Decision 48 (1999)

The response above set the foundation for the issuance of Decision 48, Regulations on Classifying Assets, Establishing and Using Reserved Funds for Covering Losses Suffered by Credit Institutions (SBV 1999). It is the first regulation that treated loan loss provision as an expense following international practices.

Learning from international practices, loan loss provision was measured based on loan loss classification. Decision 48 (SBV 1999) classifies bank loans based on their past due with fixed levels of credit risk stipulated for each loan group. Specifically, loans are divided into four groups under the term timescales, including current and restructured debts, debts overdue less than 181 days, debts overdue less than 361 days and debts overdue more than 360 days (SBV 1999, article 5) with the corresponding provision rate fixed at 0%, 20%, 50% and 100% (SBV 1999, article 6).

That Renovation towards global integration caused many debates since bank accounting needs to serve the need for Government control with a variety of objectives as discussed above. Specifically, Vu Minh (1999) estimated ‘the figure of [current credit loss] was about 300 billion dong, which was at least double or triple compared to profit of the whole state banking sector’ (p. 25; translated by the author). Therefore, he worried that commercial banks would have no profit remaining after provision under Decision 48:

If all profit is used for provision making, where is the profit to pay tax to finance the state budget, to modernise banking technology to catch up with the world that is changing hourly and daily and to cover many daily bank expenses for ensuring its normal operation? (Vu Minh 1999, p. 25; translated by the author)

Vu Minh (1999) commented from the perspective of macro management in which the increase in loan loss provision could influence macro policy. Commenting on the issue that bank profit was not sufficient for provision making under Decision 48, Dieu (1999) raised another concern: ‘If provision is made exceeding the profit of the current fiscal year, it means financial institutions make provision from nothing’ (Dieu 1999, p. 10; translated by the author). His comment was from the perspective of bank regulators who expect commercial banks to maintain sufficient reserve to cover credit loss when it is incurred.

Under international practices, BCBS issued regulations on minimum capital, which are usually called Basel Accords I, II and III. Those regulations required banks to either add more equity capital or restrict their lending scale to ensure they have sufficient reserve to cover loan loss (Bank for International Settlements 2006; BCBS 1988, 2011). At the time when Decision 48 was issued, Vietnam did not have such

minimum capital requirement. The SBV had stipulated Decree 82 since 1998 on the minimum capital requirement but the commercial banks were not required to meet it until 3 years after the effective date (Phan Van Khai 1998). The postponement of minimum capital requirement shows the insufficiency of bank equity not only for its normal operation according to Basel Accords but also for covering loan loss provision at that time.

Facing those challenges that were specific to the context of Vietnam, the bank regulators had to limit the provision requirement, although treating provision as expense is required for prudence and globalisation purposes from the regulation perspective by experts such as To (1996), Ba Thanh and Moc Mien (1998) and Pham (2002) as discussed above. Particularly, provision as an expense is restricted only for credit risk caused by irresistible reasons such as ‘natural disasters, fires, epidemics or state policy changes’ (SBV 1999, article 7; translated by the author).

The restriction helped banks avoid a significant reduction in their profit and, in turn, their equity when loan loss provision commenced being treated as an expense under Decision 48. In addition, the tax collection amount was not affected much owing to a limited loan loss provision expense. In other words, the limitation of loan loss provision can be explained by the desire of the Government to alleviate the decline in bank profit and, in turn, the tax collection amount owing to the increase in loan loss provision.

Another explanation is that being the major, or the only, shareholder in banks, the state was very careful in protecting its stake in commercial banks by not easily recognising the loss incurred subjectively by individual customers or bank management. By limiting the provision to be made to credit risk owing to irresistible reasons only, the state preferred to prevent the loss of bank assets through the irresponsibility of bank management and staff. In the cases other than natural disasters, fires, epidemics or state policy changes, the bank management and staff have to do their best to collect the loans rather than writing them off via loan loss provision. This inference is indirectly inferred from similar requirements that aim to

assist the Government in protecting its large stake in commercial banks by such administrative rules6.

Hence, although the accounting change, in which loan loss provision began to be considered an expense, was made towards international practices, its substance was altered to serve Government control. For this reason, Pham Phu Quoc (2000) criticised that making provisions for irresistible reasons alone did not provide the market sufficient information for enforcing discipline in the business relationship between banks and their customers in lending activities.

Pham Phu Quoc (2000) argued against that stipulation:

In bank lending activities, credit risk owing to subjective reasons, such as customers deliberately not repaying, has the same opportunity to occur as credit risk owing to irresistible reasons, such as customers lacking the ability to repay. Therefore, we think that even when clients deliberately do not fulfil their obligations, banks should reserve the right to cover that risk by loan loss provision. (p. 32; translated by the author)

Pham Phu Quoc’s (2000) suggestion relies on the market economy’s perspective in which accounting information serves bank management and investors to evaluate the efficiency in lending activities to customers. For that purpose, any loan loss incurred because customers do not pay, for whatever reason, should be recorded as an expense for evaluating bank credit risk management and bank performance. In addition to the restriction above, loan loss provision was required to be reversed at the end of the financial year as follows:

The remaining balance of loan loss provision, after deducting the actual loss incurred as at 31 December each year, must be reversed to reduce loan loss

6 _{For example, under Decision 493, SOCBs have to obtain approval from the Government for writing}

off NPLs via loan loss provision (Decision No. 493/2005/QD-NHNN in 2005, article 11, para 4). Another example is requirement under Decision 488 for banks to not inform customers when their debt are written off (Decision No. 488/2000/QD-NHNN5 in 2000). Quy định về việc phân loại tài sản ‘có’, trích lập và sử dụng dự phòng để xử lý rủi ro trong hoạt động ngân hàng của tổ chức tín dụng ‘Regulation on the assets classification and use of provisions to deal with risks in the banking activities of credit institutions’. In: VIETNAM, S. B. O. (ed.) 488/2000/QD-NHNN5. Hanoi, Vietnam: State Bank of Vietnam, to prevent customers from refusing to pay their debts as discussed in the next section.

provision expense made during the year. (SBV 1999, article 7; translated by the author)

Adopting this stipulation, the loan loss provision account had no balance at the end of fiscal year, which may help to easily verify loan loss expenses for tax deduction because loan loss provision was determined based on actual loss rather than bank’s judgement from the tax perspective. In addition, according to Le Thi Thanh Nhan (2000), ‘Tax authorities are afraid that the stipulation of provision heavily relying on subjectiveness will facilitate banks in overstating expenses for tax reduction’ (p. 14; translated by the author).

Commenting on this specification, Dieu (1999) said:

It is just as if banks are allowed to establish a reserve for covering credit risk but are not permitted to store the reserve. This paradox makes provisioning meaningless; if there is no difference between having and not having a reserve, the outcome will be the same. (Dieu 1999, p. 10; translated by the author)

The stipulation and Dieu’s (1999) comment shows that loan loss provision was considered a loan loss reserve rather than an impairment loss in asset impairment test from the accounting approach. Under Decision 48, a new balance of loan loss provision was made at the beginning of the year to absorb credit loss actually incurred during the year and refunded at the end of year in case that fund was not used up. The refund to close the provision account balance at the end of the year hid the asset impairment loss on the balance sheet because the loan asset was disclosed at the original historical cost. Therefore, Le Thi Thanh Nhan (2000) claimed:

Provisions under Decision 48, although termed ‘provision of assets’ in form, have, in substance, absolutely no meaning of ‘provision for impairment loss’ for representing faithfully the fair value of assets in the financial statement. (p. 13; translated by the author)

In addition, that way of making provision is a direct write-off method rather than accrual accounting, and thus can help the Government monitor tax collection easily based on actual loss. However, its disadvantage is that loan loss was recorded late. Considering that weakness, Dieu commented:

Such income is likely taking the current financial year profit to make provision for credit risk from the previous year. Paradoxically, this will increase the financial burden for the operations of the current year. (1999, p. 9; translated by the author)

From the accounting perspective, that late loan loss recognition distorted bank earnings. Therefore, Le Thi Thanh Nhan (2000) insisted, ‘In our opinion, this [provision under Decision 48] is a very big blank in the regulation of the SBV. This issue should be urgently considered’ (p. 13; translated by the author) for two reasons. First, it is ‘the trend of economic integration with the region and the world that raises the need to integrate with the international generally accepted accounting practices’ (Le Thi Thanh Nhan 2000, p. 14; translated by the author). Second, it is ‘the upcoming birth of the stock market in which the users of financial statements, including local and foreign investors, have the right to ask for accounting information that reflects faithfully business operations’ (Le Thi Thanh Nhan 2000, p. 14; translated by the author).

Le Thi Thanh Nhan’s (2000) statements expressed the need for change in regulation on loan loss recognition as an action in response to the pressure of global integration and the development of a market economy leading to the emergence of market force. Investors should be provided information on loan loss from the accounting perspective as a requisition for supporting the growth of market discipline. This was the prerequisite for the introduction of Decision 488 (Decision No. 488/2000/QD- NHNN5) in 2000 one year after Decision 48. The issuance of Decision 488 was a part of the Government’s Institutional Reform Program under Decision No. 136/2001/QD-TTg dated 17 September 2001 by the Prime Minister as described in Section 4.4.2.3.1.