Financial Institutional Management

Q2.Government policy related to the financial sector

1/Regulation concerning banking

  Vietnam’s government has promulgated a number of laws and provisions to enhance the soundness of the credit institutions and to stimulate the provision of credit to the most productive sectors.Those laws and provisions influence the access of borrowers, particularly private enterprises, to credit from financial institutions.

  The first two fundamental banking codes (the Ordinance on the State Bank and the Ordinance on Banks, and Credit Cooperatives and Finance Companies) marked a crucial step towards institutionalising banking operations and a new structure of the banking system.Then these ordinances were replaced by the Law on Credit Institutions in 1998. This law provides a wide range of products that credit institutions are allowed to offer, ranging from the traditional financial products to funds management and insurance services. It has provisions to ensure the safety of the activities of the credit institutions, including capital norms, restrictions on asset/liability management, deposit insurance, and limits on credit institutions’ investment in real estate

According to the new law, a credit institution is allowed to lend to a single client an amount up to 15 per cent of its own capital (equity), instead of 10 per cent of old rules.Since the level of own capital (equity) of commercial banks in Vietnam is normally low, this rule in facts limits the amount of money that an individual firm can borrow .Moreover,some regulations with the aim of enhancing loan procedures of commercial banks were also implemente.For instance, the feasibility study of investment projects is expected to improve efficiency and transparency, to contribute to commercialising banks’ behaviour, and to limit the accumulation of bad loans into banks’ balance sheets. The SBV issued Decision No. 415 in 2000, requiring commercial banks in Vietnam to provide information about their clients to the SBV on a regular basis. To be more specific , this decision stipulates that commercial banks have to give details about a client to the SBV within three days after a “credit relationship” is established, provide the SBV with the details on financial health of their clients on quarterly basis. These measures are important in terms of enhancing the prudential supervision of the SBV on commercial banks. However, it is likely that these measures are not effective because the government seems to fail to enforce them

   In sum, the SBV has attempted to improve the soundness of the commercial banks by setting limits on loans given to single borrowers and tightening of the requirements on information transparency. These measures seem to crowd out private enterprises because private enterprises usually do not have good financial records.

2/Monetary policy

 Monetary policy covers a central bank’s actions to influence the cost and the availability of money and credit. Thus, it serves as a means of helping to promote national economic goals. Two instruments of monetary policy that central banks normally use are interest-rate policies and reserve requirements. While interest-rate policies affect the cost of credit, reserve requirements determine the availability of credit. Both, therefore, play an important role with respect to access to credit of firms.

In Vietnam, SBV is responsible for monetary policy as well as bank regulation and supervision. SBV is a ministerial agency under the government’s executive branch, with its headquarters in Hanoi and offices in most cities and provinces. Given its legal status and organizational structure, SBV’s policies and operations are significantly influenced by the central and local governments, as has been evident during the current macroeconomic crisis. SBV’s provincial branches are considered departmental agencies similar to other sectoral offices of the government, and a standard branch template is applied regardless of location, leading to overstaffing and local political interference

   A plan to transform SBV into a modern central bank has been approved by the Prime Minister, and both the Law on the State Bank and the Law on Credit Institutions are expected to be amended in 2009 to reform SBV on the lines similar to the Chinese strategy. This entails moving the function of banking supervision to a new departmental agency, thereby leaving SBV to focus only on managing monetary policy

 3/Interest-rate policy

  Until 1993 the SBV maintained a lending interest rate differentiation regarding borrowers (households had to pay higher interest rates than economic entities) and sectors (economic entities in agricultural and industrial sectors were charged lower interest rates than those in commercial and services sectors) (Vo, 2001).However, in 1993 the SBV abolished this differentiation.

  In the early years of doi moi, deposit interest rates were higher than lending interest rates. For instance, in March 1989 the spread between the interest rates on industrial loans and the three-month household deposit rates was minus 1.5 per cent, and it reached minus 3.3 per cent by the end of the year. This spread has become positive since December 1992 when deposit rates fell below lending rates

   Until March 1989 the official interest rates had been low, and the real interest rates had been negative . As inflation has declined, the government became concerned that the real lending rates were becoming too high, and have thus cut the lending interest rates several times since 1995 (see Table 3.4). Beginning in 1995, SBV allowed commercial banks to set deposit rates freely to increase competition in raising capital but the maximum loan-deposit rate spread was restricted to 0.35 percent per month, so indirectly, banks were still subject to both loan and deposit rate ceilings. When interest rate competition started increasing between banks, the restriction of 0.35 percent per month gradually became ineffective, and was finally formally removed. As banks became more commercialized in their operations, they began to focus more on meeting market demand rather than channeling directed credit. This created severe competition between banks and difficulties in finding bankable projects, putting a downward pressure on deposit and loan rates.

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   Up to August 2000, the SBV maintained an interest-rate ceiling mechanism. According to this mechanism, formal credit institutions were not allowed to lend at interest rates higher than the ceilings. On August 5th, 2000, the SBV replaced the ceiling mechanism with the base interest-rate mechanism regarding domestic currency based lending. Under this mechanism, the SBV sets a base lending rate and margins above this rate to serve as limits for the lending interest rates charged by banks. This new mechanism provides adequate flexibility to credit institutions and should help to enhance firms’ access to credit (IMF, 2002a) because credit institutions may be more inclined to grant loans if they are able to price loans according to credit risks. At the same time, the government also adopted a market interest rate mechanism as for foreign currency-based lending activities; the interest on dollar deposits is now based on the SIBOR (Singapore Interbank Offered Rate)