Though Vietnam was not severely stricken by the crisis, it has been affected in some ways, including economic aspects. Vietnam can learn valuable lessons from the crisis. These lessons will help Vietnam avoid the same mistakes in its development strategy and minimize its vulnerability and the likelihood of financial crisis or fragility.

There are many aspects of the Asian financial crisis worthy of study. However, my study will focus on the following questions:

- What were the main causes of the financial crisis in afflicted countries?

- What are the evaluations of Vietnam's Banking sector in comparison to that in the crisis afflicted countries?

- What can Vietnam do to reduce its vulnerability to such a crisis in the future and what can it do to strengthen its banking system in the light of the lessons learned from the Asian financial crisis and in reference to International Banking Standards ?

My study is developed in a descriptive and analytical framework only. Qualitative and comparative analysis using qualitative information will be applied to measure the extent of vulnerability of Vietnam economy and Vietnam's banking system, indicate similarities between Vietnam's banking system and those in afflicted countries. In addition, diagrams and charts will be used to support comparative analyses. It also presents implications and solutions to monitoring as well as strengthening the banking system.

The scope of the study is limited to the East and Southeast Asian countries, particularly the five most severely affected economies (Thailand, The Philippines, Malaysia, Indonesia and South Korea) and Vietnam.

Period of consideration: For the crisis afflicted countries, from 1995-1998; For Vietnam from 1996 to 1999.

Excluding introduction and conclusions, the thesis is organized into four chapters:

Chapter I: Background and literature review.

Chapter II: The weaknesses of banking sectors in Asian crisis afflicted countries.

Chapter III: The weaknesses of Vietnamese banking sectors.

Chapter I begins with a background on the role and performance of the financial and banking system in economic development, it then reviews literature on the nature and causes of financial instability, some empirical studies (debate) on the causes of Asian financial crisis.

Chapter II presents the characteristics of the banking sectors in the Asian-3 countries, and their weaknesses, which are at the center of the Asian crisis.

Chapter III focuses on analysing the weaknesses of the Vietnamese banking sector and points out similar weaknesses present in the banking sectors of the "Asian-3" countries before the crisis. This chapter also provides an estimate of the probability of the banking and currency crises of the Vietnamese banking system based on empirical studies.

Chapter IV withdraws lessons and implications for Vietnam in strengthening its banking sector. This chapter presents a number of approaches for strengthening the Vietnamese banking sector.

The banking system of a country can be broadly described as follows: The banking system is a part of the financial system. It is composed of one Central Bank (CB) and a number of commercial banks (MB).

Like a financial institution, the banking system has two main functions, i.e. maturity transformation and risk transformation.

Maturity transformation, which is transformation of short-term financial instruments into long-term financial instruments is an important function of a banking system. It enables savers to save short-term, and investors to acquire long term funds. Savers often prefer short-term to long -term savings, as it represents less risk, and less loss of liquidity.

Risk transfer is another important function of the banking system. For any investment, whether it be in financial assets or physical assets, risk is involved. Individuals with available savings may not want to take the risk; they may not be able to assess the risk; and they may not know how to protect themselves legally and financially if things go wrong. The banking system is able to reduce risk by investing the funds received from many savers in a wide range of different primary securities.

The existence of banks helps the allocation of savings to higher returns on investment, and may increase the capital formation from any given amount of gross saving.

The advantage of banking financial institutions is that they pull the small savings from many economic units and lend them in larger amounts.

Another channels through which banks impact on the savings-investment process and economic growth is the elimination of financial dualism.

In short, banks play a very important role in the mobilization and allocation of savings, especially under conditions of deficient financial markets.

The role of banks in this process is expressed in the following figure:

Source: Patrick Honohan, 1997, Figure 1, P.12

By general definition, a financial crisis is "sharp, brief, ultra-cyclical deterioration of all or most of a group of financial indicators-short-term interest, asset prices, commercial insolvency and failures of financial institutions".

• Foreign-debt crisis: a situation in which a country cannot service its foreign debt. In the particular case of sovereign debt, a foreign-debt crisis turns into a fiscal crisis.
• Currency crisis: a speculative attack which results in a devaluation or sharp depreciation of the exchange rate or forces the authorities to defend the currency by radically raising the interest rates or expending a large volume of foreign reserves.
• Banking crisis: a situation in which actual and potential bank runs and failures induce banks to suspend the internal convertibility of their liabilities or compel the government to intervene to prevent this by extending assistance on a large scale.

Theoretical literature on banking crises invariably acknowledges that the intrinsic fragility in the banking (and more generally the financial) system originates from asymmetric information. Asymmetric information is a situation in which one party to a financial contract has much less accurate information than the other party. Asymmetric information leads to three basic problems in the financial system.

2.1 Adverse selection: Adverse selection is an asymmetric information problem that occurs before the transaction occurs when investors that engaged in potentially risky projects are the ones who most actively seek out loans.

2.2 Moral hazard: Moral hazard occurs after the transaction takes place because the lender is subjected to the hazard that the borrower has incentives to engage in activities that are undesirable (immoral) from the lender’s point of view—that is, activities that make it less likely that the loan will be paid back.

Lenders may try to follow the lead of someone they believe to be better informed about, say, the probability a certain bank will fail. Herding behavior can also occur when investors lack information about the quality of those who manage their funds.

Financial instability occurs when shocks to the financial system interfere with information flows so that the financial system can no longer do its job of channeling funds to those with productive investment opportunities. Four factors that lead to financial instability are: increases in interest rates, increases in uncertainty, asset market effects on balance sheets, and problems in the banking system.

Increases in interest rates not only make troubles to lenders but also borrowers. A higher interest rate leads to greater adverse selection; that is, the higher interest rate increases the likelihood that the lender is lending to a bad credit risk.

The increase in uncertainty, therefore, makes information in the financial markets even more asymmetric and may worsen the adverse selection problem.

Economists argue that the state of the balance sheet of both nonfinancial firms and banks is the most critical factor for the severity of asymmetric information problems in the financial system. Deterioration of balance sheets worsens both adverse selection and moral hazard problems in financial markets, thus promoting financial instability.

If banks suffer a deterioration in their balance sheets, and so have a substantial contraction in their capital, they have two choices: either they can cut back on their lending in order to shrink their asset base and thereby restore their capital ratios, or they can try to raise new capital.

Figure 2 describes the propagation of financial instability in emerging-market countries. As shown in Figure2, four factors typically help initiate financial instability: (1) increases in interest rates, (2) a deterioration in bank balance sheets, (3) negative shocks to nonbank balance sheets such as a stock market decline, and (4) increases in uncertainty.

Source: Frederic S. Mishkin 1997, figure 1, p 75

Most of Economists, scholars agree on the three following group of indicators:

- Indicators of structural weaknesses

- Indicators of unsoundness:

- Indicators of prudential regulations and supervision

5.2 Evaluation of banking performance in transition economies:

Dijkstra (1996) developed a framework for assessing the efficiency of financial intermediation during the liberalization process. To this aim, he distinguished some concepts of efficiency: operational efficiency, allocative efficiency, dynamic efficiency and stability of the financial system.

The IMF (1997, 1999c) blamed the four main culprits that resulted in the Asian Financial crisis:

- Changes in external environment:

- Macroeconomic management and exchange arrangements

- Financial sector and other structural weaknesses:

- Lack of confidence

Krugman claimed that the preconditions for that panic were created by bad policies in the years running up to the crisis, specifically the problem of moral hazard in lending, mainly domestic lending, resulted in a boom and bust cycle of over-investment and asset bubble. The crisis spread from one bubble economy to another because as the bubble burst in one economy, investors would wonder whether it would bust in another bubble economy, and in bubble economies pessimism is self-fulfilling.

According to Corsetti et al.(1998a), unsound fundamentals were, at the heart of the turmoil, which was magnified by the problem of moral hazard at three different levels: (1) the corporate sector should be blamed for their cost overlooked and risky investment projects; (2) the financial sector should be accused of borrowing excessively from abroad and lending excessively at home; and (3) the international banks should be responsible for their large amount of funds to Asian banks notwithstanding the risk assessment.

- The intrinsic instability of international financial markets, subjected to bouts of panic and clearly over- reactive;

- Several external macroeconomic shocks in East Asia ;

- Weaknesses in the East Asian financial systems.

Warwick Mckibbin and Will Martin (1999) argue that the Asian financial crisis was caused and triggered mainly by shocks to the economy. The three main types of primary shocks considered are: terms of trade shocks; appreciation of the US dollar under a currency peg; and downward revisions in the anticipated profitability of investment.

Wade (1998c) raised the Bank-based high debt model in explaining causes of the Asian financial crisis. He points to the following factors explaining the crisis:

- Relatively high levels of intermediation from savers to banks;

- Highly leveraged corporate sector is vulnerable to shocks ;

- The traditional institutional structure of triangle "the business-banks-politicians".

Delhaise.P(1998) also blame the weakness in banking practice in Asia for the crisis as major causes to the Asian financial crisis.

2.1 Financial liberalization

Liberalizing the financial sector and opening the capital account is dangerous when the banks have little experience in international financial markets and when non-banks also borrow abroad. It is doubly dangerous in the context of a bank-based financial system and a high debt-to-equity corporate sector. It is triply dangerous when the exchange rate is pegged. In Asia, swift external financial liberalization with unsupervised banks and fixed exchange rates undermined the previous system of industrial and banking cooperation and exposed fragile debt structures to unbuffered shocks.

• Domestic conditions: The capital account liberalization proceeded in the early 1990s facilitated capital flows across border in East Asia, particularly short-term flows.
• External conditions:

1. Weak economic performance in many industrial countries;
2. The successful economic performance, high interest rates, relatively fixed exchange rates and sound macro-indicators in Asian economies made international creditors more confident and lured by the Asian emerging markets;
3. The intra-regional capital flows among the East Asia countries;
4. Technological achievements that facilitated massive capital reversals leading to the crisis;

• Adverse external shocks: the high degree of export concentration that benefited East Asian countries was dramatically vulnerable to changes in global market conditions.
• Macroeconomic and financial vulnerabilities
• Structural vulnerabilities.

• Weak bank lending practices
• Ineffective market discipline allowed excessive risk-taking.
• Weaknesses in supervision.

Financial intermediations in most East Asian countries are dominated by banking systems. Although the region now has some of the largest equity market capitalization in the world, the banking systems still control most new financial flows.

The main characteristics of the system at the outset of the crisis can be summarized as follows:

• Size and concentration: Total assets of the system were equivalent to about 90 percent of GDP. Commercial banks held 84 percent of total assets. The combined assets of seven state banks had been accounting for 40 percent of the entire system.
• Ownership and entry: many of Indonesia's large business conglomerates founded one or more banks. The entry of foreign banks was limited by the requirement to form either joint ventures or buy shares of domestic banks and the maximum foreign holding was set at 49 percent.
• Areas of business activities: banks were required to direct certain percentage of their lending to strategic economic sectors.

Total assets of the system were close to 300 percent of GDP. Commercial banks accounted for just 52 percent of the assets of the financial system, while specialized and development banks accounted for 17 percent. The top eight banks accounted for about two-thirds of commercial bank assets (excluding trust accounts).

Foreign banks have been allowed to open branches since 1967, although their market share remained very small.

Total assets of the system amounted to 190 percent of GDP of which the commercial banks alone accounted for 64 percent (121 percent of GDP), financial companies for 20 percent (39 percent of GDP), and specialized state owned banks for further 10 percent.

In an effort to make Bangkok an international finance center, which could compete with Hong Kong and Singapore, the BIBF was established in 1993 to formalize offshore banking business in Thailand.

In most Asian crisis afflicted countries, issues related to ownership and business practice made their financial sectors vulnerable to the variety of shocks that were experienced in 1997.

• Nontransparent ownership and portfolio problems:
• Loan concentration in the real estate sector: The economic boom in the 1980s rose the price in the real estate sector in Indonesia as well as in Thailand and in Korea. In Indonesia, there had been a sharp increase in real estate and property-related lending, which increased to about 20 percent of total outstanding loans in early 1997 and 25-30 percent at the end of 1997. In these countries, the dangers of loan concentration were heightened by difficulties in seizing and realizing collateral.
• Bank lending practices that traditionally relied on collateral rather than credit assessment and cash flow analysis makes banks especially vulnerable to excessive risk-taking and declines in asset values.
• The corporate sector in Korea, Thailand and Indonesia was highly leveraged, a factor that in combination with the pervasive nature of the corporate crisis, significantly deepened the banking crisis.

Average debt to equity ratios of companies were around 354 % in Korea, 236% in Thailand at end-1996, and 190% in Indonesia. The high corporate leverage in Korea was largely the outcome of government policies that emphasized aggressive export- oriented growth and included measures such as directed credit, subsidized loans, and explicit or implicit credit guarantees .

• Exposure of banks to market risks due to ineffective market discipline, which allowed excessive risk-taking: inadequate accounting and disclosure practices and implicit government guarantees weakened market discipline. A tradition of forbearance and "lifeboat" schemes for nonviable institutions instead of firmer corrective action or government intervention encouraged excessive risk-taking, increased moral hazard, and prevented market agents from exerting discipline.
• The health of the banking system was relied on short-term capital inflows. A large portion of the foreign borrowing by banks, particularly by merchant banks, was undertaken through overseas subsidiaries and foreign branches

	Korea	Malaysia	Thailand	Indonesia	Philippines
Total external debt % GDP
1988 1992 1996 1997	24.4 20.0 30.2 30.9	63.4 49.4 42.3 44.4	35.1 38.7 54.3 61.8	66.8 61.1 58.4 67.1	77.6 64.3 59.8 62.9
Total external debt % of exports of goods, services & income
1988 1992 1996 1997	60.1 67.5 92.1 81.2	89.5 61.3 44.6 46.8	99.6 100.8 130.3 124.4	263.6 223.5 229.8 218.3	275.5 196.6 126.7 108.8
Total short-term debt % of total debt
1988 1992 1996 1997	43.3 54.9 60.0 38.7	9.4 29.6 26.8 28.6	20.2 45.8 38.5 29.8	11.3 19.9 31.1 26.8	18.1 19.4 25.1 24.0

The point to note is that, in most countries, foreign liabilities towards BIS reporting banks are liabilities of domestic banks, as opposed to liabilities of the corporate or public non-bank sector. This confirms previous statement that a large fraction of Asian borrowing from foreign banks was intermediated by the domestic banking system.

Domestic banks borrowed heavily from foreign banks but lent mostly to domestic investors. The ratio of total short-term external liabilities (towards BIS banks) to foreign reserves at the end of 1996 was 213% in Korea, 181% in Indonesia, 169% in Thailand, 77% in the Philippines, 47% in Malaysia. These figures mean that, by the end of 1996, in the event of a liquidity crisis with BIS banks no longer willing to roll-over short-term loans, foreign reserves In Korea, Indonesia and Thailand were insufficient to cover short term liabilities, let alone to service interest payments and to repay the principal on long-term debt coming to maturity in the period.

There is indeed overwhelming evidence that the Asian banking and financial systems were very fragile-poorly supervised, poorly regulated, and in a shaky condition even before the onset of the crisis.

• Loan classification and loan-loss provisioning are very weak in crisis countries: loan classification standards in Indonesia remained inadequate. In Korea, standards for loan classification and loan-loss provisioning were rather lax. In Thailand, the rules for loan classification, provisioning, and accounting were inadequate and were applied inconsistently.
• There were no prudential limits on risk and loan concentration facilitated the highly leveraged corporate finance structure of Asian conglomerates. In Korea, limits on lending to big conglomerates were set bank-by-bank under the "basket control system. However, not only were these tighter regulations still lax in comparison to those in other OECD countries but many banks continued to breach them. In Thailand, there were no prudential limits on loan concentration.
• In these three crisis countries, there was almost no effective bank closure and exit regulation was in place.

CAMEL framework: in Asian-3 countries, Basle Committee's framework covering capital, asset, management, equity, and liquidity (CAMEL) rating system was put in place. However, most of banks in these countries did not meet the required 8% capital adequacy ratio, did not comply with the legal spending limit. Shortcomings in the legal and regulatory framework remained, particularly in the areas of loan classification and establishment of an effective exit mechanism for failed Banks.

• The prudential framework was generally weak and fragmented. In Asian-5 countries, lack of a unified system of supervision and regulation, together with the weak supervision performed by MOF and Central Banks, created favorable conditions to regulatory arbitrage and high risk practices, especially among commercial banks' trust business and merchant banks.

Bank lending practices that traditionally relied on collateral rather than credit assessment, project feasibility and cash flow analysis makes banks especially vulnerable to excessive risk-taking and declines in asset values. There is the links between high shares of bad loans, an excessive exposure to the property sector.

The financial sector in Vietnam consists essentially of the banking sector. The banking system in Vietnam has been reformed since 1988-1989 by separating commercial banking from central banking and creating four state-owned commercial banks (SOCBs) and the State Bank of Vietnam as the Central Bank. Four state -owned commercial banks (SOCBs) account for 82 percent of total bank assets. Total bank assets were equivalent to 38 percent of GDP at end-1998, total loans to 22 percent, and total deposits for 20 percent, indicating a relatively low degree of monetization of Vietnam's economy.

Vietnam's banking sector is charaterized by rapid expansion, but high concentration, low competition. State-owned Banks still occupy market power over other banks.

As in most Asian crisis afflicted countries, problems in business practice and in portfolio made the banking sector vulnerable to variety of shocks and a slowdown in their economies.

• In Vietnam, the health of the banking sector is extremely dependent on the strength of state -owned enterprises (SOEs), which are the main customers of SOCBs. Therefore, SOCBs are highly exposed to the power of SOEs, thus making Banks' financial health fragile. SOE overdues to the banking sector has risen and their exposure to foreign currency risk is high. SOEs are suffering from production inefficiencies stemming from overemployment, inefficient production technologies and unskilled labor and management.

Although direct subsidies have been largely eliminated, the implicit guarantees from the government on the nonbankruptcy of SOEs increase the banking loans to SOEs and distort the allocation of financial resources.

Enterprises	Agribank		Incombank		Vietcombank		Vietindebank	Total of SOCBs
SOEs Private enterprises J.stock and Ltd. E Cooperatives Joint Ventures	26.5% 70.0% 2.90% 0.30% 0.30%	50.00% 9.20% 37.70% 0.80% 2.40%		74.00% 3.90% 17.60% 0.10% 4.10%		91.20% 6.60% 1.40% 0.10% 0.70%		57.40% 26.80% 14.00% 0.30% 1.50%

Obviously, SOEs are always expected to absorb over half of formal credit.

• The high banking concentration and sectoral monopoly of SOCBs constrain the competition and eliminate the market principles. SOCBs occupy a dominant share in the banking sector. Therefore, most regulations and policies of the government and SBV are in favor of SOCBs. SOCBs also gain implicit guarantees from the government for their performance.
• As in Asian -3 countries, the loan concentration in the real estate sector is also the component of structural vulnerabilities of the banking sector in Vietnam. With the boom of the economy as the result of economic reform in the early 1990s, property prices rose, thus making collateral in property popular to the banks. Prior to 1997, the lending practice was mainly based on providing collateral, which is mostly land and housing rights. As said, SOEs account for nearly half of SOCBs lending operations, and SOEs accounted for 34.1% of overdue debt damages to SOCBs, whereas most of collateral of SOCBs (before 1997) were in property.
• The corporate sector in Vietnam is as highly leveraged as that in Asian -3 countries, a factor that in combination with the pervasive nature of the economic slowdown significantly deepens the banking vulnerability.

Compared to the leverage ratio of corporates in Asian-3 countries, we see that the leverage of Vietnamese corporates is as high as of Indonesian and Hong Kong corporates, higher than Malaysian and Philippines ones.

*: Vietnam's data calculated by the author based on IMF data(July 1999).

Banks do not have full information on the performance of corporations, whereas they are directed to expand unconditionally credit to state corporations. The basic accounting, auditing, and disclosure practices below international practices make lenders unable to control the use of loans by their customers therefore make them subject to significant liquidity risk. the government support and guarantee for SOEs in dealing with the banking system is demonstrated in the following forms:

1.SOEs are allowed to borrow from the Banks without meeting collateral requirements.

2.In many cases, loss -making SOEs are still allowed to borrow from banks without collateral.

3.Mechanism of maturity extension (gian no) and rolling over is very flexible for SOEs.

4.SOEs still enjoy many forms of indirect subsidies, such as writing off non-performing loans due to specific causes.

• Exposure of Banks to market risks due to ineffective market discipline, which allowed excessive risk-taking. Almost all Vietnamese commercial banks have lending practices, which rely on guarantees from the government and are always expecting directives from the State Bank. They do not have their own credit risk management system or their own credit scoring system. Credit assessing process of Vietnam's commercial banks is not proper enough to help lenders to identify weaknesses and to predict crisis. Therefore, banks prefer short-term lending to long term ones, whereas firms need long term loans to invest in expanding their production capacity.

Source: The State Bank of Vietnam, 1998

In Vietnam, lack of information is the main cause of ineffective market discipline.

Bankruptcy laws are not enforceable and combined with non-transparency in accounting and auditing practice, lack of information makes it harder for lenders to screen out good from bad credit risks, this makes information in the financial market even more asymmetric and may worsen the adverse selection problem.

In Vietnam, under the "lifeboat" scheme, loss-making firms, and minus net worth firms still exist for political purposes or to secure the domination of state sector. Low net worth directly increases the incentives for borrowers to commit moral hazard.

Another factor is unanticipated exchange rate depreciation or devaluation. Most of loans to import-export firms are in foreign currency. As Vietnam's financial market in Vietnam is underdeveloped, firms are not familiar with forward transactions or other hedging transactions. Moreover, they are unable to predict the changes in the foreign exchange markets.

• lack of asset diversification outside the countries affecting banks in Vietnam. The lack of asset diversification outside the country increases their exposure against the slowdown of domestic economy.

During the last decade, Vietnam's financial system, the main component of which is the banking sector has been undergoing reforms, changes and regulations. However, currently, the performance of the financial sector in general and of the banking sector in particular is not efficient and does not meet the demands of development of the economy due to weaknesses in regulation and supervision.

• Accounting practice, loan classification and loan-loss provisioning are very weak as well in Vietnam as in Asian -3 countries. Vietnam has the same problem and features in dealing with problem loans as in Indonesia and Korea. It is very easy to restructure loans to reduce the size of reported portfolio problems. However, compared to Asian -3 countries indicators of prudential standards in Vietnam is still weak and low, especially in term of collateral valuation.
• Weak prudential limits on risk and loan concentration is one of reasons, from the Banks' side, of highly leveraged corporate finance structure in Vietnam as well as in Asian-3 countries.

In Vietnam, though there is limit on single borrowers, due to triangle relationship SOEs-SOCBs-Government, most SOCBs continue to breach limits, thus build up excessive exposure to particular sectors.

Prudential framework was generally weak and fragmented in Vietnam's banking sector. As in most LDCs, the government in Vietnam intervenes quite massively in the operation of its State Bank. Vietnam does not have efficient capital markets, and Vietnam’s financial markets are fragmented and incomplete due to government restrictions, which discourage the development of financial institutions and instruments. The SBV is not given independence to implement monetary policy at its discretion.

3.1 Indicators of stability:

The capital base of Vietnam's banks is very weak. Prior to recapitalization in October 1998, Vietnam's highest capitalized SOCB had a ratio of capital to total assets of 5^3/₄ percent. Non-state owned banks have stronger capital base, with an average capital-asset ratio of 18¹/₂ percent. In Vietnam, capital adequacy ratio of SOCBs declined from 5.5% in 1997 to 5.0% in June 1998. Sheng (1996) argues that a reported decline in the capital ratio of 0.5 percentage would generate warning signs.

Source: IMF, (1999).

Banks overdues appear to have risen quite substantially since the end of 1995. At the end of June 1997, the data of the World Bank shows 15.4 percent of total loans as overdues, data at the end of 1997 of group of technical assistance for restructuring Vietnam's banking system-WB&IMF (11, 48) shows the overdues of SOCBs 18 percent of total loans, and 5.9 percent of overdues is irretrievable. While as suggested by Sheng (1996) that a reported increase in the stock of non-performing loans of as 2% of total loans should be seen as a matter for concern.

This indicator of Vietnamese banking sector is as high as of Indonesian and a little lower than the Korean ones.

Conclusion: Indicators of stability compared to those of crisis afflicted countries show worrying signs about the stability of Vietnam's banking sector. Moreover, Vietnam does not have deposit insurance network, thus make its banking system more instable to any shocks in the economy.

Financial deepening represents the growth of financial assets and it can be measured by the following:

1. The evolution of monetary aggregates related to national output; (M1/GDP or M2/GDP);
2. An analysis of trends of monetary aggregates related over time. This captures the growth of financial assets, as opposed to real assets;
3. The availability of long -term credits and relative size of the stock market.

3.3.1 Aggregate lending:

Despite considerable slowdown in real GDP in 1998 (5.8%-the WB Jan. 2000), growth of broad money reached 24 percent at end 1998, almost the same as in 1997, when GDP grew much faster (8.2%- the WB Jan. 2000). However, due to the slowdown in domestic consumption, sales of SOEs have stagnated, and much of the growth in credit effectively financed the accumulation of inventories.

The reliance of Vietnam's banking sector on foreign borrowing was higher than Asian-3 countries and was up to about 20 percent of total credits to the economy by banking sector.

3.3.3 Net Interest margin:

The efficiency of Vietnam's banking sector declines sharply since 1995 compared to declining level of compared countries. The sharp decline shows the instability and inefficiency in the banking sector due to economic slowdown.

Earning structure of Vietnamese commercial banks are inadequate and are relying mostly on earnings from interests. Therefore, declines in investment returns sharply reduce the earnings of banks.

Note: ^a applicable to currency crisis.

^b applicable to banking crisis.

^c Vietnam's probabilities of crisis susceptibility are estimated at end 1997,

Source: Kaminsky 1998 and the author's calculation based on IMF (1998, 1999) data on Vietnam.

Vietnam, even though is located in the crisis-stricken region, has not incurred any crisis.

However, due to indirect impacts, economic growth fell considerably from 9.3 percent in 1996 to 8.2 percent in 1997 and 5.8 percent in 1998 and then 4.8 percent in 1999 (see Figure 13), export growth fell sharply from 25% to 2.5%, foreign direct investment (FDI) continues to stagnate.

The government needs to pay particular attention to creating and sustaining a strong bank regulatory/supervisory system to reduce excessive risk taking in the financial system.

Although deregulation and liberalization are highly desirable objectives, the failure due to the asymmetric information indicates that if this process is not managed properly, it can be disastrous.

Strategy of a fixed or pegged exchange rate regime is particularly dangerous if the emerging-market country has a fragile banking system, short-duration contracts, and substantial amounts of debt denominated in foreign currencies.

State directed lending in commercial areas eventually has heavy inefficient costs contributing to the build-up of financial and structural imbalances, financial instability and crisis.

Accounting and disclosure requirement need to be beefed up considerably. Without the appropriate information, both markets and Bank supervisors will not be able to adequately monitor the banks to excessive risk taking. Proper accounting standards and disclosure requirements are therefore crucial to a healthy banking system.

One way to avoid a run or prevent a banking panic is to provide deposit insurance that insures deposits at all Banks. An alternative method for providing a safety net is for the central bank to stand ready to act as a lender of last resort.

High inflation, short durations of debt contracts cause rise in interest rates and depreciation of domestic currency, thus increase the fragility of the financial system.

Groups of categories below are only those which are thought to be helpful to specific features of Vietnamese banking sector and possible to be done in Vietnamese economic environment:

a.Improved banking sector Infrastructure

b.Strengthening of individual Financial Institutions

c.Removal of distortions

1. Improved banking sector Infrastructure

1.1 Central Bank law and the Law on Credit Institutions

The Law on the State Bank of Vietnam (The Central Bank) was passed. However, according to the new law, the National Assembly (rather than the State Bank) is authorized to approve monetary policy and policy coordination is assigned to a new Monetary Policy Advisory Council.

Though improvements have been made in a number of areas, the new prudential regulations still fall short of international standards (CAMEL framework), the new Law does not develop risk-based prudential regulations, entry and exit regulations are still loose.

• Regulations concerning loan classification, provisioning, and income recognition should be brought closer to compliance with international best practice or closer to regional practice
• Loan classification should be strengthened, and specific loan-loss provisioning requirements and general provisioning requirements should be introduced and tightened.
• The practice so far in Vietnam shows that the authority thinks of CAMEL as a long -term maximum ratio instead of minimum one.
• Violating exposure limits is very popular among commercial banks in Vietnam. Therefore, the State Bank of Vietnam is to utilize its power to introduce and improve other key prudential regulations.
• Measures should be taken to improve transparency and disclosure.

• Vietnam can take lessons of reform from the crisis countries to upgrade supervisory capacity and strengthen the powers of supervisors. Moreover, supervisors should be granted the right to demand additional loan-loss provisioning from banks, prompt corrective actions as well as a stringent intervention when problems are detected, and exit policy for financially weak Banks.
• The use of memorandum of understanding to enhance the supervisory authorities’ ability to monitor and enforce compliance with prudential ratios and performance benchmarks of financial institutions should be applicable.
• Supervisors also need incentives. In addition to political independence, pay is a fraction, through which supervisors face personal legal liability of their actions.
• To improve the ability to supervise assets there is requirement in sources of information.

1.3 Regulations Governing Non-bank Financial Institutions

• Efforts should be undertaken to address weaknesses in the operation and supervision of Non-bank Financial Institutions. In Vietnam, the operations of financial institutions are not adequately supervised, leading to unfair competitions in the financial system.

1.4 Money Market

• It is urgent to set up legal framework and facilities for establishing money market and to encourage firms and financial institutions to participate in money market.

Proper accounting standards and disclosure requirements are therefore crucial to a healthy banking system.

• Commercial Banks have to adopt new prudential reporting system and international accepted accounting standards.

The multi-pillar mechanism is the one that strengthens the incentives and capacity of owners and managers, the market, and supervisors to contribute to prudent corporate governance of banks. These pillars are: (i) Bank owners (and managers), (ii) the market (including uninsured debtholders and other possible 'co-owners'), (iii) supervisors, and (iv) Broad diversification.

Improving the legal system is relatively easy, but restructuring the banking system takes a long time. Bank restructuring is a process, not an event.

A broad-based restructuring strategy should achieve the following economic objectives: (1) restore the viability of the financial system as soon as possible so that it can efficiently mobilize and allocate funds; (2) throughout the process, provide an appropriate incentive structure to ensure effectiveness and avoid moral hazard for all market participants; and (3) minimize the cost to the government by managing the process efficiently and ensuring an appropriate burden sharing .

The allocation of responsibilities for handling the restructuring was a crucial first step in the strategy, which should take into account not only technical considerations but also political circumstances and institutional and legal frameworks already in place. Lessons from Asian-3 countries show that in these countries responsibility for restructuring was given to Restructuring Agencies.

Realistic valuation of banks’ assets is an important factor in establishing the viability of individual Banks, but it is difficult, since there is no precise method for valuing nonperforming loans, there are no market prices for nonperforming loans.

Most of Vietnamese Banks are undercapitalized and far from reaching International Best standards. Therefore, in Vietnam, gradualism for achieving compliance with inter-national standards can apply to loan-loss provisioning or capital adequacy.

The government should devise strategy whether a market-based solution or government intervention should be adopted and to decide whether to liquidate or restructure.

In Vietnam, foreign participation in the restructuring would be helpful for private banks. However, to facilitate foreign participation in the restructuring process, the Vietnamese government should liberalize regulations on foreign ownership of financial institutions.

Dealing with Impaired Assets .

Asset management companies: it is important to promulgate legal framework for establishing asset management companies to deal with impaired assets in commercial Banks. There is no single optimal solution but rather a combination of solutions for each country that may vary over time and for each bank.

A decentralized approach encourages each bank to set up its own asset management company, allows arrangement to suit each bank's conditions.

Cost of Restructuring

Estimating the cost of financial restructuring is one of the most challenging issues. To the extent of financial constraints in Vietnam, the Government's contribution to the restructuring costs in the form of bonds or blanket guarantees would be the most efficient way.

Restructuring strategies have to take into account local business practices, the availability of human resources, the deficiencies in the legal and judiciary framework, and depend largely on the degree of political support. In Vietnam, deficiencies in national legal and judicial frame-works have been major obstacles to the restructuring process. Therefore, to reduce the delay of the process, things should be done soon.

Linkages to Corporate Sector Restructuring

To the extent that corporate restructuring continues to lag behind, bank restructuring might be delayed. Generally, the two processes should proceed as simultaneously as possible, although bank restructuring should take the lead.

It is urgent to create a level playing field for all banks to provide better banking services and help to achieve efficient market outcomes in areas that were traditionally dominated by the SOCBs.

3.3. Dismantle directed credit

It is necessary to separate "policy" or directed lending from purely commercial operations of existing SOCBs. "Policy Banks" would be established as separate institutions, to be funded from the state budget, and with the precise scope of operations defined by the government. The remaining activities of the SOCBs would be consolidated and organized on a fully commercial basis.

To develop a safe and sound banking system in Vietnam, it is necessary to reduce the oligopoly and high concentration, the denomination of SOCBs in the banking sector.

The entry of foreign Banks may bring following benefits:

• Improve the quality and availability of financial services in the domestic financial market by increasing bank competition, and enabling the application of more modern banking skills and technology;
• Serve to stimulate the development of the underlying bank supervisory and legal framework;
• Enhance a country's access to international capital.

The study has made comparative, qualitative and a raw quantitative estimation of the vulnerability of Vietnamese banking system. Through the analysis in this study, it provides the readers a panoramic as well as concrete picture of the health of the banking system as the blood vessels serving the economic development.

By using systems of early warning indicators and signals, the study has pointed out similarities in structural weaknesses as well as weaknesses in prudential regulations and supervision of Vietnamese banking system and banking systems in East Asian countries. The qualitative analysis and a raw quantitative estimation of Vietnamese banking system's vulnerability have proved the need to strengthen and restructure the banking system .

In the transition period, Vietnam has two main tasks to develop the economy and avoid lagging behind too far from other regional countries. The first is build a "safe and sound" banking system. The second is to restructure corporate sector, especially SOEs. The two tasks have interdependent linkages, one determines the success of the other and both tasks should be carried out simultaneously.

Though there are numerous lessons from the Asian crisis and from restructuring experience of banking system, the thesis presents only those that are relevant to Vietnam's conditions. The thesis suggests approaches to strengthening Vietnamese banking system. Approaches suggested are aimed at: (a) improving banking sector infrastructure; (b) strengthening of individual financial institutions; (c) removing distortions; and (d) increasing competition.

Bank restructuring is a process, not an event. When the policy makers of Vietnam seem to be confused in making decisions and finding out appropriate solutions to dealing with the weaknesses in banking sector, the study presents lessons from international experience suggesting techniques and approaches that can help clarify the issues, reduce complexity, and identify possible solutions.

Therefore, perhaps the single most important lessons to be learned from the Asian crisis and from their restructuring process relates to the importance of taking concrete actions sooner rather than later.