Vietnam’s banks: revived and ready for the Asean Economic Community?

The Bánh mì 25 food stand in Hanoi makes one of the tastiest bánh mì pork baguettes in Vietnam. Although only a small stand on one of the raucously busy streets in the old town, Bánh mì 25 is rated number one for this speciality on travel website TripAdvisor.

When asked how he acquired the capital to set up this small business, the owner says: “I’d pay 11% in interest a year if I took out a loan. They even want my house or car as collateral. Rates were as high as 20% only a few years ago. I charge VND20,000 [$0.93] per baguette and my profit is VND5000 on each one. It doesn’t make sense to get money from the bank.”

The owner received financial support from his family to get Bánh mì 25 up and running. But what about small business owners who are not as lucky?

Small and medium issue

The fact that small and medium-sized enterprises (SMEs) are underserved remains an issue for Vietnam’s banking sector, which is still restructuring after ballooning non-performing loans (NPLs) to state-owned enterprises (SOEs) led to the banking crisis of 2012. According to the State Bank of Vietnam, the country's central bank and financial regulator, NPLs accounted for 4.5% of total loans at the time, though some market participants claimed the number was closer to 20%.

Since then, bankers say a change in thinking has occurred at state and central bank level. Banks are encouraged to speak openly about their loan books and consolidation is being called for to support the smallest and weakest banks in Vietnam, which number about 20.

Putting Vietnam’s banking sector in order is crucial now more than ever as the integration of the Association of South-east Asian Nations Economic Community (AEC) will lead to more foreign competitors entering the market. Successful structural reforms in SOEs, infrastructure and public administration will also be key.

Rebounding from 2012

After Vietnam joined the World Trade Organisation in 2007, the country opened up its economy and followed China’s model of capitalism mixed with heavy state control in some segments of the market. As the economy thrived, some banks were set up without a deep understanding of banking or regulation. This led to the creation of many poorly managed banks.

“A friend once said that the way to recognise Vietnamese tycoons is if they have a Rolls Royce, a beautiful wife and a bank. When the economy was doing well, a bank was seen as an accessory,” says Van Tan Hoang Vo, chief executive of Saigon Commercial Bank (SCB).

NPLs to SOEs were also part of the problem. But if three years ago the NPL issue was taboo, the government is now addressing banks’ difficulties, according to Vijay Kumar Maheshwari, chief financial officer at Asia Commercial Bank (ACB).

The meaning of owning a bank in Vietnam has changed, argues Mr Vo. “[Bankers’ thinking] has come back to what banking really should be. To keep one’s bank, people are now forced to put more money in it,” he says.

After initial steps were taken in 2013 and 2014 to prevent a banking collapse, 2015 will be the year for breakthroughs in Vietnam's restructuring process, says Le Duc Tho, chief executive of Vietinbank, while “2016 could be a time for comprehensive change and a better growth rate”.

Compared with international standards, Vietnam lags behind in regulatory terms – Basel II will be implemented across the market in 2018, while only 10 banks are piloting compliance at present. But banks’ response to Basel II is promising. Sacombank, for instance, is looking to sell a stake of its business to a foreign investor to raise more capital. It also increased capital by cutting dividends to shareholders.

But reform should not be rushed, say market participants. “We are happy to follow international standards, but the standards of the economy may not be at that level yet. If you apply regulation adequate for developed economies to a less developed market, it will harm the economy, not support it,” says Mr Vo.

Consolidation bonanza

The State Bank of Vietnam’s approach to the banking crisis was to consolidate and restructure banks to ensure no bank failed. “It was a difficult choice, but people will also be debating the Lehman decision for quite some time. Given the state Vietnam is in, there is merit in keeping small banks alive and not letting the depositor suffer. This would shake the confidence of the people on the street,” says Mr Maheshwari.

The overall number of commercial banks in Vietnam will need to drop to 20 by 2017, according to the State Bank of Vietnam, down from the current figure of 37. Market participants have welcomed this strategy. “The bank mergers and acquisitions in Vietnam are essential to a healthy banking system,” says Mr Tho.

“Progress across the industry showed a positive trend in accordance with the targets and principles set by the central bank,” says Tran Phuong, deputy chief executive at the Bank for Investment and Development of Vietnam.

To Mr Phuong, SCB – the first merger in the state’s consolidation campaign – is a success story. The bank was generated from a three-part commercial merger in 2012 involving First Bank, Tin Nghia Bank and Saigon Bank, without the state’s financial support. Shareholders have added $180m in capital to SCB in the past three years, raising its capital ratio to 9.5%, above the minimum requirement of 9%.

The government intervened to help SCB repay its interbank debt when interbank market interest rates soared to 15%. “The state and State Bank of Vietnam talked to different banks and convinced them to reschedule our payments since we could not meet repayment dates. Without this support the bank would have died fast. The banks shut you out from funding, their clients realise and you are destroyed,” says Mr Vo at SCB.

The merger was particularly successful as it occurred at the height of the banking crisis, when the legal framework regarding consolidation was still unclear. The public being unfamiliar with bank mergers complicated matters further, says Mr Vo.

The next step in SCB’s restructuring plan is to either continue under its current ownership model or sell a 51% stake to a foreign investor. Although the foreign ownership limit is 30% in Vietnam, banks undergoing restructuring can apply to sell a higher stake. SCB is gearing up for either possibility.

ACB resurgence

ACB was also heavily hit by Vietnam’s banking crisis and is now three-quarters of the way through its restructuring plan. It experienced a run on the bank for 11 days and lost 25% of its deposits when co-founder Nguyen Duc Kien and other executives such as former ACB chief Ly Xuan Hai were arrested in 2012 for what were reported as economic violations.

“We used to be rated one notch above the sovereign by Moody’s and Fitch. ACB was seen as progressive and innovative. We lost a significant part of that and started focusing on surviving. We have kind of overcome this now,” says Mr Maheshwari.

ACB went from a return on equity of 35% in 2010 to less than 8% in 2014. “We are taking the pain through the P&L [profit and loss sheet],” says Mr Maheshwari.

However, progress is being made at ACB. About six months ago, the bank's deposits grew to a level higher than they were immediately before the crisis, the bank rebranded in January 2015, and it has become the bank with the highest level of disclosure in its annual reports in Vietnam, according to some sources.

“This year will continue to be difficult from the financial side since it is our last year of restructuring. If things go to plan, 2016 could be our first breakout year,” says Mr Maheshwari.

SMEs need support

In addition to restructuring, banks are under pressure to support Vietnam’s underdeveloped SME sector to develop and compete with other AEC member states, say analysts. The market widely agrees that SMEs are underserved by Vietnam’s banks, and the problem is two-fold. Banks still are not comfortable with lending to small businesses, while SMEs often lack the skills to propose bankable projects.

According to Tomoyuki Kimura, the Asian Development Bank’s (ADB's) director for Vietnam, liquidity is not a problem. “Banks have the liquidity but they are very reluctant to lend, even to big corporations, more so to SMEs," he says. "They lack the capacity to assess the risk of investment into SMEs and find bankable projects. And SMEs do not have the capacity to propose a bankable project.”

Mr Vo says: “I cannot audit SMEs so I trust one purely based on its idea. But if [an SME owner] cannot present their idea properly, how can I convince other people on the board that they have a good idea? SME owners need to be trained and educated. They need people to help them convert these ideas into bankable projects.”

The fact Vietnam's lending market is still predominantly collateral-based also makes it very hard for an SME without collateral to get funding. Market participants feel it will be up to commercial banks to support this business segment. “Large state-owned banks will continue to fund SOEs, but commercial banks like us will focus on SMEs,” says Ly Hoai Van, deputy chief executive at Sacombank.

Preparing for the AEC

Vietnam is thought to be one of the AEC countries with the strongest potential, with its young population – about 87% of the country is below 54 years of age – and its significant consumer market.

On a macro level, the country has opened up. “In general, Vietnam has been proactive to opening its economy. The export-to-gross domestic product ratio is at 160% and the country has received about $7.2bn of foreign direct investment in 2014,” says Mr Kimura at the ADB.

But the AEC presents both threats and opportunities for Vietnamese banks. Larger, stronger state banks remain more optimistic as they are ready to deal with foreign competition.

Nguyen Hai Long, deputy chief executive at state-owned Agribank, is confident the bank is ready to compete with foreign players. “This will lead to cost reduction and diversification of banking products and services. Banks will seek business opportunities in rural and remote areas. Being a commercial bank with a large network and experience in the rural, remote and mountainous areas, Agribank will retain competitive advantages among AEC banks,” he says.

The Vietnamese banks with operations abroad are mostly state-owned. Vietinbank has operations in Laos and Myanmar, and is expanding to support Vietnamese and local import and export enterprises, says Mr Tho.

The Bank for Investment and Development of Vietnam has operations in Laos, Cambodia and Myanmar, and says that in 2015 it will be looking to increase the charter capital of its joint-venture bank and insurance company in Laos, and explore microfinance and insurance in Myanmar and investment in Cambodia, as well as other Asian markets, according to Mr Phuong.

Agribank will continue expanding its retail operations in Laos and Cambodia this year, says Mr Long. Sacombank, though not state-owned, is one of the larger commercial banks in the country and has set up 11 transaction offices in Laos and Cambodia.

Opening up

But smaller market participants feel structural reforms and setting up financial institutions such as a bond ratings agency and a commodities index are essential prerequisites to opening up the market to foreign entrants.

“We have a big population so people want to come in. But we are not strong enough to go out. First we need to do well in Vietnam and then start serving people in other countries,” says Mr Vo.

“We need to reform and strengthen our SOEs and banking sector first and meet AEC targets before opening up completely. Our economy must be stable enough to build up investor confidence,” adds Mr Van.

Medium and small banks in Vietnam remain largely focused on the domestic market, either because they are still restructuring or because they see strong potential at home. “Wealth management is basically non-existent, retail is very deposit driven, mortgages have only just picked up and there is little unsecured credit on bank balance sheets. Even in Ho Chi Minh City only 50% to 55% of the population is banked,” says Mr Maheshwari.

“We still focus on customers in Vietnam, Laos and Cambodia, but pay particular attention to the local market because the room to grow here is still enormous,” adds Mr Van.

Macro upgrade

Restructuring of the banking sector is only part of the reform needed for growth in Vietnam. As a lower-middle-income country, Vietnam’s development agenda remains complex and crosses over sectors. This is challenging for a government with a traditional sector-by-sector set up. “It is not very easy for [the government] to coordinate across ministerial boundaries,” says Mr Kimura.

The SOE reform is moving forward with the help of agencies such as the ADB. But improving enterprises’ efficiency is not easy. “There are many vested interests. In some cases, SOEs’ management submits restructuring to the ministry but actually doesn’t want to implement it. Others are very keen but selling non-core assets poses market risk because it is very difficult to find buyers,” says Mr Kimura.

SOEs also face mounting labour issues when divesting non-core business as part of their restructuring plans. “In this country, SOEs cannot simply retrench those employees. They need to come up with a safety net for surplus labourers,” says Mr Kimura. He argues that a big-picture industrial strategy to guide SOE divestment is still lacking, meaning these sell-offs have been happening on an ad hoc basis.

Infrastructure is an additional bottleneck in Vietnam. “Demand is huge but government and ADB funding are not enough. Vietnam needs to diversify funding sources for infrastructure investment, particularly by bringing in more private capital,” says Mr Kimura. But private investment can be increased only if non-tariff barriers such as bureaucratic and administrative hurdles are reduced.

To help infrastructure development, the state, with the help of the ADB, passed new laws simplifying private investment. A couple of showcase projects are now needed to make public-private partnerships mainstream infrastructure financing, argues Mr Kimura.

Vietnam’s development trajectory somewhat detoured when the banking crisis hit in 2012. Though catastrophic for some banks, it shed light on the NPL issue that was eroding the country's economy. The government’s restructuring plans, although slow-paced at times, leave market participants optimistic. Looming foreign competition from the AEC will continue motivating the state and local players to bring reform forward.