A hot sector in a cool economy

Steve Punch Financial Services Director, KPMG Vietnam

There are some good roads, but there are many in overdue need of repair.  There are some that run traffic the length of the country and some that are regionalised. 

There are quick fixes available such as identifying hazardous “hot-spots” and filling in pot holes or amending road dynamics to make them safer in the longer term.  There are new freeways under construction over main arteries that are coming to the end of their useful lives. 

These initiatives are ultimately designed and implemented to create a safer and more efficient road network.  Of course, given that drivers are the root cause of most road accidents, none of these improvements would be effective without having appropriate road safety laws and governance structures in place.

The analogy with the current state of Vietnam’s banking sector is uncanny.  The Vietnamese government announced earlier this year that the restructuring of commercial banks was a high priority for 2012 and beyond.  With assistance and guidance from the State Bank, banks will need to overcome their difficulties and look to merge with other banks, trim costs and become stronger lenders. 

Vietnam’s central bank aims to create two big lenders that are competitive within the region before 2014, and an additional 10-15 major banks that can become “pillars” to support the country’s financial system.  This proposed transition will require the banks of the future to address and reduce much of the uncertainty currently surrounding their risk management framework, and especially how they deal with Non-Performing Loans (NPLs).

Three lines of reform

Without doubt, the Vietnam banking sector is undergoing more change than other economic sectors.  Reform is being addressed along three lines, with regulatory, strategic and process initiatives.

Firstly, the most obvious driver behind restructuring the banking sector is the State Bank’s move to implement a risk based supervision framework in compliance with Basel II principles and standards.  The State Bank aims to achieve this over a five-year time period. 

Basel II, released in 2004 and required to be implemented by member countries by 2009, was originally seen by the global financial sector as a compliance headache but the Basel accords are not just about compliance.  Adopting Basel as the minimum standard for assessing the risks banks face increases overall operating efficiency and capital management.

Secondly, strategic manoeuvres by some banks looking to tie out with other local joint-stock banks to create a bigger bank, such as the merger between Habubank and SHB announced in April.  Additionally, some tie-outs have been forced by the regulator with oversight by one of the state owned banks, such as the consolidation of three Ho Chi Minh City banks in December with oversight by BIDV to represent and manage the government’s stake in the newly formed bank.

Thirdly, banks who adopt the recommendations of the Banking Committee on Banking Supervision (BCBS) are realising that there are real business benefits to be gained from implementing the Basel accords.  Capital savings, improving the bank’s reputation, rating systems, lower funding costs and more effective pricing are just some of the realised benefits. 

To achieve these benefits, significant investment in human resources, process change, IT and system enhancements, internal governance and oversight is required.  These amendments occur at the process level as part of holistic advanced risk management.

Vietnam’s banking sector is looking for a fast route back to stability

The main restructuring issues

Ultimately the restructuring process is designed to promote long term stability and confidence in the banking system through enhanced governance and accountability, improved competitiveness and strengthening the infrastructure and processes at Vietnamese banks. 

At a macro level, the government needs to carefully manage the ongoing equitisation of the state owned commercial banks (SOCBs) and other state-owned enterprises (SOEs)  Lending to SOEs is concentrated in the big four SOCBs, and this fact needs to be taken into account when evaluating the equitisation plans of SOCBs.

Regulatory issues

The State Bank will need to provide additional guidance on how to establish a Basel II risk based supervisory framework.  Additionally, this will need to be communicated to banks so that process, supervisory and reporting enhancements can be implemented.  This process is already underway with funding provided from an international agency to establish a project team to advise the State Bank’s Banking Supervisory Agency on Basel II implementation.

Capital injections

There are weaker banks that provide little incentive as a target for bigger banks.  The State Bank will need to carefully consider capital injections to some of these entities as it did with the three Ho Chi Minh City banks in December.  Even if the foreign shareholder rules are relaxed, it is unlikely that strategic foreign partners will rush to increase their stakes and inject more capital unless more clarity is provided around process and reporting of certain key metrics.

Non-Performing Loans

There are some dysfunctional and adverse current practices at Vietnamese banks and further clarity is required on the real level of NPLs.  Under IFRS, many loans now classified as performing would qualify as NPLs and loss provisions would be higher.  Vietnamese banks assess NPLs status based on overdue status rather than by assessing the borrower’s ability to repay on qualitative measures.  

The State Bank should address this issue by aligning local regulations with international practices and including qualitative measures allowed under Basel II.  One of the first steps to restructuring is the cleansing of “toxic” loans so banks can concentrate on their core business coinciding with a fresh approach to credit risk management.

Banking operations

An obvious requirement in the banking restructuring is process improvements at both SOCBs and JSCBs.  The requirement for further capital injections coupled with an understanding of the State Bank’s direction on Basel II type risk based supervision for capital requirements and risk management is forcing banks to take action. 

KPMG has recently seen a sharp increase in activity from many banks in Vietnam to assist with implementing structural and procedural enhancements designed to compliment a stronger control environment. 

These operating model changes require strategic upfront planning, careful implementation and sensitive change management.  An ongoing requirement is to also have a process in place that continually assesses the robustness and effectiveness of newly adopted processes. 

The process changes being implemented cover credit risk, operational risk, market risk, treasury allocations and expense management.  Overtime, banks will see that these changes will substantially improve their understanding of their business and add value to their bottom line.

Different bank, different solutions

The diversity of participants in Vietnam’s banking sector requires a tailored approach for each bank.  One size doesn’t fit all, and bespoke solutions are required to put into practice the State Bank’s recommendations. 

Consideration needs to be given to the practicality, timeliness and cost when assessing appropriate risk mitigation solutions.  The State Bank has “encouraged” the large SCOBs and the larger JSCBs to seek merger and acquisition opportunities among themselves as a precursor to strengthening the banking sector.

Looking forward

As Europe’s woes are yet to fully play out, it is the view of KPMG that banks in Vietnam need to be fully aware of and absolutely committed to addressing all risks they face, and to then develop appropriate mitigation strategies.  

For the smaller banks, it’s an opportunity to strengthen their business, provide greater security for their customers and for the investors to possibly sell out at a higher price.  For the bigger banks, it’s an opportunity to position themselves as being one of the banks that will remain and thrive post consolidation of the sector.  

KPMG believes that in 2012, the Vietnam banking sector will commence a period of transformation that will continue for many years.  Addressing risk issues in banking is not simply a compliance matter or a cost of doing business; it is a path to greater understanding of your business and to achieving efficiency and profitability. 

Combining State Bank oversight, advisory insight, and proactive willingness within the sector to adapt, a stronger banking system can be built in Vietnam.