Central bank should use monetary policy, not fiats

It is time the State Bank of Vietnam considers using reserve ratios to regulate the financial market, Le Xuan Nghia, deputy chairman of the National Financial Supervisory Committee, says.

What is your view on the abolishment of the deposit interest rate cap?

It should be done, but the central bank should choose the most appropriate time to act — when inflation starts to climb down.

But since the inflation rate was still high in April and we do not know how much it will be this month, abolishing it seems impossible right now.

Since interest rates are very high now, there is a also a suggestion to cap loan interest rates. What do you think about it?

I think it is unnecessary. What we need now is a package of monetary policies to achieve two objectives at the same time.

The first is to continue the tightening policy to fight inflation. The second is to stabilize the interest rate and prevent it from rising further.

Policymakers should review all the monetary policy tools available to see if some are irrational and do not dovetail with market principles so that they can adjust and promote banks’ autonomy.

So how do you suggest that the existing problems can be fixed?

The first solution is to remove a provision in Circular 19 which does not allow banks to lend more than 80 percent of their deposits. It should be replaced with a reserve requirement.

The provision is aimed at preventing commercial banks from lending too much, but it is impractical.

If the central bank sets the reserve requirement at 5 percent for instance, it will have enough money to directly channel to banks that have liquidity problems.

Looking at China, we see that inflation is at around 5 percent but the reserve requirement for large banks and small banks are 20 percent and 16.5 percent respectively. China’s central bank has flexibly adjusted the rate for both large and small banks.

The second solution should be creating advantages for the dong over the US dollar so that depositors and borrowers feel more profitable using the dong.

An effective way to do this is also by setting a reserve requirement, by setting it much higher for foreign currencies than for the dong.

This will make people, businesses, and banks prefer the dong to the greenback, thus preventing dollarization of our economy.

The third solution is for the State Bank of Vietnam to stop focusing on the deposit and lending interest rates and interfering with their ceiling and floor rates as it did.

The central bank should play a key role in deciding interest rates via open market operations so that the rate will be stabilized.

In other words, the State Bank must use its interest-rate mechanism to regulate the interbank market and then, through the interbank market, regulate interest rates rather than the credit market.

* The current rule capping the deposit interest rate at 14 percent is not effective, Le Xuan Nghia said on the sidelines of the Vietnam Annual Economic Report 2011 seminar in Hanoi, pointing out that the State Bank of Vietnam must be consistent with the anti-inflation target but also needs flexibility to provide cash to small banks and avoid shocks caused by monetary policy.

The interest rate ceiling is now much lower than the expected inflation, he said. The consumer price index was up by 17.5 percent year on year at the end of April. To ensure positive real interest rates, banks cannot pay less than 17-18 percent, he said.

In fact, for a long time, banks have borrowed from each other at up to 22-23 percent a year. So there is no reason to ban them from “borrowing” from customers at above 14 percent.

So, if there is no specific basis, of course, banks and depositors will break the ceiling. The danger of this is that people will think breaking rules is a normal thing.

This has led to a decline in confidence in SBV policy and also distorted the banking system, making it less transparent.

Market interest rates have increased due to small banks’ shortage of capital. Currently, the money the central Bank pumps into the market is mainly falling in the hands of large banks which then lend to small ones at higher interest rates.

“There are two ways for enterprises to survive: either lay off their workers en masse or invest in real estate since the current lending rate 22-25 percent per year is no longer profitable for them,” Nghia told Phap Luat newspaper last week. – Tuoitrenews

Tags: Vietnam banking industry, Vietnam finance, Vietnam financial