Vietnam Banking Industry Analysis 2017

Contents
1. Report summary ............................................................................................................................... 2

2. Life cycle and performance ............................................................................................................... 3

2.1. Credit .............................................................................................................................................. 3

2.2. Liquidity .......................................................................................................................................... 3

2.3. Profitability..................................................................................................................................... 3

2.4. Capital Adequacy Ratio .................................................................................................................. 4

3. Market segmentation ....................................................................................................................... 4

4. Drivers and Barriers .......................................................................................................................... 6

5. Regulation ......................................................................................................................................... 7

5.1. Banking regulation and supervision ............................................................................................... 7

5.2. Bank Governance ........................................................................................................................... 7

5.3. NPLs resolution .............................................................................................................................. 8

5.4. Restructuring efforts ...................................................................................................................... 9

6. Outlook ........................................................................................................................................... 10

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1. Report summary
The banking industry is in the growth cycle. In the period of 2012 to 2016, credit balance increased by
15.5% CAGR, reaching $242.4 billion USD.

Commercial banks dominate the financial sector of Vietnam, accounting for 95% of total assets. Four
largest state-owned commercial banks contribute 45.4% of total assets, whereas joint-stock banks
account 40.3%. In terms of credit distribution, industry (23%) and services (37%) receive most capital.

The banking industry benefits from positive macroeconomics and recent structural reforms in financial
sector and state-owned enterprises. Credit allocation also moves away from inefficient SOEs to retail
banking. However, despite improvement, non-performing loans (NPLs) is still a critical issue. The banking
sector suffers from low profitability. Lastly, rapid credit growth brings about new uncertainties.

The regulatory regime of Vietnam is still evolving. Vietnam still does not comply 100% with Basel I.
Financial reporting standards and reporting quality is questionable. Plus, SBV is not an independent
agency. Poor supervision result from gaps in the regulatory framework and the conflicting role of the
state. Systematic risks heighten due to the common practice of cross-ownership among banks.

Regarding NPLs, the first-line treatment is provision for credit losses. The government also encourages
M&A to patch liquidity issues. A state-owned company - Vietnam Asset Management Company (VAMC)
has been set up to purchase bad debts. However, VAMC is seen as ineffective due to its small capital
base and various legal hurdles.

To deal with mounting bad debt and to advance market efficiency, the government came up with a
detailed restructuring plan in the period of 2011-2015 and 2016. Phase 1 calls for diagnostic works,
followed by the launching of major components of the program such as bank capitalization. The final
phase entails deepening and consolidating the implementation of the reform program.

With respect to outlook, interest rate is expected to increase due to inflation pressure and the need for
new deposits to meet safety requirements. The implementation of Basel II among 10 major banks will be
the highlight in 2017. Many notable IPOs is on the horizon. Due to NPLs, the banking sector is likely to
continue to witness mixed business results.

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2. Life cycle and performance

2.1. Credit
The banking sector is currently in the growth cycle. From 2012 to 2016, total credit balance increased
by 15.5% CAGR, reaching $242.4 billion USD in 2016 (SBV, 2016).

Total credit balance (bn USD), 2012 - 2016

242.4

205.0
174.8
153.1
136.1

2012 2013 2014 2015 2016

Source: SBV, 2016

2.2. Liquidity
In 2016, deposits increased by 19%, compared to 16.1% in 2015 (NFSC, 2016). VND deposits were
estimated to account for 89.5%, whereas foreign currency deposits contributed 10.5%. In terms of
deposit term, a majority of accounts were term deposits (81%); current deposits made up 19%. Loan-to-
deposit (LDR) ratio stayed steady at 85%. The ratio of short-term capital financing medium and long-
term loan was 35%, which was below the official ceiling of 50%.

2.3. Profitability
In 2016, net interest margin increased slightly to 2.8% (NFSC, 2016). Net interest income grew 9.0%,
accounting for 79% of operating income. Compared to 2015, income from services expanded by 18.5%;
foreign currencys trading revenue surged 44.0%; proceeds from contributing capital and purchasing
stocks jumped 51.7%; other income sources gained 19.9%. Profit before provision for credit loss was
estimated to expand 10% in 2016.

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 Net interest margin, 2012 -2016

3.2%

2.8% 2.8%
2.7% 2.7%

2012 2013 2014 2015 2016E

Source: NFSC, 2016

2.4. Capital Adequacy Ratio

The Capital Adequacy Ratio (CAR) of credit institutions was 12.84% in 2016 (SBV, 2016). For state-
owned commercial banks, the rate was 9.92%, which was just a bit above the official target of 9%. By
contrast, the CAR of joint-stock commercial banks stayed at 11.80%.

3. Market segmentation
The financial sector of Vietnam consists of banks, non-bank credit institutions, microfinance
organizations, people credit funds, subsidiaries and representative offices of foreign banks.
Commercial banks are the most prominent player, representing 95% of the financial industry in terms of
assets (SBV, 2016).

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 Financial institutions in Vietnam

Source: SBV

Commercial banks are categorized into state-owned commercial banks, joint-stock commercial banks,
100% foreign-owned banks and joint-venture banks.

State-owned commercial banks: the four biggest banks are Vietcombank, Vietinbank, BIDV and
Agribank. In combination, the big four accounts for 45.4% of total assets (SBV, 2016). Recently,
the government nationalized weak banks, including Construction Bank, Ocean Bank, GP Bank.
Joint-stock commercial banks: due to burgeoning M&A activities, the number of joint-stock
commercial banks has dwindled in recent years, falling from 34 in 2012 to 28 in 2016 (NFSC &
SBV, 2016). With respect to total assets, joint-stock banks contribute 40.3%. Among 28 joint-
stock banks, only 4 banks (Sacombank, Military Bank, Saigon Commercial Bank, and Eximbank)

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 have chartered capital of over $500 million USD. By contrast, Vietinbank one of the major
state-owned banks records chartered capital of $1.64 billion USD.
Foreign-owned and joint-venture banks: the segment accounts for 9.7% of total assets.
Currently, there are 8 100% foreign-owned banks, namely ANZ, Hong Leong, HSBC, Shinhan,
Standard Chartered, Public Bank, CIMB and Woori. The number of joint-venture banks reduces
to 2, including Indovina Bank and Vietnam-Russia bank. On the other hand, the number of
foreign bank subsidiaries reaches 51.

Regarding credit allocation, industry (22%) and services (37%) account for the biggest share, followed
by commerce (18%), agriculture (10%) and construction (9%). In 2016, most sectors registered credit
expansion of over 20%, except for industry (10.9%) and construction (12.2%).

4. Drivers and Barriers

The banking industry harnesses from stable macroeconomics, i.e. economic growth is over 6.0%, VND
and inflation stays within a safe range. Recent governmental reforms have also brought about certain
positive results, notably in the banking sector and in restructuring state owned enterprises (SOEs).
Credit structure shows improvement, shifting from SOEs to retail banking. The movement is expected to
reduce pressure on asset quality.

However, major challenges persist; firstly, NPLs remain a pressing issue despite recent positive trend.
NPLs will be examined further in Section 5.3. NPLs resolution.

Secondly, the banking industry still records weak profitability. Average ROA and ROE of state-owned
commercial banks is 0.47% and 8.24%; for joint-stock commercial banks, the rates are 0.26% and 3.49%
respectively (SBV, Q3 2016). Profitability is narrowing given increasing competition in attracting deposits
and lowering loan rates. In addition, the rising cost of resolving NPLs cut into the bottom line of banks.

Finally, recent rapid credit growth implies risks. In 2016, total credit expanded by 18.25%, posing
danger to overall financial stability (SBV, 2016).

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5. Regulation

5.1. Banking regulation and supervision

According to the evaluation of World Bank, the regulatory and supervisory framework of Vietnam is
still in the developing stage. SBV administers the banking sector through prudential supervision (ensure
the safety and soundness of banking) and on-site inspection (policing violations of administrative
procedures). One of Vietnams disadvantages is that it does not comply with Basel I in its entirety.
Financial reporting and disclosure requirements are scarce; reporting quality is dubious, and there are
little non-financial disclosures. Consolidated supervision is not carried out properly; entire banking
groups are not subjected to sufficient supervision.

The authority of SBV are constrained as the bank is not independent, handicapping its ability to realize
the powers specified by the legislation. Nevertheless, the regulatory framework is seen as rather
comprehensive in terms of permissible activities, covering most of the operations of credit institutions.

Gaps in the regulatory framework also reduce the efficiency of administration. Firstly, the definition of
relevant stakeholders is limited, impeding the identification and evaluation of final beneficiaries, and
affecting other areas such as licensing, transfer of ownership, acquisitions, large exposures, related
party lending, and capital adequacy. Next, the licensing and authorization procedures are too
prescriptive and do not allow much opportunities for scrutiny. Thirdly, prudential supervisions are not
yet robust; operational and interest rates risks are still not taken into account when measuring total risk.
Finally, asset allocation and provisioning guidelines are still of subpar quality.

Although SBV is given remedial power according to the law, it is not always the case in practice.
Implementation guidance and procedures are lacking. The fact that several banks have been put under
SBVs control testifies the lack of timely corrective action framework.

5.2. Bank Governance

The role of the state is contradictory in the banking sector, diminishing the ability of banks to be
accountable. Policy objectives, directed lending, weak regulatory framework and lack of transparency
result in little responsibility for bank managements. State-owned commercial banks often suffer from
the absence of clear governance structures, with some of the tasks of a bank board are conducted by
SBV.

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Extensive cross-ownership of private banks implies potential conflicts of interest. For example, money
may be improperly disseminated to related stakeholders or unrelated speculative entities. A risk culture
is missing and risk management practices are not well-developed.

5.3. NPLs resolution

During the period of 2012 to 2016, the official NPLs rate dropped from 4.2% to 2.46% (NFSC and SBV,
2016). In 2016, the banking sector resolved $4.18 billion USD of bad debt.

Official NPLs rate (NPLs/ total credit), 2012 - 2016

4.2%

3.7%
3.6%

2.9%

2.46%

2012 2013 2014 2015 2016

Source: NFSC & SBV, 2016

As of the end of 2016, the official NPLs rate is 2.46% but it does not reflect the depth of the problem.
Different tactics are employed to play down the NPLs rate. For example, banks typically categorize high-
risk debt into Special mention loans, which is one-notch above NPLs. The actual NPLs ratio is
estimated to be 8.86% (equivalent to $21.5 billion USD), including the debt that are already sold to
VAMC and hidden bad debt (SBV, 2016).

The primary measure to tackle NPLs is provision for credit losses. Banks are required to set aside
sufficient funds to cover loans with high default risk. In 2016, total provision for credit losses was
estimated to increase by 11.9%, compared to 5.4% in 2015 (NFSC, 2016). The ratio of provision for credit
losses to reported NPLs was 57.2%.

Another measure of resolving NPLs is M&A banks to address institutions with liquidity issues. The
motivation is to avoid bank runs while refraining from using public money given the current tight fiscal
position. However, although M&A could fix imminent liquidity difficulty, the problems of underlying

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asset, capital and governance remain. In addition, the purchase and assumption (P&A) agreement is not
specified clearly under the Credit Institution Law.

SBV has also established VAMC to buy bad debts at book value (net of provisions) or at market prices.
In 2016, 21% of NPLs are sold to VAMC (NFSC, 2016). The initial chartered capital of VAMC is $24 million
USD. VAMC purchases NPLS with a special interest bond. The bonds can be used to refinance loans with
SBV but banks are required to make annual provisions of at least 20% of the bond value. Upon the
expiration of the special bonds, if the underlying debt is still not collected, banks need to repurchase
debts from VAMC at book value and return the special bonds.

The effectiveness of VAMC in settling NPLs is doubtful. The proportion of unresolved NPLs at VAMC is
still persistently high at 85%, amounting to $9.86 billion USD (equivalent to 4.3% of total credit balance).
Ultimately, the settlement of NPLs will depend on its attractiveness to banks and the determination of
financial institutions to address NPLs. VAMC bonds do not yield any interest so they may be only
appealing to a few banks that suffer from severe liquidity crisis. Lastly, if assets are transferred to VAMC
without proper management and disposition, their value may decline.

5.4. Restructuring efforts

To deal with serious bad debt and improve the efficiency of financial flows, the government adopted a
comprehensive restructuring plan in the period of 2011-2015 and 2016. In addition, it is also important
to ensure the stability of the financial market during the process of reform.

Phase 1 mainly deals with diagnostic assessment such as special financial audits to measure NPLs
correctly and operational audits on banks. In phase 2, core components of the program are
commenced, e.g. recapitalization of viable banks and orderly exit of insolvent banks. The phase also
includes the implementation of major changes in financial infrastructure and financial regulation. The
roadmap to develop capital markets and non-bank financial institutions are also initiated. In the final
phase, a full program to resolve bad debt is launched. The bank-led and VAMC components would be
underpinned by appropriate legislations. The government would deepen and consolidate the
implementation of the reform program, i.e.. introducing measures to reduce the policy burden of state-
owned commercial banks; developing a proper liquidity management framework; enacting reforms in
capital markets, financial infrastructure and regulatory regime.

According to NFSC, as of the end 2016, the restructuring program yields some positive results,
including (i) liquidity crisis is pushed back and the overall liquidity position is stable; (ii) identify and

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separate weak banks; (iii) cross-ownership and cross-investment is put under control; (iv) better risk
management and governance practices are introduced. However, difficulties remain: (i) unreasonably
large amount of accrued interest (ii) the execution of Basel II falls behind schedule. The track record of
NPLs is already discussed in Section 5.3 NPLs Resolution.

6. Outlook
In 2017, interest rate is expected to rise due to projected inflation surge and the pressure to attract
new deposits to satisfy safety requirements of SBV. Accordingly, LDR shall not exceed 80% and the ratio
of medium and long-term debt to total debt should be less than 50%.

The pilot run of Basel II will be the focal point in 2017. To meet the new CAR specification, banks need
to beef up its capital base. As evidenced in 2016, luring fresh capital is not straightforward due to scarce
domestic funds and the ceiling of foreign ownership in Vietnam banks. Given the difficulty in expanding
capital, banks may need to limit credit expansion. As a result, credit is expected to rise only 16% in 2017,
compared to 18.25% in 2016 (VCBS, 2016).

IPOs are expected to be burgeoning in the upcoming period. New listings will improve the transparency
of the sector and offer investors more choices when it comes to banking stocks. Techcombank, VPBank
and VIB are among notable debuts thanks to their large size, efficient operation and dynamic income
structure.

The banking sector is likely to continue to witness mixed business results due to NPLs. Banks that have
aggressively resolved NPLs (e.g. Vietcombank) will not need to allocate a large chunk of their earnings to
cover bad debt. On the other hand, financial institutions that still possess a large- amount of VAMC
special bonds are going to underperform in terms of profitability.

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