Banking reforms starting to add up

18:15 | 29/11/2004
As Vietnam integrates ever deeper into the global eocnomy the need for regulating the banking sector and restructuring the State-owned commercial banks has become a top priority for the government. Here the World Bank highlights why, and also explores what further action is needed to level the playing field in the realm of banking.

Heads down: the process of bringing Vietnam’s banking sector up to date will be a time consuming but crucial process

The Vietnamese government has taken a number of steps in strengthening the regulatory regime in the recent past, but there are still substantial reforms that need be made to the regulatory framework.
The amendments to the Law on Credit Institutions (LCI), passed by the National Assembly on May 26, 2004, became effective on October 1, 2004.
These new amendments further clarify the separation of policy and commercial lending, enhance the decision making autonomy of credit institutions and widen the range of the types of deposits. It allows banks to offer loans without collateral and squarely puts responsibility for credit decisions with the banks.
Moreover, the amended LCI also expands the utilisation of value-bearing papers, strengthens the internal control function, and requires the selection of independent auditors to perform the external audits of the banks. The amendments also importantly provide for full liberalisation of foreign competition in the banking sector.
Beyond the LCI, there have been regulatory changes to allow joint stock banks (JSBs) to adopt corporate governance structures that closer resemble those of foreign banks operating in the country.
New regulations also allow foreign banks operating in Vietnam to buy up to 30 per cent of shares in JSBs and to allow JSBs to list on the Ho Chi Minh Securities Trading Centre.
These changes could allow the JSBs to access better management and technology, as well as improved corporate governance practices from strategic foreign investors.
In addition, the Government announced its intention to equitise two SOCBs between 2006-2010, which could transform these banks into JSBs and further level the playing field among banks.
Despite all of these recent changes, there are major unresolved problems with regard to the regulatory framework for the four largest state - owned commercial banks (SOCBs), which together constitute over 73 per cent of the credit market.
The core of the problem lies in the uncertainty surrounding who is responsible for providing management oversight as a shareholder and the separation of the roles of the shareholder, supervisor, and manager of the SOCBs.
The State Bank of Vietnam (SBV) has management and shareholder roles as well as supervisory powers and the performance standards for SOCB management is largely based on government directives and SBV influence.
The amendments to the LCI still allow for SBV intervention in terms of operation, management, and almost all other changes within the banks, such as appointments of Board of Directors and Board of Management members and regulations explicitly gives the SBV the sole role of ownership of the SOCBs.
The presence of the SOCBs and the potential market distortions caused by government intervention in these institutions is further exacerbated by the policy lending institutions, the Development Assistance Fund and the Vietnam Bank for Social Policies.
The regulatory framework governing these institutions must be changed to fully level the playing field for all forms of banks in the sector.

Restructure state owned commercial banks
The four SOCBs adopted restructuring plans in 2001 that included reform in areas such as organisational structures, enhanced technological applications, and improved risk management. Implementation of these plans has resulted in the gradual transformation of these banks into more commercially oriented financial institutions. Through the combined implementation of these reforms, SOCBs have been able to increase the number of products and services offered to clients.
Confidence in the banks has increased, as shown by the rapid growth in bank deposits, which rose from 43 per cent of GDP in 2000 to over 56 per cent by 2003.
The SOCBs have also raised the share of credit to the private sector, growing from approximately 55 per cent in 2000 to 64 per cent in 2003. However, the quality of this lending is a concern.
Due to differences between Vietnamese and international accounting standards regarding loan classification and underlying problems with the quality of the bank data, the true size of the non-performing loan (NPL) portfolio has been controversial and is not known with any precision.
With these caveats in mind, it is estimated that accumulated NPLs of SOCBs based on international standards represent about five per cent of GDP, and about 11 per cent of all banking credit to the economy.
A key facet of the restructuring plans of SOCBs included the resolution of VND21.3 trillion ($1.3 billion) in NPLs identified at the end of 2000. VND13.9 trillion ($885 million) has been resolved, mostly through capital injections.
The remaining NPLs have proved hard to work out, bringing the resolution process to a standstill. While SOCBs have their own asset management companies (AMCs) designed to resolve the NPL portfolios, these AMCs currently lack the power to reach foreclosure, seizing assets and forcing enterprise liquidation if necessary.
Therefore, an alternative institution for NPL resolution was established in 2003 that will shortly be put to the test. This institution – the central Debt and Asset Trading Company (DATC) – was created in June 2003, but the decision on whether NPLs should be transferred to the DATC was delayed.
A daunting challenge for the DATC and the further resolution of bad debts is the creditor rights framework, which is unreliable and inefficient. Commercial insolvency in Vietnam, previously governed by a 1993 law, was rarely used in practice, except where fraud was involved. Bankruptcy and debt default carry a stigma in Vietnam, with little appreciation of the impact of market activity on competition and business failure. The new bankruptcy law is an improvement over the 1993 law, but still falls short of good practice for an insolvency system.

Further actions needed
The full liberalisation of the market to foreign banks is envisaged by the government and will happen as a result of World Trade Organisation accession and other international commitments of Vietnam beginning in 2010.
Therefore, the window of time available for the implementation of necessary regulations to bring the banking sector closer to international standards is closing fast. During the short period of relative protection for domestic banks, the SBV should move to rapidly enhance its regulatory and supervisory capacities and target compliance with the Basel Core Principles for Effective Banking Supervision. A partial assessment was conducted in 2002 and a full assessment will be conducted in 2005, which will give the SBV a robust supervisory development plan.
Strong supervisory monitoring and enforcement capabilities will be increasingly critical to ensure the safety and soundness in the banking system with increased operational autonomy of banks and the entrance of new banks into the market. In addition to these supervisory standards, the SBV should move towards other international standards, such as international accounting, anti-money laundering, monetary and financial policy transparency, and creditors rights and insolvency standards, during this transition period to full banking sector liberalisation.
Consistent with these international standards, the regulatory framework should also be gradually moved towards equal treatment to all banks and full autonomy for the banks to operate on a purely commercial basis. This will entail developing all of the regulations under the LCI amendments for the phasing-in of the liberalisation commitments.
Finally, it is imperative for the Government to act immediately to address the problematic corporate governance issues impacting the SOCBs and speed the restructuring process to bring them closer to international standards of operation and prepare them for increased foreign bank competition.
Although experience worldwide indicates that the SOCBs may be able to hold their dominant market position in the medium-term, the long-term competitive pressures could become severe and the fiscal costs of keeping the SOCBs afloat could become considerable if the banks are not properly restructured in the near future.

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