By Giang Phung & Dr. Michael Troege (*)

The active involvement of foreign financial institutions has long been viewed as good way to improve the profitability of the local banking sector. This is one of the reasons why Vietnam has launched a strategic partner program, allowing a range of foreign banks to take minority participations in local banks and to send representatives to the boards of the partner banks. These partnerships are not only a way of raising foreign investment but are also expected to generate knowledge transfers. 

The first strategic partnerships were forged in 2007 with investments in seven banks, representing roughly 17% of Vietnams banking assets. The partnership model has successively expanded to 13 banks in 2013 covering around 40% of the country’s banking assets. Initially, the law allowed single foreign owners to own a stake of up to 20% in a bank. Revisions have now resulted in an ownership cap of 30% with possible exceptions concerning the ownership of ailing Vietnamese banks.
Whether these restrictions need to be further released is a hotly debated issue. Foreign investors are lobbying the Vietnamese government to allow them to take a controlling majority. They argue that only full control will allow them to improve the profitability of Vietnamese banks. The government on the other hand is reluctant to cede control of the financial sector.

Interestingly, not all strategic partnerships have been a success. In fact, the number of partnerships has declined from its 2013 high. Some have been cancelled after a bank merger, others have been dissolved, such as the partnership between ANZ and Sacombank.

Given the debate around foreign investment in local banks it is important to understand whether strategic partnerships have really lead to a technology transfer that improves the profitability or is it simply a way of importing capital?  One way of answering this question is to compare the profitability of Vietnamese banks before and after teaming up with a strategic partner. In a similar way one can analyze the effect of foreign managers on the boards of banks. 1

The results of this analysis are surprising at first sight: There is no evidence that strategic partnerships have improved the profitability of Vietnamese banks. The only visible success was an inflow of foreign capital to the banking system, especially during the stock market boom in 2007-2008. However, neither foreign ownership, nor the mandatory representation of foreign shareholders on the supervisory board seems to have an effect on the fundamental profitability of banks, measured by the net interest margin (NIM) return on assets (ROA) or return on equity (ROE) 

More interestingly, in becomes clear that in general, foreign managers can be of help, but just not the managers that are sent by the strategic partner.  The operating profitability of banks is improved by the presence on the executive board of foreign managers that have no current relationship with partners. Banks that recruit foreign managers that are independent of their partners have significantly higher net interest margins. 

This even applies to managers that formerly worked for a strategic partner but changed their employer to join a Vietnamese bank. As long as foreign managers are working for strategic investors, there is no noticeable improvement in the profitability of Vietnamese partner banks, but when foreign managers quit strategic investors and work for Vietnamese partners, the profitability of these banks increases. 

There is a simple explication for this surprising result: Foreign banks consider that a minority shareholding cannot be a permanent solution. This implies that they have no incentives to engage in real technology transfers or improve the profitability of their partners: Either the partnership will be dissolved again or the strategic partner will increase its stake in the future. In the first case, transferring technology means that the foreign bank will strengthen a future rival. In the second case, increasing profitability now will only increase the share price of the local partner and make further capital injections more expensive. Therefore, if foreign partners want to take full control, they better first make investment and improve profitability later. Obviously, given these incentives, representatives of foreign shareholders are likely not viewed by Vietnamese bank managers as partners in a joint enterprise but as rivals for the control of the bank.

Hence, the argument made by foreign investors that they need majority control to improve profitability is only partially right. Indeed, the strategic partnership program has not done much to improve Vietnamese banks and fully foreign-owned banks are likely to be managed more efficiently. However, that does not mean raising foreign ownership stakes is the only way to improve banks. There is a cheap and easy alternative: Hire qualified foreign managers who are not connected to an investor. After the recent downsizing of European and American banks, a large pool of talented people is available on the market. They will have the incentives to really improve the performance of local banks.

(*) Giang PHUNG, Finance Department, ESCP Europe; Dr. Michael Troege, Professor, Finance Department, ESCP Europe & CFVG