Economists and bankers are expecting a switch from dollar holdings to dong assets after the central bank capped the interest rate on dollar deposits.

The State Bank of Vietnam has capped dollar deposit rates at 3 percent for individuals and 1 percent for institutions, effective April 13. Local lenders will also have to raise their reserve ratio on deposits held in US currency from May onward.

Bankers welcomed the move saying it will end the race among banks to raise their dollar deposit interest rates. Before the rate cap was imposed, local banks were offering to pay up to 6 percent annually on dollar deposits.

Ly Xuan Hai, general director of Asia Commercial Bank, said dollar rates in most other countries remained under 1 percent while they surged unreasonably to 5-6 percent in Vietnam.

Hai said the new rule will discourage foreign-currency holdings and ease pressure on the dong.

His bank now sets interest rates between 2.90 to 3 percent on dollar deposits. That compares to a maximum interest rate of 14 percent on dong savings.

Another bank manager said depositors are expected to sell dollar deposits and switch to the dong because of the widening gap between local and foreign currency interest rates. Pressure on the dong will ease when the market no longer prefers the US dollar, he said.

The manager estimated that banks in Ho Chi Minh City alone had around US$10 billion in dollar deposits, more than half of which came from individuals.

Foreign-currency loans increased 13 percent in the first three months of the year. Even though foreign-currency liquidity at banks was ensured, the central bank said dollar lending rose unexpectedly.

Experts said even companies that don’t need to import goods prefer dollar loans so they can benefit from low borrowing costs. Interest rates on dollar loans are 6-8.5 percent, approximately half of dong lending rates.

The rate cap on dollar deposits will allow banks to lower their lending rates, but Hai of Asia Commercial Bank said a sharp decline is unlikely.

The amount of dollar deposits lenders must set aside will be increased next month, and this will prevent drastic cuts in lending rates, Hai said.

Economist Le Tham Duong, on the other hand, said a cap on interest rates may force banks to find ways around the new rule.

“An administrative order often results in dodging of regulations,” he said. “If corporate demand for dollar loans remains high and banks are unable to attract dollar deposits (at the new low rates), they will be forced to break the cap.”

Duong noted that local banks have already circumvented a similar cap on dong deposits.

The State Bank of Vietnam in February recognized the 14 percent rate cap on dong deposits established earlier by the Vietnam Bank Association.

News website VnExpress reported last week that many banks, including the bigger ones, were breaking the cap. As banks had trouble raising funds amidst soaring consumer prices, they tried to attract deposits with rates of up to 18 percent a year, the report cited an official of Vietnam Bank Association as saying.