Public asset management a study of asset management companies and policy suggestions for vietnam

ABSTRACT The Vietnamese banking sector is facing difficulties with high levels of non-performing loans NPLs caused by rapid credit growth, weak risk management, connected lending, cross-

FULBRIGHT ECONOMICS TEACHING PROGRAM

PHAN THỊ MINH KHOA

PUBLIC ASSET MANAGEMENT: A STUDY OF ASSET MANAGEMENT COMPANIES AND POLICY SUGGESTIONS FOR VIETNAM

MASTER IN PUBLIC POLICY THESIS

HO CHI MINH CITY - 2013

MINISTRY OF EDUCATION AND TRAINING UNIVERSITY OF ECONOMICS, HO CHI MINH CITY

FULBRIGHT ECONOMICS TEACHING PROGRAM

PHAN THỊ MINH KHOA

PUBLIC ASSET MANAGEMENT: A STUDY OF ASSET MANAGEMENT COMPANIES AND POLICY SUGGESTIONS FOR VIETNAM

MAJOR: PUBLIC POLICY CODE: 60340402

MASTER IN PUBLIC POLICY THESIS

SUPERVISOR

Dr JONATHAN R PINCUS

HO CHI MINH CITY - 2013

CERTIFICATION

I certify that the thesis is all done by my efforts To the best of my knowledge, all resources used have been acknowledged in the thesis The thesis does not reflect the views of Ho Chi Minh City Economics University or Fulbright Economics Teaching Program

Author

PHAN THI MINH KHOA

ACKNOWLEDGEMENTS

I would like to express my appreciation to my supervisor, Dr Jonathan R Pincus for helping

me with this thesis

I would like to thank Mr Truong Minh Hoa for his help on the layout of this thesis

And finally, I would like to thank all my professors and classmates for their contribution to the

experience and knowledge that I have gained during the two year studying at Fulbright

Economic Teaching Program

Phan Thi Minh Khoa

Ho Chi Minh City – June, 2013

ABSTRACT

The Vietnamese banking sector is facing difficulties with high levels of non-performing loans (NPLs) caused by rapid credit growth, weak risk management, connected lending, cross-ownership, high amount of loans to state owned enterprises (SOEs), and loose supervision from the State Bank of Vietnam (SBV) High NPLs cause banks to hesitate to grant new loans

to borrowers At the same time, good borrowers are repaying their debts, reducing credit growth and economic growth in 2012 In order to resolve these problems, some observers have suggested establishing an Assets Management Company in Vietnam

According to past experience, AMCs are frequently used in financial restructuring Some studies have shown that using AMCs as a rapid disposition tool would achieve better results than corporate restructuring tools (Klingebiel, 2011) However, another study from the World Bank has shown that countries using AMCs as both an asset disposition and a corporate restructuring tool have a better chance to succeed (Rose, 2005) Given the economic and legal conditions in Vietnam, establishing the AMC in Vietnam as both an asset disposition and corporate restructuring tool may not yield positive outcomes Following an example of the Indonesian Bank Restructuring Authority (IBRA), the AMC should be structured as a banking restructuring agency However, in order for the AMC to achieve its objectives, it requires corporation between SBV and other government agencies as well as some adjustment in the current laws and regulations

JSBs Joint stock commercial banks

IBRA Indonesian Bank Restructuring Authority

SOCBs State-owned commercial banks

VAMC Vietnamese Assets Management Company

LIST OF BANKS

3 Agribank Vietnam Bank for Agriculture and Rural Development OTC

5 BIDV Bank of Investment and Development of Vietnam JSC Listed

10 Habubank Hanoi Building Commercial Joint Stock Bank

14 Maritime Vietnam Maritime Commercial Joint Stock Bank Unlisted

22 PG Bank Petrolimex Group Commercial Joint Stock Bank Unlisted

23 Sacombank Saigon Thuong Tin Commercial Joint Stock Bank Listed

Abbreviation Name Listing

24 SaigonBank Saigon Bank for Industry and Trade Unlisted

26 SeABank Southeast Asia Commercial Joint Stock Bank Unlisted

28 Southern

29 Techcombank Vietnam Technological and Commercial Joint-stock Bank Unlisted

30 Tien Phong Tien Phong Commercial Joint Stock Bank Unlisted

31 Trust Bank Great Trust Joint Stock Commercial Bank Unlisted

32 VIB Vietnam International Commercial Joint Stock Bank Unlisted

33 VietA Vietnam Asia Commercial Joint Stock Bank Unlisted

34 Viet Capital Viet Capital Commercial Joint Stock Bank Unlisted

35 VietBank Vietnam Thuong Tin Commercial Joint Stock Bank Unlisted

36 VCB Joint Stock Commercial Bank for Foreign Trade of

CHAPTER 1 TABLE OF CONTENTS

CERTIFICATION I

ACKNOWLEDGEMENTS II

ABSTRACT III

ABBREVIATIONS IV

LIST OF BANKS V

LIST OF TABLES AND GRAPHS IX

CHAPTER 1 INTRODUCTION 1

1.1 The Vietnamese economy and the Vietnamese banking system 1

1.2 Research objectives 3

1.3 Research questions 3

1.4 Research methods, scope and sources of information 3

1.5 Thesis structure 4

CHAPTER 2 LITERATURE REVIEW 5

2.1 Two types of banking crises 5

2.2 Solutions for banking crises 5

2.3 What are NPLs? 9

CHAPTER 3 ASSET MANAGEMENT COMPANIES 11

3.1 Asset management companies 11

3.2 Some important objectives of AMCs 11

3.3 Prerequisites 12

3.4 Some important aspect for a successful AMC 14

3.5 The AMC in Indonesia 16

3.6 For a successful AMC 24

CHAPTER 4 BANKING PROBLEMS IN VIETNAM AND THE PROPOSAL TO USE

AMCS AS A RESOLUTION TOOL 25

4.1 Brief history of the Vietnamese banking since 1988 25

4.2 Factors that contribute to high ratio of NPLs 28

4.3 Non-performing loans within the banking system – problem and difficulties 33

4.4 NPLs analysis 35

4.5 Using AMC as a resolution tool 37

CHAPTER 5 POLICY RECOMMENDATIONS AND CONCLUSION 43

5.1 Policies recommendations 43

5.2 Conclusion 46

REFERENCES 47

APPENDIX I - USING AMC AS A RESOLUTION TOOL 51

APPENDIX II - EXPERIENCES OF AMCS IN OTHER COUNTRIES 55

APPENDIX III - BANK AND NPLS ANALYSIS 58

LIST OF TABLES AND GRAPHS

Table 3.1: Recovery Rate of IBRA 22

Graph 4.1: Domestic Credit Growth 28

Graph 4.2: Domestic Credit Provided By Banking Sector (Percentage of GDP) 28

Table 4.1: Insolvency Time And Cost 39

Graph 4.3: M2 Growth And Inflation 41

Graph 4.4: Government Budget 41

In 2011 and the beginning of 2012, the world economy was still facing many difficulties The international economic downturn has affected some businesses in Vietnam, especially the exporters In addition, interest rates were very high in the year of 2011 and only began to decrease in the beginning of 2012 With high interest rates, operational costs of businesses increased Slow economic growth worldwide and domestically has also reduced revenues of businesses As the result, many listed companies on HOSE and HNX posted losses for the year of 2011 and the first half year of 2012

Both the domestic and international problems put many businesses in a difficult situation as demand decreased and operating costs increased Many businesses, especially those in real estate and state owned enterprises (SOEs), are having cash flow problems and are unable to repay their debts on time As the result, the banking system is also at risk due to the huge amount of non-performing loans (NPLs), causing some banks become illiquid, even insolvent

In addition, because of the decline in real estate prices, loans‟ collateral has decreased in value and has become illiquid The problems in the real economic sector in turn affect the banking

system Loans that businesses have problem repaying become banks‟ non-performing loans and reduce banks‟ profits and liquidity

1.1.2 Slow credit growth

For a long period, the Vietnamese economy had been growing very rapidly with credit growth over 30 percent annually The amount of loans in the banking system was nearly 140 percent

of GDP in 2010 However, credit growth has been slowing down since the beginning of 2012 For the first 10 months of 2012, credit growth was only 2.77 percent as businesses reduced their borrowing because of various reasons such as high loan interest rates, slow economic growth, high inventories, and banks‟ unwillingness to make new loans

Due to the high level of NPLs within financial institutions (FI), banks became risk-averse They increased interest rates on deposits to attract new deposits but refused to make new loans This method could help banks temporarily reduce their liquidity problem; however, it does not in fact recapitalize banks since deposits still reside on their balance sheet as liabilities In order to cover the losses from these NPLs, banks must replace this capital either out of profits or by attracting new investment Therefore, the main reason for this risk-averse attitude is that banks are undercapitalized

1.1.3 Government restructuring program

At the end of 2011, the Vietnamese government approved a scheme to restructure credit institutions from 2011 to (Decision No 254/QD-TTg, 2012) In this scheme, the resolution of NPLs has been mentioned with several courses of action such as: selling NPLs to a Debt and Asset Trading Corporation (DATC); selling NPLs to the private, non-banking sector; resolving NPLs by using risk reserve; converting debt into debtors‟ equity; and repaying NPLs that had been created by directed lending by the government

As a part of the scheme, in 2012 and early in 2013, SBV announced the merger of three small banks with high levels of NPLs (SCB, Tin Nghia, Ficombank) with the help of BIDV, the

merger between SHB and Habubank (a small bank with a high level of NPLs), and the merger between Western bank and PetroVietnam Finance Joint Stock Corporation (PVFC)

However, there are still some remaining troubled banks When auditing these banks, the audits showed that NPLs in those banks were more than 30 percent, and even more than 60 percent

in some cases Some banks had already lost all of their chartered capital and equity (Stox, 2012) For those banks, SBV intended to keep them under special surveillance SBV also proposed to create a Vietnamese Assets Management Company (VAMC)

1.2 Research objectives

This paper has two main objectives First, this paper investigates the experiences of using AMCs as resolution for banking distress in other countries, focusing on Indonesia The paper will consider the prerequisites and some important factors for successful AMCs

Second, the paper will explore the current banking problems in Vietnam, focusing on the causes of banking problems and the condition of non-performing loans within the system Using the experiences learned from other nations, the paper will consider the question of whether the country meets the prerequisites to establish a good and effective AMC and to what the government can do to enhance the probability of its success

1.4 Research methods, scope and sources of information

This paper uses qualitative methods to study the use of AMCs in other countries and to apply those experiences to the case of Vietnam

This paper only uses public information such as research from the IMF, World Bank, BIS,

other credible researchers; the financial statements (FS) of commercial banks and State owned

commercial banks (ending in December 2012) During the process of examining banks‟ FS,

the paper also uses available public information such as announcements of some Vietnamese

government officers, governors or NA representatives - especially the governor and chief

auditor of SBV, expert interviews and articles from newspapers to best estimate the amount of

NPLs for each bank

For the purposes of the research, this paper only focuses on commercial banks and SOEs,

excluding joint-venture banks and foreign owned banks because they are not included in the

restructuring program and they only account for five percent of total assets of the banking

system

Due to the lack of public information, the amount of NPLs in each commercial bank is only

estimated according to scenarios from available FS (for the 2012 fiscal year) gathered before

May 2013 Other information used in this paper is also gathered before May 2013 Therefore,

the creation of Vietnamese Asset Management Company and its operating structure is not

within the scope of this paper

1.5 Thesis structure

The rest of the paper is organized as follows Chapter 2 covers the literature on financial crises

and banking crises Chapter 3 explores the experience of using AMCs as a resolution tool in

other countries Chapter 4 presents a view of the current banking problems and the seriousness

of NPLs in Vietnam Chapter 5 concludes and discusses some policy implications

CHAPTER 2 LITERATURE REVIEW

2.1 Two types of banking crises

There are two types of banking crises: crises that start with a few troubled banks and then

spread to the whole financial system (contagion type) and crises that come from a common exposure to a macroeconomic shock that affects all institutions (macro type)

In order to resolve the crisis, it is important to understand its causes Policy tools used for the contagion type and macro type are quite different For the contagion type, closing the troubled institution may be the most appropriate policy choice, while bank closure may not be an option for crises that affect all or most institutions Therefore, if the problem was caused by poor management, the banks‟ shareholders have to be responsible for the losses Otherwise, If the damage is caused by government action or other macro factors beyond the control of the banks, government has to partially bear the consequences Therefore, in the case of systemic distress, losses are often shifted to taxpayers by issuing sovereign debt and injecting capital into the banking system (Gelpern, 2004)

2.2 Solutions for banking crises

2.2.1 Stock and flow solutions

When dealing with banking crises, countries can either use stock or flow solutions The approach used depends on the severity of the crisis and the amount of government guarantees Banks use flow solutions to strengthen their capital and solvency through profits This approach does not deal directly with bank‟s bad loans The flow approach can be risky as distressed banks may have an incentive to gamble and invest in high risk projects with the hopes of gaining higher profits

In contrast to the flow solution, the stock solution can be used when the distress is systemic with the purpose of reviving insolvent or illiquid financial institutions or liquidating unviable banks There are three types of stock solutions: namely, (1) liquidating financial institutions

that are insolvent and nonviable; (2) managing and selling non-performing loans; (3) restructuring financial institutions that are distressed but viable (Klingebiel, 2000)

2.2.2 Different type of government support

From the experiences of the crisis in Venezuela in 1994, and in Indonesia, Korea and Thailand

in 1997, liquidity support for insolvent banks can turn out to be disastrous and result in losses

to the government Managers and shareholders in insolvent banks have an incentive to gamble any money they have left (including the liquidity support) with the hope of big returns and getting out of bankruptcy Therefore, government should not extend liquidity support to bankrupt banks If the financial institutions are insolvent and non-viable, it is best to liquidate their assets and shut down their operations (Claessens, 1999)

Nevertheless, if banks‟ shareholders know that the government does not have enough resources to close their banks and fulfill their obligations to depositors, they can refuse to contribute new capital when required and continue doing risky investments

On the other hand, for the crises that come from common shocks, using an aggressive closure policy can trigger a bank run (as it did in Indonesia 1997) unless government can obtain high credibility (Gelpern, 2004) It is also not possible to shut down a large segment of the financial sector since it may cause bank runs and encourage borrowers to default on their loans by breaking the relationship between borrowers and creditors When the banking system is in crisis, the borrowers may develop an attitude that their banks may not survive longer than they

do, thus reducing their incentive to repay their debts regardless of their capabilities

Blanket guarantees may restore confidence, but the relief may be temporary if the government does not have sufficient resources to make good on its commitments, or if guarantees simply encourage more risky behavior on the part of desperate bank owners and managers

Forbearance on capital adequacy requirements is not a good policy since it worsens the problems in the banking system, especially when financial institutions are allowed to violate the rules

Debt forgiveness from the government is one popular choice when it comes to finding a resolution for financial crises because it is simple, fast, and effective in restoring borrowers‟ financial capabilities and rebuilding banks‟ balance sheets For emerging and developing countries with weak legal systems, a simple solution that minimizes choice and corruption is very important However, the use of debt forgiveness should only be a one-time offer in order

to prevent moral hazard from banks and corporations in the future The lesson is that government should not rule out debt forgiveness as one resolution method but use it in a realistic way (Arnold, 2003)

2.2.3 The use of AMCs

In the Asian crises of 1997, countries such as Indonesia, Korea, Malaysia and Thailand have used two methods to resolve their problems from rising NPLs, failures in the corporate and financial sectors, underdeveloped assets markets, and weak legal systems The two methods were the creation of AMCs and out-of-court debt restructuring frameworks (Woo, 2000) During this period, the creation of government owned AMCs was a popular choice (Claessens, Djankove and Xu, 2000)

There have been many papers written about AMCs Some papers show that using AMCs strictly as a restructuring tool has not been a great success (Rose, 2005) The paper written by Klingebiel examines the cross-country experiences of the use of AMCs in seven cases (Finland, Ghana, Sweden, Mexico, the Philippines, Spain, and the US) It shows that in the countries where AMCs were used as a rapid disposition tool had a higher chance of success than in other cases (Klingebiel, 2000) However, further research from the World Bank shows that countries which use AMCs as a tool for both rapid assets disposition and corporate restructuring have better chance of success (Rose, 2005)

Nevertheless, the type of AMC is not the main factor in success or failure The IMF study presents eleven aspects of an effective AMC: legal basis, regulatory framework, governance, selection of assets transferred, pricing, funding, incentive structure, asset disposition, legal power, lending and tax issues (Woo, 2000) Similarly, a study by the World Bank also presents some issues that need to be clarified in order to establish a successful national AMC, grouped into three categories: asset management and resolution; organizational and policy issues; and building support for the AMC (Rose, 2005)

2.2.4 Experiences from other countries’ crises

In previous crises – such as Estonia (1992), Argentina (1980-82), Japan (1946), and the United States (1933) – governments have adopted similar solutions to deal with crises First, they have established comprehensive financial restructuring programs Second, governments have strengthened public confidence by assuring that all the financial institutions that remained in business were solvent and capitalized Third, when the government had to close or freeze an insolvent bank, they kept the time of frozen deposits to a minimum to avoid flight to currency

or other substitute assets (Cleassens, 1999)

2.2.5 Uses of public funds

When the banking system is facing a systemic crisis, using public funds is necessary However, government often tends to use too little resources when reacting to a crisis That makes financial institutions unsure about the help of government, so they want to hide their problems as much as possible to avoid damaging their reputation as well as punishment from central banks The uncertainty also decreases consumers‟ confidence in the banking system and may cause large losses Therefore, public help should be large and transparent enough to restore managers, shareholders, and especially depositors‟ confidence (Claessens, 1999)

On the other hand, the government should not bail out all financial institutions (i.e existing shareholders and managers) The goals should be to allocate losses in a transparent way, minimizing the cost to taxpayers, and providing incentives for new private capital injections

The general rules are: if banks are facing temporary difficulties but are still solvent, government can inject capital into those institutions to dilute the existing shareholders‟ equity but not completely eliminate them However, if banks are insolvent, existing shareholders‟ equity and subordinated debtors should be eliminated completely before any government capital injections unless the government is responsible for those losses such as giving explicit/implicit guarantees for those non-performing loans from SOEs or public projects (Claessens, 1999)

2.3 What are NPLs?

NPLs are debt obligations that have not been serviced in a timely manner by the original debtor NPLs arise typically from financial crises from the causes of (1) rising interest rates that increases financial costs to debtors, (2) an economic downturn which reduces borrowers‟ profits and cash flow, (3) exchange rate depreciation that increases borrowing cost for loans denominated in a foreign currency or increases other input costs

How to define NPLs depends on the loan classifications of each country According to a survey of countries in Central, Eastern and Southeastern Europe, the majority of countries choose 90 days overdue loans as the definition of non-performing loans (EBCI, 2012)

IMF (2006), under financial soundness indicators, also provides some guideline for classifying loans as NPLs: (1) when debtors fail to pay principle and interest for three months (90 days) or more; or (2) when interest payments are capitalized into principle for more than three months (90 days or more)

Vietnam, following the international norm, also uses the 90-day period as criteria for defining NPLs According to SBV (circular No.02/2013/TT-NHNN), NPLs are debts that are categorized into group 3 to 5:

Group 3 debts (sub-standard) are overdue debts from 91 to 180 days; first time rescheduled

debts; or debts that have received interest reductions because debtors are unable to repay the interest, debts belong to some special cases, or debts that are recalled on the orders of the inspector

Group 4 debts (doubtful) are overdue debts from 181 to 360 days; first-time rescheduled debts

that are overdue for less than 90 days from the date of rescheduling, second time rescheduled debts, debts that are recalled by inspector‟s orders and overdue from 30 to 60 days

Group 5 debts (loss) are overdue debts above 360 days; first-time rescheduled debts that are

overdue for more than 90 days from the dates of rescheduling, second time rescheduled and overdue debts, third time rescheduled debts, debts that are recalled on the order of the inspector and overdue for more than 60 days.1

In the context of this paper, the terms NPL, distressed assets, performing loans, and performing asset are used interchangeably Because non-bank financial institutions do not account for a large percentage of the financial sector, in this paper, financial institutions and banks are used interchangeably

1 Read more on circular 02/2013/TT-NHNN For more information about difference in loan classification, read

Vu Thi Mai Tram (2012), pp 57 - 60

CHAPTER 3 ASSET MANAGEMENT COMPANIES

3.1 Asset management companies

An Assets Management Company (AMC) is an institution that receives financial assets from commercial banks (mostly distressed assets or non-performing loans), categorizes them and executes methods of resolving them AMCs can be privately owned or government owned In the concept of this paper, AMCs are referred to as government-owned AMCs or national AMCs There are two main types of AMC: AMCs that are set up as restructuring instruments and AMCs that are set up as a rapid asset disposal tool

3.2 Some important objectives of AMCs

One of the conditions for a successful AMC is to have clear and appropriate objectives Objectives may be different in different countries, depending on each country‟s macroeconomic conditions, fiscal situation and political system Woo (2000) in his paper mentions four important objectives that asset management should have:

Financial restructuring support Distressed assets can undermine financial institutions‟

stability by destroying capital and diverting their attention from their main functions as financial intermediaries AMCs can take these distressed assets off their balance sheets and provide them with liquid assets in return so that they can function normally In addition, because uncertain NPLs are taken off their balance sheets, outside investors can have a clearer view and more confidence in their valuations

A high rate of recovery is a very important equity objective for an AMC It can serve four

purposes: (1) retrieving what is owed back to creditors; (2) reassuring financial institutions that the loans can be recovered so that these institutions will not hesitate to extend new loans

in the future; (3) reducing interest premium for borrowers; and (4) reducing the cost of running the AMC; thereby, reducing the burden on taxpayers

One effective objective of AMCs is fast resolution The faster NPLs are resolved, the faster

capital is put into the economy Furthermore, NPLs also create uncertainty about the real worth of creditors as well as creditworthiness of debtors Fast resolution helps creditors lend and borrowers borrow again

Standardization of the asset market helps to create benchmarks for asset pricing as well as

prevent downward pressure on prices It can also help to reduce the crowding out of good assets and borrowers (adverse selection).2

However, the four objectives above may conflict with one another Fast resolution may not achieve a high rate of recovery or give enough time to establish and standardize asset markets Therefore, good policies have to recognize the tradeoffs between these objectives and state clearly which are the most important for government

3.3 Prerequisites

In order to achieve the above objectives, AMCs must have a supporting environment According to Woo (2000), some prerequisites of an effective AMC include the following elements

An effective legal system should be able to state clearly the rights and obligations of debtors

and creditors It should offer methods for resolving claims such as recovering debts or seizing collateral for NPLs

The legal system should strike a balance between the protection of creditors and borrowers Overprotection of creditors may cause social conflict and reduce political support for resolution On the other hand, overprotection of debtors may give debtors an incentive to delay paying their debts and disrupt credit discipline Therefore, an effective insolvency system is

2

For example, if NPLs continue to rise, banks become less willing to extend new loans They have to raise interest rates to reduce demand as well as to compensate for the losses of these NPLs When interest rates rise too high, only risky borrowers can afford those loans In addition, in cases of asymmetric information, banks are unable to tell good borrowers from bad ones, and banks will only issue new loans to risky borrowers, forcing good borrowers out of the market (Stiglitz and Weiss, 1981)

important to enhance credit discipline by not giving debtors an incentive to purposely default

on their loans and to facilitate the recovery of NPLs and the restructuring process (Woo, 2000) A good insolvency system should be able to achieve two goals:

 Allocating risks to all participants in the market in a reliable, fair, and straight forward manner so that the credit system can be enforced and economic growth can recover quickly

 Protecting benefits for all participants and the economy as well

One of the most important functions of an AMC is to liquidate underlying collateral of NPLs Without a supporting legal framework, the process of transferring title from debtors to AMCs may limit or delay the process of resolution

In addition to a good insolvency system, a fair and efficient judicial process is very important

to apply laws correctly and facilitate NPL resolution This requires the law to establish criteria

to reduce unpredictable and inconsistent outcomes from court decisions and judges to have a thorough knowledge of the law In order to facilitate NPL resolutions, courts should encourage out-of-court settlements (EIBC, 2000)

A healthy financial regulatory and supervisory framework can help to facilitate the

process of management, realization and disposal of distressed assets A good framework can

provide a good loan categorization system that can help the authorities know the exact amount

of distressed assets within each bank and the banking system as banks tend to hide the seriousness of their distressed assets From this information, the authorities can respond appropriately to resolve problems such as the amount and type of NPLs that can be transferred

to the AMC Appropriate provision rules can also be important to make banks reflect the true

value of their loans as well as the underlying collateral of impaired assets Overstating the market value of collateral assets or loans, banks can reduce the amount of provision losses on their income statement That, in turn, will reduce their incentive to sell those distressed assets

since they have to recognize the market value of the loans and incur larger losses on their income statement

A stable macroeconomic situation can help to restore and increase some value of NPLs and

increase their attractiveness For example, government can encourage foreign investors to enter into distressed assets markets by providing a stable exchange rate policy Interest rates are also an important factor that has a vital effect on the timing of selling of distressed assets

If interest rates are high, potential buyers face a tradeoff between high returns to deposit and returns on purchasing of NPLs That will reduce the amount of potential buyers and reduce asset prices On the other hand, if the interest rate is low, the cost of holding those distressed assets also reduces For this, financial institutions lose their incentive to sell these assets

3.4 Some important aspect for a successful AMC 3

A good AMC structure will help it to operate effectively It is suggested that a board of directors is needed with most of its members from outside of the AMC and free of political and interest group influence The job of the board of directors is to create incentives to prevent employees of the AMC from prolonging the existence of the agency Moreover, AMCs manage large amounts of taxpayers‟ money, so its operations need to be transparent to make managers and board of directors accountable for their actions and also prevent corruption Therefore, AMC‟s FS and objective reports should be audited regularly by independent auditors and published

3.4.1 Asset pricing

One of the most important and complicated issues when setting up an AMC is the asset pricing

rule Assets that are transferred to AMCs should be priced at fair market value for a number of

First, AMCs should not be used a tool for government to bail out financial institutions In addition, if the AMC purchases assets at above market value, financial institution may end up selling too many non-performing assets to the AMC

Second, transferring assets at above the market value can encourage more moral hazard in the future, especially for banks that are too big to fail Because banks‟ owners and managers are not responsible for the all losses they cause, they may repeat these similar risky behaviors of investment in the future

Third, the purpose of buying NPLs at market value is that the AMC can sell them latter without imposing losses on the government If NPLs are transferred from SOBs, assets should also be priced at market value and those SOBs have to realize the loss up front Otherwise, the purpose of establishing an AMC is just to cover up for the losses that those SOBs have caused However, it is usually quite difficult to price NPLs correctly, especially in the middle of a crisis or in a developing financial market (as in Vietnam) Therefore, the AMC should consider the probability of recovery, estimated cash flow, and value of collateral to calculate the approximate value of distressed assets When the AMC has to deal with a large number of non-performing assets, some tend to use uniform pricing methods such as a certain percentage

of the assets‟ book value This type of pricing is easy to implement, yet it may cause adverse selection since banks may only want to sell their riskiest assets to the AMC

3.4.2 Funding

It is essential that the AMC is sufficiently funded up front so that it can perform its functions

properly without relying on other government agencies to avoid political pressure To ensure transparency, the funds for the AMC‟s daily operations should be separated from funding for the purchasing of assets Since the amount of money needed for AMCs is quite large, it is sometime impossible to get hard cash from the government budget Generally, there are some ways to raise money for AMCs such as by issuing government bonds or AMC bonds backed

by the government

3.4.3 Special powers

Special powers can be given to AMCs in case the legal system is not advanced enough to deal with the magnitude of NPLs or when the processes of liquidation and bankruptcy are costly and time consuming For example, Danaharta in Malaysia was invested with the power to appoint an administrator to design a workout plan when corporate borrower failed to service their debts Once the plan was approved by the oversight committee, it was implemented without the negotiations between the debtor and creditor

3.5 The AMC in Indonesia

3.5.1 Indonesia before 1997

Before the crisis, Indonesia had enjoyed an extended period of macroeconomic growth GDP growth averaged eight percent per annum from 1989 to 1996 From 1992 to 1997, the fiscal balance was in surplus, inflation was low for a developing country; and credit growth was strong Asset prices were also rising during this period and reached their peak in August 1997 (IMF, 2004)

After the floatation of the Thai baht in July 1997, the rupiah faced considerable downward pressure The Indonesian government responded by widening the exchange rate spread, raising interest rates and intervening in the exchange market However, in the middle of August 1997, the government could not keep the pegged exchange rate regime and decided to let the rupiah float The rupiah depreciated from Rp 2,500 per dollar to its nadir of Rp 14,000 per dollar in January 1998

This downward movement of rupiah badly affected both the corporate and banking sectors It damaged most banks‟ balance sheets because most banks had not hedged their short-term foreign liabilities During this period, Indonesia had an open capital account; any corporations could obtain foreign loans easily After the flotation of rupiah, these corporations‟ foreign loan value in domestic currency increased tremendously This destroyed these companies‟ balance

sheets, reduced their profits, and made it difficult for them to service their foreign and domestic debt Non-performing loans increased in the banking system (EAAU, 2000)

Underlying reasons for the crisis

Before the crisis broke, Indonesian banks already had some underlying problems of lending and not having enough of a capital cushion to withstand macroeconomic shocks The ratio of assets to liabilities of Indonesia banks was only 108 percent, leaving an eight percent surplus of assets to cover liabilities However, this ratio could be smaller if banks had used

over-international accounting standards (Enoch et al., 2001)

As economic growth accelerated, the banking system was deregulated The number of banks increased from 111 in 1988 to 240 in 1994 As the banking system expanded quickly within a short period of time, supervision was loose and management skills and resources were in short supply There were many connected lending activities during the period The state banks at the time were there to provide capital for well-connected but unprofitable ventures; and the private banks were used as a tool to gather capital from deposits for the use of bank owners These connected loans later on became delinquent and non-performing after the crisis (Enoch

et al., 2001) In addition, since economic growth was rapid, and asset prices continued to

increase, banks were encouraged to lend out their money easily, developing a risky lending attitude (EAAU, 2000) Banks were also non-transparent Their FS were not published regularly and completely As the result, NPLs increased to 50 percent of total loans at the end

of 1997

3.5.2 Government Response after the crisis in January 1998

In order to contain the crisis and restore the banking system, the Indonesian government came

up with three methods: (1) a blanket guarantee for all deposits; (2) creation of the Indonesian Bank Restructuring Authority (IBRA) in 1998; and (3) improvement of the legal framework

In addition to the three methods listed above, the Bank of Indonesia (BI) also announced new

criteria for bank classifications (Enoch et al 2001) Banks would be assigned to three

categories:

Category A: for those banks with a CAR of four percent or higher

These banks were identified as healthy banks that did not need government support They were mainly small banks and joint ventures In group A, there were 74 banks, representing five percent of total deposits

Category B: for those banks with a CAR of between -25 percent and four percent

These banks needed to submit plans to BI to increase their CAR BI then would decide whether the banks could continue to operate (with recapitalizing support) or needed to close down Thirty-seven banks fell into this group Out of the 37, 21 banks were liquidated; IBRA took over seven banks; the remaining nine banks were eligible to receive 80 percent capital support from the government if they could raise 20 percent by themselves

The banks in group B, after restructuring, fell into one of four situations: (1) Closed banks; (2) Banks merged with state banks; (3) Banks that successfully raised their own capital and received support from the government without government intervention in their management; (4) Banks that failed to raise capital on their own and were controlled by IBRA

Category C: for those banks with a CAR of less than -25 percent

These banks were liquidated immediately; and their remaining assets were transferred to IBRA Seventeen banks were in this group, representing for 0.9 percent of banking assets (EAAU, 2000)

IBRA objectives and accomplishments

IBRA was created in January 1998 with an expected life of five years It was put under the control of the Ministry of Finance (MOF) Most of its staff were from MOF or BI

3.5.3 The three overall objectives of IBRA were:

 Bank restructuring, helping the banking system become stable by recapitalizing and restructuring banks, and then reselling them back to the private sector;

 Maximizing asset recovery;

 Helping the corporate sector to restructuring corporate debts and handing back assets taken over from banks to the private sector (IMF 2004)

However, with regards to selling shares back to the private sector, IBRA proceeded slowly Not until the beginning of 2002 did the first divestment begin This slow process was due to various reasons such as: delays in the course of recapitalizing and creating effective business plans for those banks; and a lack of political support By the time of IBRA‟s closure, IBRA was able to sell off all but one bank (Permata)

IBRA followed a transparent and market-orientated method to sell its assets IBRA sold banks‟ shares through public auction to strategic buyers, most of them at book value Only

bidders with appropriate requirements were allowed into the auction

Asset recovery

There were three groups of assets that IBRA needed to sell and recover their value:

 NPLs from closed banks, taken over by IBRA banks, state banks, or banks that had received capital injections from BI;

 Pledged assets from shareholder settlements;

 Shares from banks that IBRA had taken over and other bank assets from closed banks

NPLs from banks

These NPLs were transferred to IBRA at a zero price in exchange for capital support from IBRA or BI Under this group, retail and SME loans were resolved through cash settlement and direct sale – 80 percent of these loans were settled and 20 percent were sold directly IBRA achieved a 30 percent recovery rate With commercial NPLs, IBRA outsourced debt collecting to other private banks However, these private banks did not recover the debts successfully; these commercial NPLs were later returned to IBRA to be sold together with the corporate NPLs

For the corporate loans, IBRA‟s first strategy was to restructure these loans before selling them to the private sector IBRA also wanted to improve debtor companies‟ governance and management during this process However, this strategy was not very effective because it was associated with large number of loans with complex conditions and inappropriate documentation; and it received little cooperation from debtors Early in 2002, IBRA began to realize the ineffectiveness and time consuming nature of this method It started to sell unrestructured loans Overall, the recovery rate for corporate loans was 23 percent

Compared to other Asian countries, the recovery rate from NPLs of Indonesia was low, only achieving 28.5 percent, lower than the 42.7 percent achieved in Malaysia 37.7 percent in Thailand, and only higher than the 27.5 percent in Korea Also, compared to other countries, NPLs as a percentage of total loans and GDP of Indonesia were significantly higher, 64 percent and 30 percent respectively (IMF 2004)

Pledged assets from shareholder settlements

Shareholder settlement was an agreement between IBRA and the shareholders of the banks which had received capital support from BI and then broke banking regulation (mainly lending

limits) Those shareholders, in exchange for freedom from legal prosecution from IBRA, would pledge their assets (such as shares, property, debt obligations, etc.) to IBRA as payment These assets then would be placed under holding companies, established jointly between IBRA and original holders of these assets For each holding company, IBRA placed representatives on the board However, since most of the control of these companies (and the pledged assets) was under the original owners, selling off these assets was very slow Until late 2002, only after adopting a new policy did the enforcement get tougher In generally, IBRA established 44 shareholder settlements, with 28 of them meeting their obligations, six

on the way, and the remaining ten shareholders not cooperating were handed over for legal action The recovery rate was 22.4 percent, with recovery value of Rp 26.8 trillion

Shares from banks taken over by IBRA and other bank assets from closed banks

Divestment of IBRA banks did not begin until March 2002 Overall, IBRA raised Rp 15 trillion by selling shares in five banks (one remained after the closure of IBRA and would be transferred to MOF) and received Rp 4 trillion in dividends IBRA originally spent Rp 9 trillion to increase capital in these banks and another Rp 9 trillion to cover BII and Permata‟s illiquid situation In addition, IBRA also sold other closed banks‟ assets and raised Rp 11.2 trillion

Table 3.1: Recovery rate of IBRA

Face Value1 Recovery Value1 Recovery Rate

In cash and bond

After closing down banks, there was still Rp 275 trillion in assets (at face value) that IBRA needed to resolve These assets were transferred to another holding company under MOF Overall, IBRA recovered about Rp 150 trillion, about one-fourth of government expenditure

of Rp 650 trillion during the crisis That represented a cost of Rp 500 trillion to resolve the crisis, approximately 40 percent of 2000 GDP

Debt restructuring

IBRA‟s third objective was to support and revitalize the corporate sector IBRA did that by restructuring distressed debts As mentioned above, debt restructuring moved very slowly and ineffectively Political interference was strong in the case of big corporations Sometimes IBRA had to consider employment and national interest rather than just market considerations when restructuring loans

By 2002, the corporate sector had returned to health One reason was because of improvements in the macro economy The other reason may be because of the sale of un-restructured loans from IBRA to the private sector (IMF 2004)

Conclusion

IBRA achieved the most important objective of stabilizing the banking system, closing viable banks and recapitalizing insolvent but viable banks However, for its objective of asset disposition, its performance was not very satisfactory The rate of recovery was lower than other Asian countries The pace of recovery was slow during the first four years of its life, and only picked up during the period of 2002 – 2004 This delay was one of the reasons for the low recovery rate

3.5.4 Difficulties for IBRA

One problem that IBRA had to face, especially during the first few years of its operations, was

a lack of resources, including both capital and human resources When first established, IBRA did not get a specific budget Most of IBRA‟s staff got paid by their original employers (such

as MOF, BI, or banks) Its facilities were given by BI The government expected IBRA to cover its expenses from asset recoveries, which were few during the first few years

Fortunately, later on, IBRA was assigned its own budget (Enoch et al 2001)

Ineffective legal and judicial processes also worsened IBRA‟s performance IBRA took control of seven banks in April 1998, but not until February 1999 was IBRA able to take control over these banks‟ assets This delay reduced the market value of the assets Realizing this, Indonesian government amended the banking law at the end of 1998 However, even with this new law, the legal and judicial framework was still weak They reduced IBRA‟s negotiating power and the market value of the assets Despite the award of special powers, IBRA rarely used them (IMF 2004)

Another very important factor that adversely affected IBRA‟s performance was the lack of political support At the beginning of its life, there was conflict between IBRA and the government about disposing assets at discounted values, for the government did not agree to this solution After 2000, the government began to support IBRA and the sale of assets increased quickly then (IMF 2004)

3.6 For a successful AMC

AMCs are not a perfect solution to resolve NPLs The success of an AMC depends on many factors

Some of the prerequisites for a good supporting environment must be met They are: an effective legal system, healthy financial regulatory and supervisory framework, , and stable macro conditions

According to Klingebiel (2001), AMCs can only be a success if their purposes are defined narrowly and strictly to resolve insolvent and unviable financial institutions For the seven observed countries in his papers, he showed some similar characteristics that expedite the success of AMCs: having a supportive legal environment, operating in a country where the private sector plays a majority role, politically independence, and adequate funding The amount of NPLs that they received was small compared to total loans; and most of the NPLs were not politically connected (see more on appendix II)

CHAPTER 4 BANKING PROBLEMS IN VIETNAM AND THE

PROPOSAL TO USE AMCS AS A RESOLUTION TOOL

4.1 Brief history of the Vietnamese banking since 1988 4

From 1988 to 1991:

In May 1990, the Vietnamese government issued two ordinances: one on SBV and the other

on financial institutions With these ordinances, the Vietnamese banking system officially moved from one-tier to two-tier system The first tier – SBV – was responsible for managing monetary policies, issuing banknote, overseeing the financial institutions, etc

Also during that time, with the effort of liberalizing the financial system, the Vietnamese government allowed all type of economic entities to accept deposit from the public Many credit unions were created, increased number of credit unions to 7,180 for less than ten years This increased competition among credit unions, raising interest rate Without sufficient provisioning from SBV, fraud such as Ponzi scheme or financial pyramid appeared Thanh Huong perfume was one example At that time, Thanh Huong raised interest rate on deposit up

to 12 percent per month, using new deposit to pay off old ones Thanh Huong along with other fraudulent credit unions ended up in bankruptcy, causing a systemic banking crisis By the end

of 1990, there were only 160 credit unions left As the result, the People lost confidence in the banking system, causing them to withdraw their deposit and invest their savings in US dollars (Nguyen Xuan Thanh, 2003)

In 1997: The tenth National Assembly passed two laws: the Law on the State Bank of Vietnam

and the Credit institutions law

In 1999: The government established the Deposit Insurance of Vietnam

4

This part was based State Bank of Vietnam (2013) and The World Bank (2002)

From 2000 to 2002:

The SBV started a restructuring program for the four state owned commercial banks (SOCBs) and joint-stock commercial banks (JSBs) to resolve the existing problems with high level of NPLs The program focused on cleaning up SOCBs‟ balance sheet, recapitalizing them within three years, and bringing their capital adequacy up to the Bank of International Settlement (BIS) standards The four SOCBs were audited externally; and new loan classification rules were passed In addition, with the issuance of Decision No 1389/2001/QD-NHNN on November 07, 2001, four AMCs of the four SOCBs were established However, the four AMCs were not very effective in the process of liquidating assets The World Bank (2002) suggested that the government should increase protection for creditors by improving the skill

of judiciary to facilitate the insolvency proceedings

For other JSBs, 12 JSBs were closed and their licenses were revoked, reducing the number of JSBs to 36 Out of the 36 JSBs, only 34 JSBs met the capital requirement; the other two was put under SBV special controls At the time, the SBV also implemented a consolidation between healthy JSBs and JSBs that could not meet the minimum capital requirement However, according to the World Bank (2002), since most JSBs (and SOCBs) were undercapitalized by BIS standard, the merger between relative strong JSBs and weak JSBs could damage the relative strong JSBs If international accounting standard was applied for both JSBs and SOCBs, many banks may not meet the capital adequacy requirement Therefore, with weak buffer cushion and rapid credit growth, NPLs could remain a serious problem for the banking system

In 2002: the lending rate was finally liberalized

In 2008: SBV applied interest rate cap for both deposit and lending rate

In 2010: the 12th National Assembly passed new Laws on the State Bank of Vietnam and on Credit institutions