Drawing another line of defence: legal risk management in Vietnam’s banking sector

November 2014 | EXPERT BRIEFING | BANKING & FINANCE

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Since the late 1980s, the Vietnamese banking system has been considered the lifeline of Vietnam’s economy. Developments and reforms in the Vietnamese banking sector have come a long way as the State Bank of Vietnam (SBV) and the government have consistently incorporated changes into the banking system’s structure, laws and regulations and bank operations in order to move Vietnamese banks towards a system model which meets international standards while, at the same time, being appropriate for an emerging market and newly industrialised economy.

The Vietnamese banking system is still in the early stages of development and therefore banks have been facing numerous legal risks in their operations. This article argues that banks in Vietnam are potentially exposed to several fundamental challenges.

Vietnamese banking regulations

Vietnam has undergone a dramatic transformation from a centrally planned economy to a socialist-oriented market economy. The Vietnamese legal system has been developing to catch up with the rapidly changing needs of a booming economy. In respect of risk management, no specific guidance has been promulgated yet. Without the SBV’s guidance, setting up a risk management system in accordance with international standards such as Basel I, II or III, is not within the capability of Vietnamese banks. Therefore, various banks have endeavoured to duplicate internal control policies (including credit assessment systems) of one another, but such a one-size-fits-all model cannot work effectively for different banks.

In early 2014, a guidance on risk management of credit institutions was drafted by the SBV. Meanwhile, the SBV has already initiated a voluntary pilot scheme, whereby the 10 biggest Vietnamese commercial banks (i.e., Vietcombank, Vietinbank, VIB, BIDV, etc.) have been nominated by the SBV, for the first time, to apply the risk management standards of Basel II. This was a huge step made by the SBV towards restructuring the banking system and enhancing the effectiveness of internal risk management systems in Vietnamese banks and to fill in certain gaps that still remain under the SBV’s current regulations.

Poor corporate governance in Vietnamese banks

Poor corporate governance has long been the criticism of Vietnamese banks which operate with bad management practices, devoid of ethics and principles which follow the law, thereby threatening the long term solvency of the bank. The Vietnamese banking sector currently lacks several important structural factors, namely: (i) transparency of governmental actions; (ii) regulatory compliance by management; (iii) media attention; and (iv) shareholders’ responsibility in management accountability and taking control of operational risks.

While internal controls are of critical importance in assessing potential risks in a bank’s business, the supervisory board and internal auditors of Vietnamese banks, who are in charge of internal controls, are not given enough powers to manage risks. In addition, Vietnamese banks are reluctant to disclose their financial position, statement of accounts, compliance status and other legal violations. With such a non-disclosure practice, it becomes easier for management to indulge in improper practices and compromise corporate governance.

Overstretched legal departments

Vietnamese banks often have an inability to control legal risks because of the inadequacy of their control framework and their internal legal department’s failure to apply risk control. In Vietnam, the mindset is one of compliance rather than risk management. While the legal department plays an important role in ensuring comprehensive compliance of a bank’s business, personnel are often unable to manage legal risk, and oversee large, complex transactions.

Vietnamese banks should have the review of major financial transactions, or the creation of a compliance system, outsourced to a professional law firm that can provide banks with an independent legal opinion and specialised legal advice on significant transactions and business activities, or assist with identifying and mitigating risks (i.e., legal risk, organisational risk and credit risk).

Harsh reprimands by the SBV for violations

The aftermath of the ‘mega-cases’ of 2013 saw comments by the courts, the SBV and business management authorities on the interpretation of the Law on Credit Institutions 2010 (LOCI) with respect to what a bank is permitted to do. LOCI clearly states that credit institutions are entitled to do only such business which is registered in their Establishment and Operation License (EOL) and in accordance with guidance from the SBV. However, two noteworthy points remain: (i) current EOLs of credit institutions in Vietnam do not specifically list businesses under the capacity of credit institutions; and (ii) there are many types of business which lack the SBV’s guidance. In other words, many banks may be subjected to criminal sanctions for doing business illegally with their current list of services. Therefore, after the sentencing of the ACB’s executive management, tensions have also arisen in the banking sector and banks have since attempted to narrow their scope of services.

Further, if there are any danger signals of default on payments or insolvency, or a serious breach of law resulting in a risk of a loss of operational safety of a bank in the system, the SBV would then assume special control over such credit institution, and apply numerous strict policies to the bank’s organisation and operations.

Criminal and administrative offences of bankers

Fraud has increasingly become a huge problem for the Vietnamese banking industry. There has been a dramatic rise in the number of fraud cases recorded in recent years. The biggest bank fraud in Vietnam’s history was seen in 2013, committed by Huynh Thi Huyen Nhu, the former deputy head of risk management of the Ho Chi Minh City branch of Vietinbank, along with 30 accomplices whom were all internal staff. Nhu was convicted of illegally appropriating assets, forgery and defrauding investors and banks of over US$200m and was then sentenced to life in prison for these offences. In another case, tycoon Nguyen Duc Kien, former vice chairman of the founding council of ACB, received a sentence of 30 years’ imprisonment for his four alleged offences, including misappropriating company assets, intentional violations of the State’s economic management regulations causing serious consequences, tax evasion and illegal trading. These ‘mega-cases’ caused a serious loss of assets, while negatively affecting the reputation of the Vietnamese banking sector. The main reason for such criminal practices (aside from dishonesty) stems from inadequate control of operational and legal risks in a bank.

Conclusion

As a general observation, legal risks in Vietnamese commercial banks occur primarily due to the deficiency in the Vietnamese credit institutions’ risk management systems as well as the failure of corporate management to catch illegal transactions and observe a corporate governance code of conduct . On the face of this issue, it is critical that the Vietnamese banking system strengthens its scrutiny and due diligence on internal risk management during periods of aggressive credit growth, and attaches more weight to an effective mechanism to detect and report suspicious transactions made by top management in banks, as well as seeking professional advice from independent legal advisers.

Kent Wong is a partner and Ngan Ho is a junior associate at VCI Legal. Mr Wong can be contacted by email: kentwong@vci-legal.com. Ms Ho can be contacted by email: nganho@vci-legal.com. The authors would like to thank Tri Dang for his contribution to this article.

Kent Wong and Ngan Ho

VCI Legal