* Bad debt ratio climbs, adds pressure on weak banking sector
* High inflation, borrowing costs add to worry about asset quality, stability
* Central banks wants to restructure sector in 5 years, eyes M&A (Adds comments, context)
HANOI, Oct 19 (Reuters) - Bad debts at Vietnam's banks rose to 3.21 percent of outstanding loans at the end of August, and private observers say it could be much higher, adding urgency to the central bank's plans to restructure the country's banking system in coming years.
The bad debt ratio rose from 3.04 percent a month earlier, a state-run newspaper said on Wednesday.
"Bad debt has been rising gradually every month so far this year," the official Thanh Nien daily quoted a central bank report as saying.
Loans at the banks totalled 2,389 trillion dong ($114.1 billion) at end-August, the report said.
Non-performing loans in the banking sector increased by 0.68 percentage point from 2.53 percent at the end of August 2010, it added.
"The bad debt ratio of over 3 percent is worrisome for the Vietnam banking system", said Alan Pham, an economist at VinaCapital Investment Management Ltd.
Non-performing loans in Vietnam's banking system could rise to 5 percent of total loans by the end of this year under a worst-case scenario, the central bank has said.
Economists and observers, however, widely suspect the true level of bad debt in the banking system to be significantly higher than official numbers, with banks said to commonly roll over, recategorise or otherwise cover up non-performing loans.
Pham said the actual rate of non-performing loans in Vietnam's banking system could be three times the official figure because Vietnam uses its own standards for classifying bad debts, leading to a lower ratio than international standards would produce.
Vietnam's rapid economic growth in the past few years has been largely fueled by credit expansion, with loans rising 27.65 percent last year, 37.7 percent in 2009 and 53.8 percent in 2007, central bank data showed.
Banks' focus on rapid loan growth "exposes them to a sharp deterioration in asset quality should the already difficult operating environment take a turn for the worse," credit rating agency Fitch said in a report last week.
Fitch noted Vietnamese banks were thinly capitalised compared to those elsewhere in the region, and urged further efforts to beef up their reserves.
Several banks, including major listed banks, were among those with increasing non-performing loans, Thanh Nien newspaper said.
Bad debts accounted for 3.47 percent of Vietcombank's loans, while Agribank, Vietnam's largest lender, had 6.67 percent of loans classified as bad debt at end-August, the ruling Communist Party's bureau overseeing state-run businesses has said.
Major banks have been cutting loans in the interbank market in a defensive move on news about bad debts and expectations of funding strains later in the year, Thanh Nien newspaper said.
Overnight lending rates have soared to between 17 and 19 percent in the past few days and the one-month rate jumped to 30 percent on Monday, the state-run news website VnExpress (vnexpress.net) said.
The State Bank of Vietnam said on Tuesday it plans to restructure the banking system in the next five years and consider merger and acquisition activities the "indispensable trend" for the lenders.
Vietnam has more than 40 partly private banks, led by VietinBank and Vietcombank, as well as four fully state-owned banks.
Last month, Vietcombank said a unit of Mizuho Financial Group agreed to buy a 15 percent stake in it for 11.8 trillion dong ($567.3 million), in what could be the largest acquisition in the country's banking sector to date.
(Reporting by Ngo Thi Ngoc Chau; Editing by Vinu Pilakkott & Kim Coghill)
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