed on March 10 th, 2009


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Two mismatches: The banking industry has also faced a prolonged mismatch problem,

namely maturity mismatch and currency mismatch.

Maturity Mismatch: Normally, short-term deposits account for 75% of total deposits, but

the share of medium-and long-term loans in total credit rose from 22% in 1995 to about 40% in

recent years, and long-term credits account for more than 50% of total short-term deposits 21

creating a maturity mismatch risk. 22 The risks seem to be magnified in the presence of direct

lending and conflict of interest issues, especially when related to loans of questionable real estate

deals and other big projects.

Currency Mismatch: The currency mismatch was most severe during 19992002 due to

sharp increases in foreign currency deposits and a decrease in foreign currency loans, measured

as shares in total deposits and total loans, respectively. It has recently been narrowed, but

remains problematic due to its sensitivity to the exchange rate and interest rate fluctuations,

especially in the context of a rather high degree of dollarization. The SBV has attempted to

gradually eliminate dollarization but this is no easy task as some contradicting policies continue

to be in place (such as policies for encouraging remittances) and in the context of having capital

flows.

Other Issues: In the medium and long run, the banking sector of Vietnam has to deal with

the issues of implementation of international commitments, harmonization, modernization, and

improvement of human resources to improve its quality.

* International Commitments: Vietnam has to implement four major international

commitments on the liberalization of its banking services: WTO, China-ASEAN Free Trade

Agreement (CAFTA), ASEAN Framework Agreement on Services (AFAS), and US-Vietnam

Bilateral Agreement. It is expected that by 2015, Vietnam will fulfill all of these commitments

and by that time the commercial banking system will enjoy a large degree of openness.

* Harmonization: Harmonization is one of the crucial issues in the international

integration of the banking sector. At present, major incompatibilities of the Vietnamese banking

sector with the international standards exist in the accounting rules, loan schemes and service

21 these figures are much higher for some JSCBs in 200722 Hoan and Son. 2008. Ibid. 19.


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statistics. There is also a lack of efficient risk management mechanism, including banking

inspection measures.

* Modernization: modernization is a pre-requisite to improve the quality of banking

services. World Bank assessed that the technology index of Vietnamese banking system only

reached 0.47, much lower than regional countries such as Thailand and Indonesia (0.7), Malaysia

(1.08) or Singapore (1.95). 23

* Human Resources: There is a serious shortage of skilled labor for banking sector. Most

of banking employees and policy makers in the banking sector fail to meet the requirements for

English, computer skills and familiarity with modern accounting rules. At the same time, most of

the students who are graduated from domestic universities are not well equipped with above

necessary skills in order to work effectively in the banking services. In addition, there has been a

massive brain drain from SOCBs to the private sector of the economy recently.

1.4 The Impact of the Current Global Financial Crisis

In the current context of global financial crisis, according to Economic Intelligence Unit

(EIU), Vietnamese economy will grow at merely 0.3% in 2009 comparing with 6% in 2008 due

to serious shrink of domestic and external demand, and a fall of FDI and remittance. 24 In a less

traumatic scenario, IMF predicts that Vietnam is still able to achieve a growth rate of 4.75

percent in 2009. 25 However, economic decline has a negative impact on the banking system.

Small JSCBs are those which are most severely affected despite large liquidity subsidies from

SBV. Banking profit margin has fallen due to high capital costs and barrier imposed by ceiling

lending rates. Non-performing loans are expected to rise substantially in the near future because

borrowing companies have difficulty in their exports to the world market. 26

Yet, the weaknesses of the banking sector in Vietnam have been unraveled even before the

global financial crisis. Over the past few years, betting on bright economic prospective after the

WTO accession, there has been a surge of foreign investment into Vietnam, creating pressure on

23 http://www.tbic.vn/default/21/tbic_details.aspx?DataID=12606 ; accessed on March 20 th, 2009.24 http://dantri.com.vn/c76/s76-313788/kinh-te-viet-nam-chi-tang-truong-03-nam-2009.htm ; accessed on April 15 th,200925 http://www.vnexpress.net/GL/Kinh-doanh/2009/03/3BA0D12A/ ; accessed on April 8 th, 200926 According survey by Vietnam Association of Small and Medium Enterprises in 2008, 20% of small and mediumenterprises (SMEs) were already seriously affected and half of them are on the verge of bankruptcy.http://www.ssi.com.vn/Default.aspx?tabid=110&newsid=34597 ; accessed on March 9 th, 2009


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VND to appreciate and on SBV to maintain the stability of nominal exchange rate. The increase

in money supply exerted high pressure on inflation. Inflation rate was pushed up to around 25-

27% in 2008. Governments main counter-inflation measure is a tight monetary policy which

however drained out funding from the banking system and triggered an interest-rate competition.

In 2008, there was an extremely high depository rate (18-19% p.a.) and high lending rate (over

20%). There was also a widening gap between interest rates of VND (18-19% p.a.) and of USD

(6.5% p.a.), creating a wave of speculation. 27 Year of 2008 thus posed a great risk to both

bankers and their clients.

There is certain degree of differences and similarities between the context and the impact

of the current global financial crisis and the Asian financial crisis in 1997-1998 on the

Vietnamese banking system. In both cases, years before the crisis, Vietnam enjoyed a high

economic growth and a boom of foreign investment at time when the country had accomplished

major move of international integration (i.e. joining ASEAN in 1995 and joining WTO in 2007).

In both cases, just as the banking system was relatively unharmed by the Asian financial crisis, it

has not been seriously hit by the current global financial crisis more than its internal financial

turbulence.

Scholars often argue that Vietnamese banking sector was little affected by the Asianfinancial crisis because of its limited openness at that time. Yet, a decade of reforms has gone

since 1997, and with the WTO accession, the commercial banking system of Vietnam has been

more integrated into the global financial system. Increased level of financial deepening and rapid

credit expansion should make the banking sector more vulnerable to the external shock.

Moreover, immediately prior to the current global financial crisis, Vietnamese economy had

experienced serious macro imbalances as shown by high inflation rate, big trade and budget

deficit, which were exaggerated by a huge non-performing loans to the stagnant real estates and

declining securities sectors. Although the commercial banking system of Vietnam has not been

seriously impacted by the current global financial crisis, just as the 1997-1998 Asian crisis had

done, it is expected that the current context will provide the case for further reforms of the

commercial banking system.

27 Son. 2008. Ibid.


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Box 2: 1997-1998 Asian Financial Crisis and Current Global Financial Crisis: Similarities

and Differences with Respect to Vietnamese Banking Sector

1997-1998 Asian Financial Crisis Current Global Financial Crisis

Similar

context

Period of high economic growth; increased FDI; hallmark of international

integration.

Different

context

Regional integration

Shallow financial deepening

Preceded by Macro economic stability

Regional crisis

Global integration

Increased financial deepening

Preceded by macro-economic

imbalances

Global crisis

Consequences Relatively unharmed (indirectly impacted)

Launching new round of reforms Expecting new round of reforms?

2. Banking Reform Strategies and Transition Assessment

According to Saled M. Nsouli (1999), 28 in transitional economies, financial sector reform

is fundamental to promoting growth, by improving the intermediation process and increasing

efficiency in the allocation of financial resources. Besides giving greater autonomy to central

banks, there is a need for the creation of a competitive system open to foreign financial

institutions and for the enactment and effective implementation of strong prudential regulations.

Of particular importance is effective bank entry and exit regulations, which facilitate the entry of

foreign banks, thereby fostering competition, encouraging the development of increasingly

sophisticated financial products, and strengthening the domestic banking system. Transition

countries which made the least progress with bank restructuring tend to have inappropriate

incentive structures that encourage the accumulation of risky assets in pursuit of quick profits.

28 Nsouli, Saled. M. 1999. A Decade of Transition An Overview of the Achievements and Challenges. Financeand Development . June 1999. vol 36. No.2.


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Commercial banking reforms hence play an essential role in the reforms of the bank-

based financial system of Vietnam. This old issue is brought to the discussions in the new

context of global financial crisis and internal financial chaos recently. Together with it, an old

question is raised again: Is slower banking reform an appropriate policy since it has protected the

banking system from the external negative impacts? To find out the answer, this research

examines the reforms of Vietnamese commercial banking system from two aspects: policy

changes as reflected by changes in the reform approaches and policy outcomes as reflected by

transitioning structure of the banking system. The former is the reform process , whereas the

latter is the structure of the reformed banking system.

2.1. Two Reform Approaches

Stijn Claessens (1997) 29 has pointed out that there are two popular approaches to banking

reform in the transitional economies in Eastern Europe: the new entry and the rehabilitation . The

new entry approach has entailed the spontaneous break-up and privatization of state banks, a (de-

facto) policy of liberal entry of new banks, and sometimes the liquidation of old banks. The

approach is best illustrated by Russia and Estonia where it resulted in a rapid expansion in the

number of banks in the early 1990s. The rehabilitation approach has included recapitalization

and institutional development of existing state banks, some limited breakups of banks, limited privatization, and more limited entry. Typical rehabilitation approach countries are Hungary and

Poland in the early 1990s.

In practice, influenced by initial conditions and early developments, countries have

included aspects of both approaches or have yet to choose a consistent financial reform strategy.

Typical rehabilitation reformers are high financial-depth countries and new entry reformers are

low financial-depth countries. In the countries which pursued new entry approach, fiscal revenue

was small or dropped, leaving no choice to the government but ignoring the old banking system.In the countries which applied rehabilitation approach, government budget was still relatively

abundant, allowing for the re-capitalization of the old banks. 30

29 Claessens, Stijn. 1997. Banking Reform in Transition Countries. World Development Report 1996 . WorldBank. June 9, 1997

30 Claessens. 1997. Ibid. pp. 4


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In Vietnam, one can see that banking reforms have swung in between the above two

approaches with the new entry being implemented from 1988 to 2000, followed by the

rehabilitation.

The first experiment with the new entry strategy was during 1988-1990 period with

Decision 53 of Chairman of the Minister Council in 1988 that permitted all types of economic

organization, including private enterprises, to mobilize and borrow money from the public. The

effort of liberalization by that time however had gone too far and too fast in the context of

macro-economic instability and lack of institutionalization, and finally ended up with the

collapse of credit pyramid formed by bad loans and fraudulent borrowings of peoples credit

organizations.

The second phase of implementation was during 1990 1997 period and had recorded a

remarkable achievement. This was also a period when Vietnamese economy escaped from

macro-economic destabilization that prolonged from the beginning of the transitional period. As

inflation was kept under control, the financial sector is also stabilized. At the same time, rapid

economic growth created a favorable environment for the development of banking sector. The

legal environment for the banking sector is also significantly improved when a number of

important legal documents were issued such as the Law on State Bank and Credit Organizations.As a result, the number of banks increased from totally 9 (including four SOCBs) in 1991 to four

SOCBs, 51 JSCBs and 23 branches of foreign banks in 1997. 31 The system of peoples credit

organizations was re-structured and consolidated with more stringent risk management measures.

While the 1997-1998 Asian financial crisis did not have great impact on the Vietnamese

banking system, it had raised the concerns about the latters weaknesses. Among the major

concern were the non-performing loan problem, the inefficiency of the banks, and a lack of risk

management mechanism which becomes even more important in the context of deepeninginternational integration.

In 2000, the government launched a re-structure program of the banking system and it

quickly moved toward the rehabilitation direction. For the JSCBs, major measures included

31 http://www.sacombank.com.vn/newscontent.aspx?cateid=27&contentid=1808 ; accessed on March 20 th, 2009


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merge, dissolution, increase in capital and reduction of bad loans. 32 For the SOCBs, the re-

structure focused on reduction of non-performing loans, increase in capital, separation of policy

credit from commercial credit, administrative re-organization, diversification of banking

services, establishment of risk management mechanism and equitization. Important measures of

the rehabilitation strategy which were embodied in a number of government policies include:

- Establishment of AMC (Decision 43/2001/QD-TTg) and DATC (Decision

109/2003/Q -TTg) to address the debt problems of the commercial banks, especially SOCBs,

and of the SOEs;

- Consolidation of the banking system, including equitization of the SOCBs and merge or

dissolution of the inefficient JSCBs (Decision 149/2001/QD-TTg on settlement of the non-

performing loans, Decision 92/2002/QD-TTg on re-structure of SOEs and SOCBs during 2001-

2003).

- Imposition of more restrictive regulations on the establishment of the new banks (SBV

Documents 92/2001/QD-NHNN; 90/2001/QD-NHNN; 400/2004/QD-NHNN; and

888/2005/QD-NHNN).

As a result of the above control measures, the number of JSCBs fell down (from 52 in

1996 to 37 in 2004). Non-performing loan ratio had been significantly reduced, from around

20% in the 1990s to around 3.0% in 2007. 33 The efficiency of the banking sector improved

significantly as indicated by considerable increase of ROE and ROA of the commercial banks,

especially JSCBs, over the past few years. In a re-capitalization effort, most domestic banks had

increased their capital and as the end of 2007 80% of JSCBs had a registered capital of more than

VND 1,000 billion or around $US 60 millions. 34 In 2001-2005 period, SOCBs had received

VND 15,000 billion or $US 1.0 billion in their registered capital and almost $US 2 billion or 4%

GDP if the funding included the bailout for bad loans. 35 As of May 2006, the equity capital of

32 According to Vietnamese classification, bad loans include i) normal overdue loans; ii) loans that are difficult torepay; and iii) loans in the watching list (backed up by estates) and loans that are permitted by the government to

postpone the payment.33 Hao. 2008. Ibid. pp. 204.34 Hao. 2008. Ibid. pp. 20535 Du, Huynh The. 2007. Reforms of the Vietnamese Banking System: Comparative Study with China . FulbrightEconomic Teaching Program. April, 2007. pp 57


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20

4944/VPCP-KTTH that required the SBV to postpone the approval for the establishment of new

JSCBs. Document 7171/NHNN-CNH released by the SBV on August 8 th, 2008 repeated the

guideline, worrying that a continued increase in the number of the new banks will have a

negative impact on the efficiency and quality of the banking system.

The debate on the recent restrictive policy of the government concentrates on the question:

Is an increase in a number of commercial banks correlated with a decrease in the safety and

quality of the commercial banking system?

The proponents for the new entry approach argue that there is no correlation between the

quantity of the banks and the quality of the banking system. Yet, there is greater opportunity for

the economy to grow quickly as the number of good banks increases. In that case, the level of

bank per capital in Vietnam is still very low. They cited that, for example, while for over the past

decade, GDP of Vietnam had doubled, the number of operating banks only increased by a

margin of 16.6%. Comparing with foreign countries with smaller population such as Thailand,

the coverage and equity capital of Vietnamese commercial banking system are far below. 40

In contrast, the opponents argue that a temporary suspension of establishment of the new

banks is to reduce current rapid credit expansion and inflation pressure. This will help to re-

stabilize the banking system and in stead of focusing on the new entries, there is a more urgent

need to re-structure the existing poor-performing banks to reduce the burden on the banking

supervision system. 41 Regarding foreign example, they pointed to the fact that the number of

commercial banks in Thailand had decreased from 63 before the financial crisis to 31 in 2001. 42

The reforms of Vietnamese commercial banking system thus swing in between the new

entry and rehabilitation approaches. This change of policy was in response to the domestic

problems and indirect rather than direct external impact: the risk of domestic financial un-

sustainability which became more apparent in the aftermath of the Asian financial crisis, and

domestic financial instability which is followed by the current global economic and financial

crisis. Yet, in the recent event the extent that domestic financial chaos occurred before the

negative external impacts can be felt indicates the incomplete success of the previous reforms.

40 http://www.sanotc.com/News/ViewItem.aspx?hl=vi&item=299484 ; accessed on January 28 th, 200941 http://vneconomy.vn/20080810112958943P0C6/quanh-chuyen-tam-ngung-cap-phep-lap-ngan-hang.htm ; accessedon January 10 th, 200942 http://strategis.ic.gc.ca/eic/site/imr-ri.nsf/eng/gr109724.html ; accessed on January 10 th, 2009


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2) Transformation of ownership in the commercial banking system through the

establishment of new private banks and privatization of SOCBs. This is measured by asset share

of private banks (including both domestic and foreign banks). This share is around 20-25%. 45

3) Openness for competition through permission for foreign banks to establish branches

or acquire domestic banks (including SOCBs) .46 This is measured by asset share of foreign-

owned banks (in per cent) in total bank sector assets. This share is 10% in Vietnam by 2008. 47

4) Domestic credit to private sector (in per cent of GDP). This share indicates the

maturity of the transitional banking system. Low share indicates shallow penetration of the

commercial banking system into the private economy. This share is calculated from the IMF

International Financial Statistics Yearbook (2007, 2008) as 50% in 2006 and 65% in 2007.

Figure 1: Reform Progress of the Commercial Banking Sector in Vietnam

The transition index indicates mostly the level of institutionalization of the banking sector

while the other three indices indicate the openness and liberalization of the commercial banking

sector to private sector and foreigners. Comparing with other transitional economies which score

within the range 2.7-3 for their EBRD transition index, the share of private bank assets,

45 Hao. 2008. Ibid. 205.46 Fries. 2005. Ibid. 15, 1647 Hao. 2008. Ibid. 2005.

Transition index: 3

Share of private

bank assets: 25%

Share of foreign bank assets: 10%

Domestic credit

to private sector/GDP:

50%


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24

as the 1997-1997 Asian crisis has done, the current global financial crisis should provide

momentum for a new round of bolder reforms of the commercial banking system.

The reform of the commercial banking sector has to deal with both issues:

competitiveness and stability. The evidences over the past years in Vietnam have shown that new

entry strategy increased the competitiveness but it already sacrificed the stability of the banking

system. In contrast, the rehabilitation strategy helped to maintain the stability to increase the

competitiveness but in reality it already cost the latter of the banking system. The problem of

these two approaches is their implementation with little moderation. According to the above

reform progress assessment, the openness of the Vietnam banking system is still small, and the

current restrictive measures in response the global financial crisis may have negative impact on

the competitiveness of the banking system in the long run.

Vietnam need to devise a more moderate strategy, which has both new entry and

rehabilitation elements: the new rehabilitation strategy. This alternative strategy focuses on

the process rather than the structure of the banking system (i.e. the number of the banks). While

the number of the commercial banks in Vietnam may be more than other economies which have

larger GDP, the coverage of the commercial banking system in Vietnam is small due to small

number of banking branches and common use of cash in the economy. Quality not quantity of the banks is the main cause of the weakness of the banking system.

The new rehabilitation strategy does not restrict the entry of the new banks but it must

have more stringent supervising measures to ensure that the new banks operate according to the

existing standards. This is in line with the adjustment trend of the banking reform since Doi

Moi . In the long run, it aims to reduce the volatility in the reform direction. As shown in the

figure below, reform trend of the banking sector should approach the moderation OF line after a

number of adjustments.


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25

Figure 2: Reform Roadmap for the Commercial Banking Sector of Vietnam

A rehabilitation element of the alternative approach focuses on the reform of the SOCB

system. According to Stijn Claessens (1997), 48 in the transitional economies, large share of the

five biggest banks will have negative impact on the quality of the entire commercial banking

system. Large scale of the banks is a doubled-edge sword. On the one hand, it can provide the

banks with advantage due to the economy of scale that reduce management costs. On the other

hand, mega banks face the same problems of inflexibility and complexity in their management.While Vietnamese SOCBs are not big in terms of number of clients and equity capital in

comparison with the international standard, their internal structure become more cumbersome

and their staffs increase rapidly.

Moreover, in an economy where the banking sector is still controlled by the government,

the banking system becomes the instrument of public finance to channel funding into public

48 Claessens. 1997. Ibid.

Rehabilitation

New Entry N o

R e f o r m s

Masive Privatization/Equitization

S t a b i l i t y /

S t a g n a n c y o

f t h e

B a n

k i n g

S e c

t o r

Efficiency and Competitiveness of the Banking Sector

A: 2000/01

O

N: 2008

M: 2006/2007

F

K

T


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projects through the SOEs in line with the development purposes set out by the government. In

addition, there is the existence of a sort of banking repression as reflected by a variety of

government regulations on required reserve ratio, interest-rate control, credit scheme, required

state ownership, limited activities of private and foreign banks and capital flows. In maintaining

such a close government-SOE-bank triangle relationship and following the above strict

regulations, banks are compelled to drop profit maximization from their list of priorities and this

is main cause of the inefficiency and loss of the banking system. Thus, the reforms of the

commercial banking sector in Vietnam should go along with the removal of the above restrictive

measures in particular and with the liberalization of the entire financial system in general.

Conclusion

A popular logic of reforms in the transitional economies is a focus on the reforms of the

banking sector which was the base of financial system in the previous commanded economy. As

a result, most of the transitional economies start to build a bank-based financial system. This is

also true in the case of Vietnam.

Proponents of the bank-based financial system argue that it helps to maintain stability and

allows for effective supervision of the government. In fact, it also has a number of potential risks

related to non-performing public finance and efficiency problems. Recent crisis of banking

sector around the world has shown that a bank-based financial system is not the exclusive model

to maintain financial stability. Non-conformance with the safety standards and a lack of risk

management mechanism are indeed the main cause of financial instability.

In a bank-based economy, there is a hesitance to reform the banking system because banks

are interrelated with many other important economic sectors. By consequent, banking reforms

often lag behind the reforms in other sectors. As the banking reform is kicked off, there is often

no clear policy direction which is contingent upon external pressures. In case of Vietnam, the

reform direction swings between the new entry and rehabilitation approaches. Slow reforms may

protect Vietnamese commercial banking sector from short-term external impacts by chance, but

it fails to prevent the emergence of the domestic financial chaos and it will cause major longer-

term weaknesses of Vietnamese commercial banking sector by consequence. While this research

looks at the reforms of the banking sector, longer and larger vision should deal with the reform

of the entire financial system, moving a bank-based financial system toward a more balanced


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financial system which is based both on the banks and other financial markets such as stock

exchanges. At the same time, commercial banking reforms must be conducted together with the

reforms of the SBV and in other economic sectors such as SOEs and trade.


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Appendices:

Table 1: Growth Rate of Banking Asset in Vietnam in Comparison with some East Asian Countries (%)

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2Vietnam n.a n .a 27.9 32.8 28.9 142.4 41.6 23.3 15.6 25.6 31.1 33.7 28.Malaysia 12.8 21.0 18.0 23.4 9.9 3.9 7.8 4.7 5.2 9.2 12.3 Thailan 18.0 19.9 11.7 9.5 9.3 (3.7) (5.0) 15.7 10.0 6.2 5.9 Indonesia 16.7 22.8 26.1 26.5 57.4 17.1 28.3 9.3 5.5 4.8 11.2 Philippines 20.7 25.7 30.9 20.2 5.6 11.7 9.2 2.9 10.9 9.0 9.1 Singapore 9.7 10.6 10.5 11.0 21.2 5.8 0.6 9.7 (8.3) 11.6 9.4 China 26.8 23.9 26.7 23.2 18.6 12.2 11.6 16.5 26.7 19.4 14.7

Source: Author calculated from International Financial Statistics Yearbook (IMF), 2001-2008

Table 2: Banking Asset/GDP Ratio of Vietnamese Banking Sector in Comparison with some East Asian Countries (%)

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2Vietnam 16.2 n.a 14.6 15.7 18.1 20.2 44.2 56.7 64.2 66.7 73.1 82.2 93Malaysia 144.8 143.9 152.9 158.2 175.8 192.2 188.1 177.7 181.0 175.2 175.1 17Thailand 123.7 126.9 131.9 133.8 142.7 159.6 153.3 137.2 152.3 157.8 154.0 14Indonesia 57.8 58.2 60.2 64.7 69.5 71.8 73.1 74.1 68.4 65.2 61.8 Philippines 52.8 55.5 61.9 71.2 76.5 73.6 73.6 71.3 67.7 68.8 68.9 Singapore 139.8 134.0 134.3 135.9 138.5 173.0 179.8 158.5 180.9 161.0 175.0 16China 110.1 103.2 102.0 110.7 124.4 139.9 150.0 155.0 148.0 169.8 178.9 174



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Table 3: M2/GDP Ratio of Vietnamese Banking Sector in Comparison with some East Asian Countries (%)

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2Vietnam 20.1 n.a 19.8 20.9 22.6 24.2 36.4 44.6 52.1 53.0 61.6 69.3 77Malaysia 8.0 79.8 84.7 88.5 94.3 92.3 101.2 98.9 135.3 129.4 128.0 1

Thailand 79.4 78.0 79.1 8.1 91.7 102.9 108.2 105.4 115.8 113.2 115.5 11Indonesia 43.7 45.3 48.6 52.7 56.0 59.9 58.4 53.9 51.3 48.5 47.5 Philippines 42.7 47.1 51.8 56.3 62.0 61.3 64.2 61.6 58.9 59.6 56.7 Singapore 87.1 87.1 85.7 86.2 87.2 117.1 124.7 107.1 117.9 114.1 120.1 11China 103.4 100.5 103.8 111.4 122.7 133.6 146.4 152.2 145.3 153.7 162.2 158


Table 4: Cash/GDP Ratio of Vietnamese Banking System in Comparison with some East Asian Countries (%)

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2Vietnam 10.1 n.a 8.5 8.3 8.0 7.5 10.3 11.8 13.8 13.9 14.8 15.3 Malaysia 7.8 8.1 7.8 7.5 7.6 6.4 8.2 6.5 6.2 6.2 6.2 Thailand 6.6 6.7 6.8 6.6 7.1 6.9 10.2 8.3 8.3 8.7 8.9 Indonesia 4.4 4.9 4.6 4.2 4.5 4.3 5.3 5.2 4.6 4.4 4.7 Philippines 5.7 5.7 5.8 5.7 5.9 5.5 7.3 5.7 5.4 5.6 5.5 Singapore 9.5 8.7 8.3 7.9 7.6 7.4 8.1 7.1 7.7 7.8 7.9 China 16.7 15.6 13.5 12.9 13.6 14.2 16.3 16.4 14.4 14.4 14.5



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Table 5: Equity Capital of Largest Commercial Bank of Vietnam in Comparison

Banks Equity capitalAgribank (the largest) More than $US 400 mill.

Thailand (Average) $US 813 mill.

Singapore (Average) More than $US 1 bill.

Source: SVB, 2006 and IMF, 2003.

Table 6: Banking Services in Vietnam in Comparison

Country Number of Service Products

Vietnam 450-500

China 800-900

Thailand > 2,000

Malaysia 2,800-3,000

Japan 4,000-5,000

Source: Techcombank. 2004. Report on Market Survey, Center for Banking Training.

Table 7: ROE and ROA of 5 Major State-owned Commercial Banks of Vietnam in 2005

Banks ROE (%) ROA (%)

Incombank (Vietinbank) 12.74 0.49

Agribank 11.86 0.44

BIDV 7.9 0.41

Vietcombank 14.9 1.0

MHB 7.85 0.56Source: Economic and Budgetary Committee, National Assembly. 2006


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Table 8-1: Reform Progress Assessment of the Banking Sector of Vietnam in

Comparison with other Transitional Economies (1).

Country (year) EBRD

transition index

Share of private

bank assets (%)

Domestic credit

to private

sector/GDP (%)

Share of

foreign bank

assets (%)

Albania (2007) 2.7 100.00 29.00 94.2

Bulgaria (1999) 2.7 49.5 12.00 57.2

Croatia (1998) 2.7 62.5 43.5 6.6

Romania (1997) 2.7 20.00 11.5 11.5

Poland (1996) 3 30.2 18.6 14.4

Vietnam (2006-2007) (3-) 25 50 10

Source: Author calculated from EBRD transition index, 1989-2008.


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Table 8-2: Reform Progress Assessment of the Banking Sector of Vietnam in

Comparison with other Transitional Economies (2).

Country (year) EBRD

transition index

Share of private

bank assets (%)

Domestic credit

to private

sector/GDP (%)

Share of

foreign bank

assets (%)

Albania (2007) 2.7 100.00 29.00 94.2

Bulgaria (2007) 3.7 97.9 66.8 82.3

Croatia (2007) 4.0 95.3 76.6 90.4

Romania (2007) 3.3 94.3 32.9 87.3

Poland (2007) 3.7 80.5 33.4 * 75.5

Vietnam (2007) (3-) 25 65 10

Note: * year 2006Source: Author calculated from EBRD transition index, 1989-2008


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