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11/01/2024

Increasing bank charter capital: Necessary but not enough

The basic problem of regulations on the charter capital of a bank is not necessarily that an economy has too many or too few banks, or that the banks are too small.

The key to the issue of charter capital is ensuring the safety of the financial system.

A financial system is safe when banks have a high capital adequacy ratio (CAR), in other words, have enough capital to "bear" losses. If capital is low and losses are heavy, the bank will go bankrupt and because of the characteristics of this type of business, it will easily cause the entire system to collapse, implicating the whole economy. The important thing is that this coefficient depends on two factors: the numerator is charter capital and the denominator is total assets. Thus, to increase the safety of a bank or the entire system, regulators either block banks from increasing total assets too high or require banks to increase capital.

The SBV's request for banks to increase their minimum capital to 3,000 billion VND can be considered a part of the plan to increase the capital adequacy ratio for the entire system, but only requiring an increase in minimum charter capital is not enough and has potential consequences. may also increase risks. First, if the bank increases its charter capital while increasing its total assets, the capital adequacy ratio may not increase. This is a very easy possibility because when a bank mobilizes charter capital, it cannot say that the bank's return on equity (ROE) will decrease, so no one will spend money to buy shares. bonds of that bank. In order for ROE not to decrease while capital adequacy ratio increases, banks are forced to increase the rate of return on total assets (ROA), which is not easy in the current difficult situation of banking operations in Vietnam. now.

Can anyone believe that a not-so-famous bank has a ROA that is much higher than the average of the entire system? On the contrary, to attract investors while a series of banks are competing to mobilize capital, small banks will have to advertise high ROE and high dividends by silently reducing the capital adequacy ratio. (increase leverage). This means that the race to increase charter capital will make the banking system more risky.

Second, the issue of classifying bad debts and making provisions for those bad debts by banks is still far from international standards. Suppose the State Bank succeeds in increasing the capital adequacy ratio of the entire system, but if bad debts are still hidden somewhere, the capital adequacy ratio reported by banks is only a virtual number, a real number. would be much lower and the potential risk much higher. Temporarily ignoring historical bad debts, the requirement to increase charter capital will force banks to race to increase ROE/ROA as mentioned above to compete to attract capital. In this case, the risk of bad debt will increase, thus the problem of classifying and monitoring bad debt cannot be solved. The request to increase charter capital (to increase the capital adequacy ratio) therefore does not solve the system safety problem. Capital adequacy ratio (equity capital/total risk-weighted assets, capital adequacy ratio - CAR) is an important indicator reflecting the financial capacity of banks. This indicator is used to determine the bank's ability to pay term debts and face other risks such as credit risk and operational risk.

Third, when banks do not meet the conditions for charter capital, they are forced to merge. Arithmetically, this is the wrong solution because the two banks have low capital adequacy ratios after the merger. This ratio cannot increase even if the charter capital increases. Even if we ignore the capital adequacy ratio, will systemic risk decrease when small banks merge together? The SBV argues that with fewer banks, they will supervise more closely and the banks themselves will be more careful/better managed than the current small, fragmented banks. First of all, it is necessary to determine that the larger the bank, the more complex its operations and products, the more difficult it will be for the State Bank to supervise and inspect to prevent/prevent risks. In addition to the too-big-to-fail problem, many economists such as Krugman and Johnson have warned about the "too-big-to-regulate" phenomenon. This means that big banks will have many ways to "circumvent the law", or worse yet, find ways to influence the law/policy making process to their advantage.

The argument that small banks today lack expertise and operate too recklessly, in my opinion, is partly accurate. However, the solution of merging small banks and/or forcing an increase in charter capital does not solve the fundamental cause. Banking expertise and operations are not too difficult for small banks to learn (with the help of the State Bank of Vietnam). Operating small banks with 1-2 branches is much simpler than a large bank with branches nationwide and abroad. Increasing expertise depends more on training, help, and supervision from the State Bank than on mergers. After small banks merge with each other, it does not mean that their staff and leaders naturally have increased professional qualifications.

Last and no less important point, it is necessary to determine what is the main reason why small banks operate too risky (for example, racing interest rates or borrowing short-term on the interbank market to lend long-term). term). That's not because they are small and lack expertise, but rather an inevitable consequence of the fact that state-owned banks and a few large banks enjoy many incentives (accidentally or intentionally), so small banks have no choice. There is no other way than to take more risks to achieve ROE as promised to shareholders.

Circular issued on May 10 by the State Bank (SBV) stipulates that, no later than June 30, 2010, credit institutions must submit to the SBV a dossier requesting approval to increase capital to ensure the minimum legal capital level. is 3,000 billion VND. Through an article sent to Saigon Tiep Thi, economic doctor Le Hong Giang said that the key to increasing charter capital is to ensure the safety of the financial system, so increasing capital according to regulations needs to be done concurrently. Only with solutions such as debt classification and management according to international standards can the set goals be achieved.

According to Dr. Le Hong Giang