Non-performing loans boosted by regulation

Kent Wong, partner and head of Banking and Capital Market at VCI Legal

While aggressive lending strategies can sometimes result in credit risk and moral hazards, non-performing loans (NPLs) could have a negative impact on a bank’s profitability. An uptick in NPLs can be due to new issuances which are still increasing or the slow handling of NPLs.

Consequently, foreign banks strive to continue improving credit quality, actively handling bad debts and implementation of classification of assets, levels, and methods of risk provisions, as well as the use of provisions against credit risks.

During the pandemic, businesses still face many difficulties, and the real estate market is not as vibrant as before. Therefore, it is understandable that banks may handle NPLs slowly, especially when the size of outstanding loans has increased sharply over the years and negatively impacted the NPL ratio of the banking system.

The State Bank of Vietnam (SBV) requires credit institutions and foreign bank branches to strengthen inspections and supervision of the use of loans and corporate bond issuances to ensure the proper use and monitoring of investment capital.

To quicken the handling of NPLs, more detailed guidelines could be required on how to resolve them through legal proceedings. Banks may also want to improve corporate governance, code of conducts, transparency, and strengthen risk management to avoid lending to risky projects.

In April, the SBV approved Circular No.03/2021/TT-NHNN amending and supplementing several articles of another circular from last March on debt rescheduling. Circular 3 has added certain conditions to allow banks to restructure remaining due debts. In addition, provisions were made for structured debt balances within three years.

According to an analysis by VNDIRECT, Circular 3 will bring positive effects in the short and long term to credit institutions. The restructuring debt portfolio of banks may increase slightly in 2021 due to conditions allowing for expansion. Accordingly, in the first year, a credit institution must make a deduction of at least 30 per cent, 60 per cent in the following year, and 100 per cent in the year thereafter.

However, the impact of Circular 3 on banks will depend on the NPLs held by them. For banks with a high NPL ratio, the pressure on provisions when the amount of restructured debt expires could become exceptionally large.

The extension of the provision schedule with regards to restructuring debt will create a foundation for these banks to consolidate profits and improve asset quality. Moreover, the impact on banks with the lowest ratio of bad debt and restructuring debt to total outstanding loans is not significant.

Banks with good asset quality and proper provisions for risks that may have arisen from restructured debts in 2020 will not be under pressure to increase provisioning expenses in 2021, while those banks have comfortably set aside more than required.

Additional provisions that have been gradually allocated for bad debts in three years will reduce the cost of backup for banks, especially in 2021. Thus, banks are helped to achieve geographical balance for retained earnings and to enhance capital adequacy, as well promote lending for business and production. However, at the end of the restructuring period, banks must use a large amount of money to make provisions for risks, thereby reducing their profits significantly.