After decades of pursuing a closed economy and heavy reliance on state-owned enterprises, Vietnam has undergone a significant transformation and is now a bona fide Asian Tiger. Roaring ahead with annual gross domestic product (GDP) growth of 6-7%, the one-party state has attracted investors from all over the world eager to establish businesses in the country of 93 million.
In the face of robust economic growth, the country's Communist authorities have been working hard to build a more sustainable and efficient financial sector. While some progress has been made in recent years, its banking sector is still at a relatively early stage of development and many challenges remain.
For nearly three decades, the government has gradually undertaken reforms to liberalise its state-controlled banking sector, driven by the rising expectations of foreign investors and the need to comply with international and bilateral trade agreements.
Prior to 1990, State Bank of Vietnam (SBV) functioned as both a central bank and a commercial bank. As part of the reforms, its banking business was spun off into four state-owned commercial banks, leaving it to focus on central banking and regulatory activity.
In addition, to improve the efficiency and competitiveness of the sector, SBV in 2008 began granting licences for the first time to allow wholly foreign-owned banks to operate in the country. In 2014, it also raised the foreign ownership limit in local banks from 15% to 20%, which led to more foreign players entering the country.
"The banking sector in Vietnam has been through a lot of changes in the past few years and it will continue for at least the next five years," Pham Hong Hai, the CEO of HSBC Bank (Vietnam) Ltd, told Asia Focus recently.
Indeed, the sector still struggles with high levels of non-performing loans (NPLs), other structural problems and a large number of undercapitalised domestic banks. A consolidation process is continuing as the state strives to ensure systemic stability. All those in the industry believe too many of the 35 existing local banks are not up to the task.
There are also 65 foreign banks of various sizes pursuing various niches, and it is not clear how many of them will remain in the country over the longer term.
"The direction of the central bank is very clear, which is to reduce the number of local banks to 15 by 2020 and help them become stronger and more competitive," said Mr Hai.
Earlier this month, Deputy Prime Minister Vuong Dinh Hue said the country was going to limit or possibly stop issuing licences for 100% foreign-owned banks as part of the drive to encourage mergers and acquisitions (M&A) and strengthen the overall financial system in the country.
Ng Wee Siang, senior director for Fitch Ratings, expects the outlook for Vietnam's financial sector to remain stable in the short to medium term, underpinned by strong GDP growth forecast at 6.7% for 2018 and 2019%.
"[Vietnam] presents various opportunities as it evolves and has attracted decent sums of foreign direct investment (FDI) in recent years, largely from Japan, Korea and Singapore," he said. "The Vietnamese banking sector restructuring has been gradual and it will be a long-haul process. We have seen some positives in recent years, but we believe structural systemic weaknesses remain, as evident from thin capital buffers, a large NPL stock and weak profitability."
Moody's Investors Service has upgraded the outlook for its rating on the government's long-term senior unsecured debt, thanks to the country's strong growth potential, supported by increasingly efficient use of labour and capital in the economy.
The upgrade also reflects improvements in the health of the banking sector that Moody's expects to be maintained, albeit from relatively weak levels, it noted.
"Moody's currently has a positive outlook on the Vietnamese banking system. This outlook expresses our expectation of how bank creditworthiness will evolve in this system over the next 12 to 18 months and reflects largely the country's strong economic prospects," Rebaca Tan, an analyst with Moody's, told Asia Focus.
Looking ahead, she expects most of the 16 Moody's rated Vietnamese banks to extend the improvement seen in 2017 in terms of asset quality and profitability.
LOAN GROWTH AND NPLs
One of the biggest challenges for the Vietnamese financial sector is rapid credit growth, which has been weighing on banks' capital base and thus results in a limited buffer for absorbing losses, Ms Tan said.
"Capitalisation will be the key weakness for the banking system. … The capital needs of Moody's rated Vietnamese banks showed that these banks will need an additional US$7 billion to $9 billion in capital, in order to achieve Tier 1 capital ratios of 11% in 2018-19 while sustaining current growth rates," she added.
Without external capital, she says, Moody's estimates that the Tier 1 capital ratio of rated private-sector banks will drop to 8.0% by the end of 2019 from 9.4% at the end of 2017, while that of rated state-owned banks will decline to 6.1% from 6.9%.
"Banks have been growing their loan books on average by 15-20% year over year but with no capital increase," added Mr Hai of HSBC.
According to Mr Ng of Fitch, it would be difficult for the authorities to curb loan growth over the next few years as Vietnam remains a credit-driven economy.
However, the upside is that loans have become more diversified than before as banks shifted away from lending to inefficiently run state-owned enterprises (SOEs) toward small-ticket retail loans.
"While this may help mitigate the asset-quality pressure, there are still pressures for certain banks to lend to priority sectors, sometimes at preferential lending rates," he added.
In addition, as Vietnam becomes more integrated with the global economy, all banks are expected to apply Basel II standards by 2020 to improve competitiveness, governance and risk management.
Basel II is a set of international banking regulations developed by the Basel Committee on Bank Supervision (BCBS), which set minimum capital requirements for banks and require them to apply risk management methods to safeguard solvency and overall economic stability.
"Based on the standard, a lot of banks will not have enough capital as it will be much more stringent in terms of capital requirements," said Mr Hai of HSBC.
"In the medium term, a tightening of risk management as well as transition to Basel II capital norms will be key to strengthening the quality of Vietnamese banks," Ms Tan added.
Authorities have been trying to expedite the resolution of legacy problem loans through the introduction of the resolution law (Resolution 42), which took effect in August 2017.
"This could help address the asset-quality issues, but the resolution process is likely to be a prolonged one due to the considerable implementation challenges," Mr Ng said.
He explained that the new law could remove some of the legal impediments to effective loan resolution as it includes measures to improve lenders' ability to enforce collateral security, which already appears to have made banks more aggressive in seizing commercial property to foreclose on bad loans.
The law also enhances the trading of bad debt in the secondary market, allowing it to be sold to any legal entity, including foreign investors, without the need for a licence for debt trading.
In May, SBV said the NPL ratio in the system had been reduced to below 3% of outstanding loans.
While Fitch Ratings has raised the country's sovereign credit rating, it also noted that NPLs in Vietnam remain under-reported and true asset quality is likely to be weaker than stated.
"We have seen certain large and mid-sized banks take a more aggressive stance in writing off their NPLs, especially bad loans sold to the Vietnam Asset Management Company (VAMC)," said Mr Ng, attributing their stronger earnings in 2017 to a stronger domestic economy and property market.
However, rapid lending growth will continue to add to the risk of a rise in NPL creation, and the actual problem-loan ratio remains under-reported, he said.
"The financial regulations and transparency still remain very much a work in progress as the majority of the banks still do not disclose their capital ratios and there is still ample room for improvement," he said.
Mr Hai also believes that while NPLs have been reduced, they are still too high. "If you take into account loans in asset management companies or loans that haven't been classified or reported properly in the system, the NPL ratio for Vietnam today should be around 7%."
CAPITAL INJECTION
To address the capital issue, some private banks have started to turn to the equity market to raise new capital from foreign investors.
In April this year, the 25-year-old private bank Techcombank raised US$922 million from global investors, marking the country's biggest-ever initial public offering (IPO). It is now Vietnam's second-biggest listed bank after state-controlled Vietcombank.
Techcombank chief financial officer Trinh Bang told Reuters recently that the bank aimed to expand aggressively into retail banking to capitalise on booming demand in services areas such as credit cards, automobile loans and bancassurance.
Tien Phong Commercial Joint Stock Bank (TPBank ) has also sold a 15% stake to investors via a private placement with the hope of increasing its market capitalisation to at least $1 billion in the last quarter of this year.
According to data compiled by Bloomberg, shares of banks have been the best performing sector on the VN Index, rising 37% in the first quarter of this year.
"As market conditions are very favourable now and bank stocks are also running very well, listing at this time is good," Dang Tran Hai Dang, head of research at Vietinbank Securities JSC, told Bloomberg earlier.
"Improvements in the banking system have attracted foreign banks and investors as evident from the capital raising by several private-sector banks in 2017 and 2018," added Ms Tan of Moody's. "We expect to see more private-sector banks turning to the equity market in 2018 to raise capital."
However, she said it was not always easy for Vietnamese banks to raise capital given the recent volatility in their stock prices due to the trade war between US and China as well as rising US interest rates.
"This could dampen the prospects for banks seeking investor capital. Also, weaker banks that are still struggling with legacy problem assets and low profitability are likely to have trouble attracting investor interest, edged out by healthier peers," she added.
On the other hand, she said, state-owned banks have been slow to raise new capital because the Vietnamese government prefers strategic investors. Some of the state-owned banks are also near the foreign ownership limit and will face problems attracting substantial capital from foreign investors.
"In this regard, a loosening of foreign ownership limits in Vietnam will provide these banks with more options to boost their capitalisation," she said.
The existing 20% cap on foreign holdings also limits the potential for foreign banks to make significant changes to their Vietnamese partner banks' strategies or business operations.
HSBC Vietnam, for instance, has sold its entire stake in Vietnam Technological and Commercial Joint Stock Bank or Techcombank -- a move Mr Hai ascribed to the restrictive foreign ownership laws.
"After working with Techcombank for almost eight years, Techcombank has really improved ist corporate governance and become much more efficient … but if the maximum limit is 20%, there is no upside for us," he said.
MIXED SIGNALS
There are currently 10 wholly foreign-owned banks licensed in Vietnam, including HSBC, Standard Chartered, Hong Leong and CIMB.
However, amid the rapid improvement of Vietnam's financial sector, foreign banks are seen to be sending mixed signals -- some rushing for exits or selling stakes they held for a decade, while some are rushing in.
For example, ANZ Bank (Vietnam) sold its retail banking division to Korea's Shinhan Bank, transferring its two retail branches, six transaction offices and 125,000 customers. Commonwealth Bank of Australia (CBA) also sold its decade-old branch in Ho Chi Minh City to Vietnam National Bank (VIB).
Standard Chartered also sold its entire 8.75% stake in Asia Commercial Bank, the largest private bank in Vietnam by assets, after 12 years of partnership. France's BNP Paribas divested its entire 18.7% stake from Ho Chi Minh City Oriental Commercial Bank (OCB) after almost 10 years.
On the other hand, while some foreign banks decided to flee Vietnam, others have entered the country. Korea's Shinhan Bank has ramped up its presence in the last few years and more recently, Singapore's UOB also launched its operation in the country.
Nguyen Tri Hieu, an independent director of An Binh Bank, believes that the foreign sell-off stems mainly from high bad-debt ratios and inadequate risk management at local financial institutions, Asia Times reported earlier.
Fitch's Mr Ng added that in his view, the disposals by foreign banks could be driven by two key factors. "Their investments could have been seen as a distraction for management at a time when these banks were burdened by issues on their home turf, or these were non-strategic stakes and did not make much of a difference to their balance sheet."
Mr Ng added that the Vietnamese banking market would appeal to players in countries whose businesses have been or are making inroads in the country, such as Korean, Japanese and Singaporean banks, given that they have been large foreign investors in the country.
"In my view, foreign banks would have to remain selective in their target market segments where they can offer a value proposition by leveraging their strengths and brand name," he added.
HSBC's Mr Hai added that he sees the sell-off as the rationalisation process for global and regional banks as they selectively pursue more profitable market opportunities.
"My principle is that if you don't have the scale in the market, then you'd better exit because you cannot compete, and then they can then focus on their core markets. I think this is the right strategy," he said.
In addition, the departure of many foreign banks does not always imply a negative result, as joint arrangements and strategic partnerships have assisted local banks to adopt and apply more international standards to their operations.
"We believe that any partnership should be a long-term partnership and the relationship should be separated when we believe that the local partners can become successful by themselves," said Mr Hai.
