The effects of foreign bank entry, deregulation on bank efficiency in vietnam

UNIVERSITY OF ECONOMICS HO CHI MINH CITY VIETNAM ERASMUS UNVERSITY ROTTERDAM INSTITUTE OF SOCIAL STUDIES THE NETHERLANDS VIETNAM – THE NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS THE EFFECTS OF FOREIGN BANK ENTRY, DEREGULATION ON BANK EFFICIENCY IN VIETNAM BY LUONG CONG HOANG MASTER OF ARTS IN DEVELOPMENT ECONOMICS HO CHI MINH CITY, November 2017 UNIVERSITY OF ECONOMICS HO CHI MINH CITY VIETNAM INSTITUTE OF SOCIAL STUDIES THE HAGUE THE NETHERLANDS VIETNAM - NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS THE EFFECTS OF FOREIGN BANK ENTRY, DEREGULATION ON BANK EFFICIENCY IN VIETNAM A thesis submitted in partial fulfilment of the requirements for the degree of MASTER OF ARTS IN DEVELOPMENT ECONOMICS By LUONG CONG HOANG Academic Supervisor: PHAM DINH LONG HO CHI MINH CITY, November 2017 DECLARATION “I certify the content of this dissertation has not already been submitted for any degree and is not being currently submitted for any other degrees I certify that, to the best of my knowledge, and help received in preparing this dissertation and all source used, have been acknowledged in this dissertation.” Signature Luong Cong Hoang Date: November 10th, 2017 i ACKNOWLEDGEMENT Foremost, I would sincerely thank Dr Pham Dinh Long, my supervisor, for his great support and advice in this thesis Furthermore, I would like to thank the Vietnam –Netherlands Program, especially professor Truong Dang Thuy and staffs for their assistance in this thesis I also would like to thank all my friends who always standing beside me with encouragement Lastly, I would like to thank my family for their great support not only in this thesis but also in my life ii ABSTRACT This study examines the effects of foreign banks entry to the efficiency of Vietnam‘s domestic banks following the government to initiate deregulation its financial banking We also review the bank efficiency in term of bank size and ownership structure There are two principled approaches to assess the efficiency of a bank by data envelopment analysis (DEA) and stochastic frontier analysis (SFA) methods In this paper, we apply the SFA method which is suggested by Berger et al (2009), Ahn, Lee & Achmidt (2001) to estimate the cost and profit efficiency of three groups that includes 100% foreign-owned, big four state-owned and other domestic banks Based on the initial sample which is collected from the BankScope database from Bureau van Dijk and FitchRatings and also annual reports of 37 banks in Vietnam over the period of 2009 to 2015 Results indicate that big four state-owned banks are seemly efficiency on both cost and profit approach while the 100% foreign-owned banks are not the most efficiency overall However, the 100% foreign-owned banks are able to gain economy of scale in revenue while the big four state-owned and other domestic banks hardly take an advantage of economic of scale All group of bank obtain the diseconomy of scope but the level is different Key words: foreign banks entry; financial deregulation; bank efficiency; data envelopment analysis (DEA); stochastic frontier analysis (SFA); economy of scope; economy of scale iii LIST OF ABBREVIATIONS DEA Data envelope analysis SFA Stochastic Frontier Analysis SFM Stochastic Frontier Model MLDV Maximum likelihood dummy variable SBV State bank of Vietnam SOCBs State-owned commercial banks JSCBs Joint stock commercial banks CE Cost efficiency PE Profit efficiency TFE True fix effect TRE True random effect TE Technical efficiency AE Allocative efficiency EE Economics efficiency NPLs Non-performance loans LDR Loan to deposit ratio CAR Capital adequacy ratio iv TABLE OF CONTENTS DECLARATION i ACKNOWLEDGEMENT ii LIST OF ABBREVIATIONS iv CHAPTER 1: INTRODUCTION 1.1 Problem statements 1.2 The evolution of Vietnam’s banking sector 1.3 The research objective 1.4 Organization of the thesis CHAPTER 2: LITERATURE REVIEW 2.1 The theoretical literature 2.1.1 Theory of productivity and efficiency 2.1.2 The method of efficiency measurement 12 2.1.2.1 Data envelope analysis (DEA) 12 2.1.2.2 Stochastic frontier analysis (SFA) 14 2.1.3 2.2 Economy of scope and economy of scale 17 Empirical studies 19 2.2.1 Vietnamese researches 19 2.2.2 International research of foreign bank efficiency 21 CHAPTER 3: DATA AND METHODOLOGY 24 3.1 Research methodology 24 3.2 Data descriptions 29 CHAPTER 4: RESULTS AND DISCUSSION 32 4.1 Descriptive statistics 32 4.2 Regression results 37 4.3 Discussion 43 CHAPTER 5: CONCLUSION 48 REFERENCES 50 v LIST OF TABLES Table 1: Laws of domestic banks and foreign banks Table 2: A snapshot of Vietnamese Banks in 2015 (bil VND) Table 3: An overview of development of SFA’s method 16 Table 4: Data sample over the period 2009-2015 .29 Table 5: Overview of the variables of cost and profit function 31 Table 6: summary statistics of variables in period of 2009-2015 .32 Table 7: Market share of total assets, 2009-2015 (%) 34 Table 8: The mean value of ROA, ROE, 2009-2015 37 Table 9: The loan-to-deposit ratio, 2009 – 2015 (%) 37 Table 10: Mean value of cost and profit efficiency, 2009–2015 37 Table 11: Mean value of the measured overall cost efficiency, 2009-2015 39 Table 12: Mean value of the measured overall profit efficiency, 2009-2015 39 Table 13: The economy of scope for three groups of bank: 2009 - 2015 41 Table 14: The economy of scale of banks: 2009 - 2015 43 Table 15: Net interest income and non-interest income, 2009-2015 44 vi LIST OF FIGURES Figure 1: Structure of banking system in Vietnam .4 Figure 2: Economic efficiency following input approach 10 Figure 3: Economic efficiency following output approach 11 Figure 4: Economic of scale from the cost approach .18 Figure 5: The stochastic production frontier .25 Figure 6: Market share of total assets, 2009-2015 (%) .35 Figure 7: The ratio of total cost to total assets 35 Figure 8: Return of assets (ROA) 36 Figure 9: Return of equity (ROE) .36 Figure 10: Cost and profit efficiency based on time-variant specification .38 Figure 11: Cost and profit efficiency, 2009-2015 39 Figure 12: Cost efficiency, 2009-2015 41 Figure 13: Profit efficiency, 2009-2015 .41 Figure 14: The economy of scope, 2009-2015 42 Figure 15: Number of branches, 2016 47 vii CHAPTER 1: INTRODUCTION Problem statements Banks are notable institutions in any society since they importantly contribute to the 1.1 development of the economics system Via operations, banks connect the surplus and deficit capital economic agents Due to the power of financial intermediation of banking industry, there are many empirical studies with the goal to enhance the bank efficiency and stability There have been many changes in the business environment in recent years Because of the boom of economics, globalization, deregulation and technological innovation This leads to the competitive pressure and instability of banks industry Rosengard & Du (2009) describes financial deregulation as the transition from a closed to a competitive financial system To more specific, with banking system, it means that the transfer of bank from monopoly or oligopoly, where have a restriction on competition, bank entry, expansion, and diversify, to an open and more competitive in banking system The government make an effort to create “a level playing field” not only between privately owned banks and public sector banks, but also between foreign banks and domestic banks This paper examines the impact of bank deregulation on Vietnamese banking efficiency We consider which bank efficiency has improved after financial deregulation Instead of comparing the consequence of deregulation with the consequence of without deregulation, we evaluate the performance of Vietnamese’s domestic banks by using the outcome of foreign banks as the benchmark In line with Claessens et al (2001) believed that in developing countries like Vietnam, foreign banks were more efficient than the domestic banks Therefore, it is reasonable to assume that foreign banks have got a superior governing structure and organization, skilled labor force and technical innovations No previous research in Vietnam uses a set of data including foreign banks before In general, big four banks obtain the highest level both cost efficiency (0.96) and profit efficiency (0.97) The cost efficiency of foreign bank is less than other domestic bank but the foreign bank possibly obtain more profit efficiency than other domestic bank The mean efficiency score of each group is not similar In other domestic banks, the cost efficiency is higher than the profit efficiency while we look at a contrast in foreign and big four banks Figure 12 shows the changes of cost efficiency over time of each type of bank As might be seen, the cost and profit efficiency fluctuated with an unclear trend in the period of 2009-2015 Efficiency in the bank industry ambiguously increases or decreases every year - To more precise, the cost efficiency of foreign and big four almost steadily decreases over time The cost efficiency of foreign banks fluctuates with wide variation from 0.97 in 2010 to 0.90 in 2015 In meanwhile, the value of other domestic banks goes up with a small rate - Profit efficiency of Foreign and Other Domestic banks has been lower than that Big Four, except foreign banks in 2012-2013 In 2009, the gap between the average scores of profit efficiency for foreign banks and the highest profit efficiency (Big Four) is 0.01, but in 2015, it increases to negligible 0.032 In meanwhile, it is surprising that the gap between the average indexes of cost efficiency for the foreign bank is lower than the highest cost efficiency (Big four) is approximately 0.02 in 2009 And it is widely continued gap up to 0.05 in 2015 So to speak, the cost and profit efficiency of the foreign bank were smaller than big four banks and their difference increased in the period of 2009-2015 40 Figure 12: Cost efficiency, 2009-2015 COST EFFICIENCY Foreign Big four Other domestic 0,98 0,96 0,94 0,92 0,9 0,88 0,86 2009 2010 2011 2012 2013 2014 2015 Figure 13: Profit efficiency, 2009-2015 PROFIT EFFICIENCY Foreign Big four Other domestic 0,99 0,98 0,97 0,96 0,95 0,94 0,93 0,92 0,91 0,9 0,89 2009 2010 2011 2012 2013 2014 2015 Economy of scope Following the Mester (2008), the economies of scope is measured according to the cost function We have the results as its follow: Table 13: The economy of scope for three groups of bank: 2009 - 2015 2009 2010 2011 2012 2013 2014 2015 -0.5283 -0.6467 -0.6538 -0.5515 -0.3663 -0.3573 -0.3772 big four -0.5439 Other -0.6784 domestic -0.5411 -0.5719 -0.5650 -0.5357 -0.4907 -0.4413 -0.7382 -0.7577 -0.7109 -0.6793 -0.6412 -0.5865 foreign 41 Figure 14: The economy of scope, 2009-2015 CHART TITLE foreign big four other domestic -0,1 2009 2010 2011 2012 2013 2014 2015 -0,2 -0,3 -0,4 -0,5 -0,6 -0,7 -0,8 As can be seen from table 12, the measure of all of bank are less than zero that implies diseconomy of scope However, the degree of each group has a difference The mean value of economies of scope of foreign, big four and other domestic banks are less than zero and equal -0.49, -0.53 and -0.68, respectively It is mean that the diversity of product may increase total cost The level of economies of scope of the foreign banks are greater than big four and other domestic banks Furthermore, the level of economies of scope of all bank may be increased in the period of 2009-2015 Besides, the gap of the economy of scope for cost between the domestic banks and foreign banks is 0.15 in 2009, but it widened up to 0.31 in 2013 Economy of scale It is surprising that foreign banks are able to take the advantage of economy of scale The null hypothesis of constant return to scale is H0 which is defined: 𝛽1 + 𝛽2 + 𝛽3 = In fact, the sum of 𝛽1 , 𝛽2 𝑎𝑛𝑑 𝛽3 is 1.25 which is tested by the F-statistic Moreover, the p-value equals 0.0094, signifying that foreign banks are more opportunity to gain an advantage of economy of scale in revenue at the 1% significance level Foreign banks should expand their size in order to take more revenue, so to speak 42 Table 14: The economy of scale of banks: 2009 - 2015 Foreign Big Other Big four & other four domestic domestic ln(deposit) 0.176* 0.426** 0.271*** 0.304*** (1.79) (2.30) (2.74) (3.42) ln(fix-assets) 0.17 (1.68) Total 0.269*** (3.85) 0.276* (2.06) -0.233 (-1.61) -0.198 (-1.46) 0.0689 (1.40) ln(num_emp) 0.905*** (7.69) 0.0831 (0.50) 0.880*** (4.90) 0.858*** (5.32) 0.722*** (5.59) constant -1.151** (-2.36) 1.213 -0.55 -0.865 (-1.47) -1.225*** (-2.71) -1.266* (-2.02) prob 0.0094 0.1901 0.3745 0.5980 0.5067 Observations 26 25 163 188 214 Note: *, **, *** denotes 10%, 5%, and 1% significance level, respectively 4.3 Discussion Overall, the average cost and profit efficiency of Big four group is the highest in the period of 2009-2015 according to the “true” random effects This is consistent with Nguyen, Nghiem, Roca & Sharma (2016) and Vu & Turnel (2010) The main reasons may be explained by the large size banks and the government have a strong relationship at various levels Chang, Liao, Yu, & Ni (2014) proved that under the financial system regulations has been strongly supervised by the government like Vietnam, the more banks develop a relationship with the government, the more supports and monetary authority may be obtained from the government This advantage helps Big four bank to produce more outputs, save more inputs, or both Claessens et al (2001) believed that in developing countries, foreign banks are more efficient than the domestic banks In this research, we found that foreign banks not necessarily mean best with the least average cost efficiency To more specific, the cost efficiency decreased from 0.96 to 0.90 during the period of 2009-2015 The profit efficiency of foreign banks also tends to decrease from 2013 In meanwhile, it seems 43 that the efficiency level of big four and other domestic banks are more stable than foreign bank Table 15: Net interest income and non-interest income, 2009-2015 Obs Mean Std Dev Min Max Foreign Net interest income 39 947.09 807.42 21.06 2,900.16 Non-interest income 39 429.20 426.17 (8.00) 1,295.90 Net interest income 26 14,525.63 5,408.04 6,678.10 26,727.30 Non-interest income 26 3,123.53 1,210.35 737.80 5,534.90 Net interest income 174 1,992.53 1,972.75 99.80 10,355.78 Non-interest income 174 388.95 514.09 (1,181.20) 2,246.15 Big four Other domestic While the main profit of other domestic and big four banks primary come from net interest income, about times compared to non-interest income, the profit of foreign banks from interest income show a double difference to non-interest income Mainly non-interest income comes from products and services such as: card, wire transferring, overseas remittance, foreign currency trading In meanwhile, net interest income comes primarily from loans To know more about the level of loans, we are going to consider the loan-to-deposit ratio of each group in the next section Under the SBV’s Circular No.36/2014/TT-NHNN, the LDR must be maintained at 90% at State-owned commercial banks and branches of foreign banks, and 80% at cooperative, joint stock, joint venture, 100% foreign-owned banks The LDR of big four has been higher than other banks During the period of 2009-2015, the average LDR of big four, foreign and other domestic banks are about 80%, 60% and 63%, respectively Thanks to high LDR, big four may be gained the optimal ratio and earned more profit All of banks have room to increase loan in the future However, a combination of prudence and regulatory requirement depends on business model of 44 each bank If the LDR is too high, the bank may not have enough liquidity to cover by unexpected massive cash withdrawals While the regulation on domestic and foreign banks not seem very different, the difference in cost and profit between domestic and foreign bank may come from the competitive advantages of domestic banks compared to foreign banks Several advantages including:  Domestic banks have a wide trading network and a large number of employees Ho (2014) stated that the banks with more employee and branches will be preferred by customers The number of branch of foreign banks is tiny compared to domestic banks In 2016, the quantity of big four, other domestic banks and foreign banks are 4.922, 4.875 and 53, respectively Moreover, the market share in term of total assets, total loans, total costs of foreign banks is small To more specific, the market share of total assets of foreign banks has accounted for a low proportion of 3.29% in 2015  It is difficult for a new entrance, foreign banks, to attract customers who transacted with domestic banks In Asia culture, they appreciate the longterm relationship Moreover, switching banks may take the small cost (Ho 2014)  The main profit of foreign banks come from fee-based services while domestic banks also collect more interest on deposits and loans In fact, the outcome of foreign banks from interest income is about two times compared to non-interest income But this ratio is about five times for big four and other domestic banks  Moreover, these foreign banks are located primarily in metropolitan such as Ho Chi Minh, Ha Noi, Da Nang where operating and personal expenses are greater than another place The result also showed that three groups of bank have found diseconomy of scope However, the trend has increased slightly in the period 2009-2015 It means that costs 45 of single product are estimated to be lower than increasing the number of different lines of bank products It is suggested that all bank should focus on a single line of business to reduce the cost of capital In term of economy of scale, foreign banks have more opportunity to improve the efficiency of production in the future by increasing the size, output and activity level The market share of foreign banks is small In fact, figure 15 displays the branches that have been opened in Vietnam in 2016 The quantity of branch of foreign bank is truly small compared to the huge number of big four Furthermore, branches of foreign bank mainly located at the center of the big city Therefore, they are able to exploit more branch in Vietnam It may take more time for the spillover effects In summary, it is recommended that all banks should not increase the number of different lines of bank products at this time Product diversification may increase significantly cost but the return may not be as expected Instead, they should improve service quality and management skills, and develop new science and technology If foreign banks want to take the greatest advantage of economy of scale, they should expand in size substantially 46 Figure 15: Number of branches, 2016 AGR 2300 VTB 1156 BID 1006 STB 563 SHB 500 VCB 460 ACB 345 TEC 315 MAR 300 MBB 254 SCB 230 DAB 223 HDB 220 VPB 214 EIB 207 VIB 160 SEA 154 ABB 146 LVP 130 KLO 110 VIE 100 TPB 100 OCB 100 BAC 92 NAV 90 SGB 86 PGB 81 NAM 67 VCA 48 BVB 40 HSBC 15 ANZ 11 SHIN 11 VID HOL STD 500 1000 47 1500 2000 2500 CHAPTER 5: CONCLUSION 5.1 Concluding remark The banking system in Vietnam has experienced significant reforms towards deregulation since the 1990s There were several reform including decline of state ownership, entry and open branches of foreign banks, encouragement foreign institutional ownership in domestic banks, listing on the stock exchange However, the activities of foreign banks were still under the authority of regular restrictions and entry requirement The deregulation has experienced significant after WTO in 2007 that marked a vital point in the banking sector’s deregulation The restrictions on foreign bank entry were lifted in phases To more specific, following the WTO commitments, 100% foreign banks have been allowed to open in Vietnam Moreover, a strategic foreign investor may increase up to 20% shares in a particular domestic bank And a maximum of 30% shares in a particular domestic bank to be owned by all foreign holdings Claessens (2001) believed that in developing countries like Vietnam, foreign bank has more advantaged in technical innovation and human capital Furthermore, according to the microeconomic theory, deregulation should encourage competition as well We aim to explore the question of whether foreign bank entry effect the bank efficiency in Vietnam We estimate level of bank efficiency in Vietnam exploiting all the required inputs and outputs as proposed by the intermediation approach (Berger and Mester, 1997) Applying the SFA method, we estimated cost and profit efficiency of 37 banks in Vietnam during the period of 2009-2015 It is convenient to categorize according to type and ownership of banks We divide banks into groups: Big four, other domestic and foreign banks The results revealed that foreign bank group is not the most efficiency but Big four is the most efficiency in term of both cost and profit overall Our finding is consistent with the results obtained by Nguyen, Nghiem, Roca & Sharma (2016) Furthermore, banks may exist the diseconomy of scope but the level 48 of each group has the difference It means that banks should not diversify products because of increasing of costs In meanwhile, foreign bank’s group has able to exploit economy of scale in revenue by expanding the bank’s operation area Thanks to the results that have just found, it is more confidence for policy makers to make decisions 5.2 Policy implications A number of recommendations has been suggested to enhance the efficiency of banks industry in Vietnam Firstly, the competitive and fair environment should been established for all banks To more specific, privatization of SOCBs may be conducted via reducing or removing equity that held by the SBV Moreover, we should encourage foreign institutional ownership by relaxing restrictions on the activity and entry Secondly, the SBV’s management should be improved in order to upgrade the quality of banks Moreover, the independence of the SBV should be strengthened Thirdly, empirical shows that all banks should not diversify their business at this time since the cost may be increased and the revenue may be gained as expect Lastly, foreign banks have the opportunity to saving operating costs by widen their operating range 5.3 The limitation and further research The findings in this research have not considered the influence of the macroeconomic factors There are many sectors which may effect on the development of the banking industry in Vietnam such as the policy of the government, the quality of ICT infrastructure, and market concentration The competition and stability among banks has not been dug deeper in this paper It is obvious that foreign bank entry has created the competitive environment and spillover effects to bank industry However, the government’s policies should be issued to protect the domestic banks and assist the banking industry more stability 49 REFERENCES Ahn, S C., Lee, Y H., & Schmidt, P (2001) GMM 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