A strong banking sector is essential for any emerging economy wanting to join the ranks of the developed world. Vietnam lacks one. It has too many lenders, and many of them are weak.
This country of 87 million people has 42 fully fledged banks, including five state-run lenders. Add in foreign bank branches and the number is almost 100.
The banks are vastly unequal in both resources and profile. Volatility in the country’s interbank market lending rates, a war for deposit market share and rising non-performing loans (NPLs) have weakened many of these banks and led to instability within the banking system.
And that poses a danger to Vietnam’s overall economic health.
“Confidence in the banking system in Vietnam is not that high and banking penetration is quite low,” says Ivan Tan, the primary analyst covering Vietnam for Standard & Poor’s (S&P). “Chief among the reasons is there are too many banks.”
Hanoi is not oblivious to this issue. The government has set into motion a grand financial plan with which it intends to reform the country’s banking system by 2015. Among its plans are to eventually privatise portions of the state-owned banks, improve access to foreign banks and merge local banks.
The plans, which the government introduced in October, are widely seen as sensible by analysts and bankers alike. And it is already notching up some successes. On April 25, Hanoi Building Commercial Joint Stock Bank (Habubank) and Saigon Hanoi Bank (SHB) announced a draft plan to merge. Meanwhile Eximbank has taken a stake in rival Sacombank and reformed its board in its favour. A merger looks likely.
But for all these successes, it will not be easy for Hanoi to restructure its entire banking sector in a scant three years.
The difficulties inherent in integrating banks – merging branches, people and brands – will be trying enough, particularly given that most of Vietnam’s smaller lenders will be unable to afford expert international advisory.
Added to that are problems of capital weakness, insufficient risk management and political interference.
For Vietnam’s economy to grow healthily, Hanoi must make its banking reform work. But executing its plans will test the mettle of the country’s communist leadership to the utmost.
A financial failure
The consequences of Vietnam’s weak and fragmented banking system are plain to see. Its banks, many of which fail to meet even Basel I capital-adequacy requirements, are labouring under rising bad loans due to runaway credit growth and poor planning.
This is largely the government’s fault. Following the global financial crisis of 2008, Hanoi encouraged the banks to lend to boost economic growth, while stating that it would not allow banks to fail for fear of the contagion it would cause. Combined with this, real interest rates were low and even negative at times during 2010.
The result? A boom in bank lending by lenders of all sizes. But while the banks lent money at breakneck speed – lending growth averaged 28%-29% in 2010 – the banks did not keep up their deposit-taking at the same rate.
The State Bank of Vietnam (SBV) does not release loan-to-deposit ratio (LDR) data but S&P reckons that the ratio of the banks it covers stood at 95% at the end of 2010, versus 83% in 2007. Business Monitor International (BMI) pegs it at 139% for the end of 2011 and forecasts it will hit 169% by 2015, incorporating an astonishing 435% expansion of loans in just eight years.
“You have a number of small banks that are relatively new; they have grown quite quickly and the asset sides of their balance sheets have grown much more quickly than the traditional deposit component of the liability sides so that’s led to excessive funding through the interbank market at a high rate,” says Dominic Scriven, the chief executive officer of Dragon Capital, a fund with US$1 billion in Vietnamese assets under management.
After hovering below 8% for much of 2010, the overnight interbank lending rate began rising in October of that year to peak at 13% in April 2011. It remained there until recently, when it again dropped dramatically to around 9%.
Meanwhile inflation surged as a consequence of the low interest rates and rapid increase in lending, hitting 23% in August last year.
Hanoi belatedly realised the dangers of unchecked inflation and credit growth. Early last year the SBV began hiking interest rates, raising the refinancing rate and reverse repurchase rate to 15%, while in February 2011 it devalued the Vietnamese dong for the sixth time in two years. It also implemented a tighter credit policy, put a cap on bank deposit rates, increased required reserve ratios, slowed M2 money supply and decreased open-market operations.
It worked; credit growth reduced from a 28%-29% annual average in recent years to 12% last year. But these harsh measures will also heavily crimp economic growth – bad news for companies that have borrowed at interest rates of 18%.
“Once growth slows and inflation slows, businesses will face great difficulties servicing their debts,” predicts Kim Eng Tan, senior director of sovereign ratings for S&P. “There are going to be a lot of defaulters to the banks.”
Even the SBV concedes that bad debts at the banks are likely to rise. Early this year it reported that the banking sector’s bad debts for end-2011 stood at 3.31% of total assets, or VND78.65 trillion (US$3.78 billion), 69% higher than the previous year.
More recently SBV governor Nguyen Van Binh said that revised NPL figures would be between 3.6% and 3.8%. Even this prediction could be low (see box).
Winnowing out the weakest
Today Vietnam’s banking sector is weak, fragmented, undercapitalised and highly exposed to contagion, in an economy where inflation is still around 14% and the currency is volatile. No wonder Hanoi sees the need for wide-scale reform.
The government outlined a plan in October to overhaul the banking system, including capital injections and consolidation, and on November 24 last year governor Nguyen released a roadmap for the reform process.
The announcement lacked detail but not ambition. It didn’t say how many smaller banks will be merged and what constitutes a weak lender. But it did say that merged and restructured banks will be strengthened enough so that they can take on an international marketplace by 2015. And by 2020 the SBV wants to guide the creation of four financial institutions with international scale, one or two of which will be national champions in Southeast Asia.
The latter is ambitious, to say the very least. Vietnam’s biggest lender by assets, the Vietnam Bank for Agriculture and Rural Development (Agribank), had total assets of VND400 trillion (US$19.2 billion) at the end of 2008, according to BMI. By comparison, Malaysia’s CIMB had MYR300 billion (US$98 billion) in assets at the end of 2011 and Singapore’s DBS had SGD348 billion (US$280 billion) at the end of March 31.
The SBV further clarified its strategy on February 13, segregating the banks into four groups based on financial strength and size.
Vietnam’s biggest and strongest banks are in group one. These lenders are allowed to pursue a maximum annual credit growth of 17%. Group two is allowed to grow lending at 15%; group three at 8%; and group four not at all. Foreign branches are not included.
The SBV has not named the banks in each group but the market has its own ideas about who has been classified where. All five state-owned banks are considered to be in groups one and two, along with the stronger joint-stock commercial banks such as Mekong Housing Bank (MHB), Sacombank and Eximbank.
The banks that fall into category four are of particular interest because they will either have to be merged or absorbed by larger, stronger lenders.
“There are 10 banks in category four and if you’re a bank in [that] category and you’re told you can’t grow credit, it’s essentially a death penalty,” says Dragon Capital’s Scriven.
The SBV appears to hope its plan will forcibly create stronger banking entities, while getting rid of some of the industry’s worst business practices.
“If you’re a group four bank and you’re not allowed to grow your loan book at all this year then there’s no reason for you to compete for deposits,” explains S&P’s Ivan Tan, who approves of the SBV’s plan. “And since a lot of the structure – in terms of deposits and price competition – was brought about by the financially weaker banks, this will eliminate the problem of banks offering overly high interest rates.
“Secondly, because you can’t grow your loan book this is a disincentive for you to consider operating as a commercial bank. So your two options are: merge or consolidate so you can improve your standards as a group four or group three bank, or lay off loan growth for a while and improve the capitalisation of the bank again with the objective of getting out of group four.”
The process is already beginning. In December, governor Nguyen announced that three small Ho Chi Minh City-based banks that had already had liquidity problems would be merged. First Joint-Stock Commercial Bank, Tin Nghia Joint-Stock Commercial Bank and Saigon Joint-Stock Commercial Bank (SCB, not to be confused with Sacombank) became a single entity. The new bank – also called SCB – began operations on January 1.
Consolidation contenders
The industry’s reform process will not only impact the weakest lenders.
“In addition to ailing banks being pushed together and being restructured, we would expect some consolidation among healthier banks as well,” says the head of a foreign bank in Vietnam. “The potential tie-ups between the stronger banks aren’t consolidations that are necessarily being ushered in by the SBV; these will be looked at by the respective ownerships of the banks.”
A country manager for an international bank in Vietnam agrees, noting that some stronger lenders will look for opportunities to benefit from economies of scale.
“When you speak to joint-stock banks, even the larger ones, there certainly is a desire to keep growing and you do hear that they are interested in merging if there’s an opportunity,” he says.
Again, this process is just beginning. In January, Eximbank, one of Vietnam’s largest by assets, purchased Australian lender ANZ’s 9.7% share in Sacombank. Then on February 24, Eximbank proposed to elect a new board of directors and supervision board at Sacombank. An agreement was reached in March that tilts Sacombank’s board in favour of Eximbank. The market thinks a merger is imminent.
“Sacombank is always evaluated as the bank that adhered strictly to the SBV’s regulations,” said CEO Xuan Huy Tran when responding to emailed questions about the bank’s plans. “Hence, Sacombank’s strategy is also planned based on the government strategic orientations in each period.”
Tran also said that Sacombank plans to launch “suitable actions”, with regards to the acquisition of smaller rivals along with the SBV’s policy, and that it also welcomes investment from foreign banks.
Eximbank had assets of VND48.6 billion (US$2.3 billion) at the end of 2008, according to BMI. Sacombank’s assets were VND104 billion (US$5 billion) at the end of 2009. A merger would create a bank of size comparable to Vietnam’s large state-owned banks.
“We’re hearing more discussions and rumours of tie-ups between stronger joint-stock banks,” says the foreign bank head.
Then there are the merger aspirations of Habubank and SHB, both of which are considered stronger group one or two banks. Under the plan, Habubank’s name would cease to exist and the merged entity would take on SHB’s name. The entity’s combined assets would be around VND100 trillion, according to press reports – probably lower than a Sacombank-Eximbank merger but in the same league.
Challenges of implementation
The SBV’s plans are bold and well intentioned, if somewhat overdue. But consolidating and strengthening an entire banking system is much easier said than done.
It’s going to be very hard for Vietnam to conduct multiple bank M&As while ensuring that all stakeholders remain satisfied, that the new institutions are robust enough to flourish, and that they keep serving corporate and consumer financial needs.
“The process is a very complex and difficult one and [particularly given] the process of integrating the banks in a Vietnam context – there hasn’t been a lot of precedent for banks merging before,” says Scott Solberg, the head of client management, global banking for HSBC Vietnam.
He notes that the central bank may have underestimated how much time it will take for the banks to get to grips with merging infrastructure platforms, IT systems, risk-management practices, personnel and varying products.
“In a way, M&A is an easy thing to make happen but a difficult thing to make work,” agrees Louis Taylor, Vietnam CEO of Standard Chartered, who has a background in banking M&A.
“We have confidence that the restructuring will occur in terms of addressing the immediate liquidity and solvency issues,” he says. “But in terms of changing governance practice; increasing transparency; improving risk management practices; ensuring compliance with, and enforcement of, a proper regulatory regime - that's quite tough to do in a short space of time.”
Doing this successfully would ideally require some good advice. But Vietnam’s smaller banks are unlikely to be able to afford expensive international advisers to help them conduct M&A transactions.
“My analogy is that it’s like trying to put a three pin plug into a two pin socket," says StanChart's Taylor. “Do you change the plug, do you change the socket, or do you create an adaptor? That’s a decision process you face in every aspect of integrating two banks.”
This is where the SBV should step up. Given the scale of an undertaking done at its behest, the central bank should approach, and help to pay, international institutions that have experience with M&A advisory so they can help ensure the process is completed smoothly. It could also potentially pay two or three banks to advise over multiple mergers of the smaller lenders.
Foreign bankers don’t see this as a likely scenario. The SBV hasn’t been in touch and small banks simply don’t have the size or wallet to be a true business opportunity for them.
Calls and emails to the SBV requesting an interview went unanswered.
A host of problems
Hanoi’s grand bank reform plan has big aspirations, but the execution is rife with uncertainty. All the analysts and bankers that Asiamoney spoke to agreed that the roadmap is a good idea, but that there is a host of points where things could go wrong.
Chief among them is the government’s commitment to such drastic reform.
“Government discipline and commitment are very important for this to be successful,” says S&P’s Ivan Tan. “We usually take these [factors] for granted in developed systems but historically in Vietnam the government implementation track record has been patchy.”
Others see banking consolidation as a small part of a bigger puzzle that includes more responsible credit policy. This will hopefully come with a less unwieldy banking system with fewer weak banks and no debilitating battle for deposits, and an end to mounting bad debts.
Getting a handle on the country’s NPL situation will be an important first step. If the SBV cannot do this, it cannot be certain that it will not do more harm than good through its merger plans. Combining two weak banks with major bad debts is unlikely to result in one big, healthy bank: without sizeable asset injections too, it’s likely to create a bigger lender that will easily cause systemic risk.
“While it is not clear exactly how capital and liquidity support will be given to weak banks going forward, the SBV has done a good job in ensuring enough confidence in the banking system that there have been no bank runs involving queues of people on the streets demanding their cash,” says StanChart's Taylor. “In part this is because they’ve implicitly made it very clear that they won’t let a bank fall over, but what form the support takes, and whether it's the same for all troubled banks, isn’t yet clear.”
Ultimately, the best thing Hanoi could do to alleviate criticism of its banking-sector roadmap is to release more detailed information of how it intends to implement reform. Question marks already hover over its aim to complete the bulk of its consolidation plans by the end of next year.
No one fears that NPL figures pose a systemic risk and most believe that Hanoi will stand behind its banks, particularly the stronger ones.
But to truly consolidate its banking sector in a meaningful and responsible manner, Hanoi and the SBV must far better outline which banks they want to consolidate, specify the support they will offer to troubled lenders, quantify the country’s NPL problems and enlist the assistance of experienced international M&A advisers.
And they must do so quickly, or wave goodbye to any hopes of building healthy regional banks by 2020.
