New credit regulations tough on Vietnamese banks

08:48 | 05/10/2015
A key measure of a bank’s strength is its capital adequacy ratio. Over the last two years, the Basel Committee on Banking Supervision (BCBS), the international standard in the field of banking regulation, has been working towards a revised approach to the denominator of the capital ratio – a bank’s Risk Weighted Assets (RWAs).


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Basel II (2006) introduced two approaches to the calculation of credit risk RWAs: the first an internal models based (IRB) approach and the second a simpler “standardised” approach (SA). The SA assigns different risk weights to assets based on the degree of risk, making use of external ratings from ratings agencies such as S&P and Moody’s. In Vietnam, the current approach for RWA is outlined in Circular 36, whereby the regulator sets a standard risk weight for each type of banking asset.

In December 2014, the BCBS proposed revising this approach with the objective to improve the current SA for credit risk. The aim is to reduce reliance on external credit rating; increase risk sensitivity; reduce national discretion for some asset classes, strengthen the link between the SA and the IRB approach (essential credit models), and enhance comparability of capital requirements across banks. The new rules rely on specific pieces of customer information, such as Revenue and Leverage ratio of a corporate customer, to drive a risk weight. This is sometimes referred to as Basel IV, as the framework departs significantly from the SA under Basel II/III.

These moves toward a revised SA have implications for all financial institutions. As Vietnam is looking to move towards international standards for prudential banking regulations, this may have a very significant impact on the local banking sector.

First, banks face significant challenges collecting this data from all customers, and maintaining it on an ongoing basis. The accuracy of the data will also be a challenge. Data availability and need for IT investments are relevant factors to consider in the final design.

Second, it is currently uncertain how the new requirements will affect RWAs, and hence bank’s capital ratios. If the effect is to increase RWAs, this will require banks either to hold more capital or to reduce their on-and-off-balance sheet activities. This in turn could affect the cost and availability of bank finance to fund lending growth.

Third, banks are likely to re-evaluate the balance between lower and higher risk businesses. Ultimately, this will be driven by their need to improve their capital management, not the least in terms of understanding fully the capital required to support their various businesses and linking this clearly to their strategy, risk appetite, and business models.

Reaction from global banking industry

As a global firm, KPMG is hearing from many quarters that there has been significant pushback from the industry on the Basel revisions to credit risk. Although supporting the initiative of the BCBS to increase risk sensitivity and to reduce the gap between IRB and the Basel II SA, many financial institutions and banking federations have expressed their concerns and opposing opinions over the revised SA. Globally, banks and regulators are therefore treading with caution until there is further guidance from the BCBS on the revised SA.

Progress in Vietnam

The State Bank of Vietnam (SBV) has made significant progress in strengthening the banking sector with foresighted initiatives. Its challenge is to balance addressing pressing needs locally with potential revisions from the BCBS, as well as a “fit for purpose” prudential framework that does not depart significantly from standards applied globally. The idea of introducing the new standardised approach in Vietnam is sound, although it may be prudent to adopt a “wait and see” approach with respect to the new rules, so timelines and requirements should remain flexible. Laudably, the SBV is also focusing on banks improving their approach to risk management, and not just for compliance with prudential rules.

KPMG’s regulatory lead for the Asia Pacific region, Simon Topping, a former senior regulator himself, has visited Vietnam several times recently to meet with bankers and regulators. He commented, “I’m impressed by the very real progress the banks are making in strengthening their financial position and risk management capabilities, and also by the intelligent and practical approach the regulator is adopting.  There’s still a lot to do, but everything seems to be moving in the right direction.”

By Financial Risk Management team - KPMG in Vietnam

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