Proceedings of World Business and Social Science Research Conference
24-25 October, 2013, Novotel Bangkok on Siam Square, Bangkok, Thailand, ISBN: 978-1-922069-33-7
Foreign Banks in Vietnam: Determinants of Profitability and
Comparison with Domestic Banks
Lien Dinh
This study examines the determinants of foreign bank profitability and
makes a comparison on performance of foreign banks and domestic banks
using the fixed effects method. It argues that foreign bank profitability is
influenced significantly by all bank specific factors, macro-economic factors
and multinational bank indicators. The findings provide strong evidence
that total assets and other income have positive impact on profitability. An
interesting finding is that parent bank profitability indicates significant and
negative influence on foreign bank profitability. Moreover, foreign banks
perform better than domestic banks due to their ownership advantage.
When deregulation began in 2011, all foreign banks started to perform well;
they became significant competitors for local banks. This study will provide
bankers and policy makers with a greater understanding of foreign bank
profitability to compose the appropriate future strategies.
Field of research: foreign bank profitability and performance
1. Introduction
The globalization of the banking industry has stimulated many developing countries into
opening their markets to foreign banks. Therefore, foreign banks worldwide have more
opportunities to expand their networks. Vietnam has also kept up with this significant trend in
the banking industry, and has allowed foreign banks to join the market since the 1990s. The
country has gradually deregulated which has allowed the entry of foreign banks and built up
the industry infrastructure to international standards. This process started with the change to
the banking system. A one tier banking system was transferred to a two tier banking system as
a result of Decree 53/HDBT (issued 26 March 1988) (SBV, 2012b). Four state owned
commercial banks were established by separating from four main departments of the State
Bank of Vietnam. Shortly, private commercial banks were encouraged to enter the market.
Foreign bank branches and domestic privately owned banks started to set up their operations.
A gradual deregulation of foreign bank operations was seen between Decrees 13 and 22
(Tram, 2011). According to Tram (2011), Decree 13 was issued in 1991 with some limitations
in terms of: the percentage of share ownership in a joint venture; length of operation for banks,
permission for saving deposits and capital requirements. Further deregulation was effected
with the implementation of Decree 22 (issued in 28 Febuary 2006) (Government, 2006b). The
Decree allowed 100% foreign owned banks to enter the market. This type of bank was treated
as a domestic bank with respect to types of business and office expansion. Also, all foreign
banks are subjected to the national treatment from 2011 (Nguyen, 2011).
Little has been known about foreign bank performance in Vietnam until now because of the
lack of data, thus, this paper aims to explore how foreign bank perform in Vietnam. In
particular, this paper will discuss the determinants of foreign bank profitability and the
comparison between foreign bank performance and domestic bank performance. This paper
contributes to the literature in three ways. Firstly, the author applies the fixed effects method to
analyse the data of the whole banking system, with data upgraded to the end of 2012, while
the literature has examined the data only up to 2006; a six-year gap will thus be filled.
Secondly, the study will examine bank specific factors, Vietnamese macro-economic factors
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Proceedings of World Business and Social Science Research Conference
24-25 October, 2013, Novotel Bangkok on Siam Square, Bangkok, Thailand, ISBN: 978-1-922069-33-7
and multinational banking factors regarding determinants of foreign bank profitability. These
three sets of variables describe a whole picture about the determinants of foreign bank
profitability. Finally, the study compares foreign banks‟ performance and domestic banks‟
performance to provide a detailed explanation for each type of bank which has not been done
in earlier studies on this topic.
The rest of this paper is organized as follows. Section 2 reviews related literature in terms of
factors influencing profitability and comparison of domestic and foreign bank performance.
Section 3 describes the method and data used for analysis. Section 4 presents the results and
discussion on the results, while section 5 demonstrates the main conclusion.
2. Literature Review
2.1 Bank specific factors
In this section, the author will review the related literature that studied the determinants of
foreign bank profitability using data from 70 countries, European Union market, Grece and
Thailand. The results from those studies are mixed but play a crucial role as motivation for the
current study.
Firstly, in a study by Chen (2011) off 70 countries, almost all the coefficients are significant,
indicating strong impacts of bank specific factors on profitability. Chen (2011) found that the
higher the opportunity cost inccured, the higher the return that banks can achieve. Banks that
are involved in more non-interest activities, will have a decrease in their return. Regarding the
size of the banks, Chen (2011) found only small banks can benefit from economies of scale.
Having used a large set of data from 1992 to 2006, Chen‟s conclusion is highly reliable.
Secondly, Pasiouras and Kosmidou (2007) argued that foreign banks‟ profitability is
significantly influenced by bank specific factors in the European Union from 1995 to 2001.
They found that equity to total assets significantly and positively influences return on assets,
indicating that safe banks are less likely to be bankrupt and can easily expand their business
thanks to their rich equity. The cost to income ratio negatively impacts on the return because
inefficient cost management leads to the reduction of profit. Foreign banks earn lower profits
when they deliver more loans. Moreover, foreign banks experience a reduction on their return
if their size increases, which is similar to the findings of Chen (2011). Both studies used a short
time frame of data, which may not provide sufficiently strong support for measuring the
economies of scale properly.
Thirdly, unlike the study of Chen (2011) where almost all the coefficients are significant, the
study of 19 Greek bank subsidiaries‟ profitability shows only a significantly negative
relationship between foreign banks‟ total assets and return on assets (Kosmidou et al., 2007).
Kosmidou et al. (2007) found a similar result to that of Pasiouras and Kosmidou (2007) and
Chen (2011) regarding the economies of scale.
Finally, in the Thai market, Chantapong (2005) found that foreign banks benefit from their
ownership advantages in terms of advanced technology producing services. Non-interest
income shows a positive relationship with return on assets, while loan loss reserve, overhead
cost and liquidity ratio, impact on the return negatively. The more foreign banks are involved in
non-interest activities, the higher the return they earn. This is because foreign banks enjoy the
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Proceedings of World Business and Social Science Research Conference
24-25 October, 2013, Novotel Bangkok on Siam Square, Bangkok, Thailand, ISBN: 978-1-922069-33-7
market‟s share, focusing on advanced technology, while local banks can not. This situation
may occur for foreign banks in Vietnam, a developing country just as Thailand is.
To conclude, studies about many countries found mixed results on the return on assets but for
one country, Thailand. Taking Thailand as an example, foreign banks take advantage of
foreign investment conditions in developing their services and getting high returns when they
supply more modern services. It is because in developing countries, domestic banks are
inefficient and own subprime standard technology.
2.2. Macro-economic factors
The literature shows that the state of the host market‟s economy impacts on foreign bank
profitability. The main factors such as economic growth rate, inflation rate and financial
institution quality will be discussed as follows.
In examining the impact of host market factors in New Zealand, To & David (2002) include the
factor of difference in GDP growth rate between home and host countries. This factor indicates
a small influence on profitability from the mixed data on banks which focus on both the retail
market and wholesale markets. However, Kosmidou and Pasiouras (2007) found no significant
relationship of difference in the GDP growth rate between home and host countries and foreign
banks‟ profitability. One study found that the GDP growth rate in the host country has negative
influence on the return because of high competition in the host market (Pasiouras and
Kosmidou, 2007).
Chen (2011) found that the inflation rate has a positive relationship to banks‟ returns. In high
risk countries, the theory about the risk-return relationship works, which means banks facing
high risk will earn a high return. Similarly, Horen (2007) and Claessens (2001) demonstrated
that the inflation rate contributes to an increase of net interest margin. When banks face higher
risk, they adjust their interest rate spread to compensate for the risk.
Mixed results appear in the research when taking into account the quality of financial
institution, quality being an independent variable. Horen (2007) concluded that foreign banks
originating from developing countries benefit from weak institutional quality of the host market.
This may be explained by the fact that those banks experienced similar weak institutional
quality in their home countries. Foreign banks, facing unsuitable accounting standards,
“opaque” management and unprotected minority shareholders after one year of acquisition, fail
to perform well (Wahyoe, 2011). However, if the host country had a high quality institution,
foreign banks experienced a reduction in their performance because of high competition
(Claessens, 2011). Thus the result depends on the specific context of study, but generally a
low quality financial institution harms foreign banks‟ profitability.
2.3 Multinational bank indicators
This section will consider parent bank profitability and foreign bank experience as two main
multinational bank indicators. Parent banks impact on their subsidiaries‟ performance in terms
of financial and technological support. In New Zealand, parent banks‟ profit plays a dominant
role in foreign bank performance due to their ownership advantage which they transfer to their
subsidiaries (To, 2002). Nevertheless, a close relationship with parent banks means that
foreign banks are responsible for supporting their parent banks in return in the case of those
banks facing difficulties (Haselmann, 2006). Therefore, foreign banks might scale down their
size to support their parent banks. While the above studies find a close connection between
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Proceedings of World Business and Social Science Research Conference
24-25 October, 2013, Novotel Bangkok on Siam Square, Bangkok, Thailand, ISBN: 978-1-922069-33-7
parent banks‟ profitability and foreign banks‟ performance, Sturm (2008) finds no existing
relationship because “the parent banks are not necessarily able to export the attributes that
generate this profitability to new host nations” (Sturm, 2008, p. 2354).
The length of time that foreign banks operate in New Zealand has a positive impact on
profitability (To, 2002). Foreign banks in New Zealand have set up long-term strategies, so
they can enjoy low-cost deposits from local customers as well as they can limit costs emerging
in the early stage of entry (To 2002).
2.4 Comparison with domestic banks
The performance of foreign banks compared to domestic banks is different according to the
types of host markets and types of foreign banks. In developing countries, foreign banks often
perform better than domestic banks due to their ownership advantages (Claessens, 2001,
Pasiouras and Kosmidou, 2007, Havrylchyk and Jurzyk, 2011) and because the domestic
banks became weak after suffering the crisis (Manlagñit, 2011, Wu, 2011). However, in
developed countries, foreign banks face high competition and experience a reduction in profit
and perform much worse than domestic banks (Nolle, 1996, Sturm, 2008). Greenfield banks
(100% foreign owned banks) were more efficient and held a lower degree of risk than other
types of foreign banks in Asia, Latin America and Central and Eastern Europe between 1996
and 2003 (Wu, 2011).
In Vietnam, restrictions limited foreign operations in the early stages of entry, then the
deregulation began gradually, providing preparation time for local banks to develop (Nahm,
2008). Therefore, domestic banks outperformed the foreign banks due to the benefit of local
market knowledge and longevity (Nahm 2008). Among domestic banks, the state owned
commercial banks dominate the market and perform the best because of government support
and their long existence (Truong, 2011). However, their dominant role will be steadily replaced
by foreign owned banks and the active private banks when the market opens freely to these
enterprises. The above studies regarding foreign banks in Vietnam examine the data period up
to 2006; from that time until now, many changes have occurred. A study is needed to update
the data. Therefore, at what level and how foreign banks can perform in Vietnam from 2000 to
2012 will be studied, in detail, in subsequent sections.
3. Data Collection and Methodology
3.1 Data
The sample is an unbalanced panel data set of 51 commercial banks operating in Vietnam
from 2000 to 2012. There are four types of banks included in the data set such as state owned
commercial banks, private banks, 100% foreign owned banks and joint venture banks. The
data was collected from a Fitch Ratings source, which was updated only to 2011, so the author
collected the data for 2012 from banks‟ websites and from the State Bank of Vietnam through
personal contacts. Data for Vietnamese macroeconomic factors came from “Country Data”
compiled by the World Bank. Data on financial institutional quality came from the Worldwide
Governance Indicators, which was composed by Kaufmann Kraay, & Mastruzzi (2012).
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Proceedings of World Business and Social Science Research Conference
24-25 October, 2013, Novotel Bangkok on Siam Square, Bangkok, Thailand, ISBN: 978-1-922069-33-7
3.2. Methodology
3.2.1. Dependent variables
The performance of a foreign bank can be measured using the before tax profit/total assets
and net interest margin. The before-tax profit is a proxy for the profitability of banks and is
directly linked to a bank‟s overall performance. An increase in profit may come from cost
reduction or revenue surge or both at the same time. Net interest margin is used to measure
the effectiveness of banks in their core activity (lending).
3.2.2. Independent variables
One set of variables that directly affects the performance of foreign banks will be used: bankspecific indicators. Two sets of variables, the host country factors and the multinational
banking factors (which play a role as controlled variables), indirectly influence on foreign bank
profitability. Appendix 1 provides a description of all the variables and hypotheses in regard to
their relationships with profit before tax and net interest margin.
The current study will use a set of bank specific variables such as the ratio of overhead costs,
short term customer fundings, equity, loans, loan loss provision and other income, to total
assets; and total assets to the whole banking total assets. The overhead cost represents the
bank‟s ability to manage administration costs. The customer and short-term funding ratio is
used as a proxy for a bank‟s ability in attracting and accessing cheap funds (deposits and
other short-term funding). The level of bank equity reflects a bank‟s risk management strategy
and its ability to earn profits. The loan to total assets ratio can be related to two, perhaps
conflicting, aspects: a bank‟s market power in the loan market and its unwillingness to change
and engage in new services. Loan loss provision indicates the bank‟s ability to manage credit
risk. Other income is a proxy to evaluate bank ability to diversify their business and the level of
technology producing the advanced services. The ratio of total assets reflects the bank scale
as well as the market share.
In terms of the country specific factors, this study will apply the Vietnamese GDP growth rate,
the inflation rate, the depth of the financial sector and institutional quality as explanatory
variables. These variables reflect the macroeconomic environment that would indirectly affect
a bank‟s profitability. The depth of the financial sector is measured by the ratio between M2
and GDP. The institutional quality will be adopted from Kaufmann et al.,(2012), who measured
the level of governance quality.
In addition, being multinational, foreign banks are impacted by indirect factors such as the
parent bank‟s before-tax profit to total assets, and the experience of banks. It is said that the
parent bank‟s health has a positive relationship to foreign bank performance due to their
support regarding technology and finance. The length of operation will build up the foreign
bank‟s experience of the market and culture, which increases business opportunities.
3.2.3 Estimation technique
The fixed effects model is chosen rather than random effects for some major reasons. Firstly,
the data set has a number of banks (51), much larger than the number of years (13), and the
data set includes the whole banking system instead of random choices. Secondly, the author
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Proceedings of World Business and Social Science Research Conference
24-25 October, 2013, Novotel Bangkok on Siam Square, Bangkok, Thailand, ISBN: 978-1-922069-33-7
assumes that the error component (  i ) and the explanation variables are correlated. In
addition, the assumption that all individual banks‟ differences were captured by differences in
the intercept parameter (p.551) (Carter Hill, 2011). Finally, the results from the Hausman test
are larger than the critical chi-square 02.5,10  9.341 or 02.005,10  25.182 , and all results are
significant at 1% (Appendix 2). To deal with the problem of cross-section hetoroscedasticity,
White‟s transformation is applied.
The following model will be used to discuss this issue:
Iit  0  1Bit  1 X t   t Zit   it
Where Iit refers to foreign banks‟ profitability measured by the net interest margin, the ratio of
profit before tax to total assets of individual foreign bank i operating in Vietnam at time t. Bit
indicates foreign bank characteristics, Xt refers to Vietnamese characteristics and Zit
represents the parent banks‟ profitability and banks‟ experience.
The model is applied for domestic banks and all banks together in order to compare the
performance of foreign banks with domestic banks
Iit  0  1Bit  1 X t   it
Where Iit refers to domestic bank profitability measured by the ratio of profit before tax to total
assets and net interest margin of bank i at time t. Bit indicates domestic bank characteristics
and Xt refers to Vietnamese characteristics as in the original model.
This paper differs from the literature because the fixed effects model is applied to run the
regression of three sets of variables which are separated in the previous studies. In particular,
Kosmidou et al., (2007), Pasiouras et al., (2007) and Horen (2007) investigated the bank
specific factors and macroeconomic factors, but not multinational banking factors. To (2002)
combined the investigation of bank specific factors with multinational bank factors, but not
macroeconomic factors. Consequently, a study conducting three sets of variables together is
necessary to provide a deep understanding of determinants of foreign bank profitability. In
addition, the literature examines the different ranges of variables to the current set of variables
regarding to the same group of indicators. For instance, Kosmidous et al., (2007) considers
exports from a host nation to Greece, or the difference between the GDP growth rates of the
host and home country, while the author evaluates the annual GDP growth rate, inflation rate
and the quality of financial institutions. Furthermore, the literature limits the data length to
2001, which is far from the current time. Thus, upgrading the data is one of the current study‟s
objectives.
4. Empirical Results
4.1. Determinants of foreign bank profitability and a comparison with domestic banks
The results indicate that total assets and other income show significant and positive
relationships with foreign bank profit before tax (Table 1). Almost all foreign banks‟ scales are
small because of the restrictions and the „early stage of entry‟ factor. Therefore, if they can
increase their size, they will earn a higher profit before tax. Furthermore, an increase in total
assets means an increase in investment, which produces a high return at the later stage. This
result concurs with that of Havrylchyk (2011) who found that foreign banks in 11 Central
Eastern European countries
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Proceedings of World Business and Social Science Research Conference
24-25 October, 2013, Novotel Bangkok on Siam Square, Bangkok, Thailand, ISBN: 978-1-922069-33-7
Table 1: Determinants of banks’ profit before tax
Intercept
Bank specific factors
Cost
Foreign banks
Domestic banks
All banks
-0.092(-0.960)
-0.027(-1.546)
-0.027(-1.661)*
1.144(1.124)
0.473(4.290)***
0.508(3.589)***
Customer deposits
-0.015(-0.332)
-0.003(-0.851)
-0.003(-0.855)
Equity
-0.061(-0.557)
0.044(3.251)***
0.037(2.650)***
0.024(1.041)
0.005(1.197)
0.005(1.139)
Loan
Loan loss provision
0.668(0.626)
-0.001(-0.325)
-0.001(-0.482)
3.382(2.025)*
0.007(0.400)
0.012(0.621)
Other income
Macro-eco factors
0.142(2.359)**
-0.017(-1.156)
0.001(0.089)
Growth rate of GDP
-0.047(-0.131)
0.092(2.571)**
0.113(2.980)***
0.039(1.206)
-0.008(-0.901)
0.001(0.075)
-0.009(-0.254)
0.005(0.342)
0.011(0.739)
0.047(0.751)
0.013(2.851)***
0.014(3.078)***
0.641
0.605
193
218
292
338
Total asset (ratio)
Inflation rate
Financial ins quality
The depth of fin system
Multi bank factors
Parent bank's profit
Experience
Adjust R
Hausman test
Observation
-0.141(-2.122)**
-0.001(-0.523)
0.493
33.01
44
***: Statistically significant at the 1% level; **: at the 5% level; *: at the 10% level
experienced the economies of scale if they increased their sizes. Foreign banks in Vietnam are
still small, and an increase in size will increase their return. In 2001, the median of total assets
of Greek subsidiaries was 439 million EUR (Kosmidou et al., 2007), while the average total
assets of four joint venture banks in Vietnam was 76 million USD (author calculated from the
data source).
An increase in other income leads to a rise in foreign bank profitability, indicating that foreign
banks benefit from their ownership advantage. The profit structure of foreign banks differs
highly from that of domestic banks. While domestic banks earn 80% of their profit from interest
activities, foreign banks earn 80% of their profit from non-interest income (Bank, 2009). They
develop many sophisticated services regarding payment for international trade such as money
transfers, foreign exchange, guarantees, letters of credit, forfeiting, etc. Domestic banks focus
on traditional business such as making loans and they cannot compete with foreign banks
regarding the provision of services. This result concurs with the findings of Chantapong (2005).
It is interesting that parent bank profitability indicates a significant and negative impact on
foreign banks‟ profit before tax. It contrasts with the findings of To (2002), Kosmidou et al.,
(2007) and Chen (2011). However, Haselmann (2006) concluded that due to their close
relationship with parent banks, foreign banks have to reduce their scale in order to support
their parent banks in instances where they face financial difficulties. The GFC, which occurred
in 2007, adversely affected banks worldwide. Thus, many parent banks had to reallocate their
resources to compensate for losses incurred. Moreover, Vietnam is a developing market
whose size is small. Parent banks may not focus much on boosting their subsidiaries‟
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Proceedings of World Business and Social Science Research Conference
24-25 October, 2013, Novotel Bangkok on Siam Square, Bangkok, Thailand, ISBN: 978-1-922069-33-7
operations. In addition, the limitation on raising deposits causes difficulties for foreign bank
expansion, which makes it difficult for parent banks to strongly support their subsidiaries.
Another possible reason for that result is that when parent banks earn higher profits in their
home market than in foreign markets, they may scale down the operation of their foreign banks
to concentrate on the home market (Haas, 2006).
There are four significant determinants for domestic bank profitability: cost, equity, GDP and
the depth of the financial system. Due to their dominant role in the market, domestic banks
may transfer some part of the cost to customers, so they can still earn high profits despite an
increase in cost (Horen, 2007). All banks in Vietnam met the minimum capital requirement of
3,000 billion VND (21,000VND/USD) in 2013 (Nguyen, 2013). The capital of four state owned
banks dominated the market while that of the foreign banks are equal or just over the minimum
requirement. Consequently, equity appears to be one contributor to the profitability of domestic
banks.
GDP shows a strong and positive influence on the domestic banks while it shows no significant
impact on foreign banks. During the period from 2000 to 2012, GDP growth rate remained
high, starting at 6.78% and reaching a peak of 8.45% in 2007, before slightly reducing to
5.03% in 2012 (WorldBank, 2012). Domestic banks took advantage of this to offer more loans.
Furthermore, if the country‟s economic development is progressing well, customers easily
repay their debts. This result corresponds to that of Pasiouras at el., (2007).
The „depth of financial system‟ factor contributes to an increase in return for domestic banks.
In Vietnam, due to the fast development of both the stock and real estate market, demand for
credit increased quickly during 2007-2011 (Worldbank 2012). In addition, to deal with the
economic downturn after the GFC, the government applied an expansionary monetary policy,
which encouraged banks to lend more money. As a result, the high level of M2/GDP was
created (Nguyen, 2013).
4.2. Determinants of foreign bank efficiency and a comparison with domestic banks
The cost ratio has a significant and positive relationship with the net interest margin for all
banks at 1% of significance. During the period 2001-2006, all banks experienced a reduction in
cost efficiency due to their increased investment in modern technology such as the
establishment of automatic teller machines, and computer software upgrades (Vu, 2010). This
result is in line with Horen‟s (2007) study. Due to their dominant role in the market, domestic
banks may transfer some part of the cost to customers through high interest rates. Foreign
banks in developing countries (income per capita under 4,810USD) realise a higher interest
margin than foreign banks in countries with a greater income per capita (Horen, 2007).
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Proceedings of World Business and Social Science Research Conference
24-25 October, 2013, Novotel Bangkok on Siam Square, Bangkok, Thailand, ISBN: 978-1-922069-33-7
Table 2: Determinants of banks’ net interest income
Intercept
Bank specific factors
Cost
Customer deposits
Foreign banks
Domestic banks
All banks
-0.005(-0.106)
-0.001(-0.066)
-0.006(-0.494)
1.405(3.548)***
1.272(8.930)***
1.291(9.616)***
-0.012(-0.569)
-0.005(-1.259)
-0.006(-1.319)
Equity
0.004(0.114)
0.032(2.445)**
0.027(2.240)**
Loan
0.008(0.763)
0.009(1.728)*
0.008(1.907)*
Loan loss provision
0.156(0.381)
-0.006(-2.005)**
-0.006(-2.650)***
Total asset (ratio)
1.214(0.658)
0.016(0.805)
0.018(0.912)
Other income
Macro-eco factors
0.119(3.002)***
0.007(0.322)
0.019(0.969)
Growth rate of GDP
0.233(1.224)
0.054(1.612)
0.087(2.470)**
Inflation rate
0.023(1.352)
0.011(1.183)
0.016(1.827)*
Financial ins quality
0.004(0.327)
0.021(2.135)
0.021(2.194)**
The depth of fin system
Multi bank factors
-0.018(-0.550)
0.005(0.910)
0.006(1.237)
Parent bank's profit
-0.039(-1.555)
0.760
34.65
0.718
176.31
0.718
228.04
44
298
344
Experience
Adjust R
Hausman test
Observation
0.002(1.075)
***: Statistically significant at the 1% level, **: at the 5% level; *: at the 10% level
Therefore, foreign banks in Vietnam are most likely to have a high interest margin because
Vietnam is a middle income country with GDP per capita (in 2011) was 3,400USD (WorldBank,
2012). Moreover, because of the high demand for credit, all banks may increase their interest
rates.
The ratios of equity to total assets, and of loans to total assets, indicate a significant and
positive relationship with the interest margin of domestic banks. To increase the safety of the
banking system, the Vietnamese government has required all banks to raise the capital
adequacy ratio (CAR) from 8% to 9% (Government, 2010). In addition, all banks had to raise
their capital to the minimum 3000 billion VND (20,000VND/USD) at the end of 2010
(Government, 2006a). As a result, small domestic banks compete to mobilise their captial
through a high interest rate. Furthermore, the Circular 02/2011/TT-NHNN, limiting the
maximum deposit rate to 14% annually but allowing negotiated lending rates, causes the
bridge to transfer cost to customers (Government, 2011).
Loan loss provision demonstrates a negative and significant relationship with the interest
margin of domestic banks. This is not because domestic banks manage the interest spread
well, but because they lose from bad debts. While loan loss provision does not impact
seriously on foreign bank net interest margin, it does do so for domestic banks because of
their inefficient risk management. Banks who lend to customers mainly base decisions on
relationships rather than on customers‟ fiancial health. In addition, the loan loss provision has
a strongly negative impact on banks‟ profitability in Vietnam due to the economic downturn of
2008 (Huỳnh, 2013).
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Proceedings of World Business and Social Science Research Conference
24-25 October, 2013, Novotel Bangkok on Siam Square, Bangkok, Thailand, ISBN: 978-1-922069-33-7
Other income becomes a significant contributor to the net interest margin of foreign banks
because of their type of customers. Vietnam is one of the destinations of foreign direct
investment with a high FDI/GDP ratio and GDP growth ratio, accompanied by the recent entry
of foreign enterprises (Worldbank 2012). Foreign banks in Vietnam may firstly focus on foreign
customers from their home countries or from other countries rather than on local customers.
Therefore, foreign banks enjoy an increase in interest income because their customers do not
pay much attention to the interest rates but to the quality of service and safety. Moreover, their
customers may remain in a loyal relationship since they use almost all the banks‟ non-interest
services (Bank, 2009).
Only domestic banks benefit from Vietnamese financial institutional quality because they may
own rich experience from their longevity and internal relationships. Financial institutional
quality is measured in terms of six indicators by Kaufmann et al., (2012). The financial
institutional quality of Vietnam was around -0.5 during the period from 2000 to 2011, which is
lower than the average level (Kaufmann, 2012). Local banks are knowledgeable about local
business culture, which mainly depends on relationships. It is to be noted that four state owned
commercial banks were separated from the State Bank of Vietnam in 1988, thus they have a
close relationship with the people in charge of policy making. The weak regulation provides
domestic banks with an opportunity to break the law. For instance, the circular 02/2011/TTNHNN allows banks to negotiate their lending rate with customers. Banks can apply different
interest rates based on the extent of their close relationship with their customers, and
sometimes this is not in line with the regulation: they may apply a lending rate which is lower
than the deposit rate to attract high profile customers or increase the deposit rate through a
promotion scheme (Miêu, 2012). Although authorities acknowledge this problem, they are not
able to control or punish the banks which break the law.
In conclusion, foreign banks perform better than domestic banks because they benefit from the
ownership advantage in terms of risk management and advanced technology. As a result they
become significant competitors for domestic banks gradually. This result differs to the literature
studying the same topic in Vietnam because the study period of literature was limited from
2001 to 2006. This consequence is expected by the government as its effort to restructure the
weak banking system.
5. Conclusion
The present paper has investigated the determinants of foreign banks‟ profitability and made a
comparison of performance between domestic and foreign banks in Vietnam. The findings
indicate that total assets and other income contribute positively to foreign bank profitability.
Parent bank‟s profit impacts negatively on the foreign bank profitability. This may need a
further study for a greater understanding of the reason on the effect of parent bank profitability.
The overall picture of the banking system indicates that foreign banks seem to perform better
compared to domestic banks as a whole, due to their high investment in technology and
efficient risk management. Although inheriting a high ratio of assets and longevity than foreign
banks, domestic banks face the highest loan loss provision ratio.
From those results, some suggestions can be made for the banking sector in Vietnam and for
future research. The state owned commercial banks should restructure their scale to reach
optimal size. Moreover, they should invest more in advanced technology to keep up with their
competitors. Cooperation with foreign banks in adopting advanced technology or in learn from
their experiences, is also a good strategy for developing the banking system.
10
Proceedings of World Business and Social Science Research Conference
24-25 October, 2013, Novotel Bangkok on Siam Square, Bangkok, Thailand, ISBN: 978-1-922069-33-7
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Proceedings of World Business and Social Science Research Conference
24-25 October, 2013, Novotel Bangkok on Siam Square, Bangkok, Thailand, ISBN: 978-1-922069-33-7
APPENDICES
Appendix 1: Variables description and hypothesis
Variables
Description
Dependent:
-PRO
-NIM
The profit before tax to total assets
Net interest margin
Bank-specific factors
-CO
-EQ
-LOA
-CSF
-LLP
-TOA-Ratio
-OIN
Macro economic factors
-GDP
-INF
-FIQ
Multinational banking factors
-PAR
-EXP01
Hypothesis
(direction)
Cost to total assets
Equity to total assets
Loan to total assets
Customer and short term fundings to total assets
Loan loss provision to total assets
The ratio of total assets to the all banks‟ total assets
Other income
+
+
+
+
+
The gross domestic production annual growth rate
Inflation growth rate annually
Financial institution quality of Vietnam
+
+/-
The parent banks‟ profit before tax
Length of operation
+
+
Appendix 2: Redundant Fixed Effects Tests
PRO
Effects Test
FB
Cross-section F
3.672395
Cross-section Chi-square
33.01425
7
0
Cross-section F
5.623312
-40,240
0
193.086
40
0
Cross-section F
5.148527
-49,277
0
Cross-section Chi-square
218.8536
49
0
Domestic
Cross-section Chi-square
Whole
Statistic
Prob.
(7,23)
0.0083
ROE
Effects Test
FB
Cross-section F
3.936533
Cross-section Chi-square
34.65362
7
0
Cross-section F
4.962934
-40,246
0
176.314
40
0
Cross-section F
5.431552
-49,283
0
Cross-section Chi-square
228.0436
49
0
Domestic
Cross-section Chi-square
Whole
Statistic
d.f.
d.f.
Prob.
(7,23)
0.0058
13