HANOI UNIVERSITY FACULTY OF MANAGEMENT AND TOURISM

Financial and monetary theory

Topic 5: Financial structure

1. Nguyen Huyen Trang 2. Le Thu Hang 3. Tran Thu Hang 4. Nguyen Thi Tuoi

ID: 0904010116 ID: 0904010026 ID: 0904010030 ID: 0904010112

Hanoi, 5/10/2011

ABSTRACT
From the information and date gathered, this report gives a total view on Vietnams financial market. With the main function is moving funds from savers to spenders via two main ways; direct and indirect finance, financial market contributed greatly to a high productivity and efficiency of the entire economy, create favorable environment to reconcile the interest of different economic entities as well as create favorable conditions for the financial transactions. In addition, by proving the existing of the eight observations on U.S financial structure in Vietnams illustrate the operation of this market as well as the advantages and disadvantages of the two method of financing. Finally, utilizing the knowledge learned combining with the characteristics of Vietnams financial market, this report give an advice for the most common type of business in Vietnam in how to raise fund for its operations.

I. Overview
In nearly 20 years of renovation, Vietnams financial market have significant development. Typically, the safety of Vietnams financial market is consolidating every single year, the liquidity and interest rate issue of the banking system is much better. The management of Government in financial market had been institutionalized and have a closer coordinated. Financial structure was improved, extend the sphere of action, and become more flexible more diverse, attracting more participations than before. Based on flow of fund in financial market, its structure can be classified into 2 categories, including direct and indirect finance. Direct finance is the situation where borrowers borrow fund directly from lenders in financial market, by selling them securities. Common methods for direct financing include a financial auction, where prices of the securities which had been refusing by the current shareholders is bid upon, or an initial public offering, where securities is sold for a set initial price. Another modality of funds flow is indirect finance. According to Valentine et al, 2006, pp.4, funds are usually transferred from surplus to deficit units via financial institutions which act as intermediaries, borrowing from surplus units to lend deficit units. This process is called intermediation or indirect financing. Financial intermediaries are financial organizations that carry out transferring fund function from people who have surplus fund to others. Unlike direct finance, borrowers borrow fund directly from lenders, indirect one transfers fund via the third-party institutions. Financial intermediaries can include banks, securities companies, depository institutions, credit union and so on. In Vietnam, there are fully many kinds of financial intermediaries which are followed:

Commercial banks: Bank regulation in Vietnam issued on May 23th 1990 is

determined that commercial banks are currency trading organizations whose main and often activities are to receive deposit from customer with repayment responsibility and use these funds to make loans and carry out discount transaction and payment means. Beside the growth of financial market, the number of commercial banks also increases and develops significantly. There are 5 the State commercial banks (Joint Stock Commercial Bank for Foreign Trade of Vietnam, Vietnam Bank for Industry And Trade, Bank for

Investment and Development of Vietnam, Vietnam Bank for Agriculture and Rural Development, and Housing Bank of Mekong Delta), 37 joint-stock commercial banks, policy bank, 5 wholly foreign-owned banks.

Securities companies: The number of security companies also rises. In 2000,

Vietnamese security market legally operates with only 4 security companies but there are 61 security companies in 2007 with 5,735 billion VND charter capitals. And nowadays, this figure is increased to over 100 companies. Security companies contribute to promote privatization procedure of businesses. It proves that these companies helped posted businesses have condition to approach capital that public invest with stability and low cost.

Finance companies: In Vietnam, there are 17 finance companies and 13 financial

leasing companies, most of which belong to The State economy corporations such as EVN Finance Company, Cement Finance Company, Petro Vietnam Finance Company, etc. The advantage of finance companies is that they invest large and long-term capitals into important projects, for example, finance investment, hydropower project and shipbuilding project. However, in Vietnam, finance companies belong to organizations which use state capital.

Insurance companies: Vietnam insurance is a competitive and potential insurance

market. The appearance of insurance market brings to customers many benefits from hazard insurance in daily life. At present, insurance companies are managing a large amount of capital that is long-term capital, used to invest into projects to earn profit. According to Association of Vietnamese insurers, the number of life insurance contract on June, 2011 reach to 382,662 contracts, increasing by 8.22% to the same term last year. 144,864 of them is Prudentials contract, 69,631 contracts is Bao Viet Life insurance and Manulife signed 37,222 contracts. Total value of life insurance is 401,000 billion VND. Moreover, business also raise fund through Fund Management Company, pension fund, mutual fund. The development of financial intermediaries created a large amount of fund for businesses that help them grow productivity, expand business scale.

II. Compare and contrast: Direct vs Indirect finance

Recently, Vietnams financial system has developed widely and rapidly, which diversify the channel of raising funds for business expansion. However, in order to raise funds quickly and effectively, it is necessary for business to determine the characteristics of these above channels as well as the whole financial system. Through many research and evaluation in the international financial market, economists have found several basic observations to explain to understand how the financial system works.
1. Observation 1: Stocks are not the most important source of external financing.

In order to determine whether the first observation is appropriate or not in case of Vietnam, we need the information about the total debt on the economy and the market capitalization. All the data collected were modified in form of a graph below to help the reader have a total view about the debt situation in Vietnam.

It can be seen clearly from the graph above that from 2007 to 2010, there was a double increase in the total amount of debt on the economy from just over 1 billion VNDs to about 2.6 billion VNDs. Similarly, the market capitalization slightly rose during the period although they

suffered a sharp decrease in 2008. However, at any time of the given period, the total debt on the economy is always at least twice as much as the market capitalization. In conclusion, obviously stocks are not the most important source of external financing for business. They can raise funds by calling debts from several kinds of intermediaries such as commercial banks, insurance companies, finance companies, pension funds, etc. These intermediary channels are of much benefit to both lenders and borrowers; specifically it reduces the credit risk through the diversification of the funds received. It means that they invest in a portfolio of assets whose returns do not always move together; with the result that overall risk is lower than for individual assets. The form of fund flow in the two methods, in essence, is contrary; as a result, the advantages of indirect finance can be the drawbacks of the opposite. Specifically, in direct finance, usually, lenders are individual, unlike the expertise in financial intermediaries, their ability in collecting and analyzing information is limited, consequently, due to the risk assessment process less effectively, and it also leads to the higher cost of search and transaction.
2. Observation 2: Issuing marketable debt and equity securities is not the primary way

to raise funds. In proving this observation do exist in Vietnams financial market, lets have a look at a result gathered in the Annual Meeting 2011 of CFO Vietnam. Among 300 businesses participated, about 32% agree that bank loans remain their main funding sources in recent years. Another sources can be point out is internal financing (21%) and reciprocal of customers (17%). It is unable for every company to issue securities and savers can not exactly know about companys performance to assess their securities. It is a weakness of direct finance; businesses just can raise funds by issuing stock or bond only when they have good credit rating. Moreover, indirect finance is more adopt for lender to lending out their surplus funds because of its liquidity transformation. Lender can require financial intermediaries pay back their funds when they need them for other purpose. Because of these reasons, we can conclude that beside issuing marketable debt and equity securities, businesses can call fund by other ways such as through financial institutions.

3. Observation 3: Indirect finance is more important than direct finance.

Securities markets are important in Vietnamese finance recent years; we can see it through a sharp increase in the number of public companies and the number of market capitalization. It is easy to see the reason for this development is that issuing securities widens the alternative for businesses in terms of calling funds directly from lenders who can be individual or other organizations. In terms of lenders they can avoid costs of intermediaries because they will match with borrowers directly. And another good point of this kind of finance is that there are many investors who need fund to invest in their project in the market so that lenders has chance to chose one of them that they think it is the best choice. However, in reality, when a company issue securities, there is a small proportion of them can be sold for the individual; the rest will be bought by intermediaries. This fact due to several disadvantages existing in direct market. Obviously, when an individual invest in a kind of securities he must analyze a lot of information relating to the securities in order to decide whether he should by or not. This analysis can be bias, inaccurate and also timely and costly; as a result they can make a wrong decision which makes him face default risk. Another striking point to note is that in direct finance, surplus funds will be transfer directly from lenders to borrowers. In order to agree this transaction, both of them have to match some conditions such as maturity, method of payment which is difficult in the market with a large number of lenders and borrowers with different requirements. Furthermore, savers cannot withdraw their funds when they want because it depends on businesss operating activities. Meanwhile, when lenders deposit their fund into a commercial bank, for example, the bank has responsible to pay back when they require although they must accept some losses because terminating deals. In addition, individual does not have a lot of money on hand but they have too many investible choices among many kinds of securities so it will take a long time for a company to raise enough funds for investment. As a result, this is better for the businesses call fund from big organizations such as commercial banks, mutual funds, pension funds or insurance companies. These organizations can buy a large amount of securities which help company

quickly raise enough funds for investing in their project. Simultaneously, they can reconcile the conflicting preferences of lenders and borrowers, they help spread out and decrease the risk for the depositors. From these points we can conclude that the indirect finance is many times more important than direct finance.

4. Observation 4: Financial intermediaries are the most important source of external

funds. In Vietnamese financial system, the financial intermediaries are become more and more diversify and developed. According to some newest statistic from General statistic office, financial system in Vietnam now include banks which contain five State Commercial Banks, 37 Commercial Joint Stock Banks, five Joint-venture Banks, five Wholly Foreign-owned Banks and many branches of banks through the country, 17 Finance companies, 13 Finance Leasing Companies and 47 Fund management companies and some other organizations. These organizations provide a large amount of funds for the whole economy which can benefit the borrower a lot because the intermediaries collect all the source of fund from savers to investors, as a result, the investor can borrow the amount of money they need whether it is a big or medium amount. The saver also can happy with the intermediaries system because they can deposit money in form of currency or gold in the system to get the interest with different maturity but not be much worried about the credit risk because the bank has responsible to pay back when savers require although they must accept some losses because terminating deals. Moreover, the bank will take a charge of reconcile their conflicting needs. These are contrast with the case of direct finance where surplus funds will be transfer directly from lenders to borrowers. In order to agree this transaction, both of them have to match some conditions such as maturity, method of payment which is difficult in the market with a large number of lenders and borrowers with different requirements. Furthermore, savers cannot withdraw their funds when they want because it depends on businesss operating activities. These are also the reason why the direct market is not familiar with Vietnamese but the intermediaries become so popular in Vietnam. We can see it clearer through all the data and information shown in observation 1 in which the total debt are much

more than the market capitalization. In addition, the bank loans take a major part. We collected some data from newspaper and website and found out that, in 2007, the amount of money banks lent out was about 935,398.71billion VNDs accounting for 76.2% of the total debt on the economy, this figure for 2009 was 81.37%. All this information improve that financial intermediaries, particularly banks, are the most important source of external funds use to finance businesses.

5. Observation 5: The financial system is among the most heavily regulated sector of

the economy. No denial, the financial system plays a key role in producing an efficient allocation of capital, which contribute to higher production and efficiency for the overall economy, it also means that they can rule the whole economy if the government loses their control of them. That is the reason why, financial system becomes one of the most heavily regulated sector of the economy. Vietnam is not an exception; all activities in financial system have to follow a series of regulation stated in several Law. For example:

The Law on securities and other related circular decisions and decrees state all the requirement about disclosure of information such as they need to be complete, timely and accurate and they need to be conducted by the general director. In addition, the law states issuing regulation on registration, depository, clearing and settlement of securities, the condition for a company to be allowed for public offering, etc.

The Law on State Bank of Vietnam which regulate the required reserve, the amount of assets they can hold and restriction on branching, the regulation of credit operation, opening accounts, payment and cashing operation of State Bank, conditions to establish a new bank, etc.

Moreover, there are some regulatory agencies supervising and controlling all acts of financial system like Ministry of Finance, the State Bank of Vietnam or State securities commission of Vietnam.

6. Observation 6: Only large, well-establish corporations have easy access to

securities markets. A large number of funds can be raised via securities markets; however, having the right to participate in this market is not simple, businesses must follow a series of regulations. It can be seen clearly through the offer and post up securities to the stock exchange. Lets take the process of calling stock to be an example. First of all, business must have, at the time of registration of the offer, a minimum amount of paid up charter capital of ten billion Vietnam dong calculated at the value recorded in the accounting books. Secondly, they have to be profitable in the two years consecutive and no loss forward calculated up to the year of registration of the offer. Moreover, there must be an issue plan and a plan for utilization of the process earned from the offer tranche, passed by the general meeting of shareholders. According to the website, named tapchitaichinh.vn, the number of small and medium scale enterprises, which have the charter capital less than ten billion Vietnam dong (based on Decree 90/2001/N-CP) is about 98%, in other word, the enterprises have right to offer securities to the market is only 2%. Eventually, we can conclude that only large, well-establish corporations have easy access to securities markets.
7. Observation 7: Collateral is prevalent feature of debt contracts.

All the time, default risk have significant influence on the intention of lending out funds, consequently, collateral has appeared as an instrument with the main function of protecting lenders. Collateral is the property promised to the lenders if the borrowers defaults. If a borrower defaults on a loan, the lender can sell the collateral and use the proceeds to make up for looses on the loan. Thats why collateral became a prevalent feature of debt contracts.

The Circular no. 17/2011/TT-NHNN of the State Bank, issued on August 18, 2011 is regulated about provisions on loans secured by pledge of valuable papers to credit institutions. Valuable papers are explained as certificate of collateral that is used to ensure repayment responsibility. It can be property ownership (house, land, building, and factory) or other valuable documents. This paper must have compulsory characteristics. Firstly, it has to belong to property of borrower and is not issued by them. Secondly, it not only has right to convey but also has to be unexpired before debt maturity. Because of its feature and function it can be proved that collaterals play an important role on the debt contract.
8. Observation 8: Debt contracts are extremely complicated and place substantial

restriction on the behavior of borrowers. Debt contract is contract in which a lender agrees to provide funds today in exchange for a promise from borrower, who will replay that amount plus interest at some point in the future. A debt contract is agreement between two sides including lenders and borrowers and it is given some deals of them. A debt contract includes at least some following information: The full name and address of lender and borrower Content of debt contract: amount of debt Purpose of this lending Debt maturity Interest rate and method of payment Responsibility and obligation of lender and borrower Terminating debt contract before maturity Supplementing and liquidating contract Solving dispute The validity of this contract

It is necessary to be clear about responsibility of both sides. In the case of restriction, when one of them, especially borrowers violates this contract, they must be tackled through deals in this debt contract that was agreed by lenders and borrowers. Hence in order to protect lenders, debt contract should be set up carefully and has agreement between lenders and borrowers.

III. Giving advice for a corporate customer.

Based on the fact that 98% enterprises in Vietnam are small and medium scale, and the numbers of private enterprises increase over time, from 24% to 30% in the top 500 business in 2009, we choose the private and medium one to give advice of how to raise funds for its operations. Each operating activities requires funds with different features such as time to maturity, type of credit, interest rate. In term of maturity, raising funds can be divided into two categories; raising for short term and long term purposes. When business wants to raise short-term funds for investing in current asset like paying for transactions, account payable, salary payable, etc, people may think about bank loans as the first choice, however business borrow from banks only if there is no available short-term source of capital because short-term bank loan usually requires higher interest rate and higher transaction cost in Vietnam. Moreover, when business finances their activities internally, they have three benefits. The first one is freely in making decision. They are not accountable to any outside entity, do not need to explain their business decisions to anyone outside the company or seek any approval before making changes or expansion. Another thing is flexibility. If business borrows from outsider, it will be a big problem if they cant afford to repay the principal as well as interest payment in the maturity date. However, that will never happen if they finance internally, business can adjust payment term in accordance with their current cash flow and other unanticipated circumstances. Eventually, if business still do not have enough ability to make the payments, this will not affect the credit score because they do not have to report to major credit agency if things do not go as planned, that is the last advantage of internal financing. Because of the characteristics of bank loans and internal financing mentioned above, our advice for this kind of business is utilizing any internal financing such as personal savings and business reserves. Besides, business also needs long-term funds to solve other operating activities such as investing in a long term project, plan for production and service, which are made in Vietnam. Due to the longer term of investment, the volume of funds needed is larger, too. Normally, internal funds, which play a key role in raising short term funds, cannot afford, business tend to think about financial intermediaries such as: commercial banks, finance companies, mutual funds, pension funds, etc. Based on the development of different intermediaries, we advise this private and medium business to raise fund through banking system. As mentioned above, the

transaction cost of bank loans is high in Vietnam but it can be compensate by the longer term of maturity. Moreover, it seems to be banks is one of not many institutions that can issue debt with a high volume to achieve the need of business. In conclusion, our advice for the business, which is private and has medium scale, is that they should finance internally in case of raising short term funds and borrow from banks when they need funds for any long term operating activities.

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APPENDIXES

Table: Market capitalization vs total debt on the economy