GROUP ASSIGNMENT
International Finance

REGULATION OF INTEREST RATE
BY THE STATE BANK OF VIETNAM (SBV)

Group Members:
Pham Duc Trung
Vu Hieu Trung
Phan Tung Nguyen
Nguyen Thu Phuong
Tran Quoc Loc

English Speaking Group 2
Intake 13
CFVG Hanoi



1.2

Interest Rate and Inflation 5

1.3

Interest Rate and Exchange Rate/Trade Balance 5

1.4

Interest Rate and the Financial Market 5

1.5

Balance Among Factors 6

2.

T
HE
I
NTEREST
R
ATES
R
EGULATING
M
ECHANISM BY
SBV 8
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Regulation of Interest Rate by the State Bank of Vietnam (SBV)

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F
OREWORDWe would like to present to you our study on the Regulation of Interest Rate by the State
Bank of Vietnam (SBV) as our team’s assignment for the course of International Finance,
CFVG, Hanoi, Vietnam. We hope that this study can give you some information and analysis
on the monetary policies of Vietnam. We would like to express our sincere thank to Dr.
Michel Henry Bouchet, for his lessons and guidance during the course.

Pham Duc Trung
Vu Hieu Trung
Phan Tung Nguyen
Nguyen Thu Phuong
Tran Quoc Loc

MBA Intake 13

important for investment. On the other side, if the investment is high (e.g. in booming
economy), banks demand more money by increasing DEPOSIT rates, while increase
LENDING rates to compensate and get profits from the investors (who are hungry for
money).
Collectively, a low real interest rate will boost consumption and investment, which
results in the growth of [HOT] economy; while a high real interest rate tends to COOL the
economy. Empirical evidence in Vietnam shows that, when the effect of inflation is removed,
the Real GDP goes in opposite direction against Real Interest Rate.
-4
-2
0
2
4
6
8
10
12
2000 2001 2002 2003 2004 2005
Real GDP Growth Rate (%)
6.2
6.4
6.6
6.8
7
7.2
7.4
7.6
7.8
Real Interest Rate (%)
Real Interest Rate - Three-month deposits (households)

D1
D2
S1
S2

1.3 Interest Rate and Exchange Rate/Trade Balance
In an open-door market, the interest rate also greatly affects the exchange rate and
trade balance of country. If the interest rate of one country is high, it attracts the capital
inflow, which results in the increase of foreign currency supply; this in turn increase the local
currency value and import, while discourages the export.
Generally, the above-mentioned relationships work well in a developed economy. But
in developing world, the inefficiencies of financial market and the irresponsiveness of
economy usually limit the relationships. Especially for Vietnam, where there are still many
restrictions on the capital flow and foreign exchange transaction, the interaction between
interest rate and exchange rate is limited.
1.4 Interest Rate and the Financial Market
In this study, the financial market is defined as the middle-man between the saving (S)
and the investment (I), which brings the unused capital to the investors. In this market, the
interest rate can be considered as the price of money, which plays a critical role in
competition among the banks.
Deposit side vs. Lending side:
The utility package offered by the banks to the depositors mainly includes the interest
rate, the quality of service, and the credibility. If the banks can not compete with higher
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Regulation of Interest Rate by the State Bank of Vietnam (SBV)

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service quality and creditability, the only weapon for competition is the interest rate. In
addition, a bank with low service quality and creditability usually offers high deposit interest
rate. This is really the case for Vietnam, where all the state-owned banks offer lower deposit

8.76

8.64

Time - 9 months 8.04

8.16

8.04

8.58

9.06

9.00

Time - 12 months 8.40

8.40

8.40

8.40

9.18

9.24

Time - 24 months 9.00


amount, and to capture the bigger market share. To obtain high deposit amount, the bank may
increase the interest rate of deposit. With the big amount of deposit obtained, the bank can
also offer good quality of loans, and gain more and more power on the lending side (in term
of availability, flexibility and amount).
On the other side, to release the captured deposit, the banks can not increase the
lending interest rate too high. The “price war” of interest rate is always a danger for the
banking system, because it deduces the margin (lending rate – deposit rate – operation
expenses) and it can lead the banking system to crisis. In Vietnam, the failure of some small
banks (or small credit institutions) in 1990s is one bloody experience of this type.
1.5 Balance Among Factors
As discuss above, the interest rate interacts with other economic factors: (i)
consumption/ investment (or collectively GDP); (ii) inflation; (iii) exchange rate; (iv) stability
of financial market.
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As the Central Bank of Vietnam, SBV always try to find out a balance to monitor the
interest rate. Based on the degree of interaction between interest rate and other factors, SBV
can generally pursuit following policy:
a) Liberalizing Interest Rate: This is an irreversible trend for many countries in the
world, because it can help allocate resources (money) effectively and efficiently. This is one
of the reforms suggested by John Williamson, 1989, in his so-called “Washington
Consensus”;
b) Prevent harsh “price war” of interest rate in Banking System, to prevent failure of
banking system (crisis of the Financial Market);
c) Keep an eye on the inflation; in the case of Vietnam, this may be to control the
inflation rate of one-digit;
d) Given the above constraints, the real interest rate should be low enough to keep

HE
I
NTEREST
R
ATES
R
EGULATING
M
ECHANISM BY
SBV
In transition from the command economy to the market economy, Vietnam has gone
through many changes in the regulating mechanism to liberalize the interest rate from 1992 up
to now. Even, in this study, we will concentrate on the period from 2000 up to now but we
will take a look for the interest rates situation in Vietnam from during the period from 1994 to
1997 when the Vietnam economy has been shocked because of the wrong interest rates policy
2.1 The shock of interest rates during 1990s
In 1994, instead of lowering the interest rate according to the policy adopted by the
Conference of Bankers at the beginning of the year, the State Bank preserved the status quo
on the grounds that the inflation rate in the first half of 1994 had shown a tendency to become
higher by the second half than what had been planned by the National Assembly.
In 1994, the inflation rate reached 14.4%, and the real interest rate was: 25.2%-14.4%
= 10.8%. Many commercial banks had even offered much higher deposit rates (from 32% to
36% a year) and caused the real interest rate to increase to 18-22%, therefore it's obvious that
the state Bank should have reduced the interest rate in 1994. In 1996, the State Bank reduced
the interest rate four times and caused a lot of losses to commercial banks. The first joint
stock bank in Vietnam, by publicizing its balance sheet, had to admit that its interest in black
was lower than its interest in red.
Up to now, there is no answers to such questions as how many joint stock banks had to
suffer losses because of the reductions of the interest rate and how many banks had to violate
regulations on interest rates with a view to saving themselves from losses. Bits of information

the interest rate, whereas the interest rate-ceiling in Vietnam was fixed by the Government in
this period, so the central bank has to use administrative measures to enforce it, however, the
regulation didn't provide for subsidies given to banks suffering losses, therefore all officials
from the central bank tended to pay no attention to the fact that joint stock banks had raised
the lending rate. That was why many rural banks have officially offered the deposit rate of
1.6-1.7%.
2.2 Basic Rate – Period from June 2000 – May 2002
During this period, the SBV sets a promulgated interest rate, called “Basic Rate” and a
bandwidth. The basic interest rate affects all other interest rates arising in the market
economy. It is a kind of interest rates playing an important role in the market mechanism in
general and our market economy in particular. The basic interest rate is determined by the
central bank and announced on the basis of real situation and targets of the national monetary
policy. The point 12, Article 9 of the Law on the State Bank of Vietnam stipulates: " The
basic interest rate is the interest rate announced by the State Bank of Vietnam making a
ground for credit institutions to fix their business interest rates". However, it is argued that the
basic interest rate is a broad concept including different rates of capital re-allocation,
rediscount, interbank market; maximum rate for loans and minimum rate for deposits.
Other banks can set their own interest rate for local currency loans, but it is not
allowed to be higher than the sum of basic rate and bandwidth. The bandwidth for local
currency is 0.3% for short-term loans, and 0.5% for mid-term and long-term loans.
For foreign currency, the interest rate for short-term loans shall not be higher than 3-
month SIBOR+1%; and the interest rate for mid-term and long-term loans shall not be higher
than 6-month SIBOR+1%.
This regulating mechanism is rather free for other banks to set their own interest rate.
The credit expansion capability of banks is released to finance the economy, particularly by
the long-term loan. This mechanism allows the banks to manage their own strategies and
operation better than the previous. However, the basic rate and the bandwidth are set by the
SBV subjectively, and not in line with the actual conditions of money supply – demand. The
regulating tool is completely administrative, and the market forces have limited effects on the
interest rate.

This may be explained by the fact that banks usually retain more money than the required
reserve ratio (this is a usual phenomenon of developing countries). Another reason is that the
required reserve ratios is rather low, and even the increase by 3%, the ratio is only 5% in
comparison with a common 7 – 10% for developing countries. Therefore, the required reserve
ratio should not be highly appreciated as a tool for regulation of interest rate if it is not
increased to a more meaningful level.
Basic rate:
From June 2002, the basic rate is no longer compulsory for other banks, but it serves
as a “guiding indicator” for the market interest rate. It is calculated based on the interest rate
of 15 biggest banks for the best investors. Following figure is the moving trend of basic rate
in comparison with the market rate.

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Regulation of Interest Rate by the State Bank of Vietnam (SBV)

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0
2
4
6
8
10
12
2000 2001 2002 2003
Interest rate (%)
Deposit i
Auctioned i for treasury bill

3-month i on inter-bank market
Buying i on open market

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One positive sign is can be seen that the trends of inter-bank interest rate moving in
the same direction as that of discount rate. The limitation of effectiveness of these tools in
regulating the market deposit/loans may be explained by the competition force as later
discussed.
A recent development in early 2005 also justifies for the usefulness of these tools. On
15 January 2005, SBV increased both the refinancing and discount rates by 0.5% (from 5% to
5.5%, and 3% to 3.5% respectively). One 1 April 2005, SBV increase the rates for the second
time by 0.5% in an effort to prevent the high inflation rate of 9.5% for the year 2004, 1.1% for
January 2005, and 2.5% for February 2005.
Following this action, both the inflation and the market interest rate show responsive
movements. The inflation rate in is decreased to 0.1% per month, and the market interest rate
has increased by 0.36% - 0.96%.
Based on this study, and the theory of discount rate, we consider it should be better to
use the discount rate as a major tool to regulate the interest rate. However, some following
ideas may be considered to make it more effective:
- Do not take the refinancing rate as the “ceiling rate”, because principally, the
refinancing rate and the discount rate save only the outflow of money from the
SBV to the other banks, which results in the increase of money supply and the
interest.
- Do not use the discount quotas as a limitation on the amount of discounts. This
quota is both discriminated and limit the power of SBV on the money market.
Open Market Operation:
Open market operation has well developed from August 2000 to become an important

a comprehensive plan should be developed to improve the effectiveness of open market
operation as a major tool for regulating money supply and interest rate:
- Developing the inter-bank market to establish an environment for the open market
operation and to guide the interest rate for the open market operation;
- Release the medium-term and long-term bond for the open market operation;
- Encourage all the banks and financial institutions to join the auctions of open
market operation by offering attractive packages.
Generally, the regulating tools used by SBV have been approaching the modern
mechanism for a free market. Though the effectiveness of these tools is still limited, the
positive signs can be seen, particularly for the discount rate and open market operation.

2.4 Interest Rate and the Stability/Development of Financial Market
After the change of policy toward a system of freely negotiable interest rate, there is
tense competition in the financial market, which raises many concerns. Please refer to the
following figures for the market share of different types of banks in Vietnam, and that of four
biggest state-owned banks.
Share of different types of Banks
65.0%
13.0%
0.6%
21.4%
State-owned bank
Urban Commercial Banks
Rural Commercial Banks
Foreign Bank Branchs
International Finance
Regulation of Interest Rate by the State Bank of Vietnam (SBV)

inflation and foreign exchange / trade balance.
In this part, we will study two factors which serve as the final objectives for the
Central Bank to regulate the interest rate, i.e. GDP growth and Inflation
1
. Following figure
shows movement trends of interest rate, GDP growth, and inflation in Vietnam from 1999 –
2003. 1
In Vietnam, the external factors of foreign exchange / trade balance seem to have little relations, because the
inflows/outflows of capital is strictly controlled by the Government. For example, the foreign indirect investment
(FII) is largely prohibited, only several trust funds are permitted to operate within limited scope; the foreigner
are only permitted to purchase upto 30% of the local companies under strict conditions; the bonds are only
permitted to issue oversea under strict conditions. Therefore, an increase in the interest rate can not attract the
inflows of foreign currencies (say, increase demands for local currency) to increase the value of local currency
(exchange rate).
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-1
0
1
2
3
4
5
6

However, in the year 2004, the Inflation rate is as high as 9.5%, and a true tension
exists between the objective of GDP growth and the objective of controlling inflation rate.
Following figure shows the month inflation rate from 2003 up to now.
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Consumer Price Index (Monthly)
-1.00%
-0.50%
0.00%
0.50%
1.00%
1.50%
2.00%
2.50%
3.00%
3.50%
J
a
n
-
0
3
M
a
r
-
0
3

M
a
r
-
0
4
M
a
y
-
0
4
J
u
l
-
0
4
S
e
p
-
0
4
N
o
v
-
0
4

Therefore, in the year 2004, the increase rate of total loan amount is much higher than that of
total deposit (Vietcombank: loan amount increased by 23%, while the deposit amount
increased by only 11.3%; ICB: 11.6% against 2.3%). The increase rate of deposit amount for
the last 3 months (January – March 2005) is only 1%, and the bank has no other choice but to
increase the interest rate. Under same pressure and leaded by Vietcombank, other banks will
surely increase their interest rate.
At this time, probably the banks will take chance to run for the deposit and bigger
market share, because of the high competition in the financial market, as discussed above. In
respect of the effects on GDP growth, please note that the current loan interest rate is rather
high, the lowest loan rate is about 8.8%, the average is about 10.5% and the highest is 16.2%.
Therefore, an increase in loan rate will result in negative effects on the GDP growth, and the
target of 8.5% GDP growth will be hardly archived.
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3. R
ECOMMENDATION FOR
SBV
TO
R
EGULATE
I
NTEREST RATE

3.1 Improve the current regulating mechanism
(a) Intensify interest rate liberalization policy
As we analyzed in previous parts, all governments should liberalize their interest rate
policy. All administrative control on interest rate policies always result in bad effect for

Regulation of Interest Rate by the State Bank of Vietnam (SBV)

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Therefore SBV should set up interbank interest rate as targeted interest rate in each
period of time.
- SBV can use overnight rate in interbank market as targeted rate in each period of
time. Considering actual situation in Vietnam, the most suitable is deposit interest
rate in interbank market
- In order to achieve the right interest rate in interbank market, SBV has to promote
banks to attend interest rate auctions. Participants can be included big domestic
commercial banks in urban and rural area, joint venture banks and branch of
foreign banks in Vietnam. However, SBV has to regulate conditions of attending
banks to keep stability of interbank market.
- All banks would base on interbank interest rate and some other fees, characteristics
of their customers, market area… to set up their own interest rate.
Based on economical forecast in each period of time, SBV calculate and declare
targeted interest rate (in stead of existing basic rate mechanism) to orient financial market.
Sometimes, actual interest rate in market will fluctuate far from targeted rate of SBV.
Even this case, SBV should not interfere market by administrative tools. SBV should use
indirect tools of monetary policy to adjust market interest rate in accordance with targeted
rate.
SBV should abolish the existing discount operation and discount rate. It should be
replaced by interest rate for deposit of financial institutes in SBV’ s account. SBV can set up
Interest rate corridor in which ceiling rate is refinance rate and floor rate is above deposit rate.
Market interest rate is fluctuated around open market interest rate. SBV will use open market
operation to adjust market interest rate. This is current model to control interest rate in other
countries.
(c) To manage interest rates in market
SBV should abolish existing basic rate policy. Actually, basic rate does not reflect
actual demand – supply balance in financial market. Almost commercial banks do not use this

monetary should be applied as soon as possible.
However, IMF warned that SBV seems to ignore this suggestion. SBV has not yet take
enough action to follow this purpose and may be sending mixed signals to the market.
IMF also suggested that SBV should control more strictly bad debts status in Vietnam
recently. Many stated - owned companies can enjoyed favorable credit conditions so that
efficiency of investment is very low. This problem is going to result in financial crisis.
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R
EFERENCE1. Bank for International Settlements. 2005. Inflation targeting, asset prices and financial
imbalances: conceptualizing the debate, BIS Working Paper No.168. Basel, Switzerland.
2. Dinh Xuan Ha. 2005. Renewal of SBV’s Monetary Policies for a Market Economy of
Vietnam, Banking Magazine. Hanoi, Vietnam
3. Francis B. Narayan. 2000. Financial Management and Governance Issues in Viet Nam.
Asian Development Bank and World Bank.
4. General Statistics Office of Vietnam. Statistical Yearbooks 2000, 2001, 2002, 2004, 2005.
Hanoi, Vietnam.
5. IMF.
January 24, 2006.
IMF Executive Board Concludes 2005 Article IV Consultation with
Vietnam. Web-site: www.imf.org
6. IMF. January 2006. IMF Country Report No. 06/22 (including Statistical Appendix).
Web-site: www.imf.org
7. IMF. 2004. Monetary Policy Implementation at Different Stages of Market Development,