This Selected Issues paper reviews Vietnam's inflation dynamics, trade regime, performance, and external competitiveness. It analyzes the policy issues associated with strengthening of the revenue base and the changing role of government-owned firms in the national economy. It examines the reform program being pursued for nonfinancial state-owned enterprises. It describes the key features of Vietnam's banking reforms, assesses the progress made so far, and outlines the challenges ahead.

Abstract

This Selected Issues paper reviews Vietnam's inflation dynamics, trade regime, performance, and external competitiveness. It analyzes the policy issues associated with strengthening of the revenue base and the changing role of government-owned firms in the national economy. It examines the reform program being pursued for nonfinancial state-owned enterprises. It describes the key features of Vietnam's banking reforms, assesses the progress made so far, and outlines the challenges ahead.

VI. Reform of State-Owned Commercial Banks—Achievements and Challenges38

A. Introduction

97. This chapter describes key features of Vietnam’s banking reform since 2001, assesses the progress made so far and outlines the challenges ahead. It also compares the developments in Vietnam to the reform experience in other transition economies so as to provide a more balanced understanding of progress under the Vietnamese approach.

98. Vietnam’s banking sector was substantially reorganized at the outset of the transition period, but further evolution during the 1990s was quite modest.39 The monobank system was formally replaced by a two-tier banking system in the late 1980s. Defining the new roles and responsibilities for second-tier banks and creating independent institutions was no trivial achievement. However, in part as a legacy of the past, a banking system emerged that has been dominated by state-owned commercial banks (SOCBs), accounting for more than 70 percent of all bank credit and deposits, and segmented along inherited sectoral lines (e.g. agriculture, industry, and foreign trade). Some 26 foreign bank branches and over 30 semi-private joint-stock banks (JSBs) have operated on a limited local scale, serving niche markets. Foreign bank branches have also been restricted in the range of activities, while domestic joint-stock banks, sometimes established as joint-ventures with SOEs, have faced difficulties in overcoming capital shortages.

99. Operations of the dominant four large SOCBs have been characterized by weak balance sheets, in part reflecting a legacy of directed lending. The four large SOCBs have maintained an exposure to SOEs significantly above average (Table VI.1) with lack of reforms in the state-sector leading to a build-up of nonperforming loans. By 2000, the big four had accumulated NPLs totaling D 23 trillion40, representing about twice their capital, 5 percent of GDP, and 15 percent of all outstanding credit to the economy. About two-thirds of the NPLs were to SOEs.41 The four large SOCBs and their exposure to the SOE sector had thus become a key point of vulnerability in Vietnam’s financial system. The need for a more proactive corporate- and financial-sector restructuring increased further at the beginning of this decade, as competition following market-opening measures (AFTA, the USBTA, and, in the future, WTO) was set to intensify.

Table VI.1.

Vietnam: Selected Banking Indicators

article image
Source: SBV; DAF; and Fund staff estimates.

Assumes that share in outstanding loans equals average share of SOE loan commitments for state-investment credit during 2001-03.

Projection for 2003.

B. The Vietnamese Approach to Banking Reform

100. Reform efforts initiated in 2001 were centered on restructuring the four large SOCBs and putting them on a commercial footing. More broadly, however, the reforms also aim at strengthening the regulatory, supervisory and institutional frameworks for more efficient banking.42 In addition, the authorities have also pursued consolidation of numerous small and undercapitalized JSBs.

101. By relying on banks’ internal capacity for change, the success of the reforms was to rest on three key components: (i) phased and conditional recapitalization with public funds, based on SOCBs’ meeting bank-specific operational and financial reform targets; (ii) phase-out of policy lending; and (iii) improved accounting and disclosure standards. These principles were adopted by the SBV in its overall bank restructuring framework (Figure VI.1). In line with this gradual approach, the framework also provided for a phasing-in of prudential standards, such as on required capital adequacy ratios43.

Figure VI.1.
Figure VI.1.

Vietnam’s Approach to Banking Reform – An Overview

Citation: IMF Staff Country Reports 2003, 381; 10.5089/9781451840254.002.A006

102. Consistent with the overall restructuring framework, all four large SOCBs completed individual restructuring plans in 2001 with specific reform measures and performance targets. Key targets were then selected by the SBV as semi-annual milestones setting minimum conditions for a phased recapitalization of each SOCB. Milestones, which primarily consist of NPL resolution targets and operational measures, such as improving credit risk management or undertaking audits based on international accounting standards (IAS), have been monitored by a special unit in the SBV.

103. Along with this approach, an initial estimate of the cost of SOCB reform was integrated with the overall budget framework. The initial cost estimate approved by the government in 2001 was D 17 trillion, or about 4 percent of GDP, to be financed primarily by non-negotiable government bonds. However, more recently, analytical audits of the SOCBs in line with IAS, and factoring in rapid credit growth requiring additional capital, point to recapitalization needs and thus an overall cost of reform of around 7 percent of 2003 GDP.

C. Progress in Banking Reform

104. Despite a comprehensive and systematic effort to engage all relevant levels of banking, progress in implementing the reform program has been mixed. Progress has proved particularly difficult in areas that directly affect SOCBs’ relation to SOEs, but some initial improvements have been made in resolving collateralized NPLs44 and in key regulatory areas such as loan classification and provisioning. This notwithstanding, all SOCBs became eligible for state-funded recapitalization. The already limited incentives for reform, given government ownership of the banks, were thus diluted further.45

105. Resolving NPLs, in particular to SOEs, has been slow. After meeting the first quarterly NPL resolution target in March 2002, SOCBs missed subsequent targets by a wide margin as they failed to resolve uncollateralized NPLs to SOEs. Debt resolution guidelines46 issued in October 2001 outlined the principles of the restructuring of SOE bank debt47, but have not provided banks with sufficiently specific instructions on dealing with such problem debtors. While there are no specific incentives to restructure SOE loans, banks do not have a mandate to trigger loan-workouts. Moreover, restructuring loans to SOEs has been hampered by the entanglement of government agencies and officials at the national and local levels with SOCBs’ management.

uA06fig01

Vietnam: Cumulative NPL resolution of four large SOCBs through 2003

(In billions of Dong)

Citation: IMF Staff Country Reports 2003, 381; 10.5089/9781451840254.002.A006

Source: SBV (Monitoring Unit) and SOCBs.

106. While some of the new lending to SOEs has been shifted to specialized policy-lending institutions, in particular the Development Assistance Fund (DAF), SOCBs remain by far the single largest provider of credit to SOEs. Since 2000 bank credit to SOEs has declined from 45 percent to 38 percent of total bank credit (Table VI.1). At the same time, DAF credit to SOEs has grown rapidly, so that the combined bank and DAF credit to SOEs as a fraction of total outstanding loans has bottomed-out at 46 percent in 2002 and is projected to increase in 2003. While non-SOCBs have nearly halved their credit exposure to SOEs, SOCBs’ exposure has declined only moderately and remains four times as high as that of the other banks.

107. In terms of new lending since 2000, SOCBs have given priority to asset growth over profitability. In spite of liberalized interest rates, interest rate margins have eroded substantially as SOCBs have largely refrained from increasing lending rates while offering higher deposit rates to finance rapid credit growth. As a result, capital-asset ratios (measured using domestic accounting standards) have declined further and the cost of SOCB restructuring –driven by the need to cleanup balance sheets and restore adequate capital - has likely risen.

uA06fig02

Vietnam: Interest margins and capital of four large SOCBs

Citation: IMF Staff Country Reports 2003, 381; 10.5089/9781451840254.002.A006

Source: SBV; and Fund staff estimates.1/ Capital before injection of recapitalization banks in 2002 Q3.

108. In the area of transparency, some initial progress has been made to move loan classification closer to international standards and strengthen the accounting information available to monitor progress of SOCB restructuring. In December 2001 Decision 1627 was adopted, requiring banks to classify the entire loan balance as overdue if any interest and/or principal payment becomes overdue. Furthermore, to help assess the true size of NPLs and accurately monitor improvements in banks’ performance, the four large SOCBs have been undergoing IAS audits of their financial statements beginning with the year 2000 accounts. Based on these audits, banks have also been instructed to implement an initial plan for phasing in loan loss provisions. However, implementation of the new loan classification remains non-transparent48 and plans to address key qualifications of the IAS audits have not yet been carried out.

109. Strengthening banking supervision, in particular of SOCBs, remains a challenge. The allocation of supervisory responsibilities among the various departments involved at the SBV, the lead agency in banking supervision, is complex and may need simplification. Enforcement mechanisms where banks violate prudential and other regulations need to be tightened. In addition, supervision by the central bank may be affected by the SBV’s co-ownership function at the SOCBs.

D. International Comparison Across Transition Economies

110. Macroeconomic stability and rapid monetization have led to bank intermediation levels in Vietnam that are well above those in many other transition economies (Figure VI.2). With more than 40 percent of GDP intermediated as credit to the economy, the banking system plays a key role in contributing to Vietnam’s overall economic growth and stability.

Figure VI.2:
Figure VI.2:

Banking System Performance in Selected Transition Economies

Citation: IMF Staff Country Reports 2003, 381; 10.5089/9781451840254.002.A006

Source: IFS. 1/ Lending rate minus deposit rate in local currency.

111. In terms of achieving financial deepening, bank restructuring has led to a wide range of results across transition economies in Eastern Europe, the Commonwealth of Independent States (CIS) and East Asia. The more successful reformers, such as the Czech Republic, Poland and Hungary, after some decline in the transition, show relatively high levels of bank intermediation from households to the private sector. At the other end of the spectrum are the former CIS republics, where despite several years of reform, the role of the banking sector remains extremely limited. Output declines, a severe loss of confidence in the banking system and a shortage of creditworthy companies have all contributed to intermediation levels that are significantly below those of Vietnam.49 One of the highest intermediation levels recorded is for China, which, like Vietnam, has been pursuing a gradual reform approach to transition.

112. Regarding progress in addressing structural constraints, however, Vietnam appears to be much more similar to CIS countries than the more successful reformers of Eastern Europe (Table VI.2). As in Vietnam, state-owned banks with weak lending practices subject to influence from privileged state-owned enterprises, continue to dominate the banking industries in many CIS countries. Moreover, accounting standards and disclosure requirements fall generally short of international best practice and banking supervision remains limited, in part owing to considerable constraints in human resources. By contrast, in Central Europe and the Baltics implementation of a strong regulatory and supervisory framework in compliance with international standards, and aggressive restructuring of state-owned enterprises, all have contributed to facilitating the transition to a commercially oriented banking system. In all these cases, opening the banking sector to foreign private investors was a key restructuring measure that contributed to success.50

Table VI.2.

Banking Systems in Transition Economies - An Overview

article image
Sources: Borish et al. (1996), Karacadag (2003), Tang et al. (2002), Zoli (2001); and IMF country reports (various issues).

113. The cost of banking reform has varied substantially across transition economies and still appears to be relatively modest for Vietnam. Apart from the size of the initial banking sector problem the cost of reform crucially depends on the credibility and timeliness of hard budget constraints imposed on both banks and the corporate sector, supported by needed reforms in bank management, in particular profit orientation and risk management, governance, and the regulatory framework. Based on international experience, delays in addressing structural weaknesses in Vietnam’s financial system, in particular at the interface to the corporate sector, are likely to increase the ultimate cost of reform.51

114. Vietnam’s reform experience so far, appears to match most closely that of China. In both cases, gradual reforms combined with strong economic growth and relative macroeconomic stability have led to some of the highest bank intermediation levels–significant NPLs notwithstanding - among transition economies. At the same time, the banking systems remain dominated by state-owned banks and internationally acceptable accounting standards are being gradually phased-in; in China’s case with the adoption in 2002 of a 5-tier loan classification system and phased-in provisioning. An important difference between the two countries is that, in China a significant portion of NPLs were transferred to a centralized Asset Management Company (AMC), whereas NPL resolution remains the responsibility of individual banks in Vietnam. In terms of the cost of reform, tentative estimates suggest that the burden of NPLs and the need for recapitalization in Vietnam are modest compared with China, partly reflecting much lower intermediation levels in Vietnam.

E. Challenges—Maintaining Reform Momentum

115. Vietnam’s banking sector, while already playing a more important role in financial intermediation than in many other transition economies, continues to face severe structural challenges.52 The transition towards a market-oriented two-tier commercial banking system is still incomplete. The existing approach relies on state-ownership of the four large SOCBs and their own capacity to reform. Within this framework more can be done to induce and enable banks to become commercially sound. Key elements to bring forward reforms include:

  • Strengthening incentives for managers and staff to ensure commercially-based decision-making. The current compensation scheme of SOCB management rewards balance-sheet growth while not penalizing risky businesses.53 The need to invest in training and technology, to provide for adequate loan loss reserves, and, above all to price credit risk adequately, should also become central objectives. Performance contracts of managers should reflect these factors and in particular profits after adequate provisioning for risks and non-performing loans.

  • Simplifying SOCB’s mandate. The phase-out of non-commercial lending operations should be accelerated. This would include the requirement that SOCBs make deposits at specialized policy-lending institutions at below-market interest rates.

  • Building capabilities for sound commercial decision making, in particular improved credit risk management Twinning arrangements with internationally reputable partners could prove particularly useful for transferring critical management know-how. In addition, efforts to train thousands of credit officers and managers need to be strengthened, including through increased technical assistance.

  • Strengthening creditor rights by providing banks with more effective means to resolve NPLs, especially to loss-making SOEs. Approval of financial and operational restructuring plans for SOEs with NPLs should be streamlined. SOCBs should be able to initiate the process of SOE restructuring by calling to order a workout committee that is to agree on a restructuring plan within set deadlines. SOCBs should play a key role in these committees as they have access to critical information and they have already begun to develop relevant expertise in their respective loan workout units. To enhance effectiveness, SOCBs should first focus on the SOEs with the largest NPLs.54

116. Providing banks both with incentives and key instruments to operate commercially would be supported by measures that create an environment more conducive to reforms, including:

  • Creating a level competitive playing field. The current framework still hampers competition, by practically prohibiting foreign bank branches to offer dong and foreign currency deposits to households,55 increase their branch network and/or acquire domestic banks. While commitments under the USBTA would result in a phase-out of competitive restrictions on US banks, these should apply to all foreign banks to promote a more competitive domestic banking environment.56

  • Strengthening bank supervision. Without improved supervision, progress in bank restructuring cannot be independently assessed, a necessary condition for reform incentives. To better monitor banks’ performance, supervision will need to be strengthened, in particular in the area of risk assessments, and streamlined, including through consolidation of responsibilities.

117. The existing incentives for reform provided through recapitalization, albeit limited, should be more fully exploited. The incentives created by recapitalization may appear modest as long as banks are state-owned and thus are implicitly guaranteed to operate.57 However, rewarding successful banks in a transparent and public manner could have a demonstration effect and limit moral hazard. Therefore, stricter enforcement of the eligibility criteria for public recapitalization funds would help limit the cost of the reform program.

118. Beyond the existing approach, privatization could prove a valuable option to modernize the banking system. As in other transition economies, a reputable foreign equity partner would help provide banks with critically needed management know-how to successfully restructure their operations; it would also reduce the cost to the state of adequately capitalizing the SOCBs.58 Through a demonstration effect privatization of a large SOCB could also make the banking system as whole more competitive and efficient. The attractiveness of banks for foreign investors, however, will also depend on overall progress to commercialize Vietnam’s banking system and create a level competitive playing field.

F. Conclusion

119. Vietnam’s banking reform program needs to be pushed ahead. Under the current approach the four large SOCBs remain wholly state-owned and their transition to commercially oriented banks relies entirely on their internal resources and the credibility of incentives set by the government. The existing approach to reform should be strengthened in three critical areas: (1) strengthening the incentives for reform of banks and their management, including through performance contracts and strict recapitalization conditions; (2) improving credit risk management in line with international practice, supported by substantial technical assistance (including through twinning arrangements); and (3) providing banks with more effective mechanisms to resolve NPLs. Moving beyond the existing approach would likely entail privatization of a large SOCB by seeking a strategic foreign equity partner.

References

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38

Prepared by Olaf Unteroberdoerster.

39

For an analysis and comparison of transition country developments in the 1990s see IMF (2000), and Exeter and Fries (1998).

40

Based on banks own reports and domestic accounting standards (VAS), these estimates were tentative at best given weaknesses in banks accounting data that hamper a consistent and stringent assessment of NPLs across all banks.

41

Consisting mainly of directed loans and uncollateralized NPLs.

42

International experience shows that a successful transition towards a sound commercial banking system depends on progress in all these areas (de Juan, 1996).

43

An 8 percent capital adequacy requirement was adopted in 1999 but not enforced.

44

Resolution of collateralized NPLs, which are typically to the private sector, was sped up by streamlining regulations on the sale of collateral, permitting banks to bypass the state auction center.

45

Two phases of recapitalization have been completed by June 2003, providing banks with non-negotiable recapitalization bonds of D 5.3 trillion (nearly 1 percent of GDP).

46

Decision 149/2001/QD-TTg of the Prime Minister.

47

The most important principle is that any debt relief provided by SOCBs to SOE via financial restructuring of NPLs is to be linked to operational restructuring of SOEs.

48

For example, neither some of the SOCBs nor supervisors have so far been able to quantify the impact of the new classification scheme on the amount of overdue loans.

49

Another indicator of banking system performance, spreads between lending and deposit rates, may indicate that Vietnamese banks operate at relatively low margins. While this could point to relative efficiency, insufficient loan loss classification and provisioning requirements and ceilings on lending rates combined with limited commercial decision making, as mentioned above, make a comparison difficult.

50

The accession process to the European Union (EU) has also provided a significant impetus to institutional reform. For an in-depth review of SOCB reforms in the transition economies of Eastern Europe and the CIS countries see Sherif et al. (2003).

51

For a discussion of the intricate links between enterprise and bank reform in Eastern Europe see van Wijnbergen (1998) and Borish et al. (1996).

52

These challenges, including “poor financial capacity”, “high non-performing debts”, “low professional skills”, and “poor supervision”, are also noted in the SBV’s “Plan on International Economic Integration of the Banking Sector in Vietnam” (Decision 663, June 23, 2003).

53

SOCB managers’ salary, like that of other SOEs, is tied to the size of their enterprise and some profit-related portion, which however is unadjusted for risks.

54

Bank-led restructuring efforts will also have to be coordinated with efforts to resolve interenterprise debt through a central Debt and Asset Management Trading Company (DATC) that is under development.

55

Foreign bank branches are not permitted to offer FCDs to households. Further, their offering of dong deposits to non-borrowing customers is limited to 25 percent of their capital.

56

The most important concessions under the USBTA include (1) phase-in of national treatment in the dong deposit market, (2) national treatment in equity participation in privatized SOCBs, and (3) majority foreign ownership of banking institution after 3 years of the agreement.

57

See Neale and Bozsik (2001) who describe the case of Hungary where lack of credibility of incentives for government run banks led to several rounds of failed recapitalization with public funds.

58

Illustrative scenarios based on 2000 IAS audits and assumptions on credit growth around 15 percent indicate that funds needed to restore SOCBs’ capital adequacy would make up half of the recapitalization cost through 2005. More capital would be needed to support higher credit growth rates.

Vietnam: Selected Issues
Author: International Monetary Fund
  • View in gallery

    Vietnam’s Approach to Banking Reform – An Overview

  • View in gallery

    Vietnam: Cumulative NPL resolution of four large SOCBs through 2003

    (In billions of Dong)

  • View in gallery

    Vietnam: Interest margins and capital of four large SOCBs

  • View in gallery

    Banking System Performance in Selected Transition Economies