Information about Asia and the Pacific Asia y el Pacífico
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Vietnam: Selected Issues

International Monetary Fund
Published Date:
July 1999
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Information about Asia and the Pacific Asia y el Pacífico
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III. Banking reform1

1. After a period of rapid expansion in the mid-1990s, Vietnam’s banking sector has come under mounting pressure from the slowdown in growth and the deteriorating financial condition of the state enterprise sector in the past two years. In response, the authorities have taken a number of measures, including with the assistance from the World Bank and the Fund, to facilitate the necessary restructuring, and have started developing a comprehensive strategy for banking reform. This chapter first provides a background on recent monetary and banking developments, and discusses the nature of the problems facing the Vietnamese banks—which is relatively well understood—and the scope of the problems—which has yet to be fully assessed. The chapter then reviews the authorities’ reform initiatives since 1998, and concludes with an outline of an approach to banking reform that builds on these initiatives.

A. Economic Setting

2. Monetary and banking developments in 1998 reflected the difficult tasks facing the policy makers—containing inflation, maintaining currency stability, salvaging the joint-stock banks (JSBs), and cushioning the economy—especially the state enterprise sector—hit hard by the regional crisis that sharply slowed the growth in output, exports, and foreign direct investment inflows. Given the small number of monetary instruments available, conflicting policy objectives, and a deteriorating macroeconomic outlook, measures undertaken were not always coherent. In particular, credit policy was too accommodative, with considerable expansion in credit to the SOEs in the second half of the year pushing up inflation and potentially aggravating the financial condition of banks and enterprises.

3. Despite considerable slowdown in real GDP growth in 1998 (estimated at 3½ percent by the staff), growth of broad money reached 24 percent at end-1998, almost the same as in 1997, when GDP grew much faster (8¼ percent) (Appendix Table 21). Rapid expansion in credit to state-owned enterprises was a major contributing factor, accounting for 40 percent of broad money growth during 1998. Credit to SOEs began to accelerate noticeably in the third quarter, reaching 22 percent at end-1998, compared with an average of 15 percent in 1995–97. This expansion came at the expense of credit to nonstate-owned enterprises, which rose by just 2 percent in real terms and accounted for only a third of the increase in total credit during 1998, compared with two-thirds in 1995-97. The other major contributing factor was the increase in net foreign assets, resulting from an inflow of foreign currencies into the banking system (partly related to higher private transfers from abroad), and a reduction in foreign liabilities (discussed below). Reflecting slower income growth and expectations of exchange rate depreciation, the growth of dong deposits decelerated sharply in 1998 (to 22 percent from 38 percent a year ago), while the growth of foreign currency deposits remained strong (36 percent), even after accounting for exchange rate valuation effects (Appendix Table 22).

4. Rapid monetary expansion had two main macroeconomic effects in 1998. First, credit growth and inflation were highly correlated: changes in credit growth has tended to lead to changes in inflation within 1-2 months (Figure III. 1). Faster credit growth in the second half of 1998 thus continued to push up inflation in early 1999.

Figure III.1.Growth of Credit and Inflation, 1996-99 1/

Three-month percentage changes

1/ Credit data for January-March 1999 are staff estimates.

5. Second, credit growth and industrial production were also highly correlated in 1998 (Figure III.2). However, due to the slowdown in domestic consumption, sales of SOEs have stagnated, and much of the growth in credit effectively financed the accumulation of inventories (estimated by the staff to have contributed 4½ percentage points to the real growth rate of GDP). More importantly, credit expansion failed to stimulate the GDP growth, as output in agriculture and services decelerated sharply in the second half of 1998.

Figure III.2.Credit and Output, 1995-98

6. To expand credit to the SOEs, commercial banks reduced their excess reserves (Figure III.3) and increased their borrowing from the SBV in the third quarter of 1998 (Appendix Table 23). (When excess reserves were getting depleted, the SBV reduced in February 1999 the reserve requirement to 7 percent from 10 percent of short-term deposits.) Much of the increase in SOE credit was in the form of directed lending and medium and long-term loans (Table III. 1).2 This suggests that the state-owned commercial banks (SOCBs) were encouraged to lend to the SOEs for infrastructure and similar projects in order to help the SOEs sustain production and employment in a difficult period.

Table III.1.Vietnam: Composition and Growth of Credit, 1994-98 1/, 2/
Credit to the economy (in billions of dong) 2/33,34542,27650,74462,20164,26765,67368,87772,596
Dong lending20,47225,92632,18042,80145,26947,05849,17454,284
Working capital loans15,85720,23825,01730,29331,21431,21531,35834,035
Medium and long term loans2,0163,5034,6269,19910,35311,74413,29515,265
Construction and investment loans under state plan2,2101,7142,1682,8713,2493,6404,0794,547
Other instruments389471369438454459442437
Foreign currency loans12,87316,35018,56419,40018,99818,61519,70318,312
Composition of credit (percent of total)
Dong lending61.461.363.468.870.471.771.474.8
Working capital loans47.647.949.348.748.647.545.546.9
Medium and long term loans6.
Directed loans 3/
Foreign currency loans38.638.736.631.229.628.328.625.2
Growth of lending (annual percentage changes)
Total credit to the economy26.820.022.623.122.521.016.7
Dong lending26.624.133.033.733.928.826.8
Working capital loans27.623.621.121.619.311.512.4
Medium and long term loans73.832.198.984.290.389.065.9
Directed loans 3/-22.426.532.449.348.157.958.4
Foreign currency loans27.
Composition of credit (percent of total)
Total credit by state-owned banks82.879.675.577.278.179.780.581.4
Dong lending66.267.670.676.878.177.877.279.8
Working capital loans50.251.453.453.152.850.648.148.8
Medium and long term loans7.210.311.217.318.720.422.123.7
Directed loans 3/
Foreign currency loans33.832.429.423.221.922.222.820.2
Growth of credit (annual percentage change)
Dong lending24.419.036.337.034.230.627.8
Working capital loans24.618.524.725.620.613.112.9
Medium and long term loans74.523.493.980.988.591.668.7
Directed loans 3/-22.426.531.742.437.144.547.1
Foreign currency loans16.93.3-
Composition of credit (percent of total)
Total credit by nonstate-owned banks17.220.424.522.821.920.319.518.6
Dong lending38.236.941.241.943.147.547.653.0
Working capital loans36.235.437.635.135.037.437.241.1
Medium and long term loans2.
Directed loans 3/
Foreign currency loans61.863.158.858.156.952.552.447.0
Growth of credit (annual percentage change)
Dong lending45.460.915.715.432.117.420.8
Working capital loans46.953.
Medium and long term loans17.5236.9112.2119.8217.994.167.6
Directed loans 3/15.79.411.
Foreign currency loans53.634.112.83.6-7.7-9.1-22.9
Source: Data provided by the State Bank of Vietnam.

Derived from the monetary survey data for four state-owned commercial banks and 24 nonstate-owned banks.

Includes credit to state-owned enterprises, cooperatives, shareholding and limited liability companies, joint venture enterprises, and the private sector.

Includes construction and investment loans under state plan, and loans by foreign grant and investment agent funds.

Source: Data provided by the State Bank of Vietnam.

Derived from the monetary survey data for four state-owned commercial banks and 24 nonstate-owned banks.

Includes credit to state-owned enterprises, cooperatives, shareholding and limited liability companies, joint venture enterprises, and the private sector.

Includes construction and investment loans under state plan, and loans by foreign grant and investment agent funds.

Figure III.3.Required and Excess Reserves, 1995-99

7. On the demand side, the expansion in credit was boosted by the decline in interest rates on dong loans. In particular, with rising inflation, nominal interest rates relatively unchanged and a depreciating exchange rate, real interest rates on dong loans fell by over 5 percentage points to 5½ percent between January and December 1998, while the real cost of borrowing in dollars remained above 17 percent through September 1998 (Appendix Table 24); as the exchange rate has effectively been fixed since September 1998, the real interest rate on foreign currency loans dipped to negative levels in early 1999 (Figure III.4). The shift from dollar to dong loans has worked to the benefit of SOCBs, while the nonstate-owned banks (including foreign bank branches, which are the main suppliers of foreign currency loans in key urban centers), reduced their foreign currency lending in 1999 (Table III. 1)

Figure III.4.Real Interest Rates, 1993-99

B. Nature and Scope of Problems

8. At the end of 1998, Vietnam’s banking system consisted of four state-owned commercial banks (accounting for 82 percent of total bank assets), 51 joint-stock banks, whose shareholders include state-owned enterprises and private entities (accounting for 10 percent of total assets), and 23 branches of foreign banks and four joint-venture banks (together accounting for 8 percent of total assets).3 Total bank assets were equivalent to 38 percent of GDP at end-1998, total loans to 22 percent, and total deposits for 20 percent, indicating a relatively low degree of monetization of Vietnam’s economy.

9. As in other transition economies, the problems affecting Vietnam’s banking system originate in incomplete reforms of the financial sector and the SOEs. The SOCBs still account for 80 percent of loans and deposits and their lending remains subject to official intervention. Accounting practices make credit evaluation problematic; the banking supervisory framework is weak; and supervisors have difficulties in enforcing the existing prudential rules. This has especially affected the performance of the joint-stock banks, which have accumulated large nonperforming loans and short foreign currency positions due to imprudent lending and weak regulatory standards, and many are undercapitalized and suffer from serious governance problems. Banks, in turn, have been hampered in their efforts to improve accountability and transparency by the lack of appropriate accounting standards for businesses. As a result, banks find it difficult to evaluate the feasibility of projects they are asked to finance, and the value of collateral their customers have to offer.4 This state of affairs has left the banking system weak and vulnerable, and the regional economic crisis has further strained its fragile condition.

10. Many problems can further be traced to the poor performance of state enterprises, which are the main customers of the banks, especially the SOCBs. In particular, financial discipline remains weak, and although the SOEs no longer receive direct budgetary subsidies and real interest rates have been kept at positive levels, state enterprises receive extensive fiscal, trade, and credit privileges.5 A thorough reform of the SOE sector should therefore be a key complement of a longer-term strategy for rehabilitation of the financial system.

11. While weaknesses in accounting practices and in banking supervision make it difficult to adequately assess the true state of the banking system at the moment, the available data indicate a steady deterioration in banks’ balance sheets since the mid-1990s, partly related to the loss of impetus in the reform process. The data further indicate that the most vulnerable segment of the banking sector today are the joint-stock banks (JSBs). Although their presence in most areas is small, JSBs account for more than 25 percent of banking sector assets in Ho Chi Minh City, which accounts for a quarter of Vietnam’s GDP, 40 percent of foreign direct investment inflows, and over half of exports.6 The main problems in terms of potential risks for macroeconornic stability are contained in the following paragraphs.

Foreign exchange exposure

12. A major source of risk that emerged in the banking sector in the past two years was the default on a number of deferred letters of credit (L/Cs) by some joint-stock banks, triggering an immediate reaction from the international banking community. The ruling of the Supreme Court in July 1998 failed to enforce payment of the L/C obligations, further eroding international confidence in the Vietnamese banking system. However, over the second half of 1998, the backlog of late L/C payments was reduced by some US$350 million to about US$200 million at the end of 1998.7 The clearance of the L/Cs was reflected in the improvement in banks’ foreign exchange position in 1998: the SOCBs increased their net long foreign currency position (to 160 percent of their capital), while the nonstate-owned banks, which traditionally have maintained short foreign currency positions, for the first time achieved net long positions in the second half of 1998 (Table III.2).8

Table III.2.Vietnam: Open Foreign Currency Positions of Commercial Banks, 1994-98 1/
Net aggregate long (>0) or short (<0) foreign currency position 2/
In millions of U.S. dollars134144115217338460545753
State-owned banks157182211270419451528717
Nonstate-owned banks-22-39-96-53-8291737
As percent of aggregate foreign assets and liabilities11.
State-owned banks13.212.311.
Nonstate-owned banks-1.9-2.6-5.1-3.0-
Net short-term long (>0) or short (<0) foreign currency position 3/
In millions of U.S. dollars148280332385487629680785
State-owned banks252390451452575607643751
Nonstate-owned banks-104-110-119-67-89223735
As percent of aggregate foreign assets and liabilities12.518.917.521.626.735.139.540.5
State-owned banks21.326.323.825.431.533.937.338.7
Nonstate-owned banks-8.8-7.4-6.3-3.8-
Sources: Data provided by the State Bank of Vietnam, and staff estimates.

Derived from the monetary survey data for four state-owned commercial banks and 24 nonstate-owned banks.

Foreign assets, less foreign liabilities.

Deposits with foreign banks, less foreign currency deposits of nonresidents and short-term foreign currency borrowing.

Sources: Data provided by the State Bank of Vietnam, and staff estimates.

Derived from the monetary survey data for four state-owned commercial banks and 24 nonstate-owned banks.

Foreign assets, less foreign liabilities.

Deposits with foreign banks, less foreign currency deposits of nonresidents and short-term foreign currency borrowing.

13. Roughly 30 percent of total bank credit is extended in foreign currencies (over 50 percent in the case of nonstate-owned banks), of which over 70 percent to the SOEs (Table III.3).9 The exposure to exchange risk is especially large for the JSBs, which make foreign currency loans far in excess of their foreign currency deposits (Figure 5). While the SOCBs reduced their high foreign currency leverage during 1998, their indirect exposure remains very high, as the SOEs often have used foreign currency loans for domestic operations. Another concern is the continued rise in overdue foreign currency loans (Table III.3), a trend which could foreshadow a wave of bankruptcies, especially in the private sector, and mounting difficulties in the nonstate-owned banks that are the main lenders to the private sector.

Table III.3.Vietnam: Foreign Currency Lending of Commercial Banks, 1994-98 1/
Share of foreign currency loans in total loans (percent)38.638.736.631.229.628.328.625.2
State-owned banks33.832.429.423.221.922.222.820.2
Nonstate-owned banks61.863.158.858.156.952.552.447.0
Foreign currency loans by sector (percent)
State-owned enterprises81.376.375.868.869.170.871.072.2
Joint stock companies7.79.87.412.
Joint ventures4.711.414.517.116.214.714.415.0
Private sector6.
Growth of foreign currency lending27.
By bank (12-month percentage change)
State-owned banks16.93.3-
Nonstate-owned banks53.634.112.83.6-7.7-9.1-22.9
By sector (12-month percentage change)
State-owned enterprises19.312.8-5.2-4.3-2.54.4-0.9
Joint stock companies62.7-
Joint ventures210.
Private sector-
Share of overdues in foreign currency loans (percent)
By bank
State-owned banks9.
Nonstate-owned banks1.
By sector
State-owned enterprises8.
Shareholding and limited liability companies4.14.610.364.
Joint ventures0.
Private sector1.02.86.522.619.323.014.022.4
Source: Data provided by the State Bank of Vietnam, and staff estimates.

Derived from the monetary survey data for four state-owned commercial banks and 24 nonstate-owned banks.

Source: Data provided by the State Bank of Vietnam, and staff estimates.

Derived from the monetary survey data for four state-owned commercial banks and 24 nonstate-owned banks.

Figure III.5.Foreign Currency Loan-to-Deposit Ratios, 1994-98

Nonperforming loans

14. Rapid deposit growth in the banking sector in the mid-1990s has masked a significant increase in nonperforming loans. Overdue loans (officially classified nonperforming loans) amounted to 12½ percent of total loans (7¼ percent of total assets) at end-September 1998, compared with less than 8 percent of loans (5 percent of total assets) at end-1995 (Appendix Table 25). However, overdue loans are under-reported in official statistics on account of vague definitions and current prudential and accounting regulations, which minimize loss provisioning and allow repeated roll-over of loans. Thus, despite the high proportion of overdues, loan loss provisions (which are not risk-weighted) remained less than 1 percent of total loans during most of 1998, clearly not reflecting the underlying risk of loan losses (Table III.4).

Table III.4.Vietnam: Bank Soundness Indicators, 1994-98 1/(In percent; end of year)
Capital/Total AssetsCapital/Total Loans 2/
Mar.Jun.Sep.Dec. 2/Mar.Jun.Sep.Dec. 2/
Deposit money banks6.
State-owned commercial banks5.
Nonstate-owned banks7.725.114.616.517.318.118.617.510.128.523.826.327.229.430.729.3
Loans/Deposits4/Loans/Total Assets3/
Mar.Jun.Sep.Dec.Mar.Jun.Sep.Dec. 2/
Deposit money banks146.3127.9122.4110.5109.5101.5100.463.261.458.959.960.557.758.356.9
State-owned commercial banks148.1136.6125.5108.6105.199.897.059.957.
Nonstate-owned banks140.9102.6113.8117.5128.2122.9117.676.388.361.562.863.661.560.559.6
Profits/Total AssetsProfits/Loans
Mar.Jun.Sep.Dec. 2/Mar.Jun.Sep.Dec. 2/
Deposit money banks0.100.300.730.771.291.160.920.470.170.481.
State-owned commercial banks0.200.390.850.751.191.100.850.420.330.681.471.261.981.881.480.75
Nonstate-owned banks-0.27-0.250.320.831.691.401.190.71-0.36-0.290.521.322.662.281.961.18
Loan Loss Provisions/Total LoansLoan Loss Provisions/Overdue Loans
Deposit money banks0.
State-owned commercial banks0.
Nongovernment banks0.
Source: Data provided by the State Bank of Vietnam.

Based on the monetary survey of four state-owned commercial banks and 24 nonstate-owned banks.

Reflects recapitalization of SOCBs in October 1998 through conversion of frozen loans from the State Bank of Vietnam.

Excluding loans to government.

Excluding government deposits.

Source: Data provided by the State Bank of Vietnam.

Based on the monetary survey of four state-owned commercial banks and 24 nonstate-owned banks.

Reflects recapitalization of SOCBs in October 1998 through conversion of frozen loans from the State Bank of Vietnam.

Excluding loans to government.

Excluding government deposits.

• Among the SOCBs, the share of overdues in total loans varied in 1998 from 2½–5 percent for the two stronger banks, to 19–23 percent for the two weaker banks. Based on recent audits using international standards, however, NPLs at SOCBs were estimated at 30–35 percent of their total loans at end-1997 (on a weighted average basis), with a range from 17–25 percent for the two stronger banks, to 40–45 percent for the two weaker banks.

• NPLs of the nonstate-owned banks soared during 1997, largely reflecting problems with the letters of credit, and these banks have since surpassed the SOCBs in terms of the share of overdues, which stood at 17½ percent at end-September 1998. Individual banks were, however, in considerably worse shape, as illustrated by the fact that two such banks were closed by May 1998. Recently, the authorities estimated the size of NPLs at the joint-stock banks at 30–40 percent.

15. The maturity mismatch in the composition of assets and liabilities is another serious problem affecting banks’ liquidity. Virtually all bank deposits are of less than one-year maturity, while about 20 percent of all loans have a maturity of more than one year. This maturity mismatch is in large part caused by the ceiling on lending rates, which squeezes interest rate margins and constrains the issuing of longer-term liabilities to match the longer-term assets. In addition, the maturity structure of overdue loans is extremely unfavorable, with well over half of nonperforming loans overdue by more than 180 days.

Capital adequacy

16. The capital base of Vietnamese banks is very weak. Prior to recapitalization in October 1998, Vietnam’s highest capitalized SOCB had a ratio of capital to total assets of 5¾ percent (Table III. 4). Nonstate-owned banks had a stronger capital base, with an average capital-asset ratio of 18½ percent, and an average capital-loan ratio of about 30 percent.10 However, the State Bank’s assessment of the joint-stock banks in Ho Chi Minh City in 1998 revealed that many banks were severely undercapitalized and that much of the capital consisted of borrowed funds.

17. In October 1998, the State Bank recapitalized the four state-owned commercial banks by converting into capital the D 2.4 trillion of SBV loans to these banks, which were for the most part “frozen” since the split of the monobank in 1990.11 As a result of this operation, capital adequacy of the four state-owned commercial banks improved and presently exceeds minimum legal capital requirements established by the State Bank in October 1998. According to staff estimates, adjusted capital/asset ratios are much lower, and an additional D 6.4 trillion (1.9 percent of GDP) would be needed to recapitalize the four SOCBs up to the desirable capital/asset ratios (Table III. 5).12 While the clearance of frozen debt in principle represents a welcome step,13 its timing is inauspicious, as it might create the expectation on the part of the SOCBs that they would be bailed out by the State Bank each time the economy and their own performance deteriorates.

Table III.5.Vietnam: Capital Adequacy of State-Owned Commercial Banks, 1998
Sep. 1998RecapitalizationOct. 1998Min. legalDesirableCapital
amount 1/ActualAdjusted 2/capital 3/capital 4/deficiency 5/
(In trillions of dong)
(In percent of total assets at end-October 1998)
Sources: Data provided by the State Bank of Vietnam; and staff estimates.

As per SBV Decisions on Conversion of Loans into Capital for state-owned commercial banks, October 1998.

Capital is adjusted by excluding existing loan loss provisions, and an imputed loss equivalent to 50 percent of overdue loans. Assets are adjusted by excluding 50 percent of overdue loans as of end-September 1998 as nonperforming assets.

As per Decree of the Government on the Legal Capital for Credit Institutions, October 3,1998.

Based on the assumption that capital adequacy ratios should exceed minimum standards established under Basle principles.

Difference between desirable and adjusted capital/asset ratios.

Sources: Data provided by the State Bank of Vietnam; and staff estimates.

As per SBV Decisions on Conversion of Loans into Capital for state-owned commercial banks, October 1998.

Capital is adjusted by excluding existing loan loss provisions, and an imputed loss equivalent to 50 percent of overdue loans. Assets are adjusted by excluding 50 percent of overdue loans as of end-September 1998 as nonperforming assets.

As per Decree of the Government on the Legal Capital for Credit Institutions, October 3,1998.

Based on the assumption that capital adequacy ratios should exceed minimum standards established under Basle principles.

Difference between desirable and adjusted capital/asset ratios.

Profitability and operational issues

18. The Vietnamese banks’ profitability is very low. Two of the four state-owned banks have been reporting zero profits in the past four years. The largest SOCB, which received relatively favorable reviews in international audits conducted since 1994, reported small losses in 1994–95, but its performance improved steadily, and in the first nine months of 1998 its gross return on assets averaged a respectable 0.84 percent. Nonstate-owned banks had an average gross return on assets of 1.4 percent, and a gross return on loans of over 2 percent, in the first nine months of 1998. However, many joint-stock banks faced losses.

19. Governance problems and management weaknesses in Vietnamese banks are widespread. In the present environment, it is difficult for SOCB managers to actively pursue the basic tasks of bankers in market economies (processing information about customers and investment opportunities, assessing risks through contingency-based credit appraisal, spreading risk through asset diversification, managing liquidity through active loan collection and continuous transformation of assets). This state of affairs partly reflects the undeveloped state of financial markets and inadequate legal, accounting, and regulatory framework, but it also resulted from the lack of competition in the banking industry and the predominant structure of ownership, which provides little incentives for bank managers and employees to improve their performance.

20. Weaknesses in banking supervision and prudential regulations contributed to the problems. In particular, the SBV’s licensing criteria were not strong enough to prevent the mushrooming of weak institutions; loan classification is based primarily on the time past due rather than the loans’ credit risk; the loan loss provisions until recently limited the amount of total provisions for bad loans; collateral valuation issues have not been properly addressed; and current inspection procedures focus on statutory compliance with guidelines issued by the State Bank, rather than an assessment of capital adequacy in line with the banks’ risk profiles.

C. Reforms Since 1998

21. Recognizing that the nature and scope of problems in the Vietnamese banking sector called for a comprehensive approach to banking reform, the authorities started in May 1998 to address the problems of the joint-stock banks, and have recently begun developing a strategy to restructure the large SOCBs. On a parallel track, efforts have been underway to strengthen bank legislation and upgrade the enabling environment for banking reform. A Bank Restructuring Committee, headed by a Deputy Governor of the State Bank of Vietnam, was established in early 1998 to oversee reform, particularly of the systemic risk emerging in weak joint-stock banks in Ho Chi Minh City.

Joint-stock banks

22. In mid-1998, the SBV assessed the scope of distress in 18 joint-stock banks in Ho Chi Minh City. Based on triggers that included measures of insolvency, illiquidity, and losses relative to capital, the State Bank intervened in eight banks under two different regimes: a “special control regime,” under which teams from the SBV took over all key aspects of bank operations (deposits taking, however, continued); and a “special supervision regime,” under which prudential oversight was strengthened in order to correct shortcomings in operations, although the existing management continued to run day-to-day operations of the banks. Two joint-stock banks that were placed under the special control regime have since been closed.

23. In early 1999, the authorities prepared a plan to reorganize all 51 joint-stock banks in Vietnam (Box III. 1). Bank-by-bank restructuring plans have also been developed, allowing for the closure/merger of up to eight banks. The plan emphasizes operational reforms, debt workouts, and recapitalization (including through an increase in the foreign ownership limit up to 50 percent of bank capital). Public funds would be used sparingly for recapitalization, and under appropriate conditions for other restructuring operations. Separately, plans for a limited deposit protection scheme aimed at small depositors were prepared. In the next stage of this process, the authorities plan to develop, with assistance from the World Bank, guidelines for establishing a transparent resolution mechanism for handling troubled banks.

24. The authorities are also planning to establish an asset management company (AMC) to facilitate corporate debt restructuring and help the banks reduce the burden of nonperforming loans. The AMC would be funded mostly by the government, and would buy and sell bank loans secured by the collateral that the banks could not liquidate because of the nature of assets, lack of documents, or origin of the loans. Although auction mechanisms were piloted to sell foreclosed collateral, substantial further work is needed on collateral liquidation. A key prerequisite in this area is to improve the enabling legal environment and the functioning of the real estate markets and the court system.

Box III.1.Summary of the Restructuring Plan for the Joint-Stock Banks

In early 1999, the State Bank of Vietnam submitted to the government a plan for strengthening and reorganizing the joint-stock commercial banking system. The main elements of this plan are as follows.


  • 31 urban joint-stock banks (JSBs) (of which 18 bank in Ho Chi Minh City), and 20 rural JSBs.


Establish banks that operate safely, provide services of good quality, have adequate capital and size, and are competitive. The SBV also recognizes the need to reduce the number of weak joint-stock banks, and improve their management and operations.


  • Group 1—Banks with normal operations that need further improvement to become more competitive (8 urban JSBs and 12 rural JSBs);
  • Group 2—Banks facing some weaknesses in activities or inadequate legal capital (7 urban JSBs and 3 rural JSBs). These banks are considered to be viable, but need to strengthen their operations more substantially than the JSBs in group 1, and during this period the scope of their activities must be limited;
  • Group 3—Weak banks with high risk of insolvency and low legal capital that need to be thoroughly restructured (12 urban JSBs and 3 rural JSBs);
  • Group 4—Banks that are insolvent and are subject to license withdrawal (3 urban JSBs and 1 rural JSBs). Two urban JSBs have already been closed.

Implementation strategy

  • Bank strengthening (Groups 1 and 2) would include: amending the banks’ charters; recapitalizing banks to conform with minimum capital requirements (the SBV proposed to raise foreign ownership in some banks to 30–50 percent); replacing management and reorganizing the work of executive, management, and supervision boards; improving the skills of staff, especially in credit operations; and improving the quality of deposit taking, credit, and guarantee operations with a view to promoting safe and sound bank practices, reducing nonperforming loans, and raising profitability;
  • Restructuring would focus on banks in groups 3 and 4. These banks would not be allowed to carry out external payments or expand the scope of activities during the restructuring process, and if their operations did not sufficiently improve, would be subject to license withdrawal. Restructuring methods would include:
  • Mergers (which should be voluntary and would receive government support under certain conditions), and acquisitions;
  • Temporary capital injections by SOCBs and appointment of new management to restructure the operations of a JSB. The additional SOCB shares would be sold once the JSBs are restructured;
  • Placing a JSB under receivership of a strong SOCB or a JSB, to which deposits would be transferred. The receiving bank would be provided with the state funds on a temporary basis to recover debt and liquidate the assets of the bank received. Eventually, the bank’s license would be withdrawn and bankruptcy proceedings initiated.
  • Placing JSBs under SBV’s special control or supervision regime and revoking the bank’s license.


The plan would be implemented in two phases:

  • In 1999, all JSBs would prepare restructuring plans for approval by the SBV. Banks in Group 3 would be placed under SBV’s special control, and an initial round of mergers and closures would be carried out.
  • In 2000, banks in Groups 1 and 2 would strengthen their operations, and the remaining banks in Groups 3 and 4 would be merged or closed.

State-owned commercial banks

25. Efforts to restructure the SOCBs are still at the early stage: international standard audits of four large banks were completed in early 1999; their frozen loans (inherited from the monobank system) were cleared in the October 1998 recapitalization exercise described above; and a general strategy for the sector, including assessments of the four large banks, was outlined in early 1999. Major weaknesses of SOCBs identified in these assessments included high risk profile of the banks’ asset portfolios, low profitability, heavy reliance on lending activities and a low quality of other banking services, costly operations with a large number of staff (estimated at about 40,000 at end-1998, or about 2 percent of the total state sector employment), and inadequate internal controls and information management systems.

26. Based on these assessments, the SBV developed in early 1999 an overall restructuring plan that aims at improving the competitiveness and soundness of SOCBs, strengthening their internal operations and management, and integrating them with the international financial system. Under current thinking, the plan would include structural and operational measures, as well as debt workouts. On the structural side, the emphasis is on separating commercial and policy lending (discussed below). Operational reforms would provide for:

  • Autonomy in the formulation of business plans and the distribution of revenues;
  • Reorganization of management boards and boards of directors;
  • Establishment of independent committees for internal control and supervision;
  • Strategy for streamlining management operations and operational staff, including through staff retrenchment, which would be under the purview of individual SOCBs;
  • Improvements in management information systems and accounting standards, which would be upgraded to comply with international accounting standards; and
  • Improvements in management development and staff training.

27. The plan also considers various options for dealing with nonperforming loans and their macroeconomic impact, but does not make any firm recommendations in this area. As a significant step, the plan sees as necessary the selection of one SOCB for equitization on a pilot basis after the year 2000. The sales of shares would be open to strong foreign banks (under the allowable cap), so as to increase capital and gain management experience. The government is expected to approve the overall restructuring plan in the first half of 1999; subsequently the SBV would develop, with World Bank assistance, business plans for each of the SOCBs.

Policy banks

28. As part of the SOCB restructuring plan, the authorities intend to separate “policy” or directed lending from purely commercial operations. In the first, transitional stage, policy lending would continue through existing SOCBs, but would be clearly separated in the accounts of the banks. In the second stage, “policy banks” would be established as separate institutions, to be funded from the state budget, and with the precise scope of operations defined by the government. The first such bank to be established will likely be Bank for the Poor, currently an affiliate of Bank for Agriculture and Rural Development making loans to poor farmers. In the future, if conditions permit, the authorities will consider establishing an export-import bank and an investment development bank to provide concessional loans for the promotion of exports and infrastructure construction. The remaining activities of the SOCBs would be consolidated and organized on a fully commercial basis.

Prudential regulations, bank supervision, and legal environment

29. The new Law on the State Bank of Vietnam, passed in December 1997, consolidated the existing central banking regulations and clarified authority for monetary policy. The law authorizes the National Assembly to approve monetary policy (rather than the State Bank), and assigns policy coordination to a new Monetary Policy Advisory Council.

30. The Law on Credit Institutions, passed in the same session, requires banks to adopt improved business practices. Pursuant to the two laws, the State Bank began to promulgate during 1998, with MAE and World Bank assistance, 24 new government decrees on monetary policy, foreign exchange issues, prudential regulation and supervision of credit institutions, and other key topics. Although the new prudential regulations still fall short of international standards, improvements have been made in a number of areas:

  • The loan classification scheme began to reflect credit risk assessment, although it remains primarily based on the time past due of the loan;
  • Banks will be allowed to establish loan loss provisions of 20–100 percent of the total value of loans classified in four different loan risk groups (previously, banks had to observe a limit on the aggregate size of loss provisions for tax purposes equal to 2 percent of total loans);
  • The minimum ratio of capital to risk-weighted assets was set at 10 percent for all banks (previously, 5 percent on a nonrisk-weighted bases); the definition of a bank’s capital was strengthened; and conversion of off-balance sheet items to on-balance sheet items was addressed;
  • Banks will also have to observe various prudential ratios to ensure the safety of their operations, including the ratio of medium and long-term loans to short-term liabilities, and the ratio of liquid assets to short-term liabilities. The SBV was also authorized to establish limits on exposure to interest rate risk and liquidity risk;
  • A draft CAMEL framework for assessing a bank’s overall financial condition has been developed, covering the ratings for capital, asset quality, management, earnings, and liquidity.

31. The authorities are continuing their efforts to improve and streamline these regulations, and have also agreed to develop risk-based prudential regulations. On this basis, the SBV intends to strengthen, through a risk-based approach, its supervisory capacity in on-site inspections, off-site surveillance, and accounting and auditing. These improvements should in time enable bank supervision in Vietnam to move closer to the Basle Committee’s Core Principles for Effective Banking Supervision.

32. The authorities have recognized that progress in bank restructuring also will require significant improvements in enabling legal and regulatory environment. In this area, the authorities have undertaken to strengthen the rules on bank licensing, bankruptcy (which now covers enterprises and banks under the same regime), collateral valuation and foreclosure, and the transfer of land-use rights. The need to implement international accounting standards to ensure true and accurate information on the financial condition of banks and bank borrowers has been recognized. To further this work, a new chart of accounts has been implemented by the State Bank and commercial banks as of January 1999.

D. Approach to Banking Reform

33. In recent decades, many countries have experienced banking problems requiring a major and often expensive overhaul of their banking systems (see Sheng (1996) and Sundararajan and Baliño (1991)). As in Vietnam, these problems typically had domestic causes—weak banking supervision and corporate governance, outside interference in lending decisions, inadequate capital, poorly developed financial sector infrastructure—and were exacerbated by external shocks, cyclical downturns, and domestic structural weaknesses. Countries have taken different approaches to resolving their banking crises, with differing degrees of success. Useful and fairly uniform lessons emerged, however, when countries were ranked by the success of their reform efforts, and by comparing the use of the available strategies, policies, and tools for reform (see Dziobek and Pazarbasioglu (1997)).

34. Against the background of these experiences, the authorities’ reform objectives—to develop a safe, sound, and competitive banking sector that will help protect macroeconomic stability, instill financial discipline, and facilitate Vietnam’s international economic integration —are highly appropriate. The prompt action to contain the problems of the JSBs, and the intention to rely on market-based instruments to develop a restructuring program also are pertinent.14 Another welcome element is the emphasis on a comprehensive approach— encompassing the JSBs, the SOCBs, and the regulatory framework—as well as the intention to coordinate banking and SOE reforms. There are, however, some additional approaches from successful experiences that are relevant for Vietnam, and could become part of a more detailed strategy of banking reform. The key approaches can be summarized as follows.

  • Diagnosis of the nature and extent of banking problems is an important component of successful reform programs. It would thus be important to supplement preliminary assessments of the JSBs and the SOCBs with more in-depth analyses of their loan portfolios and operating practices, with a view to preparing detailed business plans for individual banks.
  • Firm exit policies are an integral part of best practices. In order to maintain public confidence in the banking system in Vietnam, it would thus be necessary to develop an effective resolution mechanism for rehabilitating weak but viable joint-stock banks, and for closing the insolvent ones. Such a mechanism typically includes transparent triggers for intervention by bank supervisors; procedures on the timing and nature of actions to be taken; criteria for liquidity support and transfer of deposits to safe banks; criteria for acceptance of rehabilitation plans; and conditions for closure, merger, or rehabilitation.
  • Operational restructuring is seen as a necessary condition for banks to improve their flow behavior and return to profitability and sustained solvency. Key elements of successful operational restructuring typically include:
  • Replacing management, which is usually seen as one of the most important immediate steps to restore confidence, given that management deficiencies often are a major contributing cause of the banks’ problems. In practice, successful banks typically used incentive measures such as closely monitored, performance-related management contracts, which define the responsibilities and the structure of incentives facing directors;
  • Formulating business plans that focus on core products and competencies, and aim at cutting operational costs by selling off branches, reducing the number of staff, ceasing unprofitable activities, and disposing of unproductive assets (e.g., real estate investments);
  • Improving internal procedures for credit assessment, collateral valuation, risk management and pricing, monitoring the condition of borrowers, ensuring payment of interest and principal, and active loan recovery. While the SOCBs in Vietnam already have in place such procedures, they mainly use them mechanically, in order to comply with various statutory rules, rather than as part of their own internal procedures;
  • Strengthening governance structures by enforcing internal controls and audit, improving systems of accounting and asset valuation, and creating internal incentive structures to align the interests of managers and staff with those of the owners. For example, managers and staff should be given strong incentives to disclose the true financial condition of their banks to banking supervisors and the public;
  • Twinning arrangements, whereby reputable foreign banks are hired to lead the operational restructuring of weak domestic banks, and prepare them for equity participation by strategic foreign partners in 2–3 years. Several state-owned banks in the Eastern European transition countries moved very quickly with reform once such twinning arrangements with foreign banks were put in place. Twinning arrangements could be particularly useful in Vietnam, given the binding nature of the human resource constraint.
  • In tandem with operational reforms, banks would typically begin restructuring nonperforming loans, i.e., dealing with their “stock” problem.
  • The priority is usually to arrest further accumulation of bad assets by restricting certain lending operations (for example, new lending to the heavily indebted enterprises and lending without collateral) and any injections of capital and other public resources into the state-owned banks;
  • In cases of successful bank restructuring, a portion of nonperforming loans, typically was removed from the banks’ balance sheets and transferred to a separate loan recovery agency;
  • At the same time, loan workout (foreclosure or asset sales) was initiated to recover some of the costs of bank restructuring and send signals to delinquent borrowers. Especially important in this area are clear legal rules on bankruptcy, land-use rights and property ownership, collateral valuation and foreclosure, as well as the use of internationally accepted standards in accounting, loan classification, and loan loss provisioning. Loan workouts can be done in a central organization, usually operated by the state, or in special loan collection units, usually established in larger banks. Such units manage and work out recoverable but overdue loans, and make realistic loan-by-loan assessments of the banks’ loan portfolios. One advantage of the bank-based loan workout is that it preserves the bank-client relations—one of the most valuable assets in banking—and makes it easier to rehabilitate these relations once the problem loans are repaid. Banks also develop valuable asset resolution skills and assume the responsibility for solving the problem of nonperforming assets;
  • The potential size of the bad loan problem and the cost of its resolution need to be carefully and repeatedly assessed, and different financing options examined, so that this operation does not threaten macroeconomic stability.

Recapitalization is typically the last step in the restructuring process. Once the balance sheets have been cleaned up and operations substantially improved, state-owned banks can be successfully recapitalized, and their commercial operations prepared for partial or full privatization.

Private equity participation in state-owned banks worked well in many countries. More generally, experience from a wide range of countries indicates fairly unambiguously that the goal of developing a sound and efficient banking sector historically could not be accomplished within predominantly state-owned banking systems (see Roulier (1997)). In particular, private ownership that seeks commercial profit lends itself more easily to good governance than does state ownership. From a regulatory perspective, private ownership also offers a separate potential source of capital without tapping fiscal resources. By contrast, state ownership contains significant risks, including:

  • Resources are being wasted trying to recapitalize and restructure banks rather than opening the banks to private equity participation;
  • Conflicts of interest for the state as owner, regulator, depositor, borrower, monetary authority, tax authority, and employer (including to insolvent and unviable bank borrowers) are virtually impossible to avoid;
  • Skill sets and compensation schemes in state-owned banks do not provide incentives to maximize the return on invested funds;
  • In terms of the market structure of banking industry, international experience suggests that competitive and efficient banking systems are characterized by a relatively small number of banks, none of which has dominant market power, supported by a firm financial regulatory framework. The overall number of commercial banks and market power of individual banks thus are typically reduced as a result of bank restructuring, while prudential regulations, banking supervision, and the accounting, regulatory, and legal standards are upgraded to comply with the current international practice.
  • Finally, establishing a level playing field between different types of banking institutions has fostered competition and standardization of banking services, and has helped achieve efficient market outcomes in areas that were traditionally dominated by the state-owned commercial banks. In particular, many countries established a level playing field for foreign banks in the areas of capital requirements, collateral rules, banking supervision, access to the secondary market, and the lender of last resort facilities.

35. While the government’s reform agenda to be accomplished remains large, the progress made in bank restructuring since 1998 is encouraging. Another encouraging sign is that commercial banks themselves are beginning to adjust to a more difficult operating environment. Credit approval procedures are being reinforced more firmly, and closer loan monitoring has become common. Efforts are also being made to address the maturity mismatch between banks’ assets and liabilities by issuing bonds and offering long-term deposits. Local banks have broadened their loan portfolios to include private, small and medium-size firms, and small market traders, while foreign banks have expanded their customer base and lending in local currency.


    DziobekClaudia and CeylaPazarbasiouglu (1997) “Lessons and Elements of Best Practice”inWilliamE. Alexanderet al.Systemic Bank Restructuring and Macroeconomic Policy (Washington: International Monetary Fund).

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    RoulierRichard P. (1997) “Governance Issues and Banking System Soundness”inCharlesEnoch and JohnH. GreenBanking Soundness and Monetary Policy (Washington: International Monetary Fund).

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    ShengAndrew (1996) Bank Restructuring: Lessons from the 1980s (Washington: World Bank).

    SundararajanV. and J.T.Baliño (1991) Banking Crises: Cases and Issues (Washington: International Monetary Fund).

1This chapter was prepared by Dubravko Mihaljek.
2Directed lending includes construction and investment loans under state plan, and onlending of foreign grants. In addition, many loans not classified as directed are believed to be made on the basis of perceived national need rather than on strictly commercial principles.
3The four state-owned commercial banks are: Vietcombank (the major foreign trade bank), Bank for Agriculture and Rural Development, Industrial and Commercial Bank, and Bank for Investment and Development; at the end of 1998, the former two banks accounted for about 22 percent of total banking sector assets each, and the latter two for about 19 percent each.
4This problem is especially acute for small and medium-size firms, which frequently keep very rudimentary accounts, and affects severely the joint-stock banks, which are their main lenders.
5The SOEs are typically allowed to roll over loans for half the length of the original maturity, or for 3–6 months. After renewing the loan once or twice, banks usually classify the loan as past due.
6Together with foreign bank branches in Ho Chi Minh City, JSBs account for 60 percent of total lending in the city.
7Most of these L/Cs were owed by the JSBs after their customers—who purchased goods from foreign suppliers on 12–18-month L/Cs—failed to repay the local banks. Not infrequently, the goods were delivered, sold, and the funds used to speculate in real estate, with the hope that a quick profit could be made before the L/Cs became due.
8An additional source of foreign exchange risk is guarantees offered by Vietnamese banks to their domestic customers; no data on the amount of guarantees are available, however.
9About one-third of foreign currency loans to state-owned enterprises consisted of on-lending of funds borrowed by the government abroad.
10Minimum capital requirements are specified in dong (in U.S. dollars for joint venture and foreign banks), and include loan loss reserves (“reserve capital”) as part of capital.
11The SBV originally made these loans to the SOCBs for onlending to the SOEs. As the SOEs never repaid the loans, the SOCBs’ liability to the SBV was “frozen” (the loans were nonetheless listed as credit from the SBV in the monetary accounts). The loans in question were reclassified as claims on government to recognize the latter’s ultimate responsibility for recapitalization.
12In calculating capital deficiency, capital was adjusted by excluding existing loan loss provisions and an imputed loss equivalent to 50 percent of overdue loans, while assets were adjusted by excluding 50 percent of overdue loans as nonperforming assets. The assumption behind desirable levels of capital adequacy (10 percent of risk-adjusted assets) is that capital adequacy ratios should exceed minimum standards established under Basle principles, and should be highest for Vietcombank (i.e., 12 percent), because it is exposed to greater risk as Vietnam’s major international trading bank.
13Under previous procedures, the Ministry of Finance, the State Bank, and local governments had to certify that such loans could not be collected. The Ministry of Finance would then cover the loss in the form of capital injections.
14Country experiences show that a particularly costly alternative in terms of long-term growth is the recourse to nonmarket instruments of bank restructuring—interest and exchange controls, strengthening of state banking and directed lending to priority sectors, limiting competition, and restricting the scope of banking activities.

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