Business issues 40854 Bulletin Lao PDR THE BUSINESS INFORMATION CENTER AT THE LAO NATIONAL CHAMBER OF COMMERCE AND INDUSTRY No. 5 July 2007 Major Steps Towards Improving the Legal Infrastructure of the Financial Sector in Lao PDR The development of the financial sector requires a sound and ultimately increasing access to finance for Lao legal framework, which enhances the ability of financial businesses. Specific improvements provided through institutions to operate and provide needed services. In the new law include: Lao PDR, the legal framework of the financial sector remains weak evidenced by the fact that bank lending · Equalconditionsforlocally-owned,state-ownedand in Lao PDR decreased from 3,265 billion Kip ($307 foreign-ownedbanksregardingtheminimumcapital million) in 2005 to 3,011 billion Kip ($299 million) in 2006. requirement and branch network establishment; Moreover, total loans in the banking sector represent · Prompt corrective action for seriously only 8.7% of GDP, compared to over 75% in Thailand, undercapitalized banks; and the loan deposit ratio is only 39.4% and has declined · A clear and comprehensive two-stage licensing from 2005. These figures show that much more could be process; done to improve the depth and outreach of the financial sector. The lack of a strong financial sector infrastructure · Modern techniques for bank governance that is one of the main problems. supplement the Enterprise Law; · Comprehensive provisions to prevent conflicts of Table 1: Financial depth and outreach in Lao PDR interest; · A broad range of enforcement actions; and · Provisions for resolving bank insolvency. In addition to the Law on Commercial Banks, the Bank of the Lao PDR (BOL) has also revised the Presidential Decree on the Management of Foreign Exchange and Precious Metals. The purpose of the amendments to this decree is to remove provisions that discriminate against commercial banks that are not state-owned, focusing on the following: · Whereby the current decree requires foreign Source: Compiled by IFC-MPDF based on data from BoL, World Bank and ADB exchange bureaus to sell foreign exchange only to Overview of the Legal and Regulatory state-owned commercial banks or to BOL, these Environment for Commercial Banking bureaus will be allowed to sell foreign exchange to With the clear objective of strengthening the legal and regulatory framework for commercial banking, the government of Lao PDR has recently taken several important steps. The most recent development in This bulletin is published with support from the Mekong Private Sector Development Facility (MPDF), a multi-donor funded initiative managed by the the financial sector is the promulgation of the Law on International Finance Corporation (IFC), the private-sector arm of the World Bank Commercial Banks in early 2007,1 which supports sound Group. financial sector and banking practices including creating The "Business Issues Bulletin" provides those interested in business issues an environment where all commercial banks - private, with a short summary and analysis of a particular topic affecting the business environment in Lao PDR, and exposure to different opinions held by various foreign and state-owned - operate on a level playing stakeholders on the topic. field. The increased competition in the banking sector The statements and opinions presented here are only meant to provide brought about by the promulgation of this law will result additional reference material and do not reflect official opinion of the Lao National in improving the service level of the financial sector Chamber of Commerce and Industry (LNCCI) or IFC-MPDF. Readers are welcome to copy and distribute the information contained in this bulletin provided acknowledgement is given to LNCCI/MPDF as the source. 1 The law was prepared with assistance from the International Finance Corporation's Mekong Private Sector Development These amendments are expected to be approved by the Facility (IFC-MPDF). government in the coming months. any bank; will also strengthen our supervisory capacity through · Whereby the current decree requires foreign reviewing and revising existing prudential regulations, investors in mining and other business activities and training our staff. involving the exploitation of natural resources to maintain accounts at state-owned commercial Mr. Paul Freer, Managing Director, banks, these mining and natural resources Phongsavanh Bank businesses will be allowed to use the services of The Law on Commercial Banks is an important any banks, including private commercial banks; legislative framework that suggests the government · Wherebythecurrentdecreeallowsforeigninvestors is serious about developing the banking sector in Lao to borrow from local banks only for working capital PDR. However, the devil will be in the detail ­ the timely purposes, banks will be allowed to provide more roll out of implementing decrees and regulations (in loan products for foreign clients on a long-term particular the implementation of the Secured Transaction basis giving them access to a wider range of Law) and the enforcement of such will be key to seeing financing from local banks. the banking sector develop and grow. Deposits will not be fully leveraged in terms of lending until banks can The new commercial banking legislation and the rely on a transparent and enforceable legal framework. amendments to the decree have leveled the playing field Uncertainty in any environment acts as a deterrent to for all types of banks in Lao PDR. As a result, Australia investment. The Law on Commercial Banks is a bold andNewZealandBank(ANZ)enteredintoajoint-venture step and one that has already proved itself in attracting agreement in March 2007 with Vientiane Commercial international players to the market and the opening of Bank (VCB), a locally established bank. These reforms wholly Lao owned commercial banks such as ours. in commercial banking have also encouraged the This can only be good for business and the government International Finance Corporation to invest in VCB by and the sponsors of this newly promulgated law are taking a 10% stake in the bank. to be applauded. When transparent and enforceable Having promulgated the Law on Commercial Banks, the implementing decrees are rolled out, expect to see a challenge ahead is to ensure effective implementation raft of innovative products and services launched by through additional decrees and regulations, including an Phongsavanh Bank! implementingdecree,strengthenedprudentialregulations in the area of loan classification and provisioning, and Need for Effective Secured Transactions guidelines and instructions for bank supervisors and Legal Framework inspectors.3 A recent diagnostic of the financial sector carried out Mr. Sengdeuane Pannhasith, Director General, by IFC-MPDF revealed that only 20-30% of households Bank and Financial Institutions Supervision and private enterprises have access to finance. The Department, Bank of Lao PDR diagnostic also identified the following barriers limiting access to finance: The promulgation of the Law on Commercial Banks is an important step in the development of the banking sector in · Lending decisions are based almost entirely on our country. By creating a level playing field for domestic collateral; and and foreign banks, and private and state-owned banks, · Banks generally do not accept movable and the Law on Commercial Banks will encourage stronger intangibleassetssuchasmotorvehicles,machinery, competition, which is a prerequisite for developing a equipment, accounts receivable and inventory as strong commercial banking sector. It is expected that collateral, but instead require immovable assets increased competition will result in strengthening the (property or user rights to land) as security for a service level of the financial sector and improving access loan. to bank financing for businesses in the country. At the same time, this law also provides an effective regulatory Consequently, the majority of businesses in Lao PDR, of and supervisory tool consistent with international which more than 90% are small and medium enterprises practices to ensure healthy growth of the financial sector (SMEs), are unable to access finance for business and protect the interest of depositors. expansion. This has a negative impact on the ability of the private sector to create more jobs, increase the tax To support the implementation of the Law, a more detailed base and contribute to national prosperity. implementing decree will be developed with the technical assistance from IFC-MPDF. The decree will focus on If banks were able to feel more comfortable to lend on details of the licensing process, bank governance and movable and intangible assets, SME access to bank structure, banking operations/activities, supervision and financing would be greatly enhanced. For this to occur, inspection, rehabilitation and insolvency. Along with the legal infrastructure for secured transactions needs the development of the implementing regulations, we to be strengthened. Although the Secured Transactions Law promulgated in May 2005 allows banks to accept movable assets and intangible property as collateral, 3IFC-MPDF will be providing further support to the BOL to draft these necessary implementing regulations. it has not yet been implemented. In order to further 2 facilitate the ability of banks to lend based on movable it allows more businesses, particularly SMEs, access and intangible assets, the following measures will need to financing provided that all other factors are aligned. to be taken: However this law has been in existence since May 2005, and we await the promulgation of an implementing · Improvetheexistinglegalandregulatoryframework decree to instruct lenders and borrowers on how the law by issuing the necessary implementing decree for is to work. the Secured Transactions Law; · Improve the supporting infrastructure for secured We all understand how problematic it is for lenders to lending by establishing a pledge registration realize on security held when a debtor defaults and a system, which will enable lenders to quickly register loan becomes bad. This needs to be rectified in the their financial interest in an asset and search for implementing decree so that lenders are given the right existing claims in a database; to obtain loan repayments through the sale of security · Banks will need to strengthen their credit risk property. management capacity by developing expertise In this regard the implementing decree requires some in loan portfolio management, enhancing their form of self help for lenders, particularly in the case of understanding of the risks and technical aspects of moveable property, whereby a lender can seize and particular industries and improving monitoring and secure its ownership of the goods promptly in the case client relationship management; and of a defaulting debtor. A national registration system, · SMEs will need to develop and maintain proper preferably computerized, is also needed which would accounting records, which provide sufficient allow lenders to record the security they hold and which financial information for banks to carry out loan others can easily access to check whether security is held assessments. over a particular item. This will ensure that a moveable item is not used as security for a loan more than once. To support the government's effort in promoting lending This registration process needs to be simple, fast and by based on movable and intangible collateral, the Asian notice only. Development Bank has been working with the Ministry of Justice and other relevant agencies to develop the As lenders we look forward to the promulgation of the implementing regulations for the Secured Transaction implementing decree, which will provide more clarity Law. It is envisaged that these regulations will provide around the intent of the law. Of course lenders should guidelines for the establishment and operation of an not look to security as the only way to lend money but effective pledge registration system as well as rules also require access to proper financial information and and procedures for the repossession of movable and repayment capacity in support of any loan proposal. intangible property. Borrowers themselves will need to maintain proper financial records. However, this is another subject in its Mr. Sengdeuane Pannhasith, Director General, own right. Bank and Financial Institutions Supervision Department, the Bank of Lao PDR Dr. Aksone BOUPHAKONEKHAM, Chairman, Banque pour le Commerce Exterieur Lao We are currently working with the Ministry of Justice and other relevant ministries to develop the implementing In addition to having an effective legal framework in the decree for the Secured Transactions Law, which will form of laws and implementing regulations, supporting enable businesses to use both their movable and infrastructure such as a pledge registration system, immovable assets as collateral for bank credit. This which will enable lenders to quickly register their financial decree, together with the plan to establish a pledge interest in an asset and search for existing claims, is registration system, is expected to facilitate the country's a necessary condition to encourage more lending, lending market. especially to SMEs, who generally lack land and property. I anticipate that the implementing regulation for the Mr. Allan Marlin, ANZ Shareholder Representative Secured Transactions Law currently under development Lao PDR, ANZ Banking Group Ltd. will provide us with a broad scope of assets that may be The Secured Transactions Law is one of the most used as security, clear rules on priority for the secured important pieces of legislation in respect to providing an creditor, and effective enforcement upon default. understanding of what type of assets are available to be taken by lenders as security for finance lines extended. Non-bank Financial Institutions-Leasing The law distinguishes the different forms of security Businesses in Lao PDR consider their limited access to available to lenders and authorizes the use of moveable finance as a major constraint to doing business. Since property as a legal form of security. The effect of this the reliance on collateral-based lending is the principal is that those who do not have access to immovable hindrance for many businesses from accessing bank property and title are able to offer other forms of assets loans, in particular for SMEs, finance leasing is an to lenders. alternative financial product, which could be utilized The promulgation of this law is good for Lao PDR as to mitigate collateral requirements. Although lease 3 financing can be complicated, it helps businesses to budgeting; structure financing based very much upon the individual - 100% financing is available; situation of the user of the equipment (the lessee). Some businesses lease because of cash flow or tax - Payments can be structured to more closely align considerations, some for country risk reasons and others with a company's seasonal business activities and for convenience or budgetary reasons. income; - Operating budgets may permit lease finance when The Decree on Finance Leasing was issued in 1999 and a capital budget does not allow the purchase of an is largely consistent with international best practices. To asset; date, however, not a single finance leasing company - Benefits to balance sheet structuring; has been established in Lao PDR. One of the main reasons for the absence of finance leasing is the lack of - It allows better utilization of tax benefits by both regulations concerning the requirements and licensing lessor and lessee; procedures for establishing finance leasing companies. - It provides a hedge against technological Implementing guidelines for the Decree on Finance obsolescence; and Leasing are needed which would: - Itmayoffernonfinancialservicessuchasequipment service and maintenance (operating leases). · Provide guidelines and procedures for licensing finance leasing companies; What is required to ensure leasing is practicable are · Clarify repossession rights of lessors; and decent implementing guidelines that provide a framework · Define the tax treatment of finance leasing so that it of the intent of the Law but allow the lessor and lessee to is not disadvantaged vis-a-vis bank lending. In this agreeonspecificdetailsintermsoftheleaseagreements way leasing will be a competitive financial product. between the two parties. There needs to be a formal registry where the interests of the lessors in moveable Mr. Sengdeuane Pannhasith, Director General, assets can be registered. Finally, repossession rights Bank and Financial Institutions Supervision which allow the lessor to regain possession of goods Department, Bank of Lao PDR they rightfully and legally own. Leasing is a widely used financial product in many In terms of tax treatment, there should be no turnover countries. However, to make leasing a viable product in or value added tax associated with finance lease Lao PDR, we will need to further improve the existing transactions and no withholding tax payments applicable. legal framework by clearly defining the rights and Tax rules should also ensure that matters such as responsibilities of both lessors and lessees and making depreciation and deductibility of lease payments do not it easier for lessors to repossess leased property in the disadvantage finance leasing. event of default on the part of lessees. Conclusion Mr. Allan Marlin, ANZ Shareholder Representative Lao PDR, ANZ Banking Group Ltd. Improving access to finance in Lao PDR depends greatly on the development of the country's financial While it is true that there has been a Decree on Finance sector infrastructure. With the passage of key legislation Leasing in existence for some time it is likely that no concerning the leveling of the playing field for private, one has acted under this legal framework because of state-owned and foreign commercial banks, a major the absence of any implementing guidelines and clarity step forward has been taken to extend the outreach and around the ability of a lessor to regain possession of availabilityoffinancialservicestothebusinesscommunity. the goods that are owned by the lessor if the lessee However, to enhance the ability of commercial banks to decides not to maintain the lease payments.Additionally, lend, a clearer regulatory framework with regard to the the accounting and tax regimes need to be favorable pledging, registration and repossession of collateral is for leasing to be competitive with traditional forms of needed. The issuance of implementing regulations to finance. the Secured Transactions Law and the development of a pledge registration system will enhance the ability of There is far greater awareness nowadays that most commercialbankstousemovableandintangibleproperty businesses make money by using equipment and not as collateral. Improving the enabling legal framework owning it. There are numerous benefits available from for leasing is also necessary to diversify the financial using lease financing as follows: products available in the market. With the development - It allows businesses to retain cash reserves for a of this legal infrastructure, financial institutions will be company's core business activities; better able to provide the financing needed to support businesses to expand, add jobs and create wealth for - Fixed payments usually at fixed interest rates allow the country. for more accurate forecasting of cash flow and Business issues · Publisher: LNCCI Business Center · KM 5, Ban Phonphanao, Vientiane · Tel: 856-21-412579 · Fax: 856-21-452580 Bulletin · Reviewed by: Mr. Khunthavong Dalavong, LNCCI Secretary General · Layout and printed by: V.V. Design and Publishing · E-mail: vv_dap@yahoo.com, 500 copies · License No. 177/C by Ministry of Information and Culture, dated 21/02/05