Discussion Paper 60: WOLZ, Axel: The Transformation of Rural Finance Systems in Vietnam

Diskussionsschriften der Forschungsstelle für Internationale Wirtschafts- und Agrarentwicklung eV (FIA), Nr. 60, Heidelberg 1997

 
 
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C o n t e n t s

Abstract

1 Introduction

2 Transformation of Agricultural Production (Decollectivisation)

3 Affects of the doi moi on (rural) finance systems

3.1 Collapse of the Traditional Credit Cooperatives

3.2 Establishment of a new formal finance system

3.2.1 The Bank for Agriculture and Rural Development (VBA)

3.2.2 The Vietnam Bank for the Poor (VBP)

3.2.3 The Network of People's Credit Funds (PCFs)

3.2.4 Private Banks in Rural Areas

3.3 Major Problems Affecting the Formal (Rural) Finance System

3.3.1 Limited Access to Financial Services

3.3.2 Limited Supply of Financial Innovations

3.4 Semi-Formal Finance Systems in Rural Areas and Their Links With the Formal Sector

3.5 Informal Finance Systems in Rural Areas

4 Conclusions

5 Bibliography

Annex

 

Abstract

The adoption of the doi moi policy in 1986 led to a far-reaching transformation of the agricultural sector. Collective farming was given up and private family farms were legally accepted as the principal unit of agricultural production. This policy shift was followed by a rapid increase in production levels. Vietnam became the third important exporting nation of rice. This sharp increase would not have been possible if there had not been a functioning informal fi nance system in the rural areas. The formal financial system had been in disarray and the network of credit cooperatives rapidly collapsed. The classical mono-banking system which characterised all socialist countries proved to be highly ineffective and c ostly. New institutions had to be set up. In the late 1980s the government has introduced the two-tier banking system. The Vietnamese Bank for Agriculture (VBA) was created out of a department of the State Bank and became operational in late 1990. The Vie tnamese Bank for the Poor (VBP) was established in 1995. In addition, since 1993 the State Bank supervises the set-up of a network of People's Credit Funds (PCF) which are organised like cooperatives. Similarly, banks and mass organisations were encourage d, often with the help of foreign non-government organisations, to support informal savings and credit groups in rural areas and provide links to the banks. While first promising steps have been taken, the limited access to credit is one of the most urgen t constraints to rising productivity in farm and non-farm activities in the rural areas. It will take a long time until a viable rural finance system will be established which responds to the needs of the rural clients, satisfactorily.

1 Introduction

In line with the rapid economic transformation since the adoption of the doi moi policy in Vietnam the whole financial sector had to be reorganised. Up to now, this process has not been terminated, yet. With respect to the agricultural secto r and the rural economy the decollectivisation of agricultural production led to the re-emergence of family farms which need, among others, a viable rural finance system in order to make full use of its potential and, hence, to ensure an adequate level of income for the farming population. This paper looks at the development and present state of rural finance systems with an emphasis on the perspective of prospective rural clients.

Within this paper (rural) finance systems (or financial sector or financial infrastructure) will be understood as follows. They comprise "all savings and financing opportunities and the financial institutions which provide savings and financing opportu nities, as well as the valid norms and modes of behaviour related to these institutions and their operations." (KRAHNEN/ SCHMIDT: 3-4) According to the degree how these systems fall under the rules and regulations in a given country they can be distinguis hed between formal, semi-formal and informal systems. The formal financial system comprises all institutions and transactions which are legally subject to national financial market regulation (banking legislation and supervision). The semi-formal system c overs all formalised ("registered") financial institutions which are not subject to banking supervision, e.g. credit cooperatives or financial activities supported by NGOs or mass organisations. The informal financial system falls completely outside of th e legal infrastructure of the economy. It comprises all financial activities among family members, friends and neighbours, money lending and pawnbroking, as well as mutual savings and credit associations. These institutions are not registered and, hence, are not subject to supervision by the banking and monetary authorities. Generally, these activities are not covered by the national statistics (KRAHNEN/SCHMIDT: 31-32).

This paper is structured as follows: In the next chapter a brief outline about the decollectivisation process in agricultural production will be given. The major part of this paper deals with the effects of the doi moi policy on the rural financ e systems. This chapter has been divided into five parts. In the first part the rapid collapse of the credit cooperatives in the early 1990s is discussed which severely damaged the confidence of the rural population in the formal and semi-formal financial systems. In the second part the set-up of the formal rural finance systems is reviewed which is followed by a discussion about the major problems facing farmers and rural entrepreneurs in getting access to this system. In the final parts the semi-formal and informal rural finance systems will be assessed. Finally, in the last chapter major conclusions out of the discussions on the rural finance systems will be drawn.

2 Transformation of Agricultural Production (Decollectivisation)

During the last decade Vietnam implemented far-reaching economic reforms which led to impressive growth rates. A decollectivisation process in agriculture has been started which resulted in the re-establishment of private land use rights, re-emerge nce of private farming and private (mostly small-scale) traders in the rural areas. The enforced agricultural production cooperatives were dismantled. While the majority were no more operational, they kept on existing "on paper". Most of them are supposed to be transformed into service cooperatives in line with the Cooperative Law effective from 1 January 1997. In these days, farming in Vietnam is based on a family farm basis, again. However, private ownership of agricultural land has not been introduced, the land can be rented for long-term periods. In this respect the security of the usufructuary rights had been ensured.

Although some minor experiments with household contracts were introduced during the late 1960s in (North) Vietnam, the decollectivisation process started on a large scale in 1981 when the contract farming system had been introduced with the enactment o f Directive 100. At that time it was not intended to abolish the agricultural production cooperatives. It was looked for a way to improve the internal efficiency. Soon afterwards the Party pushed again for a socialist transformation of the entire country. Therefore, the reforms of 1981 did little more than create a temporary improvement in the static efficiency of the collective sector. Output growth slowed around 1983-84. By 1985 output growth stagnated and the per capita staple production had started to decline alarmingly. Therefore, when shortages of food became regular during the mid 1980s the doi moi policy opened the door for more autonomous ways for production under the responsibility of the household. (LOUNG: 202-208; FFORDE/de VYLDER: 134- 141)

With the adoption of the Land Law in 1988 (Resolution 10) farmers were given the opportunity to farm on their own. From now on, the farm households and no more the agricultural production cooperatives were considered the basic unit of agricultural prod uction. Farmers were allowed to manage plots of land on their own which were allotted by the production cooperatives, i.e. they were given the land use rights in exchange for paying a tax while the state retained ownership rights. Most farmers opted to un dertake farming on a family farm basis. However, the Law restricted the transferring of land use rights to occasions such as a farm household moving in or out of the cooperative and the death of the person holding land use rights.

Although the Constitution, as amended in 1992, reaffirmed that land and other natural resources in Vietnam are owned by "the entire people", there was a clear need to legalise the transferability of land use rights and to provide the security to land u se which a market economy needed. With the adoption of the revised Land Law in July 1993 the land use rights of the farmers have been strongly secured. From now on, households and individuals to whom the state has assigned land have the right to exchange, transfer, rent, inherit, and mortgage land use rights. In this respect, the revised land law sanctions the emergence of a land market. The land can be rented for a period of 20 years for annually cropped land and aquaculture and 50 years for perennially cropped land, with the possibility of renewal at the end of the first contract. With respect to the amount of land per household, the Law puts an upper limit at three hectares per household for annually cropped land, with specific limits in each locality to be defined by the Government (KERKVLIET: 82-85).

This economic liberalisation in agricultural production resulted in a sharp increase in production output. While up to the mid 1980s Vietnam used to be a rice importing country, it quickly changed to the third largest exporting nation of that commodity . In light of the recent past, when famine and poverty were common occurrences in rural areas, the present abundance of food represents a major step forward. While the economic position of the farmers has improved significantly during the last years, it i s, on average, still not enough for accumulating some surplus for investments. Similarly, some agricultural regions benefited more than others. Out of the seven regions in Vietnam three regions comprising the Northern Mountains and Midlands, the Central H ighlands and the North Central Coast lag far behind. On the other side, two regions comprising the Mekong Delta and the Red River Delta saw a rapid increase in agricultural production and farm incomes (FFORDE/SÉNÈQUE: 116). Besides the very good natural conditions, the reasons seem to be the better developed infrastructure and their close location to the major urban centres.

This rapid increase in agricultural production has to be seen in light of the sharp decline of the established organisations of the up- and downstream sectors. Amongst others the formal finance system operational up to the late 1980s collapsed as will be discussed below. Most of the necessary capital has been financed by the farmers themselves and through the informal finance sector. However, this strategy does not provide a sustainable development pattern leading to further improvements in agricultura l production. Therefore, in spite of this huge success the agricultural sector will have to undergo more profound changes if it aims to continue to be competitive nationally and internationally. A continuation of the rural transformation process is needed . This transformation not simply requires changes in agricultural production or shifts in the distribution of resources but includes amongst others the reorganisation of rural finance systems.

3 Affects of the doi moi on (rural) finance systems

Financial sector reforms have been an important part of the overall economic reform process under doi moi. The pre-reform period was characterised by a state monopoly over finance, a pervasive subsidy system, negative real interest rates and an inverted interest rate structure with deposit rates above lending rates. This led to unrestrained budgetary expenses, excessive money supply, financial disintermediation and hyperinflation (see Table A1 in the annex). It seemed to be no exaggeration t hat "the financial system went out of control" (SEIBEL, 1996: 36). Initial reforms in 1987 were directed at trade and monetary liberalisation, but were not very successful. The reforms of 1989 were mainly anti-inflationary, and included sharp increases in the interest rate, devaluation of the official exchange rate (see Table A2 in the annex) and limits to credit expansion. This was complemented by measures to reduce the overall fiscal deficit through the elimination of budget subsidies, the reduction of credit to state enterprises and streamlining of the bureaucracy (ABIAD, a: 8). The enforcement of these measures contributed to the rapid collapse of the credit cooperatives in 1990-91.

Before 1988, Vietnam was characterised by a mono-tier banking system, comprising the State Bank of Vietnam (SBV) and two specialised institutions (i.e. the Bank for Investment and Development, established in 1958 and the Bank for Foreign Trade (Vietcom bank), established in 1963). Through its network the SBV provided all domestic banking services. As in other socialist countries, SBV became the interface between planning and budgeting processes and state enterprises according to the central plans. Resou rces were allocated administratively. Loan appraisal, risk management and other key elements of banking became irrelevant. Basically, the SBV had two functions:

In 1988, the country gave up the mono-banking system and adopted a two-level system, with the SBV) retaining its central bank functions. Two state-owned commercial banks were created out of departments of the SBV - the Agricultural Bank of Vietnam (VBA ) and the Industrial and Commercial Bank of Vietnam (ICBV). During the ten months following the reform of early 1989, which allowed for positive real interest rates, deposits with the two government-owned banks grew at 335%. It has been remarkable that ho usehold deposits showed a growth rate of 630%, while enterprise deposits just grew by 185% (SEIBEL, 1996: 37). This just reflected the fact that financial resources of the households could be tapped by the formal system if the conditions were right. Howev er, soon fundamental weaknesses of the financial infrastructure in intermediation became apparent. The newly-formed commercial banks were but arms of the SBV, which in turn failed to carry out central bank functions. The financial discipline was not maint ained and inflation re-emerged. Without new reforms further progress would have been difficult. These were implemented in adopting a new banking law, effective 1 October 1990. Among others these reforms enabled VBA to undertake commercial banking operatio ns. In addition, it was given greater autonomy (SEIBEL, 1992: 52; ABIAD, a: 1).

This reform laid the foundation for the expansion and differentiation of the financial infrastructure, moving from state finance to commercial banking. Banking has been one of the first areas of the economy to be deregulated and opened up to the privat e sector. While in 1993 the banking sector was dominated by the four state-owned banks which together accounted for about 90% of lending, total banking assets came up to about 38.8 trillion VND. This just equalled about 30% of the GDP, which has been low compared to other countries in Asia (ABIAD, b: 13). Vietnam has been and still is underbanked, although major improvements have been accomplished. But a lot more has to be done until a viable system will be operational. In 1996, still about 80% of the len ding is handled by the four state-owned banks (FEER, 17/7/1997). However, in 1997 the institutional set-up looks quite heterogeneous. In addition to the four big state-owned banks, there is the newly established Vietnam Bank for the Poor (VBP) which is cl osely linked with the VBA, an emerging network of people's credit funds and 54 joint-stock banks. Besides the national institutions there are 24 foreign banks (operating 28 branches), four joint-venture banks and 70 foreign-bank representative offices (FE ER, 25/9/1997).

From the clients' point of view, it can be concluded that the most important developments affecting the rural finance sector during the transition from central planning to a market have been the changes of the formal (and semi-formal) financial infrast ructure and its way of operation. In line with the effects of the national policies the traditional credit cooperatives rapidly collapsed in 1990-91. On the other side, new institutions and organisations have been built up in order to ensure economic deve lopment in rural areas. The most important developments have been the following ones:

a) the establishment of the VBA;

b) the establishment of the Vietnam Bank for the Poor (VBP) in 1995;

c) the set-up of the people's credit funds (PCF) under the supervision of the SBV; and

d) the emergence of new private joint-stock banks (rural share-holding banks).

These developments will be discussed below. In addition, it will be assessed whether the rural population can make use of these financial innovations in order to improve their economic situation, or whether they have to rely on informal financial arran gements.

3.1 Collapse of the Traditional Credit Cooperatives

The present situation of the rural finance system can only be fully understood if one takes note of the development of the rural credit cooperatives up to their collapse in the early 1990s. They were already established in 1956 in North Vietnam, an d 1983 in the South. Their main purpose was to gather small deposits and provide credit to individuals, farm households, small businesses and production cooperatives. Already in the early 1960s about 5,500 rural credit cooperatives had become operational, about another 2,000 were set-up during the early 1980s. In the late 1980s, their number stood at 7,180 (ABIAD, a: iv).

Although they were set up as local financial intermediaries on behalf of the SBV, they were operating in isolation from each other, without any network links. In reality, they were predominantly established within small communities beyond the direct re ach of the SBV and managed by local people's committees. Actually, the term cooperative did not describe a form of mutual self-help, but rather reflected an operation which was organised by the administration. (DAUBERT, 1996a: 23).

Most of them have fallen prey to the financial reforms of the late 1980s. As rural collectives went out of business, their loans from credit cooperatives became non-performing. There was no system of reserve assets or deposit insurance. The SBV did no more automatically refinance the credit cooperatives as it used to do before the banking reform in 1989. With arrears mounting, the large majority of the credit cooperatives collapsed. By the end of 1990 only 160 of those rural credit cooperatives were st ill operational (SEIBEL, 1992: 64). With the adoption of the new banking law in 1990, just 80 of them received a licence to go on operating. Up to early 1997 78 out of those 80 cooperatives have been transformed into people's credit funds (PCFs, for more details about the PCFs see Chapter 3.2.3) (SEIBEL, 1997: 20).

Besides the effects of the monetary and banking policies in the late 1980s, the credit cooperatives were badly prepared to function as full-fledged rural banks. The supervision by SBV was poor, the staff in charge of management were badly trained, ofte n incompetent. In addition, a number of cases of fraudulent behaviour by the staff and (local) officials had been reported. Therefore, it was no surprise that panicked depositors rushed to withdraw their money. (Small) private enterprises - in general jus t recently established - were particularly affected by the collapse of the credit cooperatives. At that time these cooperatives were their only source of formal credit (FFORDE/de VYLDER: 265).

The major effect of the collapse of the credit cooperatives seemed to be psychological. "The public's faith in the financial system was seriously damaged, and the issue of corruption and economic crime in general came to the surface. The confidence cri sis - and, of course, the negative real rate of interest all through 1990 and 1991 - also affected the formal banking system; many people withdrew their deposits to buy gold and dollars, as illustrated by the sharp increase in the price of these assets du ring the latter half of 1990 and 1991" (FFORDE/ de VYLDER: 266). Therefore, the acceptance of the formal finance system has been somewhat tarnished by the bad experience from the past. (Rural) people had to rely on informal arrangements.

3.2 Establishment of a new formal finance system

As already discussed above, the government implemented far-reaching monetary and banking reforms in the late 1980s which were required to lay the foundation of a sound formal finance system, but which also led to the collapse of the credit cooperat ives. The state was no more in a position to bail out these cooperatives. At that stage the majority of the rural population had no access to the formal financial system. New institutions and organisations had to be established, which not only had to gain the confidence of the population (i.e. the access to banking services is available on a large scale) but also had to provide these services in a cost-effective manner. Actually, the newly-established financial system has to be cost-reducing for the clien ts to meet the Schumpeterian qualification for financial innovations (v. PISCHKE: 122-123). There are first indications that these innovations did in deed lead to cost-reductions for rural clients in making use of banking services. Those institutions most relevant for the rural population will be discussed below.

3.2.1 The Bank for Agriculture and Rural Development (VBA)

Of the four state-owned banks, it is the VBA that has a rural credit mandate. While the VBA has been created in 1988 out of a department of the SBV, it could only start operating once the new banking laws became effective 1 October 1990. It actuall y started to become operational in December 1990. Although it is empowered to undertake all commercial banking functions, its focus lies on financing all types of enterprises in the rural areas, i.e. public institutions as well as the emerging private sec tor (ABIAD, a: 20).

At its start VBA took over the branch network of SBV in the rural areas. Over the years it has steadily increased in network and provides the largest one of all banks in Vietnam. At the end of 1996, it managed 2,564 branch offices spread all over the c ountry (SEIBEL, 1997: 4). In order to reach more and more clients in the rural areas VBA has introduced a number of innovations, like using mobile banking units, operating transaction offices at the commune level and introducing a system of joint-liabilit y group lending. In addition, VBA has a number of agreements with mass-organisations covering provisions of financial services to groups made up of mass-organisation members (JOHNSON: 2), which will be discussed below. It has to be stressed that while the network has been expanded, the number of staff has been reduced at the same time by about one fourth.

With the expansion of its network VBA had been able to enlarge its clientele rapidly. In its first operations in 1990 VBA provided credit almost exclusively to state-owned enterprises. However, it quickly adopted to changed economic conditions when pri vate farming became the dominant mode of agricultural production. It changed from being essentially a conduit of government funds to the state-owned enterprises to being a bank with a commercial outlook, lending primarily to farm households (JOHNSON: 2). Authorisation for lending to farm households was given in July 1991, and within six months the bank had lent about 405 billion VND (about US$ 36 million) to 558,680 households. The average size of loan came up to about US$ 65 per household. Initial repaym ent rates were excellent. At that time farm households just accounted for about 10% of the total loans. In the following year VBA reduced its credit delivery to the state-owned enterprises and the agricultural production cooperatives, significantly (LE/Mc CARTHY: 121).

The share of rural households having access to credits managed by VBA increased rapidly from 9% in 1992 to about 30% in (early) 1994 (BOSCHERT et al.: 16). In 1995, it was estimated that about 5 million out of a total of 12 million farm households (or about 42%) received a loan by VBA. In 1996 even about 7 million households (or about 58%) have been reached by VBA. This rising share of rural households with access to financial services of the VBA is reflected in their rising share of its total loan por tfolio. While 1991 rural households received about 10% of the total loans, their share increased to 43% in 1992 and to 65% in 1993 (BERGERET: 19). In 1995 about 82% of all credits went to rural households while state-owned enterprises received the rest (F EER: 16/10/1997). Similarly, the size of the average loan increased from about US$ 65 in 1991 to about US$ 187 in 1994. In 1996 the average loan size is estimated to come up to about US$ 150. While this amount is still quite small, it reflects the need fo r higher investments in the rural areas, but also that rural households develop a more intimate relationship with VBA (ABIAD, b: 17; VBA: 14/4/1997).

When VBA was established it was supposed to provide all type of credit, but in reality only short and medium term credit has been available, so far. Actually, VBA's overall loan portfolio is dominated by short-term loans, accounting for almost 90% of i ts lending in 1995 (ABIAD, b: 17). This pattern did not change up to early 1997. However, in line with the decline of the inflation rate credit rates went down as well. But VBA still does not have the authority to set-up rates for both credit and savings according to the market forces. During all the years since its inception the interest rates which are charged and paid by the VBA are determined within the framework specified by the SBV. However, over the years VBA has gained greater flexibility in setti ng their own interest rates. On the other side, since VBA is the dominant source of rural finance other intermediaries have to follow their rates.

In late 1991 the average lending rate stood at about 3.5% per month. But there was a sharp discrepancy between the rates farm households had to pay compared to state-owned enterprises. While the former were charged 4-5% per month, the interest rate for the latter stood at just 2.4% per month. The average lending rate was equal to the deposit rate paid on three-month deposits which meant that VBA could not cover their costs and made losses on financial intermediation (LE/McCARTHY: 121, 145). During 1992 , VBA adopted a more commercial attitude. As of June 1992, state-owned enterprises had to borrow at the same rates as the private sector. Due to the higher inflation rate in 1991 savings were mobilised at 3.5 % per month and credits were given to farm hou seholds at 5-6% per month. A certain positive margin could be managed to cover banking costs which contributed to VBA's institutional viability. As the inflation rate declined rapidly during 1992, deposit rates have become positive in real terms, again (S EIBEL, 1992: 101).

In late 1995 the average rate for short-term loans stood at 2.1 to 3.0% per month, and 1.7 to 1.9% for medium-term loans. Deposit rates for individual savers ranged from 0.7% on demand deposits to 1.4% per month on time deposits (ABIAD, a: 27). During 1996 the SBV cut the credit rate which VBA was supposed to charge its customers in four steps. Lending rates have dropped to the lowest level ever in the recent past (NGUYEN: 1). In early 1997 the interest ceilings of VBA for short-term credit stood at 1. 45% per month and for medium and long-term credit at 1.55% per month. However, for the time being medium and long-term credit is only available on a limited scale. On the other side, the interest rate for savings comes up to 0.7% per month for daily depos its, 0.9% for three months deposits and 1.0% per month for six months deposits. Keeping in mind that the annual inflation rate stood at 4.6% in 1996, these rates are definitely encouraging savings. However, for the time being no long-term saving products are available. This might reflect the still limited trust of customers in the formal finance system. But bankers know that they have to develop long-term savings products (VBA: 14/4/1997).

When VBA started handing out credit to rural households they were provided on an individual basis. It used to ask for collateral and a guarantee by the authorities of the local commune. At that time family farms had been fairly recently established and a proven repayment record did not exist. Therefore, it is not surprising that VBA's action had been limited by the type of clientele it could reach, i.e. the medium-sized and well-to-do farmers who could provide collateral. Hence, its scope was limited t o about 20-30% of all farmers (BOUSQUET: 73-74). Starting from 1995, VBA adopted a new credit policy and made use of joint-liability groups. For loans up to 1 million dong, no collateral is needed. The joint-liability group acts as a guarantee, i.e. these small loans are only processed via groups. For loans between 1 - 10 million dong a guarantee by a third party is required. For loans over 10 million dong there is still a need for a collateral. Land use rights are accepted as collateral. In case of non-r epayment, the VBA is trying to recover the loan with the help of the local people's committee since there is no land market for the time being. In this respect, the collateral in form of land is more a formality, since, in reality, the VBA cannot rent or sell the land. Most commonly, houses, motorbikes and durable consumer goods are accepted as collateral. Those who own assets go on to approach the staff of VBA directly on an individual basis. (ABIAD, a: 27-28; VBA: 14/4/1997).

Therefore, the expansion of its customer base among rural households can be explained to a large extent by the fact that VBA opened up for those rural households who could never dream of getting a credit on their own but only under the umbrella of a jo int-liability group. In 1995 about 74,000 joint-liability groups had been set-up which had been voluntarily joined by poor households. In early 1997 about 150,000 joint liability groups are supported. While about 100,000 groups are pure credit groups, the other 50,000 are savings and credit groups. All these groups are informal ones and are not registered in a strict sense. However, all these groups are supervised and looked after by the various mass organisations (see for more details Chapter 3.4 below). Similarly, all groups have to be certified by the people's committees at the commune level. Otherwise they will be not eligible for any loans by VBA. Credit for these groups is only provided on a short-term basis, medium to long-term credits is not avail able for the time being.

In general, the joint liability groups comprise 10 - 20 members. Responsibility concerning all repayment modalities lies with the group. Members agree that they have a joint responsibility for repaying loans. The bank officer is in close contact with t he head of the respective group. There are no group applications. Each credit application is processed on an individual basis. Similarly, those who are saving have their own individual saving passbook (VBA: 14/4/1997). It is planned to shift all activitie s with respect to joint-liability groups to the newly established Vietnam Bank for the Poor (VBP; see for mare details Chapter 3.2.2). VBA is supposed to target the business with more potential or wealthier clients in the rural areas.

In its first years of operation, VBA suffered losses. During the last years VBA has been quite successful in setting up a financial infrastructure in the rural areas. About 90% of total credit extended to rural households by formal financial institutio ns is handled by it (VBA: 14/4/1997), although this share might include the activities managed by VBP as well. Repayment rates have been very good. Already in 1993, VBA recovered 98% of its loans to rural households compared to about 50% of its loans to s tate-owned enterprises, which might also explain why it reduced its services to these enterprises. In that year, VBA posted an after tax profit for the first time amounting to about VND 2.7 billion (US$ 0.6 million) (SEIBEL, 1996: 44). In 1994 and 1995, i ts annual net profits continuously increased to VND 23 billion and VND 48 billion, respectively. VBA became the first commercial bank in Vietnam which has been audited by an international auditing firm, which confirmed good progress (PHAM: 23). However, i t was impossible to assess the bank's bad debt in the audit. At least VBA for the first time created provisions for bad and doubtful debts of VND 257 billion (FEER: 16/10/1997). While its economic position might not yet be that profitable as shown in its own reports, VBA stands on a sound basis. From the clients' point of view VBA is the most important source of rural finance. Without it, it will be impossible to improve production capacity and efficiency of rural enterprises within the next years.

3.2.2 The Vietnam Bank for the Poor (VBP)

The VBP was established by a decree in August 1995. It is a state-owned bank but it is not supposed to be managed along commercial lines, i.e. it is a non-profit bank. It was intended that the approaches of VBA and VBP complement each other. Its ob jectives are to contribute to hunger eradication and poverty alleviation in Vietnam. All poverty lending programmes are to be centralised by it. VBP started operating 1 January 1996. It did not set-up its own national infrastructure but makes use of the e xisting branch network and staff of VBA, under the terms of an agency agreements. Therefore, with respect to the clients bank personnel at the local level handling both VBA and VBP activities is the same.

VBP intends to alleviate poverty through the provision of credit to those who do not qualify for individual loans because of limited ownership of potential collateral. Therefore, loans are only provided to those eligible households which are members of a joint-liability group. VBP makes also use of the network of the existing 150,000 joint liability groups. However, it is the rule that one client can only approach one bank for credit at the same time, i.e. either VBA or VBP (VBA; 14/4/1997). Gradually, VBP will take over the loan portfolio already lent out to the poor by VBA at preferential interest rates.

Eligible households are only those which are classified as poor under the strict Vietnamese criteria. As (absolute) poor are defined those households which earn less than a certain monthly income converted into rice value: (a) in urban areas under 25 k g per person; (b) in flat land and midland rural areas under 20 kg per person; and (c) in mountainous areas under 15 kg per person. Based on these criteria, it was estimated that in 1995 about 3.3 million households (or 22.8% of all) had to be classified as poor. By far the majority of those were living in rural areas (HA: 25).

Those eligible for loans get credit at preferential interest rates of 1.0% per month in 1997. These rates are set by SBV and they are by far lower than the rates asked by VBA which stand at about 1.5%-2.0% for rural households. In addition, clients are not charged any commissions or fees. Loans are only provided for production or related purposes. In most cases borrowers are not handed over the credit in cash but in kind. The credit programme is linked with extension in order to ensure that it leads to higher incomes. VBP closely collaborates with professional organisations and appropriate ministries in addition to the mass organisations for supervising and supporting the groups (HA: 26).

Lending by VBP has spread over the country fairly quickly, particularly to the far-inland, remote and highland zones. By 15 May 1996 731,000 households have borrowed VND 735 billion (on average over VND 1 million or about US$ 90 per household) through 69,000 joint-liability groups. The repayment of both principal and interest is good and overdue loan rate is very low. (HA: 25). As of 31 December 1996, the total amount borrowed increased to VND 1,769 billion distributed among 1.3 million households. The average credit stood at VND 1.37 million or about US$ 120 (BOSCHERT et al.: 5).

The funds available for VBP are not enough to cover the demand. Its capital base is still too small to cover all poor households. Most of its capital is provided by SBV and foreign sources. In addition, VBP has started to promote savings among its clie ntele, again in collaboration with the mass organisations. About 15% of its capital is mobilised by the rural population by now. It is planned to broaden its capital base in the future. Similarly, the number of clients is supposed to be expanded. VBP plan s to reach about 3.2 million poor households by the year 2000.

It is unlikely that VBP may be able to cover the entire costs that must be incurred in reaching out to the poor. In order to cover the preferential interest rates VBP has to receive budgetary subventions and contributions from SBV (ADB: 112), which see ms to be the price for the preferential credit rate ceilings. No exact figures about the scope of this subsidy are available. The approaches of VBA and VBP have been supposed to complement each other, but "in reality they correspond to two extremes in the institutional lending, on the one hand a commercial attitude and on the other a paternalistic one requiring subsidy" (DAUBERT, 1995: 3). For the time being it is too early to come up with a final assessment.

3.2.3 The Network of People's Credit Funds (PCFs)

After the collapse of the rural credit cooperatives in the early 1990s it was quickly realised that VBA could not fill the void left. Therefore, SBV had been entrusted to reorganise a rural credit cooperative system in a cautious and prudent manner . One of the most important objectives had been the need to restore public confidence in the formal rural finance system. Therefore, the term "cooperative" had been deliberately excluded from the name of this newly-established finance institution. Since J une 1993 credit unions or a network of People's Credit Funds (PCF) has been gradually established. These unions are commune level savings and credit cooperatives, inspired by the Desjardins model. The mobilisation of local idle funds and the provision of credit services is its main function. Most of the few still viable (traditional) rural credit cooperatives were transformed into a local credit fund (LCF)-group, but most LCFs have to be set-up from the scratch. Three main features characterise the PCF-ap proach: There is (a) an improved local access for borrowers and savers through controlled transaction costs; (b) a risk-sharing across local lending units, and (c) an emphasis on savings mobilisation and loan repayment (ABIAD, b: 17).

The set-up of the PCF-system can be described as formal finance system development from both sides, from above and from below. The initiative to establish the PCF-system has been taken up by SBV. It provides a very intensive support in controlling, sup ervision and training of staff, particularly during the implementing stage. This approach is a good show case for finance system development from above. On the other side, the PCF-system is designed as a member-owned organisation, which aims at mobilising savings from its members. It has to be managed according to the economic principle of cost-covering. It is not designed to receive subsidies by the state; no "easy money" will be available. Since the members own this finance institution, they have the ri ght to participate in decision-making. In this respect, the set-up of the PCF-system is an approach for genuine development from below. Because of its organisational set-up the credit funds fall under the stipulation of the Cooperative Law, effective 1 Ja nuary 1997. As financial institutions they have to follow the regulations as required by the Banking Law (BOSCHERT et al.: 20-21, 46). The 16th draft of this law is supposed to be adopted by the National Assembly by the end of November 1997.

With the set-up of the PCF-network it is not only intended to create a viable rural finance system, but also to repress "high-interest illusion and unhealthy credit competition in rural areas (and to) promote cooperative spirit among the rural people" (VU: 3). To foster a cooperative spirit seems to be an important feature in running the PCF-system, particularly at the local level. The PCF-system is supposed not only to be managed profitably but also to promote self-help and mutual assistance among its members. This is a distinguished feature in comparison to other commercial banks (VU: 4).

The PCF-system comprises three managing levels, i.e. the local credit funds (LCF), the regional credit funds (RCF) and, on top, the central credit fund (CCF). The CCF, the apex organisation, has been established in August 1995. The RCFs will be establi shed gradually. While all units are legally independent and do their accounting separately, they are interlinked with each other. The three levels have to be integrated in line with their respective functions to ensure a smooth operation of the whole syst em. The functions of CCF are to ensure relations with government and internal-external financial credit organisations, to regulate resources within the system, to make accounting, lending and borrowing services to the whole system. RCFs have the function to coordinate local activities. The LCFs manage direct relations with their members in providing credit and mobilising savings (VU: 3).

Once established on a pilot-basis, the PCF-network spread fairly quickly all over the country. This approach proved to be extremely popular and it has operated efficiently. In September 1997, the PCF-system comprised the CCF, 9 RCFs and 923 LCFs. The d evelopment during the last three years looks as follows:

Table 1: Development of PCF-Network since 1993

Date

Number of LCFs

Number of RCFs

Members

Deposits
(mil US$)

Loans
(mil US$)

Aug. 1994

78

n.a.

33,583

3.8

5

Dec. 1994

153

n.a.

n.a.

n.a.

n.a.

31 July 1995

200

2

n.a.

n.a.

n.a.

Dec. 1995

534

3

>150,000

23

35

30 Sept 1996

847

9

378,978

67

103

28 Feb 1997

881

9

413,815

n.a.

n.a.

Sept. 1997

923

n.a.

n.a.

n.a.

n.a.

Source: JOHNSON: 3; NGUYEN: 11; SEIBEL, 1996: 38; VNA, 17/10/1997;

This rapid expansion of the PCF-network is a reflection of the urgent need by the rural population for viable finance systems. At the end of 1996 membership was increasing even more rapidly than the number of LCFs. While on 30 September 1996 eac h LCF comprised, on average, 447 members, their number grew to 470 members by the end of February 1997. This increase above proportion can be seen as an indicator for the rising attractiveness of membership in an LCF. Similarly, it reflects a rising confi dence of the rural population in the formal finance system (BOSCHERT et al.: 29).

An even more rapid expansion of the PCF-network is planned for the coming years. The designed target for the year 2000 is to have a total of 3,000 LCFs (VU: 6). At that time about 30% of all communes are supposed to be covered by a local credit fund. I n the long run it is envisaged to have an LCF in every second commune. Similarly, the network of RCFs will be enlarged. While at the beginning it was planned to set-up an RCF in each province, it is now envisaged to come up with 20-25 RCFs in the end (BOS CHERT et al.: 25-26).

Basically, the internal structure looks as follows: Members join and form an LCF, a number of LCFs provide capital for, form and become members of an RCF, while all LCFs and RCFs have their shares in the CCF. However, during this period of establishing and strengthening the system, SVB and other state-owned banks are still involved as shareholders at the higher levels for the time being. As it was already discussed above, the PCF-approach combines elements of formation from above with the participation of the members in the decision-making process.

Actually, in reality, the establishment of an LCF is initiated by SBV or its branches and not by interested persons at the local level. With the help of the local people's committees the need for establishing a credit fund in a certain area is assessed . Similarly, it is looked for 15 potential founding members, the minimum number required for setting-up an LCF. These persons need to be better-off than the general public since for founding an LCF a base capital amounting to VND 50 million (or about US$ 4,400) is required. Hence, each of the 15 founding members has to buy minimum shares amounting to VND 3.333 million (or about US$ 300) per person. As it is reflected in the rapid spread of LCFs, the selection of 15 founding members and raising of the mini mum base capital do not seem to be a major problem. Why these persons buy the minimum share capital is not fully understood since - as it will be shown below - the financial services offered seem to be more attractive for those groups which are not that r ich. Once the LCF has been registered and is authorised for providing financial services, it aims at recruiting more members. In general, they are open for all type of persons including the poor. Those who want to become member have to buy a share amounti ng to VND 50,000 (or less than US$ 5) only. The LCF, as an autonomous institution, has the right to scrutinise applying persons with respect to self-help potential, asset base and reputation (SEIBEL, 1997: 13-14). In general, all application are accepted. In this respect, the LCFs are characterised by two types of members; on the one side, there are the founding members who have invested quite some money in setting up an LCF. On the other side, there is the general public who have acquired their member sh are for a more nominal sum. Whether these newly-joining members participate in the same way in the decision-making process as the founders is not known at this stage.

There is only limited information available about the membership structure of LCFs. It can only be indirectly deduced from the structure of the borrowers. About two-thirds of them are farmers, about 20% are rural traders while about 11% can be classifi ed as rural artisans or small-scale entrepreneurs (BOSCHERT et al.: 30). Due to this professional heterogeneity of its membership two main risks are reduced which often affect financial intermediaries with a highly homogeneous membership structure. On the one side, the effects of seasonality and synchronic timing are not that predominant since savings and credit needs do not coincide at the same periods for all members. Therefore, the financial solvency over the year is more likely ensured. On the other s ide, credits taken for financing economic activities are spread over quite different purposes. The potential risks of default in undertaking these activities can be better balanced. In this respect, the LCFs can balance the financial problems of their mem bers to some extent (ARMBRUSTER: 231 - 232; BINSWANGER: 119).

Supply and balancing of liquidity among the LCFs is handled by the RCFs; the supply and balancing of liquidity among RCFs is ensured by CCF. A number of LCFs join together in setting up an RCF. However, the next RCF has to be located within a reasonabl e distance to the LCFs. In case the next RCF is too far away, these LCFs are directly attached to the SBV and the financial services are handled by its regional branches. In the long run, it is envisaged that each LCF will be member of an RCF. The share c apital of the RCFs is kept by the LCFs within its area. In addition, shares are owned by SBV which are supposed to be sold to (newly-established) LCFs in the long run. The minimum share for each LCFs amounts to VND 5 million (or about US$ 450). Each LCF h as to contribute the same amount for getting its share at the CCF. Those LCFs which are not member of an RCF contribute VND 10 million directly to the CCF (BOSCHERT et al.: 26).

The CCF is managed in the legal form of a cooperative. The equity capital stands at VND 200 billion (or about US$ 17.7 million), of which 40% are held by SBV. The share of the state-owned and private banks is limited up to 30%. Up to the end of 1996, V ND 108 billion have been paid in. SBV contributed VND 80 billion, the four state-owned banks VND 20 billion and one joint-stock bank VND 2 billion, while the RCFs and LCFs just managed to pay in VND 6 billion, so far. In the long run, it is envisaged that RCFs and LCFs take over all shares held by SBV and the other banks (BOSCHERT et al.: 28).

The concept in running the PCF-system is based on two basic principles: to mobilise savings as much as possible and to cover the costs incurred out of the margins in interest rates. Within a relatively short period of time, the PCF-system attracted a s ignificant amount of money in savings. By the end of 1996, savings by the members amounted to VND 752 billion (or US$ 67). On average, savings per member came up to about US$ 170 which is remarkable keeping in mind that the average income per capita in ru ral Vietnam stands at about US$ 100. In addition, savings are increasing rapidly, within the second half of 1996 by about 42%. Saving rates paid out to the members stand at around 1% per month. One of the major drawbacks, so far, is as with the VBA the to tal lack of saving products for medium and long-term purposes. Therefore, about 90% of all savings are put in three-months deposits (BOSCHERT et al.: 31).

The volume of credit provided to the members increased quite rapidly as well. By the end of 1996, it stood at VND 1,121 billion (or US$ 103 million). Due to the fact that almost all loans are of a short-term nature, the real volume of credit available over the year seems to be higher. The average amount of credit came up to US$ 315. The average interest rate asked for loans for a period of six months stands at 1.6%-1.8% per month. This rate is somewhat lower than the upper limit of 1.8% per month set b y SBV. Nevertheless, the interest margin is high enough to cover all administrative and transaction costs of the PCF-system. In 1996, there had been an overall profit of about US$ 3.4 million which is a precondition in achieving its goal of long-term viab ility (BOSCHERT et al.: 32-33). Part of its funds have to be refinanced by SBV. The interest rate on these funds stood at 1.2% per month in early 1997. Due to the fact that the saving rates are lower there is a strong incentive for the LCFs to mobilise sa vings to broaden their capital base (SEIBEL, 1997: 24).

One of the main characters of the LCFs in performing rural financial services is the rule to restrict their services to the membership. Only membership savings and other information about the members provide a certain track record when it comes to lend ing. Personal reputation is an important criteria. Actually, members protect each other through their own discipline and social pressure. Therefore, credit losses have been very small. The default rate of the whole PCF-system comes up to 1.2% of the outst anding debt. The main reasons have been natural disasters and reductions of agricultural prices (VU: 3). For larger scale loans collateral is required. Since all credits are short-term, the provision of collateral is not a problem for the time being. Only consumer goods are accepted and no land. If medium and long-term credit will be provided in the future, the limited use of land as collateral might pose a problem (BOSCHERT et al.: 34).

Theoretically, there should be competition with VBA, VBP and the private banks, but in reality there is none, so far. On the one side, the volume of savings and lending as well as its number of members (and clients) is still quite small compared to the respective figures of VBA. It is estimated that the PCF-network covers about 5% of the rural clientele for the time being. In any case, for those who are members of an LCF, the financial services offered are quite attractive. Credits are tailored to the needs of the clients. Credit applications are quickly processed. It just takes about two days to come up with the decision. The paper work is kept to a minimum. In comparison, credit applications with the VBA and VBP need a long time until a decision is t aken. Generally, it takes about 10 - 15 days, often even more than a month. In addition, people feel that the application process with VBA and VBP is more cumbersome, and credit supplied by VBP is limited. But also getting credit through a semi-formal cre dit group might take quite some time due to the irregular meetings of the credit committees (SEIBEL, 1997: 23; GRET: 18/4/1997).

In conclusion, it can be stated that the rapid spread of the PCF-network reflects the urgent need for rural financial intermediaries. The network is still not fully operational, yet. As it is envisaged the network has to be enlarged and strengthened wi thin the next few years. Because of the bad experience in the past the cautious approach of expansion has to be commended. It is based on savings mobilisation, loan repayment and cost-covering out of the margin in interest rates. In 1996, a small profit c ould be managed. No subsidies or "easy money" are provided by outside sources. However, SBV provides a lot of services in making sure that the PCF-system will become a viable financial intermediary in the long run; some of them like the provision of train ing might be seen as a hidden subsidy. From the members' and clients' point of view there seem to be three major concerns which will have to be addressed in the future:

(1) While PCF-network has been set-up in line with the cooperative principles, there is no denying that the SBV has been and still is the major driving force for setting up this financial system. The staff of SBV checks which localities are appropriate and with the help of the commune committees identifies the founding members for an LCF. There seems to be no problem in finding the required minimum number of 15 persons to form an LCF. Once the LCF is registered other persons may join. At that stage the LCF has two types of members; on the one side, the 15 founding members who have bought shares of a value of VND 3.333 million each, on the other side, the joining members who have to buy a share of the minimum value of VND 50,000. How this difference in financial commitment is affecting the decision-making process is not known at this stage. In addition, it is not known whether the members regard the LCF already as their own organisation for which they are responsible in line with the cooperative princip les. However, to foster the voice of the membership and to follow the requirements of the Cooperative Law, it is planned to set up a General Federation of PCF in due course. This federation aims to carry out central coordination functions for the whole sy stem (VU: 5). At present, it seems that the decision-making power of the members is quite restricted.

(2) Up to now, almost all savings and credit services are only available for short-term purposes (i.e. for a period up to six months). But farmers and rural entrepreneurs have to increase their efficiency and productivity further to stay competitive. I n order to do so, they are in need of medium and long-term credits. These credits should be financed as much as possible by long-term savings in order to limit a dependence and higher interest rates due to the need of refinancing through SBV and other com mercial banks. Besides, business activities of the PCF-network is limited by the interest ceilings for savings and credit set by SBV. Although ceilings affect all other banks as well, they should be abolished. The interest rates should be determined by ma rket forces in order to force the PCF-network to offer competitive financial services to its members.

(3) The improvement of the access to rural financial intermediaries has been identified as one major requirement to reduce rural poverty. While the price for acquiring a minimum share to become member seems to be low, it seems to be too extensive for m ost of the poor. Most of the members are those rural inhabitants who can afford to pay for the minimum share and to have regular savings, i.e. those who are better-off (DAUBERT, 1996b: 2). The average amount of credit standing at about US$ 315 seems to co nfirm this statement. Therefore, the PCF-system only has a limited role to play with respect to reducing rural poverty. Its major accomplishment will be to provide a viable rural finance system which stimulates economic development which contributes to po verty eradication, indirectly. On the other side, the rich in the villages are not so much interested in joining the PCF-network since they need larger amounts of credit for medium and long-term periods (SEIBEL, 1997: 14). So far, the PCF-network has been established predominantly in those areas which are economically better-off and infrastructurally better developed. Since the PCF-system has to become viable first, this approach is understandable. In the next years the network has to spread more equally all over the country and to cover the marginal regions as well.

3.2.4 Private Banks in Rural Areas

Banking has been one of the first areas of the economy which had been deregulated and was opened to the private sector. Soon the number of joint-stock banks increased rapidly. Vietnam has now 54 joint-stock banks, but only 16 of them operate in rur al areas. Most of these are located in the south. The private joint-stock banks can be classified according to their ownership into three groups:

(a) banks whose stockholders are state-owned enterprises (SOEs);

(b) banks whose stocks are owned by SOE and private individuals; and

(c) banks owned exclusively by private individuals.

Joint-stock banks owned by SOEs usually have a large equity base and operate in the main cities of Hanoi and Ho Chi Minh. These banks provide a full range of banking services and cater mainly to large companies. In general, SOEs are also the majority s tockholders of mixed joint-stock banks. The joint-stock banks owned exclusively by private individuals or entities are those operating in the rural areas. Their equity base is small, ranging from VND 300 million to VND 3 billion. In general, the rural joi nt-stock banks are small in their geographical coverage (one district) and in their business activities (ABIAD, a: 14).

The focus of lending by rural joint-stock banks is on farm households and traders in their service area. Loans are generally small, ranging from VND 1 to 3 million, and for short-term purposes, only, i.e. for purchasing seeds, fertilisers and insectici des. Lending through joint liability groups has cut down their transaction costs, and so has the simplification of their loan procedures. Starting from a low basis the expansion in savings mobilisation of these banks had been encouraged. The repayment rat e is remarkably high at 98%, the 2% default resulting from crop damage due to pests and natural disasters. The interest rate charged to the clients is generally about 0.5-1% higher than the VBA rate. All banks require collateral for loan approval, which i ncludes land use certificates and appliances like motorbikes and television sets.

One of the main drawbacks of joint-stock banks is the fact that they remain vastly undercapitalised and are suffering a liquidity crunch (FEER, 25/9/1997). Therefore, they rely heavily on other banks as a source of funding. A large proportion of their funds (about 50 to 80%) is borrowed from VBA at 2.6% per month (in 1995), and these funds are on-lent to farm households at 3%. This system makes the supposedly private rural banks, in effect service centres or de facto branches of VBA. Hence, they cannot effectively compete with VBA in the loan market. Another major constraint of these banks is the deposit interest rate limitation imposed by SBV which limits their effort to attract more savings and to expand their equity base. However, first steps have b een taken to encourage savings from rural traders. In addition, the lack of medium and long-term funds impedes their development (ABIAD, a: 15).

In conclusion, it becomes evident that rural joint-stock banks do not play any significant role as financial intermediaries for the time being. Their market share comes up to a few percent, only. Due to their heavy reliance on VBA as a source of financ e they are in a no position to compete, just to fill gaps left by VBA.

3.3 Major Problems Affecting the Formal (Rural) Finance System

The banking sector is affected by a massive state intervention. With a short exception in 1988-89, real interest rates in the state banking system were not only negative, but lending rates were lower than saving rates. Only from 1992 onward these i ndicators were reformed in order to provide the basis for a viable banking sector without the need for permanent state subsidies. However, even in these days state intervention is characterised by two main instruments: (1) direct subsidies of the interest rates for credit, particularly through the VBP, and (2) transfer of foreign funds to the state-owned banks which are lent on within the limits of the interest ceilings to the clients. This second instrument can be seen as an indirect subsidy. Both instru ments are reducing the need of the banks to mobilise their own resources through savings and to manage their activities in a cost covering manner. Only if these aspects are part of their business strategies, banks in Vietnam will develop as viable financi al intermediaries (SEIBEL, 1997: 3). In addition, the rural areas are characterised by an underdeveloped banking structure providing financial services. The VBA cannot fill this gap alone.

From the clients' point of view there are two interdependent shortcomings which hinder their access to formal rural finance systems. On the one side, the demand for credit has increased by a large proportion due to the rapid economic development in Vie tnam. The formal financial system's capacity to meet this increased demand is limited due to its lack to mobilise savings. In addition, farmers and rural entrepreneurs must get access to financial innovations in order to increase their efficiency and prod uctivity. Both aspects will be discussed separately although they are interlinked to a large extent.

3.3.1 Limited Access to Financial Services

One of the most important problems at the commune level for farmers, traders and small-scale entrepreneurs alike is the limited access to credit. Demand for credit outpaces supply, even keeping in mind the efforts undertaken during the last decade. On the other side, the promotion of private savings has not been a priority up to the late 1980s. As it was discussed above, the mono-banking system was characterised by negative interest rates. There had been no incentive either for the population to sa ve or for the banks to stimulate savings. Private bank savings was quite unusual. However, private savings by private households seemed to be substantial at that time. Savings were held in the form of gold, US$ and rice. With the financial reforms and the reduction of the inflation rates interest rates became positive in real terms which had two implication: (1) It offered attractive returns to the general public resulting in an inflow of domestic resources into the banking system. (2) It offered a positi ve margin for the banks which covered their transaction costs and induced them to start some private sector lending (SEIBEL, 1992: 91-95).

But even once the financial reform had been implemented it takes quite some time to convince the population to put most of their excess funds into bank accounts. While there are no detailed figures available about the savings of private rural household s the results of the Vietnam Living Standards Survey (1994) referring to the year 1993 give some evidence. The average savings per rural household were estimated to stand at about VND 1.8 million (or about US$ 170). Only about 7.4% of the total savings we re deposited in banks. On the other side 44% of the savings were invested in gold, another 20% was saved in form of building and houses, and more than 10% was kept in cash. These figure reflect the enormous untapped reservoir of domestic resources. With t he rural credit needs estimated at about US$ 3 billion for that year, there is little danger of excess liquidity ensuing from massive savings mobilisation (SEIBEL, 1996: 40; ABIAD, a: 104). Still, in these days Vietnamese are characterised as deeply suspi cious of banks and that they prefer to keep their money in cash, invest in gold or buy consumer goods. "Vietnam remains an overwhelmingly cash-based economy" (FEER: 24/10/1996).

Nevertheless, the formal finance system did manage to attract savings from the population during the last years. In the late 1980s it stood at about 1% of the GDP. In 1989 domestic savings was a mere 2% of GDP while foreign savings inflow was about 9% of GDP. In 1992, domestic savings stood already at 10.5% while foreign savings declined to just 1.6% of GDP (FFORDE/SÉNÈQUE: 102). Up to 1995 domestic savings have risen to about 17% of the GDP. These figures show that the banks' reputation has been enhanced. But there is still further need for reform in order to strengthen public confidence in the system. Savings still lag levels seen in the neighbouring countries and are too small to finance the investment needs (FEER: 19/12/1996; NGUYEN: 2). The increase of savings cannot only be explained by positive interest rates and rising confidence in the formal finance system it also reflects the erosion of social safety nets that has taken place in recent years. Without collective protection, fami lies seek to build up their own reserves. This is another argument why better savings products are needed (FFORDE/de VYLDER: 307).

Another drawback for a rapid continuous expansion of the formal finance system seems to be the lack of an insurance system for savings. A legal framework protecting savings is still missing. In addition, as was mentioned above, all state-owned banks ar e plagued by the fact that their level of bad debts is difficult to estimate. Since the memory of credit cooperative collapses is still fresh, people are reluctant to put all their surplus cash into bank accounts (FEER: 24/10/1996). On the other side, VBA , like the other state-owned banks, is not forced that much to mobilise savings. It can rely on refinancing by foreign sources and provisions by SBV on a rather cheap basis. Therefore, the need to develop a range of attractive products to promote savings among the rural population is not that urgent (HAUSKRECHT: 5). Other rural financial intermediaries are too small and too dependent on SBV for the time being to start with financial innovations on their own.

3.3.2 Limited Supply of Financial Innovations

Based on the discussions above, it can be concluded that the amount of credit provided by the formal financial institutions is limited. Savings are not that forcefully encouraged and, if saving opportunities are provided they are on a short-term pe riod, only. The clients are left with the choice between daily, three months and six months deposits. There are neither other options than saving accounts nor saving products for medium to long-term periods available for the time being. On the other side, if credit is available it is also provided on a short-term basis only; in general for a period up to six months. But the amount supplied is by far too small to satisfy demand. The main constraint facing farmers and rural entrepreneurs alike is the limite d access to credit, not only to short-term credit but also to medium and long-term loans in order to finance investments. Investments are one of the main prerequisites to improve the efficiency of the existing production activities and to venture into new ones; e.g. farmers have to improve animal husbandry and diversify their crop production pattern in order to earn higher incomes. The investments e.g. in high breeding stocks, perennial crops, buildings and machines can only be financed if there is the op portunity for repaying within the lifecycle of the investment itself. If investments have to be financed out of their own savings only, the development prospects of most farmers and other rural entrepreneurs are severely limited.

However, not only the banks themselves have to be blamed for this lack of financial innovations to farmers and rural entrepreneurs. On the other side, rural clients can only offer limited values as securities for long-term credit. There is a lack of as sets which can be sold easily and, therefore, be used as collateral. In many countries, the ownership title of land is accepted as a collateral for any type of investment. In Vietnam, the ownership of land rests with the state or "the entire people". The farmers have long-term land use rights. The revised Land Law in July 1993 ensures that households and individuals to whom the state has assigned land have the right to exchange, transfer, rent, inherit, and mortgage land use rights. In this respect, the r evised land law sanctions the emergence of a land market (DAO: 157). However, not all households have received their land use certificates already. The state is quite slow in distributing them among the farm households. By the end of 1996, just 47.3% of t he cultivable and forest land had been properly certified. The main reasons are shortages of funds and qualified cadaster experts as well as poor technical equipment (DAILY NEWS: 28/1/1997).

In other words, farmers or any owner of land have the right to provide their land use certificate as collateral for getting credit. In reality, however, banks have been reluctant to accept agricultural land. It is difficult to assess its value, since t here is no open market for buying and selling. Similarly, assessing the value of buildings and structures is spurious at best. Furthermore, collecting and foreclosing on collateral is a nightmare. For example, a banker must petition the state for permissi on to seize an asset after a default occurs (FEER: 24/10/1996). Due to legal stipulations, banks are not allowed to seize land from farmers defaulting in their repayments. It is more or less impossible to evict those farmers and auction their land. In gen eral, banks just accept houses and durable consumer goods as collateral when providing a larger amount on a short-term basis. As discussed above, only VBA has started recently to offer medium-term loans. Anyway, the lack of proper securities will hamper t he offer of long-term loans (BOSCHERT et al.: 34).

This situation has led to two contradictory developments. On the one side, Vietnamese banks are awash with cash. They just lend to a few entrepreneurs only, i.e. those few with collateral and an adequate track record. Actually, a number of banks do not dare to provide credit because of uncollectable debts (NGUYEN: 1), although VBA is not following this approach. On the other side, farmers and rural entrepreneurs have to look for other options in getting loans. They have to enter into semi-formal and in formal arrangements to receive needed funds. Land might be mortgaged in informal credit transactions since the provider of credit might use the land by cultivating the land himself or by renting it within the village community. In addition, joint-liabilit y groups have spread all over the country. At least for small loans (up to VND 10 million) no collateral is required, if the borrower is member of a group. Even if it were possible to get credit secured by the land use title it would be more difficult for women to get it than for men. In general, men are registered as household heads and land is registered in their name. This is one reason why especially the Vietnam Women's Union (VWU) is encouraging the formation of joint-liability groups among women and is looking for links with the formal banking system (TRAN/NGUYEN: 212), as it will be discussed below.

3.4 Semi-Formal Finance Systems in Rural Areas and Their Links With the Formal Sector

While the formal banking system has been and still is expanding to reach more and more rural clients demand for credit is by far outpacing supply. As discussed above, much more capital is needed to preserve growth in the agricultural sector and the rural economy in the years to come. As the vast number of rural households could not get access to the formal financial sector due to lack of collateral, they set up joint liability groups on a self-help basis. Since the early 1990s the mass organisation s, to a limited extent, supported by foreign NGOs encouraged micro-finance schemes and the formation of groups. At the beginning the emphasis was laid on the provision of credit. Most of these groups are linked to the formal financial system, in general t o VBA or VBP. For the banks the joint liability groups opened a way to increase the number of their clients rapidly in a cost-effective manner. Transaction and administration costs could be kept at a low level.

A number of mass organisations are active in microfinance, of which the Vietnam Women's Union (VWU) is the most active nation-wide. Many of the others such as the Farmers Association, Veterans Association or Peasant's Union assist in the disbursement o f loans under specific programmes. To some extent, these programmes are supported by NGOs which might influence the focus and rationale of the respective programme. In general, a joint liability group comprises 5 to 30 members. Depending on the scheme the implications of being member varies. They vary between full joint liability for any loans taken by group members through to individual liability for individual loans (JOHNSON: 3-5). All groups are characterised by the fact that a certain solidarity among group members has to be established and that peer pressure replaces collateral. This solidarity can be most probably realised if the following key requirements are met:

Since 1991 the mass organisations were encouraged to help their members to get access to the banking system. They do not on-lend funds, but act as brokers rather than as financial intermediaries bearing credit risks. Since starting the number of volunt ary self-help has increased steadily. As of December 1993, there were about 35,000 of them (TRAN/ NGUYEN: 203). At the end of 1995 VWU alone was looking after more than 50,000 women's savings and credit groups spread all over the country (JOHNSON: 3). In early 1997 more than 150,000 groups have been operational, most of them under the auspices of VWU. Concerning their number it can only be estimated since while groups are easily registered at the local commune committee, they can easily dissolve as well.

The joint liability groups are characterised that credit is provided at market rates, only. However, as was discussed above, the interest ceilings are determined by SVB and passed on to VBA. Actually, all schemes are not free to set their own savings a nd credit interest rates according to the local situation. Because of the predominant position of VBA, the rates applied by all schemes have to be in line with those of VBA. Local authorities only tolerate a small deviation. Therefore, particularly those schemes managed with support of NGOs have a limited chance to cover the costs involved and to set up a viable system (DAUBERT, 1996b: 3). The funds for credit come up either through own savings but predominantly through links with the banks. In some schem es there is a reliance on donor funds due to lack of fund mobilisation. In general, credit is provided in small amounts. But there are increases, as production skills, management capacity and borrower needs expand. Most credits in rural areas are borrowed for a period up to six months (ABIAD, a: 46).

At the beginning, when joint liability groups have been set up, emphasis had been laid on the provision of credit. The mobilisation of savings has not been stressed. Only recently, it was realised that savings have to be encouraged to enable the scheme s to generate their own funds. Some schemes are too dependent on external resources and have no chance to become sustainable. When it comes to borrowing, loans are in general provided on an individual basis. In addition, the applications of group members have to be screened and approved by the local people's committee.

Right from the beginning it was looked for links with the formal finance system, i.e. the VBA and VBP, to make use of its funds. The linkages cover the mass organisations, NGOs and the banks. In general, the linkage strategy is designed to combine the effectiveness of self-help groups as grassroots financial intermediaries on small local markets with the superior capability of banks of integrating into larger markets, thus balancing off the former's lack of access to sources of refinance and the latter 's lack of physical and cultural proximity to small savers and borrowers (SEIBEL, 1996: 73). The mass organisations supervise the joint liability groups and provide support in group formation. Since they have been active at the commune level anyway and a number of groups existed already, although with a different focus, these extra-efforts were not that costly.

While savings are encouraged now, they are not compulsory. Concerning VWU, it is left to the joint liability groups themselves whether savings form a part in their activities. The promotion of savings has not been required in their collaboration with V BA, so far. But many groups have started savings on their own, now (MARD: 15/4/1997). However, with the help of foreign funds VWU has set-up a guarantee fund with VBA amounting to VND 500 million. This guarantee fund covers any losses by VBA in case of no n-payment of any VWU-supported group (BOSCHERT et al.: 43).

All schemes report very high loan repayment rates. Typically, they range between 95% and 100%. With respect to the repayment rate of the groups under the auspices of VWU, VBA reports a rate of 99.9%. Actually, the risks of the banks are almost non-exis tent. Where there have been difficulties it is amongst the richer borrowers undertaking larger and more risky investments. The poor are generally considered to have a sound repayment history. It is a significant observation that in Vietnam the poor are ca pable of taking and repaying loans at interest rates equal or somewhat higher than those available for equivalent loans from the main rural finance institution, the VBA. The rural people value easy and continued access to credit over other factors such as the low cost of credit (JOHNSON: 10; VO: 27).

At present, the semi-formal finance institutions show two major draw-backs. On the one side, their resource base is very small. As the promotion of savings had not been their priority, they can be described as a simple transmitter of fund for the banks . In the meantime, they have realised this drawback and have started to mobilise internal funds. On the other side, the joint liability groups are more or less informal groups. They are registered with the local people's committee but they can dissolve ea sily. These groups lack the capacity to transact legal business. In the long run, this might be required to do larger and long-term finance transactions. As a matter of fact, these semi-formal groups might join an LCF or might establish their own LCF once they fulfil the basic requirements (BOSCHERT et al.: 18, 45). Another option might be to strengthen and systematise the existing links with VBA to improve the access to medium and long-term loans by farmers and rural entrepreneurs which will also likely result in the strengthening of the VBA and its presence in the rural areas (ABIAD, a: 48).

3.5 Informal Finance Systems in Rural Areas

Knowledge about informal finance systems in Vietnam remains weak and primarily based on anecdotal evidence. Therefore, not many facts are known or figures about its size can be given. Although formal and semi-formal systems have expanded rapidly du ring the last years the bulk of financial intermediation still seems to be done informally. Based on rough calculations referring to economic growth in the early 1990s when an annual economic growth rate of 10% could be observed, it is assessed that most of necessary investments had been contributed by the private sector. As was shown above, the formal financial sector could not fulfil this task. What has been typically Vietnamese in this situation, is "that almost all of the financial intermediation requ ired to shift these flows around the economy was occurring informally ." (FFORDE/VYLDER: 306).

Nevertheless, there are some scattered information about the importance of informal finance systems in the early 1990s, particularly with respect to credit. The data collected by the Vietnam Living Standards Survey 1994 reveal private individuals are t he most important source of credit, in most cases family members, relatives, friends and neighbours. Their share comes up to about 40%. Another third of the rural households borrow from private money lenders, while about one quarter relies on banks and ot her sources. In general, there is no obligation to pay interest for those credits obtained by private individuals. On the other side, money lenders charge an interest rate of more than 100% p.a. (ABIAD, b: 15). However, the survey seems to have neglected other informal finance institutions which play an important role, particularly the savings and credit associations. Actually, four major informal financial institutions can be distinguished (SEIBEL, 1992: 73). These are:

(1) Mutual lending among friends and neighbours at negotiated rates depending on social relationship, reputation of the borrower, maturities, etc. The annual interest rates to be paid vary between zero and more than hundred percent.

(2) Rotating savings and credit associations have a very long tradition in Vietnam. Usually these groups are referred to as ho in the North and hui in the South. They are promoting periodic savings contributions which in turn are rotated as a fund among a limited group of persons who trust each other. Members of these associations come mainly from the same hamlet. The savings and credit can be made either in cash or in kind. In general, membership averages 10-15 persons. The period of eac h lending cycle varies, but the most common is three to five months. Decision on interest rates, membership and loan amounts are made either jointly by all members, by a bidding process or made solely by the organiser. The lifecycle of a specific savings and credit association ends when every participant has obtained once the total fund collected at each turn. While in general rural households make use of these institutions to bridge short-term needs, they can also be set-up to finance long-term investmen ts, e.g. a group may last over a couple of harvest seasons (ABIAD, b: 17; LOUNG: 58).

(3) As already reported in the Vietnam Living Standards Survey rural households rely to a large extent on specialised moneylenders, which includes pawn-brokers as well.

(4) In addition, traders are giving advances in cash or kind on the basis of the promise to receive or buy the products at harvest time. However, as rural traders have to become established themselves during the last years their capital base is rather limited. But it can be assumed that they will become a more important source of rural credit in the years to come.

Informal financial systems are characterised by two facts. On the one side, all funds lent in the informal market are locally mobilised. On the other side, the interest rates charged used to be above the inflation rate in the early 1990s and bear posit ive real returns. In these days, they reportedly are above the formal sector rates. There is no denying that an easy access to credit, timely availability and quality of service are more important to farmers and rural entrepreneurs than the level of inter est rates (SEIBEL, 1992: 73-74; ).

However, there are limits for an expansion of the informal rural finance system. There are limits to the size of credit accumulated within this system. As the rural economy improves larger-scale investments covering longer periods are needed to keep th e momentum. In addition, farm units and other rural enterprises will (at least for some production activities) gradually move from family ventures to other types of organisational patterns. This economic transformation requires a better-developed formal f inancial system. The informal credit market, based on personal knowledge of each debtor and strict liability, will become increasingly obsolete (FFORDE/de VYLDER: 307).

4 Conclusions

There is no denying that the financial systems have been improved significantly during the last decade. With the collapse of the credit cooperatives in the 1990-91, the confidence of the population in the formal finance system had been at a very lo w level. The formal finance systems had been reorganised and new institutions have been set-up, i.e. VBA, VBP, rural joint-stock banks and a vast expanding network of LCFs. With the support of the mass organisations VBA and VBP established links with semi -formal finance systems in the rural areas. The network of the banks has become more dense and is covering most rural areas by now. From the rural clients' perspective it is much easier now than a decade ago to make use of financial services. However, the range of services offered is still quite limited. Credit is only available for short-term purposes and the mobilisation of savings is still at a beginning.

In this respect, it can be concluded that the financial institutions have been built, but they have to be strengthened during the next years to become fully viable. One of their main tasks has been and will be to expand cautiously so that the people de velop more and more trust and confidence in these newly emerging institutions. In addition, they have to adjust to a rising demand in financial products by the rural population due to economic development. For the time being, the provision of credit does not meet the demand. Similarly, farmers and rural entrepreneurs have no opportunity to get loans on a medium to long-term basis which limits their investment options to a large extent. Therefore, it is not surprising that rural households rely on informal finance systems to satisfy their needs as far as possible.

One of the major requirements for a viable formal finance system concerns the mobilisation of savings. Up to now banks relied mainly on external sources and only very slowly encouraged savings. Nevertheless, savings rates are positive and savings have increased since the early 1990s. But savings can only be put into banks as short-term deposits. There is no range of products to attract savings. Similarly, banks are required to observe the interest ceilings as given by SBV.

However, for farmers and rural entrepreneurs it is not enough to rely on a smooth running saving and credit system. Their position will be more secure in the long run if they can produce in an economic environment which enables them to set-up their own capital base (ARMBRUSTER: 287). They have to make profits to have own funds available for investments and to be in a better position vis-à-vis the banks. During the last years rural incomes increased to some extent but it is estimated to stand at about US$ 100 per capita. This level of income does not allow for larger and long-term investments. Therefore, besides strengthening financial institutions other institutions are needed to ensure higher incomes. For example, the marketing of agricultural products is very cumbersome and with an effective system including marketing cooperatives and private traders, farm gate prices can be increased rapidly. Similarly, due to ineffective land markets, land cannot be used as collateral for long-term credits.

From the clients' point of view it seems that the existing and gradually strengthening formal finance system is focusing on different groups. The poor, i.e. those with very low incomes and no collateral have to rely on the services of the VBP. They for m joint-liability groups to cut the transaction costs involved. Nevertheless, it has to be evaluated whether these subsidised funds are used for genuine investments or whether they can be seen as a hidden welfare approach. For the better-offs in the rural areas the LCFs are attractive for savings and credit. This group does not have collateral of much value at its disposal, but they rely on enough income to build-up a reliable savings record. Similarly, this group is also attracted by joint-liability grou ps which are connected with VBA. Besides for the group of the better-off, VBA is attractive for the real rich households in the rural areas. These households do not have to join joint-liability groups, but can apply for credit on an individual basis. For them larger amounts for investments are needed, which they can secure with collateral. For the time being, there is no competition among the various financial institutions. But they have to compete daily with the informal financial system.

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Annex

Table A1: Annual Rate of Inflation, 1986 - 1996

Year/Source

1

2

3

1986

 

487

487

1987

 

317

 

1988

 

311

410

1989

 

35

 

1990

 

67

 

1991

67.5

67

67.4

1992

17.5

17

12.4

1993

5.2

 

5.2

1994

14.4

 

14.4

1995

12.7

 

12.7

1996

4.5

 

 

Source: 1 = BOSCHERT et al.: iv; 2 = FFORDE/de VYLDER: 301;
3 = NGUYEN: 11

Table A2: Development of Exchange Rate (VND/US$), 1985 - 1997

Year/Source

Official State Rate
(1)

Free Market Rate
(1) (2)

1985

1.2

70

 

1986

14

261

 

1987

107

883

 

1988

135

n.a.

 

1989

3,971

4,618

 

1990

5,045

5,595

 

1991

 

9,705

12,200

1992

 

11,233

11,200

1993

 

10,659

10,642

1994

 

10,962

10,954

1995

 

 

11,005

1996

 

 

11,035

15/9/1997*

 

 

11,703

Source: 1 = FFORDE/de VYLDER: 214; 2 = BOSCHERT et al.: iv;
* = FEER: 25/9/1997