Basel prudency ensured in banks

SBV looks to protect capital and ensure the safety and security of Vietnam’s banking sector

One of the most significant changes introduced by Decision 457 is a comprehensive definition of the capital of credit institutions. Under the Law on Credit Institutions, capital is defined as “the actual value of the chartered capital, reserve funds, and a number of other liabilities of credit institutions, as stipulated by the SBV.”
Capital serves as a basis for calculating certain key prudent ratios applicable to banking operations. However, the Law on Credit Institutions and its subsequent regulations do not provide any further guidance or clarification of this definition.
For the first time, Decision 457 divides a credit institution’s capital into two tiers with tier one capital being shareholders’ equity and other common shareholders’ funds, and tier two capital comprising the additional internal and external resources available to the credit institution.
Tier one capital basically consists of chartered capital, retained earnings and reserves replenished from a credit institution’s profits (eg, reserves for chartered capital supplement, financial provisions, and investment and development). Under Decision 457, tier one capital also serves as a basis for calculating the limit for purchasing and investing in the fixed assets of a credit institution - currently the limit is set at 50 per cent.
Tier two capital basically consists of the increased value of certain assets following their re-valuation (including 50 per cent of the increased value of fixed assets being re-valued and 40 per cent of the increased value of investment securities being re-valued); the increased or supplemental capital from internal and external sources (including convertible bonds, preferred shares and certain subordinated debt instruments); and general loan loss provisioning (not exceeding 1.25 per cent of the total risk-weighted assets).
There are certain limitations on tier two capital. Tier two capital is limited at 100 per cent of tier one capital and the aggregate value of convertible bonds, preferred shares and other subordinated debt instruments cannot exceed 50 per cent of tier one capital.
A detailed two-tier capital mechanism will likely make it possible for credit institutions to calculate more accurately and increase their capital values, which were primarily calculated on the basis of tier one capital under regulation prior to Decision 457. It would therefore probably be easier for the credit institutions to comply with capital-based prudent requirements.
Together with the addition of the above tier two items, Decision 457 also excludes the total reduced value of fixed assets or investment securities following their re-valuation from the capital of a credit institution as well as the total paid-up equity or shares made or held by a credit institution in other credit institutions and the total paid-up equity or shares made or held by such credit institution in investment funds and enterprises which exceeds 15 per cent of its capital, and resulting losses.

Minimum capital adequacy ratio
Credit institutions, except foreign bank branches, are required to maintain their capital at least equal to 8 per cent of their total risk-weighted assets. Risk-weighted assets include on-balance-sheet items such as cash, gold, deposits, loans and receivables, and off-balance-sheet items, such as guarantees, loan commitments and letters of credit and acceptances assessed by applicable risk weighting factors.
Based on the risk level, the risk weighting factors applicable to the on-balance-sheet items are 100 per cent, 50 per cent, 20 per cent and 0 per cent, as the case may be. Off-balance-sheet items, depending on their relative risk level in comparison with a direct credit, must be first converted into credit exposure equivalents through the use of credit conversion factors of 100 per cent, 50 per cent, 20 per cent or 0 per cent, and then be risk-weighted at rates of 100 per cent, 50 per cent or 0 per cent. For example, a VND1 million bid bond has a credit conversion factor of 50 per cent and a risk- weighted factor of 100 per cent. Thus, the risk-weighted asset value is (VND1 million x 50 per cent x 100 per cent = VND500,000).
In fact, probably most, if not all, state-owned banks will not reach the 8 per cent minimum level. As a result, the SBV sets out a phase-in period of three years from the effective date of Decision 457 on May 15, 2005, for the state-owned banks to increase their minimum capital adequacy ratio to 8 per cent, provided that the annual increase is at least equal to one-third of the shortage capital. Nevertheless, non-state-owned banks do not benefit from this phase-in period and it is likely that certain banks will have to call for additional capital.

Credit limits
Decision 457 requires that credit institutions, except foreign bank branches, formulate their internal policies regarding the criteria for determining a ‘single customer’ and a ‘group of affiliated customers’, and the credit limits applicable to each of them.
‘Group of affiliated customers’ is a new term that is broadly defined. Generally, a group of affiliated customers of a credit institution are two or more customers that have any of the following mutual relationships: ownership (eg, an individual owns at least 25 per cent of the chartered capital of a legal entity or a legal entity owns at least 50 per cent of the chartered capital of another legal entity); management (eg, an individual is the chairman of the board or general director of a legal entity); or partnership (eg, a company or individual is a partner in a partnership).
It is expected that credit institutions will face numerous difficulties managing credit limits applicable to a ‘group of affiliated customers’. Credit institutions will now have to store information not only about a customer, but also about its affiliated parties. The customer database of each credit institution must be regularly updated to keep up-to-date with any changes in the status and relationship of a customer. This task seems to be a mission impossible given that the number of customers in credit institutions is increasing very rapidly on a daily basis. In addition, information exchanges within a comprehensive credit institution system may not be easy as few Vietnamese banks have a fully computerised nationwide database network.
Decision 457 also imposes a loan limit for a single customer of 15 per cent of a credit institution’s capital and a loan and guarantee limit for a single customer of 25 per cent of a credit institution’s capital. As such, if a credit institution extends loans to a single customer up to the 15 per cent limit, it can only issue guarantees to the same customer up to 10 per cent of its capital.
In addition, the loan limit for a group of affiliated customers is 50 per cent of the credit institution’s capital while the loan and guarantee limit for a group of affiliated customers is 60 per cent of the credit institution’s capital. The financial lease limit for a single customer is 30 per cent of the finance leasing company’s capital and the financial lease limit for a group of affiliated customers is 80 per cent of the finance leasing company’s capital.
Similar limits apply to foreign bank branches, although the limits are based upon the capital of the parent banks rather than the allocated capital of the branches.

Liquidity ratio
Credit institutions must regularly maintain a minimum liquidity ratio of 25 per cent between the assets realisable on demand and the liabilities payable within the following month. A minimum ratio of 100 per cent is stipulated between the total assets realisable within the next following seven business days and the liabilities payable within the next following seven business days.

Maximum loan percentages
Any commercial bank is entitled to use up to 40 per cent of its short-term resources to fund medium- and long-term loans. With respect to other credit institutions, the applicable maximum percentage is 30 per cent. The short-term resources allowed to be used to fund medium- and long-term loans include deposits (demand deposits or deposits with terms of less than 12 months), individual savings (demand savings or savings having terms of less than 12 months), and short-term valuable papers issued by a credit institution.

Restrictions
A credit institution is permitted to invest up to 40 per cent of its chartered capital and reserves in enterprises, investment funds, investment projects and other credit institutions in the form of capital contributions or share purchases. The maximum investment by a credit institution cannot exceed 11 per cent of the capital of the target company or project. Investments whose values exceed the limitations must be subject to SBV approval.
It is unclear under Decision 457 whether the deposits in overseas accounts of Vietnamese banks used to purchase shares in foreign companies under asset management arrangements with account banks are subject to the above limitations. Further guidance from the SBV on this issue may be required.

Conclusion
The issuance of Decision 457 is a positive signal reflecting the determination of the SBV to better protect the safety and security of Vietnam’s banking system. However, it remains to be seen whether Decision 457 will be successfully implemented in practice. Vietnamese credit institutions will most likely face numerous difficulties in complying with this decision. Therefore, the SBV will have to closely monitor the implementation of Decision 457 so that it could provide prompt guidelines and instructions.