The Vietnamese banking sector in transition

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The Vietnamese banking sector in transition

Looking for promising investment opportunities

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The Vietnamese banking sector in transition

Looking for promising investment opportunities

Author Jasper M. Koopman

Student number 1083023

University University of Groningen Faculty Management and Organization Specialization Financial Value Management

Supervisors RuG Prof. Dr. L. Karsten Dr. B.J.W. Pennink

Institute Consulate General of the Netherlands Ho Chi Minh City, Vietnam

Supervisor Consulate: Drs. A. L. M. van Zeeland

Consul General of the Netherlands Year of publication 2007

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Management summary

This report is written for the Consulate General of the Netherlands in Vietnam and its objective is to inform Dutch companies on the developments in the Vietnamese banking sector and to discuss whether there are promising investment opportunities. The question that will be answered by this report is What will be the expected impact of the reforms in the

Vietnamese banking sector and will this facilitate promising investment opportunities for Dutch companies?

To give an answer to this question the domestic sector has been analysed on three different levels. An analysis of the external context of the sector has been made by looking at the Vietnamese culture and its influence on the legal tradition and the development of certain types of business systems. The historical developments were also discussed on this level. The analysis reveals an overwhelming influence of the state on the sector. The government is slowing down the reform of the banking sector because its main focus is maintaining social stability instead of developing a market oriented economy in the short term. The legal system is weak and does not support rapid changes in the banking sector. Purely on the basis of the national culture the Vietnamese economy should be able to continue growing at a high rate but this is the only strong positive aspect in the external context of the domestic banks.

The second level of analysis is on the level of the internal context of the banking sector. The competitiveness of domestic banks and the influence of increased foreign bank entry are the central subjects on this level. This part is completed with a brief overview of the current banking sector. The competitiveness of the domestic sector has been specified by looking at six determinants of competitive advantage. All six determinants did not form a basis for competitive advantage for the domestic sector. The main reason for the absence of the capability to develop competitive advantage has been the lack of rivalry between the domestic banks. As a result the domestic banks will probably have great difficulties with competing with the foreign banks which will enter the country more and more. Although the market is characterized by its small size and a large number of banks, the domestic banks recently have seen an extreme growth in size and profitability. This large profitability of the sector is a sign of low competition and increased foreign bank presence will put pressure on the profitability of the domestic banks.

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Acronyms and Abbreviations

CC Credit Cooperation

EVD Economische Voorlichtingsdienst

FDI Foreign Direct Investment

HSTC Hanoi securities Trading Centre IAS International Accounting Standards

IncomBank The Vietnam Industrial and Commercial Bank

NSCERD Steering committee for state owned Enterprise Renewal and Development

NPL Non performing loans

OECD Organisation of Economic Co-operation and Development

PCF People Credit Fund

PPP Purchasing Power Parity

SBV The State Bank of Vietnam

SME Small- and Medium-sized Enterprises

SOB State Owned Banks

SOCB State Owned Commercial Banks

SOE State Owned Enterprises

UNHDR United Nations Development Report USBTA United States Bilateral Trade Agreement VAFI Vietnam Association of Financial Investors

VAS Vietnamese Accounting Standard

VBID The Vietnamese Bank for Investment and Development VBSP Vietnam Bank for Social Policies

VND Vietnamese Dong1

WTO World Trade Organization

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This report is the result of research I conducted for the Consulate General of the Netherlands in Ho Chi Minh City. During a period of seven months I stayed in Vietnam and was allowed to call myself Junior Assistant to the Consul General, a title which proved to be helpful in opening doors and making appointments. The Consul General, Drs. A. L. M. van Zeeland and his team have been essential in making my stay in Vietnam a pleasant and fruitful one and I would like to thank them for making me acquainted with the Vietnamese culture and helping me out for my research. Without their assistance and the use of their network it would have been impossible to collect all the information I used for this report.

Besides conducting my own research I have assisted the consulate in day to day activities, helped organizing a business seminar in Dalat and I have written a short report on the micro credit sector in Vietnam.

I look back at a wonderful time in Vietnam, it’s a fascinating and lively country and it has taken a special place in my heart. I hope this report reflects my enthusiasm and that it proves valuable to the reader. Finally I would like to thank every one who made a contribution to this report.

Jasper

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Chapter 1 Introduction

The Socialist republic of Vietnam is currently going through a period of change, the country is evolving from a centrally planned economy into a market oriented economy. This transition is realized by the government using a reform policy called ‘Doi Moi’ (Vietnamese for renovation) which started over twenty years ago and continues until today.

Since the Doi Moi started in 1986 the government has initiated several reform programs and one of the most important programs is the (partly) privatization of state owned enterprises (SOE). This process, with as centrepiece equitisation, is meant to diminish the influence of the state in the economy. Until nowadays, the SOEs play a central role in the Vietnamese economy and they absorb up to a third of the available bank credit (under preferential interest rates) and enjoy other preferential treatments from the authorities, e.g. land allocation and taxes. This has a negative impact on the development of the private sector. By turning SOEs into joint-stock companies and divest them partially, the state wants to diminish its influence on the economy and develop a level playing field for all companies. The purpose is to stimulate the economic development of the private sector.

One of the business sectors in which it will be very important to create such a level playing field is the financial sector. A transparent and stable financial sector which is functioning effectively and which provides a full range of financial services is one of the key sectors in securing and facilitating growth, reducing volatility and helping the poor2. But since all the major banks in Vietnam are owned by the state the financial sector is not operating according to market principles and it is not effective at all. The state owned banks did not have to be competitive and were content to live off state subsidies. This resulted in a credit allocation process which did not depend on the nature or the risk of the business, but rather on the decisions made by the communist party (CP) which governs the country. This allocation process still continues up to today. In order to make sure that credit will be allocated in accordance with market principles and not on the basis of governmental regulations, the state wants to equitise the state-owned commercial banks (SOCBs). As a result the government is now looking for foreign banks and investors who want to become (strategic) shareholders in one of their banks.

Partly due to the Doi Moi the Vietnamese economy has been growing rapidly for the last ten years. GDP has been growing more than 6% per year over the last 6 years and even reached over 8 percent in 2006. Despite this growth Vietnam continues to be a rather poor country with a GDP of $3,100 per capita3 (PPP). The economic growth has led to an enormous increase in the demand for credit, especially by the fast growing private sector which played an important role in the recent growth. As a result, the domestic banks are no longer capable of providing the necessary credit to fuel the expansion of the businesses in Vietnam. The country is lacking capital for development investments and if they rely solely on the State budget then they cannot finance rapid development4. Therefore Vietnam is now starting to turn to the international financial community to attract foreign capital and to transfer knowledge into their own organisations.

Part of the growth comes from the export of products. Currently the largest export partners of Vietnam are the US, Japan, China, Australia and the EU5. Vietnam needs these large markets

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Finance for Growth, World Bank policy research report 2001

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CIA World Factbook Vietnam, 2006 estimate.

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Vietnam News, 19-01-2006

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to export its considerable and increasing output of commodities and manufactured items6. Therefore Vietnam has made several trade agreements, like the USBTA7, and in January 2007 it became the 150th member of the WTO. The country had been trying to become a member for several years and during the Hong Kong accession negotiations in 2005 they were already close to achieving this goal. But in the end there were still some key points which had to be settled. In January 2006 Vietnam had signed pacts with twenty-two WTO members but it still had to close deals with the US, New Zealand and Australia who are all key members of the WTO. The banking sector turned out to be one of the major barriers for WTO accession. The WTO had become more prudent with regard to the banking sector of countries that want to join their organization, since the banking sector of China has turned out to be problematic. These WTO discussions mainly focus on the creation of a level playing field within the sector. There are numerous laws and regulations that protect the domestic banks against foreign competition. This has made the Vietnamese banking sector a relatively closed sector, only 10 percent of total market assets are foreign owned. The WTO agreements together with the bilateral trade agreements have put pressure on the government to open up the banking sector for foreign competitors, reduce the influence of the state on the sector and to enable fair competition between foreign and domestic organisations within the financial sector.

The principal goal of the Consulate General of the Netherlands is to stimulate the trade between Vietnam and the Netherlands. One way of doing this is informing Dutch companies on promising investment opportunities. The three factors mentioned above i.e., the equitisation of the SOCBs, the search for foreign investors by domestic banks and the external pressure to open up the banking sector for foreign entrants, together have made the banking sector of Vietnam a turbulent one. The developments have created opportunities for foreign banks and investors to invest in or enter the Vietnamese banking sector. Whether or not the

current opportunities in the banking sector are promising is the central question of this report.

The outcomes of the research will assist the Consulate in informing Dutch banks, financial service providers and other investors about the ongoing developments in the banking sector and elaborate on the possibilities to enter or invest in the sector. This in turn will lead to competitive advantage for Dutch companies and may hopefully, in the end, stimulate the bilateral trade between Vietnam and the Netherlands.

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Nick Freeman, The Banker, June 2004

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Chapter 2 Research design

Introduction

In this chapter the research design will be discussed. The first paragraph contains the problem statement and according to De Leeuw (2000: 290) a problem statement consists of a research objective, a research question and the demarcations of the research. The second paragraph deals with the research methods and the third and final paragraph of this chapter will set out the structure of this report.

2.1 Problem statement

Research objective:

Analyze the reform process in the Vietnamese banking sector to find out whether there are promising opportunities for Dutch companies to invest.

Research question:

What will be the expected impact of the reforms in the banking sector and will this facilitate promising investment opportunities for Dutch companies?

To give an answer to this central question the banking sector will be analyzed at three different levels of aggregation. The external context of the banking sector will be the macro level of this report, the internal context will be the meso level and the third and lowest level of aggregation, the micro level, will be at the level of business processes within banks.

Macro level

The analysis of the external context of the banking sector will begin with analyzing the national culture of Vietnam. The national culture is important because it has a broad influence on the national and organizational context in which banks have to operate (Thomas, 2002). The national culture will be categorized using a framework designed by Hofstede (2005) who developed five dimensions along which a national culture can be classified.

This national and organizational context establishes demands and constraints on the choices the Vietnamese (managers) make and they lead to certain roles and work behaviour. The next step will be to analyse how this national and organizational context has lead to certain types of business systems. This analysis will be performed using research done by Whitley (1992) who has analysed the relationship between the institutional context of a country and the business systems which it generates. The analysis will lead to an explanation of the main characteristics of the Vietnamese business systems.

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Meso level

Once the external context of the banking sector has been discussed it is time to turn to the consequences it has on the internal context of the banking sector. Whether or not the external context has lead to a competitive banking sector will be the main subject of this level of analysis. This competitiveness will be of importance for two reasons. On the one hand it will show a potential new entrant what to expect from the competitiveness of the domestic banks and on the other hand this competitiveness will influence the decision whether or not investments should be made in a domestic bank. Whether the domestic banks will succeed relative to foreign banks will depend on the possession and creation of sustainable competitive advantages (Porter 1990). Both potential new entrants and investors will thus base their investment decision on whether the domestic banks poses such advantages. This competitiveness of the domestic sector will be analysed using a model designed by Porter (1990). He has analysed the individual determinants of national competitive advantage and these determinants will be discussed individually to see whether the domestic banking sector has or is able to create sustainable competitive advantage, or not. Chapter four will first give an overview of the current actors in and characteristics of the banking sector, followed by chapter five which deals with the competitiveness of the sector.

The Vietnamese banking sector has been relatively closed but the current reforms enable an increased foreign entry. This entry of foreign competitors will affect the sector and this will be the final aspect which will be analysed on the meso level of the report. Cleassens et. al.(2000) have done extensive research on the effects of foreign entry on domestic banking sectors and their theory will be applied in chapter six, in order to predict the effects of increased foreign entry on the Vietnamese banking sector.

Micro

The third level of aggregation, the micro level, will be at the level of business processes within banks. There is no in depth discussion of every individual bank but a number of general processes will be discussed instead.

The domestic banking sector has been dominated by the government through the state owned banks. The influence of the external and internal context of the sector resulted in business processes like information distribution, division of responsibilities and ownership structures which were not subject to the forces of a free market. These processes can be regarded as part of the way in which the banks are managed. They are important because potential investors will only invest in a bank when they are confident in whether the business is being well managed and whether it will continue to be profitable in the foreseeable future. It is essential for this confidence that it is based on good corporate governance (Mallin C. A., 2004). Without good corporate governance it will be extremely difficult to benefit from competitive advantages in the banking sector. Using a framework designed by Mallin C. A. (2004) the corporate governance practices within the domestic banking sector will be analysed. His framework is used because it pays special attention to the development of different corporate governance practices. Since the banking sector is going through a period of change it will be interesting to see whether and how these developments, with a focus on the equitisation of the state owned banks, will affect the corporate governance practices within the domestic banking sector. This analysis will take place in chapter seven.

Analysing the sector at these three different levels and from different perspectives will create an extensive image of the Vietnamese banking sector and its developments.

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Figure 2.1 Conceptual model.

In this model culture is the factor that exerts great influence on the legal tradition and the institutional context. The latter two have directly influenced the historical developments of the sector whereas culture has had more of an indirect effect on the historical developments. All four factors together constitute the external context of the banking sector, they form the environment in which the banks have to operate. The macro level forms the basis of the internal context of the banking sector. The effect of the external context on the domestic banking sector is the subject of the meso level. By analysing the competitiveness of the domestic banks it will become clear what the effects have been of the external context in which they operate. The competitiveness is important for competing with foreign banks who will increase in number. The effects of increased foreign entry will be the most important effects on the sector in the near future and will therefore be part of the analysis of the internal context of the Vietnamese banking sector. The external and internal context form the basis for the business processes within banks. Corporate governance has been chosen on this level of analysis because recently it has received increased attention in the international business community.

This model leads to five sub question which will be answered throughout this report. One additional question, sub question two is introduced. The answer to this question will give an overview of the banking sector at present which is part of the meso level of this report.

Together these three levels of analysis will provide the input to answer the question whether one should enter or invest in the Vietnamese banking sector.

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Sub questions:

1. What was the setting in which the banking sector originated and what were its main historical developments?

2. Who are the current actors in the Vietnamese banking sector and what are the important characteristics of the sector at present?

3. Do the domestic Vietnamese banks create sustainable competitive advantage? 4. What will be the expected effect of foreign bank entry on the domestic banking

sector?

5. What is the actual role of corporate governance in the Vietnamese banking sector? Together the answers to these sub questions will provide an answer to the central question, which will be presented in the concluding chapter of this report, chapter eight.

Demarcations

- This report has been conducted in Ho Chi Minh City and Hanoi and although the former is the financial capital and the latter the governmental capital of Vietnam, the findings can not be regarded as being representative for the whole country.

- During the interviews with several bank representatives and sector experts, certain topics proved to be very sensitive. Especially employees of state owned banks turned out to be unwilling to answer some questions about directed lending and non performing loans. As a result more indirect sources of information had to be used. - Some of the information is sourced from various newspapers and magazines. Some of

these media tend to be overoptimistic about the banking sector, while keeping relatively silent about some of the less positive aspects of the sector. The information from these so called ‘propaganda machines’ might not give a genuine representation of reality.

- Due to the limited amount of time available for this research this report will not contain an in dept analyses of every single domestic bank, but instead it contains a general analyses of the whole domestic sector with a focus on a few topics.

2.2 Research methods

The research conducted for this report is a descriptive one. The goal is to describe the main developments within the sector, its main characteristics and to develop an instrument for the Dutch consulate they can use to inform potential investors and entrants.

Three different methods have been applied to collect the necessary data.

Initially the focus of the data collection methods was on desk research. Reading country reports, newspapers, reports on the banking sector and other documents provided the necessary background for the research. Conversations with colleagues from the consulate provided a basic understanding of the Vietnamese economy and of the banking sector.

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The first interviews were of the unstructured type8 with many open questions. Due to the open character of the questions and the sensitivity of some of the topics discussed the interviews were taken oral. The disadvantage of this kind of interviews is that it is time consuming and since the interviews were not anonymous the interviewees might have given socially acceptable answers.

During the final phase of the data collection period the main data collection method continued to be interviewing. But since the exact research topics became more clear the interviews became more structured and can be regarded as semi-structured interviews. Completely structured interviews were not possible for the same reasons mentioned earlier; the sensitivity of certain subjects. Because of this sensitivity the information concerning these subjects sometimes had to be collected in an indirect manner. During the interviewing phases, experts on the Vietnamese banking sector were interviewed and due to the unstructured form of data collection the data collection had a qualitative character.

The third data collection method used was through observations. This type of data collection has been used a little because the aim of this research was to look for opinions and knowledge, which are both difficult to observe (Baarda, De Goede, 1998). Observations did add to the research because they helped forming an image of the Vietnamese culture and economic development. Observations also gave an impression of the working methods and procedures within the domestic banks and organisations which were visited.

The focus of the data collection method shifted during the research process but all methods were used simultaneously during the different phases of the data collection period and were not mutually exclusive.

Reliability

In this report only a limited number of characteristics of the banking sector will be discussed to find out whether investments should be made. By analysing these characteristics of the Vietnamese banking sector at three different levels (external environment, internal environment and business processes) the investment advise will be based on many different inputs in order to increase the reliability.

In Vietnam, having an extensive network is very important for data collection. Whether an other research would replicate the conclusions of this research would depend heavily on the network used. Many different sources of information have been used during this research to get the necessary data, partly because of the sensitivity of certain subjects and the resulting hesitation to share all available knowledge with the researcher.

Validity

The validity of this report depends on the indicators which are used to decide whether or not one should enter or invest in the Vietnamese banking sector. This report can be regarded as valid because it combines many different opinions from experts within the sector and other data from reliable sources, it presents an overview of the current developments within the sector and gives a well funded expectation of the future state of the Vietnamese banking sector.

Boxes

Boxes with text are used throughout the report to provide occasional extra information like experiences during the research or real life examples.

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Chapter 3 External Context of the banking sector

Introduction

This chapter focuses on the external context of the Vietnamese banking sector. The first paragraph will deal with the Vietnamese culture and its influence on the external context of the sector. The second paragraph discusses the institutional context and the resulting Vietnamese business systems. The third and final paragraph covers the historical development of the banking sector of Vietnam. The history is important since it explains many of the current characteristics of the sector. And since the goal of this report is to ‘control the future’ developments of the sector, George Orwell (1949) would suggest to begin with ‘controlling the past’ and that is what will be done in this paragraph.

3.1 Vietnamese culture

Culture is one of the factors influencing the external context of the banking sector. Culture consists of systems of values, attitudes, beliefs and behavioural meanings that are shared by members of a social group (society) and that are learned from previous generations (Thomas, 2002). An investment decision can be made more careful if an investor is aware of some of the basic characteristics of the Vietnamese culture and its influence on businesses.

The Vietnamese culture will be categorized using a model constructed by Hofstede. Hofstede (2007) has developed five dimensions along which different cultures can be compared. The results of these comparisons do not provide a list of absolute values on the different dimensions but rather positions countries in relation to each other. The five dimensions are, power distance, individualism vs. collectivism, masculinity vs. femininity, uncertainty avoidance and long-term vs. short-term planning (see Appendix 1 for an extensive discussion of the dimensions). The relative position of the Vietnamese culture on each of the dimensions (determined by Hofstede) will indicate certain consequences for the external context of the banking sector. Vietnam’s position on the five cultural dimension will be discussed, each followed by the major consequences of this relative position for the external context. Only the consequences which are most relevant for the Vietnamese banking sector will be discussed. Power distance

Vietnam scores 70 points on the power distance dimension which places it in the upper part of the countries on position 25 of a total of 74 countries. This means that Vietnam has a relative high power distance compared to the other countries. This position leads to the following cultural characteristics:

- The hierarchical system is based on inequality and superiors and subordinates consider each other as fundamentally different.

- There is a lot of supervisory personnel

- Salary systems show a great gap between the basis of an organisation and top management

- Employees are relative low skilled

- Top management is used to using status symbols and having privileges - Power has priority over law and there tends to be more observed corruption - Centralisation is popular

Individualism vs. Collectivism

Vietnam scores 20 points on this dimension which places it on the 61st position of a total of 74 countries. This makes it a strong collective culture. The following characteristics are a result of this position:

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- The state plays a dominant role

- Harmony and consensus are the ideals of society - Social networks are an important source of information - Personal relations are more important than the task Masculinity vs. femininity

On this dimension Vietnam takes the 58th position on the list of 74 countries. It scores 40 points which makes it a low feminine society. This results in the following characteristics: - There is a communal sense of decisiveness

- In management intuition and consensus play an important role - Conflicts are resolved by compromises en negotiations

Uncertainty avoidance

The fourth dimension is the dimension of uncertainty avoidance. When comparing the countries with each other it appeared that Vietnam is an uncertainty accepting society. With only 30 points it has taken the 69th position of a total of 74 countries. This acceptation of a high level of uncertainty has the following consequences:

- Uncertainty is considered a part of every day life, the Vietnamese life day by day. - Relative risky investment behaviour

- There is little tress

- There is tolerance for a lack of clarity and chaos Long-term vs. short-term orientation

The fifth and final dimension concerns the planning orientation of the Vietnamese.

The study that provided the relative comparison on this dimension investigated only 39 countries. With 80 points Vietnam takes the fifth place and is thus considered a long-term oriented society. This long term orientation results in:

- Economical and sober use of means and goods - Relatively high investments in real estate

Vietnam’s position along the five dimensions has consequences for the external context in which banks have to operate in Vietnam. How this context has lead to certain business systems will be discussed in the next paragraph The effects of the Vietnamese culture will also become visible in other parts of this research.

3.2 The Vietnamese business system

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fact that the Vietnamese market economy is still in its infancy makes some parts of the analysis a little less relevant, the concerning parts will be highlighted in this paragraph. The extent to which individual nations are characterised by distinctive ways of organizing and directing firms depends on their internal homogeneity and external differences (Whitley 1992). Societies in which industrialization was both more recent and more state directed generate more homogeneous business systems which are relative specific to them. The relative high level of ethnic and cultural homogeneity and the heterogeneity between them has generated strongly distinctive types of business systems which can be directly related to particular institutional features of the nation. As major agents of industrialization, dominant economic actors here reflect and reproduce the distinctive features of this process in each society , and so are more directly affected by pre-industrial institutions.

In Vietnam the speed of industrialization and its direction by powerful and autonomous state elites contributed to the more direct influence of pre-industrial institutions than in many Western societies.

Institutional features

The major institutional features of Vietnam are:

- A considerable homogeneity, stability and isolation fore some time before Western imperialism affected the country in the nineteenth century

The homogeneity is partly due to the fact that throughout history Vietnam has been at war with many of the great powers of the world (Red Khmer, China, USA) to preserve their independence and identity. The Vietnamese have shown great strength and perseverance in defending their country which can be seen from the patriotism and strong national identity. The French only colonised Vietnam in the late 19th century.

- A primacy of vertical loyalties and duties

Compared to Western societies the Vietnamese society contributes significant value to family membership. Together with the recent communist history this has limited the diffusion of individualism. The Western emphasis on individual rights duties and identities has not developed to any notable extent.

- A weakness of formal laws and the legal system

There is no separation between the legal institution and the state. This lack of a distinct and autonomous legal system has had major consequences for the sort of business systems that have developed in the country. It also influenced the role of the state in steering economic development

- A subservience of merchants to the political elite

Vietnam’s strict communist regime for the past thirty years together with the lack of an institutional distinct legal system resulted in the subordinate position of the private sector. The country lacked a separate elite of private wealth holders i.e. a strong private sector, committed to economic developments and able to mobilize capital independently of the state.

Dominant role of the state

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of the state executives and bureaucracy has meant that economic development has taken place without involving organized labour movements. In general the labour movement has been weak as a political force. The bulk of industrial development has been financed through (state) bank credit, both formal and informal and the capital market has played only a minor role. In periods of high economic growth this has enabled the state to exercise direct influence on the firm’s activities and choices. The strong state influence during industrialization has restricted the development of unions and groups based on occupational interests, this has made the labour markets highly segmented and deprived of pressure groups.

As a result of this business environment a distinctive business system has developed in Vietnam with the following characteristics:

• Legal and contractual forms of trust and obligation are less important in regulating relations between business partners and between superiors and subordinates. Instead reputational and personal bases of trust play a much grater role.

• Legally and financially defined and bounded firms are often not the only significant unit of economic action, rather alliances between owners and managers coordinate activities and share risk. Thus firms and markets tend not to be two sharply opposed and separate principles of co-ordination but rather overlap and mix. As will become clear in the next chapters, in Vietnam there are strong relationships between the directors of banks and other institutions which cross the boundaries of firms.

• Task and role specialization within authority systems is limited. Duties and posts are left flexible often with overlapping responsibilities and multiple jobs held by the same person. More on this subject in chapter 7 on corporate governance.

• Employment terms and conditions differ substantially between different groups of workers. This difference is rather small in Vietnam because the government still decides on minimum wages and labour regulations. Another reason is the fact that there is only a small difference between the appreciation of male versus female workers compared to the differences observed by Whitley in the East Asian countries he investigated (Vietnam is a feminine society, see paragraph 3.2).

3.3 Historical Developments in the banking sector

The first part of this paragraph deals with the history of the formal banking sector. Besides the (government-)regulated formal part there has also developed an informal banking sector. The informal sector will be dealt with at the end of this paragraph. This paragraph also contains discussions on the sequence of liberalization chosen by the Vietnamese government in the ‘Doi Moi’ and on the results of the intimate relationship between the SOCBs and the SOEs.

3.3.1 Formal sector

During the French colonisation, which started in 1847, the Second National Party Congress, (held in 1951), established a national bank, the State Bank of Vietnam (SBV). During that period Vietnam was divided in a northern and a southern part. The SBV was part of the infrastructure of the Northern provinces of Vietnam and at that time its functions were9:

- Control of issuance of banknotes - Money circulation

- Management of the state treasury

- Management and control of foreign exchange and money transactions - Mobilisation of funds

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- Provision of loans for production - Commodity circulation

After the French had left Vietnam in 1954, all financial institutions in the North of Vietnam were nationalised and merged with the SBV. The main functions during this period were supporting/ financing construction activities in the North and the war in the South. After the unification of the country in 1976, all the financial institutions in the South were also nationalised and added to the SBV. Since then the banking sector was a centrally coordinated system. During the period 1976- 1989 Vietnam had a one-tier banking system which was owned and controlled by the state. At that time, the SBV acted both as a central bank and as a commercial bank for the government. The financial system wasn’t much more than an instrument for executing government policies, continuously accommodating the needs of the state budget and those of the state owned enterprises.

In 1958 the Vietnamese Bank for Investment and Development (BIDV) was established. This bank was specialised in the financing of large (primarily infrastructural) investments for SOEs. In 1963 they established the Bank for Foreign Trade (Vietcombank). This bank was responsible for all financial transactions relating to foreign trade. Since the two banks were fully owned by the government and operated by the SBV there was no change to the one-tier system. The restrictions placed on the SBV operations by the government and the redundant nature of this type of centrally controlled monetary policy however made financial and monetary conditions difficult10.

Several currency reforms took place in 1976, 1979 and 1985 to control inflation, over expenditure by the state and macro economic unbalances. But these reforms didn’t deliver the expected results, inflation even reached 775 percent in early 1986. One cause of this inflation was probably the fact that during the 1970s and 1980s the government just printed more money whenever they needed credit for investments and expenditures11. At the same time there was interest rate inversion (deposit rates were higher than lending rates). After these attempts in vain the government became aware that they had to do something different. During the sixth Communist Congress at the end of 1986 the government designed a comprehensive reform policy. This policy was called ‘Doi Moi’ which, in the Vietnamese language, means ‘renovation’. This marked the beginning of the transitional process during which Vietnam has changed from a centrally planned economy towards a more market oriented society. The goal of the reforms was to loosen government control over the economy. In 1987 the government decided to transform the state owned banks into commercial banks and in 1988 they decided to dissolve the one-tier banking system and to separate the commercial banks from the SBV in order to establish a two-tier system. The SBV was made responsible for the management of the banking system and obtained the duties of a central bank.

The Vietcombank and the BIDV were transformed into SOCBs and in 1991 they established two additional new SOCBs; The Vietnam Industrial and Commercial Bank (Incombank) and the Bank for Agriculture and Rural Development (Agribank). As the names of the SOCBs already suggest, each bank was responsible for different sectors and the banks did not interfere in each other’s sector.

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Kousted J. et. al. ,From Monobank to Commercial Banking 9

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In this same period another type of financial institution, the Credit Cooperatives (CCs) gained popularity. The first CCs were established in 1956 and during the mid-1980s their number grew rapidly. The main function of the CCs was to provide funds for isolated communities who were beyond the reach of the SBV. At the end of the 1980s the number of CCs had risen to more than seven thousand. But then in 1989 the Government initiated the process of de-collectivisation and privatisation of the agricultural sector. As a result the sector saw a rapid growth in private enterprises, which soared the demand for credit.

The Agribank could not provide the credit demanded by the new agricultural enterprises because they were only entitled to serve SOEs. In order to obtain the necessary credit, the agricultural enterprises turned to the CCs. However, the CCs lacked enough refinancing facilities, back-up funds and deposit insurance12. The often poorly trained staff, had great difficulties to meet the demand for credit. Some CCs tried to attract local savings by offering attractive rates but the subsidies dried up and the arrears13 mounted. This caused the depositors to panic and rushed to withdraw their money. The results were disastrous and the vast majority of the CCs went bankrupt. The CCs got into trouble and a lot of households lost their savings. As a result many newly established small- and medium sized enterprises disappeared. This development had a strong negative influence on the general belief of the Vietnamese society towards the reliability of the formal financial system. This in turn led to an increase of popularity of the informal financial system which will be discussed at the end of this paragraph. After this crisis the government decided to strengthen the Agribank by allowing it to lend money directly to peasant families. Some of the remaining CCs were transferred into commercial banks but those banks had to cope with high arrears from the beginning as a heritage of the old CCs.

During the same period the government allowed the establishment of private commercial banks, some branch offices and representative offices of foreign banks.

Three forms of domestic commercial banks were put in place: stock banks (JSBs), joint-venture banks (JVBs) and the old credit cooperatives (after the crises referred to as people’s credit Funds (PCFs). The JVBs were all 50:50 joint ventures between a SOCB and foreign financial institutions from neighbouring countries. Many of the early JSBs were closely affiliated with State Owned Enterprises, indicating that the Government’s dominance was still unchanged in the early 1990s.

The first foreign banks entered the country in 1992 and during the four following years their number increased rapidly but stabilised in the late 1990s (Table 3.1). The foreign banks had to operate under restrictive regulations, which meant that they were limited in the amount of deposits they could have, limited in the amount they could extend to a single borrower, licenses were only extended for a 20 year period and they were limited in their activities.

12

Kousted J. et. al. ,From Monobank to Commercial Banking ,15

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Table 3.1

Development of the number of commercial banks

0 5 10 15 20 25 30 35 1991 1992 1993 1994 1995 1996 1997 1998 1999 Year N u m b e r o f b a n k s

Urban Joint-stock Banks Rural Join-stock Banks Joint-venture Banks Foreign banks

Source: State Bank of Vietnam, 2002

The first wave of reforms in the banking sector occurred in the late 1990s. One of the main results of these reforms was that the sector changed from a one-tiered to a two tiered banking sector. ‘On paper’ the SBV became an independent central bank and supervisory institution (tier 1) and the rest of the banks became the operating system (tier 2). But in reality the SBV is generally believed to continue to be hardly independent and the influence of governmental agencies is still very large. Although there are separate tiers in the banking sector, the SBV hasn’t been separated from the political influences.

Since the Vietnamese Government started to reform banking sector, one of the major goals has been to maintain social stability. After the experiences with the CCs they are very reluctant to major rapid changes in the financial system. This meant slow reforms. After the East Asia Financial crises in 1997 there was significant international pressure (World bank and IMF) on the government to implement another round of comprehensive reforms but the government has ignored these pressures and has ever since followed a slow process with only moderate changes at a time. This slow pace of reforms is supported by a large part of the ruling elite because they are afraid to loose power and income due to the reforms. This has lead to internal friction within the Communist Party (which in fact is the ruling elite) regarding the steps to be taken. This slows down reforms further.

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open judicial disputations. Due to the fact that Vietnam was occupied by the French for more than seventy years, it has a French legal system which consists of a civil law type. Vietnam is thus more comfortable with rigid bright-line rules and legal certainty. This makes that Vietnam is less responsive to sectors and conditions that change frequently, which is currently the case in the financial sector. This lack of judicial discretion is likely to have a negative effect on financial sector development.

3.3.2 Sequence of liberalisation

In Vietnam, the liberalisation of the financial sector has preceded the liberalisation of the private sector. This has led to the situation wherein the SOCBs dealt with companies owned by the state which weren’t active in a free and open market. This led to difficulties in evaluating the profitability of (potential) customers, since they were not subject to the forces of a free market environment. The lack of transparency within the relationship between the SOEs and the SOCBs and the absence of full insight in financial data leads to difficulties in analyzing the credit worthiness of a SOE. This sequence of liberalization continues to have implications for the liberalization processes and results because the state owned banks were allowed to pursue an overall objective of profit maximization, while their customers were still controlled by the government. The government continues to be able to direct credit to SOEs and decides on the credit terms. This has lead to a situation where profits made by SOCBs in the private sector are paid out as subsidised credit to the state owned enterprises. This created a difficult situation for the state owned banks, which hardly turned into profitable organisations.

Vietnam is changing its economy into a market oriented one, while it continues to be a non democratic country. Zakaria (2004) argues that a liberal democracy is the best system a country can have for its economy and society. A liberal democracy is a political system that is not only characterised by free and honest elections, but also by the constitutional state, the separation of control and the protection of the constitutional rights like freedom of speech, freedom of religion and freedom of possession. Vietnam continues to be a communist country with only one political party. The country is not democratic at all, all major decisions are taken by the communist party and it is far from a liberal democracy. Zakaria uses a study by Przeworski and Limongi (1997) to show that a country has a higher chance of changing successfully to a democratic system when it has a higher gross national product (GNP). The study calculated that in countries with an GNP of less than US$ 1500,- per capita the average life expectancy of a democratic government was only eight years. The life expectancy rises with a rise in the GNP. Vietnam currently has a GDP of US$ 730 per capita14 (2006 estimate) which makes it likely that a democratic system would not survive if it was implemented in the near future. The Vietnamese government is focussing on economic development before political reforms. This economic development will likely lead to a) a more powerful civil society and private sector and b) the government will change its relationship with the civil society and private sector. The relationship will become less greedy and will focus more on regulations, the government will become more sensitive for the needs of the society. These two aspects are crucial for the development of a liberal democracy.

The desire of the Vietnamese government to reform the economy from a centrally planned to a market-driven system will lead to unintentional side effects because capitalistic growth is the best economic growth for the development of a liberal democracy15. The fact that the

14

EVD, Vietnam Factsheet

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Vietnamese government is not pushing hard for democracy can thus be regarded as a positive factor for the future development of a liberal and democratic Vietnam.

3.3.3 Relationship between the State Owned Banks and the State Owned

Enterprises

The government has been in charge of the banking sector ever since the establishment of the SBV and they have used the SBV, and later on the other commercial banks as well, as instruments to provide credit to SOEs. Often these loans were provided without collateral and without clear agreements concerning the repayment of the debt and interest arrangements. This paragraph will give a brief indication of the negative effects this close relationship had on the state owned commercial banks.

- Since the foundation of the SOBs and later the SOCBs the government has used them for channelling money to SOE. In time the SOCBs and the SOEs developed a close relationship and credit was extended without any analysis of the creditworthiness of the SOEs. The SOEs are characterised by low efficiency and they have great difficulties in paying and servicing their debts. This led to bad debts which have become a heavy burden for the balance sheets of the SOCBs. More on the bad debts in the chapter seven.

- The SOCBs loaned money to the SOEs. These SOEs were each concentrated within the sector for which the individual SOCBs were responsible. This limited diversification has caused that risk exposure for the SOCBs has become very high. - The SOCBs provided unsecured loans and the non-standard and non-transparent

provisioning rules further enhances the problem. Resolving the bad-debts will show to be difficult as well as crucial to the sector.

- Because of the fact that the government had extensive control over the allocation of credit, the staff of the SOCBs has hardly any experience in credit screening and judging whether credit should be extended or not. Loan assessment was no common practice. This point is closely related to the fact that the employees at the bank have poor experience with market based transactions and insufficient information about the private sector. This has led to imposed credit rationing on private enterprises and stringent collateral requirements which in turn led to difficulties for private firms to fulfil the requirements for obtaining a loan.

These problems and the results they have had for the current banking sector will be discussed further in the subsequent chapters of this report.

3.3.4 Informal bank sector

Next to the formal banking sector the informal sector banking sector is active as well. In this sector one receives credit from friends and family, but also from professional moneylenders who do not report their business to the authorities. Due to the difficulties of getting credit from the formal credit institutions, the informal sector has become relatively large in Vietnam. Especially in rural areas a large part of the loans is provided by non formal moneylenders. The two main reason are that the poor rural families cannot provide collateral in order to obtain a loan and secondly, they are not capable of meeting the standards for loan application, i.e. they are not capable of writing a proper application letter. A survey conducted in 199016 revealed that 73 percent of the loans in rural sectors were provided by informal moneylenders

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of which 40 percent were friends and 33 percent were professional lenders. These money lenders are part of the same community as the borrower which provides them with the necessary information on their credit worthiness.

Besides the difficulties in the formal sector, the informal sector has become very important in Vietnam because the Vietnamese try to keep their possessions out of the official books. This is done for tax-evasion reasons but also to prevent the government from being curious about where the money came from (in the beginning the communist government didn’t even allow the Vietnamese to have a private account). As a result it is very common in Vietnam to keep the majority of your savings at home, in VND, US$ and gold.

In Vietnam education is considered very important and families are trying very hard to get their children to study abroad. Suppose a family has an opportunity for a son to study in London. Since the college fees are often very high, the family might not be able to finance the tuition and housing costs. The family then will turn to their relatives and friends and ask them to contribute to the needed funding. At another moment, the family and friends who contributed in turn will ask for help in financing a new house or a car.

Box 3.1

The lending rates the informal moneylenders use are significantly higher than those in the formal sector, but sometimes it is the only way to obtain credit. Sometimes the informal sector is preferred because of the possibility to get credit within a very short time period, without providing collateral. The informal sector normally isn’t used for larger credits because the moneylenders often do not have much money to lend and also because it is considered illegal.

3.4 conclusion

This chapter has given an overview of the external context of the Vietnamese banking sector. It became evident that the Vietnamese state has an overwhelming influence on the sector. The state is very influential and the fact that in Vietnam power is more important than the legal system (perhaps this is where the tolerance for chaos originated) further increases their authority. The discussion of the historical developments has revealed several reasons why the reform processes have been slow and lengthy since the beginning:

1. The French civil law tradition slows down reforms

2. Extensive links between the state-owned productive sector and the financial sector. 3. Earlier crises during the reform process also restrict the current reforms due to a

lack of trust in the formal banking sector.

4. Liberalisation of the financial sector has preceded the liberalisation of the private sector.

5. Vietnamese tradition of consensus governance in concert with the ruling elite’s preference for social and political stability.

Purely on the basis of the cultural dimensions Hofstede (2007: 227) ‘reasons that, from a cultural perspective, Vietnam should be able to realise a new economic miracle’. The long term orientation and its consequences serve as a good basis for economic growth. But the necessary reforms to create a level playing field in the sector will probably take many years. The fact that it will also take years before Vietnam will become more democratic can be considered as a good thing for the social stability and economic success in the future. The external context of Vietnam thus seems most suitable for long term investments.

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Chapter 4 Current Vietnamese banking sector, Actors and

Characteristics

Introduction

This chapter is the first chapter at the level of the internal context of the Vietnamese banking sector. It will provide a description of the sector at present. All major participants will be discussed followed by an overview of the most important characteristics. The goal of this chapter is to give a short introduction to the current banking sector.

4.1 Actors

This paragraph will give a brief overview of the different banks which are present in the sector. Currently there are 5 State Owned Banks, 37 Joint-Stock commercial Banks, 27 foreign bank branches, 4 joint venture banks, 5 finance companies, 8 finance leasing companies, nearly 1000 Cooperative credit institutions and over 75 representatives offices of foreign credit institutions. The sector is characterised by its small size in terms of capital, deposits and loans but a relative large number of commercial banks.

This relatively large number of banks is due to the fact that 20 years ago the government has granted many licences to begin a bank. The general conception is that at least some of those banks were used to invest large sums of money ‘earned’ by influential party members. A few years ago the government has almost stopped with providing licences for new banks. New entrants are therefore forced to take over an existing bank banks when they want to enter the market . The government is hoping this will have a positive effect on the quality of the sector.

Box 4.1

State Bank of Vietnam

As discussed in the previous chapter, the State Bank of Vietnam (SBV) is a governmental body and is the central bank of Vietnam. The SBV has three principal functions:

- State management of monetary and banking operations - Issuer of bank notes and coins

- Banker for credit institutions and provider of monetary services to the government The SBV is responsible for establishing the value of money, ensuring the maintenance of the safety of banking activities and credit organizations. They do not provide any banking products to customers but since they are major shareholder in all the state owned commercial banks, which in turn are major shareholders in many of the joint stock commercial banks, they are very powerful. Despite the fact that it is formally an independent institute, it is far from independent from political powers. The SBV is facing numerous interventions from other state agencies in implementing its monetary policy.

State Owned Commercial Banks

The State Owned Banks are the principal state owned credit institutions. The five major SOCBs are:

- Bank for foreign trade of Vietnam (Vietcombank)

- Industrial and Commercial Bank of Vietnam (Incombank) - Investment and Development Bank of Vietnam ( BIDV)

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All SOCBs, but the MHB, are characterized by an extensive branch network throughout Vietnam. The activities of the SOCBs are heavily influenced by the SBV and thus by the government and communist party. As discussed in the previous chapter, this has resulted in an intimate relationship between the SOCBs and SOEs, a relationship which continues until today. And although the percentage of loans from SOCBs to SOEs has decreased from 90 percent in 1990 to 70 percent in 200417 the SOEs are still using up the majority of the available credit and the lending through the SOCBs continues to be channelled to SOEs. The SOCBs are dominating the lending market and they account for 70-80 percent of total banking assets. Each SOCB was established to serve a specific segment of the market which is reflected in their individual names. Until today the different SOCBs remain strong in their specific sector which indicates that they have an advantage from the long experience within those sectors. Besides the experience factor, there is also the influence of the tight relationship which developed between the banks and the SOEs within a specific sector which resulted in an ongoing focus on a particular sector. Another explanation is the fact that the government and the Communist Party (CP) are trying to keep each bank to its own specific sector as to retain more control over its activities. This ongoing concentration on certain industry sectors continues to cause a higher than average risk exposure.

Agribank

The Agribank is the only individual bank which is discussed in this chapter. The reason is that it is by far the largest SOCB in Vietnam but its activities can be regarded as development support. The Agribank is mainly active in the rural areas of the country where it provide financial assistance to the poor rural population. The government has decided that this bank will not be equitised before 2010. The Agribank has a very low profitability but saw an increase in profits of 59,3 percent compared to 200418. The bank can only exist because of the vast amounts of credit provided by the state. This allows it to extend credit far below market rates.

Joint-stock Commercial banks

The majority of the JSBs is rather small with only a few branches. A list of the 26 largest joint stock commercial banks (in terms of legal capital) is included in appendix 2.

As can be seen from figure 4.1 the JSBs are very small compared to the SOCBs. The JSBs have been growing rapidly, but their growth has been constrained by the segmentation of the market. Apparently the markets of the SOCBs and the JSBs are separated in terms of deposits and borrowers. The SOCBs deal more with larger (governmental) businesses and the JSBs focus more on the smaller loans. Another barrier for growth is formed by the introduction process of new products which is a lengthily process. Approval by the SBV can take over a year which further curbs their development and growth.

The SOCBs have large stakes in the join stock banks and despite the fact that the markets of the two types of banks are separated, the influence of the state is potentially larger, than one would think. When one compares the banks with each other, and considers them as completely separated entities one has to bear in mind that they are in fact closely related to one another. For example, currently the Vietcombank and the Asian Commercial bank are major strategic shareholders in the Eximbank.

17

IMF (1999/2006)

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The financial conditions of the JSBs banks seem to be in good shape, in 2005 dividends were at a minimum of 15 percent, and profits have increased rapidly over the first period of 2006. These banks are trying to expand their networks as fast as they can and they are trying to gain market share to become an attractive partner for a foreign investor.

As a result of the increase in chartered capital the banks might receive a bigger cash injection than they can handle. These large investments must be managed and since most banks have a shortage of well trained staff, this extra cash injection will increase the risk of mismanagement if the scope of activities will grow to fast. Most joint stock banks reported after tax annual profits of 20 percent with average dividends of 20 percent as well, three times as high as deposit interest rates in VND19.

Joint Venture Banks

There are 4 Joint-venture Banks (JVBs). This are joint ventures between the government and foreign financial institutions and/or Credit Cooperatives. For example, the Indovina bank is a joint venture between the Vietcombank and the Taiwanese Cathay United Bank, each contributing 50 percent and the VID Public Bank is a joint venture between the BIDV and Malaysia’s Public Bank Berhad. There are only 13 branches of JVBs in total.

Non commercial banks and financial service providers.

By setting up several social policy banks, the government tries to separate the policy directed lending from the commercial activities of the commercial banks.

Vietnam Development Assistance Fund (DAF)

This fund is established to provide credit to people who do not qualify for a loan from a regular bank. This might be because they cannot provide collateral. Since the regular banks are working more and more profit oriented, they do not longer provide these kind of loans. DAF has become a very large fund with an huge amount of capital. DAF doesn’t charge market-based interest rates, but rates which are much lower. This makes the DAF a competitor in the banking sector as a credit provider. DAF provides subsidised credit to SOEs and at the of end 2004 it had about $4.9 billion in loans outstanding, which is about 11 percent of GDP. 90 percent of these loans are extended to SOEs. Subsidised interest rates can have a detrimental effect on the overall development of the SOEs. They might get used to this kind of cheap credit and might not have an incentive to start competing for credit at market-based interest rates.

Vietnam Bank for Social Policies

The Vietnam Bank for Social Policies (VBSP) is a non commercial bank. Just like the Agribank it provides loans for poor households especially in rural areas, for example loans to enable children to go to a university 20.

Foreign Bank Branches/ Representative Offices of foreign Banks

There are 27 branches of foreign banks in Vietnam and they account for 10 percent in terms of total bank assets. The foreign banks have been present for quite a long time now, but they have been heavily restricted in their operations.

They mainly have been servicing their foreign customers and only since the last couple of years they are allowed to provide more banking services to Vietnamese clients. It is difficult

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Vietnam news November 2005

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The Vietnamese banking sector in transition

The Vietnamese banking sector in transition

The Vietnamese banking sector in transition

Management summary

Acronyms and Abbreviations

Table of contents

Chapter 1

Introduction

Chapter 2

Research design

2.1 Problem statement

2.2 Research methods

Chapter 3

External Context of the banking sector

3.1 Vietnamese culture

3.2 The Vietnamese business system

3.3 Historical Developments in the banking sector

3.3.1 Formal sector

3.3.2 Sequence of liberalisation

3.3.3 Relationship between the State Owned Banks and the State Owned

Enterprises

3.3.4 Informal bank sector

3.4 conclusion

Chapter 4

Current Vietnamese banking sector, Actors and

Characteristics

4.1 Actors

Joint-stock Commercial banks

Joint Venture Banks

Non commercial banks and financial service providers.

Foreign Bank Branches/ Representative Offices of foreign Banks