Banks incorporate Basel II standards

Ten Vietnamese banks were chosen to undergo the Basel II pilot scheme before rolling it out nationwide from 2020, Photo: Le Toan

The very first Vietnamese banks to graduate from the Basel II pilot programme were state-owned Vietcombank and joint stock commercial bank VIB, which last week successfully completed the process a year ahead of the scheduled 2020.

As per Circular No.41/2016/TT-NHNN issued by the State Bank of Vietnam (SBV) in 2016, the Vietnamese banking system must be prepared to apply Basel II standards when tighter regulations on banking operations with a capital adequacy ratio (CAR) of at least 8 per cent come into force from January 2020.

A total of 10 banks were selected three years ago, including Vietcombank and VIB, to undergo a pilot scheme for capital and risk management in compliance with Basel II standards. Once the trial has been completed, Basel II application will be rolled out throughout the ­entire banking system from 2020 onwards. Lenders who are capable of implementing new regulations sooner than the given timeline are able to apply early.

According to VIB CEO Han Ngoc Vu, the lender has internally phased in the stricter international banking standard to monitor the capital adequacy level as per Circular 41 since April 30. It therefore officially asked the SBV to approve an early application of the minimum CAR in line with Circular 41 on January 1, 2019.

Circular 41 itself will bring in a number of great benefits to both the banks that apply it and also to the banking system which will strengthen its safety and operation. Vu has therefore suggested that the SBV come up with incentives in terms of a flexible credit growth target that encourages those that are capable of implementing the regulation sooner than the given deadline.

In particular, banks should be able to decide their own credit growth rate in line with their ability to meet the capital requirements under both ­Circular 36 on bad debts and Circular 41 on capital ­adequacy.

In addition, Vu also proposed a mechanism for lenders who applied Basel II early to expand their network to a maximum of 15, instead of 10 under the current regulations.

“We believe that managing growth indicators, including credit growth and network, in compliance with minimum capital requirements, will reduce administrative management, but enhance market mechanism management,” Vu said.

“This will encourage banks to raise capital and entice investors to invest in banks that apply the international standards, and what comes out at the end of the day is that this will further facilitate the success of the implementation of Circular 41 as well as the resolving of bad debts at Vietnam Asset Management Company,” he said.

“Credit growth on the other hand will still be under control under Circular 41 with stricter capital requirements, it would not be easy for banks to grow should they not have the capability to bolster their owner’s equity,” he added.

In response to VIB’s proposal, SBV Governor Le Minh Hung noted that for those that have met the CAR requirements, the central bank will give them a higher credit growth target for 2019.

“We will have different credit growth targets for different banks. For those that have complied with Circular 41 like Vietcombank and VIB, they will get a higher growth target than those that who have not,” he said.

For the proposals on network, he said that the authorities will look closely into relaxing the requirements on branch and network expansion for those who implement Basel II standards ahead of time.

Lingering issues

Although Vietcombank and VIB have both been acknowledged for their efforts in implementing the CAR requirements under Basel II ahead of time, other banks may not see such an easy journey on the way to being Basel II-compliant.

According to Dang Linh Chi, partner at Baker McKenzie Vietnam, whilst the framework for Basel II compliance has been in place with the back up of Circular 41 and 13, in reality, the CAR at banks are still calculated based on Basel I standards.

“The 8 per cent CAR that we see is calculated based on Basel I standards, yet under Basel II, the CAR calculation is much stricter, and so the CAR has been lowered substantially,” Chi said.

Basel II comes with a three-pillar concept consisting of minimum capital requirements to address risks, supervisory review, and market discipline with a set of disclosure requirements.

The second pillar, as Chi noted, is the area where banks have faced issues on quality and their information management system. As the control of input data has yet to be standardised, the data regarding output cannot be accurate.

“The quality of data entry personnel and risk handling personnel are still under par or underqualified to meet the actual requirement,” Chi said, adding that Vietnam has a number of new banks, which may bring difficulties as Basel II requires a trail of information from at least the previous seven years.

Smaller banks, she added, are more likely to comply with Basel II standards as their assets and transactions are more compact, therefore being more adaptable at switching their data entry model than larger banks.

“To comply with Basel II, banks ought to raise their capital to meet the CAR standards, this will give rise to the possibility of higher lending rates and operating costs,” she told VIR.

Raising capital puts banks in a chicken and egg scenario, in which banks want to apply Basel II, yet the foreign ownership limit currently capped at 30 per cent is preventing local banks from acquiring sufficient capital.

Nevertheless, should banks manage to get enough capital together to pass through the gates of Basel II, they will then be able to raise their standards, enhance their competitiveness and bolster their stock values for shareholders.

Pushing the limits

According to StoxPlus’ Vietnam Banking Report 2018, whilst the local banking sector has gradually picked up its momentum in recent years thanks to positive earnings reported last year and in the first half of 2018, the CAR continues to remain a hurdle amongst local banks.

The report pointed out that most banks had their CAR reduced by 1-2 per cent in 2017, following a period of strong credit growth in the same year.

Local banks would reportedly require an additional $9 billion to ensure their Tier-1 capital ratio of 11 per cent in 2018 and 2019.

Without external capital investments, Tier-1 capital adequacy will be reduced to 8 per cent for joint stock commercial banks, and 6.1 per cent for state-owned commercial banks by the end of 2019. This follows from 9.4 to 6.9 per cent at the end of 2017.

According to StoxPlus, in order to comply with Basel II requirements by 2020, banks would need to raise their Tier 1 and Tier 2 capital. Numerous approaches have been used including paying stock rather than cash dividends as seen in the case of BIDV, VietinBank and others.

Through their initial public offering (IPO) or private placements that took place during the course of 2017 and 2018, banks like HDBank, TPBank and Techcombank were able to pump their Tier-1 capital up.

Meanwhile, state-owned banks including Vietcombank, VietinBank and BIDV have made attempts at issuing long-term bonds with five to 10 year tenures in a bid to maintain their CAR.

BIDV, for instance, has succeeded with its second bond issuance in 2018 with VND430 billion ($18.69 million) being added to its Tier 2 capital basket. VietinBank, likewise, has boosted its Tier-2 capital with VND2.43 trillion ($105.65 million) through its bond issuance.

While such methods seemed to work one way or another, Tier 2 capital cannot get higher than Tier 1 capital as per the prerequisites of Basel II.

Hanoi-based Bao Viet ­Securities (BVSC) wrote in its daily notes last week that the large-scale bond issuances carried out by the likes of BIDV, ­Vietcombank, ­VietinBank, Military Bank, and HDBank during the last months of the year came about as a result of lenders in need of capital who must ­ultimately meet the CAR ­requirements.

“Liquidity in most banks is getting uptight when ­deposit growth is slower than credit growth, with deposit growth of BIDV, VietinBank, and Vietcombank in the first nine months was 10.9, 9.7, and 9.2 per cent, respectively, while their credit growth was 11.5, 11.9, and 15.1 per cent, respectively,” BVSC said.

“The bond issuances will get banks to bear higher ­interest rate risks as most of these bond issuances are of a ­long-term nature. This can therefore cause the profits of the bond issuers to be put under pressure in the years to come,” the securities firm said.