Why should credit growth quotas remain necessary?
The credit growth quota regime was officially deployed in 2011 when Vietnam’s economy was experiencing hyperinflation stemming from excessive money supply. The credit growth quota regime put the cap on the banking industry’s credit expansion announced by the State Bank of Vietnam (SBV) at the beginning of each year. Based on the credit growth quota for the entire banking industry, the SBV will determine the credit growth for each commercial bank depending on its financial health such as its credit quality and credit management efficiency.
For the SBV, credit growth quotas are an important vehicle to bring about healthy growth for the banking industry in the past years, contributing to macro-economic stability. For economic experts, however, the credit growth quota regime mirrors the subjective imposition by the SBV without properly attending to the development plan of each commercial bank, resulting in “ask-and-give” deals not conforming to the market-oriented economy. Meanwhile, commercial banks can map out their own credit growth targets based on their financial power and management capacity.
First of all, we need to review the pivotal role of bank credits in the economy, and whether such a fundamental has changed considerably in the past ten years or not.
Vietnam’s banking industry plays a starkly different role
The banking industry plays an important role in each country. For Vietnam, the banking industry assumes a specially important role in funneling capital into the economy. A national capital market comprises bank credits, the stock market, and the bond market. While bank credits are deemed an indirect financial channel, capital from the stock market is the direct funding source as enterprises can mobilize funds directly from the market. Vietnamese banks’ credit growth in 2021, despite far slower than in preceding years, was still among the steepest in Asia.
In an efficient capital market, bank credits will mainly serve short-term capital demands of enterprises, while the stock market will meet their long-term capital demands. Funds mobilized by banks, by nature, are mainly short-term capital, so it is suitable for banks to respond to short-term capital needs.
However, as the stock market as a capital channel is still far from effective, banks in Vietnam have over the past several decades catered to both short-term and long-term capital demands of the economy. Data made public manifest the structures of both mobilized funds and credits at ten biggest commercial joint-stock banks in Vietnam. These figures show how banks are using short-term deposits to finance long-term demands. In other words, the banking industry in Vietnam has also been overarching, encompassing the financial market as well. The capital allocation efficiency in the banking industry can therefore give way to either macroeconomic stability or instability in the national economy.
When the economy is overheated, banks will also see a surge in the credit growth, but with low cost-effectiveness. This was proven in the 2006-2010 period when credit annually expanded 30% to 50%, but with a poor incremental capital output ratio (ICOR) as this excessive growth was translated into GDP growth of only 7-8%.
The credit impulse index is formulated by having the incremental credit in a year divided by the national GDP. The lower the index is, the more effective the credit will be in spurring economic growth. By using the credit impulse index to measure the cost-effectiveness, it is apparent that during the period when the credit quota regime has been imposed, the capital efficiency has much improved. Currently, Vietnam has been able to maintain a high economic growth rate of some 7%, but money supply and credit growth now are far lower than those before 2012.
Over the past several years, the policy of selective credit growth has always been a vital orientation for commercial banks in Vietnam to achieve efficient governance of the banking industry’s assets. The selective credit growth also stimulates the growth of non-credit income streams via the diversification of financial services for enterprises.
Credit quotas help improve macroeconomic stability
The banking industry plays an important role in the economy, but it poses both pros and cons. When the banking industry operates efficiently, it helps accelerate economic growth. But if banks pursue short-term profits and fail to allocate funds efficiently, bad debts in the economy will increase. Moreover, an increase in money supply triggered by credit growth may plunge the economy into high inflation.
While in the U.S., the Federal Reserve controls money supply via the Federal fund rate, in Vietnam, money supply is controlled via commercial banks. Loans given by commercial banks are the key factor that spurs money supply in the economy. The incremental money supply via credits is the driver of inflation.
For a developing economy like Vietnam, failure to control inflation will result in instability. However, by resorting to the credit quota regime, the SBV has achieved its goal of macro-economic stabilization as inflation is put under control, and the forex rate is kept within a narrow fluctuation range, contributing to the attraction of foreign investment into Vietnam owing to investors’ high confidence in Vietnam dong.
If a vehicle, not the most efficient one as it might be, has been working efficiently, then we should think twice when considering to change it. Other more logical vehicles might not necessarily work better as they might not be suitable for the domestic economy. The Vietnamese economy will continue to rely on credits as the key resource to maintain growth, so any intention to do away with this credit quota regime must be weighed carefully by policymakers if bitter lessons from the past are not to be repeated.