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The Banking Outlook for Vietnam

by internationalbanker

By Jane Winterbottomjane.winterbottom@internationalbanker.com

Vietnam’s banking sector began 2015 on a positive note, with Moody’s having upgraded the financial system from “negative” to “stable” in mid-December. According to the credit-ratings agency, the improvement reflected the “increased stability in the operating environment for the banks, as well as in Vietnam’s macroeconomic situation, and a reduction in liquidity stress in the system”. Since 2012, inflation and interest rates in Vietnam have stabilised significantly, dropping from double digits to fairly constant, sustainable levels, while higher amounts of foreign direct investment (FDI), a decisive shift from deficit to surplus in the country’s current account, and new government policies specifically aimed at promoting economic stability have all played their part in providing a brighter outlook.

A period of reform

Vietnam is also beginning to bear the fruits of its three-year structural-reform plan, in which the country’s prime minister, Nguyn Tn Dũng, implemented measures to overhaul the country’s banking system, beginning in 2012. Under the plan, Vietnam would accelerate the privatisation of state-owned banking institutions and encourage or force the merger or acquisition of weaker banks. After a decade of rapid growth, several local banks were hastily set up to finance the surge in the number of new real estate projects. This resulted in an alarming proportion of new lenders not having the adequate infrastructure, knowledge or experience to operate efficiently, which in turn led to the banking system being lumbered with substantial quantities of bad debt. Indeed, by November 2013, 4.55 percent of total loans issued by Vietnam’s banking sector were classed as non-performing loans. Although this ratio was reduced to 3.87 percent by October 2014, the government has stated that it aims to cut this figure down to a maximum of 3 percent by the end of the year. Between January 2012 and March 2015, the State Bank of Vietnam (SBV) gave the green light for four mergers and two acquisitions among domestic banks, while between six and eight such deals are expected in total throughout 2015.

The central bank, SBV, wants banks to sell their bad debts to its asset-management arm, The Vietnam Asset Management Company (VAMC), while maintaining a reserve buffer of 20 percent of the value of the bad debt. At the end of last year, VAMC acquired approximately $5.7 billion in non-performing loans, underlining its efforts to repair a banking sector that has been somewhat constrained by insufficient capital and impaired balance sheets.

One of the problems arising from these efforts, however, is that the potential losses from the banks’ belt-tightening measures are being passed on to their customers. Nguyen Tu Anh, a senior researcher from the Central Institute for Economic Management, observed in May that banks are expanding the disparity between lending and borrowing rates, stating that “depositors are offered low interest rates on their savings, while borrowers have to pay more for loans”, and warning that customers will continue to bear the brunt unless the country finds a better way to tackle bad debt. 

Prioritising consolidation of the banking sector

With more than 40 local banks, the SBV has made sector consolidation a key goal. There has been abundant evidence of such consolidative measures being implemented so far this year. In February, the central bank took over the loss-making Vietnam Construction Bank and put it under Vietcombank, which is more than 90 percent state-owned, while purchasing all of Construction Bank’s shares for VND0. The lender was struggling with bad debt and poor liquidity, with SBV’s deputy governor, Nguyen Phuoc Thanh, justifying the takeover as being in the interests of its owners and shareholders. Le Tham Duong, economist of the Banking University of Ho Chi Minh City, described the move as a “time’s up” warning note for the remaining weak banks.

Then, in late April, the SBV completed the acquisition of Ocean Bank, after the insurmountable losses that the lender incurred meant that it was unable to raise its charter-capital level to the minimum level of VND3 trillion (USD138 million), as required by the SBV, and therefore was also acquired for VND0. Furthermore, several members of its management board were arrested at the beginning of the year, including the bank’s former CEO Nguyen Minh Thu, due to alleged involvement in unlawful lending practices. The SBV has stated that several of Ocean Bank’s operations have seriously violated Vietnamese banking law. It would therefore appear that a serious crackdown on banking incompetence and corruption is also underway, emphasising the efforts Vietnam is making to improve its financial services.

The SBV’s consolidation drive is expected to improve efficiency within the industry through the increased exploitation of economies of scale and the reduced burden on regulators. However, it is also thought that implementation of the new rules concerning ownership structure will be a pressing challenge in the interim, while long-term problems will continue to persist, including poor asset quality, low capital-buffer levels and a general lack of transparency that exists across a myriad of banking activities. Nonetheless, the absorption of weaker banks by the bigger lenders is expected to heighten asset quality and execution risks for the new consolidated entities.

Reducing interbank funding

In addition to the acquisitions, much of the SBV’s focus this year has been on reducing the banking system’s traditionally high levels of interbank funding. This interdependence had previously exposed banks to significant systemic liquidity risks, as the high levels of interbank borrowing meant that the danger of contagion, in the event of one bank experiencing a liquidity squeeze, remained a concern.

The SBV has been moderately successful in alleviating this threat, with the reliance on interbank funding having fallen over the past year. The central bank introduced new regulations in February 2015 that allow banks to hold less than a 5-percent stake each in a maximum of two other financial institutions, which, it is assumed, will lower the magnitude of interbank ownership within the sector and thus reduce ongoing concerns regarding corporate governance. Banks have been given until February 2016 to comply with the new rules; if they hold more than a 5-percent stake in other credit entities, they will have to divest shareholdings or merge as appropriate. 

Gearing up for regional integration

Many of the restructuring moves by Vietnam are attempts to get its banking system in shape for ASEAN (Association of Southeast Asian Nations) banking and economic integration at the end of the year. Under the ASEAN Banking Integration Framework (ABIF) agreement, which was signed in March by all 10 member nations including Vietnam, each country is required to have bilateral arrangements in place with a regional neighbour by 2020, mandating the establishment of banking services within that neighbour’s borders. This will open up the doors to a virtually unrestricted flow of capital, labour, goods and services, including financial services. Given the more intense competition that will emerge throughout the banking environment in Southeast Asia, it has therefore been of paramount importance for Vietnam to ensure that it is seen to be receptive to FDI, and that it allows a much greater foreign-banking presence.

In the years leading up to and following Vietnam’s accession to the World Trade Organization in January 2007, which has effectively normalised the country’s trade relations with the US, Vietnam has experienced rapid economic growth. Indeed, since 2000, China has been the only Asian economy to have grown faster than Vietnam. Rising FDI has been pivotal in helping the nation to post impressive growth figures, with FDI levels of $10-$12 billion per year being recorded from 2009 to 2013, rising to more than $15 billion in 2014 and contributing crucially to last year’s 6-percent GDP growth.

It has been the Vietnamese government’s official policy to encourage FDI as part of an overall development strategy to improve its business and investment landscape, and to support the competition against its ASEAN neighbours. The policy has generally been deemed as successful—in PwC’s 2014 CEO Survey for the Asia-Pacific Economic Cooperation (APEC) region, business leaders ranked Vietnam seventh out of 21 countries—ahead of Malaysia and Thailand—as a potential investment destination in the near future. The growing investment appetite towards Vietnam should present opportunities for lenders to expand their loan portfolios, and consequently, their share of the regional market.

More foreign ownership required

There are currently just over 45 different banks operating in Vietnam, consisting of a diverse mix of large, state-owned commercial banks, smaller private banks and a handful of foreign banks. At present Vietnam has six banks that have full foreign ownership: Standard Chartered Bank, HSBC, ANZ, South Korea’s Shinhan Bank and Malaysia’s Hong Leong Bank Berhad and Public Bank Berhad. Moreover, the banking system contains a further 49 representative offices and 43 branches that have been opened by other foreign banks, four joint venture banks, 17 financial firms, 12 financial leasing companies and nearly 1,100 credit funds. It is expected that a greater influx of foreign banking will occur upon the official establishment of the ASEAN Economic Community at the end of 2015. However, Vietnam limits the degree of foreign ownership in any domestic bank to 30 percent at present, as well as placing a limit of 20 percent on strategic investors in domestic bank ownership, and 15 percent on non-strategic investors.

The country is gradually increasing its exposure to foreign banking, with the government expected to issue a decree before the end of the year that will remove the 30-percent limit for overseas ownership. Most recently, in a move being viewed as a stepping stone towards the eventual opening of a wholly foreign-owned domestic bank, the State has recommended that the SBV grant a licence to Singapore’s United Overseas Bank (UOB). Given that Singapore is among Vietnam’s prime trading partners, the Ministry of Planning and Investment (MPI) has been pushing the government to give UOB the license to expand its operations within Vietnam and allow the bank to be actively involved in the country’s financial-restructuring process by taking over domestic banks.

It may be that the lenders with a sizeable proportion of state ownership are in the best position to immediately benefit from the integrated ASEAN community, especially as those lenders already have a banking presence in neighbouring countries and are invariably the biggest banks in the country by total assets. The country’s biggest lender, state-owned Agribank, which has nearly VND763 trillion ($35.16 billion) in assets, has retail branches in Laos and Cambodia; Vietinbank already has well-established operations in Myanmar and Laos; and the Bank for Investment and Development of Vietnam has a visible presence in Laos, Cambodia and Myanmar, with stated plans to expand activity in all three countries through insurance, microfinance and investment operations.

The need to address the underbanked sectors

Although Vietnam’s restructuring programs have been regarded positively on the whole, the overwhelming majority of the population having little access to financial services remains a key problem. Data from the SBV shows that only 20 percent of Vietnam’s 90 million citizens have bank accounts, which rises to an underwhelming 50 percent in Ho Chi Minh City, the most populated urban area in the country, while only 3 percent of the entire population have credit cards.

It is also generally agreed that the SME (small to medium enterprise) sector is underbanked. The Asian Development Bank’s director for Vietnam, Tomoyuki Kimura, believes that the problem originates with the lack of appropriate infrastructure in both the banking industry and the SMEs themselves, rather than with any specific liquidity shortage in the banking sector. Banks “lack the capacity to assess the risk of investment into SMEs and find bankable projects”, according to Mr. Kimura, while “SMEs do not have the capacity to propose a bankable project.” Vietnam’s lending market is also characterised by a significant requirement for loan collateralisation. SMEs, therefore, are finding it difficult to obtain financing without being able to provide collateral in return.

It is worth noting that Vietnam’s modern banking industry has essentially been in existence for only 25 years, starting after 1990’s announcement of the Ordinance on the State Bank of Vietnam and the Ordinance on Banks, Credit Cooperatives and Financial Companies, both of which established a two-tier financial system within the country. This has meant that the industry has had a very steep learning curve, amid a process of rapid liberalisation. As the country’s economy expands, and FDI continues to establish a growing presence, further banking-sector development can be expected.

The World Bank asserted in June that it expects Vietnam’s economy to grow by 6 percent this year and will continue to rise over the next couple of years, hitting 6.5 percent in 2017. With 87 percent of the country under the age of 54, Vietnam is now perceived as being among the countries with the most potential in the ASEAN region. Low wage costs, a large population with a high savings rate, and a relatively untapped market for foreign bank participation means that there is considerable capacity in the country for financial and industrial development. However, domestic banks still lag behind foreign counterparts, while regulatory standards are not yet in line with the rest of the world. Clear challenges exist, and there are decisive weaknesses to be addressed, particularly concerning non-performing loans and the existence of small lenders with a disproportionately large exposure to real estate and risky individual loans. Should those problems be resolved in the near future, Vietnam will be in a strong position to handle the aggressive competition expected from neighbouring ASEAN-member banks.

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