Financial Sector Reform in China and Viet Nam: A Comparative Perspective

Abstract

External and internal exigencies (the Asian financial crisis, WTO membership for China; a foreign investment and growth slowdown for Viet Nam) are forcing governments to tackle with new resolve the twin challenges of state enterprise restructuring and financial sector reform. Without stronger banks, further financial opening bears high risks, but without more profitable state enterprises healtheir banks are likely to prove elusive. Both countries' financial systems have evolved dualistic structures. On one side, the state bank/state enterprise link has proven difficult to sever, reinforced as it often is by government (introducing a strong element of moral hazard). On the other, an array of loosely regulated bank and non-bank financial institutions has emerged to serve two sorts of clients: connected borrowers (often bank owners) and the high-risk segment of the credit market (small and medium-sized enterprises). The challenge facing both countries is to unify this dual structure by subjecting the state banks to commercial banking disciplines (e.g., freeing them from policy lending) and ensuring effective prudential regulation of the non-state banks and other financial institutions (and adequate protection of small depositors). Given limited bank supervision capacity, priority should be given to enforcing controls on connected lending. In time, both countries need to diversify further their financial systems to reduce bank dominance and to offer savers a wider range of financial instruments.