Cultivating key economic solutions

February 20, 2012 | 08:33
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On January 4, 2012, Vietnam’s government released Resolution 01/NQ-CP, on seven key solutions for 2012.

The fact that third and fourth on this list were to progress the quality of the workforce (3rd), and, to improve social welfare through better healthcare and a reduction in poverty (4th), demonstrates the importance being placed on finding solutions to macroeconomic challenges at the highest levels. The government lists curbing inflation as the top priority for 2012, a mandate that the State Bank of Vietnam (SBV) has already fully embraced through unprecedented monetary tightening. The second priority is the restructuring of commercial banks and state owned economic corporations.

With the SBV’s assistance and guidance, 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 additionally between 10 and 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 frameworks. In addition to reviewing credit risk processes, banks will need to reduce the negative effect of liquidity, market and other operational risks through ongoing assessment.  

#In 2008 when global credit markets froze in what was a re-pricing of risk, central bankers around the world pumped trillions of dollars of funding into the most needy banks. In addition to this, official cash rates were swiftly marked down in an attempt to stimulate borrowing and get banks lending to each other again.

The overall aim of this was to liquefy the global financial sector which was facing total meltdown in late 2008. An obvious externality of these actions is higher inflation, a risk that central bankers were prepared to take in lieu of fostering a return to global financial stability.

Liquidity risk: The World Bank recently reported that banks in Vietnam are also reporting liquidity shortages, and capital adequacy continues to be an issue. However, this is not a situation unique to Vietnamese banks. Banks around the world have to manage the asset-liability maturity mismatch, as most of the deposits are short-term, while lending is mainly offered at medium or long-term durations. This can lead to temporary liquidity problems, and banks need to manage their term funding appropriately. Prudent management of the demand and supply of funding over different time horizons can be a key contributor to banking profitability.

Credit risk: Tighter monetary policy has already had a dampening effect on credit growth and raised the level of Non Performing Loans (NPL’s). Necessary monetary action taken by the SBV has reduced credit growth from 28 per cent in 2010 to 13 per cent in 2011. Credit growth is expected to be between 15 per cent and 17 per cent for 2012. Prudent banks will review and upgrade their credit policies, ongoing assessment processes, and provision to reduce the risk that new lending will not ultimately increase their level of NPL’s, and that the credit provision is accurately stated.

The level of NPL’s reported by Vietnamese banks is 3.39 per cent. However, many industry observers believe this significantly understates the true quality of existing loans and that a 10 per cent is a more accurate reflection of the true NPL level. The main cause of this is deficient lending practices and assessment processes.

Basel and continuous improvement: While the Basel accords (I, II and III) are aimed at ensuring banks have sufficient liquidity and adequate capital to fund their business, these levels are in essence determined by an overall assessment of credit, operational, liquidity, market and other risks. The SBV is not a member country of the Bank for International Settlements. Therefore domestic banks were not held to the same mandates as member countries.

Many local commercial banks are in need of significant restructuring

However, the SBV will reform the banking governance system in 2012 in line with international practices, focusing on executing risk management system in compliance with Basel principles and standards. Basel II (2004) 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.

Banks are realising that there are real business benefits to be gained from implementing Basel, as well as potential capital savings. Improving the bank’s reputation, rating systems and more effective pricing are just some of the realised benefits.

Pervasive risk management: The SBV has mirrored in part some Basel II content (such as part of the Capital Adequacy requirements), but many domestic banks are still deficient in their overall assessment of their risk profile. International banks are currently undergoing assessment for Basel III, to be fully implemented by 2019.

In response to the SBV’s recent announcements, operational risk assessments in some Vietnamese banks are now being considered for the first time. Managing liquidity risk and market risk as part of the overall effective ALM is gaining traction with bank senior management. As discussed, enhanced credit practices are being considered. These recent actions demonstrate Vietnamese banks have taken the SBV reforms seriously and are prepared to act.

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 SBV’s recommendations. Consideration needs to be given the practicality, timeliness and cost when assessing appropriate risk mitigation solutions.

The SBV has “encouraged” the large SOE’s and the larger joint stock commercial banks to seek merger and acquisition opportunities among themselves as a precursor to strengthening the banking sector. With the sector looking to consolidate from 42 domestic banks currently to around 20, the restructuring may not be as swift as the SBV hopes. Tire kicking the risk management framework of the targets will be a prime consideration in determining the right partner. Given the central bank’s objective of ultimately having two big lenders that are competitive within the region, potential suitors for this role may require multiple tie-outs.

In addition, the ongoing “equitisation” of large entities (BIDV will list in 2012) places additional reliance on senior management to run effective risk management processes across all parts of their business. Therefore the requirement to have robust risk management processes affects both large and small domestic banks.

Looking forward: As Europe’s woes are yet to fully play out, it’s the view of KPMG that banks globally need to be absolutely committed to addressing all risks they face, and to develop appropriate mitigation strategies. The Asian Development Bank commented recently that Vietnam’s banking sector is showing signs of stress after a period of prolonged instability.

The SBV’s primary concern with the banking sector is liquidity and has put domestic players on notice. For the smaller banks, it’s an opportunity to strengthen their business, provide greater stability for their customers and to ultimately sell out at a higher price. For the bigger banks, it’s an opportunity to promote their cause as one of the two strategic and regional banks from Vietnam, but they run the risk of the weaker partner affecting their claim. 

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

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

By Steve Punch

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