OREANDA-NEWS. Plans by Vietnam's central bank to consolidate the nation's banking system, and the introduction of new rules involving ownership structure under Circular 36 are likely to benefit the sector, says Fitch Ratings. However, implementation may be a challenge, while long-term structural problems such as weak asset quality, poor transparency and low capital buffers remain.

Consolidation is likely to improve efficiency through better economies of scale, and reduce supervisory burden. The central bank State Bank of Vietnam (SBV) announced plans in recent months to approve M&A deals among the country's lenders in 2015 to reduce the number of banks to between 15 to 17 banks by 2017, from around 40.

Fitch expects the bulk of the consolidation to be led by the merging of weak, smaller banks with large state-owned commercial banks. Fitch believes the impact on state-owned commercial banks will be manageable as potential targets remain small relative to their suitors' total assets, although absorbing weaker banks could heighten asset-quality and execution risks in the near term.

In addition, new regulations under Circular 36 (effective 1 February 2015) that allow banks to hold less than a 5% stake each in a maximum of two other credit institutions are likely to help reduce the high level of inter-bank ownership in the sector, which overstates capitalisation in the banking system and raises corporate governance concerns. Banks with more than a 5% stake in other credit institutions will have one year (to 1 February 2016) to divest their shareholdings or merge with the relevant entities to comply with the new regulations.

Minimum capital requirements under Circular 36 remain unchanged at 9% for the total capital adequacy ratio (CAR) - and are unlikely to have a major impact on Fitch-rated commercial banks. Fitch-rated commercial banks have reported CAR ranging from 12.6% to 14.4% as of June 2014.

More concrete implementation of banking sector reforms, however, is likely to remain challenging in Vietnam as highlighted by the slow progress in state-owned enterprise (SOE) privatisation, and the multiple delays in implementing Circular 2 - a set of tighter loan classification rules aimed at improving asset-quality transparency.

Consolidation is also unlikely to be a panacea for the nation's banking-sector challenges, as Fitch believes high asset-quality risks and low capital buffers will continue to weigh on the industry. The agency maintains its negative outlook on the Vietnamese banking sector. This is primarily because the large stock of non-performing loans (NPLs) accumulated during past periods of excessive growth will take time to resolve, even as more supportive macroeconomic conditions may help ease incremental asset-quality pressures. The banks' loss-absorption capacities are likely to be lower than reported due to the understated NPLs and that underscores the sector's capital impairment risks.