Vietnam's central bank has begun a drive to strengthen the country's weak and inefficient banking sector through mergers and acquisitions that will create fewer but far more stable institutions.
However, experts warn that the strategy comes with potential challenges and consolidation alone will not be a cure-all.
"Vietnam requires consolidation in its banking industry as the system is fragmented with a large number of small banks which have been susceptible to liquidity pressure, asset concentration and price undercutting," Standard & Poor's primary credit analyst Amit Pandey told Asia Focus from his office in Singapore.
The large number of banks, he said, had led to limited transparency and also increased the regulatory resources required for supervision.
As larger and stronger banks start shopping for acquisitions, with the blessing of the central bank, they will need to choose targets with a strategic fit, said Mr Pandey. "Large banks need to keep in mind that integration always comes with potential challenges."
Successful integration, he said, would depend on proper valuation of targets with careful due diligence of asset quality, and fresh capital infusions where required.
Kamalkant Agarwal, an adviser to the chairman and head of international banking at Siam Commercial Bank Plc (SCB), said consolidation of the banking industry in Vietnam "should have been done a little bit earlier, but it's better late than never".
He also sees the risk from consolidation for big banks as relatively low, "The four or five state-owned banks have close to a 60% market share. The industry is dominated by few large banks and small banks are not big enough to destabilise the big banks."
M&A is one of the steps to improve the economy in Vietnam, but this step in isolation is not sufficient, "The big banks need to improve the way the process is conducted."
Mr Agarwal suggested that the three most important things for large banks to consider after an acquisition are improving management practices, corporate governance, and their ability to deal with the existing non-performing loans through resolution, restructuring or making adequate provisions.
"[After the consolidation] there will be fewer banks and the banking system will be more efficient," he said. "However, to make the industry cleaner, you need to improve the big banks, not just to consolidate."
TRANSPARENCY NEEDED
Tharabodee Serng-Adichaiwit, senior vice-president and general manager of Bangkok Bank Vietnam, said other potential challenges included the transparency of asset quality at the targeted small banks, as well as consent from shareholders if the targeted banks are listed.
He also noted that the M&A approach was not the only solution to NPL problems. The central bank has already set up Vietnam Asset Management Co (VAMC), which expects to buy between US$3.5 billion and $5 billion in bad debt this year in addition to the $6.5 billion acquired in the fourth quarter of last year.
"With the VAMC mechanism, banks can be freed from NPLs and can concentrate more on reaching new customers and obtain new liquidity for lending," he said.
This way, the government will not have to inject new capital into banks to wipe out bad debts and the banking industry is expected to improve in the next few years, according to Mr Tharabodee.
Mr Agarwal agreed that dealing with the existing NPLs was very important. "You need to deal with NPLs; you can't keep on postponing it and not doing anything," he said. "The problem doesn't go away if you just hope that things will get better in time. Some cases may happen, but sometimes the banks need to take stricter actions to deal with NPLs, similar to Thailand and Indonesia."
However, an even bigger risk is that of banks continuing to make poor lending decisions, thus creating new bad debt. "Unless you improve risk management practices and governance practices in the big banks, NPLs will continue to happen," he said.
While the NPL ratio in Vietnam has fallen sharply to 4.3% of credit outstanding as of the end of last year, analysts warn that consolidation will help resolve existing NPLs of small banks.
Andrew Fennell, an analyst and associate director Fitch Ratings in Hong Kong, said contingent risks to Vietnam's sovereign balance sheet arising from bad debts in the banking sector would not change materially as a result of mergers.
"It will not remove bad debts from the financial system. It will simply consolidate them under the umbrella of a larger banking group," he said.
Also, it's not clear how long the mergers will take. "M&A is typically a slow-moving process as it depends on individual banks to find appropriate targets at appropriate prices that will be beneficial to them," said Mr Pandey.
"I think it's ambitious to complete everything in one year. It's not going to be easy. I want to say impossible, but I think that over a two- or three-year period, they can definitely achieve that," added Mr Agarwal.
The central bank aims to consolidate 40-50 local banks in Vietnam to 20 by 2017-20, and three or four are expected to be regional contenders in terms of asset size.
STABILISING ECONOMY
The drive to stabilise the banking industry comes at a good time, as Vietnam's economy is improving steadily and is on course for more sustainable growth. Last year the economy expanded by 5.98%, the highest in three years, and the government is targeting growth of 6.2% this year, according to General Statistics Office.
The improvement is reflected in lower interest rates and the easing of inflation last year to just 4.1%, down sharply from double digits just three years earlier. Given that domestic demand remains sluggish and consumer spending low, deposit growth has outpaced loan growth, easing the liquidity stress in the banking system.
"Now, the regulator is more focused on achieving stable and sustainable credit growth rates," said Mr Pandey.
Last month, Moody's Investors Service revised its outlook for the Vietnamese banking system to stable from negative.
"Improvements in macroeconomic stability have led to strengthened systemic liquidity," Gene Fang, a Moody's vice-president and senior credit officer, wrote in the report. "Deposit growth has recently improved, driven by government policies targeted at reducing gold and foreign currency deposits.
"At the same time, banks have lowered their reliance on interbank funding, which had exacerbated systemic liquidity risks, because the very high levels of interbank borrowing meant that a liquidity squeeze at any one bank could spread quickly to other banks."
The report also suggested that this improved condition is largely due to the higher levels of foreign direct investment (FDI), a shift in the current account balance to a surplus from a deficit, and a policy preference for stability over growth.
In November, Fitch Ratings also raised Vietnam's rating to three levels below investment grade. "Our recent upgrade of Vietnam's sovereign rating primarily reflected improved macroeconomic stability and stronger external balances," said Mr Fennell
He noted that the contingent sovereign liabilities from bad debts in the banking sector could be as high as 18% of GDP, but Vietnam could potentially grow out of the problem over time, given strong GDP growth and more sustainable credit growth trends in recent years.