Lessons from the global financial crisis and recommendations to Vietnamese banking sector

1 CHAPTER 1: GLOBAL FINANCIAL CRISIS AND ITS CAUSES 4 AND EFFECTS TO THE WORLD BANKING SECTOR.... Impacts of global financial crisis to the world banking sector.... Differences of Vietna

VIETNAM NATIONAL UNIVERSITY, HANOI

MASTER OF BUSINESS ADMINISTRATION THESIS

Supervisor : Dr Tran Phuong Lan

đ a i h ọ c q u o c O ' a H P IV V

TRUNG TẦM THONG Tin ĨHỰ yi£ N

ầ r L o / 6 9

Hanoi - 2010

TABLE OF CONTENTS

Acknowledue i

Abstract ii

Tóm tat vi

1 able o f contents xi

List of Abbreviations XV List of Tables xvii

List cf B o x e s xviii

List if Figures xix

Introduction 1

CHAPTER 1: GLOBAL FINANCIAL CRISIS AND ITS CAUSES 4 AND EFFECTS TO THE WORLD BANKING SECTOR

1.1 Financial crises and its impacts to the eco n o m y 4

1.1.1 Definition o f a financial crisis 4

1.1.2 Types of financial crises 4

1.1.3 Causes o f financial crises 7

1.1.4 Impacts o f financial crises to the economy in history 10

1.2 Global financial crisis in 2008 - 2009 19

1.2.1 The causes o f the c r is is 19

1.2.2 The development o f the crisis 33

1.3 Impacts of global financial crisis to the world banking sector 34

1.3.1 IvOsses and default increase due to owning or financing mortgage 34 derivaiives

1.3.2 Limited liquidity in the system - impact from difficult inter-bank 36 market

1.3.3 Losses in market value as stock price plummeted 39

1.3.4 Banking activities stagnancy and Credit drain 41

1.3.5 Collapses and Merger & Acquisition, nationalization 42

1.3.6 Confidence in banking system deterioration 45

1.3.7 The end of investment banks era 46

1.3.8 Large-scale lay-off, dismissal and unemployment in banks 47

CHAPTER 2: A N A L Y SIS THE V IE T N A M E S E BANKING SECTOR BE FOR E AND A F T E R THE FINA N CIAL CRISIS 52 2.1 \ietnam ese socio-economic context during global financial crisis 52

2.1.1 Excessive capital inflow 52

2.1.2 Inflation challenge and credit growth 53

2.1.3 Stock market sliding and real estate bubble swelling 54

2.1.4.Twin deficit 55

2.2 T ie Vietnamese banking sector before global financial crisis 56

2.2.1 Early stage o f development 56

2.2.2 Fast growth 58

2.2.3 Banking sector structure 59

2.2.4 Participation o f economic groups into banking sector 64

2.2.5 Undiversified banking services 65

2.2.6 \Veak risk management 66

2.2.7 )ver heated loan growth in 2007 66

2.2.8 Cooling loan growth rate in 2008 68

2.2.9 \ mapping of Vietnamese banks before the global crisis 69

2.3 Vietnamese banking sector after Global Financial C r is is 73

2.3.1 Analyzing Vietnamese banks by CAMELS model 73

2.3.2 Bank mapping in the crisis (in 2008) 83

2.3.3 Bank mapping after the crisis (in 2009) 88

2.3.4 Little change in market share 90

2.3.5 Mergers & Acquisition (M &A) 89

2.3 6 Inpacts on foreign banks in Vietnam 92

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2.3.7 Little change in banking personnel 93

2.4 Analysis of the similarities and differences between the Vietnamese 94 and US banking sector context before and during the financial crisis

2.4.1 Similarities of the Vietnamese and u s banking sector context before 94 and during the financial crisis

2.4.2 Differences of Vietnamese banking sector context to u s context 97 leading to the global financial crisis

Summary of Chapter 2 100

c HAPTER 3: LESSONS AND RECOMMENDATIONS 101

3.1 Lessons from the global financial crisis 102

3.1.1 Improving capitalization and leverage management lessons 102

3.1.2 Risk Management practices lessons 104

3.1.3 Separating commercial banks from investment banks 111

3.1.4 Transparency improvement lessons from u s and Euro zone’s banks 112

3.2 Recommendations to the Vietnamese Banking sector 115

3.2.1 Recommendations to Policy making level 115

3.2.1.1 More oversight and supervision from the authorities 115

3.2.1.2 Building SBV into a Central Bank in its exact meaning 117

3.2.1.3 Upgrading the legal system 124

3.2.1.4 Transparency improvement in authorities level 124

3.2.1.5 Improving deposit insurance activities 125

3.2.1.6 Improving banking personnel in Government level 127

3.2.2 Recommendations to banking governance and management 128

3.2.2.1 Improving capitalization in commercial banks 128

3.2.2.2 Improving liquidity management in commercial banks 129

3.2.2.3 More robust risk management in commercial banks 129

3.2.2.4 Mergers and Acquisitions (M&A) activities in banks 134

3.2.2.5 Improving transparency in Vietnamese commercial b a n k s 134

3.2.2.6 Developing banking services by diversification and IT investment 135

3.2.2.7 Improving personnel from commercial banks level 137

Summary of Chapter 3 138

C onclusion 139

Bibliography 140

Annex 01 146

Annex 02 156

Annex 03 159

G lossary 160

xiv

LIST OF A BB R EV IA TI O N S

SOCB State-owned commercial bank

J SB Joint-stock bank

SBV State bank o f Vietnam

MOF Ministry of Finance

IMF International Monetary Fund

DIV Deposit Insurance o f Vietnam,

SCIC State Capital Investment CorporationFED Federal Reserve

CPI Consumer Pricing Index

MBS Mortgage-backed security

SEC Securities and Exchange CommissionARM Adjustable-rate mortgage

CDO Collateralized debt obligation

CLO Collateralized Loan Obligation

CDS Credit Default Swap

ABS Asset-backed security

CRA Credit rating agencies

BHC Bank holding company

Ỉ D ie Federal Deposit Insurance CorporationSOE State-owned enterprise

NPL Non-Performing-Loan ratio

ROA Return On Asset

ROAA Return On Average Asset

ROE Return On Equity

ROAE Return On Average Equity

VAS Vietnamese Accounting Standards

IHRS International Financial Reporting StandardsNIM Net interest margins

SSG Senior Supervisors Group

NBFI Non-bank financial institution

CAR Capital Ratio

ECB European Central Bank

TARP Troubled Asset Relief Program

LIST OF TABLES

Table 1.1: Depreciation in GNP in some ASEAN Nations in 1997-1998 Table 1.2: Depreciation o f some ASEAN Nation’s currency in 1997-1998 Table 1.3: Depreciation of some ASEAN Nation's Per capita income

in 1997-2005

Table 1.4: Preliminary Capital Appreciation Contributions to the S&P500Table 1.5: Number o f job cuts from banks, insurer and funds since August 2007

Chapter 2:

Table 2.1: Financial Markets in Vietnam (Percentage o f GDP)

Table 2.2: Banking Sector in Vietnam (Percentage of market share)

Table 2.3: Foreign strategic stakes in Vietnamese Banks

Table 2.4: Investment o f economic groups and SOEs

Table 2.5: Profit comparison o f Vietnamese banks and banks in other countries

Table 2.6: Profitability and o f Efficiency o f Vietnamese banks in 2008

Table 2.7: Sliding bank stock price in 2008, 2009

Chapter 1:

LIST OF BO X ES

Box 1.1: A short list o f some major financial crises since 20th century

Box 1.2: How are MBSs (Mortgage backed securities) traded?

Box 1.3: A bank run - Northern Rock

Chapter 1:

xviii

LIST OF FIGUR ES

Figure 1.1: Unemployment Rate o f us (1890 - 2008)

Figure 1.2: USA annual real GDP from 1910-60

Figure 1.3: Wall Street Crash on the Dow Jones Industrial Average 1929 Figure 1.4: us Credit Market Debt as Percentage o f GDP

Figure 1.5: Growth in us Household Mortgage Debt

Figure 1.6: us Sub-prime mortgage loans in total mortgage loans (Quantity and percentage)

Figure 1.7: Breakdown o f Securities Backed by us Home Mortgage Collateral (January 2007)

Figure 1.8: The Growth o f the CDSs Market

Figure 1.9: Moody's Profit per Employee vs Total ABSs Issuance

Figure 1.10: Northern Rock share prices, day open (2005-2008)

Figure 1.11: Market value in October 2008 compared with Quarter 2, 2007Figure 1.12: Gold price fluctuation from September 2008 to 2009

Figure 2.4: Vietnam's Twin Deficits 2003-2008

Figure 2.5: Vietnam's banking market is in an early stage o f development Figure 2.6: Cash over M2 o f Vietnam, compared with regional countries Figure 2.7: Market share o f Vietnamese banks

Figure 2.8: Deposit market share 2008

Figure 2.9: Credit market share 2008

Figure 2.10: Credit growth and deposit growth versus GDP growth

Figure 2.11: Lending procedures in JCBs

Figure 2.12: Credit growth for 7 months in 2008

Figure 2.13: Banks’ mapping in 2007

Figure 2.14: NPLs ratio under VAS

Figure 2.15: NPLs ratio under VAS and IFRS

Figure 2.16: NPLs on some Vietnamese banks by 2008-end

Figure 2.17: After-tax profit o f 2008 compared with 2007 for some Vietnamese banks

Figure 2.18: Efficiency Ratios o f commercial banks in 2008

Figure 2.19: Price figure oflisted banks compared with VN Index

Figure 2.20: Banks grouping 2008

Figure 2.21: Bank mapping plan in 2009

Figure 2.22: Breakdown o f Capital Flows into Vietnam

Figure 2.23: Real Estate's outstanding loans on total outstanding loans

Figure 2.24: Vietnamese stock market from 2000 to now

Necessity of the thesis

Financial crises are no strangers to world economies in recent times: the collapse

o f the savings and loans industry in the United States in the 1980s, the Asian financial crisis of the 1990s But the recent us mortgage sub-prime crisis was truly different Stunning in its breadth, speed and dramatic consequences (Cally Jordan , 2009), the us crisis spread widely into the global financial crisis and affects almost every comer o f the world

Around the world, hundreds o f millions o f people are affected Almost every countries, rich and poor are affected, however, at different level

Banking industry is one o f the most impacted areas The crisis has a reverse pattern Crisis moved from the financial sector to the real economy And then weakening o f corporate sector will spread to financial sector

Vietnam, no longer cut off from the world economy, was hit too As the more integrated into the world economy, the more Vietnam’s economy affected by the

up and down in the world economy In a developing country like Vietnam, though the impacts on banks are not as directed as those in the us, but are large enough for bank management boards, investors, officials, law makers, specialists

as well as depositors to concern about

Many international and domestic researches have been carried out on the impacts

o f the global financial crisis to the economy o f Vietnam, but few o f them emphasize the lessons from the global financial crisis to the Vietnamese banking

sector and recommendations for it That is the reason for the author to carry out this research “Lessons from the Global Financial Crisis and Recommendations to Vietnamese Banking Sector".

Another reason for choosing this topic is that the banking sector holds an essential part in economic development in every country In Vietnam as many Asian countries alike, banks play a key role in channeling credit to firms, particularly those firms not able to acquire funding from capital markets or other sources Besides, banks also serve as custodian o f a significant portion o f household saving

For these above reasons and due to self interest, through this thesis, the author hopes to sketch and analyze some impacts o f the global crisis on Vietnamese banking sector in order to draw some lessons and recommendations for Vietnamese banks and the authorities to overcome difficulties in challenging time to come and better prevent possible crises

Scope o f work

The thesis covers impacts of the global turmoil on both the world and

Vietnamese banking industry And it focuses on Vietnamese banking industry conditions before and after the crisis to draw lessons and recommendations to this industry

Methodology

To fulfill the thesis, the author use qualitative interviews with local banks managers, state officials and Vietnamese and foreign experienced experts in banking and finance to understand the causes and effects o f the global financial

crisis to the world and Vietnamese banking sector to draw lessons and recommendations to the local sector.

Besides, various recent reports on banks from international organizations and local banks as well as securities companies are a worthy reference information Internet searching in reliable websites contributes some good data to the thesis

Contributions of the thesis

The thesis contributes some lessons from the current global financial crisis to the banking industry o f the world in general and of Vietnam in particular Then it draw some recommendations to Vietnamese authorities and banking managers in ways to tackle the global crisis and ways to better prepare for possible future crisis

CHAPTER 1

GLOBAL FINANCIAL CRISIS 2007 - 2009 AND ITS CAUSES AND

EFFECTS TO THE WORLD BANKING SECTOR

1.1 Financial crises and its impacts to the economy

1.1.1 Definition of a financial crisis

The term financial crisis is applied broadly to a variety o f situations in which some financial institutions or assets suddenly lose a large part of their value (D.D C'haturvedi, 2009) In the 19th and early 20th centuries, many financial crises were associated with banking panics, and many recessions coincided with these panics Other situations that are often called financial crises include stock market crashes and the bursting of other financial bubbles, currency crises, and

sovereign defaults(1 \

A financial crisis can be understood as a loss o f confidence in a country's currency or other financial assets causing international investors to withdraw their funds from the country Financial crisis can be in many different types as mentioned below

1.1.2 Types of financial crises

/ 1.2. / Banking crises

When a bank suffers a sudden rush o f withdrawals by depositors, this is called a

bank run (D.D Chaturvedi, 2009).

Since banks lend out most o f the cash they receive in deposits, it is difficult for them to quickly pay back all deposits if these are suddenly demanded, so a run may leave the bank in bankruptcy, causing many depositors to lose their savings unless they are covered by deposit insurance A situation in which bank runs are

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widespread is called a systemic banking crisis or just a banking panic (D.D

Chaturvedi, 2009) A situation without widespread bank runs, but in which banks are reluctant to lend, because they worry that they have insufficient funds available, is often called a credit crunch In this way, the banks become an accelerator o f a financial crisis

Examples o f bank runs include the run on the Bank o f the United States in 1931 and the run on Northern Rock in 2007 The collapse o f Bear Stearns in 2008 has also sometimes been called a bank run even though Bear Steams was an investment bank rather than a commercial bank The U.S savings and loan crisis

o f the 1980s led to a credit crunch which is seen as a major factor in the U.S recession o f 1990-91 (http://en.wikipedia.org)

/ 1.2.2 Speculative bubbles and crashes

Economists say that a financial asset (for example: stock, property ) exhibits a

bubble when its price exceeds the present value o f the future income (such as

interest or dividends) that would be received by owning it to maturity If most market participants buy the asset primarily in hopes o f selling it later at a higher price, instead o f buying it for the income it will generate, this could be evidence

that a bubble is present If there is a bubble, there is also a risk o f a crash in asset

prices: market participants will go on buying only as long as they expect others

to buy, and when many decide to sell, the price will fall (D.D Chaturvedi, 2009).Well-known examples o f bubbles and crashes in stock prices and other asset prices include the Dutch tulip mania, the Wall Street Crash o f 1929, the Japanese property bubble of the 1980s, the crash o f the dot-com bubble in 2000-2001, and

US housing bubble in 2006

/ 1.2.3 Financial crises

When a country that maintains a fixed exchange rate is suddenly forced to

devalue its currency because o f a speculative attack, this is called a currency

crisis or balance o f paym ents crisis When a country fails to pay back its

sovereign debt, this is called a sovereign default While devaluation and default

could both be voluntary decisions of the government, they are often perceived to

be the involuntary' results o f a change in investor sentiment that leads to a sudden

stop in capital inflows or a sudden increase in capital flight (D.D Chaturvedi,

2009)

Several currencies that formed part o f the European Exchange Rate Mechanism suffered crises in 1992-93 and were forced to devalue or withdraw from the mechanism Another round o f currency crises took place in Asia in 1997-98 Many Latin American countries defaulted on their debt in the early 1980s The

1998 Russian financial crisis resulted in a devaluation o f the ruble and default on Russian government bonds

/ 1.2.4 Wider economic crises

Negative GDP growth lasting two or more quarters is called a recession An especially prolonged recession may be called a depression, while a long period

o f slow but not necessarily negative growth is sometimes called economic stagnation (D.D Chaturvedi, 2009)

Since these phenomena affect much more than the financial system, they are not usually considered financial crises by nature But some economists have argued that many recessions have been caused in large part by financial crises One important example is the Great Depression, which was preceded in many

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countries by bank runs and stock market crashes The subprime mortgage crisis and the bursting of other real estate bubbles around the world has led to recession in the U.S and a number o f other countries in late 2008 and 2009.

1.1.3 Causes of financial crises

When looking at financial crises in history, though they have some different developments, they had some similarities in their causes

1.1.3.1 Strategic complementarities

It is often observed that successful investment requires each investor in a financial market to guess what other investors will do In many cases investors have incentives to coordinate their choices For example, someone who thinks other investors want to buy lots o f Japanese yen may expect the yen to rise in value, and therefore has an incentive to buy yen too Likewise, a depositor in Indy Mac Bank who expects other depositors to withdraw their funds may expect the bank to fail, and therefore has an incentive to withdraw too Economists call

an incentive to imitate the strategies o f others strategic complementarity

(http://en.wikipedia.org)

1.1.3.2 Leverage

Leverage, which means borrowing to finance investments is frequently cited as a

contributor to financial crises When a financial institution (or an individual) only invests its own money, it can, in the very worst case, lose its own money But when it borrows in order to invest more, it can potentially earn more from its investment, but it can also lose more than all it has Therefore leverage magnifies the potential returns from investment, but also creates a risk of bankruptcy Since bankruptcy means that a firm fails to carry out all its promised payments to other

firms, it may spread financial troubles from one firm to another The average degree o f leverage in the economy often rises prior to a financial crisis.

1.1.3.3 Asset-Hability mismatch

Another factor believed to contribute to financial crises is asset-liability

mismatch, a situation in which the risks associated with an institution's debts and

assets are not appropriately aligned (http://en.wikipedia.org) For example, commercial banks offer deposit accounts which can be withdrawn at any time and they use the proceeds to make long-term loans to businesses and homeowners The mismatch between the banks' short-term liabilities (its deposits) and its long-term assets (its loans) is seen as one o f the reasons bank runs occur (when depositors panic and decide to withdraw their funds more quickly than the bank can get back the proceeds o f its loans)

In an international context, many emerging market governments are unable to sell bonds denominated in their own currencies, and therefore sell bonds denominated in us dollars instead This generates a mismatch between the cuưency denomination o f their liabilities (their bonds) and their assets (their local tax revenues), so that they run a risk o f sovereign default due to fluctuations in exchange rates

1 1.3.4 Lack o f knowledge

Many analyses of financial crises emphasize the role o f investment mistakes caused by lack of knowledge It is pointed out that crises often follow soon after major financial or technical innovations that present investors with new types of financial opportunities Unfamiliarity with recent technical and financial

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innovations may help explain how investors sometimes overestimate asset values.

Recently, the crash of the dot com bubble in 2001 arguably began with too much delightment with Internet technology If the first investors in a new class of assets (for example, stock in "dot com" companies) profit from rising asset values as other investors leam about the innovation, then still more others may follow their example, driving the price even higher as they rush to buy in hopes

of similar profits I f such "herd behavior" causes prices to spiral up far above the true value of the assets, a crash may become inevitable If for any reason the price briefly falls, so that investors realize that further gains are not assured, then the spiral may go into reverse, with price decreases causing a rush o f sales, reinforcing the decrease in prices

1.1.3.5 Regulatory failures

Governments have attempted to eliminate or mitigate financial crises by regulating the financial industry Regulation has two main goals The first one is transparency, that is making institutions' financial situations publicly known by requiring regular reporting under standardized accounting procedures The second goal is making sure institutions have sufficient assets to meet their obligations, through reserve requirements, capital requirements, and other limits

on leverage

However, excessive regulation has also been cited as a possible cause of financial crises In particular, the Basel II Accord has been criticized for requiring banks to increase their capital when risks rise, which might cause them

to decrease lending precisely when capital is scarce, potentially aggravating a financial crisis

1.1.3.6 Fraud

Fraud has played a role in the collapse o f some financial institutions, when companies have attracted depositors with misleading claims about their investment strategies, or have stolen the resulting income Many rogue traders that have caused large losses at financial institutions have been accused o f acting fraudulently in order to hide their trades

1.1.3.7 Contagion

Contagion refers to the idea that financial crises may spread from one institution

to another, as when a bank run spreads from a few banks to many others, or from one country to another, as when currency crises, sovereign defaults, or stock market crashes spread across countries When the failure o f one particular financial institution threatens the stability o f many other institutions, this is

called systemic risk (D.D Chaturvedi, 2009).

1.1.4 Impacts of financial crises to the economy in history

Financial crises occur with surprising frequency, in every decade in the past century there has been at least one big shock to a major economy's financial system Analyzing the crises o f the 20th century shows that the impact o f past arises on the real economy was by no means uniform, and it depended, critically,

Dn the way governments acted to recapitalize the banking system and to restore stability and confidence

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Box 1.1: A short list o f some major financial crises since 20th century

• 1907 - Panic oi' 1907 - or 1907 Bankers' Panic - a financial crisis that occurred inthe US when its stock market fell close to 50% from its peak the previous year, was marked by numerous runs on banks and trust companies and bankruptcy

across the nation

• 1910 - Shanghai rubber stock market crisis

• 1930s - The Great Depression - the largest and most important economic

depression in the 20th century

• 1973 - 1973 oil crisis - oil prices soared, causing the 1973-74 stock market crash

• 1980s - Latin American debt crisis - beginning in Mexico

• 1987 - Black Monday (1987) - the largest one-day percentage decline in stock market history

• 1989-91 - US Savings & Loan crisis - the failure of 747 savings and loan

associations in the u s with the ultimate cost of the crisis is estimated to have

totaled around $160.1 billion

• 1990s - Japanese asset price bubble collapsed when real estate and stock prices greatly inflated

• 1992-93 - Black Wednesday - speculative attacks on currencies in the European Exchange Rate Mechanism

• 1994-95 - 1994 Economic crisis in Mexico - speculative attack and default on Mexican debt

• 1997-98 - 1997 Asian Financial Crisis - devaluations and banking crises across Asia

• 2007-09 - The American financial crisis of 2007-2009 helped create the global financial crisis of 2008-2009, thus creating the late 2000s recession

Source: http: enW ikipedia org; Xinhua Agencies

In the past century, there are more than ten financial crises in the world (listed in Box 1.1) Among them, three biggest crises in term o f loss are the Great Depression, banking crisis that inaugurated Japan's “lost decade” in the early 1990s and the Asian financial crisis o f the late '90s

The impacts o f these big crises in history will be analyzed below

/ 1.4.1 The Great Depression

The Great Depression was a severe worldwide economic depression in the decade preceding World War II from about 1929 until the late 1930s or early 1940s It was the longest, most widespread, and deepest depression o f the 20th century The depression originated in the United States, triggered by the stock market crash o f October 29, 1929 (known as Black Tuesday), but quickly spread

to almost every country in the world

The Great Depression had devastating effects in virtually every country, rich and poor Personal income, tax revenue, profits and prices dropped, and international trade plunged by half to two-thirds Unemployment in the United States rose to 25% (Figure 1.1) GDP dropped 30% at the bottom (Figure 1.2) Cities all around the world were hit hard, especially those dependent on heavy industry Construction was virtually halted in many countries Farming and rural areas suffered as crop prices fell by approximately 60 percent Facing plummeting demand with few alternate sources o f jobs, areas dependent on primary industry industries such as cash cropping, mining and logging suffered the most (http://www.thegreatdepressioncauses.com)

Countries started to recover by the mid-1930s, but in many countries the negative effects o f the Great Depression lasted until the start o f World War II

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Figure 1.1: Unemployment Rate o f us (1890 - 2008)

U nited States In e m p lo v m e o i R ate (1890 - 2008)

— Estimated °/o U nem ploym ent % Unemploym ent

Source: u s Bureau o f Labor Statistics

Figure 1.2: USA annual real GDP from 1910-60 (the years o f the Great

Depression (1929-1939) highlighted)

Year

Source: http://en Wikipedia, org/

Due to a combination o f runs on deposits, high levels of bank leverage, progressive deleveraging o f the economy, and limited ability o f the Fed to intervene, this quickly became a protracted economic downturn in which more than 9,000 financial institutions either went into bankruptcy or sought governmental assistance, and the economy experienced massive deflation.

The Wall Street Crash o f 1929 (See Figure 1.3), also known as the Great Crash

or the Stock Market Crash o f 1929, was the most devastating stock market crash

in the history of the us, taking into consideration the full extent and duration of its fallout Many people blamed the crash on commercial banks that were too eager to put deposits at risk on the stock market

Figure 1.3: Wall Street Crash on the Dow Jones Industrial Avarage 1929

Source: http://en.Wikipedia, org/

1.1.4.2 Japanese asset price bubble

The Japanese asset price bubble was an economic bubble in Japan from 1986 to

1990, which recorded total losses o f 15% o f GDP and in which real estate and

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stock prices greatly inflated The bubble's collapse lasted for more than a decade with stock prices bottoming in 2003 (www.imes.boj.or.jp)

In the decades following World War II, Japan implemented stringent tariffs and policies to encourage people to save their income With more money in banks, loans and credit became easier to obtain, and with Japan running large trade surpluses, the yen appreciated against foreign currencies This allowed local companies to invest in capital resources much more easily than their competitors overseas, which reduced the price o f Japanese-made goods and widened the trade surplus further And, with the yen appreciating, financial assets became very lucrative

With so much money readily available for investment, speculation was inevitable, particularly in the Tokyo Stock Exchange and the real estate market The Nikkei stock index hit its all-time high on December 29, 1989 when closing

at 38,915.87 (www.imes.boj.or.jp) Additionally, banks granted increasingly risky loans Besides, property prices were highest in Tokyo's Ginza district in

1989, with choice properties fetching over 100 million yen (approximately $1 million US dollars) per square meter ($93,000 per square foot) Prices were only marginally less in other large business districts o f Tokyo Then tens o f trillions

o f dollars worth were wiped out with the combined collapse o f the Tokyo stock and real estate markets (http://en.wikipedia.org)

With the economy driven by its high rates o f reinvestment, this crash hit particularly hard Investments were increasingly directed out o f the country, and manufacturing firms lost some degree o f their technological edge As Japanese products became less competitive overseas, the low consumption rate began to bear on the economy, causing a deflationary spiral The Japanese Central Bank

set interest rates at approximately zero When that failed to stop deflation some economists, such as Paul Krugman, and some Japanese politicians, advocated inflation targeting, which is an economic policy in which a central bank estimates and makes public a projected, or "target," inflation rate and then attempts to steer actual inflation towards the target through the use o f interest rate changes and other monetary tools.

1.1.4.3 Asian Financial Crisis 1997

The Asian Financial Crisis was a period o f financial crisis that gripped much o f Asia beginning in July 1997, and raised fears o f a worldwide economic meltdown due to financial contagion

The crisis started in Thailand with the financial collapse o f the Thai baht caused

by the decision o f the Thai government to float the baht, cutting its peg to the USD, after exhaustive efforts to support it in the face o f a severe financial overextension that was in part real estate driven At the time, Thailand had acquired a burden o f foreign debt that made the country effectively bankrupt even before the collapse o f its currency

Though there has been general agreement on the existence o f a crisis and its consequences, what is less clear is the causes o f the crisis, as well as its scope and resolution Indonesia, South Korea and Thailand were the countries most affected by the crisis Hong Kong, Malaysia, Laos and the Philippines were also hurt by the slump The People's Republic o f China, India, Taiwan, Singapore, Brunei and Vietnam were less affected, although all suffered from a loss o f demand and confidence throughout the region

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Although most of the governments of Asia had seemingly sound fiscal policies, the International Monetary Fund (IMF) stepped in to initiate a $40 billion program to stabilize the currencies o f South Korea, Thailand, and Indonesia, economies particularly hard hit by the crisis (Ricky Schmidt, 2009) By 1999, analysts saw signs that the economies of Asia were beginning to recover.

The crisis had significant macro-level effects, including sharp reductions in values o f currencies, stock markets, and other asset prices o f several Asian countries The nominal u s dollar GDP of ASEAN fell down sharply in 1998 Indonesia had the highest fall in GNP in 1998 compared with 1997 (Table 1.2) Many businesses collapsed, and as a consequence, millions o f people fell below the poverty line in 1997-1998

Table 1.2: Depreciation in GNP in some ASEAN Nations in 1997-1998

Country

GNP (US$1 billion)

ChangeJune 1997 July 1998

Fable 1.3 shows that despite the prompt raising o f interest rates to 32% in the Philippines upon the onset o f crisis in mid-July 1997, and to 65% in Indonesia upon the intensification of crisis in 1998, their local currencies depreciated just the same and did not perform better than those o f South Korea, Thailand, and Malaysia, which countries had their high interest rates set at generally lower than 20% during the Asian crisis.

Table 1.3: Depreciation of some ASEAN Nation’s currency in 1997-1998

Source: School o f Advanced International Studies o f Johns Hopkins University

According to CIA World Fact book, per capita income (measured by purchasing power parity) in some Asian countries even shrank in 2005 compared with that

of 1997 (Table 1.4), suggesting long-lasting impacts from the financial crisis

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Table 1.4: Depreciation of some ASEAN Nation’s Per capita income

in 1997-2005

Per capita income

Source: CIA World Fact book

After the Asian crisis, international investors were reluctant to lend to developing countries, leading to economic slowdowns in developing countries in many parts o f the world And within East Asia, the bulk o f investment and a significant amount o f economic weight shifted from Japan and ASEAN to China and India

1.2 Global financial crisis in 2008 - 2009

1.2.1 The causes of the crisis

The financial industry faced one o f its most turbulent years ever in 2008, at the centre o f the crisis, with monumental changes taking place daily To fully understand how trouble on Wall Street has affected world banking industry, we need to look back at the origin o f the problem, the cause o f the crisis

1.2.1.1 US Expansionary monetary policy in 2001 - 2004 and “House fo r ỈOYV-

income p eo p le” policy

To pull the economy out o f economic recession due to dot.com bubble as well as September 11th 2001 event, Bush administration implemented Expansionary monetary policy and low interest rate for credit expansion for a long time The Federal Reserve (FED) reduced base interest rate from 6.5% in 2001 down to 1% in 2003 After a year maintaining interest rate o f 1% , FED increased the rate again to 5.25% in June 2006 This increased the monetary base supply from 5%

to 10% in the phase 2001-2004 (Dinh Tuan Minh, 2009) Similar as 1920s, low interest rate in a long period did not lead to an increase in Consumer Pricing Index (CPI) However, it was the main reason to misleading investment Investors poured money into assets market, stock market and housing market, which led to a hot growth Consumers increased borrowing to buy houses, cars and other luxurious goods Misleading investment in the economy created more and more ill-shaped structure

The increase o f total us credit market debt was much more sharply than the increase o f GDP By the end o f 2007, us credit market debt is approximately 340% o f GDP (Figure 1.4)

20

Figure 1.4: u s Credit Market Debt as Percentage of GDP

Chait 7: Ư.S C i»d* N a k v t D*bt a s o f GDP

P * I C « I*

195Ỗ 1ỠƠ w» *»70 1975 1WQ 1965 1»Q 1W5 2Q00 2Ữ05 2007'

SOUK* f e a t Tữ n es* r* t Bureau or Ecoitoinếe *gHysiỉ Have I A tftjftcs 0*r C attuabora ' 2007 utvxM ipt 03

Source: Nguven Quang A, Financial crisis and its effects to Vietnam banking industry, 2008

In addition, “ House for low-income people” policy o f Bush administration led to sharply increasing property credit, u s households assumed more mortgage debts'" in the period 2 001 - 2007 than before (Figure l 5)

Figure 1.5: Growth in us Household Mortgage Debt

C hat ? Giowth in U.S Household Matgag* Debt

SOtH C* 1ề:t*nế B M H tl r t i r w * t « y i c t i* iK t « iC «

Source: Nguven Quang A, Financial crisis and its effects to Vietnam banking industry, 2008

1.2.1.2 Abundant foreign capital inflow

Besides domestic funds, another sources o f capital in the us recently was foreign capital inflow The global patterns o f saving and investment evolved over the past decade affected credit markets in the us and some other industrial countries

At the most basic level, the role o f banks and other financial institutions is to take the savings generated by households and businesses and put them to use by making loans and investments Importantly, in the global financial system, saving need not be generated in the country in which it is put to work but can

come from foreign as well as domestic sources In the past 10 to 15 years, the us

and some other industrial countries have been the recipients of a great deal of foreign saving Much o f this foreign saving came from fast-growing emerging market countries in Asia and other places where consumption has lagged behind rising incomes, as well as from oil-exporting nations that could not profitably invest all their revenue at home and thus looked abroad for investment opportunities Indeed, the net inflow o f foreign saving to the us, which was about 1.5% o f its national output in 1995, reached about 6% o f national output in

2006, an amount equal to about 825 billion us dollars in today's dollars (Suiwah Leung, 2009)

Saving inflows from abroad can be beneficial if the country that receives those inflows invests them well Unfortunately, that was not always the case in the u s and some other countries Financial institutions reacted to the surplus o f available funds by competing aggressively for borrowers, and in the years leading up to the crisis, credit to both households and businesses became relatively cheap and easy to obtain One important consequence was a housing boom in the United States, a boom that was fueled in large part by a rapid expansion o f mortgage lending, much o f which were sub-prime lending (Suiwah Leung, 2009)

1.2.1.3 Sharply increasing sub-prim e lending <2>

On one hand, the surplus o f available funds enabled people to borrow money to buy houses On the other hand, financial institutions had beneficial incentives to give loans to these people, even subprime clients Then incentives were the key reason to sharp increase in sub-prime lending

The establishment o f state-backed financial institutions

The US financial system consists o f two giant financial institutions in credit and mortgage backed by the state: Fannie Mae (Federal National Mortgage Association) and Freddie Mac (The Federal Home Loan Mortgage Corporation) These institutions hold the responsibility o f buying back mortgages o f other financial institutions as well as directly participating in mortgage lending to maintain the low rate credit flow and provide more money for housing finance They own or guarantee five trillion dollars in debt and securities and about half

o f all o f the home loans sold in the United States (Harry Wallop, 2008) They keep some loans but resell others as mortgage-backed securities*3’ (MBSs) to investors worldwide To carry out this jobs, Freddie and Fannie can receive direct credit from us Treasury, enjoy tax exemption and stay out o f the supervision o f Securities and Exchange Commission14* (SEC) Due to such privileges, Fannie Mae and Freddie Mac extended their subprime credit to create

a housing bubble Moreover, as the two institutions were allowed to securitize*51 mortgage loans to sell out to other financial institutions, the risk o f housing bubble spread to the whole us financial system

High risk appetites financial institutions

Fannie Mae and Freddie Mac, together with other investment banks, took mortgages, packaged them together in mortgage-backed securities, split them up

a hundred ways, sold and traded them, and made a lot o f money doing it When the supply of traditionally qualified boưowers diminished, these investment banks lowered their lending standards, which then created so-called sub-prime mortgage loans, to continue earning profit (Nguyen Due Huong, 2010)

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The problem is that the original investment banks offering loans were not strict enough in taking the responsibility o f testing the debtors’ ability to refund Whereas they were only interested in signing the loan contracts and sell them out The reason was that they had fees for making contracts, then the more contracts they could make, the more they could earn Then it comes back to the problem of incentives o f original institutions to make enormous profit for themselves.

From the middle o f the 1990s, sub-prime mortgage loans exhibited spectacular growth in the us (Figure 1.6)

Figure 1.6: US Sub-prime mortgage loans in total mortgage loans (Quantity and percentage)

10 mortgage loans Right

axis, %

5

0

Source: Havard Joint Center for Housing Studies

Normally, sub-prime mortgage loans are loans provided to higher-risk borrowers

at interest rates which are 200 to 300 basis points higher than the interest rates of loans granted to ‘prime* borrowers (Suiwah Leung, 2009) A large portion of

these debtors either had an unsatisfactory credit history or a history of payment problems In addition, there is also an Alt-A category'6’, which include otherwise relatively good borrowers, who either lack reliable proof of income or have a high debt-to-income ratio At the beginning o f 2007, according to IMF estimates, sub-prinme loans represented 15 per cent o f the total mortgage loan portfolio in the US while A It-A loans comprised another 5 per cent (M Nagy, V E Szabo, (2008) According to estimations, the ratio o f sub-prime and Alt-A category loans within the securitized mortgage loan portfolio was 14 per cent and 12 per cent, respectively (Figure 1.7)

Figure 1.7: Breakdown of Securities Backed by us Home Mortgage Collateral (January 2007)

Breakdow n of securities backed by us home

The rapid expansion of sub-prime and Alt-A loans peaked between 2004 and

2006 A good indication o f this expansion was the simultaneous growth in sub­prime and Alt-A loans, which together represented 40% of the portfolio o f new loans in 2006, as opposed to 10% in 2003 (Suiwah Leung, 2009) During this period, even debtors with a poor credit history were able to obtain loans as us

real estate prices continued to increase Both borrowers and lenders assumed that housing prices would continue to increase and that the capital gain from home price appreciation would be sufficient to pay back the loans o f the home-owners Then both lenders and borrowers were eager in the creatine loans process as they thought they surely gain much profit for the time to come with the increasing home price

Due to the fact that from the end of 2003, growing interest rates made it increasingly difficult for some sub-prime borrowers to obtain financing, lenders gradually started to relax their credit conditions Thanks to the relaxed credit standards, an increasing number o f borrowers were offered loans even though their equity was less than 10% and they did not have sufficient proof o f income,

or enjoyed lending options with negative depreciation, or lower installments in the initial incentive period As a result, by 2006 the share of adjustable-rate mortgages'7’ (ARMs) ensuring lower initial interest payments typically for up to two years, had reached 50% in the sub-prime category (Suiwah Leung, 2009)

1.2.1.4 Securitization process and more complex financial products

The strong demand o f investors for high-yield instruments also contributed to the dynamic expansion o f sub-prime mortgage loans To satisfy this need, the us

financial industry’ designed securities that combined many individual loans in complex, hard-to-understand ways These new securities later proved to involve

substantial risks that neither the investors nor the firms that designed the securities adequately understood at the beginning.

Mortgage-backed securities were issued in growing quantities along with their repackaged version, structured loan products called Collateralized debt obligations18’ (CDOs), which transferred the credit risks associated with sub­prime mortgages to investment groups with varying risk appetites

Financial specialists in Wall Street and financial centers all over the world collected the mortgage contracts'4’ and offer the market creative derivative bonds which are assured by the mortgage contracts called Mortgage Backed Securities (MBSs) Other common products are Collateralized Debt Obligation (CDOs) and Collateralized Loan O bligation"01 (CLOs) which are derivative bonds backed by loan contracts In u s only, the value o f housing mortgage contract amounted more than 12,000 billions USD and the number o f CDOs and CLOs was equivalent to that There is no exact number for the whole world but it must amount to tens o f billions USD (Nguyen Due Huong, 2010)

To protect themselves from risks o f bad debts, investors o f such derivatives bought an “insurance product” call Credit Default Swap (ll) (CDSs) This is a kind o f insurance that the seller assures to execute the debt payment for the buyer in case the debtor goes bankruptcy, gets solvency or the credit rating downgrades them Then the CDSs became a derivative investment product challenging mis-happening events Figure 1.8 below showed the sharp increase

in CDSs in the period 2001-2008

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Figure 1.8: The Growth of the CDS Market