VIETNAM'S BANKING SECTOR

UNCLAS SECTION 01 OF 05 HANOI 000335

SIPDIS

STATE PASS USTR FOR EBRYAN
STATE ALSO PASS USAID ANE AFERRARA and DMCCLUSKEY
TREASURY FOR OASIA
USDOC FOR 4431/MAC/IFP/OKSA/HPPHO
BANGKOK FOR USAID

SENSITIVE

E.O. 12958: N/A
TAGS: EFIN ECON EAID ETRD VM BTA FINREF SOE
SUBJECT: VIETNAM'S BANKING SECTOR

REF: 03 HCMC 1157

SENSITIVE BUT UNCLASSIFIED - PLEASE HANDLE ACCORDINGLY.


1. (SBU) SUMMARY: Vietnam's banking sector is presently
characterized by a few dominant state-owned commercial banks
(SOCBs),a number of comparatively small joint stock banks
(JSBs),and some foreign banks. In recent years, the GVN
has undertaken a number of reforms, with the goals of
ensuring the banking system's stability, expanding services,
and rationalizing domestic resource allocation by ensuring
that they are dedicated to commercially viable activities.
The reform program focuses on four main areas - the
restructuring and commercialization of SOCBs, restructuring
of JSBs, meeting Vietnam's international commitments, and
improving the regulatory framework and enhancing
transparency. Unfortunately, many areas of concern remain
largely unresolved. Progress on restructuring the SOCBs is
sluggish. Classification of non-performing loans (NPLs) has
improved, but deficiencies persist in both the accounting
and strategy. Furthermore, the slow pace of SOE reform may
negate efforts to address this issue. Foreign banks
continue to compete on an unequal footing with Vietnamese
banks. Although directed lending has been largely removed
from the SOCBs, it continues to take place. In addition, it
is now concentrated in institutions outside the formal
banking system, thus eliminating the ability to account for
total lending in Vietnam. Finally, despite efforts to
strengthen the SBV, it remains weak and fragmented. END
SUMMARY.

STATE-OWNED COMMERCIAL BANKS
--------------


2. (U) Vietnam's state-owned commercial banks (SOCBs)
dominate its financial sector, with the four largest SOCBs
representing around 70 percent of the system's total assets.
The Ministry of Finance (MOF) "owns" the SOCBs. The GVN has
stated that it intends to preserve the domination of SOCBs
by developing them into commercially-oriented financial
intermediaries. Towards this end, it has begun implementing
a restructuring plan for the four largest SOCBs. In June
2003, SBV announced its plan to equitize the remaining SOCB,
the Mekong Housing Bank, between 2006 and 2010. In 2005, a
plan for equitization is to be undertaken. The preparations
are to include an independent financial and portfolio audit
based on IAS, a diagnostic assessment of its operations, and
a review of its external policy and legislative environment.


3. (U) Over the past year, a number of developments have
increased the number of products and services offered to
clients of SOCBs and raised the share of their credit
allocated to the private sector. (Note: Despite this
increase, the private sector continues to complain about
lacking access to capital, and SOCBs remain extremely
cautious about lending to it, and do so only on a highly-
collateralized basis. End Note.) SOCBs still view state-
owned enterprises, especially large state-owned
corporations, as their core customers and give them priority
access to credit. This credit is extended mostly on an
unsecured basis, relying on the government's support and
implied backing given to those companies. Because financial
health and credit risk are not adequately assessed, credit
margins are not properly priced, which in turn may narrow
the banks profitability. Even though their application
appears irregular, SOCBs have drafted credit manuals. Due
to this weak credit risk analysis and unofficial ceilings,
most SOCBs are encountering difficulties implementing the
recent interest rate liberalization that allows banks to
freely determine the rates that they charge.


4. (U) Vietnam chose to retain Vietnam Accounting Standards
(VAS) and not adopt International Accounting Standards
(IAS). However, it has improved VAS, causing loan
portfolios to be reclassified based on rules that are close
international norms. (Note: Previously, VAS simply counted
the amount of the missed loan payment. Now, when a payment
is missed, banks must follow international practice and
count the entire loan amount as non-performing. End Note.)
The four SOCBs also completed donor-funded IAS audits for
2000 and 2001 and improved loan loss provisioning. They
began launching a computerized banking system pilot program
that will allow customers to withdraw money at any branch
instead of just the one where they opened their account.

5. (SBU) Although the GVN and SOCBs made some progress on
resolving NPLs and improving capital adequacy, problems
especially persist in these areas. The SBV alleges that the
SOCBs have resolved around 30 percent of their stock of NPLs
(identified as of December 2000). However, the actual
percentage of NPLs remains difficult to estimate, because
many banks are now rescheduling and restructuring loans in
order to ensure that they meet their NPL targets. Even
though the SBV has declined to estimate the amount of NPLs,
simply stating that restructuring has reduced the amount,
international experts estimate that NPLs account for between
15 and 25 percent of Vietnam's loan portfolio. Difficulties
in this area also remain, because many loans lack
collateral, especially those to state-owned enterprises
(SOEs). Therefore, the GVN is discussing a mechanism that
would trade the debts of SOEs scheduled for equitization.
Still, delays in SOE reform have made it difficult for SOCBs
to meet their resolution targets (see septel on SOE reform).


6. (SBU) After declaring that it would undertake a
conditional recapitalization based on banks' reform efforts,
the GVN found the banks' restructuring plans too dated and
vague to be practically used for targeting recapitalization.
Therefore, the past three phases of recapitalization valued
at 7.75 trillion VND (approximately a half billion USD) have
not occurred in a transparent manner, do not appear to have
dealt with underlying problems in the banking system, and
were based on separate targets from the Ministry of Finance
and SBV. The GVN has simply injected more capital into all
SOCBs without requiring that they address systemic problems.
If capital structures are not changed, such continuing large
expenditures will be of little value for the development of
the banks and may dilute incentives for reform. (Note: The
World Bank estimates that the actual recapitalization needs
of SOCBs may exceed five times that already provided if
current NPL estimates are accurate. End Note.)


7. (U) Several additional operational changes are envisaged
in the current restructuring, which should encourage SOCBs
to operate in a more market-oriented manner with management
held accountable for operations and results. The GVN has
agreed to the importance of separating the GVN's ownership
role of the SOCBs from day-to-day activities. A clearer
separation of the roles and responsibilities of the Board of
Directors and the bank management is also to be developed in
the near future. While the Board will be responsible for
setting and ensuring compliance with the overall credit
policies of the bank, the management will only act as
implementers. Furthermore, SOCBs will establish separate
credit and risk management teams. To assist with these
changes, a number of donors are funding "twinning" projects
that bring together respected international banks and SOCBs.
Although hope remains high that these programs will help the
SOCBs, the lack of human resource capacity may prevent them
from achieving their ambitious goals.

JOINT STOCK BANKS
--------------


8. (U) In Vietnam, joint stock banks (JSBs) have in many
ways taken on the role of local, "private" banks. (Note:
Every JSB still has some level of state interest and
indirect SBV management. End Note.) Following a recent
series of mergers and liquidations, thirty-six JSBs now
operate in Vietnam and account for approximately 12 percent
of the lending. Primarily geared toward small and medium-
sized enterprises and private companies, JSBs play an
important role in providing credit and banking services to
the private sector. In addition, they tend to be more
dynamic and customer oriented than SOCBs. However, they
lack extensive networks and expertise in international trade
and complex transactions.


9. (U) Although parts of this sector have posted strong
growth and performance, approximately one third are still
encountering problems in these areas. The SBV continues to
strictly monitor these weaker ones, encouraging them to
merge and revoking licenses when necessary. In addition,
most JSBs have undergone restructuring to increase their
viability. SBV has provided capacity training for managers
in order to strengthen personnel management, and like the
SOCBs, the GVN has increased their charter capital.
However, some regulatory discrimination between JSBs and
SOCBs remain. Unlike SOCBs, JSBs are not permitted to open
an extensive branch network. (See reftel for more
information about a successful JSB.)

FOREIGN BANKS
--------------


10. (U) Although Vietnam's banking services have evolved in
the past few years, the "rules of the game" continue to vary
significantly for different players, with foreign banks
experiencing the greatest limitation on their operations.
Among other issues, SBV still tightly controls the granting
of banking licenses. At present, 27 branches and 42
representative offices of foreign banks operate in Vietnam,
accounting for approximately 24 percent of the banking
system's chartered capital, 15 percent of lending, and
around 8.5 percent of the sector's assets. Leading foreign
banks with branches in Vietnam include Citibank, JP Morgan
Chase, HSBC, Deutsche Bank, Standard Chartered, and ANZ, and
Wachovia recently opened a representative office. In
addition, there are four joint venture banks in Vietnam,
which account for around 3 percent of lending.


11. (U) With the 2001 U.S.-Vietnam Bilateral Trade
Agreement (BTA),Vietnam made a number of commitments in the
field of financial services. The GVN has generally sought
to address these obligations through a non-specific
assurance that BTA obligations take precedence over domestic
legislation in cases of conflict. Specifically, the SBV has
stated that BTA provisions shall become effective
immediately when due regardless of the status of domestic
legislation. It plans to address this commitment by issuing
individual regulations each time an obligation comes due
rather than issuing a "blanket" decree.


12. (U) Among other commitments, the GVN agreed to increase
the ratio of deposits in Vietnamese Dong (VND) from an
original level of 25 percent of the branch's legal capital
under the terms of the BTA. This ratio is to increase
annually for U.S. banks until full national treatment is
applied in year eight (starting December 2008). U.S. banks
are currently allowed to accept Dong deposits at a level of
250 percent of their legal capital. In addition, in
response to significant lobbying from non-U.S. foreign
banks, the SBV decided in September to increase their ratio
to fifty percent of their legal capital.


13. (SBU) A number of new products were introduced in a
limited number of foreign banks and SOCBs in 2003. The SBV
is now allowing a few banks to offer currency options on a
trial basis. It also permitted some, including Citibank, to
provide interest rate swaps on a provisional basis. In
general, foreign banks find themselves at a disadvantage
when it comes to introducing new products since the SBV must
approve each one. In addition, foreign banks are limited in
their branch networks, restricted on accepting Dong
deposits, prevented from taking initial mortgage interest in
land use rights, and not allowed to issue credit cards.
(Note: Under the terms of the BTA, U.S. banks will be
allowed to take mortgage interest starting in December 2004
and issue credit cards in December 2009. End note.) They,
therefore, tend to provide only wholesale banking services
and concentrate on multinational corporations and foreign
invested enterprises. This reliance makes their business
vulnerable to the flow of foreign direct investment.

POLICY LENDING INSTITUTIONS
--------------


14. (U) One of Vietnam's major reforms in recent years has
been to move "policy lending" out of SOCBs by creating the
Development Assistance Fund (DAF) and the Bank for Social
Policy (VBSP). The DAF is a specialized institution aimed
at conducting policy-based lending to large scale, medium-
and long-term projects. Although the GVN has committed to
revising the DAF's governing framework in 2004, its purpose
will remain unchanged. The VBSP is designed to provide
preferential lending to targeted poor and remote households.
However, because it is both a deposit taking and a policy
lending institution, inherent risks exist for those deciding
to invest in the VBSP.


15. (SBU) These extra-budgetary institutions were created
to shift the problems associated with policy lending from
the financial sector. Unfortunately, they could create a
significant burden on the budget depending upon the quality
of the lending and whether final borrowers can service their
debts. Given the DAF's lack of transparency and expertise
in credit and risk management, this possibility appears
highly likely. This risk is further exacerbated by the fact
that these institutions appear to be the GVN's current quasi-
fiscal method to maintain SOEs.

THE STATE BANK OF VIETNAM
--------------


16. (U) The State Bank of Vietnam acts as the supervisory
and regulatory body for the banking sector. The SBV, in
cooperation with a number of donors and international
financial institutions, is working to strengthen its
internal processes and enhance the quality of inspection.
In the past, it simply focused on ensuring that financial
institutions complied with laws and regulations whereas now,
it is attempting to analyze asset quality and risk. In
addition, it is trying to strengthen its independence and
supervision of the banks within its jurisdiction. Unlike in
the U.S., though, the SBV is not an independent body, and it
continues to operate under government guidance.


17. (U) In addition to its role as supervisor/regulator,
SBV also acts as the SOCBs' shareholder even though the
SOCBs are officially "owned" by the Ministry of Finance.
The SBV is tasked with acting as the state body managing the
banking system. To that end, the SBV has permanent
representation on Supervisory Boards and appears, through
various appointments, approval, and licensing processes, to
be involved in such daily activities in SOCBs that are
essentially powers to be exercised by the owner. This dual
role jeopardizes the SBV's independence in supervising
SOCBs, distorts the playing field for other institutions,
and makes business decisions difficult to undertake.


18. (U) Organizationally, SBV possesses a heavy, fragmented
structure, which can lead to issues falling between the
cracks, duplication of work, and slow internal flow of
information. Furthermore, the reporting lines from
financial institutions to various departments are unclear,
resulting in inefficiencies, overlapping information, and
the potential that some data is not reviewed. Finally,
SBV's regional structure with 61 branch offices limits the
central government's ability to direct overall operations.
Experts have recommended that the GVN substantially reduce
this number and clarify the reporting lines. An expert
evaluation of nine of the Basel Core Principles identified a
number of weaknesses, including a lack of consistency,
transparency and accountability in the banking system and in
the bank supervision process.


19. (SBU) COMMENT: Unfortunately, most of the banking
system reforms that Vietnam has undertaken in recent years
appear to be mere "window dressing" rather than an effort to
address systemically the system's weaknesses. The main
areas of concern - SOCBs, directed lending, non-performing
loans (NPLs),a level playing field, and State Bank of
Vietnam (SBV) supervision - remain largely unresolved. This
situation has created significant risks to the system, which
are exacerbated by the high current rate of credit growth to
the economy. (Note: Estimated at around 30 percent for
2003, this growth rate concerns the international financial
institutions, as well international experts. End note.)


20. (SBU) COMMENT CONT'D: Still, even though it is
occurring slowly, the policy environment continues to
improve, and donor technical assistance, especially the
USAID-funded Support for Trade AcceleRation (STAR) project,
is raising the GVN's capacity to implement reforms.
Vietnam's senior leaders accept that reform in this area
must take place if future economic growth goals are to be
achieved. However, the emphasis appears to be on "managing"
the changes and reform necessitated by international
commitments and domestic economic conditions rather than
pushing forward aggressively. While fears about risks and
challenges remain, fairly solid agreement exists within the
GVN about the need to bring Vietnam's economy into
conformity with international standards, meet its BTA
obligations, and accede to the WTO. Vietnam's financial
sector and broader economic reform commitments, especially
those in the BTA, have and will shape the discussion
regarding banking reform and ensure that it continues into
the future. BURGHARDT