Many Vietnamese banks are widely believed to be suffering from bad debts. Assessing the seriousness of the issue, however, is proving difficult.

The exact nature of the crimes Kien allegedly committed has also been vague. The initial arrest was reportedly for "conducting business illegally". Kien is the co-founder of Asia Commercial Bank (ACB), the biggest private-sector bank in the country. It is 15-per-cent owned by British banking group Standard Chartered.

According to central bank data, non-performing loans totalled 4.47 per cent of total lending as of May 31 this year, up from 3.07 per cent at the end of last year.

But in August, central bank governor Nguyen Van Binh admitted that bad debt in the banking system could be as high as 10 per cent, much worse than local banks are reporting.

Analysts at Fitch Ratings are even more pessimistic, believing that about 15 per cent of loans could be non-performing. A recent report by Barclays suggested 20 per cent.

Last Friday, Moody's downgraded Vietnam's sovereign credit rating because of bad debts. Somewhat confusingly, however, Standard & Poor's recently upgraded Vietnamese banks, arguing that the situation was improving.

There is certainly no shortage of stalled or abandoned construction projects in the nation's urban areas - notably Ho Chi Minh City and Hanoi. Many local developers who began projects during the height of the property boom in 2009 are now suffering from the need to cut prices in order to boost sales of office and apartment blocks. Bankruptcies are also rising, particularly among local steel companies and retail stores struggling to compete with foreign chains.

After years of high inflation and allegedly reckless bank lending, the country has entered a period in which banks are unwilling to lend, making it difficult for businesses to invest. The result is slower growth, which in turn makes it difficult for companies to pay back loans. Overnight inter-bank rates have surged in recent weeks in response to a spate of deposit withdrawals. But so far, there have not been any bank runs.

Some sort of restructuring plan for Vietnam's banks is clearly needed.

A proposal to allow foreign banks to increase their shareholdings in local banks and even permit eventual majority ownership seems like a good idea. But with many such banks already facing problems at home, the scheme may not attract the necessary capital.

One alternative is some form of government-financed bailout. Such a move certainly seems more practical now than it would have been a few years ago. The government's budget deficit, which was equal to 9 per cent of GDP in 2009, now stands at less than 4 per cent. Other numbers are also looking good. The currency has stabilised, inflation is under control and trade deficit has narrowed significantly compared to last year.

And while the government's debt to GDP ratio stands at 44 per cent, this is considerably better than that of many financially stressed European states.

Foreign observers, however, seem focused on the downside. An article in The Wall Street Journal last month noted that if Barclays is correct in estimating that 20 per cent of bank loans are non-performing, Vietnam's banking sector would be carrying up to US$16 billion in bad loans. This is equal to almost 12 per cent of GDP.

At that level, an International Monetary Fund-financed bailout seems almost inevitable.

The scandal at ACB, meanwhile, seems far from over. On September 27, police announced their intention to prosecute four more senior bank executives. Police described former ACB chairman Tran Xuan Gia and vice-chairmen Le Vu Ky and Trinh Kim Quang as co-conspirators with Kien and bank CEO Ly Xuan Hai.

But are things really as bad as they seem? An alternative interpretation is that Kien's arrest had more to do with a power struggle within the ruling Communist Party than any problem in ACB.

Several prominent local tycoons with links to senior members of the Communist Party have been arrested in recent weeks. Kien is closely associated with Prime Minister Nguyen Tan Dung, who is known to be at odds with President Truong Tan Sang over economic strategy. Among the issues dividing the two politicians is how the government should deal with problems such as corruption and the unproductive state enterprise sector.

Gia, the former ACB chairman, may also be caught up in all the politicking. He was minister for planning and investment from 1996 to 2002.

That said, Vietnam's banks are clearly in trouble. The situation requires careful monitoring.

By Bruce Gale - The Straits Times - October 5, 2012