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Focus: Asia Finance – Vietnamese interest rate developments

1 April 2009

In brief: Consumer finance companies and banks in Vietnam have recently had some reason to rejoice, thanks to a joint effort by the State Bank of Vietnam and the Vietnamese Government to stimulate consumption, lending and investment activity. Partner Thomas Miller (view CV) and Senior Associate David Hinchey report.

How does it affect you?

There will be scope for bigger margins on consumer lending in Vietnam with the removal of the interest rate cap on 'loans for everyday living' and on credit cards.

Local credit institutions will get a boost, with short-term business lending now subject to a 4 per cent subsidy. Offshore lenders will need to look at rates if they are to stay competitive.


Consumer lending in Vietnam – the removal of the interest rate cap

Many foreign financial institutions had commenced their licensing procedures to establish locally based finance companies or banks in 2007 or early 2008. Along with local credit institutions, they were in the process of ramping up their business plans, only to be greeted by an overly heated market in desperate need of cooling when inflation peaked at around 28 per cent pa in mid 2008.

One of the State Bank of Vietnam's (SBV) responses to the high inflation, unsustainable asset price increases and the deposit race between local banks that were clamouring to get access to funding, was to introduce, under Decision 16-2008-QD-NHNN On the Mechanism of Basic Interest Rate Denominated in Vietnamese Dong (Decision 16), dated 16 May 2008, a cap on deposit and loan interest rates at 150 per cent of the basic interest rate in Vietnamese dong (the benchmark rate promulgated on a monthly basis by the SBV).

The basic interest rate peaked at 14 per cent pa in June 2008, where it stayed until October and has since been substantially reduced to only 7 per cent pa, consistent with the significant drops in interest rates around the globe. A basic interest rate of 14 per cent meant that credit institutions were restricted from lending at any more than 21 per cent pa in Vietnamese dong; still high by the standards of many other jurisdictions, but a problem for locally based credit institutions, many of whom could not get their own funding much below the 21 per cent cap, putting a severe squeeze on margins.

To get around this squeeze and nominally stay within the interest rate cap, many credit institutions began introducing a raft of new fees and other means to increase their returns on loans. The range of fees that started to appear included establishment fees, advisory fees, fees for reviewing credit profiles, fees for appraising lending projects and many others. In addition, many credit institutions started to require their borrowers to deposit money (usually from the loan proceeds) with the credit institution as security or a 'margin deposit' for the loan.

The SBV was reasonably quick to take action in response to these new fee structures. In June 2008 it put an end to the practice by issuing a number of official dispatches and notices that prohibited activities that indirectly increased the cost of borrowing over the interest rate cap. The first of these official dispatches, issued on 10 June 2008, appeared to permit fees provided that the (effective) interest rate did not exceed the interest rate cap. The SBV then followed up its own decision nine days later with a further official dispatch, which appeared (although its language is quite vague) to prohibit all forms of lending-related fees. Under this dispatch, it was only the interest component that would be a permitted cost on a Vietnamese dong loan.

To demonstrate its commitment to the interest rate cap and these prohibitions on lending-related fees, the SBV pursued some branch heads of local commercial banks, ordering that they be sacked for breaching the new rules. A Techcombank branch head was sacked for requiring a borrower to provide a 'margin deposit' that brought the borrower's effective interest rate over 24 per cent pa, while a Sacombank branch head was sacked after requiring an interest rate on a borrower's loan to be in excess of the 21 per cent pa cap. We are not aware of any officers from foreign banks or foreign finance companies facing a similar fate, so the reasonably high-profile nature of these SBV orders may have been a sufficient deterrent for the rest of the market.

Times have certainly changed in recent months. As the economy deteriorated, the interest rate cap proved more and more unnecessary, as it presented a major constraint on credit availability and growth. As a result, the SBV overturned the interest cap under Circular 01-2009-TT-NHNN Permitting Credit Institutions to Negotiate Interest Rates on Loans for Everyday Living and on Lending Via Issuance and Use of Credit Cards (Circular 01), dated 23 January 2009, but only to a limited extent. Under Circular 01, the SBV permitted local credit institutions to negotiate interest rates on 'loans for everyday living' and the lending via the issuance and use of credit cards 'based on the supply and demand on capital markets and the credit ratings of borrowers'.

The meaning of lending via the issuance of credit cards is reasonably easy to determine, but 'loans for everyday living' is somewhat open to interpretation. We have taken it to refer to traditional consumer lending; that is, lending for personal, domestic and household purposes. The market in Vietnam seems to have formed the same view, given the changes to product offerings and relevant interest rates in the consumer segment of the market.

We spoke with SBV representatives to clarify what this phrase meant, and they referred us to Decision 1627-2001-QD-NHNN of the SBV Issuing Regulations on Lending by Credit Institutions to Clients (Decision 1627), dated 31 December 2001. Decision 1627 includes a reference to a permitted loan type being a 'loan for servicing living conditions'. This phrase is also open to interpretation, so, when pressed as to how they interpreted this phrase, the SBV representatives said that it referred to anything other than the other types of loans permitted under Decisions 1627, being loans for 'the implementation of investment projects, plans for production, business and services'. As such, if a loan is not for these investment, business or production-type purposes, it is likely to be a 'loan for everyday living' or a 'loan for servicing living conditions' – in other words, we understand, consumer lending.

The market has been swift to respond to the removal of the interest rate ceiling on consumer products. Consumer lending rates are now hovering between 12 to 14 per cent pa, which is 1.5 to 3.5 per cent higher than they would be under an interest rate ceiling with the basic rate at 7 per cent pa. Rates are even higher at some credit institutions (in the area of 18 per cent pa) particularly where no security is provided by the borrower. Local commercial banks have also introduced a range of new consumer lending products, including a variety of new home loans, car loans, and construction and renovation loans, with promises of quick approvals for new customers. As well, some local commercial banks, in a bid to outpace the competition, have started offering their customers gifts (eg gold and free life insurance products).

Unfortunately, despite the new product offerings and other incentives, the take-up rate with consumers has been poor, with many prospective borrowers seeing the increased rates as prohibitive. As such, it may be some time before the intended effects of the removal of the interest rate cap on consumption and lending activity are seen, as banks start reducing their rates to more palatable levels and consumers adjust their mindset to an interest rate regime without any caps.

What we are also yet to see is the abolition of the interest rate cap on deposits, which remains at 150 per cent of the basic interest rate under Decision 16. Although many banks are unlikely to want to offer deposit products with rates in excess of the interest rate cap, some may wish to offer more sophisticated structured deposit products with deposit rates linked to other market events, derivative products, commodities or foreign exchange rates where the return may be higher than a standard deposit rate. The rates possible on these products will, however, still be limited by the cap. The SBV is also yet to formally repeal or replace its dispatches on lending fees, although lending fees on consumer lending products may again be possible given the removal of the interest rate cap.

Business lending – Government interest rate support

On the same day that the SBV introduced Circular 01 removing the interest rate ceiling for consumer lending, the Prime Minister issued Decision 131-2009-QD-TTg on Interest Rate Support for Organisations and Individuals for Borrowing from Banks for Production and Business (Decision 131). Decision 131 may have a significant short-term impact for foreign banks looking to lend in foreign currency into Vietnam.

Under Decision 131, the Government established an interest rate support regime that is stated to assist in reducing manufacturing costs for products and goods, maintain production and business and create jobs. The interest rate support is available for loans from state commercial banks, shareholding commercial banks, joint venture banks, foreign bank branches, 100 per cent foreign-owned banks and on 10 March 2009, was extended to include a limited number of finance companies (those which comply with the required prudential ratios and which have a ratio of bad debts to outstanding total loan balances of less than 5 per cent).

The level of interest rate support is 4 per cent pa but only applies to short-term (no more than eight months) Vietnamese dong loans and provided that the loan contract is signed and drawn down between 1 February 2009 and 31 December 2009. Any loan where interest rate support is provided must be used to satisfy working capital requirements for production and business activities, although certain sectors – including education and training, cultural and sporting activities, trading and consultancy services, investment and business in securities and real property trading – are excluded from the interest rate support regime.

Credit institutions that provide finance under the interest rate support regime must deduct interest equivalent to 4 per cent pa from the interest payable by their borrowers. This interest is then refunded by the SBV, following the submission of a quarterly report on all relevant borrowers and interest deductions for that quarter (although some recent SBV guidelines indicate that this can take place on a monthly basis). Given that the interest rate ceiling still applies to business lending, this will reduce the interest payable under short-term Vietnamese dong working capital facilities to no more than 6.5 per cent pa, down from the current maximum under the cap of 10.5 per cent pa.

To date, the interest rate support regime has proved, as expected, very popular. Local commercial banks have started to increase their deposit rates, given their need for increased Vietnamese dong funds to meet demand for interest rate supported short-term loans. The popularity of the interest rate support program is likely to present some issues for foreign banks looking to lend in foreign currency into Vietnam. Foreign loans have often proved popular, as the rates on US dollar and other foreign currency loans have been significantly lower than the rates on Vietnamese dong loans. This new interest rate support regime is likely to create a far more level playing field, which may limit Vietnamese borrowers' willingness to look offshore for funding.

Published 1 April

For further information, please contact:

Thomas Miller
Partner, Ho Chi Minh City
Ph: +84 8 3822 1717
Thomas.Miller@allens.com.au

 

Robert Fish
Partner, Singapore
Ph: +65 6535 6622
Robert.Fish@allens.com.au

 

Matthew Barnard
Partner, Hong Kong
Ph: +852 2903 6212
Matthew.Barnard@allens.com.au