Factors affecting capital safety of commercial banks in Vietnam

he adjustment of capital levels can increase indirect costs. Because, the issuance of new capital or liquidation of existing capital can be viewed by investors as a signal that the bank's market price is higher than its intrinsic value, thus increasing the adjustment cost. 2.2.2. Macro factors 2.2.2.1. Economic growth Banks can change the level of capital to adapt to the risk fluctuations arising from changes in the economic environment. During the economic downturn, the economic activities were ineffective, affecting the quality of bank assets, especially increasing bad debts. In general, during the economic downturn, banking activities faced many risks, losses, and "eroded" bank capital. Therefore, banks can take preventive measures by holding more capital. During periods of growth, there is less risk that banks can hold less capital. Thus, the relationship between CAR and economic growth is negative (Wong et al., 2005). 2.2.2.2. Inflation High inflation represents an increase in the total price of goods and services leading to a decrease in the purchasing power of money. When inflation is high and unexpected, it can cause losses to the economy. High inflation often translates resources from lenders and savers to borrowers because borrowers can repay debt with lower value currencies. Rising inflation rates interfere with the ability of the "financial industry to allocate resources efficiently". The relationship between inflation and the development of the banking industry, especially capital adequacy, is negative (Boyd et al., 2001). 2.2.2.3. Interest rate According to Demirguç-Kunt & Detragiache (1997), higher lending rates may adversely affect the ability of borrowers to repay loans. High lending rates lead to higher rates of customer bankruptcy and high lending risk, which increases bank risks. This can have a negative impact on the capital safety of banks, as many borrowers are unable to pay off their debts. Therefore, when examining the impact of interest rates on CAR, studies are often interested in lending rates. 2.2.2.4. Exchange rate An increase in the exchange rate indicates a decrease in the value of the local currency relative to the foreign currency. The exchange rate is a measure of the value adjusted for inflation of the local currency against the average through the rights of some foreign currencies. The impact of changes in the exchange rate on the bank's CAR through profits, depending on the size of the bank's operations in foreign currencies. The impact of exchange rates on CAR depends on the proportion of assets of the overseas banking system. in foreign countries. For banks with a large number of foreign stocks and assets, when the exchange rate increases, its CAR will be 10 larger. For banks with a low number of foreign stocks and assets, when the exchange rate rises, CAR is lower (Bahihuga, 2007). 2.2.2.5. Capital adequacy of the banking system In assessing the financial strength of a bank, the market and rating organization may assess the bank's capital adequacy in relation to other banks. Therefore, commercial banks often keep CAR at a higher level to distinguish them from other banks. Banks use their capital as a signal for competition with banks of the same size in the market (Wong et al., 2005). Therefore, when the average CAR of the banking system is higher, the pressure on commercial banks to increase their CAR is higher. 2.2.2.6. Pressure of capital adequacy regulations Banks must comply with the capital regulations to ensure safe and healthy banking operations such as minimum CAR regulations. The minimum CAR can be specified for banks or for individual banks depending on the rules of each country. In case of violation of regulations, banks will be subject to penalties. Therefore, the pressure from regulations is an important factor affecting the capital safety of banks. CHAPTER 3. CAPITAL ADEQUACY AND FACTORS AFFECTING CAPITAL ADEQUACY OF COMMERCIAL BANKS – CASE OF VIETNAMESE BANKS 3.1. Situation on capital adequacy of Vietnamese commercial banks 3.1.1. Legal provisions on capital adequacy Vietnam's banking system is gradually completing the regulations on capital safety in accordance with international practices and standards. The roadmap for implementing international standards on capital safety is clearly stated in the development orientation of the banking system in the coming time. Currently, commercial banks in Vietnam determined CAR with Circular 36 and must ensure minimum CAR is equal to 9% and the minimum level of capital level is 4%. CAR of Vietnamese commercial banks is calculated by equity capital on total risky assets. The minimum level of capital is calculated by Tier 1 capital on total risky assets. In which, equity capital is determined by total of tier 1 capital and tier 2 capital minus deductions, total risk-weighted assets is total assets adjusted for credit risk. 3.2.2. Capital adequacy ratio of commercial banks in the sample The average CAR of Vietnamese commercial banks in the period of 2008-2017 is over 10%, exceeding the minimum CAR prescribed. However, in the period of 2008-2012, the CAR gap between commercial banks was quite large, and there were still commercial banks that did not ensure minimum CAR. n the period of 2013-2017, the average CAR was at 13% - 14%, down from CAR in the period of 2008-2012. However, the average CAR of commercial banks at this stage is still higher than the minimum CAR and no banks have CAR below the minimum level. 3.2. Situation on factors affecting capital adequacy 3.2.1. Bank size Vietnamese commercial banks in the period of 2008-2017 have constantly expanded their assets, especially since the implementation of the credit institution restructuring project. Under the scheme of restructuring credit institutions since 2011, commercial banks must ensure the legal capital of VND 3,000 billion. This regulation has forced commercial banks to increase capital in many different ways, thereby affecting the assets size of commercial banks. 11 3.2.2 Leverage ratio The average leverage ratio of Vietnamese commercial banks is within the permitted limits. However, in 2008, 2009, 2011, 2015, 2016 and 2017, some commercial banks had higher leverage ratios than the limits. At the same time, there is a big difference in the leverage ratio of Vietnamese commercial banks. As the asset size expands, so does the leverage ratio. Besides, it also shows that regulations on leverage ratio have not been focused on implementation in Vietnam in recent years. Therefore, in the coming time, regulatory agencies should pay attention to control the implementation of regulations on leverage ratio, contributing to ensuring safety and soundness for banking activities. By using too much leverage, it increases the risk of loss of liquidity of commercial banks. 3.2.3 Loans The average lending ratio of Vietnamese commercial banks generally ensures the safety framework CAMELS's loan proportion is less than 60%. In particular, due to the impact of the world financial crisis, The average lending ratio of Vietnamese commercial banks in 2010-2011 decreased compared to previous years and was at low level, below 50%. In the next period of 2012 -2107, the proportion of loans of Vietnamese commercial banks increased again at over 50%, by 2017 reached 60.57%. 3.2.4. Non-performing loans and Non-performing loans sold to VAMC Except for the years 2012, 2013, 2014, the bad debt ratio of Vietnamese commercial banks in the period of 2008-2017 all ensured the safe limit set by the SBV at 3%. In the period of 2012- 2014, the rapid increase in bad debt was due : (i) the impact of the economic crisis and macroeconomic instability, (ii) (i) the impact of the economic crisis and macroeconomic instability, (ii) bad debts as a result of the weak operation of the banking system. In the period of 2015-2017, the bad debt ratio was controlled within safe limits as prescribed by the State Bank. According to regulations, Vietnamese commercial banks with non-performing loans ratio of 3% or more must sell non-performing loans to VAMC. Since 2013, Vietnamese commercial banks have sold non-performing loans to VAMC. Selling non-performing loans helps Vietnamese commercial banks reduce non-performing loans on the balance sheet, reduce credit risks and thus increase the bank's capital adequacy. The non-performing loans that Vietnamese commercial banks sold to VAMC increase in the period of 2013-2017. In 2013, on average, each commercial bank sold VND 1.177,469 billion of non-performing loans to VAMC, in 2017, that figure reached VND 7.199,00 billion. In particular, the most bad debts sold to VAMC are commercial banks: Agribank, BIDV... 3.2.5. Provision for credit risk The average credit risk provision ratio shows that the average credit risk provision ratio was the highest in 2011-2014 and tended to decrease gradually from 2012-2017. Levels of credit risk provisioning, including general provisioning and separate provisioning for each debt group. According to the researchers' assessment, the grouping of debts, especially bad debts, has not reflected properly and therefore has not been fully provisioned (Tran Tho Dat and Le Thanh Tam, 2016). This implies risks for Vietnamese commercial banks and causes unpredictable consequences. When credit risk happens, commercial banks will not have enough reserve fund to 12 cover losses. 3.2.6. Liquidity The liquidity of Vietnamese commercial banks tended to decrease in the period of 2008- 2017. The average liquidity ratio of Vietnamese commercial banks in the period of 2008-2012 was over 20%, ensuring that according to international standards Moody's and CAMELS were over 20% (Vietnam did not have specific standards for liquidity ratio). However, in the period of 2013-2017, the average liquidity rate of Vietnamese commercial banks dropped to below 20%; in 2015, 2016, 2017, the liquidity ratio was: 14.39%; 12.72%; 14.44%. At the same time, many banks have much lower liquidity ratios than international standards. 3.2.7. Profitability The average ROE of Vietnamese commercial banks during 2008-2017 is lower than the international standard of ROE. Low ROE shows that commercial banks' activities are not really effective, affecting the ability of commercial banks to raise capital as well as threaten the ability of commercial banks to ensure capital safety. 3.2.8. Economic growth Vietnam has applied many measures to overcome the crisis and economic recession period 2008-2014. In the period of 2015-2017, the economy began to show signs of recovery, closed an economic cycle and opened a new cycle. Economic growth in the period of 2015-2017, although lower than the period before the global financial crisis, gradually improved, creating favorable conditions for stability and development in all areas of the economy. economics as well as banking operations. 3.2.9. Inflation Compared to the previous period, the period from 2015 to 2017, the rate of inflation increased gradually at the allowed level, the economy was stable and increased again, the inflation rate in 2017 was 4.4%. Low inflation in recent years has contributed to exchange rate stability, monetary and financial stability. A lower or higher inflation level than the target inflation is always unexpected, negatively affecting the economy. Increased inflation will reduce the real value of income and assets, reduce investment opportunities and debt repayment capacity and thus threaten the capital adequacy of commercial banks. 3.2.10. Interest rate After the implementation of the goal of reducing interest rates, Vietnam's lending interest rates have decreased by about 50%, from 15.79% / year (in 2008) to about 7.07% (in 2017). Lending rates decreased rapidly in the period of 2011-2017, bringing great benefits to businesses, banks and the economy of Vietnam. For banks, the low lending interest rate level helps them significantly reduce credit risk as businesses cannot repay loans due to high interest rates. For the economy, reducing lending interest rates contributed to supporting economic growth and increasing national competitiveness. 3.2.11. Exchange rate The policy of exchange rate management of the State Bank of Vietnam, the exchange rate and foreign exchange market of Vietnam have gradually stabilized, limiting exchange rate risks for businesses. The liquidity of banking system has been improved, confidence in the value of Vietnam dong has been strengthened, and dollarization has fallen sharply. This contributes to 13 ensuring safety and health in the operation of Vietnam Cooperative. 3.3. Analysis of capital adequacy level of Vietnamese commercial banks Based on the status of capital adequacy as well as the factors affecting capital adequacy of Vietnamese commercial banks, the author gives some advantages and limitations on the capital adequacy of Vietnamese commercial banks. Nam as follows: 3.3.1. Advantages: It can be seen that, since the SBV implemented restructuring the TTCD system, by the end of 2011 until now, the Vietnamese commercial banking system has achieved certain achievements in ensuring capital safety as follows: Firstly, the regulations on capital safety are increasingly being improved according to international standards (Basel II). Currently, Vietnam commercial banking system implements CAR calculation according to Circular 36/2014/TT-NHNN. Circular 36 generally guarantees Basel I's regulations and in the coming time the Vietnamese commercial banking system will implement CAR according to Basel II. The SBV has built a roadmap for implementing Basel II with the goal of implementing Basel II standards for the entire banking system by 2020. To achieve that goal, the SBV has had specific programs and actions such as: Promulgating legal documents regulating CAR for commercial banks and foreign bank branches - Circular 41/2016/TT-NHNN. Circular 41 provides basic provisions for calculating CAR according to Basel II. Secondly, the capital adequacy ratio of Vietnamese commercial banks exceeded the minimum requirement of 9%. Analysis of the situation of capital adequacy of Vietnamese commercial banks shows that the average CAR of Vietnamese commercial banks is above the minimum safety level set by the State Bank. Thus, it can be seen that the equity capital of Vietnamese commercial banks has ensured the prudential ratios for assets with credit risk as prescribed. As a result, Vietnamese commercial banks can deal with possible losses to credit activities, contributing to ensure the safety of the bank's operations as well as the safety of depositors. Thirdly, the increasing capital of banks helps banks maintain CAR as required when the assets size is increasing. In recent years, Vietnam's banking system has been constantly expanding in terms of own capital and total assets. Expanding the equity capital, total assets help banks improve their financial capacity and competitiveness to meet market requirements. Increasing equity capital helps banks ensure stability, safety and soundness in operations when asset size is increasing. By equity and assets, specifically credit risk assets directly affect the CAR of banks. 3.3.2. Defect In recent years, according to the Basel II implementation roadmap proposed by the State Bank of Vietnam, Vietnamese banks constantly improve their financial capacity, management capacity ... to gradually improve and prepare conditions to implement Basel II. However, the capital adequacy of Vietnamese commercial banks still has limitations that need to be improved and improved as follows: Firstly, CAR is not equal among types of banks and lower than other countries in the region. 14 The average CAR of Vietnamese commercial banks, although higher than the minimum CAR, is not evenly different among types of banks. In particular, the state-owned commercial banks have lower CAR than the group of commercial banks and foreign commercial banks and close to the minimum requirements. Besides, if compared to other countries in the region, CAR of Vietnamese commercial banks is lower than other countries in the region, and has tended to decrease in recent years. Secondly, CAR of Vietnamese cooperatives does not meet Basel II standards while developed countries have implemented Basel III. CAR of the current Vietnamese banking system is calculated according to Circular 36/2014/TT-NHNN, only ensuring CAR according to Basel I. According to this calculation, CAR only takes into account credit risk. The determination of equity capital and credit risk-adjusted assets to determine CAR according to current regulations still does not meet Basel II standards.. Thirdly, CAR of Vietnamese commercial banks tends to reduce, threatening the capital adequacy of banks in the coming time. Actual data shows that CAR of Vietnamese commercial banks tends to decrease. Especially, according to the assessment of the State Bank of Vietnam in the coming time, when calculating CAR according to Basel II, the CAR of commercial banks will continue to decrease if there is no additional adjustment in equity capital. According to the new CAR calculation method (compared to the current calculation method): (i) The bank's equity will decrease and (ii) risk adjusted assets will increase due to tighter credit risk weighting. and adding both market risk and operational risk. CHAPTER 1. ANALYZING OF FACTORS AFFECTING CAPITAL ADEQUACY OF VIETNAMESE COMMERCIAL BANKS 4.1. Hypothesis Previous studies have shown that the bank's capital adequacy is influenced mainly by the banks' decisions as well as the capital adequacy regulations. However, studies also show that macroeconomic factors also have certain effects on capital adequacy of banks. Based on previous and actual studies in Vietnam, the author makes the following research hypotheses: Table 4.1 The hypotheses of the research model Symbol Hypotheses Expected sign Base citation H1 This loan is inversely correlated with the capital adequacy of commercial banks. - Aspal et al (2014); Büyüksalvarci & Abdioğlu (2011); Bokhari & Ali (2012) H2 Non-performing loans is negatively correlated with capital adequacy of commercial banks. - Ahmad et al. (2008); Gropp & Heider (2007); Asarkaya & özcan (2007) H3 Provision for credit risk is positively correlated with capital adequacy of commercial banks. + Ahmad et al (2008); Büyüksalvarci & Abdioğlu (2011); H4 Bank's profitability is positively + Berger et al. (1995); Wong et al. 15 Symbol Hypotheses Expected sign Base citation correlated with capital adequacy of commercial banks. (2005); Asarkaya & Özcan (2007); Bokhari & Ali (2012); Büyüksalvarci & Abdioğlu (2011) H5 Bank size is negatively correlated with capital adequacy of commercial banks. - Wong et al. (2005); Alfon et al. (2005); Asarkaya & özcan (2007); Büyüksalvarc & Abdioğlu (2011); H6 Leverage is negatively correlated with capital adequacy of commercial banks. - Ahmad et al. (2008); Büyüksalvarci & Abdioğlu (2011); Bateni et al. (2014); H7 Liquidity is positively correlated with capital adequacy of commercial banks. + Berger & Bouwman (2009); Aspal et al (2014); Trương Thị Hoài Linh (2016) H8 Non-performing loans sold to VAMC is positively correlated with capital adequacy of commercial banks. + H9 Capital adequacy ratio in the previous period was positively correlated with capital safety of commercial banks + Wong et al (2005); Asarkaya & özcan (2007); Dhouibi,R. (2016) H10 The level of government ownership is negatively correlated with the capital adequacy of commercial banks - La Porta et al. (2002); Gerschenkron (1962); Shleifer và Vishny (1998) H11 The growth rate of the economy is negatively correlated with the capital adequacy of commercial banks - Wong et al (2005); Alfon et al. (2005); Asarkaya & özcan (2007); Trương Thị Hoài Linh (2016); H12 Inflation is negatively correlated with capital adequacy of commercial banks - Shaddady & Moore (2015); Williams (2011); Akhter & Daly (2009); H13 Interest rates are negatively correlated with capital adequacy of commercial banks - Demirguç-Kunt & Detragiache (1998); Shaddady & Moore (2015); Williams (2011) H14 The exchange rate is negatively correlated with the capital adequacy of commercial banks - Williams (2011); Shaddady & Moore (2015) H15 Capital adequacy ratio of the banking system is positively correlated with capital adequacy of commercial banks + Asarkaya & özcan (2007) Mohamed Romdhane (2012); Alfon et al (2004); 16 Symbol Hypotheses Expected sign Base citation H16 The pressure of regulations is positively correlated with the capital adequacy of commercial banks + Kleff & Weber (2003); Wong et al. (2005); Asarkaya & özcan (2007); Hypothesis H1: Loans are negatively correlated with capital adequacy of commercial banks. The effect of the loan on the capital adequacy of the bank is considered through the proportion of loans in total assets. When the proportion of loans in total assets increases, it also means the risk increases. A lower loan ratio indicates that the bank invests less in the loan and is therefore less risky (Bikker and Metzemakers, 2007). As such, loans may be negatively correlated with capital adequacy. Hypothesis H2: Non-performing loans is negatively correlated with capital adequacy of commercial banks. High NPL ratio and low loan quality will increase credit risk. When credit risk occurs, it will cause losses to the bank and at the same time threaten the safety of depositors. Thus, bad debt may be inversely correlated with capital adequacy of Vietnam commercial banks. Hypothesis H3: Provision for credit losses is positively correlated with the capital adequacy of commercial banks. Allowance for credit losses reflects the ability of commercial banks to offset their estimated losses. The higher the ratio of provision to total loans, the greater the ability to offset losses when risks occur, thereby increasing the ability to ensure safety for commercial banks. Thus, credit risk provision is positively related to capital adequacy of banks. Hypothesis H4: Bank's profitability is positively correlated with capital adequacy of commercial banks. Profitability affects the ability of banks to raise capital. For commercial banks with good profitability, they will create favorable conditions for banks to raise capital through retaining profits for reinvestment. In addition, when the bank retains profits for reinvestment, shareholders will require a higher return. Therefore, the bank's profitability is positively correlated with the bank's capital adequacy.. Hypothesis H5: Bank size has negatively correlated with capital adequacy of commercial banks Demsetz & Strahan (1997) argue that large banks enjoy better diversification and therefore operate with lower capital ratios. Big banks often have smaller reserves of reserves than small banks because big banks mean "too big to fail." So, capital inherent safety is inversely proportional to the size of the bank. Hypothesis H6: Leverage has negatively correlated with capital adequacy of commercial banks The leverage ratio and capital adequacy of the bank are negatively correlated. This means that banks with low leverage have high capital adequacy. Because banks have low loans, it is not difficult to raise new capital and thus holds more equity than banks with high loan ratios. Hypothesis H7: Liquidity is positively correlated with capital adequacy of commercial banks 17 High capital increases the ability to create liquidity for banks. When liquidity risks occur, the bank's capital ratio will be reduced. Liquidity risk is the case where a bank is not able to fulfill its financial commitments, causing loss of assets or unexpected expenses. To avoid such situation and maintain financial stability, banks need to maintain sufficient "liquid" capital buffer Hypothesis H8: Non-performing loans sold to VAMC is positively correlated with capital adequacy of commercial banks. By selling bad debts to VAMC, commercial banks will reduce the size of bad debts on the balance sheet. Bad debt on the balance sheet will reduce the denominator - the total risk assets when determining CAR, thus increasing the capital adequacy ratio or increasing the capital adequacy of co