Developments for Vietnam to watch in midst of bank crisis

In 2008, the US investment bank Bear Stearns, on the verge of collapse, had to be rescued by J.P. Morgan. This marked the beginning of the global financial crisis of 2008, which sent the global economy into a deep recession and caused significant economic damage, including massive employment losses.

Patrick Lenain, senior associate at the Council on Economic Policies

Today, several banks are once again in trouble. As of March 22, four large banks were in distress.

Silicon Valley Bank (SVB), a $212 billion US bank specialising in tech startups, collapsed when it was unable to meet deposit withdrawal requests and had to be taken over by federal regulators.

A few days later, Signature Bank, another midsized US bank with assets of $110 billion, also suffered a severe liquidity crisis and was seized by federal regulators.

This was followed by First Republic Bank with assets of $205 billion, which was hit by rating downgrades and a tumbling share price and had to be rescued by large liquidity injections.

The banking turmoil then spilled over to Europe, with the dramatic collapse of Credit Suisse, one of the 20 largest banks in Europe, with assets of $556 billion.

Unable to face a run on its deposits, Credit Suisse was taken over by Union des Banques Suisses at a late hour on Sunday night, just before the opening of Asian financial markets. This was done at a fraction of its previous value following negotiations arranged by Swiss regulators. This marked the end of a banking history dating back to 1856.

Around the world, policymakers now seek to re-establish confidence. The US Treasury Secretary Janet Yellen has mentioned the full guarantee of deposits in midsized banks. US Federal Reserve chair Jerome Powell has announced a new liquidity backstop to prevent the risk of contagion. European Central Bank president Christine Lagarde has stated that it is fully equipped to provide liquidity support to the system if needed.

Yet, could history repeat itself? Could another financial crisis spread globally, including to Vietnam? It is impossible to predict what will happen, but Vietnam should watch for four developments carefully.

When too many customers withdraw money simultaneously, a perfectly healthy institution can suddenly be in danger, photo Le Toan

Bringing down inflation

Firstly, what happens to interest rates is crucial. Financial crises often happen following periods of sharp monetary tightening. Fifteen years ago, the Fed raised its funds rate from 1 to 5.25 per cent in only 26 months, putting mortgage loan borrowers under severe pressure.

This time, Fed chair Powell has raised interest rates even more rapidly - only 12 months. Bond markets have sharply retreated, inflicting losses on investors. This does not affect banks holding bonds to maturity, but SVB was forced to sell bond holdings when depositors suddenly withdrew their deposits, suffering losses that wiped out its capital cushion.

In Vietnam, commercial banks also hold bonds, which have suffered from the rise of interest rates. VinaCapital’s chief economist Michael Kokalari estimated unrealised losses of $3 billion among Vietnam’ listed banks, which can be easily covered by tier-1 capital.

The State Bank of Vietnam (SBV) already decided to cut its regulatory interest rate by 0.5 to 1 per cent on 15 March, which will ease the pressure.

The recent decline of Vietnam’s inflation rate (4.3 per cent in February, below the target rate of 4.5 per cent) will encourage further easing of monetary policy. If there are no adverse developments in the Ukraine conflict, the recent decline in global commodity prices will further bring down inflation.

Secondly, banking confidence is also crucial. The three US midsized banks and Credit Suisse were brought down by the sudden loss of confidence, which triggered bank runs.

When too many customers withdraw their money simultaneously from their deposit accounts, a healthy banking institution can suddenly become illiquid, and possibly insolvent if it must engage in fire sales of its assets at depressed prices.

Banks are inherently fragile because of their role in maturity transformation: they attract short-term deposits to make long-term loans or purchase financial assets. This works well when confidence is strong, but can be fatal when panic settles in. This is why central banks act as lender of last resort and stand ready to provide as much liquidity as necessary. It is also why regulators require deposit insurance, which instils trust among depositors.

In Vietnam, deposit insurance covers the first $5,000 of bank deposit, well below international standards (around $108,000 in the Euro area and $250,000 in US banks). An official statement regarding the coverage of deposits in the case of turmoil can help to retain confidence in the banking system.

Stress-testing

Thirdly, bank liquidity is crucial. Banks should be able to meet withdrawal requests at any time, so as to protect their reputation and retain customer confidence. Ample liquidity cushions may depress banks’ earnings in the short term, but is essential to ensure resilience when unexpected events occur.

According to the SBV, Vietnam’s banking system had an average loan-to-deposit ratio of 74.35 per cent at end-December 2022.

This is considered as safe by international standards. However, this does not provide a full protection. Credit Suisse’s loan-to-deposit ratio was at the safe level of 74 per cent at end-2021, which did not prevent its rapid collapse.

When faced by a lack of liquidity, banks can obtain credit from the central bank, though large amounts of borrowing from the central bank may be interpreted by investors as a sign of distress. Stress-testing bank liquidity under scenarios of unexpectedly large withdrawals can provide useful guidance.

Finally, Vietnam should monitor how the banking turmoil affects the global economy. A highly open economy deeply integrated in global supply chains, Vietnam’s economic prospect depends on what happens overseas.

So far, the global economy has been immune to banking troubles. The Organisation for Economic Co-operation and Development upgraded in mid-March its short-term economic projections and now forecasts global economic growth of 2.6 per cent this year and 2.9 per cent next year, with particularly robust expansion in India (5.9 per cent and 7.1 per cent), Indonesia (4.7 per cent and 5.1 per cent) and China (5.3 per cent and 4.9 per cent).

Global inflation is projected to decline, thanks to lower commodity prices, reducing the pressure on central banks’ monetary policy. In addition, large liquidity backstops offered by the Fed and Swiss National Bank to support distressed banks will lift financial markets – and will also help emerging markets like Vietnam.

The World Bank recently projected that Vietnam’s economic growth will reach 6.3 per cent this year and 6.5 per cent next year, slower than in 2022 but still among the strongest in the world, and inflation coming down below target. Overall, Vietnam is so far well protected from the impact of the financial turmoil, though developments should be watched carefully, with authorities ready to restore confidence if needed.

This new crisis should encourage Vietnam to reassess its plans for hosting a large international financial sector. Banking systems are inherently fragile, and repeated crises inflict large costs to public budgets and social conditions – making citizens bear the cost of banks’ excessive risk taking.

Vietnam needs bank lending to invest in shared prosperity, upgraded education, transport infrastructure, renewable energies, and access to digital technologies, but this funding should come from safe and stable sources.