The development of factoring services in Vietnamese commercial banks

Table of Contents
Table of Contents........................................................................................................................ 1 1. 2. 3. Introduction ......................................................................................................................... 2 An overview about the Banking industry in Vietnam ......................................................... 2 The growth of the factoring service in Vietnamese commercial banks .............................. 3 3.1 3.2 4. What is factoring? ........................................................................................................ 3 The growth of factoring service in Vietnamese commercial banks ............................. 4

Domestic reverse factoring-valuing model ......................................................................... 7 4.1 4.2 4.3 Perfect capital market .................................................................................................. 7 Model description ........................................................................................................ 7 Model ........................................................................................................................... 8

5.

Conclusion ........................................................................................................................... 8

References ................................................................................................................................ 10

1.

Introduction One of the most conspicuous trends in the world today is to prompt international economic

integrations rapidly. Investments, transferring goods, services and capitals have been expanded more and more. Besides, the development of science, particularly information and technology, and financial markets do have strong impacts on the structure and development of the worldwide economy, it opens up new chances to developing countries. Vietnam is at one of them who are standing among those opportunities. Generally, to a developing country, banking and finance are considered the backbone of the economy. In order to achieve more success in this field, Vietnamese commercial banks are attempting to reach their goals using product-diversifying policies to meet the requirement of clients. Factoring is considered a useful tool in providing financing to firms, which are in need of money to enlarge their production. Recently, factoring has been applied in Vietnam. Although in international financial markets, factoring is no longer a new service, Vietnamese banks are still encountering many obstacles in providing this service due to its low sales. With the aim to figure out more about factoring, this essay is to focus on the development of factoring services in Vietnamese commercial banks. 2. An overview about the Banking industry in Vietnam Before 1990, Vietnams banking system was on the same level. There was not any difference between managing and business functions. The state bank was both the central bank and a commercial bank. In May 1990, the government renewed the banking system by dividing the banking system into 2 levels, in which the goals and duties of each level are differentiated clearly: The state bank of Vietnam is the only bank which has the right to issue currency, suggests monetary policies and applies the laws to adjust banking businesses and credit institutions. Commercial banks and non-bank financial institutions perform the currency circulation, credit, payments, foreign exchange and banking services throughout the national economy. During many years of reform, Vietnams banking system has gained significant achievements as well as restrictions. Overall, the development of Vietnamese banking system and financial market is very fast, however, the quantity is not in proportion with the quality. Many commercial banks were opened but they were not able to compete with others due to a number of reasons, therefore, some of them had to merge together or be taken over by bigger ones to survive. Moreover, the
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number of banks is rather high but almost of them have small scale and their profitability is lower than the average level of banks in Asia. Finally, in comparison with other Asian banks, Vietnamese banks have low safety and the proportions of non-performing loans are still high. (Hang & Hong 2013) 3. 3.1 The growth of the factoring service in Vietnamese commercial banks What is factoring? Factoring is a viable alternative to other external financing sources available for firms (banking loans, leasing or venture capital) by which a business can increase its cash-flow in order to fund expansions (Laura & Vasilescu 2010) or factoring is a complete financial package that combines working capital financing, credit risk protection, accounts receivable bookkeeping and collection services (Factor Chains International n.d.). In other words, factoring is a transaction between a business and a third party called a factor, in which the business (usually the sellers or the exporters) sells its account receivables to the factor (usually the banks) at a discount (often around 80% of the account). Besides traditional factoring, there is another type called Reverse factoring. In contrary to the traditional one, the ordering party is usually large companies the buyers, selecting invoices that they want to be paid earlier by the factor. This is a really collaborative project between the supplier, the ordering party and the factor. Based on regional operations, factoring can be divided into 2 kinds: Domestic factoring: there is no international trade contract, every operation happens

in the same country and there is only one factor. International factoring: this type can be used if there is an international trade

contract between the importers and exporters. There can be more than one factor. Benefits of factoring services: For the seller: Improve cash flows and liquidity; increase sales thanks to offering competitive terms of sales; reduce non-performing loans and limit credit fault; low costs; opportunities to take advantage of supplier discount. (RVA & DAVID 2010) For the buyer: be able to purchase commodities on convenient conditions; boosting purchasing power. (RVA & DAVID 2010) For the factor: diversify services and products; maintain and expand the share market; enhance the prestige in the domestic and international markets; make profits from charging fees. (RVA & DAVID 2010).

Vietnamese commercial banks have provided factoring service since 2005 with the first start of Deutsche Bank in January 2005. The number of banks offering this service has increased rapidly, in which 4 banks are the members of the Factor Chains International (FCI). 3.2 The growth of factoring service in Vietnamese commercial banks Overall, factoring has only been applied in Vietnam for 10 years and many banks and financial institutions are the members of the FCI, creating a good environment for them to compete and learn from international partners. Factoring is a modern banking service, which shows the product-diversifying policies of banks to minimize risks and maximize profits. Factoring prompts other services such as international payments, monetary business or trading on the forex market to thrive. Below, the development of factoring services in Vietnam will be analyzed in more details. The total volume of factoring: Vietnam accounts for the minor volume of factoring in comparison with other countries in Asia (as the figure 1 illustrates) and the trend fluctuated during the years while the trends in other countries are upward. In some developing countries such as China or Japan, their total volumes of factoring are very big: 343,759 and 97,210 respectively. Meanwhile, in Vietnam the figures are very tiny, just under 100 million Euros. However, it can be seen that, the speed of growth in factoring services in Vietnam was very high from 2006 to 2009. Although starting later than other countries, this service has shown a spectacular development. Figure 1: Comparison between the total Factoring Volume of Vietnam and of other Asian countries from 2006 to 2012

Source: (Factors Chain International 2013)

Chart 1: Total factoring volume of Vietnam from 2006 to 2012

100 80 60 40 20 0 2006 2007 2008 2009 2010 2011 2012

Source (Factors Chain International 2013) As we can see from chart 1, the total volume of factoring rose steadily from 2006 to 2008 and reached a peak of 95 million Euros in 2009. From 2009 onward, the volume dropped slightly due to the impact of the global crisis (many companies in Vietnam reduce their producing scale, therefore, the number of trade contracts decreases as well). The figure shows that most companies in Vietnam are still not interested in using factoring to develop their business or many companies do not have enough standards to approach this service (The major clients of Vietnamese commercial banks are big companies or state-owned corporations, because hey have high credit and liquidity). The density of domestic and international factoring services: In Vietnam, factoring is mainly used for domestic transactions. Figure 2 demonstrates that the major development of factoring is financed by domestic factoring with the total turnover accounting for over 65% (40 million Euros) in 2012. Though Vietnam is opening strongly to the worldwide market, international factoring is not applied as much as domestic one because this is a very new service in Vietnam and not many people understand the benefits of it and they are still afraid of some risks arising outside the national border when they do a business with foreign partners. Besides, the number of companies providing factoring in Vietnam is only 6, therefore, many businesses currently cannot approach the service.

Source: (Factors Chian International 2013) The major clients using factoring services: In Vietnamese commercial banks, their clients, who use factoring services, are mainly big companies or similar clients of the banks (which have long term relationships with the banks or state-owned corporations). Therefore, the expansion of the service is not high because commercial banks barely grand credit terms to small companies, which have low liquidity and credit. As a consequence, companies with small scale cannot approach the service to improve their production. Moreover, international trade contains a lot of difficulties as companies cannot access full information about their foreign partners. This problem prevents small enterprises to make deferred sales to overseas buyers. Having said that, the level of integration of Vietnamese commercial banks is not high because of their weak international connections (not many banks have branches overseas, Ebanking has been applied in Vietnam recently but still shows great limitations and the linguistic ability of bankers is not good enough to deal with complicated transactions). Market share: Vietcombank is the best commercial bank in Vietnam providing factoring services, especially international factoring. In July 2004 in Hongkong, the Asian Banker a prestigious magazine in the world, awarded best domestic bank in the commercial financing sector prize to Vietcombank. Vietcombank provides both Traditional factoring and reverse factoring. Currently, Vietcombank makes up the largest revenue for factoring in Vietnam, both domestically and internationally, and its revenue continues to rise year after year since 2005. Asia Commercial Bank (ACB) is another big name in providing factoring services. This is the first bank to apply this service in Vietnam. ACB is known as a modern bank, which always use new technologies in conducting the operations of the whole system. In Vietnam, ACB in the second largest supplier of factoring services. Although the market share of 2 banks above is really big, it does not mean other banks cannot compete with them. Some banks usually offer attractive promotions such as cutting down on fees to attract more clients using their service. One of the most salient is the service
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of Vietnam International Bank (VIB). The important point is that VIB can provide factoring services to their clients without mortgages if the clients meet all the demand of the bank. This is a flexible regulation to help VIB gain more opportunities than its rivals, but it can also result in higher risks for the bank. 4. Domestic reverse factoring-valuing model In this essay, the model to value reverse factoring (Laere 2012)will be introduced in brief to see the difference between a transaction with reverse factoring and without it. The model is developed to estimate the benefits that the buyer, the supplier and the factor can gain in the international context. This essay will only mention the model designed in the context of perfect capital markets. In case of imperfect capital markets, the result of the model is different. 4.1 Perfect capital market A perfect capital market (Ezzell 1980) is the market, in which: There are no tax, transaction costs or others costs related to securities trading. Investors and companies can trade similar sets of securities at competitive market

prices equal to the present value of their future cash flows. A company will not change its cash flows generated from its investments and will not

announce new information about their operations. 4.2 There are no arbitrage opportunities in perfect capital markets. Model description

Summary: The buyer approves the invoice of a supplier at t=0. This invoice is available for discount to the supplier and the supplier sells the invoice to the bank at t=0 automatically. At maturity, if the buyer is not defaulted, it will pay its account payables to the supplier and the payoff at maturity is considered stochastic within the payment period. Below are all factors that are related to valuing reverse factoring model: Lnrf , lrf : Payment term without and with factoring b: Supply chain finance premium charged by the bank to the supplier rf: Annual risk free rate ri annual financing rate of actor i i: risk premium for actor i i: benefit from reverse factoring for the supplier, the buyer and the bank Lt: Loan at time t Dti: binomial stochastic variable, 0 in case of default between time 0 and t. EQt [.] Risk neutral expected cash flow at time t q: Risk neutral probability of default
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Based on all factors listed and the hypothesis above, the value of the stochastic cash flow V0[.] at t=0 can be estimated as: V0 [Dt ] = E V0. 4.3 Model From what has been developed above, the model is designed to value the benefits for the buyer, the supplier and the bank. Finally, the total benefits of the whole supply chain will be taken together. As the perfect capital markets should not add value, the total profit is equal zero. Buyer: The benefits that the buyer receives from reverse factoring in perfect capital markets is estimated by the model as: b = (rf +b) (lrf lnrf) . The benefits that the buyer receives is positively related to the payment period extension and its risk premium. Supplier: The benefits that the supplier receives from reverse factoring in perfect capital markets is estimated by the model as: s=(rf +b)lnrf (rf +b +b)lrf and its profit is negatively related to the payment period extension, the fee of reverse factoring and the buyers risk premium. Bank: The benefits that the bank receives from reverse factoring in perfect capital markets is estimated by the model as: f = e
- l b rf i Q i t [D t]

e-rft = e-(rf+i)

(e-rflrf e-(rf+b)lrf). The benefit of the bank only

depends on the fee of reverse factoring and the payment period. Supply chain: The total profit of the whole supply chain in perfect capital markets is estimated at: sc = b+s+f = (rf +b) (lrf lnrf) + (rf +b)lnrf (rf +b +b)lrf + e-blrf (e-rflrf e-(rf+b)lrf) =0 Overall: In perfect capital markets, reverse factoring does not give value to the supply chain, but it causes a redistribution of income for the participants. 5. Conclusion When Vietnam becomes a member of WTO, the banking sector is the one, which needs most transformation and renovation to compete with international rivals. Therefore, Vietnamese banks always try to diversify their products and services. Factoring only appeared in Vietnam since 2004 and to date it has become an efficient financial instrument to guarantee the consistent operation of companies. Besides, it is also a profitable product for the banks to diversify their business and make more benefits. Although factoring services are still new in Vietnam and in need of more standardized regulations, it is predicted that, this service will
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prosper in the future, especially when Vietnam integrates more into the international environment. (2418 words)

References
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<http://www.fci.nl/images/fci_annul_review_2013.pdf>. Hang, LTT & Hong, DB 2013, The position of the Vietnamese Banking system in regional and global arena, viewed 22 January 2013, <http://tailieu.vn/xem-tai-lieu/dinh-vi-he-thongngan-hang-viet-nam-so-voi-cac-nen-kinh-te-trong-khu-vuc-va-tren-the-gioi.1349287.html>. Laura & Vasilescu, G 2010, 'INTERNATIONAL FACTORING -- A VIABLE FINANCING SOLUTION FOR FIRMS.', Young Economists Journal / Revista Tinerilor Economisti, vol 8, no. 14, p. 28. RVA, O-C & DAVID, A 2010, 'FACTORING AGREEMENT - FINANCING METHOD FOR', vol 10, no. 4, pp. 5-7.
RVA, O. -C., & DAVID, A. (2010). FACTORING AGREEMENT FINANCING METHOD FOR THE COMPANIES IN LACK OF CASH-FLOW. Annals of the University of Petrosani Economics, 289-296.

Dalton, J. E. (n.d.). Factoring Harvard Business Review, 14(2), 186-199. Silbert, Theodore H, Financing and Factoring Accounts Receivable, Jan/Feb1952, Vol. 30 Issue 1, Harvard Business Review, p39-54. Fiordelisi, Franco; Molyneux, Philip, Efficiency in the factoring industry, 5/20/2004, Vol. 36 Issue 9, Applied Economics, p947-959. Silverman, Herbert R, FACTORING AS A FINANCING DEVICE, Vol. 27 Issue 5, Harvard Business Review, p594-611. Ittleson, H. Anthony, Factoring: Opening new routes in international trade, Vol. 67 Issue 9, Management Review, p48. Leora Klapper, The Role of Factoring for Financing Small and Medium Enterprises, June 2005. Ezzell, JAMAJR 1980, 'The Weighted Average Cost of Capital, Perfect Capital Markets, and Project Life: A Clarification', Journal of Financial and Quantitative Analysis, vol 15, no. 03, pp. 719-730.

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Laere, MV 2012, 'Modelling international reverse factoring-and the future of supply chain finance', Master of science in finance dissertation, Industrial engineering and Management Science, Eindhoven. Solutions for the development of factoring in Vietnamese commercial banks, <http://luanvan.net.vn/luan-van/de-tai-thuc-trang-va-giai-phap-phat-trien-nghiep-vu-baothanh-toan-tai-cac-ngan-hang-thuong-mai-cua-viet-nam-11926/>. McKinsey, Supply chain finance: From myth to reality, October 2010 Enrico Camerinelli, Payment strategies and systems, Journal of Payments Strategy & Systems, Volume 3, Number 2 , April 2009, p114 128 Asian Development Bank, < http://www.adb.org/>. The state bank of Vietnam,

<http://www.sbv.gov.vn/portal/faces/en/enm/enpages_home?_adf.ctrlstate=q9hbi7knr_4&_afrLoop=6201006664675500>. Joint stock commercial Bank for Foreign Trade of Vietnam,

<http://www.vietcombank.com.vn/?lang=en>. Asia Commercial Bank, <http://www.acb.com.vn/en/>. Vietnam International Bank, <http://vib.com.vn/>

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