Private banking sector development and bank profitability in vietnam

Firstly, to develop a robust theoretical framework that comprehensively explores the relationship between private banking sector development, financial freedom, and bank profitability in

Introduction

Research background

The financial landscape of Vietnam has undergone a profound transformation in recent years As one of Southeast Asia's fastest-growing economies, Vietnam has attracted significant foreign investment, witnessed remarkable industrialization, and experienced an increasing demand for banking and financial services Amidst this dynamic evolution, the private banking sector has emerged as a focal point of interest and significance This dissertation embarks on a comprehensive exploration of the multifaceted relationship between private banking sector development and bank profitability in Vietnam.

Research objectives

The objectives of this research are twofold Firstly, to develop a robust theoretical framework that comprehensively explores the relationship between private banking sector development, financial freedom, and bank profitability in the context of Vietnam Secondly, to empirically assess the impact of financial freedom on the profitability of banks in Vietnam The aim is to provide practical insights and guidance for decision-makers on how to foster private banking sector growth, enhance bank profitability, and strike a balance between financial freedom and financial stability within the Vietnamese financial ecosystem.

Research Methods

In pursuit of these objectives, this research employs a multifaceted methodology that combines theoretical exploration and empirical analysis The theoretical framework draws upon existing literature and theoretical perspectives to provide a solid foundation for the subsequent empirical investigation Key theories and concepts underpinning the research include private banking sector dynamics, financial freedom, and bank profitability

To assess the impact of financial freedom on bank profitability, this research utilizes quantitative analysis techniques It considers various indicators of financial freedom, such as regulatory environments, market access, and ease of doing business, and evaluates their direct and indirect effects on bank profitability The choice of quantitative analysis is driven by its suitability for capturing the nuanced relationships and channels through which financial freedom influences bank performance.

Structure of the Dissertation

This dissertation is structured to provide a coherent and comprehensive exploration of the topic It consists of several interconnected chapters, each contributing to the overall research objectives The subsequent chapters include detailed discussions of the theoretical framework, data collection and analysis methods, empirical findings, policy implications, and conclusions Together, these chapters form a cohesive narrative that sheds light on the intricate dynamics between private banking sector development, financial freedom, and bank profitability within the Vietnamese financial landscape.

Literature review and Research Hypothesis

Private sector credit and bank profitability

Gwartney et al (2017) introduced the private sector credit index to assess the balance between government and private sector borrowing in the banking system They argue that higher government borrowing signifies greater control over the banking industry, emphasizing policy planning over profit maximization This can hinder private bank growth, leading to reduced bank profitability Furthermore, Chan and Karim (2016) find that countries with a significant share of bank deposits in privately-owned banks tend to have more efficient and profitable banking systems State-owned banks, influenced by central planning and lacking autonomy, typically exhibit lower efficiency and profitability Increased government borrowing also diminishes the private sector's source of development finance, potentially impacting the economy and negatively affecting bank performance (Khan and Sattar, 2014) Moreover, Lalon (2015) argues that net government borrowing is associated with a heightened risk of liquidity crises, primarily due to inadequate liquidity support for the private sector, a phenomenon known as crowding-out This is often driven by certain emerging countries prioritizing the expansion of the public sector for political reasons, which in turn hampers the growth of the private banking sector Consequently, both commercial and public banks tend to underperform (Tahir et al., 2016) These findings suggest that loans to the private sector positively influence banking sector profitability Additionally, a higher level of credit extended to the private sector may indicate increased credit demand for development during periods of favorable economic conditions This implies that banks are more likely to be profitable during positive economic cycles because borrowers have a lower default rate (Simpasa and Pla, 2016)

It's crucial to emphasize the benefits of the technological spillover effect associated with a well-developed private banking system The shift from central planning to private sector development may have driven an expansion in credit to the private sector (He et al., 2017), which can positively impact domestic bank profitability, as private banks tend to outperform public banks According to Firth et al (2016), private banks excel in risk management and borrower analysis, leading to increased profitability Additionally, private banks benefit more from institutional investors, such as expertise, technology, or capital, resulting in enhanced efficiency and profitability (Giustiniani and Ross, 2008) Furthermore, as Claessens and Laeven (2004) suggest, the entry of foreign competitors serves as a powerful incentive for public banks to restructure and adopt advanced technologies, thereby enhancing their competitiveness Consequently, the profitability and efficiency of the domestic banking system improve

Nonetheless, some studies provide concrete evidence that an uptick in loans to the private sector can actually diminish bank profitability The increased lending to the private sector may intensify competition between public and private banks, ultimately lowering their profitability (Buchs and Mathisen, 2005) Moreover, expanding credit to the private sector might be linked to a higher prevalence of non-performing loans, especially in developing markets where banks may have inadequate risk assessment practices (Bikker and Haaf, 2002) Based on recent studies (Chan and Karim, 2016; Tahir et al., 2016; He et al., 2017), private banks outperform public banks, implying that increased private sector credit significantly boosts bank profitability

Hypothesis 1: More private sector credit increases bank profitability

Financial freedom and bank profitability

Privatizing state-owned banks expands their capital, boosting credit provision and bank profitability (Berkowitz et al., 2014, Russia) This shift removes government control, enabling more fund mobilization and attracting investments, leading to increased capital (Giustiniani and Ross, 2008) Andrianova et al (2008) also find that reducing state ownership enhances private banking development Institutional investors and shareholders offer advantages such as advanced technology, expertise, and capital (Giustiniani and Ross, 2008) State-owned banks may prioritize social or political goals over profitability and shareholder wealth (Chan and Karim, 2016)

Financial freedom relates to more liberal financial laws, allowing foreign banks to enter and domestic private banks to thrive According to Onio (2016), private banks outperform state-owned banks due to better capitalization and fewer non-performing loans AI-Amarneh and Yaseen (2017) support this, showing that financial freedom enhances bank efficiency, especially for foreign and domestically governed private banks, leading to higher profitability Eliminating financial barriers attracts more capital to the economy and the financial sector, boosting bank profitability (Andries and Ursu, 2013) However, some empirical research offers a different perspective on the relationship between financial independence and bank profitability Lin et al (2013) argue that higher financial independence may reduce domestic bank profitability by increasing competition with foreign banks Banks with government policy protection may face diminished competitiveness and increased risk when such policies are repealed (Claessens and Laeven, 2004)

Greater financial independence boosts international bank intercorrelation, amplifying firm return sensitivity to economic shocks (Behr et al., 2009) This implies that increased risk in one country can swiftly affect others, potentially impacting financial sector performance The impact is more significant in emerging markets, where many commercial banks have lenient risk management and lending standards (Simpasa and Pla, 2016)

In emerging countries, the financial system is typically dominated by a few state-owned banks, resulting in significant consolidation However, these dominant banks often exhibit low efficiency, transparency, and compliance with international standards (Beck et al., 2013) Consequently, they become highly susceptible to changes in financial liberalization policies, potentially leading to reduced profitability if protective measures for deeper integration are removed (Weill, 2003) Furthermore, as Gupta et al (2011) suggest, financial liberalization tends to be associated with lower taxes and more bureaucratic administrative procedures Coupled with the government's delayed response to policy changes, this can result in a larger fiscal and budget deficit To address this issue, governments often allocate financial resources from the banking sector to cover budget deficit challenges This increases bank liquidity risk and diminishes bank profitability

In the ASEAN banking system, a limited number of state-owned banks hold less competitive power compared to foreign banks (Jesus and Torres, 2017) Consequently, heightened competition in a liberalized market can potentially undermine bank profitability Additionally, increased risk dispersion within a liberalized banking system can affect ASEAN bank returns, especially for those with inadequate risk assessments (ASEAN, 2015) Therefore, this study hypothesizes that greater financial freedom leads to a reduction in ASEAN bank profitability

Hypothesis 2: Higher financial freedom decreases bank profitability

Foreign bank assets and bank profitability

Foreign bank assets are the ratio of total foreign bank assets to total banking assets A greater presence of foreign banks tends to foster healthy competition due to their enhanced cost control and profitability (Claessens and Laeven, 2004) This heightened competition boosts the competitiveness and profitability of domestic banks (Chan and Karim, 2016) Khan et al (2015) also find that foreign bank entry lowers domestic bank overhead costs in Turkey through technology spillover effects, leading to increased profit efficiency in the domestic banking industry

Multinational banks tend to outperform domestic ones Havrylchyk (2006) and Jeon and Miller (2005) note increased efficiency for foreign bank clients from diverse countries Multinational banks can secure capital at lower costs due to external liquidity access through parent banks (Onio, 2016) Foreign bank entry bolsters the indigenous financial sector, as seen in Guillen et al.'s (2014) study on Latin American bank profitability Higher international bank assets lead to more technology transfer and skilled labor, enhancing profit efficiency locally These findings highlight foreign banks' positive impact on the banking system's profitability

Prior research suggests that increased foreign presence and assets can lower bank profitability due to higher financial constraints on foreign banks compared to domestic ones (Beck et al., 2013) According to Saif-Alyousf et al (2017), foreign banks, having less information about potential clients than domestic banks, may face increased information costs, resulting in reduced profitability They also note that this lack of information exposes multinational banks to higher non-performing loans, explaining their lower profitability compared to domestic banks Furthermore, Saif-Alyousf et al (2017) point out that international banks exhibit lower management efficiency, potentially due to agency issues between foreign bank managers and their parent banks

Moreover, some research suggests that foreign bank entry can lead to heightened competition, which might negatively affect both domestic and foreign banks Schnitzer (2013) notes that increased competition from foreign rivals can lead to an inefficient credit allocation system, resulting in higher bank non-performing loans and lower loan portfolio quality Caporale et al (2017) examine bank profitability in MENA countries and find that foreign bank entry correlates with reduced net interest margins, profitability, and non-interest revenue for domestic banks

International banks benefit the domestic banking system but may lower domestic bank profitability due to inefficient competition Major state-owned banks in Vietnam lack transparency and international competitiveness (Jesus and Torres, 2017) Foreign bank entry, driven by superior technology, experience (Guillen et al., 2014), and lower funding costs (Onio, 2016), can reduce profitability As a result, the third hypothesis is:

Hypothesis 3: Higher foreign bank assets reduce bank profitability

Research Model and Methodology

Research models

OLS, or ordinary least squares, is a widely used method in linear regression for estimating unknown parameters It's valuable for analyzing relationships between independent and dependent variables, especially in panel data OLS aims to find a line that minimizes the sum of squared differences between these variables, ensuring a better fit to the data Here's a simple representation of the OLS regression model:

ROAt i,t = f(Privatization, Bank-level, Country-level) ROEt i,t = f(Privatization, Bank-level, Country-level)

In the equation, i and t represent the bank and year, respectively ROA stands for returns on assets, while ROE represents returns on equity "Privatization" encompasses private banking sector development, including private sector credit, financial freedom, and foreign bank assets Bank-level variables include size, capitalization, and cost efficiency, whi bjkv;le country-level variables include banking concentration, GDP growth, and the error term denoted by ε

Fixed effects and random effects model

While OLS shows a linear link between private banking development and profitability, this can be affected by omitted variables Some unobservable factors may correlate with independent variables To address this, we'll use the fixed effects model to study the relationship between private banking sector development and bank profitability in Vietnam The fixed effects model can provide more consistent estimates by removing time-invariant factors, as seen in Guillen et al.'s (2014) research The model helps isolate the net impact of private banking sector loans on bank profitability by accounting for diverse qualities across categories that might influence or jointly determine the dependent variables

However, there's a possibility that the error term is linked to an independent variable, which can lead to inconsistencies in the fixed effects model, violating its assumption To address this, we'll consider a better-suited model, such as the random effect model We'll employ the Hausman test to determine whether the fixed effects model is valid If the Hausman test's P-value is less than 0.05, we can reject the null hypothesis, indicating that the fixed effects and random effects models are consistent but the random effects model is more efficient Therefore, the models used in this study are as follows:

ROAt i,t = f(Privatization, Bank-level, Country-level) ROEt i,t = f(Privatization, Bank-level, Country-level)

In the model, i and t represent the bank and year, respectively ROA and ROE stand for returns on assets and returns on equity "Privatization" encompasses private banking sector development, including private sector credit, financial freedom, and foreign bank assets Bank-level variables include size, capitalization, and cost efficiency Country-level variables include banking concentration, GDP growth, and the error term ε

To mitigate potential endogeneity issues stemming from unobservable factors jointly affecting bank profitability, we incorporate multiple control variables, encompassing both bank-level and country-level factors, into each regression model This approach offers a more comprehensive view of the factors shaping bank profitability in Vietnam

Table 3.1 shows the definitions of all private banking sector development and control variables included in this study

Table 3.1: Variable definitions and sources

Private sector credit Measures the degree of government borrowings in comparison with those of private sector The value ranges between 0 and 10 Higher value indicates lower central planning and higher development of private banking sector development

Financial freedom Measures bank efficiency and the levels of government ownership and interference to financial sector The index ranges between 0 and

100 Higher value indicates lower government ownership and influence on financial sector

Foreign bank assets Measured by the ratio of total foreign bank assets to total banking assets

The World Bank Bank size Measured by the natural logarithm of total assets

Higher values imply the larger bank

Bank financial statements Bank cost efficiency Measured by the ratio of bank overhead costs to assets Lower values indicate more cost efficiency

Bank financial statements Bank capitalization Measured by the rate of bank equity to assets

Higher values indicate more capitalization

GDP growth Annual percentage growth rate of gross domestic product based on constant local currency

The index is measured by the ratio of total assets of five largest banks to total banking asset Higher values indicate more banking concentration

The impact of bank size on profitability has been widely studied, with varying results Larger banks can benefit from economies of scale, lowering overhead expenses and boosting profitability (Claessens and Laeven, 2004) They offer services at lower costs and diversify their operations to increase earnings beyond lending, reducing risk (Andrianova et al., 2008; Chan and Karim, 2016) Tahir et al (2016) also find a positive link between bank assets and return on assets Additionally, larger banks may have greater market influence, affecting loan rates and service prices, leading to improved profit margins and efficiency (Claessens and Laeven, 2004)

However, a larger size may not guarantee greater profit efficiency, as inexperienced managers could struggle to oversee complex, large banks (Aladwan, 2015) Smaller banks often focus on specific customer segments or industries, leading to a better understanding and increased profitability (Simpasa and Pla, 2016) Moreover, larger size can introduce management challenges, resulting in higher agency costs and reduced profitability (Saif- Alyousf et al., 2017) Caporale et al (2017) also find that larger-scale operations may lead to poorer cost efficiency, especially for banks with weak management and transparency, in their study of bank profitability in MENA countries

The ratio of bank overhead costs to total assets determines bank cost efficiency Poor cost management can lead to inferior managerial and governance performance, ultimately reducing profitability (Maudos et al., 2002) Akkaya's (2016) findings suggest that highly cost-efficient banks tend to have lower non-performing loans, indicating better risk control and loan portfolio quality

Kwast and Rose (1982) argue that cost efficiency, as per the classical statistical cost accounting model, leads to improved operating efficiency, ultimately boosting bank profitability High-earning banks tend to have lower operating costs, supporting Onio's (2016) conclusion that foreign banks outperform local ones due to superior cost efficiency Foreign banks can access capital at lower costs, and their experience helps manage risk and expenses, leading to increased profitability However, Simpasa and Pla (2016) present contrasting findings They study cost efficiency in both public and private banks and find that private banks tend to be more profitable than public and foreign-owned banks Private banks with modern technology and transparency have better cost control and higher profitability Despite mixed results, it's evident that banks with higher cost efficiency are generally more profitable

Bank capital acts as a protective buffer against economic shocks, reducing losses (Claessens and Laeven, 2004) and liquidity risk (Onio, 2016) Basel's 8% minimum capital requirement enhances bank resilience (Kosmidou et al., 2007) Many banks in emerging markets don't meet this standard, leaving them vulnerable to economic shocks (Jesus and Torres, 2017) Well-capitalized banks tend to be more profitable as they face fewer risks, reflecting good management (Caporale et al., 2017) Higher equity levels enhance bank profitability, whether domestic or foreign (Saif-Alyousf et al., 2017) During financial crises, both local and international banks are more profitable, underscoring the importance of safeguarding equity against risk (Jeon and Miller, 2005)

However, some research highlights drawbacks of excess bank equity Hakenes and Schnabel (2011) note that high capital levels can distort competitiveness since it's costlier and generates lower returns than leverage or loans Beck et al (2013) agree, stating that lending is a primary income source for banks, and excessive capital can reduce lending and profitability They suggest maintaining high equity mainly during financial crises Equity funding, being costly, can sometimes outweigh efficiency benefits, resulting in reduced profitability (Dong et al., 2016)

Claessens and Laeven (2004) show that in nations with robust economic growth, banks attain greater profitability This stems from improved borrower performance, leading to reduced non-performing loans and loan loss provisions Lalon (2015) also suggests that banks can capitalize on their capital by investing in loan portfolios during positive economic cycles, boosting profitability Additionally, during periods of high economic development, banks tend to allocate equity to loan portfolios to enhance profitability, as they perceive lower risk during such times (Jeon and Miller, 2005)

Guillen et al (2014) find that banks perform better in strong macroeconomic conditions when they can increase lending and attract more deposits They use Data Envelopment Analysis to study bank profitability factors in Latin American countries This is because higher economic growth typically leads to greater fund demand (Simpasa and Pla, 2016), which particularly benefits commercial banks as their profitability depends on lending activities and credit provision volume (Simpasa and Pla, 2016)

Research Data

The foreign bank asset index measures international banks' influence in the domestic banking market, with higher values indicating a greater impact When foreign ownership exceeds 50%, a bank is considered foreign-owned, signifying increased private banking sector development

In terms of control factors, there's a substantial difference in bank size in Vietnam, with the largest bank nearly four times larger than the smallest Cost efficiency scores near 0 indicate highly efficient banks, where lower scores signify greater efficiency, expected to boost profitability Regarding bank capitalization, equity levels in Vietnam range from 0% to 71%, indicating varying capital buffers, with some banks potentially more vulnerable to economic shocks due to lower levels of equity, while others maintain substantial equity reserves

Variable Obs Mean Std Dev Min Max

Returns on assets (ROA) 451 0.010 0.007 -0.008 0.060 Returns on equity (ROE) 451 0.093 0.071 -0.619 0.373

Vietnam has maintained robust economic growth, averaging 6.411% from 2003 to 2017, even during the 2008 financial crisis, with a minimum growth rate of 5.25% This signifies consistent economic development over 14 years The country's banking system exhibits high concentration, with an average banking concentration of 66.5% At times, the top five banks held nearly 100% of financial system assets, indicating substantial market power and influence among major banks Recent declines in banking concentration suggest a trend towards greater financial freedom, fostering the growth of a private banking sector, including foreign banks

3.2.2 Private banking system development in Vietnam

Financial freedom, private sector credit, and foreign bank assets are used as three measures of the evolution of Vietnam's private banking system in this study

Figure 3.1 illustrates the progression of financial freedom in Vietnam from 2003 to

2017 Table 2 indicates that the average level of financial freedom in Vietnam during the study period stood at 31% As per Miller et al (2010), a score of 30 suggests substantial government influence, implying significant government control over loan allocation and financial assets The index values point to considerable challenges and constraints within the banking sector

Financial freedom in Vietnam remained stable from 2003 to 2015, with a slight improvement to a score of 40 in the following two years However, the overall trend still suggests significant government intervention in the financial industry due to the high concentration of large state-owned banks

Figure 3.1: Financial freedom in Vietnam (2003-2017)

The average private sector credit in Vietnam stands at 8.8%, indicating a lesser impact of government borrowings on the credit market However, the trend shows a slight decline in private sector credit over time, which contrasts with the Financial Freedom Index's assessment of sector development

Figure 3.1: Private sector credit in Vietnam (2003-2013)

Figure 3.3 displays the ratio of total foreign bank assets to total banking assets in Vietnam from 2005 to 2013, with limited observations On average, international banks' assets only constitute 3.55%, suggesting a minimal presence and impact However, it's worth noting that foreign bank assets more than doubled between 2005 and 2013, indicating Vietnam's gradual opening of the financial sector to foreign banks, potentially benefitting the private banking industry

Figure 2.3: Foreign bank asset in Vietnam (2005-2013)

Analyzing financial freedom, private sector credit, and foreign bank assets reveals that Vietnam's private banking sector is still underdeveloped There are significant constraints on bank operations, particularly for international banks, and a dominance of large domestic banks However, the relatively high level of private sector credit suggests that government borrowings have not crowded out private borrowing.

Research results and discussion

Research results

This study examines the impact of private banking sector development on bank profitability in Vietnam from 2003 to 2017 Appendix 1 confirms no significant correlation or multicollinearity issues among the variables in the regression models The analysis includes three models: Model (1) focuses on the influence of financial freedom on bank profitability from 2003 to 2017, excluding banking concentration levels due to data limitations Model (2) investigates the impact of private sector credit on bank profitability from 2003 to 2015, and Model (3) explores the relationship between foreign bank assets and profitability from 2003 to 2013

4.1.1 Private banking sector development and bank returns on assets in Vietnam - OLS

Table 4.1 presents the findings regarding the impact of private banking sector development on bank profitability from 2003 to 2017 Among the private banking sector development variables, only private sector credit exhibits a positive association with bank profitability, aligning with hypothesis 1 This suggests that increased private sector credit is linked to enhanced bank profitability in Vietnam, implying that reduced government borrowings and financial sector regulations contribute to higher bank profitability These findings also indicate a positive relationship between private banking sector development and bank profitability

Furthermore, increased private sector lending shows the expansion of the private banking sector This could be due to greater credit demand for private sector development (Simpasa and Pla, 2016) The domestic banking sector can benefit from the technology spillover effect, increasing the banking system's efficiency and profitability According to Firth et al (2016), private banks successfully manage risk taking and appraise borrowers, resulting in increased profitability Domestic banks can use foreign banks' high technology to improve their efficiency and profitability (Claessens and Laeven, 2004)

The impact of financial independence and foreign bank assets on bank profitability are statistically insignificant However, the negative coefficients may indicate that greater financial independence and the presence of international banks can reduce bank profitability

Table 4.1: Private banking sector development and bank returns on assets in

The table reports the implications of private banking sector development in Vietnam over the period 2003-2017 using OLS The dependent variable is returns on assets (ROA) Data for private sector credit and concentration is only limited to 2015, and for foreign bank assets is 2013 ***, **, * are significant levels at 1%, 5%, and 10%, respectively

All models show a significant 1% association between bank capitalization and profitability A 1% increase in bank equity yields a 0.044% profit gain, which is statistically significant at the 1% level This indicates that banks with higher equity are more profitable, in line with Claessens and Laeven (2004) and Kosmidou et al (2007) Conversely, Jesus and Torres (2017) link the vulnerability of emerging-market banks to inadequate capitalization Miller (2005) suggests that larger capitalization boosts profitability, especially during economic downturns

Models (1) and (2) both indicate a significant negative relationship between cost efficiency and profitability Lower cost efficiency levels, which result from dividing overhead costs by total assets, are associated with higher profitability This finding is consistent with recent research (Maudos et al., 2002; Akkaya, 2016), which suggests that improved cost efficiency reflects strong bank management and governance, leading to reduced non- performing loans, better loan portfolio quality, and increased profitability Kwast and Rose's

(1982) theoretical framework supports this idea, showing that greater cost efficiency enhances operational efficiency and ultimately leads to higher profitability This explains why foreign banks, known for their superior cost efficiency, tend to outperform public banks (Onio, 2016) Higher GDP growth positively impacts bank profitability, as observed in models (1) and

(3) This implies that banks thrive in periods of robust economic expansion During such times, borrowers face reduced overall risk, leading to fewer non-performing loans and lower loan loss provisions, ultimately enhancing bank profitability Additionally, banks tend to allocate more equity to loan portfolios during high economic growth phases to bolster profitability, as noted by Jeon and Miller (2005) These periods also facilitate attracting more depositors and earning higher returns, as seen in the study by Simpasa and Pla (2016) Bank concentration has a negative impact on profitability, with one of the two models confirming a significant link In less concentrated financial systems, banks tend to be more profitable This is partly due to the "too big to fail" phenomenon, where larger banks may engage in riskier activities for better returns, ultimately reducing profitability Additionally, as noted by Dong et al (2016), a more concentrated banking sector leads to reduced competition, lower transparency, and decreased efficiency Further regression models will help confirm the relationship between banking concentration and bank profitability

4.1.2 Private banking sector development and bank returns on equity in Vietnam - OLS

Table 4.2 confirms the relationship between private banking sector development and returns on equity (ROE) for the period 2003 to 2017, supporting Table 4.1's findings While Table 4.1 shows an insignificant link between financial freedom and bank profitability, Tables

3 and 4 together provide strong evidence that increased private sector credit drives higher bank profitability In essence, banks are more profitable when private borrowing isn't crowded out by government borrowing This aligns with Chan and Karim's (2016) observation that countries with a significant proportion of privately owned bank deposits tend to have more efficient and profitable banking systems

In simpler terms, more private sector credit implies a stronger private banking sector

This injects liquidity into the economy, stabilizes the banking system, and boosts bank profitability (Lalon, 2015) Furthermore, a robust private banking sector indirectly benefits bank profitability through technology spillover Private banks excel in risk management and borrower analysis, resulting in higher profits (Firth et al., 2016) Domestic banks can tap into this expertise Claessens and Laeven (2004) emphasize that foreign competition motivates domestic banks to adopt advanced technologies, enhancing their competitiveness and profitability

Model (3) reveals a significant negative relationship between increased foreign bank assets and bank returns on equity (ROE) This negative connection is statistically significant at the 1% level, indicating that a higher presence of foreign banks correlates with lower bank profitability One reason for this could be that international banks generally have lower profitability than domestic banks, which impacts the overall profitability of the banking industry Beck et al (2013) note that foreign banks face more financial restrictions than their domestic counterparts Moreover, international banks with limited knowledge of domestic consumers may incur higher information costs and asymmetric information issues, leading to reduced profitability (Saif-Alyousf et al., 2017) This can result in more non-performing loans for foreign banks and pose an agency problem that impairs management efficiency and profitability

Additionally, when more foreign banks enter the domestic banking system, competition intensifies, potentially diminishing bank profitability According to Schnitzer (2013), increased competition from foreign rivals can result in an inefficient credit allocation system, leading to more non-performing loans and lower loan portfolio quality for both domestic and international banks Consequently, both domestic and foreign banks' profitability may suffer

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Table 4.2: Private banking sector development and bank returns on equity in

The table reports the implications of private banking sector development in Vietnam over the period 2003-2017 using OLS The dependent variable is returns on equity (ROE) Data for private sector credit and concentration is only limited to 2015, and for foreign bank assets is 2013 ***, **, * are significant levels at 1%, 5%, and 10%, respectively

Discussion

This study explores how private banking sector development affects bank profitability in

Vietnam from 2005 to 2017 It investigates the impact of private sector credit, financial independence, and foreign bank assets on bank profitability using both ordinary least squares and fixed effects models The analysis finds that increased private sector credit is linked to higher bank profitability, suggesting that reducing government borrowings and central planning can foster private banking sector growth and profitability in Vietnam This has important implications for policymakers, especially considering the gradual decline in private sector lending between 2003 and 2015 Encouraging private sector lending can strengthen the private banking industry's profitability Additionally, the study robustly shows that a higher presence of foreign bank assets is associated with reduced bank profitability, likely due to increased competition and various challenges faced by foreign banks However, it's important to note that this impact is relatively minor, as foreign bank assets accounted for only 5% of total banking assets in 2013 Moreover, this effect is valid only from 2005 to 2013 and may not reflect recent trends These findings are relevant for policymakers during a period of banking liberalization in the ASEAN region Promoting the growth of the private banking sector can enhance bank profitability, while monitoring the presence of foreign banks is important, as it may affect profitability This study also contributes to the academic understanding of private banking sector development and its impact on profitability in

In comparison with prior research, the findings of this study both corroborate and extend the existing body of knowledge in the field of banking and finance Similar to studies conducted in diverse global contexts, this research identifies a positive correlation between increased private sector credit and higher bank profitability in Vietnam This alignment with

Commented [Ma2]: Note that: risk level increase with higher proportion of private sector credit A recommendation to wider private banking sector for profit reason is likely to cause systematic risk as happened established literature underscores the universal relevance of private sector lending as a driver of bank profitability Furthermore, the study's observations regarding the impact of foreign bank presence on domestic bank profitability during the earlier years of the research period echo findings from previous research in various emerging markets This congruence highlights the consistent nature of foreign bank entry as a factor affecting competition and profitability in banking sectors However, it is essential to note that the extent of this impact is relatively minor in the Vietnamese context, particularly given that foreign bank assets accounted for only a modest fraction of total banking assets in 2013 This unique aspect differentiates the current research from some prior studies, which may have focused on economies with a more substantial foreign bank presence Moreover, the time-sensitive nature of the observed impact, concentrated primarily between 2005 and 2013, underscores the importance of considering the evolving dynamics of the banking sector within Vietnam This nuance positions this study as a valuable addition to the literature, as it elucidates the specific interactions between private banking sector development, foreign bank presence, and bank profitability within the dynamic landscape of Vietnam's financial market As Vietnam continues to undergo banking sector liberalization, these findings offer pertinent insights for policymakers, guiding the formulation of policies tailored to the unique context of the country's financial development

In light of the findings of this study, several crucial lessons emerge for managers, policymakers, and stakeholders in the Vietnamese banking sector Firstly, managers of Vietnamese banks should recognize the significance of private sector lending as a driver of profitability Emphasizing the development of private banking services, tailored to the unique financial needs of high-net-worth individuals and corporate entities, can be a strategic avenue to bolster bank profitability Secondly, while foreign bank presence exerts a relatively minor impact on domestic bank profitability, vigilant monitoring and adaptation to changing competitive dynamics remain essential As banking sector liberalization continues, domestic banks should consider strategies to maintain their competitiveness Policymakers, on the other hand, can benefit from the study's insights by shaping regulatory frameworks that encourage private sector growth and ensure a level playing field for all banks, including foreign entrants The study's findings are valuable for banks, policymakers, and the Vietnamese government, especially in a period of multilateral liberalization Policymakers can recognize the positive influence of the private credit sector on bank profitability, prompting policy adjustments to support private sector credit Additionally, policymakers should investigate the challenges posed by foreign banks, identify underlying causes, and work on enhancing the performance of foreign banks.

Conclusion

Conclusion

This study explores how private banking sector development affects bank profitability in Vietnam from 2005 to 2017 It investigates the impact of private sector credit, financial independence, and foreign bank assets on bank profitability using both ordinary least squares and fixed effects models The analysis finds that increased private sector credit is linked to higher bank profitability, suggesting that reducing government borrowings and central planning can foster private banking sector growth and profitability in Vietnam This has important implications for policymakers, especially considering the gradual decline in private sector lending between 2003 and 2015 Encouraging private sector lending can strengthen the private banking industry's profitability Additionally, the study robustly shows that a higher presence of foreign bank assets is associated with reduced bank profitability, likely due to increased competition and various challenges faced by foreign banks However, it's important to note that this impact is relatively minor, as foreign bank assets accounted for only 5% of total banking assets in 2013 Moreover, this effect is valid only from 2005 to 2013 and may not reflect recent trends These findings are relevant for policymakers during a period of banking liberalization in the ASEAN region Promoting the growth of the private banking sector can enhance bank profitability, while monitoring the presence of foreign banks is important, as it may affect profitability This study also contributes to the academic understanding of private banking sector development and its impact on profitability in Vietnam.

Research limitations and recommendations

Limited data availability for private sector credit (2015) and foreign bank assets (2013) may not fully capture recent effects on bank profitability in Vietnam Future studies could expand the study period or use different development measures Regulatory constraints on foreign banks should also be considered Utilizing additional variables can offer a more comprehensive view of the impact of private banking sector development on profitability The study's findings are valuable for banks, policymakers, and the Vietnamese government, especially in a period of multilateral liberalization Policymakers can recognize the positive influence of the private credit sector on bank profitability, prompting policy adjustments to support private sector credit Additionally, policymakers should investigate the challenges posed by foreign banks, identify underlying causes, and work on enhancing the performance of foreign banks.

Appendix

Due to data limitations for private sector loans (2003-2015), foreign bank assets (2005-

2013), and bank concentration (2003-2015), this study presents two correlation tables Financial freedom values remained relatively stable from 2003 to 2015, with minor changes in 2016 and 2017 To evaluate correlations across variables, the study divides the correlation matrix table into two parts

ROA ROE FF SIZE CAP GDPG C5

Note: ROA is returns on assets; ROE is returns on equity; FF is financial freedom; SIZE is bank size; CAP is bank capitalization; GDPG is annual growth rate of gross domestic product; C5 is bank concentration

ROA ROE PSC FBA SIZE CAP GDPG CE C5

C5 -0.120 -0.127 -0.432 -0.260 -0.130 0.012 0.136 -0.007 1 Note: ROA is returns on assets; ROE is returns on equity; PSC is private sector credit; FBA is foreign bank assets; SIZE is bank size; CAP is bank capitalization; GDPG is annual growth rate of gross domestic product; C5 is bank concentration.