Current Background of Moral Hazard in Vietnamese Commercial Banks 11 3.2.. LIST OF ABBREVIATIONS AND ACRONYMS ABBank An Binh Commercial Joint Stock Bank BIDV Joint Stock Commercial Bank
Background and Rationale
Since the 1986 Renovation, the Vietnamese economy has witnessed remarkable growth, driven by an open business environment that encourages participation from various economic entities A key highlight of this transformation is the rapid development of the banking system, which has significantly impressed all stakeholders involved in the nation's economic progress.
Over the past three decades, from 1986 to 2016, the Vietnamese banking system has experienced significant growth in both quantity and quality, now comprising 46 active banks, with commercial banks making up 87% of this total Modern banks serve as vital sources of funding while also providing a wide range of services that support the establishment, operation, and development of various economic entities.
Banks play a crucial role in the financial system, necessitating reliable sources of funds, facilities, and skilled human resources The majority of banking operations are managed by staff, making it essential for employees to be well-qualified to mitigate risks As banks expand and serve more customers, they face increased risks, including potential harm from individuals seeking personal gain, which can adversely affect both the banks and their clientele.
Moral hazard poses a significant risk as both the economy and banking system evolve, increasingly threatening banks and leading to detrimental effects on individuals, organizations, and the overall economy of Vietnam.
Recent studies have emerged in Vietnam addressing the issue of moral hazard within the banking system Despite annual reports from the Ministry of Planning and Investment (MPI), the Ministry of Trade (MOT), and the Ministry of Commerce (MOC), there remains a notable lack of comprehensive research focused specifically on the moral hazard present in commercial banking.
This study, titled “Moral Hazard and Suggested Solutions for Vietnamese Commercial Banks,” addresses the critical issue of moral hazard in the banking sector, an area with limited existing literature It aims to provide a comprehensive overview of moral hazard within the banking industry, identify its primary causes, and propose actionable solutions to mitigate this challenge By focusing on these key factors, the research seeks to enhance understanding of the dynamics within the commercial banking system and contribute to both theoretical frameworks and practical approaches to minimizing financial losses The methodology employed in this study primarily utilizes qualitative methods.
Research Purposes
This research aims to provide a comprehensive overview of the moral hazard issues within the Vietnamese banking system in recent years It seeks to identify the underlying causes of moral hazard by analyzing significant case studies where the banking sector has incurred losses Additionally, the study addresses the concerns of policymakers regarding the elimination of moral hazard in Vietnam's banking industry.
Research Questions
For the objectives to be achieved, the following questions were addressed in this study
Question 1: What is commercial bank?
Question 2: What is the problem of moral hazard in commercial banks in Vietnam?
Question 3: What are the significant cases of moral hazard in Vietnamese commercial banks?
Question 4: Why does moral hazard occur and how does it affect banking industry?
Question 5: How to reduce the moral hazard in commercial banking system in Vietnam?
Research Methods
To achieve the outlined targets and objectives, a diverse array of information sources and analytical methods were employed Knowledge and critical data were sourced from academic books, journals, newspapers, magazines, breaking news, and statistical records Specific data sources were identified, and relevant theories and prior studies were meticulously evaluated to gather significant case studies and sufficient data for a comprehensive analysis and interpretation.
Research Schedule
The research was carried out under the supervision of Mrs Le Thi Minh Que (M.A), Department of Foreign Languages, started in April 2018 and finished in June
Thesis Structure
The organization of the current study is structured as follows:
Chapter 1 outlines the background, rationale, and objectives of the research, while Chapter 2 establishes the theoretical framework for the study This chapter provides a comprehensive overview of key definitions, explores the functions of commercial banks, and examines the concept of moral hazard within the banking system.
Chapter 3 examines moral hazard in Vietnam's commercial banks, presenting qualitative case studies to uncover its underlying causes The final chapter summarizes key findings and draws conclusions, offering policy recommendations to address moral hazard issues within the banking system, while also discussing the study's limitations and proposing avenues for future research.
Definitions of Commercial Bank
According to Investopedia, banks were established to fulfill the need for entities that can efficiently utilize funds and facilitate the funding process within the financial system A commercial bank, as a key type of financial institution, accepts deposits, provides checking account services, and extends various loans—including business, personal, and mortgage loans Additionally, commercial banks offer essential financial products such as certificates of deposit (CDs) and savings accounts to individuals and small businesses.
A commercial bank is a financial institution where individuals and businesses conduct their banking activities, distinct from investment banks According to US law, a bank is defined as a business that accepts deposits withdrawable on demand, such as through checks or electronic transfers, while also providing loans for commercial purposes Specifically, a commercial bank focuses on accepting deposits and granting loans to both businesses and individuals, and will be referred to simply as "bank" in this context.
A commercial bank, as defined by Sayers, is an institution whose debts are widely recognized and accepted for settling debts between individuals This definition highlights the pivotal role of financial institutions in facilitating debt transactions.
In Vietnam, commercial banks are authorized as credit institutions to engage in a range of banking activities, including accepting deposits, offering loans, and providing payment services, alongside other profit-driven business operations.
Since the inception of the banking system, banks have provided essential services including accepting deposits, issuing loans, facilitating currency exchanges, discounting various financial instruments, and offering credit services to support government and corporate activities.
3 A British economist and historian specialized in the history of banking
4 Law No47/2010/QH12 of June 16, 2010 on Credit Institutions
In today's fluctuating global economy, banks are increasingly integrating into the economic landscape by expanding their service offerings These services now include insurance, underwriting, equipment leasing, securities trading, and financing for international trade.
Vietnam's commercial banks have experienced remarkable growth and play a crucial role in the country's developing economy Their significance stems from the vital functions they perform, which will be explored in the following section.
Roles of Commercial Banks
Commercial banks play a vital role in the economy by providing essential services and actively participating in business activities Their significance can differ based on the size and condition of the national economy, yet they consistently fulfill key functions These include acting as intermediaries, offering payment services, managing risks, and performing various other tasks, making them an indispensable part of both large and small economies.
Commercial banks play a crucial role as intermediaries by connecting customers and firms They transform individual deposits from investors into substantial loans for businesses, enabling small investors to collectively support larger enterprises This process is essential, as individual investors often lack the necessary information to identify and fund firms in need of capital.
Commercial banks play a crucial role in the economy by allocating assets through the mobilization of funds, primarily by issuing debts and investing in profitable projects Beyond merely connecting surplus funds with those in need, these banks also function as brokers, acting as agents for investors to help them attract and manage funds This dual role benefits both commercial banks and their customers, as banks leverage their informational advantage to manage funds more effectively and minimize risks By doing so, commercial banks not only enhance their profitability but also contribute to a more efficient financial ecosystem.
7 part in the business, cost of transactions could be reduced as commercial banks have the economies of scale to screen and monitor borrowers
Commercial banks offer a secure and convenient payment solution for customers through checking accounts Payments can be processed via various methods, including tele-transmission, which enables direct transfers between accounts at the customer's request This system accommodates both paper and electronic orders, allowing transactions through the internet or mobile devices Additionally, customers can utilize electronic cards such as ATM, VISA, MASTER CARD, or PAYPAL for automatic payments at the point of sale Another alternative is writing a cheque, which allows the beneficiary to collect funds directly from the issuing bank.
Banks play a crucial yet often overlooked role as payment agents both domestically and internationally They issue debit and credit cards, enabling account holders to make purchases effortlessly, and facilitate wire transfers between institutions By lending their credibility to financial transactions, banks ensure that instruments like checks are widely accepted, as merchants rely on the bank's name for assurance This convenience eliminates the need to carry large amounts of cash, as merchants accept various payment methods provided by banks Consequently, banks streamline the collection of payments, acting as intermediaries that securely transfer funds from importers to exporters, thus enhancing trade efficiency and boosting economic activity.
Commercial banks serve various roles, including a significant policy function, acting as an indirect channel for government intervention in the macro-economy For instance, the Mexican central bank plays a crucial role in transmitting monetary policy to the broader economy, highlighting the importance of commercial banks in economic management.
8 central bank directly controls only the quantity of notes and coin in the economy whereas the bulk of the money supply consists of deposits
A central bank has the ability to adjust the supply of cash or outside money, which can directly influence a bank's reserve status and its capacity to generate loans and deposits, all without the need for formal regulation of the bank's portfolio (Wilson and Saunders, Monetary Secrecy and Selective Disclosure).
The article "The Emerging-Market Case of Mexico’s Monetary Reporting" by Wilson and Saunders analyzes the behavior of Mexico's central bank in its implementation and reporting of monetary policy Historically, the central bank announced its monetary policies only three times a year, which contributed to the economic collapse in the early 1990s due to banking mismanagement In 1995, as part of an international aid package, the bank was mandated to provide weekly updates on its monetary activities and regulatory changes This shift allowed commercial banks to act as delegated monitors, facilitating government regulation of the financial market and the broader economy while minimizing excessive administrative burdens.
Moral Hazard in Commercial Banking System
Lack of Shared Information
Information asymmetry occurs when one party possesses crucial details about a contract or outcome that the other party lacks For instance, an investment firm may have access to undisclosed projections indicating a high likelihood of the company failing within two years Meanwhile, investors without this knowledge may mistakenly believe the company is thriving and has a promising future.
Principal – Agent Problems
In scenarios where agents such as insurance brokers, real estate agents, financial advisors, or accountants have conflicting incentives with their principals, moral hazards can arise For instance, an insurance broker may recommend a policy exceeding a client's actual need of $100,000 to secure a bonus for policies over $150,000 Similarly, a real estate agent might push for a sale by promoting a property without disclosing recent crime issues in the neighborhood, ultimately prioritizing their commission over the client's best interests.
In summary, moral hazard arises when one party in a transaction acts in bad faith, offers deceptive information regarding its financial status, or is motivated to engage in excessive risk-taking to secure profits before the contract is finalized.
CHAPTER III ANALYSIS AND DISCUSSION
Current Background of Moral Hazard in Vietnamese Commercial Banks 11 3.2 Causes and Effects of Moral Hazard on Banking Industry
Asymmetric Information in Commercial Banking System
Information asymmetry occurs when there is a disparity in access to relevant knowledge, often seen between buyers and sellers This issue is particularly pronounced in markets such as insurance, credit, and labor, where it can lead to significant market failures Examples include elderly individuals being unable to obtain health insurance, small businesses facing credit limitations, and minorities experiencing job discrimination.
Asymmetric information poses a significant challenge in financial markets, particularly in borrowing and lending scenarios, where borrowers typically possess more knowledge about their financial situation than lenders This disparity makes it difficult for lenders to accurately assess the likelihood of borrower default While lenders may attempt to mitigate this issue by reviewing past credit histories and stable income evidence, such measures provide only limited insight Consequently, lenders often impose higher interest rates to offset the associated risks In an ideal scenario with perfect information, banks would not need to charge this risk premium.
In the banking sector, information asymmetry refers to the uneven distribution of crucial information that impacts decision-making for both parties involved in a loan agreement For instance, when an entrepreneur seeks funding for a business idea, they typically present their business plan to a bank Despite the bank's efforts to conduct thorough due diligence before approving the loan, the entrepreneur possesses a deeper insight into the potential returns and risks associated with the business than the lender does This imbalance can significantly affect the lending process and the overall success of the investment.
Asymmetric information can lead to inefficient outcomes, particularly in the banking sector This thesis will specifically examine the impact of asymmetric information within the credit segment of banking.
Asymmetric information initiates a downward economic spiral for entities, leading to imbalances that result in adverse selection and moral hazards These vulnerabilities can culminate in market failure, which occurs when the pursuit of self-interest by individuals or firms yields inefficient outcomes.
Adverse selection arises when firms with poor credit risks, characterized by high inherent risks and suboptimal investment channels, are more likely to secure loans compared to firms with strong credit risks that possess better investment opportunities and lower risks.
Due to information asymmetry, lenders struggle to distinguish between good and bad credit risks, leading them to impose a blanket premium on interest rates as a safeguard against potential losses This practice discourages financially sound firms from seeking loans, as their strong credit history is undermined by the inflated rates Conversely, less creditworthy firms are incentivized to borrow, knowing their cash flows may mask their true risk profile.
20 should be charged an even higher interest rate As a result, lenders end up with a loan portfolio comprising almost entirely of bad credit risks
Moral hazard arises when borrowers, after receiving funds, may be tempted to breach loan covenants by investing in high-risk, unethical projects that could lead to significant losses for lenders This issue is exacerbated by information asymmetry, as lenders often lack insight into borrowers' activities Additionally, the high enforcement costs associated with debt covenants contribute to the prevalence of moral hazard, making it challenging for lenders to monitor compliance effectively.
In this case, the lender concludes that pursuing borrowers to invest in designated projects is not worthwhile, allowing them the freedom to engage in high-risk investments instead.
In the banking sector, distinguishing between moral hazard and adverse selection can be challenging due to the ambiguous boundaries between the two concepts Typically, these issues arise from information asymmetry, which can be categorized into four distinct scenarios based on the timing of the information disparity.
1 Right lending Right use of loan Normal
Wrong lending Right use of loan Adverse selection
3 Right lending Wrong use of loan Moral hazard
Wrong use of loan Both
Table 1: Possible chances of asymmetric information 13
Information asymmetry can be categorized into three primary cases: normal circumstances when the loan is sound, adverse selection when the bank errs while the customer is innocent, and moral hazard when the customer is at fault despite the bank's correctness However, the interplay of adverse selection and moral hazard can complicate matters, as banks possess only a moderate understanding of their customers While banks strive to gather information, the completeness of this data often relies on the customers themselves, making it unjust to hold banks accountable for every detail they lack Additionally, customers may engage in deceptive practices, such as document forgery or bribery, to manipulate banks In such instances, if a bank extends credit based on misleading information, it may be a victim of moral hazard rather than at fault.
Despite technological advancements aimed at reducing asymmetric information, the issue persists, particularly in the banking sector, where moral hazard remains a significant challenge This complex problem will be explored in the following section, detailing its definition and the reasons behind its occurrence.
This article explores the deceptive practices and moral failures within the banking system in Vietnam, highlighting significant financial crimes that have resulted in enormous losses, often amounting to thousands of billions It will examine the methods employed by criminals, the extent of the damages incurred, and the penalties imposed for these offenses.
Cases Caused by Customers
a The VDB Dak Lak – Dak Nong case
In this case, the major defendants regarding businesses were: Cao Bach Mai – Director of Minh Nhat Ltd., and Tran Thi Xuan – Director of Nhat Tan Ltd
In 2008, following the State's implementation of favorable export loan policies featuring low interest rates and minimal collateral, Cao Bach Mai provided funds to Nguyen Thi Loan, instructing her to have her nephew Hung in China establish Quan Heng Ltd Mai then directed Hung to sign and stamp blank papers, which she used to fabricate export contracts to secure loans from VDB Dak Lak – Dak Nong Additionally, Mai sold these signed blank papers to Tran Thi Xuan for 20 million VND each, enabling Xuan to engage in similar fraudulent activities.
In the case involving VDB Dak Lak – Dak Nong, the perpetrators not only committed fraud but also fabricated various documents, including purchase lists, cash payment receipts, VAT invoices, and customs declarations, to secure advance disbursements and facilitate bank withdrawals.
The defendants colluded with Vu Viet Hung, the Director of VDB Dak Lak – Dak Nong, to secure loans without collateral Hung unlawfully transferred funds into the defendants' accounts at a different bank, enabling them to withdraw an amount equivalent to the required guarantee asset They then deposited this amount into their accounts at VDB Dak Lak – Dak Nong as collateral.
Within 2 years from 2008 to 2009, Cao Bach Mai used 71 export contracts to get
Seventy loan contracts totaling 1,005 billion VND were identified, with 64 of these being fraudulent, leading to the misappropriation of 940 billion VND Following the actions of Cao Bach Mai, Tran Thi Xuan utilized 65 counterfeit export contracts to secure 64 loan agreements amounting to 938.5 billion VND, which were subsequently usurped, resulting in a loss of 232 billion VND.
Mai and Xuan faced difficulties in repaying their existing loan, prompting them to seek a new loan from another bank to cover their overdue payments They persuaded Nguyen Thi Van, Dang Thi Ngan, and Nguyen Thi Kim Loan to approach Orient Commercial Bank in Ho Chi Minh City for borrowing funds, utilizing forged deposit contracts with VDB as collateral.
The stolen amount of OCB was 530 billion VND In particular, Nhat Tan borrowed 150 billion, Song Cau Cooperatives borrowed 50 billion; Minh Nhat took
100 billion, Phat Long took 200 billion and Thuy Ngan accounted for 30 billion b The Phuong Nam Company versus several commercial banks
Phuong Nam Ltd., established in 1998, later became Phuong Nam Food Stuff Corporation Jsc (Phuong Nam Jsc.), specializing in shrimp gathering, processing, and trading shrimp feed and breeding materials The company's shareholders include Lam Ngoc Khuan (former Chairman), his wife Tran Thi My, their daughter Lam Ngoc Han (a Vietnamese American and former director), and grandchild Huynh Phuc Que.
Between 2008 and September 2012, Khuan's business suffered losses exceeding 996 billion VND To recover financially, he instructed his daughter and associates to engage in fraudulent activities to secure bank loans This involved creating 19 falsified financial reports that falsely indicated a profit of nearly 41 billion VND, and inflating inventory values from 123 billion VND to 747 billion VND to meet mortgage requirements.
Khuan faced allegations of creating unauthorized duplicates of original documents, including raw shrimp purchase records and production cost balance sheets These copies were falsely certified as "copied as original" and stamped by the company for submission to banks for disbursement purposes.
Between 2008 and 2011, Khuan and his wife misappropriated over 28 billion VND in loans to construct a luxury villa in Soc Trang During this period, Khuan’s daughter and chief accountant, Lam Minh Man, were instructed to misallocate nearly 72 billion VND for fictitious foreign business trips and receptions for trading partners In late 2011, upon learning of an investigation into their illegal activities, Khuan and his wife fled to the USA under the pretext of seeking medical treatment When banks realized Phuong Nam Jsc could not repay its debts, they summoned Lam Ngoc Khuan, who was deemed most responsible, to address the loan defaults; however, Khuan was nowhere to be found.
Figure 4: 7 Banks’ losses to Phuong Nam Company 14
In July 2012, Lam Ngoc Han fled to the USA, leaving behind a staggering debt of 1,752 billion VND, primarily owed to seven banks Investigations revealed that Lam Ngoc Khuan and Lam Ngoc Han were key figures in a significant embezzlement scheme, orchestrating fraudulent activities through Chief Accountant Lam Minh Man and Deputy Director Trinh Thi Ngoc Phuong to misappropriate over 785 billion VND in loans.
Duong Thanh Cuong, a resident of District 6 in Ho Chi Minh City, was born in 1966 and has been convicted of five crimes, including property fraud, tax evasion, and bribery He received a 20-year prison sentence in 1996 for his offenses.
In 2006, Cuong was released early from a decade-long prison sentence and subsequently founded two construction companies, Tan Dai Phat Jsc and Thanh Phat Ltd., with registered capital in the hundreds of billions of VND However, upon his return to society, he engaged in an even more audacious act of fraud.
14 VNExpress: Nhung ngan hang gap han voi thuy san Phuong Nam
In 2007, Thanh Cuong, in a relationship with Ly Van Chuc, the director of Agribank Binh Chanh, applied for a loan for the Tan Dai Phat 5-star hotel project in Da Lat Cuong fabricated several documents, including a capital contribution contract, payment invoices, land deeds, and a project budget, significantly inflating the land's value from 3 billion VND to 47 billion VND to secure over 19 billion VND in funding from Agribank Binh Chanh.
Agribank discovered that Tan Dai Phat lacked authorization to operate a hotel business, prompting the bank to demand immediate loan repayment Unable to settle the debt, Thanh Cuong sought credit from Chuc for Thanh Phat Ltd to sustain the project However, instead of investing the new funds into the project, the money was diverted to cover Tan Dai Phat's loan obligations By June 2013, the total losses from this deception exceeded 27 billion VND, which included both the principal and interest from two separate loans.
Agribank Branch 6 Ho Chi Minh City
From 2007 to 2009, Duong Thanh Cuong orchestrated a fraudulent scheme involving a loan of 1,300 billion VND from Agribank Branch 6 By October 2012, this deception resulted in a staggering loss of nearly 1,600 billion VND for the bank.
Penalties and P unishment Enforced
a VDB Dak Lak – Dak Nong
Table 2: Bank staff’s penalties for VDB Dak Lak – Dak Nong case
Table 3: Customer’s penalties for VDB Dak Lak – Dak Nong case
Dang Thi Ngan 20 years imprisonment
Nguyen Thi Kim Loan 20 years imprisonment
Fraudulent appropriation Violating lending regulations in credit institutions’ activities Truong Dinh Hai
Violating lending regulations in credit institutions’ activities
Ta Thi Xuan Y 8 years imprisonment
Tran Xuan Loc 5 years imprisonment
Lam Huu Hanh 5 years imprisonment
Vo Tien Dat 5 years imprisonment
Nguyen Thi Hong Lien 3 years suspended sentence
In this case, as the instigators – Lam Ngoc Khuan and Lam Ngoc Han – have escaped, the penalties for customer side are still undecided
Table 4: Bank staff’s penalties for Phuong Nam Company case
Violating lending regulations in credit institutions’ activities
ABBank 10 years imprisonment in total
Sacombank 15 years imprisonment in total
Vietcombank 16 years imprisonment in total
VDB 28 years imprisonment in total c Dong Phuong Company versus Agribank
Table 5: Bank staff’s penalties for Dong Phuong Company case
Violating lending regulations in credit institutions’ activities
Ho Van Long 19 years imprisonment
Truong Quoc Bao 12 years imprisonment
Truong Nhat Quang 12 years imprisonment
Nguyen Hoang Quoc Thuy 9 years imprisonment
Table 6: Customer’s penalties for Dong Phuong Company case
Duong Thanh Cuong Fraudulent appropriation
Life imprisonment Abuse of trust appropriation
Abuse of positions to appropriate properties
25 years imprisonment Abuse of position and power while performing official duties Thai Cuong Abuse of trust appropriation 8 years imprisonment d Lifepro Vietnam versus Agribank
Table 7: Bank staff’s penalties for Lifepro case
Abuse of position and power while performing official duties
22 years imprisonment Irresponsibility causing severe consequences
Defendants of Agribank South Ha Noi
Pham Thi Bich Luong Abuse of position and power while performing official duties Violating lending regulations in credit institutions’ activities
30 years imprisonment Chu Thi Kim Hien
Table 8: Customer’s penalties for Lifepro case e HuynhThi Huyen Nhu 4,000 billion “great crime”
Table 9: Penalties for Huynh Thi Huyen Nhu
Counterfeiting seals and documents of agencies and organizations