GROUP ASSIGNMENT International Finance REGULATION OF INTEREST RATE BY THE STATE BANK OF VIETNAM (SBV) Group Members: Pham Duc Trung Vu Hieu Trung Phan Tung Nguyen Nguyen Thu Phuong Tran Quoc Loc English Speaking Group Intake 13 CFVG Hanoi HANOI, JUNE 2006 International Finance Regulation of Interest Rate by the State Bank of Vietnam (SBV) Table of Contents FOREWORD THE ROLES OF INTEREST RATE 1.1 Interest Rate and Consumption/Investment 1.2 Interest Rate and Inflation 1.3 Interest Rate and Exchange Rate/Trade Balance 1.4 Interest Rate and the Financial Market 1.5 Balance Among Factors THE INTEREST RATES REGULATING MECHANISM BY SBV 2.1 The shock of interest rates during 1990s 2.2 Basic Rate – Period from June 2000 – May 2002 2.3 Freely Negotiable Interest Rate – Period from June 2002 up to now 2.4 Interest Rate and the Stability/Development of Financial Market 13 2.5 Balance among three Objectives of Inflation Control, GDP Growth and the Stability of Financial Market 14 RECOMMENDATION FOR SBV TO REGULATE INTEREST RATE 17 3.1 Improve the current regulating mechanism 17 3.2 Set up and perfect indirect monetary tools 18 3.3 Determine clear objectives of monetary policy 19 REFERENCE 20 Page of 20 International Finance Regulation of Interest Rate by the State Bank of Vietnam (SBV) FOREWORD We would like to present to you our study on the Regulation of Interest Rate by the State Bank of Vietnam (SBV) as our team’s assignment for the course of International Finance, CFVG, Hanoi, Vietnam We hope that this study can give you some information and analysis on the monetary policies of Vietnam We would like to express our sincere thank to Dr Michel Henry Bouchet, for his lessons and guidance during the course Pham Duc Trung Vu Hieu Trung Phan Tung Nguyen Nguyen Thu Phuong Tran Quoc Loc MBA Intake 13 CFVG, Hanoi, June 2006 Page of 20 International Finance Regulation of Interest Rate by the State Bank of Vietnam (SBV) THE ROLES OF INTEREST RATE Interest Rate is a key economic factors, which have close relations with other factors In this section, we will study such relation and the level of interaction between interest rate and other factors in Vietnam 1.1 Interest Rate and Consumption/Investment Interest rate and consumption: Because the consumption is by individual and households and the borrowing for consumption is very low in Vietnam, it relates more closely with the deposit interest rate, than the lending rate If the REAL DEPOSIT interest rate is high, people tend to save more money in deposit, rather than spending On the other side, if the consumption is high, the income available for saving is low, and the banks have to increase deposit interest rate to get more deposit Interest rate and investment: In respect of investment, it concerns more about businesses, who increase their investment if they can borrow money at low REAL LENDING interest rate In Vietnam, where bank loans are major local sources of financing investment, interest rate is very important for investment On the other side, if the investment is high (e.g in booming economy), banks demand more money by increasing DEPOSIT rates, while increase LENDING rates to compensate and get profits from the investors (who are hungry for money) Collectively, a low real interest rate will boost consumption and investment, which results in the growth of [HOT] economy; while a high real interest rate tends to COOL the economy Empirical evidence in Vietnam shows that, when the effect of inflation is removed, the Real GDP goes in opposite direction against Real Interest Rate 7.6 7.4 7.2 6.8 6.6 2000 -2 -4 Real Interest Rate (%) 7.8 10 Real GDP Growth Rate (%) 12 2001 2002 2003 Real Interest Rate - Three-month deposits (households) Real Interest Rate - Short-term lending Real GDP (annual percentage change) 2004 2005 6.4 6.2 Page of 20 International Finance Regulation of Interest Rate by the State Bank of Vietnam (SBV) 1.2 Interest Rate and Inflation Following the quantity theory of money, as the interest rate increases, the money supply decreases, and the price tends to decreases to balance the equation of quantity theory of money (MV ≡ PV) In addition, an increase in interest rate will cause both the consumption and investment demand to decrease as discussed above, which results in the decrease of aggregate demand of economy, and a lower equilibrium price can be expected due to the move of demand curve to the left However, this effect seems to be SHORT-TERM because the decrease of investment will finally result in the decrease of supply (decrease of T), which in turn moves the supply curve to the left and bring the price back to the first equilibrium position (1) Price S2 P1 P2 (3) (2) (4) MxV = PxT S1 D1 D2 Quantity 1.3 Interest Rate and Exchange Rate/Trade Balance In an open-door market, the interest rate also greatly affects the exchange rate and trade balance of country If the interest rate of one country is high, it attracts the capital inflow, which results in the increase of foreign currency supply; this in turn increase the local currency value and import, while discourages the export Generally, the above-mentioned relationships work well in a developed economy But in developing world, the inefficiencies of financial market and the irresponsiveness of economy usually limit the relationships Especially for Vietnam, where there are still many restrictions on the capital flow and foreign exchange transaction, the interaction between interest rate and exchange rate is limited 1.4 Interest Rate and the Financial Market In this study, the financial market is defined as the middle-man between the saving (S) and the investment (I), which brings the unused capital to the investors In this market, the interest rate can be considered as the price of money, which plays a critical role in competition among the banks Deposit side vs Lending side: The utility package offered by the banks to the depositors mainly includes the interest rate, the quality of service, and the credibility If the banks can not compete with higher Page of 20 International Finance Regulation of Interest Rate by the State Bank of Vietnam (SBV) service quality and creditability, the only weapon for competition is the interest rate In addition, a bank with low service quality and creditability usually offers high deposit interest rate This is really the case for Vietnam, where all the state-owned banks offer lower deposit rate than private banks, but they can get much more deposits than the private banks, because the creditability of state-owned bank is very high (no failure due to the Government’s support), while private banks are fiercely competing with each other for deposits Please refer to the following table for the current deposit interest rate (May, 2006) of three biggest stateowned banks and private banks Deposit Interest Rate (%) Time - months Time - months Time - months Time - 12 months Time - 24 months Time - 36 months State-owned Banks VCB ICB BIDV 7.44 7.56 7.56 7.80 7.80 7.80 8.04 8.16 8.04 8.40 8.40 8.40 9.00 9.00 9.00 9.12 9.12 9.12 ACB 8.16 8.40 8.58 8.40 9.12 9.36 Private Banks SACOMBANK TECHCOMBANK 8.52 8.40 8.76 8.64 9.06 9.00 9.18 9.24 9.78 9.72 9.96 It is also noted that the interest rates of all state-owned banks are nearly same On the other hand, the utility package offered by the banks to the investors mainly includes the low cost of capital, service quality, the quality of loans (in term of availability, flexibility, and amount) In addition to the quality of investment/loans and service quality, lending interest rate is also a key competition factor However, because there is more differentiation, and the banks’ bargaining power is stronger on the lending side, the competition force is always fiercer on the deposit side Interest Rate and Financial Crisis: There is always a force to push the banks to race for the higher deposit and loan amount, and to capture the bigger market share To obtain high deposit amount, the bank may increase the interest rate of deposit With the big amount of deposit obtained, the bank can also offer good quality of loans, and gain more and more power on the lending side (in term of availability, flexibility and amount) On the other side, to release the captured deposit, the banks can not increase the lending interest rate too high The “price war” of interest rate is always a danger for the banking system, because it deduces the margin (lending rate – deposit rate – operation expenses) and it can lead the banking system to crisis In Vietnam, the failure of some small banks (or small credit institutions) in 1990s is one bloody experience of this type 1.5 Balance Among Factors As discuss above, the interest rate interacts with other economic factors: (i) consumption/ investment (or collectively GDP); (ii) inflation; (iii) exchange rate; (iv) stability of financial market Page of 20 International Finance Regulation of Interest Rate by the State Bank of Vietnam (SBV) Consump tion/Inve stment Inflation Real Interest Rate Exchang e Rate Stability of Financial Market As the Central Bank of Vietnam, SBV always try to find out a balance to monitor the interest rate Based on the degree of interaction between interest rate and other factors, SBV can generally pursuit following policy: a) Liberalizing Interest Rate: This is an irreversible trend for many countries in the world, because it can help allocate resources (money) effectively and efficiently This is one of the reforms suggested by John Williamson, 1989, in his so-called “Washington Consensus”; b) Prevent harsh “price war” of interest rate in Banking System, to prevent failure of banking system (crisis of the Financial Market); c) Keep an eye on the inflation; in the case of Vietnam, this may be to control the inflation rate of one-digit; d) Given the above constraints, the real interest rate should be low enough to keep high GDP growth, because the real interest rate has a strong relation with consumption and investment as discussed above We will discuss more deeply into these policies in next part Page of 20 International Finance Regulation of Interest Rate by the State Bank of Vietnam (SBV) THE INTEREST RATES REGULATING MECHANISM BY SBV In transition from the command economy to the market economy, Vietnam has gone through many changes in the regulating mechanism to liberalize the interest rate from 1992 up to now Even, in this study, we will concentrate on the period from 2000 up to now but we will take a look for the interest rates situation in Vietnam from during the period from 1994 to 1997 when the Vietnam economy has been shocked because of the wrong interest rates policy 2.1 The shock of interest rates during 1990s In 1994, instead of lowering the interest rate according to the policy adopted by the Conference of Bankers at the beginning of the year, the State Bank preserved the status quo on the grounds that the inflation rate in the first half of 1994 had shown a tendency to become higher by the second half than what had been planned by the National Assembly In 1994, the inflation rate reached 14.4%, and the real interest rate was: 25.2%-14.4% = 10.8% Many commercial banks had even offered much higher deposit rates (from 32% to 36% a year) and caused the real interest rate to increase to 18-22%, therefore it's obvious that the state Bank should have reduced the interest rate in 1994 In 1996, the State Bank reduced the interest rate four times and caused a lot of losses to commercial banks The first joint stock bank in Vietnam, by publicizing its balance sheet, had to admit that its interest in black was lower than its interest in red Up to now, there is no answers to such questions as how many joint stock banks had to suffer losses because of the reductions of the interest rate and how many banks had to violate regulations on interest rates with a view to saving themselves from losses Bits of information gathered in 1996 showed that rural joint stock banks had to increase the deposit rate to 1.61.7% a month, thus they had certainly been allowed to violate the interest rate-ceiling of 1.5% A branch of foreign banks has violated the regulation on interest rate-ceiling by requiring local banks to deposit 50% of loans supplied by this branch, thus it has doubled the lending rate on loans in foreign currencies This branch, therefore has avoided the danger of bad loan because it held 50% of the loan supplied Calculations publicized by the press showed that in 1996 banks had to suffer losses because even if they could lend 80% of their deposits, they couldn't collect enough interest on loans to cover their interest in red, that is, their overheads became losses In July 1997 when the interest rate-ceiling was reduced, no attention was paid to losses suffered by joint stock banks If they observe the bank margin of 0.35%, the deposit rate will be only 0.65% and become unattractive, therefore joint stock banks have to offer a deposit rate of 0.8-0.85% to 3month deposits, and raise bank charges in order to reduce potential losses Let's study an example: With deposits of 100 billion, a bank has to pay 0.8-0.85% interest, or 80-85 million If it can lend 80 billion (this is rarely seen in reality) and receives interest at 1%, or 80 billion, it will certainly suffer losses because it has to pay the overheads The loss will be bigger if it pays 0.85% interest on deposit Only State-owned commercial banks (except for banks for agriculture) can avoid losses because its call deposits represent over 50% of its total deposits Strange to say, the State Bank has paid no attention to this situation although many bankers at the conference have given voice to the regulation on Page of 20 International Finance Regulation of Interest Rate by the State Bank of Vietnam (SBV) interest rate-ceiling The State Bank has thought that joint stock banks as well as state owned bank had to suffer losses in order to carry out the regulation on interest rate In order to avoid losses and bankruptcy, joint stock banks have to find ways to increase the lending rate One of alternatives is to follow in footsteps of the branch of foreign bank as stated above When the interest rate-ceiling is reduced, it's necessary to help joint stock companies to avoid losses When the central bank wants to encourage the economic development, it will lower the interest rate, whereas the interest rate-ceiling in Vietnam was fixed by the Government in this period, so the central bank has to use administrative measures to enforce it, however, the regulation didn't provide for subsidies given to banks suffering losses, therefore all officials from the central bank tended to pay no attention to the fact that joint stock banks had raised the lending rate That was why many rural banks have officially offered the deposit rate of 1.6-1.7% 2.2 Basic Rate – Period from June 2000 – May 2002 During this period, the SBV sets a promulgated interest rate, called “Basic Rate” and a bandwidth The basic interest rate affects all other interest rates arising in the market economy It is a kind of interest rates playing an important role in the market mechanism in general and our market economy in particular The basic interest rate is determined by the central bank and announced on the basis of real situation and targets of the national monetary policy The point 12, Article of the Law on the State Bank of Vietnam stipulates: " The basic interest rate is the interest rate announced by the State Bank of Vietnam making a ground for credit institutions to fix their business interest rates" However, it is argued that the basic interest rate is a broad concept including different rates of capital re-allocation, rediscount, interbank market; maximum rate for loans and minimum rate for deposits Other banks can set their own interest rate for local currency loans, but it is not allowed to be higher than the sum of basic rate and bandwidth The bandwidth for local currency is 0.3% for short-term loans, and 0.5% for mid-term and long-term loans For foreign currency, the interest rate for short-term loans shall not be higher than 3month SIBOR+1%; and the interest rate for mid-term and long-term loans shall not be higher than 6-month SIBOR+1% This regulating mechanism is rather free for other banks to set their own interest rate The credit expansion capability of banks is released to finance the economy, particularly by the long-term loan This mechanism allows the banks to manage their own strategies and operation better than the previous However, the basic rate and the bandwidth are set by the SBV subjectively, and not in line with the actual conditions of money supply – demand The regulating tool is completely administrative, and the market forces have limited effects on the interest rate Therefore, the mechanism has been replaced by negotiable mechanism on June 2002 2.3 Freely Negotiable Interest Rate – Period from June 2002 up to now From June 2002, the interest rate was freely negotiable by the new policy of SBV that “the banks can fix their own interest rate on loans on the basis of market capital supply – demand and the creditability of borrowers” Page of 20 International Finance Regulation of Interest Rate by the State Bank of Vietnam (SBV) This new policy has completely freed the market interest rate The SBV no longer control the interest rate directly, but they start to use many indirect tools, including required reserve ratio, basic rate, refinancing and discount rate, open market operation Required Reserve Ratio: The required reserve ratio can be set between – 20% as required by the Law on State Bank However, the actual ratio set by SBV is too low to have considerable effects on the money supply: Types of financial institutions Required reserve ratio Dec 2002 Aug 2003 Jul 2004 State-owned banks, Urban banks, Foreign bank branch 3% 2.0% 5% Rural banks 2% 1.5% 4% Others 1% 1.0% 2% In July 2004, SBV increase the required reserve ratio by – 3% This is an action to control the inflation Theoretically, other banks have to increase the loan interest rate to offset the loss of revenue due to additional “dead money” retained in their reserve account at SBV, otherwise their profit ratio will be reduced However, in July 2004, the interest rate in the market is as high as 11% - 14% per year, and the SBV pays interest rate on the required reserve amount (SBV does not pay interest on the reserve in excess of requirement) Therefore, the market interest rate has not increased as expected Though the theory suggests that an increase in the required reserve ratio will result in a decrease of money supply, there seem to be no clear correlation between the two in Vietnam This may be explained by the fact that banks usually retain more money than the required reserve ratio (this is a usual phenomenon of developing countries) Another reason is that the required reserve ratios is rather low, and even the increase by 3%, the ratio is only 5% in comparison with a common – 10% for developing countries Therefore, the required reserve ratio should not be highly appreciated as a tool for regulation of interest rate if it is not increased to a more meaningful level Basic rate: From June 2002, the basic rate is no longer compulsory for other banks, but it serves as a “guiding indicator” for the market interest rate It is calculated based on the interest rate of 15 biggest banks for the best investors Following figure is the moving trend of basic rate in comparison with the market rate Page 10 of 20 International Finance Regulation of Interest Rate by the State Bank of Vietnam (SBV) 12 10 Deposit i Interest rate (% ) Auctioned i for treasury bill 3-month i on inter-bank market Buying i on open market operation Short-tem i on loan Basic rate 2000 2001 2002 2003 As shown on the figure, the market rate tends to increase, but the basic rate is set to decrease Therefore, “basic rate” can not serve as a “guiding indicator” for the market interest rates This is a direct outcome of policy change to the freely negotiable interest rate Such administrative tool as basic rate is now obsolete and causes no effect Therefore, the basic rate should not be used by SBV as a regulating tool any more Refinancing and Discount rates: From March 2003, SBV established two rates to guide the market interest rate, say “refinancing rate” and “discount rate” The discount rate is used in coordination with the discount quotas set by SBV for each bank on monthly basis The refinancing rate and discount rate is intended to serve as the “ceiling” and “floor”, respectively, for the inter-bank rate (including for open market operation), but it is shown in following figure that both the intended ceiling and floor rate are lower than other rates 12 10 Refinancing i Interest rate (%) Discount i Deposit i Auctioned i for treasury bill 3-month i on inter-bank market Buying i on open market 2000 2001 2002 2003 Page 11 of 20 International Finance Regulation of Interest Rate by the State Bank of Vietnam (SBV) One positive sign is can be seen that the trends of inter-bank interest rate moving in the same direction as that of discount rate The limitation of effectiveness of these tools in regulating the market deposit/loans may be explained by the competition force as later discussed A recent development in early 2005 also justifies for the usefulness of these tools On 15 January 2005, SBV increased both the refinancing and discount rates by 0.5% (from 5% to 5.5%, and 3% to 3.5% respectively) One April 2005, SBV increase the rates for the second time by 0.5% in an effort to prevent the high inflation rate of 9.5% for the year 2004, 1.1% for January 2005, and 2.5% for February 2005 Following this action, both the inflation and the market interest rate show responsive movements The inflation rate in is decreased to 0.1% per month, and the market interest rate has increased by 0.36% - 0.96% Based on this study, and the theory of discount rate, we consider it should be better to use the discount rate as a major tool to regulate the interest rate However, some following ideas may be considered to make it more effective: Do not take the refinancing rate as the “ceiling rate”, because principally, the refinancing rate and the discount rate save only the outflow of money from the SBV to the other banks, which results in the increase of money supply and the interest - - Do not use the discount quotas as a limitation on the amount of discounts This quota is both discriminated and limit the power of SBV on the money market Open Market Operation: Open market operation has well developed from August 2000 to become an important tool for SBV to regulate the money supply and interest rate Following is the dramatic growth of transaction in the open market operation: 45000 40000 Total transaction of open market operation 35000 SBV bought SBV sold Billion VND 30000 25000 20000 15000 10000 5000 2000 2001 2002 2003 Page 12 of 20 International Finance Regulation of Interest Rate by the State Bank of Vietnam (SBV) Basically, all the necessary procedures for mature open market operations have been developed However, these operations grow mainly by the quantity rather than quality The main players are the state-owned banks (more than 95% of transaction) About 30% session is failed, and the means of transaction (bond) is only limited to treasury bonds and deposit certificates Other medium-term and long-term bonds have not be put on the stage The auction is based more on the volume rather than the interest rate Therefore, the open market operation does not reflect the money supply – demand in the market, but only the exchange the quantity among the state-owned banks From this view, a comprehensive plan should be developed to improve the effectiveness of open market operation as a major tool for regulating money supply and interest rate: - Developing the inter-bank market to establish an environment for the open market operation and to guide the interest rate for the open market operation; - Release the medium-term and long-term bond for the open market operation; - Encourage all the banks and financial institutions to join the auctions of open market operation by offering attractive packages Generally, the regulating tools used by SBV have been approaching the modern mechanism for a free market Though the effectiveness of these tools is still limited, the positive signs can be seen, particularly for the discount rate and open market operation 2.4 Interest Rate and the Stability/Development of Financial Market After the change of policy toward a system of freely negotiable interest rate, there is tense competition in the financial market, which raises many concerns Please refer to the following figures for the market share of different types of banks in Vietnam, and that of four biggest state-owned banks Share of different types of Banks 21.4% State-owned bank 0.6% Urban Commercial Banks Rural Commercial Banks 13.0% Foreign Bank Branchs 65.0% Page 13 of 20 International Finance Regulation of Interest Rate by the State Bank of Vietnam (SBV) Shares of biggest state-owned banks 16.1% 11.6% 52.7% Agribank BIDV Vietcombank ICB All other banks 10.6% 9.1% It is clearly shown on the figures that the state-owned banks are dominant (65%) of the financial market One key feature is that the four biggest state-owned banks have quite similar market share (16.1% - 11.6% - 10.6% - 9.1%), therefore, the competition tends to be high Recently, these four banks have formed many syndicates to finance big projects, which is may be a sign of “cartels” to ahead the growing power of strong foreign banks, which are penetrating the market recently There is also a high tensile between the banking industry and the informal financial middle-men, who account for about 25% of the overall financial market Due to these facts, the competition is high, and a race of interest rate is an immediate danger for the stability of financial market Therefore, the SBV is always aware of the risk for financial market in determining the interest rate policies 2.5 Balance among three Objectives of Inflation Control, GDP Growth and the Stability of Financial Market As discussed in Part 1, the interest rate has a direct relation with the consumption and investment, which in turn relate directly to the GDP (Y) It also has close relations with the inflation and foreign exchange / trade balance In this part, we will study two factors which serve as the final objectives for the Central Bank to regulate the interest rate, i.e GDP growth and Inflation1 Following figure shows movement trends of interest rate, GDP growth, and inflation in Vietnam from 1999 – 2003 In Vietnam, the external factors of foreign exchange / trade balance seem to have little relations, because the inflows/outflows of capital is strictly controlled by the Government For example, the foreign indirect investment (FII) is largely prohibited, only several trust funds are permitted to operate within limited scope; the foreigner are only permitted to purchase upto 30% of the local companies under strict conditions; the bonds are only permitted to issue oversea under strict conditions Therefore, an increase in the interest rate can not attract the inflows of foreign currencies (say, increase demands for local currency) to increase the value of local currency (exchange rate) Page 14 of 20 International Finance Regulation of Interest Rate by the State Bank of Vietnam (SBV) 6 4 3 Interest rate % Annual growth rate % (GDP, Inflation) GDP growth rate Inflation 1 Discount rate 1999 -1 2000 2001 2002 2003 As discussed in Part 1, the higher the interest is, the lower GDP and the higher the inflation rate is However, in almost all economies, there are always objectives of higher GDP growth rate and lower the inflation rate As we can see in the above figure, during 1999 – 2003, Vietnam seems to archive both targets of high GDP growth rate and low Inflation rate Please note that during this period, Vietnam and the South East Asia had just got out of the financial crisis in 1999 Therefore, the SBV has applied an “easy monetary policy”, trying to lower the interest rate to foster the GDP growth Partly thank to this policy, the money has pumped into the economy at the increase rate of 17.6 – 39% per year (increase of M2), and the total loan has increase by 21.4 – 38.1% In 1999 – 2003, the inflation rate is very low as of 0.1% in 1999, -0.5 in 2000 (deflation) Therefore, there is no danger of high inflation rate, and an “easy monetary policy” is very useful to push up the GDP growth rate and increase the Inflation rate to a more safety level During this period, the objective of GDP growth rate is in line with the objective of controlling inflation rate However, in the year 2004, the Inflation rate is as high as 9.5%, and a true tension exists between the objective of GDP growth and the objective of controlling inflation rate Following figure shows the month inflation rate from 2003 up to now Page 15 of 20 International Finance Regulation of Interest Rate by the State Bank of Vietnam (SBV) Consumer Price Index (Monthly) 3.50% 3.00% 2.50% 2.00% 1.50% 1.00% 0.50% 0.00% 3 03 -0 -0 -0.50%nar ay Ja M M 3 03 -0 l-0 pov Ju Se N 4 04 -0 -0 nar ay Ja M M 4 04 -0 l-0 pov Ju Se N 05 -0 nar Ja M -1.00% Sources: General Statistics Office; Please note that the inflation rate in Vietnam has a seasonal peak from November to February due to high consumption around the New Year Holiday For the year 2004, the SBV has try several tools to reduce the inflation rates, which include increasing the required reserve ratio (July 2004), stabilization of exchange rate (August 2004), issuing treasury bonds (September 2004) Especially, in January 2005, SBV has shown a strong action to increase the discount rate and refinancing rate by 0.5% per year, associating with intensive open market operation On April 2005, SBV increase against the discount rate by 0.5% to 4.0% These strong actions seem to be effective in controlling the inflation rate down to 0.1% in March 2005, particularly after the regulation by the tools of discount rate and open market operation Right after the second-time increase of interest rate by SBV, Vietcombank – a leader of the financial market – has started to increase its deposit interest rate on April 2005 As explained by the Vietcombank’s executives, the banking industry is under a hard time to obtain the deposit amount Due to the high inflation, if the banking industry does not increase the deposit interest rate, the net interest rate may be negative (interest rate < inflation rate) Therefore, in the year 2004, the increase rate of total loan amount is much higher than that of total deposit (Vietcombank: loan amount increased by 23%, while the deposit amount increased by only 11.3%; ICB: 11.6% against 2.3%) The increase rate of deposit amount for the last months (January – March 2005) is only 1%, and the bank has no other choice but to increase the interest rate Under same pressure and leaded by Vietcombank, other banks will surely increase their interest rate At this time, probably the banks will take chance to run for the deposit and bigger market share, because of the high competition in the financial market, as discussed above In respect of the effects on GDP growth, please note that the current loan interest rate is rather high, the lowest loan rate is about 8.8%, the average is about 10.5% and the highest is 16.2% Therefore, an increase in loan rate will result in negative effects on the GDP growth, and the target of 8.5% GDP growth will be hardly archived Page 16 of 20 International Finance Regulation of Interest Rate by the State Bank of Vietnam (SBV) RECOMMENDATION FOR SBV TO REGULATE INTEREST RATE 3.1 Improve the current regulating mechanism (a) Intensify interest rate liberalization policy As we analyzed in previous parts, all governments should liberalize their interest rate policy All administrative control on interest rate policies always result in bad effect for economic development In order to solve this problem, SBV should liberalize interest rate to operate financial market more freely Now Vietnam has reached almost enough conditions to strengthen interest rate liberalization policy: - Quite stable and firm macro economy to bear external shocks to Vietnam economy - Vietnam has adequate legal system to adjust international relationships - Financial market has been appeared in Vietnam and has been operating efficiently Day by day, financial activities have been operated in accordance with market signals - Financial institutions, especially Banking system have developed stably - SBV has enough power to control financial market as necessary… Operating in financial market by the role as bank for other banks, SBV has reached high financial reserve to stabilize market Therefore SBV should improve the current regulating mechanism to intensify current interest rate liberalization (b) To determine targeted interest rate Many experts in this fields suggested that SBV should select interbank interest rate as objectives of monetary policy because of following reasons: - Inter-bank interest rate is operating as wholesale price in financial market It can affect interest rate in financial market through retail interest rate of each financial institutes - SBV can control actual interest rate in market by this mechanism - Development of Interbank market in Vietnam has reached to certain level to bring objectives of monetary policy into reality - Interest rate Liberalization policy can be effective as long as interbank market operates efficiently with good management of capital of commercial banks As many financial institutes can attend interbank market, the interest rate can be operated freely as market regulation Page 17 of 20 International Finance Regulation of Interest Rate by the State Bank of Vietnam (SBV) Therefore SBV should set up interbank interest rate as targeted interest rate in each period of time - SBV can use overnight rate in interbank market as targeted rate in each period of time Considering actual situation in Vietnam, the most suitable is deposit interest rate in interbank market - In order to achieve the right interest rate in interbank market, SBV has to promote banks to attend interest rate auctions Participants can be included big domestic commercial banks in urban and rural area, joint venture banks and branch of foreign banks in Vietnam However, SBV has to regulate conditions of attending banks to keep stability of interbank market - All banks would base on interbank interest rate and some other fees, characteristics of their customers, market area… to set up their own interest rate Based on economical forecast in each period of time, SBV calculate and declare targeted interest rate (in stead of existing basic rate mechanism) to orient financial market Sometimes, actual interest rate in market will fluctuate far from targeted rate of SBV Even this case, SBV should not interfere market by administrative tools SBV should use indirect tools of monetary policy to adjust market interest rate in accordance with targeted rate SBV should abolish the existing discount operation and discount rate It should be replaced by interest rate for deposit of financial institutes in SBV’ s account SBV can set up Interest rate corridor in which ceiling rate is refinance rate and floor rate is above deposit rate Market interest rate is fluctuated around open market interest rate SBV will use open market operation to adjust market interest rate This is current model to control interest rate in other countries (c) To manage interest rates in market SBV should abolish existing basic rate policy Actually, basic rate does not reflect actual demand – supply balance in financial market Almost commercial banks not use this basic rate as reference SBV should abolish preferential interest rate policy Actually, this movement is delayed in Vietnam compared with other neighboring countries This policy would damage financial market, operation of banking system There are only some specialized banks in Vietnam can issue the preferential interest rates for some special objectives Now, there are some financial institutes in Vietnam operating as banks They set up their own interest rates that are sometime higher than market interest rate or rate declared by SBV This problem causes bad effect to market mechanism of interest rate generally Therefore, all banking operations of financial institutes must be controlled and regulated by legal system These interest rates must be follow common market mechanism 3.2 Set up and perfect indirect monetary tools Generally, SBV has targeted its monetary policy from direct monetary tools to indirect ones This movement is connected closely with Liberalization of interest rate From the year Page 18 of 20 International Finance Regulation of Interest Rate by the State Bank of Vietnam (SBV) 1994, Credit limit mechanism was deleted, replacing by other tools as compulsory reserves, refinancing, open market… These monetary tools must be perfected gradually following international practices 3.3 Determine clear objectives of monetary policy Now, SBV has been operating monetary policy with complicated objectives Inflation rate is increasing strongly in the year 2005 and beginning of 2006 However, SBV still concluded that high inflation rate has not been resulted from monetary policy Therefore, SBV has not yet applied strict monetary policy in order to keep high growth rate as planned SBV should quickly clear this paradox to stable the financial market Actually, credit growth in Vietnam is very high In addition, bad debts are expanding through out Vietnamese banking system Real estate market reduction resulted in very low credit from customers in this field Therefore IMF suggested SBV to slow credit growth Clear target in this time is to reduce credit to keep financial market more safety Strict monetary should be applied as soon as possible However, IMF warned that SBV seems to ignore this suggestion SBV has not yet take enough action to follow this purpose and may be sending mixed signals to the market IMF also suggested that SBV should control more strictly bad debts status in Vietnam recently Many stated - owned companies can enjoyed favorable credit conditions so that efficiency of investment is very low This problem is going to result in financial crisis Page 19 of 20 International Finance Regulation of Interest Rate by the State Bank of Vietnam (SBV) REFERENCE Bank for International Settlements 2005 Inflation targeting, asset prices and financial imbalances: conceptualizing the debate, BIS Working Paper No.168 Basel, Switzerland Dinh Xuan Ha 2005 Renewal of SBV’s Monetary Policies for a Market Economy of Vietnam, Banking Magazine Hanoi, Vietnam Francis B Narayan 2000 Financial Management and Governance Issues in Viet Nam Asian Development Bank and World Bank General Statistics Office of Vietnam Statistical Yearbooks 2000, 2001, 2002, 2004, 2005 Hanoi, Vietnam IMF January 24, 2006 IMF Executive Board Concludes 2005 Article IV Consultation with Vietnam Web-site: www.imf.org IMF January 2006 IMF Country Report No 06/22 (including Statistical Appendix) Web-site: www.imf.org IMF 2004 Monetary Policy Implementation at Different Stages of Market Development, Monetary and Financial Systems Department, IMF John Williamson 2002 Did the Washington Consensus Fail? Washington, DC Le Hoang Nga 2005 Monetary Policies of Vietnam: Conditions and Solutions, Banking Magazine Hanoi, Vietnam 10 State Bank of Vietnam Inter-bank Trading Information in the First Quarter, 2006, Banking Research Bulletin Hanoi, Vietnam 11 State Bank of Vietnam Annual Reports for the years 2000, 2001, 2002, 2004, 2005 Hanoi, Vietnam 12 Articles on Websites: www.imf.org (International Monetary Fund), www.bis.org (Bank for International Settlements), www.globalfinance.org (Glob@l Finance, CERAM), www.sbv.gov.vn (State Bank of Vietnam), www.mof.gov.vn (Ministry of Finance of Vietnam), www.vneconomy.com.vn (Vietnam Economic Review), and many other media Page 20 of 20 ... of 20 International Finance Regulation of Interest Rate by the State Bank of Vietnam (SBV) FOREWORD We would like to present to you our study on the Regulation of Interest Rate by the State Bank. .. many bankers at the conference have given voice to the regulation on Page of 20 International Finance Regulation of Interest Rate by the State Bank of Vietnam (SBV) interest rate- ceiling The State. .. national monetary policy The point 12, Article of the Law on the State Bank of Vietnam stipulates: " The basic interest rate is the interest rate announced by the State Bank of Vietnam making a ground