Why Vietnam's Banks Need A Faster, Bolder Consolidation Process

Primary Credit Analyst: Amit Pandey, Singapore (65) 6239 6344; amit.pandey@standardandpoors.com Secondary Contact: Ivan Tan, Singapore (65) 6239-6335; ivan.tan@standardandpoors.com

Table Of Contents
Fragmentation Is A Key Risk Consolidation Efforts Have Met With Moderate Success Restricted Foreign Ownership Thwarts Consolidation Consolidation Is Not The Solution To Everything

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Why Vietnam's Banks Need A Faster, Bolder Consolidation Process

The consolidation of Vietnam's fragmented banking industry is a work in progress. Standard & Poor's Ratings Services believes consolidation is vital for a sustainable recovery of Vietnam's banking sector. The banking regulator understands the importance of consolidation, with the State Bank of Vietnam recently reiterating its intention to facilitate the process. However, progress in the past few years has been slow. We believe consolidation in Vietnam's banking industry will speed up only if the process involves State Bank of Vietnam and the country's larger banks along with an increased role for foreign investors. A well-executed consolidation can improve our assessment of the banking system's competitive dynamics. However, a poor implementation could result in continued industry instability, which is likely to undermine banks' capacity to support economic growth in Vietnam. Overview Vietnam's banking industry is in a consolidation phase, which the government and regulator support. In our opinion, consolidation will bring several benefits to the banking industry and can improve our assessment of the system's competitive framework. Clearing nonperforming loans (NPLs) from banks' balance sheets, fresh capital infusion, and improved risk management and governance will have to accompany consolidation for its full benefits to accrue.

Fragmentation Is A Key Risk

High fragmentation poses challenges to the stability of Vietnam's banking system. The system currently has two tiers: five majority state-owned commercial banks (SOCBs); and more than 30 joint stock commercial banks (JSCBs). It also has joint venture banks, 100% foreign-owned banks, foreign bank branches, finance and leasing companies, and cooperative banks--all of which have a small market presence. The SOCBs, including the four large ones-- Vietnam Bank for Agriculture and Rural Development (Agribank), Vietnam Joint Stock Commercial Bank for Industry and Trade (Vietinbank), Joint Stock Commercial Bank for Foreign Trade of Vietnam (Vietcombank), and Joint Stock Commercial Bank for Investment and Development of Vietnam (BIDV)--account for 43% of the system's assets, while the more than 30 JSCBs account for only 42% (see chart 1).

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Why Vietnam's Banks Need A Faster, Bolder Consolidation Process

Chart 1

The small scale of operations of some JSCBs hampers industry stability, in our view. The higher borrower concentration of some small banks makes their asset quality particularly vulnerable. For example, Hanoi Building Commercial JS Bank, a small lender, had to merge with Saigon Hanoi Commercial JS Bank in 2012 because of its large exposure to Vietnam Shipbuilding Industry Group. Small JSCBs tend to rely on wholesale funding, including the interbank market, especially during periods of high inflation and monetary tightening, given their limited branch network and small deposit franchise. Such funding can be volatile and lead to asset-liability mismatches, as seen in late 2011 and early 2012, when several small banks faced a liquidity crunch as policy rates went up in response to rising inflation. The situation has improved since then for many banks. Smaller banks don't have high product or client differentiation compared with SOCBs and large JSCBs. This forces them to use pricing on loans as well as deposits as a key competitive strategy, lowering overall industry profitability. The large number of banks in the system also tests the capacity of regulatory resources required for supervision. Less than a quarter of JSCBs are listed entities. Unlisted banks sometimes have even weaker information disclosure than listed banks and don't undergo regular investor scrutiny, making it far more likely for any weaknesses in their governance and performance to go undetected.

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Why Vietnam's Banks Need A Faster, Bolder Consolidation Process

Consolidation Efforts Have Met With Moderate Success

The regulator included industry consolidation as one of the key objectives in its bank restructuring plan in 2011, which is aimed at reforming the sector by 2015. The regulator has reiterated its stance in the past few months. A few mergers and acquisitions (M&A) and changes in ownership have taken place since late 2011 (see table 1). But the process has been slow so far and largely focused on the weaker banks that the regulator has identified.
Table 1

Mergers And Acquisitions In Vietnam's Banking Industry Since 2011

Year 2013 Entities Involved Merger of Western Commercial Joint Stock Bank and PetroVietnam Finance Joint Stock Corporation to form Vietnam Public Joint Stock Commercial Bank TrustBank adopted a new name of Vietnam Construction Bank after changing ownership to Thien Thanh Group DaiA Commercial Joint Stock Bank merged into Ho Chi Minh City Development Joint Stock Commercial Bank (HDBank) 2012 2011 Saigon Hanoi Commercial Joint Stock Bank's (SHB) acquisition of Hanoi Building Commercial Joint Stock Bank Merger of First Joint-Stock Commercial Bank, Vietnam Tin Nghia Commercial Joint Stock Bank, and Saigon Joint Stock Commercial Bank (SCB)

The SOCBs and large JSCBs have refrained from making acquisitions until now. We believe one of the key reasons for this is that banks are unsure of the true asset quality of the potential targets, given weak disclosures, lenient classification standards for NPLs, and the lack of uniform NPL accounting. The industry's reported gross NPLs were 3.6% in December 2013, but the reported stressed loans (gross NPLs including the rescheduled loans), were much higher at 9%. The regulator allowed banks to reschedule loans to help borrowers tide through a sluggish economy. Further, large banks already have a substantial branch network (see chart 2) and deposit market share, therefore acquisitions may not have brought in a whole lot of benefits, particularly in terms of franchise augmentation.

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Why Vietnam's Banks Need A Faster, Bolder Consolidation Process

Chart 2

Several large banks are more concerned with managing their own operations and asset quality in a sluggish economy than thinking about consolidation. Some of the larger banks themselves are exploring the possibility of selling their stakes (up to 30%) to foreign strategic investors to boost their capitalization. In this scenario, M&A activity has not been a top priority for many of them. However, we believe some large SOCBs may look to acquire small banks going forward, especially if such a move increases their retail customer relationships and product capabilities. Most SOCBs have traditionally focused on the corporate and state-owned enterprises (SOE) sectors, and are looking to enhance their retail operations. After the regulator implemented restrictions on NPLs and capital for opening new branches late last year, it became harder for some small banks to expand, possibly making them more open to M&A. We believe large JSCBs may also consider M&A, as shown by Saigon Thuong Tin Commercial Joint Stock Bank (Sacombank)'s recent proposal to acquire Southern Bank. Nevertheless, acquirers may look for some government support while making acquisitions. This could include permission to offload NPLs of the target bank to Vietnam Asset Management Co. before the takeover. It could also include getting the regulator's feedback on the target's asset quality to facilitate correct valuation, given the regulator is likely to have more information. Acquirers may also ask for tax incentives for a few years after the acquisition to increase profitability and shore up capital. We believe the regulator may share information on the asset quality of the

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Why Vietnam's Banks Need A Faster, Bolder Consolidation Process

acquisition targets as this facilitates the resolution of NPLs. Several other triggers and benefits for industry consolidation exist, in our view. Some SOEs own substantial stakes in banks. Under the broad SOE reform process, SOEs are selling their stakes in banks to focus on their core operations, for which they will require deep-pocketed investors. Cross-ownership in banks is also prevalent in Vietnam, wherein a bank or owner group holds stakes in several other banks. We believe industry consolidation could help lower systemic risk by reducing cross-ownership. In our opinion, banks' current strategy of using their profits to reduce NPLs will be a long-drawn affair that could constrain their ability to support economic growth in Vietnam. A simultaneous equity issuance by several small banks to clear up their balance sheets will be challenging. A better option is the amalgamation of smaller banks to create large banks, which could accomplish consolidation along with attracting fresh capital. However, consolidation that is carried out without clearing existing NPLs off the balance sheets of targets or fresh capital issuance may weaken the credit profile of acquirers, whether SOCBs or large JSCBs. It therefore becomes vital to have a fresh pool of capital and an investor base to support consolidation. We believe the availability of such capital in the domestic market is likely to be limited.

Restricted Foreign Ownership Thwarts Consolidation

In our view, foreign investors, including foreign banks could help speed up Vietnam's banking industry consolidation. Increasing foreign ownership in local banks is not a new phenomenon in Asia. It was done to facilitate bank restructuring after the Asian financial crisis (of 1997): Thailand allowed foreign investors to hold majority shareholding in Thai banks for up to 10 years; and Indonesia allowed foreign ownership up to 99% (though in 2012 this was revised lower to 40% with further enhancement only on prior approval). Banks in developing economies consistently need capital to support growth. Therefore, some countries such as India allow foreign institutional investors to hold up to 74% in private banks on a case-by-case basis. Several foreign banks already have minority stakes in Vietnamese banks (see table 2), and interest from foreigners, especially Japanese banks, remains high. Japanese banks are venturing into retail operations in overseas markets. And Vietnam is one of the important markets because an increasing number of Japanese corporate entities, including small companies, are expanding operations there.
Table 2

Foreign Bank Shareholding In Vietnamese Banks

Vietnamese Banks Vietnam Joint Stock Commercial Bank for Industry and Trade (Vietinbank) Joint Stock Commercial Bank for Foreign Trade of Vietnam (Vietcombank) Vietnam Technological and Commercial Joint Stock Bank (Techcombank) Vietnam Export Import Commercial Joint Stock Bank (Eximbank) Asia Commercial Joint Stock Bank (ACB) An Binh Commercial Joint Stock Bank (ABBank) Vietnam International Commercial Joint Stock Bank Foreign Shareholder Bank of Tokyo-Mitsubishi UFJ Mizuho Corporate Bank Ltd. HSBC Sumitomo Mitsui Banking Corp. Standard Chartered Bank Malayan Banking Bhd. Commonwealth Bank of Australia

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Why Vietnam's Banks Need A Faster, Bolder Consolidation Process

Table 2

Foreign Bank Shareholding In Vietnamese Banks (cont.)

Orient Commercial Joint Stock Bank (OCB) Southeast Asia Commercial Joint Stock Bank (SeAbank) BNP Paribas Socit Gnrale

Foreign investors could bring in much required capital and consolidation to the system apart from improving banks' governance, risk culture, and management. However, Vietnam restricts foreign ownership of local banks. A single strategic foreign investor cannot hold more than a 20% stake in a local bank, and total foreign ownership can't exceed 30%. For Japanese banks, minority shareholding is not an efficient way to use their capital, in our opinion. Also, we believe that minority investment does not give the foreign banks enough control over the key areas of strategy and risk management. A recent rule change allows higher foreign ownership in Vietnamese banks in special cases (e.g., as part of the restructuring of a weak bank), subject to the prime minister's approval. We believe this may be the first step in allowing foreign banks to have larger stakes in Vietnamese banks.

Consolidation Is Not The Solution To Everything

In our opinion, while the benefits of consolidation are many, improving the health of the Vietnamese banking industry requires much more to be done. We believe cleaning up NPLs, infusing fresh capital, strengthening risk management and governance, and improving regulation and supervision are essential for a stable and strong system, and for the benefits of consolidation to accrue. A well-executed consolidation can improve our assessment of the banking system's competitive dynamics. A greater role by larger banks and foreign strategic investors can help such a process. But without comprehensive measures, the consolidation process will be protracted and may fall short of the intended outcome. Under Standard & Poor's policies, only a Rating Committee can determine a Credit Rating Action (including a Credit Rating change, affirmation or withdrawal, Rating Outlook change, or CreditWatch action). This commentary and its subject matter have not been the subject of Rating Committee action and should not be interpreted as a change to, or affirmation of, a Credit Rating or Rating Outlook.

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