SBV's Special Loan Policy: A Double-Edged Sword?

(SGI) - The revised draft Law on Credit Institutions presented to the National Assembly during the 6th session of Session XV reveals disparities compared to the previous draft submitted during the 5th session.

SBV's Special Loan Policy: A Double-Edged Sword?

The State Bank (SBV) now exclusively provides special loans with a 0% interest rate and no collateral in the event of a mass withdrawal of funds, contingent upon the bank reporting the situation to the SBV. Banks withdrawing funds without reporting, indicating self-sufficiency, won't receive support but are obligated to implement a plan to address the cause of the mass withdrawal.

The concern arises from the potential long-term impact of such specific support measures on the entire banking system, despite their short-term effectiveness in averting a wave of withdrawals at a specific bank. Three essential questions need clarification:

1. Is the State Bank of Vietnam's argument for including a special loan with a zero interest rate in the draft reasonable?

  1. 2. What do the final lending rules of central banks worldwide indicate about special lending?

3. Are there alternative tools that can replace special loans with 0% interest and no collateral in emergency situations?

Addressing the first question: The State Bank contends that this measure is appropriate in emergencies due to limited bank assets that do not meet collateral requirements. In the absence of sufficient collateral during a mass withdrawal, the provision of a special loan with a 0% interest rate and no collateral is deemed necessary to prevent panic withdrawals from spreading throughout the system. The State Bank cites experiences from countries like the USA and Switzerland, including crisis cases involving Silicon Valley Bank, Signature Bank, First Republic Bank, and Credit Suisse Bank, to justify the need for a timely response mechanism to mass withdrawals that could potentially threaten system safety.

In my opinion, the SBV's argument is incongruent with the context. In the cases of the four American and Swiss banks mentioned, all underwent a bank failure resolution process. Regulatory agencies found suitable buyers for their assets and debt obligations, with the remaining bad assets either transferred to a bridge bank or taken over by the state for a waiting period of about two years before being sold again. The state covered all final damages during the processing, a practice known as "Living Wills," which is periodically updated every two years when the bank is operating normally.

The question arises: In an emergency where people withdraw funds en masse, what actions will supervisory and management agencies take? The primary focus is to ensure free and unrestricted access to the checking or savings accounts of all depositors, or only secured depositors, despite the bank's failure. There is no free intervention by the Central Bank; equity and secondary debts of bondholders are written off, the new buyer of the failed bank covers debt obligations for fund withdrawals, and any remaining loss is borne by taxpayers.

These developments are part of the "Living Wills" processing process, updated every two years when the bank is operating normally. For small, local banks, the process is expedited, taking only two days over the weekend, and by the first Monday of the following week, the failed bank has a new owner and operates normally.

Addressing the second question: The State Bank's role as the lender of last resort, free and without restrictions, is vital for instilling confidence in the entire banking system, preventing the risk of a mass collapse. However, this role is not established in response to specific incidents of mass withdrawals and insufficient collateral; rather, it is infrequently enacted, as seen in instances like the 2010 Law on Credit Institutions, occurring once in more than a decade.

Central banks worldwide adhere to the Bagehot doctrine, considered a guiding principle for emergency lending. The doctrine emphasizes that central banks must act as lenders of last resort without restrictions but must also "follow market interest rates and have collateral." While emergency intervention by central banks during financial crises yields substantial benefits by mitigating long-term growth damage, the insistence on market interest rates and collateral serves a crucial purpose.

Charging market interest rates and requiring collateral is essential because providing loans at preferential rates, even at 0%, may lead commercial banks to procrastinate addressing the root causes of withdrawal problems, potentially even violating the law. Without these conditions, banks could exploit the Central Bank's seemingly infinite liquidity, delaying necessary reforms.

The rationale behind requiring collateral for SBV's special/emergency loans to banks is to maintain market discipline. Without this regulation, market discipline would be significantly weakened, and banks might engage in lending to risky projects irrespective of the collateral's quality. The expectation that the State Bank will immediately grant special loans without collateral during a liquidity crisis could incentivize imprudent lending practices.

Returning to the Vietnamese context, there is a paradox. Despite business calls to lower credit standards for easier access to credit capital during a challenging period, the State Bank of Vietnam has staunchly refused to lower standards. However, it is now the State Bank that argues for generous lending to banks facing mass withdrawals. This shift raises questions about consistency in policy.

Market discipline, recognized as one of the three pillars of Basel standards and integral to global central bank regulatory frameworks, is compromised by including special loan regulations with a 0% interest rate and no collateral in the draft. In specific situations, the State Bank appears to prioritize protecting banks over maintaining market discipline.

Capital regulations play a crucial role in incentivizing prudent behavior by banks. The more resources a bank has, the less likely it is to take excessive risks. The World Bank's 2020 report on changes to the legal framework of central banks since the 2008 global financial crisis highlights a global trend of central banks increasingly strengthening capital regulations. However, the draft's encouragement of special loans contradicts this trend, suggesting a departure from the emphasis on capital regulations in favor of generous interventions by the Central Bank.

Regarding the third question: There are indeed many alternative tools that are more effective. First and foremost is the enhancement of the supervisory role and the empowerment of the State Bank, coupled with increased accountability. Properly executed, this approach makes it challenging for a situation similar to the current one to arise. Moreover, legalizing situations like the State Bank giving free loans to banks experiencing mass withdrawals is implausible.

Other viable alternatives involve reinforcing the financial capacity of banks to withstand shocks. Additionally, if the aforementioned measures prove insufficient and banks still face failure, a comprehensive study of a self-dealing process akin to the bankruptcy procedures observed in the United States and Switzerland can be adapted to Vietnam's specific circumstances. This would not only ensure and bolster depositors' confidence but also compel those responsible to bear the consequences.

In the event that all these strategies are effectively implemented but there are still instances of bank failures, the remaining damage from addressing weak banks will ultimately be borne by the state budget. In a few cases, profits might be redirected to the Ministry of Finance. This concept aligns with the essence of the term "last resort" in the context of the "lender of last resort" role assumed by the Central Bank. However, when faced with the phenomenon of widespread mass withdrawals and rapid, exceptionally generous lending interventions, the Central Bank can only be described as the "first lender" to the beneficiaries. The primary responsibility lies with the individuals causing the consequences of such situations.

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