Increasing the charter capital of banks – An urgent task that needs to be controlled

This article was written by our Managing Partner Nguyen Van Phuc and Vu Trung Thanh published in the Legal Electronic Magazine on January 11, 2024. Below is the English version:

On December 28, 2023, the State Bank of Vietnam issued Decision No. 2486/QD-NHNN on the amendment of the business license of Lien Viet Post Bank ("LP Bank"). Accordingly, the State Bank of Vietnam has approved LP Bank to increase its charter capital by an additional amount of VND 5,000 billion to the charter capital. At the same time, the National Citizen Bank ("NCB") was also approved to contribute VND 6,200 billion to the charter capital. The charter capital increase has been quite active, although it is only at the beginning of the year. However, it is not an abnormal situation in 2023 as the statistics show that the State Bank of Vietnam has approved the increase of charter capital for 21 joint-stock commercial banks, mainly using the bank's equity (retained profits and reserve funds)[1].

Charter capital is one of the most important elements for commercial banks. This is because it ensures the safety of banking activities and at the same time is the basis for expanding the business of commercial banks. When the economy is in recession, lending is restricted and charter capital is increased to maintain the "resistance" of banks. In addition, the increase of charter capital is the means to increase the minimum capital adequacy ratio, which is the target set by the government in the Nation Project provided in Decision No. 412/QD-TTg dated March 31, 2022 and Decision No. 689/QD-TTg dated June 8, 2022. Finally, the increase of charter capital is an urgent task in both the short and long term. However, the increase of charter capital of commercial banks must be controlled in order to ensure the safety of the entire banking system.

Sources: https://phaply.net.vn

The urgency of increasing the charter capital of commercial banks

To n order to ensure operational safety, commercial banks are required to maintain the Capital Adequacy Ratio (CAR). The Law on Credit Institutions 2010 stipulates that commercial banks must maintain a capital adequacy ratio of not less than 8% or higher as prescribed by the State Bank from time to time[2]. The aforementioned ratio is guided by Circular 41/2016/TT-NHNN, which stipulates that the charter capital is one of the components of the numerator in the calculation formula of CAR. Therefore, the increase in charter capital is also the strengthening of banking activities. In addition, the increase of charter capital allows the bank to expand its business activities and increase the bank's resilience to financial risks or macroeconomic fluctuations.

In order to respond to the challenges of the new stages and to improve the capacity of commercial banks, the State aims to increase the minimum capital adequacy ratio of commercial banks to 11-12% in the period from 2021 to 2025 and to maintain the minimum of 12% in 2030, in accordance with Decision No. 412/QD-TTg on the approval of the project for improving national credit until 2030 and Decision No. 689/QD-TTg on the approval of the project for "Restructuring of credit institutions in connection with the settlement of bad debts within the period from 2021 to 2025".

The average CAR of state-owned commercial banks, as stipulated in Circular 41/2016/TT-NHNN, is currently recorded at 9.25% and 11.5% for private commercial banks [3]. Although the above figures are in line with the minimum capital adequacy ratio stipulated in the Law on Credit Institutions, it is only the minimum rate compared to the aforementioned national projects. The CAR of commercial banks in Vietnam is still lower than other countries in Southeast Asia. In addition, the economic recession affects the ability to repay the loans, which leads to the increase of bad debts. The above reasons have encouraged banks to increase their charter capital to combat economic difficulties.

It can be seen that the increase of charter capital is an urgent demand of commercial banks. This demand is evidenced by the vibrancy of charter capital increase activities in 2023. Commercial banks can increase their charter capital by paying dividends by shares, issuing ESOP, issuing shares to foreign strategic investors, or issuing more shares to other investors, etc. For state-owned banks, the policy to increase charter capital will also be adopted[4]. However, the CAR of commercial banks remains low and it will encourage banks to participate in the "race" to increase charter capital in the coming years.

The risks of massive bank capital increases

Sources: https://phaply.net.vn

Aside from the positive effect of the charter capital increase, the fact that many banks will "run" for the increase will lead to some potential risks

First, when banks raise charter capital intensively, it may lead to non-performing loans. When the charter capital is increased, it will expand the scale of banks, and this will lead to more risk. When the economy is facing recession, bad debts arise from the expansion of business is possible.

In addition, in order to attract investment, banks must increase the return on common equity (ROE), because it is easier to increase the ROE more than the return on assets (ROA). Increasing ROA (or at least preventing it from declining) and increasing capital adequacy at the same time is a complicated task for many banks, especially smaller ones. Therefore, the rush to increase charter capital may result in banks hiding bad loans or altering other safety indicators.

Second, raising capital also means that banks may receive investments from new or existing investors. This is one of the many problems that banks are currently facing, when cross-ownership and bank manipulation is still an issue.

Some solutions to ensure safety as banks increase charter capital

Sources: https://phaply.net.vn

Despite potential risks, increasing charter capital is an essential requirement for banks to implement their business plan. Therefore, from the perspective of the management agency, the State Bank of Vietnam needs to consider some specific solutions as follows:

First, the State Bank of Vietnam must ensure that commercial banks comply with the classification of bad debts and the provision for bad debts. To achieve this, the State Bank of Vietnam and other banking supervisory agencies need to strengthen their role in inspecting commercial banks' compliance with internal regulations on lending, debt management, and risk provisioning policies. At the same time, the implementation of debt classification, off-balance sheet commitments, and the establishment and use of risk provisions by commercial banks should be inspected.

Second, it is essential to amend and supplement the provisions of the Law on Credit Institutions to prevent cross-ownership. The solution to the problem of cross-ownership is to increase the transparency of the ownership of commercial banks and to limit the manipulation of credit institutions by their affiliates. Such a solution must be specifically stipulated in the Law on Credit Institutions and the guiding instruments, and by expanding the subjects considered as affiliated persons, internal personnel and the executives of credit institutions.

Third, the management agency must supplement the provisions to ensure the right to regular inspection of commercial banks to prevent nominal ownership, as well as measures to trace the source of contributed capital and ensure that this source of funds does not come from existing investors of the bank.

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