The State Bank of Vietnam has proposed setting up a company with initial capital of VND100,000 billion to trade bad debt in the banking system. Is it possible that this company alone can resolve the problem?
High on the country’s economic agenda this year is the restructuring of the banking system to make it healthier and more efficient. In doing so, the authorities will have to deal with hefty bad debt.
Ambivalence about a debt trading company
According to Nguyen Van Binh, governor of the State Bank of Vietnam, bad debt held by banks has risen to 10% of total funds borrowed, almost the same as the ratio forecast by foreign organizations.
By end-2011, the total amount lent to businesses had reached around VND2,580,000 billion, of which VND258,000 billion has now turned bad and half of this bad debt is irrecoverable.
Other bad loans are still surfacing in part because, over a long period of time, banks lent enormous sums to state-owned and private businesses to buy stocks, develop apartment projects and trade real estate.
A debt trading company has been proposed with capital totaling VND100,000 billion. But how would such a company be organized? How would debt be traded? What would be criteria for debt trading? Perhaps the first thing to do would be to determine the real value of the bad debt.
Depending on how bad debt is, the amount to be paid could be 10%, 20% or 50% maximum. Possibly some debts would not be bought if they were too bad, allowing such indebted companies to go bust. Of course, the bank holding such debt would have to accept certain losses.
Moreover, a fair warning should be issued before setting up a debt trading firm. VND100,000 billion may not be enough. The combined debt owed by just 12 state conglomerates and corporations is VND218,738 billion, according to data of the Ministry of Finance in its state-owned enterprise restructuring plan.
Where would the capital for such a company come from? If it comes from the State budget, the money might be used to the advantage of some interest groups, thus easily giving rise to “ask and give” practices. If the company is not well run, then the State will be liable for debt this company incurs.
So the proposed debt trading company must be run in a transparent way. Additionally, if two banks sell their debt to each other for mutual interests rather than the public interest, then the debt will continue to circulate within the banking system. If the debt trading firm exists outside the banking system, it may expel all the bad debt from the banking system, thus avoiding the aforementioned phenomenon.
In order for a debt trading firm to operate in a professional manner, according to the rules of the market, it must be established with capital from the private sector – primarily private banks. Any bank that does not want to contribute capital would not be able to sell bad debt to the company. The Government could contribute 20% to 30% of the capital, instead of being the primary sponsor or taking on the bad debt directly.
According to Nguyen Tri Hieu, a financial expert, the experience of America, China and Japan in settling bad debt is good for Vietnam. The U.S. government, by way of the Fed, took strong action by pumping capital into the banks to save them without intervening extensively in the banks’ operations. The Chinese government erased bad loans taken out by state-owned companies. At the same time, the Japanese government allowed overly weakened banks to collapse.
In 2008 the subprime mortgage crisis in the U.S. came in the wake of the bursting of the real estate bubbles. The situation in Vietnam now is not at all different. In a bailout of the U.S. financial system, the U.S. Treasury spent up to US$700 billion. This amount was used to purchase back bad debt held by banks, recapitalize banks, and buy preferred stocks from banks.
The Fed only owns the preferred stocks, so it does not participate in the administration of banks, thus creating good opportunities for banks to restructure on their own.
In China in late 1999 and early 2000, subprime loans made up over 40% of the funds lent by banks. One factor leading to the Chinese government’s success was to wipe out bad debt, 70% was owed by state-owned companies. At the time, China set up four companies to manage the asset companies to handle all subprime mortgages, estimated at up to 670 billion yuan.
The Chinese government also paid out 40 billion yuan to eliminate the debt owed by state firms and recapitalize commercial banks by distributing government bonds.
At the beginning of 2000, bad debt held by Japanese banks went up to trillions of yen as real estate bubbles burst. The Japanese government’s first step was to inject trillions of yen into the large banks and to establish a series of investment funds to which private capital was contributed to buy bad loans. However, these two measures did not have much impact. In the end, the government nationalized many banks and thus forced weak banks out of the market. And they succeeded.
More policy measures needed
As such, a company that would buy and sell subprime loans cannot solve the problems of bad debt or increase the flow of capital into the economy. Other simultaneous, comprehensive solutions are needed in sync with compatible policies. If bad debt is purchased but not handled correctly, then such debt will be passed on to others.
Tomoyuki Kimura, Asian Development Bank country director for Vietnam, said to settle bad debt effectively, lender banks must monitor whether borrowers use money as committed.
He also has suggested debt should be transformed into capital linked to restructuring businesses. Converting debt into capital contributions is to put into action certain measures designed to restructure businesses, such as erasing a certain percentage of principal and interest, rescheduling loans, changing lending terms, supporting markets and administration, and offering financial support to assist their clients to recover, he explained.
This may be a new direction towards solving bad debt and strengthening the financial system in general and the banking sector in particular.
Another measure would be to re-finance debt. This means lending additional funds to finance the payment of old debts. However, risk is associated with this measure. For weak businesses, refinancing their debt will lead them into an even more dangerous territory. In reality, it is difficult to draw a line between re-funding debt to hide bad debt and re-funding debt to spur business activity. If the purpose is only to conceal bad debt, then it is truly no different from “putting old wine in new bottles.”
Whatever measures are taken to reduce bad debt – establishing a debt trading company, turning debt into capital and re-funding debt, they must be carried out in a cautious and transparent manner.