Lack of Competition in Rural Financial Markets

In Vietnam the lack of competition between formal and semi-formal rural financial institutions directly related to government policies and preferences as implemented through government controlled financial institutions. This becomes evident through the following summary of key characteristics of the three most dominant institutions, the Vietnamese Bank for Agriculture and Rural Development (VBARD), the Vietnamese Bank for the Poor (VBP) and the Peoples Credit Funds System (PCF).

Table 6.5: Characteristics of institutions serving the agricultural sector

VBARD VBP PCF

Above 4 million About 2.2 million Approximately 0.7 million

Customer

Table 6.5: Characteristics of institutions serving the agricultural sector VBARD is one of the largest networks in Vietnam and the for two-thirds of all credit in 2001. before the end of the loan period.

In most cases credit is not handed over in cash but in kind.

The mission statements and the mode of operation of the reviewed institutions provide an explanation for the lack of competition between the rural financial institutions. Exercising significant direct control over all three institutions, the government has laid down an

explicit division of labour towards providing financial services for all income segments of the rural population.

In addition, the local communes, people’s committees and mass organisations play a crucial role in the identification, screening and follow-up on clients for each type of institution. The result is that the initiative to form joint-liability groups and/or to contact potential lenders comes from the institutions themselves. This is a top-down approach which originates in a desire to divide the market between the institutions in order to extend their outreach. The segments served by the three institutions can be summarized as follows:

VBARD Up until 1995 the primary clientele of VBARD was the medium and well-to-do farmers, who could provide collateral. Starting from 1995 the VBARD introduced joint-liability groups where small loans are processed via groups. In 1997 about 150,000 joint liability groups are supported. This initiative has to some extent made VBARD credit available to less-well-off households, but the majority of the clients still remain in the upper income segments of the rural population.

VBP As indicated by its name and the requirement to lend only to people classified as being poor, the VBP serves the less well off segments. The restriction to supply only one financial product has, however, been found to restrict the ability of VBP to reach the very poor. These destitute households have frequently been found to regard VBP loans of typically VND 1-2 million as being too large. The reports of poor households actually turning down loan offers are, according to the ADB, ‘legion’. In addition, many poor households oppose the special repayment structure of VBP loans. Many households assess that the postponement of the payment of the principal until the end of the loan period represent too high a risk;

many would in fact prefer small and frequent instalments of both principal and interest.

Another factor contributing to the exclusion of the very poor from the formal financial system are the transactions costs when applying for a loan.

PCFs The PCFs require borrowers to buy shares, and the implicit screening mechanisms have been built in through the use of local peoples committees and the practice to pay out loans in kind. This implies that the PCF system predominantly caters for the better off households – in effect excluding poor households who are left with a choice between the VBP and informal finance.

In evaluating the potential negative effects of this lack of competition it is, however, important to point out that financial sector analysts are divided on the question of how important increased financial sector competition is.

One group of analysts is of the opinion that lack of competition will have adverse effects on financial sector performance and development, including limited financial innovation, lack of incentives to reduce costs and poor quality of services. Another group of analysts points to panel data analyses (Demirgüz-Kunt & Detragiache 1998), which suggest that banking sector fragility often increases as a result of the erosion of franchise values that frequently follow from financial sector liberalisation. The key problem is that the countries in question frequently fail to build an appropriate institutional framework for the supervision and regulation of the financial sector. As a result governments find it difficult to curb and control bank behaviour. Banks whose franchise values are eroded shift to riskier business strategies in an attempt to gamble for their resurrection. In many developing countries the end result is costly financial sector crises.

The dispute over whether or not financial sector liberalisation is beneficial has led to the emergence of alternatives to financial liberalisation and increasing competition. Hence, Hellmann, Murdock and Stiglitz (2000) propose an alternative strategy of financial restraint. One basic aspect of their model is that creating profit opportunities for banks will result in banks becoming more stable institutions with better incentives for monitoring borrowers. This in turn will reduce the moral hazard problems when banks imprudently gamble for their survival. As a result overall financial sector stability will improve.

The question of which approach will be suitable for the Vietnamese rural financial sector is not an easy one to answer. The overall lack of transparency in the financial sector (in combination with non-standardised accounting procedures) obstructs attempts to evaluate the frailty of the individual institutions.