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Fulbright Research Project / Assigned Country: Vietnam

September 2000 – June 2001

Nam Tran Thi Nguyen

Nam Tran Thi Nguyen
Fulbright Research Paper





















Nam Tran Thi Nguyen
Fulbright Research Paper


The economic development of Vietnam during the 1990’s has been well documented.

Initiated in 1986, the “Doi Moi” or Renovation reforms began the transformation of Vietnam

from a centrally planned economy into a market economy and have resulted in tremendous

economic growth for Vietnam.1 Throughout the 1990’s, Vietnam relied primarily on Foreign

Direct Investment (FDI) and private consumption as the engine of economic growth; and, as long

as growth continued impressively, the government’s commitment and push for structural reforms

faded into the background. In 1996, the Asian Financial Crisis hit most Asian economies.

Vietnam began to feel the effects of the Crisis in 1997 when FDI dried up and state-owned

enterprises posted heavy losses. As economic growth slowed, the structural weaknesses of the

economy surfaced and became the forefront of debates, particularly the fragile state of the

banking sector. The government realizes the importance of an effective banking sector to the

health of the economy and has voiced firm commitments to reform the antiquated sector. In an

effort to shed some light into the nebulous conditions of the banking sector, this paper seeks to

explain the transformation of the banking system from a centrally planned system into a market-

oriented system, delve into the issues that continue to plague the banking sector, and examine the

issues crucial to the development of a modern banking system and essentially, a more

comprehensive financial system.

In order to establish the platform necessary for achieving sustainable growth, Vietnam

must restructure its financial system. An effective and competitive financial system functions as

a mechanism that efficiently mobilizes and allocates capital and contributes to the

macroeconomic stability of an economy. In the case of Vietnam, the current financial system
Vietnam experienced growth of 9% per annum during the first half of the 1990’s.

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can be characterized as rudimentary, consisting of primarily the banking system. Prior to the

reforms of the late 1980’s, the banking system functioned as a credit rationing mechanism, a

mechanism used by the government to distribute capital within the centrally planned economy.

Thus, to understand the state of the financial system of Vietnam and its direction, one must

examine the transition of the banking system from a mono-banking system to a market oriented

two-tier banking system; comprehend the issues arising from the relationship between the

banking system and state sector; and grasp the growing importance of the private sector and the

developing capital markets.

This paper consists of four primary sections. Section I examines the transformation of

the banking system from a mono-banking system into a commercial, two-tier banking system.

This transformation began in 1986 with structural reforms that resulted in the creation of a two-

tier banking system, with banking functions divided between the central bank and commercial

banks. During this restructuring period, the government, acting through the central bank, utilized

interest rate as the primary mechanism for policy implementation. The structural transformation

and policies implemented will be assessed to understand their contributions to the economic

growth of the 1990s, as well as the shortcomings of the banking reforms. A clear understanding

this transformation is crucial to understanding the inherent weaknesses and current fragile state

of the banking sector. Section II dives straight into the current state of the banking system and

the reforms implemented following the Asian Financial Crisis of 1997. In this section, the

ideological and political tie between the banking sector and state-owned enterprise (SOE) sector

will be explored to better understand the reform process and fundamental complications. Section

III examines long-term issues of the banking system and the complexities of banking reforms in

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relations to other reforms, particularly SOE restructuring, private sector growth, regulatory and

framework reforms, and incentive factor. Lastly, section IV looks at the critical issues in

developing a more comprehensive financial system, specifically the development of the stock

and bond markets.

Incomplete reforms of the past decade have left the banking system in a precarious state.

By elucidating the past and present conditions of the banking sector, this paper hopes to provide

the basis for a comprehensive understanding of the banking sector and its direction.

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Prior to the Renovation reforms initiated in 1986, Vietnam functioned under a centrally

planned economy in which the government, not the market, dictated the objectives and modes of

production. In its transition to a market-oriented economy, Vietnam had to fundamentally

change the infrastructure of its economy. In the case of its financial infrastructure, the period

from 1988 to 1992 marked drastic changes, initiated by the structural shift from a mono-banking

system to a two-tier banking system in 1988. Under the mono-banking system, one entity

accounts for both central and commercial banking responsibilities; whereas, under the two-tier

system, the central bank controls monetary policies, leaving the commercial banks to handle

commercial banking activities. Since the initial spurt of reforms, the government has dragged its

feet, partly due to an indirect effect of the glacial pace of SOE reforms. The failure to cleanse

the banking system of the values, objectives and operations of a centrally planned economy

leaves the banking system in a weak and fragile condition. Under such vulnerable conditions,

the banking system cannot perform its role as the financial intermediary and facilitate the process

of capital mobilization and allocation, thus becoming a hindrance to the development and

modernization of the economy.

Banking Structure Before Renovation

Under a centrally planned economy, the mono-banking system functioned as an entity

responsible for implementing financial and monetary policies with the objective of providing the

necessary means for the state sector to meet the targets of production. Formed in 1951, the State

Bank of Vietnam (SBV), formerly known as the National Bank of Vietnam, was entrusted with

both the functions of a central bank and a commercial bank. As a central bank, the SBV

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regulated monetary policy, managed the national reserves and issued banknotes. As a

commercial bank, SBV mobilized savings from the public and allocated credit to enterprises.

From 1976 –1985, the objectives and operations of the banking system can be summarized as


The major task of the Bank is, through its credit supply and monetary
management, to participate in establishing and promoting a planning economy.
The Bank has to increase rapidly credit to ensure capital sufficient for businesses
and production operations of the state sector, helping them develop production in
accordance with the plans.2

Under the mono-banking system, funds were mobilized from households and the state sector and

channeled back to the state sector.


Households SOEs

Saving deposits Mandatory deposits

During this ten-year period, the imprudent use of interest rate mechanism and credit rationing by

the SBV created financial chaos and contributed to the abysmal economic conditions of Vietnam.

By using the banking system to support the state sector and state-owned enterprises, the

government created an environment of dissavings, inefficient capital allocation and inflationary


As a central bank, SBV’s failure to manage interest rate policy contributed to an

environment of dissavings and inflationary pressures. From 1980 – 1987, while inflation rate

escalated, interest rate was virtually at a standstill. As a result, interest rate in real terms reached
Decision of the Fourth Vietnamese Communist Party Congress, Su That Press, 1997, p.45.

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negative levels. Deposits in banks lost value as inflation outpaced interest earned on deposits,

resulting in an environment of dissavings. Households ceased to deposit their savings into state

banks. Instead, they channeled their savings into real assets, such as real estate, gold and foreign

currencies. State-owned enterprises, which were required to establish deposit accounts with the

banks, took advantage of the loose supervision from banks to retain their cash. These SOEs then

used the cash to purchase and hoard commodities in their inventories, which were then sold in

the black market for profits.3 In an environment of negative real interest rates, dissavings from

households and state sector occurred, which in turn drastically reduced the capital available for


In a market economy, interest rate is the price of credit. Depositors supply capital to

banks in return for an interest on the deposited capital. The banks in turn lend the deposited

capital to borrowers at an interest greater than the value of the deposit rate plus the transaction

cost. Under a market economy, a bank will not lend unless interest rate on credit exceeds the

value of interest rate on deposit accounts plus transaction cost, and enterprise will not borrow

unless the benefits of borrowing outweighs the cost of credit. Under the mono-banking system,

interest rates were not determined by the interaction between the demand and supply of credit,

but rather by the needs of the state sector. To encourage investments in the state sector, the

authorities set lending rates at low levels to reduce the cost of borrowing capital. By artificially

suppressing the lending rates, the authorities created excess demand for credit and a gap in

official rates and market rates.4 In other words, enterprises, even those with excess capital,

would borrow to take advantage of the difference between official and market rates. As a result,

Phan, Minh Tue, Literature Review of the Development of the Vietnamese Banking System…, 1998.
Patrick, Hugh and Park, Yung Chu, The Financial Development of Japan, Korea, and Taiwan, Growth Regression
and Liberalization, 1994, p.337-338.

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artificial credit demand increased, while supply of credit fell sharply. By 1985, total credit

outstanding stood at 36 billion VND and total savings stood at 9.4 billion VND.5 Without

external investments and credit, the government had to print money to fill this gap, resulting in

the hyperinflation of the 1980s. At one point, inflation was in excess of 400%.

The misuse of interest rates during this period resulted directly from the practice of credit

rationing. A fundamental tenet of a centrally planned economy is the allocation of scarce

resources, such as capital, to priority sectors. Under such a policy, heavy industries received the

bulk of available credit, while light industries, trade and service sectors remained credit hungry.

Without market instruments, lending was not based on risk assessment but based on government

directives. “Credit has not been allocated according to the principle of highest returns, financial

resources have not been supplied to investment, while they could have been earning real returns.

Thus, credit has been in surplus in areas (for some uses) and in deficit in others.”6 This

undisciplined approach to lending has resulted in high levels of non-performing loans (NPL),

then and today, highlights the issue at the core of the failure of the Vietnamese banking system.

By the mid-1980, the banking system was in disarray. Credit rationing policies distorted

the allocation of resources. Imprudent monetary policies discouraged the mobilization of

savings and contributed to the hyperinflation of 1980s. When Vietnam decided to implement the

Renovation reforms, it also began the reform process for its banking system. In 1988, the

authorities relinquished its mono-banking ideology and created a two-tier banking system to

complement its push towards a market-oriented economy.

Phan, Minh Tue, Literature Review of the Development of the Vietnamese Banking System…, 1998.

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Structural Reforms post-Renovation

The implementation of the Renovation reforms brought two major changes to the banking

system of Vietnam. First, the structure of the banking system took on a new form. In 1988, the

banking system shifted from a mono-banking system to a two-tier system, whereby

responsibilities of a central bank were separated from those of commercial banks. Under the

two-tier system, the State Bank of Vietnam retained the responsibilities of the central bank,

specifically responsibilities for monetary policies. Commercial banking responsibilities were

transferred to the two newly created state-owned commercial banks. By creating a two-tier

banking system, the government had hoped to create a competitive banking system that would

respond more efficiently to the demand and supply of credit, thus creating a system of financial

intermediaries capable of responding to the needs of individuals and businesses in a market-

oriented economy. By structurally unbuckling the commercial banking activities from the

devices of the central bank, the authorities reshaped the system into what it is today. Second,

from 1988 to the Asian Financial Crisis in 1997, the SBV proved adept at implementing interest

rate policies to mobilize funds and control inflation. During this period, interest rate control was

the key ingredient in the monetary policies implemented by the SBV. In theory, under a two-tier

banking system, the central bank aims to stabilize the financial sector and the economy with its

monetary policies. The commercial banks assess those monetary policies and economic

conditions to determine the cost of borrowing and lending, thus dictating the mobilization of

funds and allocation of credit. The reforms of the late 1980s and early 1990s have had a positive

effect on Vietnam's banking system, as evidence in the steady increase in deposits and a

diversification in lending. However, reforms have not gone far enough. As unveiled by the

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Asian Financial Crisis, the two-tier banking system of Vietnam has proved inadequate in its role

of the financial intermediary.

In 1990, the government implemented the Decree Law on the State Bank and the Decree

Law on the Banks, Credit Cooperatives, and Finance Companies, creating the financial

institutions that are present in Vietnam today. Currently, the banking sector is dominated by the

four state-owned commercial banks (SOCBs): Bank for Foreign Trade of Vietnam

(Vietcombank), Vietnam Industrial and Commercial Bank (ICBV), Bank for Investment and

Development of Vietnam (BIDV), and Vietnam Bank for Agriculture and Rural Development

(VBARD). These four banks account for approximately 80% of total lending (see Table I.1). In

addition to the four SOCBs, the banking system includes: 51 joint-stock banks, whose

shareholders include state-owned enterprises and private entities; 23 foreign bank branches; and

4 joint-venture banks.

Table I.1: Features of State-owned Banks

Institution Description Assets Assets
(in billion VND) (% of Total)

As of December 31, 1998

Vietcombank Primary import-export bank 33,683 20.6
ICBV Specializes in industrial finance 33,548 20.5
BIDV Specializes in finance for development 30,714 18.8
investment and infrastructure projects
VBARD An agriculture finance specialist 36,119 22.1
Total SOCBs 134,063 82.0
Joint Stock banks Non-state banks; Ownership consists of 16,349 10.0
private investors and SOEs
Foreign Bank Branches Multi-national banks, such as Citibank 13,079* 8.0*
and ANZ
Joint Venture Banks Joint venture between foreign banks and
state banks
Total Banking Sector 163,491 100.0
Source: State Bank of Vietnam, IMF and Standard & Poor's
* Numbers are inclusive of foreign bank branches and joint venture banks.

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In this paper, discussions on the banking sector will be limited mostly to domestic banks.

Foreign related banks account for merely 8.0% of total bank assets and currently face rigorous

restrictions that prevent them from becoming more active in the banking sector.7 Regulations

restrict foreign banks to receiving only 25% of deposits from non-borrowing customers, thus

limiting the banks’ ability to raise local funds and participate in dong lending. Consequently,

these banks cater to mainly foreign and joint venture companies and large national enterprises

and their involvement are often in the form of trade finance in cross border transactions.

Under this reformed structure, the commercial banks are allowed to set their interest

rates, subject to the restrictions set by the SBV. There are no direct restrictions on deposit rates,

but the restrictions on the maximum interest rate on loans and on the spread on the profit margin

between loan interest rate and deposit interest rate substantially affect the strategies of each bank.

Even with these restrictions on interest rate implementation, the commercial banks have

managed to more efficiently mobilize funds relative to the mobilization efforts in the 1980s.

With the rapid growth in deposits, lending consequently has become more diversified. Overall,

reforms did have positive results…the increase in deposits and diversification of lending marked

the positive trends of the first half of the 1990s.

Capital Mobilization

Throughout the 1980s, savings were in the form of commodities: household savings

went into commodities such as gold and US dollar and corporate savings went into unnecessary

inventories and equipment. By the late 1980s, the liberalization of the economy and the reforms

of the banking sector evoked a shift in private saving behavior. The 1989 reform in interest rate

Foreign related banks include joint venture banks since joint venture banks face the similar regulations and
restrictions that foreign banks face.

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policy in which interest rates on deposits were adjusted from strongly negative to positive real

terms established a fundamental working tool for the banking system to initiate a serious capital

mobilization campaign. As real interest rate became positive, saving deposits became a more

attractive item in saving portfolios. By implementing sensible interest rate policies, the

government and banking sector managed to provide people with an alternative to commodity

savings and was able to harness part of the growing individual wealth that resulted from the

economic boom. Consequently, during the 1990s, bank deposits on average increased more than

40% per annum (Table I.2).

Table I.2: Growth of Deposits

1992 1993 1994 1995 1996 1997 1998
(in trillion VND)
Dong Deposits 8.1 10.6 14.8 22.0 28.3 37.6 49.2
Demand Deposits (1) 4.0 4.8 5.0 6.9 10.2 14.7 18.2
Time Deposits (2) 4.1 5.8 9.8 15.1 18.1 22.9 31.0
(Annual Percentage Changes)
Dong Deposits -- 30.9 39.7 48.6 28.7 32.8 31.0
Demand Deposits -- 10.0 4.4 37.3 48.6 43.8 24.2
Time Deposits -- 41.5 69.0 54.3 19.6 26.6 35.3
Source: State Bank of Vietnam and IMF estimates
(1) Deposits without time restrictions on withdrawals. Nominal rates for demand deposits are minimal, and often
equates to slightly negative real rates.
(2) Deposits with time restrictions (3-month, 6-month, 9-month, 1-year). Nominal rates for time deposits are
higher than those for demand deposits, equating to positive real rates.

In looking at the type of deposits, one should focus on the time deposits. Time deposits

serve as a better indicator of public confidence in the banking system than demand deposits,

since time deposits have the time dimension that demand deposits lack. Demand deposits can be

seen as stashing one's money into the bank to safeguard it from a home robbery, whereas time

deposits can be viewed as investments. The deposit trends from 1989 to 1998 contain two

visible kinks. The first kink occurred during the period of 1990-91 with the collapse of the credit

cooperatives. With a capital base of 862 billion VND, of which only 83 billion VND was their

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own capital, these credit cooperatives lent 791 billion VND. At the end of 1990, overdue loans

stood at 510 billion VND, equivalent to 64.5% of total loans.8 Unable to recollect these loans,

the credit cooperatives collapsed, which quickly eroded the public confidence in the banking

system. Time deposits in banks fell drastically in 1991, as people opted to put their savings in

real assets and commodities. Even those who continue to put their money in banks substituted

time deposits with demand deposits.

In 1992, deposit growth turned upwards as the government pushed interest rates to

positive levels in real term. From 1993 to 1995, deposits grew at a rapid rate, and by 1994,

confidence in the banking system was virtually restored. The government and SBV had

achieved credibility in its adjustments of interest rates to incorporate inflation and ensure a

positive real rate of interest. Besides increased credibility in interest rate policy, public

confidence bloomed as economic growth maintained its impressive rate of 9% per annum, FDI

reached record levels ($ 9.5 billion in 1995), and inflation stabilized. Furthermore, financial

assets, namely savings deposits, became more attractive as non-financial assets stabilized and

even depreciated in value, i.e. the Vietnamese dong (VND) stabilized against the U.S. dollar and

the price of gold dropped. Accordingly, time deposits grew at 69% in 1994 and 54% in 1995.

The second kink in deposit growth occurred at the end of 1996 with the outbreak of the

Asian Financial Crisis. In the wake of the Asian Financial Crisis and the mounting burden of

overdue loans in the Vietnamese banking system, particularly in the joint-stock banks,

individuals became more cautionary with their savings. Growth in dong deposits declined from

48.6% in 1995 to 28.7% in 1996. More drastic is the decline in the growth of time deposits,

World Bank, Vietnam – Financial Sector Review: An Agenda for Financial Sector Development, Report No.13135,
March 1995.

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which fell from 54.3% in 1995 to 19.6% in 1996. However, despite the two visible kinks in

deposit growth, saving deposits overall grew at a rapid pace during the 1990s. Prudent interest

rate policy, coupled with a growing economy and improving macroeconomic stability, played a

pivotal role in the growth of bank deposits. At the micro level, confidence in the banking system

stem from the simplification of banking procedures, particularly at the SOCBs. SOCBs have

improved their computer networks and remittance systems, which significantly simplifies the

transfer of funds between bank branches. Though, remittances between different banks have

seen little progress and remain a major hindrance to the modernization process of the banking

system. Other improvements include the elimination of the disclosure requirement,9 shortening

of the time required to make a withdrawal, and increase in the number of transaction offices

across the country.

Despite the rapid growth in deposits over the past decade, the banking system has made

little progress with the mobilization of long-term funds. Most banks tend to keep saving deposits

for less than six months, due to the uncertainty of the minimum deposit rate set by the SBV.

Banks do not want to incur the risk of a fluctuating interest rate. At this point in time, the SBV

as a central bank has not established itself as a credible and politically independent institution.

Furthermore, after two decades of central planning and various banking collapses, public

confidence in the banking system is still tenuous. And, without a deposit insurance system,

individuals are still weary of depositing their money in the bank for a longer period of time.

Credit Allocation

In modernizing its banking system, the Vietnamese government and banking officials had

to change its concept of credit allocation from credit rationing to the state sector to prudent credit
Prior to 1997, individuals were required to disclose the source of deposit money.

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distribution to state and private sectors base on risk analysis. To a certain extent, the authorities

have achieved success in shifting from credit rationing policies and moving towards a more

diversified credit allocation, as evidence from the increase in credit to the private sector. The

private sector, which accounted for less than 10% of total credit in 1991, has seen its share of

total credit rise to 48% by the end of 1998. Private sector share of credit within SOCB credit

portfolio has also risen. At the end of 1998, SOCB had lent 43% of total credit to the private

sector (Graph I.1).

Graph I.1: Credit Distribution to SOEs and Private Sector

Credit to SOEs Credit to Private Sector

40.0 40.0
Trillion VND
Trillion VND

30.0 30.0

20.0 20.0

10.0 10.0

0.0 0.0
1994 1995 1996 1997 1998 1994 1995 1996 1997 1998

SOCB NonState Banks SOCB NonState Banks

Source: IMF and State Bank of Vietnam

Interestingly, the banking system achieved greater credit diversification despite the

continuing dominance of state banks in lending activities. Throughout the 1990s, SOCBs’ share

of total credit to the economy has remained relatively steady, floating from the high 70

percentiles to the low 80 percentiles. According to the International Monetary Fund, SOCBs’

share of total credit stood at 81.4% in 1999. Overall, credit growth of SOCBs has kept pace with

overall credit growth (Graph I.2).

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Graph I.2: Distribution of Credit

Annual % Change 100.0
1994 1995 1996 1997 1998
T otal Credit
SOCB Credit
NonState Bank Credit

Source: IMF and State Bank of Vietnam

The diversification of credit to both state and non-state sector signifies a positive result from the

reforms of the early 1990s; however, these reforms fall short in dealing with crucial steps needed

to modernize the banking system. Behind the improvement in credit allocation looms three

immediate and important questions: 1) even though the private sector account for almost half of

total credit, does private sector receive equal access to credit as SOE 2) does private sector have

access to different types of credit and 3) is credit allocation really based on risk analysis?

Up until 1996, non-state banks, consisting of joint-state banks and foreign banks, were

steadily gaining shares from SOCBs in the lending market. The flexibility and aggressiveness of

the non-state banks compared to those of the SOCBs enabled them to push credit lending to high

levels during the period of rapid economic expansion. However, it is also the non-state banks'

aggressive and at times undisciplined lending, particularly those of the joint-state banks, that

resulted in high levels of non-performing loans (NPLs). NPLs grabbed worldwide attention

when the Asian economies began spiraling downward in 1996. Both state and non-state banks

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incurred high levels of NPLs, but the collapse of some high profile joint-stock banks in Ho Chi

Minh City channeled the initial wave of criticism and reprimands to the non-state sector.

Clearly, the dominance of the SOCBs within the banking sector has major implications.

First, SOCBs’ umbilical tie to SOEs and political influence translates to unequal access to capital

for the private sector. Legally, there is no discrimination between state own enterprises and

private enterprises. However, SOCBs discriminate against private enterprises in the following

ways: 1) private enterprises often cannot get the bank to issue a letter of credit (L/C) unless they

have deposits with the bank equal to 100% of the amount they wish to borrow 2) private

enterprises cannot use under-construction projects as collateral, whereas state enterprises can 3)

SOEs have state assets to use as collateral and 4) private enterprises cannot utilize their real

property when forming a joint-venture as collateral, whereas SOEs may.10 The relationship

between SOCBs and SOEs will be explored in further detail in a later section of the paper. The

four issues outlined above highlight the obstacle that collateral requirements pose to private

enterprises in attaining access to credit, particularly medium and long-term credit. Enterprises

have strong needs for long-term capital to invest in their infrastructure and equipment, however,

they have little collateral for securing the credit. Banks exacerbate the situation by evaluating

collateral strictly and often setting values of collateral assets at 50% of their market value. Thus,

private enterprises are forced to look for loans from the informal financial sector,

friends/relatives and informal credit market, which consists of groups of money lender and

rotating saving and credit association call hui societies. However, capital mobilized from friends

and relatives is limited and capital from informal credit market is of short maturity and requires

Saito, Hideto, The Current Status of the Financial Sector in Vietnam, May 1997.

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high interest payments. Consequently, these enterprises borrow strictly for working, short-term

capital needs.

The inadequate supply of medium/ long-term capital affects both the state and private

sectors. Banks contend that longer-term loans are difficult to grant because companies generally

are either low profit businesses or even if businesses are highly profitable, they lack the

collateral. Other reasons pointed out by banks include: concern for the rising level of bad debt,

lack of information about the companies and industries, high interests rates, and borrowing

restrictions placed on banks (i.e. limiting lending to l0% of owned capital). All these issues are

valid explanations for the banks' strict stance on lending medium/ long-term capital. However,

the underlying macro issue that obstruct the medium/ long-term credit market, a fundamental

issue that officials must find solutions to before other reforms can be implemented, lies with

banks’ limitations on maturity transformation and restrictive interest rate structure. As pointed

out in the Credit Mobilization section, individuals hold their savings in short-term deposits.

Enterprises, on the other hand, require credit to invest in long-term fixed investments, such as

technology, equipment and infrastructure. As intermediaries, banks must utilize bank deposits to

allocate appropriate credit, which in Vietnam's case require the transformation of short-term

deposits into longer-term credit. Currently, banks are using a method of pulling short-term

deposits with different maturities to change the term and provide longer-term loans.11 The

increased in saving deposits and the utilization of maturity transformations have allowed banks

to steadily increase the proportion of medium/long-term credit as a percentage of total credit.

However, the mismatch in maturities between deposits and longer-term credit substantially limits

banks’ ability to grant longer-term credit. Thus, by the end of 1998, medium/long-term lending
Horiuchi, Akiyoshi, Reformation of Fiscal and Financial System in Vietnam, May 1997.

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in dong denominations accounted for 21% of total lending, whereas working capital loans in

dong denominations still accounted for 47% (Graph I.3).12

Graph I.3: Breakdown of Dong Lending

Total Dong Lending
(% of Total Credit)

1994 1995 1996 1997 1998

Working Capital M edium/ Long-term Other

Source: State Bank of Vietnam

* Other includes mostly construction and investment loans under state plans, and loans by foreign grant and
investment agent funds.

The second underlying issue hindering a more rapid expansion of medium/ long-term

credit resides with the imprudent lending rate structure. In a market-based banking system,

interest rates on long-term lending should be higher than rates on working capital lending to

reflect the maturity and credit risks of the loans. However, in the Vietnamese banking system,

the interest rates on working capital loans has been consistently higher than interest rates on

medium/long-term loans. Again, interest rates in Vietnam are dictated by the SBV. In this case,

SBV places a ceiling on lending rates and throughout the early 1990s, purposefully set lending

rates at attractive levels to induce enterprises to seek out loans to build infrastructure and buy

equipment and machinery. Commercial banks, without incentives to incur riskier loans, are

International Monetary Fund, IMF Staff Country Report No. 99/55, July 1999.

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discouraged from extending longer-term lending. Only since 1996 have interest rates on

medium/ long-term loans outpaced the rates on working capital loans (Graph I.4).

Graph I.4: Real Lending Rates, 1994-1999

Real Lending Rates (%)












Working Capital Fixed Capital

Source: IMF and State Bank of Vietnam

A prudent interest rate structure would provide the proper incentive for banks to issue

longer-term credit. First, in order to effectively meet the demands for longer-term credit, banks

need to find sources of longer-term funding. But, to encourage individuals to invest in long-term

investments, banks must establish their credibility and offer instruments of long-term

investments, such as longer-term certificate of deposits, bonds, etc. At present, the bond market

is weak and ineffective and will be discussed in a later section. Establishing credibility and

gaining the tools to offer more complex investment instruments require that banks improve and

modernize their operational structure and governance. These issues are part of a larger

fundamental problem of the banking sector. As the banking system shifts from a collateral-based

system to a risk-assessed based system, banks must be given the tools to perform their risk

assessments. Internally, the banking system needs strict and consistent standards to classify its

assets and liabilities and improvements in governance and management. Externally, to assess the

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risk of a company, banks need to be able to understand the company’s business and financial

statements and the industry. Politically, the authorities need to sever the political tie between the

banking sector and state-owned enterprises to level the playing field and improve efficiency.

Prior to the Asian Financial Crisis, banking reforms occurred at the macro level, i.e. the

restructuring of banks and banking functions and the liberalization of interest rate structure.

However, following the initial spurt, the pace of reforms has waned. Weaknesses in accounting

practices, banking supervision and regulatory infrastructure leave the banking system fragile and

vulnerable. The Asian Financial Crisis demonstrated to Vietnam that an unstable

financial/banking system could lead to macroeconomic instability and economic fallout. In the

next two sections, the affects of the Asian Financial Crisis on the banking system and current

reforms and long-term outlook of the banking system will be examined.

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From 1992 to 1997, the Vietnamese economy grew at a rate of 9% per annum. During

this period of tremendous growth, large inflows of Foreign Direct Investment (FDI), with

investments coming mostly from Asian countries, and huge imports led to a boom in

consumption and domestic investment. From 1992 to 1996, Vietnam experienced negative net

exports, as imports outpaced exports. However, by 1998, the Asian Financial Crisis cut deep

into the Vietnamese economy as Asian economies froze investments and domestic consumption

slowed, resulting in a sharp decline in FDI and import. Without the surge in FDI and private

consumption, Vietnam’s export growth and productivity growth could not retain the high

economic growth experienced during the first half of 1990’s (Table II.1). Accordingly, the

International Monetary Fund estimates that real GDP growth of Vietnam declined to 3.5% by the

end of 1998.13

Table II.1: Contribution to real GDP Growth

(in Percentage)
1992-1997 1997 1998
Domestic Demand 13.4 1.7 2.3
Private Consumption 9.1 5.8 5.1
Foreign Direct Investment 3.4 3.9 -8.3
Net exports of goods and services -4.6 6.5 1.2
Real GDP 8.8 8.2 3.5
Source: IMF

The Asian Financial Crisis contributed to the economic slowdown in Vietnam by substantially

reducing FDI and domestic demand, but more drastically, the crisis exposed the underlying

structural weaknesses of the economy, particularly that of the state-owned enterprise (SOE) and

banking sector. Years of strong economic growth masked the frail infrastructure and enabled

International Monetary Fund, IMF Staff Country Report No. 99/55, July 1999.

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Vietnam to act sluggishly with structural reforms. Not surprisingly, numerous SOEs suffered

financially during the crisis and the banking sector proved ineffective as a financial intermediary.

The Ailing SOE Sector

As of 1998, there were 5,800 state-owned enterprises in Vietnam. From 1996 to 1998,

the state sector accounted for approximately 42% of GDP, yet its contribution to economic

growth fell from 51% in 1996 to slightly negative in 1998 (Table II.2).

Table II.2: Contribution to real GDP Growth

1996 1997 1998
(Percentage points)
GDP 9.3 8.2 3.5
State 4.7 3.9 -0.5
Nonstate 3.2 2.7 2.9
Foreign invested 1.4 1.6 1.1
(Percent of Total GDP Growth)
State 50.5 47.6 -14.3
Nonstate 34.4 32.9 82.9
Foreign invested 15.1 19.5 31.4
(Percent Share in GDP)
State 42.8 43.1 41.3
Nonstate 49.5 48.3 49.5
Foreign invested 7.7 8.5 9.2
Source: International Monetary Fund
Note: GDP calculations at constant prices 1992-1998.

Clearly, the economic downturn in Asia substantially affected the SOE sector. The economic

downturn resulted in the stagnation of domestic demand and the rise in competition from Asian

countries. Stagnating domestic demand has led to stagnating sales from SOEs and an

accumulation of inventories. The devaluation of the Asian currencies resulted in cheaper exports

from these countries. The relatively cheaper exports from other Asian countries compete directly

with Vietnamese SOEs for market share, and without the cost advantage, Vietnamese SOEs have

difficulty competing against its more efficient Asian counterparts. The Asian economic

slowdown exposed the inefficient and uncompetitive nature of the SOEs. In an effort to assess

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the SOE sector, the Ministry of Finance (MoF) developed a reporting system that categorized

SOEs into three groups. At the end of 1997, MoF reported that 40% of SOEs were considered

“profit-maker”, 44% were “temporary loss-maker”, and 16% were “permanent loss-maker”.

According to the World Bank, even before Vietnam felt the effect of the Asian economic

slowdown, it was estimated that less than two-fifths of SOEs were profitable. The economic

slowdown merely exacerbated a sector already in distress.

As stated earlier, the SOE sector maintains an “umbilical” tie to the banking sector. The

worsening of the SOE sector directly affects the banking sector in two ways. First, bank credit

pumped into unreformed SOEs is a misallocation of scarce capital. According to the IMF, the

increase in SOE credit in 1998 was mostly in the form of directed lending and medium and long-

term loans, suggesting that SOCBs were influenced into making the loans to help SOEs sustain

production and stay afloat. Directed lending includes construction and investment loans under

state plan and onlending of foreign grants. Second, loans to non-profitable SOEs hampers

banks’ portfolios and credit liquidity by significantly augmenting the probability of incurring

non-performing loans (NPLs). Officially, the permanent loss-makers classify 30% of their short-

term loans as overdue and a bank debt to fixed asset ration of around 90%, compare to a ratio of

less than 50% for profit makers. According to World Bank estimates, at the end of 1997 the

temporary loss-maker and permanent loss-maker had debts of approximately 20 trillion and 43

trillion VND, equivalent to $1.4 billion and $3 billion, respectively. In a market where total

credit at commercial banks stand at approximately $7.2 billion,14 the debts incurred by loss-

makers are significant. The economic slowdown simply reduced the number of enterprises

capable of servicing their debts and raised the level of NPLs. If the SOEs do not improve their
Capital Intelligence, National Banking Environment: Vietnam, November 1998.

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operations and become more efficient, banks will have to shoulder higher NPLs, leading to a

decline in capitalization and liquidity and possibly a financial crisis that will require substantial

budgetary support. Clearly, reforms of the SOE sector must be a key component to a thorough

strategy for reforming the banking sector.

Direct Effects of Asian Financial Crisis on Banking Sector

The Asian Financial Crisis and the resulting economic downturn evoked the much needed

awareness to the stagnation of banking reforms in Vietnam, stagnation that has left the banking

system in a state of disarray and vulnerability. The Crisis compelled the government to deal with

the immediate issues threatening the stability of the banking system, specifically the foreign

exchange exposure, the mounting level of non-performing loans, the weak capital base and the

profitability and operational issues of banks. Furthermore, the Crisis revealed the precarious

conditions of the joint-stock banks (JSB), the most vulnerable segment of the banking sector. It

was the default and failure of some major JSBs in Ho Chi Minh City that set off the alarm on the

fragile state of the entire sector. Even though JSBs account for a small portion of commercial

banking activities, but in Ho Chi Minh City, which accounts for one quarter of Vietnam's GDP,

40% of FDI and over half of total exports, JSBs account for more than 25% of banking assets

and together with foreign bank branches account for 60% of total lending in the city.15 The

instabilities of JSBs pose macroeconomic threats to the economy of Ho Chi Minh City, and thus

a threat to the overall economy.

Foreign Exchange Exposure

The banking system’s direct exposure to exchange rate risk is mitigated by prudential

controls. However, banks face indirect exchange risk through their clients. According to the
International Monetary Fund, IMF Staff Country report No. 99/55, July 1999.

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World Bank, approximately one-third of total credit is foreign currency denominated, of which

70% is extended to SOEs. Since enterprises do not have instruments to hedge currency risks and

do not have adequate currency reserves, they face extreme difficulty in servicing their

obligations when the economy experiences a downturn, especially the weakening of the export

sector. In the case of Vietnam, the above situation has translated into a continuing rise in the

overdue of foreign currency loans. Within SOCBs, shares of overdue foreign currency loans

rose from 6.6% in 1995 to 15.4% in 1998. For non-state banks, overdue in foreign currency

loans rose from 1.2% in 1995 to 17.9% in 1998.16

The exchange rate risk is especially high for JSBs, since JSBs make foreign currency

loans far in excess of their foreign currency deposits. The problems with JSBs surfaced in

traumatic fashion in 1997 and 1998 when some large JSBs in Ho Chi Minh City defaulted on a

number of deferred letters of credit (L/C)17, thus triggering negative reactions from the

international banking community. In Vietnam, letters of credit are issued through collaborative

efforts from Vietnamese banks and foreign banks. Vietnamese banks issue the L/Cs on behalf of

local importers; however, foreign suppliers require guarantees from foreign banks before they

accept the L/Cs and deliver the goods. The L/Cs calamity arose when local importers defaulted

on payment for goods and the Vietnamese banks declined to repay the overseas banks. These

defaults were in part due to the economic downturn that created hardships for local importers;

however, a number of the defaults came as the result of local importers pursuing a quick profit.

Local importers imported the supplies and subsequently sold them in the domestic market. They

then used the funds generated from the transaction to speculate in real estate, with the hope of

State Bank Vietnam and IMF estimate.
Letter of Credit (L/C): a bank’s promise that goods will be paid for upon presentation of shipping documents. L/C
is a tool used to facilitate foreign trade.

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making a quick profit before the L/Cs came due. When economic growth halted and real estate

speculations faltered, companies could not generate the funds to make payments on the L/Cs. As

payments became overdue, JSBs had to assume the obligations of the L/Cs. By the end of 1998,

Vietnamese banks owed approximately $200 million to foreigners, with more than 100 million

owed to Korean companies.18

Poor Asset Quality

The L/Cs problem points to a more alarming issue that besieges the entire banking sector,

the issue with non-performing loans. The problems with the letters of credit reflect the

deteriorating balance sheets of joint-stock banks. At the end of 1998, NPLs at JSBs stood at

17.5%. Recently, with the market volatility and economic slowdown, authorities estimated that

NPLs at JSBs to be at 30 – 40%, an astounding figure but a figure that is still far below estimates

by the IMF using internationally accepted standards. The precarious situation with JSBs can

potentially have adverse affects on the overall economy. However, a more pressing concern for

the authorities is the increasing level of NPLs within the state-owned banks, which if left

unchecked has the potential to evoke a financial crisis and thus, an economic meltdown in

Vietnam. According to the SBV, non-performing loans at SOCBs account for approximately 12

– 14% of total assets in mid-1999 compare to 5% of total assets in 1995. However, based on

audits using international standards, NPLs at state-owned banks were estimated to be 30 – 35%

of total loans at the end of 1997.19 Any further increases in the levels of NPLs could lead to

liquidity problems and declining capitalization. In the short-run, these problems require

budgetary support and translate to an increase in fiscal cost for Vietnam. The World Bank and

Schiffrin, Anya, “Cleaning House”, The Vietnam Business Journal, August 1999.
IMF, IMF Staff Country Report No.99/55, July 1999.

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IMF estimates that the cost of bank restructuring, i.e. writing-off unrecoverable loans and re-

capitalizing banks, would increase 1 or 2% of GDP annually from the existing capital cost

estimate of 8 – 10% of GDP per annum.20 In the long-run, an incapacitated banking system

cannot efficiently mobilize and allocate capital within an economy, and thus hinders economic

development and growth.

Weak Capital Base

Another threatening problem facing the banking sector is the weak capital base.

Recently, the government issued a requirement that state-owned banks meet the minimum capital

base requirement of $100 million; however, by international standards, these nominal terms are

still relatively small. A small capital base substantially restricts the flexibility of banks in

allocating capital and confines the diversity of banks’ portfolios, which essentially exposes the

banks to greater internal and external shocks. On paper, the capital to asset ratio of 5.0% and

capital to total loans of 8.6% for SOCBs indicate that SOCBs are adequately capitalized.21

However, the absence of reliable disclosures, particularly with loan loss provisions and non-

performing loans, cloud the validity of the ratio. By convention loan loss provisions are counted

as capital reserve. The actual level of loan loss provisions within the SOCBs should be much

lower than official numbers since a large portion of those provisions should have been written

off to reflect the true level of non-performing loans. Thus, capital must be adjusted to reflect the

appropriate level of loan loss provisions. Total assets also must be adjusted to exclude the over

due loans that should be classified as non-performing assets. Under more stringent guidelines

IMF and World Bank, “A Framework for Cutting Losses of SOEs,” August 25, 1999.
Joint-stock banks had an average capital to asset ratio of 18.5% and capital to total loans ratio of 30%. However,
an SBV assessment in 1998 revealed that many of the JSBs were severely undercapitalized and much of the capital
came from borrowed fund. IMF Staff Country Report No. 99/55, July 1999.

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for reporting and classifying non-performing loans and loan loss provision, the capital to asset

ratio should reveal that the capital base of SOCBs is actually very weak. It is not surprising that

a weak capital base plagues the SOCBs. These banks experience very low profitability and have

difficulty generating capital. Of the four state-owned banks only two have reported profits

during the past four years. Also, they are state-owned and thus do not have access to private

capital investment. Lastly, budgetary support from the government is minimal; however,

bailouts are often advised against since they create expectations that the government is prepared

and willing to support and assist in bailouts when difficult circumstances arise.

Regulatory and Operational Issues

It is well understood that the underdeveloped nature of the financial system and the

inadequate state of the legal, accounting and regulatory framework hinder banks from pursuing

its basic market-oriented banking tasks. Furthermore, the inadequacies of banking supervision

and regulations prevent the banking system from shifting to risk-based assessments. For

example, loan classification is still based on time past due rather than on the loan’s credit risk,

issues with collateral valuation have not been defined and settled and loan loss provision until

recently was restricted to a maximum of 2% of total loans.22 In addition to the regulatory and

operational issues, the incentive issue presents a formidable obstacle. The Vietnamese banking

system simply does not provide incentives for bankers to operate in a market-oriented manner.

This incentive issue will be explored in a later section of the paper.

The 2% restriction on loan loss provisions was implemented for tax purposes, i.e. to prevent banks from eluding
taxes by writing profits as loan loss provisions.

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Current Banking Reforms

As summarized by the World Bank in a report published in December 1999, Vietnam:

Preparing for Take-off, the Vietnamese government has developed a five-track reform program

that includes: restructure JSBs, restructure SOCBs, improve regulatory, supervisory and legal

framework, leveling the playing field for all banks, and developing the human resources in the

banking sector. As of 1999, the following measures have been implemented:

• Completed financial assessment by SBV of all 52 JSBs and independent diagnostic audits
of the four SOCBs by international consultants;
• Issued regulations on “Special control” regime including revoking licenses of troubled
banks and “special supervision” regime which strengthens supervisory oversight;
• Closed four JSBs in Ho Chi Minh City, placed another six JSBs under SBV’s “special
control” regime and merged two JSBs;
• Initiated development of legal framework for removing non-commercial lending
activities from SOCBs: submitted to the government a plan to shift the Bank for the Poor
into a Policy Bank to lend to socially targeted groups and issued a decree to establish a
Development Support Fund to be funded by the budget to provide loan guarantees and
interest subsidies for strategic purposes;
• Issued several prudent regulations for banking operations.

Clearly, most of the measures mentioned above were undertaken to deal with the most

threatening issue of the banking sector, the precarious conditions of the joint-stock banks. The

other measures address the core problem of the SOCBs, the banks’ non-commercial lending

activities. However, those measures are at this point merely proposals. SOCBs are still trying to

develop a restructuring plan, and implementation is still far off. As for improving regulations,

the SBV has issued new regulations regarding prudential ratios, limits on lending to a single

borrower, and clearer standards for classifying loans and loan loss provisions. The liberal

classification of loans under the old regulation was a major impediment to an accurate

assessment of the health of the banks. However, the new regulation fails to rectify the core issue,

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which is the need to disclose and classify the whole value of the loan overdue when any part of

the principal or interest is overdue.23 If the SOCBs were to switch to international standards for

classifying loans, about 35 – 40% of total loans would be classified as non-performing loans,

which would greatly reduce the asset levels of all banks. This explains why the government and

SBV have not acted aggressively in reforming the classification of loans. Clearly, still much

more work needs to be done to incorporate international accounting standards into the banking

system and move towards a risk-based system.

Currently, loan classification remains primarily based on the time past due, rather than on the risk of the loan.
This current scheme does not reflect the probability of loss.

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The Asian Financial Crisis in 1997 devastated the economies of Asia. The Crisis

signified the importance of a stable financial system to economic stability and growth. Over the

next three to four years, the Vietnamese authorities will focus on implementing a Three-Year

Agenda aimed at developing a healthy banking system. The table below is a World Bank

summary of the government’s three-year agenda (Table III.1).24

Table III.1: A Three-Year Agenda to Develop the Banking System

Restructuring JSBs and SOCBs
• Create a sound and transparent mechanism for resolution of failed/ troubled financial institution.
• Implement regulatory framework for all 51 JSBs and action plans for all JSBs in phases.
• Establish an Asset Management Company (AMC) to facilitate corporate debt restructuring. AMC
would buy and sell bank loans secured by collateral that the banks could not liquate because of the
nature of the asset, lack of documents, or origin of the loans.
• Agree on key elements of the restructuring plans between the government and SOCB involving
strengthening management, resolving NPLs and developing phased capitalization.
• Complete detailed restructuring plan for each SOCB and develop an implementation table.
• Equitize one of the four large SOCBs by the end of 2002.
• Remove non-commercial lending activities except when there is a specific government guarantee.

Strengthening Legal, Regulatory and Supervisory Framework

• Adopt the international standard for classifying NPLs.
• Adopt regulations that prohibit lending to shareholders and directors.
• Move towards risk-based approach to bank supervision.
• Develop plan to upgrade accounting standards and systems to international standards.
• Initiate training programs for banking staff in credit risk management.

Leveling the Playing Field for All Banks

• Relax restrictions on dong deposit mobilization by foreign banks.
• Ensure that SOCBs have no preferential treatment relative to JSBs.

At this point, reforms are focused on the near-term health of the banking sector, i.e. the

containment of the problems with JSBs and the shifting to market-based instruments and

internationally accepted standards. The government’s medium-term reform objectives, as

outlined in the three-year agenda, are appropriate. However, to implement these reform

World Bank, Vietnam: Preparing for Take-off?, December 1999, p.35.

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objectives requires strenuous commitment, the commitment to establish a modern and

competitive financial system. Vietnam must concentrate on the short and medium-term reforms

but maintain focus on the long-term objective. In order to achieve its of goal developing a

modern, sound and competitive banking sector, Vietnam must deal with the fundamental issues

of 1) creating the infrastructure and environment necessary for the implementation of banking

functions and 2) providing incentives for people and institutions to pursue banking activities

according to the law and in competitive manners. These two fundamental issues will be

examined in context to the development of a regulatory framework and operational

infrastructure, the reforms of the state-owned enterprise sector, the growth of the private sector,

and the incentive factor to clarify and offer insights into long-term reforms and objectives.

Development of Operational Infrastructure and Regulatory Framework

As mentioned above, the development of a regulatory framework and operational

infrastructure is crucial to banking reforms, not to mention to overall economic reforms. In the

past three years, the government has passed new laws and decrees to strengthen the banking

sector. New bank regulations have resulted in improvements in a number of areas, such as

clearer loan classification, more robust loan loss provision, and stronger capital to asset ratio.25

To enforce these new regulations, banks need to restructure its operations. Key elements to

operational restructuring include:

• Investments in Human Capital. Replace the old management team with a capable team
and equip bank officers with skills to carry out basic banking duties. At this time in
Vietnam, firing workers represent a major headache for firms, not to mention firing
management. Also, with the scarcity of banking professionals, replacements would be
hard to find. Under these circumstances, the near-term solution is to train a number of
Vietnamese bankers at the management level and perhaps import bankers from abroad.

Refer to IMF Staff Country Report No. 99/55 by International Monetary Fund, July 1999, for detail.

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The long-term approach is to create incentives for people to enter the banking profession
and establish well-developed training programs.
• Improve Internal Procedures. Banks on a constant and procedural basis must examine its
credit conditions, collateral valuation, borrowers’ performances, and capital intake from
loan repayments and interest payments. These procedures increase the probability that
banking regulations are being followed.
• Strengthen Governance Structure. Banks must create incentives for management and
employees to enforce internal controls and audit.
• Engage in Twinning Arrangements. Vietnamese bankers do not have much experience
managing market-oriented, risk-based banks. By engaging in twinning arrangements, a
Vietnamese bank can hire a reputable international bank to help with its operational
restructuring in return for equity participation by the international bank 2 to 3 years down
the road. This arrangement enables domestic banks to utilize financial professionals and
their expertise for the restructuring process, a valuable option especially since Vietnam
lacks experienced banking professionals.

These banking regulations and operational reforms are specific to the banking sector. In

conjunction to these sector-specific reforms, the government must also focus on the legal and

regulatory reforms that affect all aspect of the economy; for without these legal and regulatory

reforms, banking reforms would be virtually non-applicable.

It is said that Vietnamese enterprises have three sets of financial books: one for the

authorities, one for the World Bank/IMF, and one for internal purposes. The government

recognizes the importance of tightening accounting standards and the need to shift to

international accounting standards to ensure accurate information and financial reporting at both

enterprises and banks. Currently, laws on accounting and auditing are weak and not enforced.

Clarity and transparency are still a long way from becoming the norm in Vietnam due to its

secrecy laws. The state still has vast power over institutions and enterprises as legitimized by the

State Secrecy Act. In other areas, authorities have focused and undertaken steps to strengthen

regulations on bank licensing, bankruptcy, collateral valuation, and foreclosure. However, in the

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long-run, these reform measures are futile if the government continues to adhere to such

ideologically incompatible laws as the State Secrecy Act.

Reforms of the State-owned Enterprise Sector

As documented in this paper, the state-owned enterprise sector maintains an umbilical tie

to the banking sector and is the primary culprit for the heavy NPLs experienced by banks. When

the government initiated SOE reform in 1989, it began with the consolidation of the SOE sector

and a drastic cut in direct budget subsidization to SOEs.26 From 1989 – 1992, the consolidation

process drastically reduced the number of SOEs from 12,000 to 6,000, mostly through mergers

and closures. In theory, the cut in direct subsidies from the government brings about more

financial and operational discipline within the SOEs. In the case of Vietnam, the lack of state

funding was offset by privileged access to scarce capital from other sources, particularly credit

from state-owned banks. Banking regulations heavily favor SOEs, as exemplified in a recently

introduced law that abolished the need for SOEs to provide collateral in obtaining state funding.

A banking law that requires the SBV to act to “facilitate social economic development in a

manner consistent with socialist orientations” best summarizes SOEs’ privileged access to the

banking sector.27 “State-owned credit institutions may extend unsecured loans pursuant to the

direction of the government. Any loss on such loans occurring as a result of objective reasons

shall be dealt with by the government.”28

In other transitional economies, authorities have pursued SOE reforms through

aggressive privatization schemes. In the case of Vietnam, SOE reforms began with a strong

spurt with the consolidation of the sector from 1989 – 1992, but thereafter have progressed

Prior to reforms, state funds had to be provided to the SOEs to cover their ongoing failure to meet their budgets.
Article 1.3 LSBV.
Article 52 LCI.

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painstakingly slow. The government established equitization schemes in 1992.29 However, from

1992 – 1997, only 17 SOEs were equitized. The slow progress has been the result of a number

of factors…most importantly, owning government bodies have been unwilling to give up control

and managers and workers have been unwilling to trade in the social safety net and security of

state ownership for the risk and rewards of a market economy. Furthermore, the authorities still

emphasize the importance of SOEs to the growth of the economy. In a speech in March 2001,

Le Kha Phieu, the general secretariat of the Communist Party from 1996 to 2001, declared

“state-owned enterprises must play the primary role in the growth of Vietnam.” Under such

mindset and approach, it is no wonder that enterprise reforms progressed extremely slowly

during the 1990s. Not surprisingly, it took the Financial Asian Crisis and economic downturn to

bring the issue of SOE reform back to the forefront of policy debate. The glacial pace of SOE

reforms has two direct repercussions on the banking system: 1) the unprofitability and inability

of SOEs to service their loans has resulted in unstably high levels of NPLs and 2) the large

presence of the SOE sector in the economy and its preferential treatment by the authorities

squeezes the private sector from the tight credit market.

In the long-term, the government must push more aggressively with SOE reforms,

particularly hastening the pace of equitization. Equitization changes the structure of ownership

and provides management and staff with incentives to improve performance and achieve

profitability. A smaller and more efficient SOE sector eases the burden on the government (and

fiscal budgets) and the banking sector and strengthens the private sector. In 1998, the

government picked up the momentum of SOE reforms by equitizing 39 SOEs. In 1999, 149

Equitization is the conversion of state-owned enterprises into joint stock companies. The Vietnamese government
uses equitization as the official term in place of privatization.

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enterprises were equitized, followed by another 350 enterprises in 2000. Despite the recent pick-

up in the pace of equitization, the ratio of SOEs equitized against the number scheduled under

the restructuring program is still low (Graph III.1). Authorities plan to consolidate another 3,800

SOEs, either by equitization, merger or bankruptcies, by 2005.

Graph III.1: Slow Pace of Equitization

400 100%

350 90%
300 No. of companies equitized
Accumulated equitization ratio* 70%
250 60%

% Ratio

200 50%

150 40%
50 10%
0 0%
1993 - 1997 1998 1999 2000E 2001E
*Note: The equitization ratio refers to SOEs equitized against the total number scheduled for equitization
Source: World Bank, CSFB

Given the Vietnam’s track record in recent years, the achievability of the plan seems out of

reach. To increase the pace of equitization, authorities must cope with the entrenched interests

of SOE managers, workers, local officials and even ministry officials. At the ministry level,

authorities must establish a firm commitment to develop and implement a comprehensive reform

program. At the worker level, strengthening the social safety net to support laid-off individuals

is a must. These safety nets must aim to compensate workers for their loss incomes during the

period of unemployment as they transition to new jobs and provide the training support to

improve worker mobility.

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The SOE sector is clearly a drag to the economic health of Vietnam. SOEs consume

bank credit and other sources of scarce capital. Their protected monopoly hinders competition

and private sector involvement, which essentially hinders increased efficiency and higher

economic growth. Reforming the SOE sector is vital to the reform process of the banking sector,

as well as the long-term health of the economy.

Growth of the Private Sector

In the past, Vietnam has placed the primary emphasis on the state-sector as the organic

engine of growth. However, the SOE sector has proven highly inefficient and represents a major

impediment to the health of the banking sector. The private sector, consisting of farmers,

household enterprises, private small-medium enterprises (SME) and foreign invested enterprises

and accounting for 51% of economic output, has the potential to become the engine of economic

growth and macroeconomic stability. In order to harness the potential of the private sector, a

range of reforms must be implemented, such as trade, private investment, SOE, and banking. In

this paper, private sector growth will be examined in context with SOE and banking reforms. A

vigorous private sector can unleash the human capital potential of Vietnam. For years, Vietnam

has been known for its capable and hard working labor force. The population currently stands at

85 million with over 50% under the age of 25 and over 90% is literate. By leveling the playing

field for all enterprises, both state and private, particularly equalizing access to bank credit,

Vietnam can harness the potential of the private sector and its human capital.

One of the major impediments to the growth of the private sector is the inadequate access

to capital. During the past decade, credit to the private sector has grown to approximately 49%

of total credit. This growth was promising, particularly to the agriculture sector, which received

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the bulk of the credit. However, for SMEs, faster credit growth did not translate to equal access,

especially in terms of medium and long-term credit. Access to medium and long-term credit is a

problem for all enterprises, but private enterprises face a tougher hurdle than SOEs because of

collateral requirements. SOEs do not need collaterals to obtain loans, whereas private

enterprises must meet high collateral requirements, a narrow field of acceptable collateral assets,

and low collateral valuations by banks. Clearly, the bulk of medium and long-term credit goes

straight to SOEs. Without access to longer-term credit, private enterprises cannot investment in

technology and infrastructure developments necessary for expansion. Private enterprises,

specifically SMEs, are forced to work with sub-optimal equipments and factories. SMEs are

highly export oriented and operate in labor-intensive sectors like garments, seafood, footwear,

and plastic products. Vietnam’s competitive advantage lies with these labor-intensive, export

oriented sectors; hence, it is imperative that authorities allow private enterprises more flexibility

and better access to capital to take advantage of such opportunities. Conversely, the growing

importance and modernization of the private sector undoubtedly will provide additional pressure

for the authorities to reform the banking sector. From the perspective of the private sector,

banking reform will improve the situation with NPLs, increase liquidity, lower policy oriented

lending to SOEs, and give private sector greater access to banking credit. Furthermore, a

comprehensive reform of the banking sector necessitates a similar push with reforms of the SOE

sector. SOE reforms, specifically equitization and divestitures, could enlarge the SME sector by

adding more enterprises and thus, jump-start the private sector. As pointed out by Oleh

Havrylyshyn and Donal McGettigan in a recent report, the implementation of comprehensive

equitization schemes, in conjunction with reforms to improve the private sector, is key to SOE

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reforms.30 In other words, private sector, SOE, and banking reforms are each indispensable

aspects of each sector’s reform agenda.

Incentive Factor

At the heart of Vietnam’s economic struggles lies the entrenched system of a centrally

planned economy, a system that lacks the incentive factor. Under the centrally planned system,

the State set specific physical targets for each state enterprise in each sector and even specifies

where to obtain inputs for production, what technology is appropriate, and where to sell the

products. Neither employees nor citizens had incentives to maximize efficiency or exceed

expectations. The same mentality applies to the banking sector, and in a market-oriented

economy, the lack of incentive hinders bankers’ judgment and impedes bankers’ from taking the

necessary risks in a risk-oriented market. The authorities can reform banking regulations and

framework, but without a thorough change in ideology to provide the proper incentives for

bankers, a risk-based commercial banking system will be hard to achieve.

In Vietnam, bankers avoid taking risks in lending credit, especially to private enterprises,

since a bad loan can send the bankers to jail. The monetary incentive for bankers to take such

risks is minimal, and the chances of the loan becoming a bad loan are too high. Bankers are at

the mercy of a statue that gives the authorities the power to press charges against them using the

accusation of harboring “the intention to contravene and cause serious consequences making loss

of Socialist properties.” Consequently, banks tend to play safe by lending to SOEs and setting

high collateral requirements and low collateral valuation to discriminate against the more risky

private enterprises. At present, offences committed in businesses and trading activities are

Oleh Havrylyshyn and Donal McGettigan, Privatization in Transition Countries: A Sampling of the Literature,
1999, WP/99/6.

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considered criminal offences. The current civil law in Vietnam does not issue sentences severe

enough to punish business and trading offences; therefore, the authorities send these cases to the

criminal court with the objective of deterring others from committing such offences.

Specifically, when an enterprise is charged with offences, the banker/s involved in lending to the

accused enterprise also take full responsibility. The authorities accuse the banker of

irresponsibly granting huge loans to the accused enterprise, which contributed to the enterprise’s

offences, and due to the banker’s lack of diligence, the loans will turn into NPLs and result in

losses to the State. To further highlight the problem arising from an inappropriate incentive

scheme, take for an example a banker who faces a situation whereby a loan to an enterprise

temporarily becomes a bad loan. The banker must decide either to refinance the loan to aid the

enterprise through its temporary hardship or begin the process of foreclosure. By foreclosing the

enterprise, the banker takes away the opportunity for the enterprise to withstand the hardship and

perhaps surface later as a fully functional business. If the banker decides to extend the loan and

refinance and the enterprise eventually collapses, then there is some probability that the banker

will be charged with “the intention of causing losses to State properties.” Under such

circumstances, the banker will likely not extend the loan, since the repercussion outweighs the

minimal financial compensation. During the past few years, SOCBs have been criticized for not

aggressively utilizing idle deposits, i.e. for not fully utilizing deposits as lending credits.

Without a proper incentive scheme, bankers’ hesitation is not surprising. Clearly, in order to

establish a modern, risk-based banking system, the authorities must provide the proper incentives

for bankers to take the necessary risks…the authorities must create a system of risk and reward

to incentivize both bankers and employees.

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The crux of this paper has focused on the past, present and future of the banking sector.

Banking in Vietnam is still fairly basic, consisting of mostly short-term deposits and short-term

lending. The economy needs a stable system and more importantly, a modern system to support

a modern economy. At present, Vietnam must concentrate on reforming the banking sector, but

it must also focus on developing the capital markets, particularly the bond and stock markets.

The presence of capital markets would provide an alternative venue for the allocation and

distribution of capital and ease the credit burden of the banking sector.

Stock Market

The stock market plays an integral part in the mobilization of capital, especially in a

modern economy. In the case of Vietnam, a stock market would not only facilitate capital

mobilization but would also provide more impetus for SOE reforms, specifically impetus for

equitization. After a decade of delays and frustrations, the stock market in Ho Chi Minh City

(HCMC) finally opened in July 2000. The opening of the stock exchange marks an important

step in building a modern financial sector, but much more needs to be done to broaden the role of

the stock market. Currently, the stock market is highly restricted, both by regulations and

uncertainty. The market is limited to nine hours of trading per week and stock prices are

restricted to movements of no more than 2% of their opening prices. Furthermore, the

authorities have set stringent eligibility requirements for listing on the stock exchange. Stringent

eligibility, coupled with enterprises’ uncertainty about the stock market, has resulted in only four

listed companies. At present, companies are skeptical about listing on the exchange, mostly

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because listing would require financial disclosure. Consequently, the exchange today consists of

four listed companies and a series of government bonds.

Investors have greeted the stock exchange enthusiastically. Stock prices have soared.

Investors line up at security companies two hours before they open to buy shares, signifying the

unbalance state of enormous demand and insufficient supply. After a decade of waiting,

investors are hungry for shares and have the capital to buy them. The State Security

Commission (SSC), the entity responsible for the regulations and operations of the stock market,

needs to act aggressively to increase company listings. More importantly, the SSC must

cooperate tightly with security companies to develop an underwriting program. With the current

listing process, companies merely register to make shares available for trading; meaning no

capital is raised for the company. An underwriting program would create the venue for

enterprises to raise capital for investments and entice enterprises to view the stock exchange

more positively, since the capital generated from the underwriting goes directly to the

enterprises. Furthermore, a stronger stock market would provide more impetus to improve

regulatory framework and pursue reforms, including banking, SOE and private sector reforms.

Bond Market

In addition to the stock market, the bond market represents another venue for raising

capital, especially medium to long-term capital. Currently, the Vietnamese bond market consists

solely of government and bank issued bonds. The bond market is weak and lacks liquidity, i.e.

there is no secondary market for bonds. In August 2000, the SSC permitted round lot bond

trading to occur on the stock exchange in an attempt to stimulate the bond market. However, the

first bond transaction on the stock exchange occurred nine months later in April of 2001.

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Investors have kept their distance from bond buying and selling because bonds yield low-profit,

despite the low-risk investment. With the lukewarm bond market in Vietnam, banks have

requested permission to issue bonds overseas. Currently, there are no corporate bonds listing in

Vietnam; however, PetroVietnam, presently in collaboration with BP Amaco to develop the Nam

Cong Son Oil reserve, is working with Morgan Stanley to issue $300 million of bonds overseas.

Clearly, Vietnam must look overseas to find bond investors and jumpstart its bond issuance. As

the stock exchange expands and domestic investors become more sophisticated, bonds will

become more attractive as investors seek to diversify their portfolios.

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In August 2000, Vietnam took a major step onto the global trade arena when it signed a

trade agreement with the U.S. The agreement will open the U.S. market to Vietnamese

enterprises; a market that experts say is worth $1 billion to the Vietnamese economy per annum.

Furthermore, in another three years, Vietnam’s concessionary status under the AFTA (Asia Free

Trade Agreement) agreement will terminate. At which time, Vietnam will undoubtedly face

heavier competition as it lowers its tariffs on most products and eliminates certain quotas to meet

ASEAN standards. Vietnam at present stands at a juncture: should it aggressively pursue

reforms to take advantage of new found opportunities or play the more politically stable “wait

and see” game and risk falling further behind. Vietnamese people seem all too eager to take

advantage of these new opportunities. They greeted President Bill Clinton with open arms. The

streets of Ho Chi Minh City are littered with Internet cafes and cell phones. Lines form outside

of security companies for the opportunity to invest in the stock market and perhaps the future

“Microsofts” of Vietnam. Parents and students spend hard earned money to take English and

computer lessons to gain the upper-hand in the competitive market for well-paying, office

positions. The people seem to enthusiastically embrace technology and opportunities. Is the

government committed to creating the necessary infrastructure to unleash this enthusiasm and


As pointed out in this paper, reform of the banking sector is crucial to the development

and growth of the overall economy. The banking system acts as the financial intermediary

between the savers and investors and the borrowers (borrowers being both individuals and

enterprises). Individuals need capital to turn ideas into businesses. Enterprises need capital to

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expand and grow. The authorities understand that a competitive banking system that mobilizes

and allocates capital according to the principle of risk and reward is important to the health of the

economy. But, to establish such a system requires a firm commitment to reforms and a break

from the past. A firm commitment to reforms means pushing through with short-term reforms,

i.e. restructuring the joint-state banks, reorganizing the state-owned banks, and setting up a

policy bank; while maintaining focus on long-term reforms, i.e. establishing a credible

accounting and regulatory framework, accelerating SOE and private sector reforms, and creating

the proper incentive scheme. During the past decade, the large inflows of FDI have fuelled

investments and economic growth. Now, as foreign investments dwindle, Vietnam must rely

more on itself for capital. Furthermore, Vietnam wants to modernize its economy; and, a stable

and effective banking system is crucial to the modernization process of an economy.

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Borish, Michael, Long, Milland, and Noel, Michel, Restructuring Banks and Enterprises –
Recent Lessons from Transition Countries, World Bank, 1995.

Capital Intelligence, Vietnam: National Banking Environment, November 1998.

Ibid., Bank Industry Risk Analysis – Vietnam, November 1998.

Citibank Cash Management Asia Pacific, Vietnam, October 2000.

Havrylyshyn, Oleh and McGrettigan, Donal, Privatization in Transition Countries: A Sampling

of Literature, 1999.

Horiuchi, Akiyoshi, The Vietnamese-Japanese Joint Studies Hanoi Workshop Background Paper
– Fiscal and Monetary Policy – Executive Summary: Reformation of Fiscal and
Financial System in Vietnam, May 1997.

International Monetary Fund, IMF Staff Country Report No. 99/55 – Vietnam: Selected Issues,
July 1999.

Ibid., IMF Staff Country Report No. 99/56 – Vietnam: Statistical Annex, July 1999.

Ibid., IMF Staff Country Report No. 98/30 – Vietnam: Selected Issues and Statistical Annex,
April 1998.

Ibid., IMF Concludes Article IV Consultation with Vietnam, August 2000.

Lau, Joseph and Chem, Chia Tse, Vietnam: Cautious Optimism, Credit Suisse First Boston:
Emerging Markets Economics Research, August 2000.

Phan, Minh Tue, Literature Review of the Development of the Vietnamese Banking System and of
the Related Theoretical Debates Since the Late 1980s, 1998.

Sakurai, Kojiro, The Vietnamese-Japanese Joint Studies Hanoi Workshop Background Paper –
Fiscal and Monetary Policy – Macroeconomic Developments Focusing on Monetary
Economy, May 1997.

Saito, Hideto, The Vietnamese-Japanese Joint Studies Hanoi Workshop Background Paper –
Fiscal and Monetary Policy – The Current Status of the Financial Sector in Vietnam,
May 1997.

Schiffrin, Anya, Cleaning House, The Vietnam Business Journal, August 1999.

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Vietnam Banking & Finance Media Monitoring Service, SOE Equitization on NA Agenda Again,
December 2000.

Vietnam Investment Review, Five-point Reform Plan Wins IMF Loan Approval, April 2001.

Ibid., Banking and Finance, April 2001.

World Bank, Vietnam: Preparing for Take-off? – How Vietnam Can Participate Fully in the East
Asian Recovery, December 1999.

Ibid., Vietnam – Financial Sector Review: An Agenda for Financial Sector Development, Report
No. 13135, March 1995.

Ibid., Vietnam – Public Sector Management and Private Sector Incentives, An Economic Report,
Report No. 13143, September 1994.

Ibid., Vietnam – Transforming a State-owned Financial System – A Financial Sector Study of

Vietnam, Report No. 9223, April 1991.