II. Recent Developments in the Banking Sector16
1. The Lao banking sector mainly consists of three state commercial banks (SOCBs), of which the largest by far is the Banque pour le Commerce Exterieur (BCEL). The state-owned Agriculture Promotion Bank serves mainly rural households, providing agricultural loans (some of which are subsidized), and administers donor-funded microenterprise credit schemes through its extensive branch network. As of end 1999, the SOCBs accounted for 70 percent of total assets of the banking sector. In addition, seven branches of foreign banks (all but one from Thailand) and one representative office, accounted for 21 percent of total assets, and joint-venture banks accounted for the remaining 9 percent.
2. Efforts to improve the operations of SOCBs have been ongoing since the mid 1990s. The SOCBs were recapitalized in 1994 when 77 percent of SOCB bad loans, amounting to 1 percent of GDP, were removed from their balance sheets. About 70 percent was written off and the other 30 percent was transferred to the BOL to be collected. In a second step to the earlier process, the smaller SOCBs were consolidated in 1999 as the six smaller provincial state-owned banks were merged into two (Lao May Bank and Lane Xang Bank). At the same time new operation manuals and business plans were prepared and new Boards of Directors were appointed. Technical assistance from the Asian Development Bank also facilitated the introduction of new credit and risk grading classifications, and the setting up of internal debt-workout units in the three SOCBs.
3. Paralleling these efforts were measures to improve the regulatory framework. Over the past three years, the prudential regulations which encompass capital adequacy, lending to large borrowers, foreign currency exposure, and other issues have been improved. Although not fully at international standards, they are relatively simple and are a major improvement from previous versions. However, the enforcement of prudential supervision has been very weak and resulted in regulatory forbearance. In particular, due to the high level of nonperforming loans most of the prudential regulations were not complied with, including the accrual of interest on nonperforming loans.
4. Similarly, although efforts have been made to develop supporting institutions, they have not been effective. Credit information bureau and deposit insurance regulations have been issued but they have not yet been implemented. A government-owned company was established to manage a deposit insurance fund in January 2000. The BOL Decree Law required all commercial banks to contribute 0.5 percent of total deposits of the previous year to the fund, but implementation of this scheme is effectively on hold due to lack of sufficient resources, compared to the large potential liability. Furthermore, a BOL-run credit information bureau (CTB), authorized to compile and share information on defaulting borrowers and their payment record, has not yet started operation. The BOL also established a Banking Supervision Department in 1999 but a lack of sufficient resources has hampered the conduct of rigorous on- and off-site inspections.
5. The underlying weakness of SOCB management and operations was exacerbated by macroeconomic instability and state-owned enterprise (SOE) distress. In particular, the steep kip depreciation between 1997 and 1999 aggravated already weak balance sheets and significantly increased the ratio of NPLs to about 70 percent. Open currency positions in the banks, which took dollar deposits and extended kip loans, and also borrowers, who took loans in dollars but earned kip revenues, both wiped out significant capital from SOCBs’ balance sheets. SOCB problems were also closely linked to the financial distress of the SOEs, especially the large ones. Although the government is attempting to stop directed lending, pressure remains to roll-over existing bad loans or extend new loans to SOEs on noncommercial terms or for economically unjustifiable projects.
6. Through much of 2000, credit developments have been particularly worrisome. After attracting large amounts of foreign currency deposits in 2000, banks started to expand lending rapidly and in dollar terms, SOCB credit grew by 40 percent over the year17. Most of the credit was in foreign currency, which was coupled with a sharp decline in their net foreign assets. The net foreign assets coverage of foreign currency deposits stood at an all time low of 36 percent in December 2000 down from 68 percent at end-March 2000. With an already high NPL ratio, the recent credit expansion threatens a further deterioration in portfolio quality, and suggests the closer monitoring of credit by the BOL is needed.
7. The state owned banks need to be restructured in order to create robust banking institutions. The main elements of restructuring should include resolving the NPL problem, implementing phased and conditional recapitalization, improving governance, and enhancing the environment for sound banking. While the long term objective would be to create a healthy banking system, interim measures are needed to stop the deterioration of the SOCBs balance sheets. These include implementing proper loan classification, undertaking international standard audits, and closely monitoring credit growth.