* 20 pct stake allowed for strategic investor, without govt approval
* Total foreign shareholding stays capped at 30 pct
* Foreign shares could surpass 30 pct cap in "weak" banks
* Bad loans, small stakes limit attractiveness - economist
By Ho Binh Minh and Nguyen Phuong Linh
HANOI, Jan 7 (Reuters) - Vietnam will allow foreign investors to buy bigger stakes in its banks from next month, a move that could give some relief to its crippling debt problem but is short of the reforms experts say are needed to strengthen its economy.
A government decree, announced on Tuesday said effective on Feb. 20, foreign banks could be allowed to buy majority stakes in domestic lenders considered weak, and marginally greater shares than at present in stronger banks. It did not stipulate what constituted a "weak" bank.
The move is one of a series of incremental steps taken by Vietnam's communist government to revive a once-thriving economy that has been stuck in a quagmire, in large part due to high levels of toxic debt and tight lending that has hurt retail growth and led to bankruptcies of tens of thousands of small businesses.
The State Bank of Vietnam (SBV) last year set up an asset management firm to buy bad debt from lenders in return for bonds in an effort to tackle the region's highest ratio's of non-performing loans (NPLs).
However, what the central bank's firm does with the NPLs it buys remains unclear.
Independent economists estimate the NPL ratio to be in double digits and say the problem requires a more comprehensive solution, including more transparency and liberalisation of the banking sector to lure foreign expertise and capital.
According to the new decree, a single "strategic foreign investor" will be allowed a maximum 20 percent of a Vietnamese bank without government approval, up from 15 percent now. The 30 percent cap on total foreign ownership remains in place.
It would raise the foreign ownership limit beyond the 30 percent if an overseas institutional investor wanted to buy into weak banks, it said, without elaborating. An SBV report to the legislature in November said there were 11 weak banks in Vietnam, although it said eight had been "restructured".
Bui Kien Thanh, an independent economist and former government advisor, said the changes would have limited appeal to foreigners because stakes permitted in stronger banks were too small and the extent of the NPL problem in Vietnam was still unclear.
'BAD DEBT BARRIER'
"It doesn't mean anything to foreign investors as they would still only play a passive role in a bank, they don't have right to decide anything," Thanh said.
"The chance to buy a 100-percent share of a weak bank is also very difficult as no one wants to pay a lot of money to buy a bank with high rates of non-performing loans... the biggest barrier is bad debts."
Overseas banks are among seven foreign strategic investors that have so far bought into about 10 Vietnamese banks - half of them listed - among the nearly 40 in the country, according to Thomson Reuters data
Among the foreign banks with stakes in Vietnamese ones are HSBC Holdings, in Techcombank; Commonwealth Bank of Australia in VIB; and United Overseas Bank of Singapore in Phuong Nam. In those three cases, the foreign bank got government approval to hold 20 percent.
The new decree outlined seven criteria to qualify a bank as a foreign strategic investor, including at least $20 billion in assets in the year before buying a stake.
The concept is similar to what is now on offer in Thailand, which had a debt crisis of its own more than a decade ago, although Vietnam's solution offers significantly lower caps on foreign stakes.
Foreign investors can own up to 49 percent in Thai lenders, while majority foreign ownership has been allowed on a case-by-case basis, such as the 72 percent in Bank of Ayudhya , and 94 percent CIMB Thai Bank, mostly as a means to inject more capital.
Vietnam's government has promised reforms as part of a "master plan" aimed at boosting economic growth that was 5.42 percent last year, up slightly from 5.25 percent 2012, which was the slowest in 13 years. Vietnam's economy grew about 7-7.5 percent annually from 2004-2007.
TIGHT GRIP REMAINS
Frivolous lending, much of it to state-run firms, put the brakes on that growth and investors say reforms to date and those in the pipeline have been disappointing, with the state retaining its tight grip on an economy that needs to be liberalised.
The benchmark VN Index closed up 0.2 percent on Tuesday. Although banks were the biggest gainers, changes in foreign ownership caps were unlikely to be a game-changer long-term, analysts said.
"The new decree doesn't have much effect on listed banks, but would boost the banking sector in the long term," said Tran Minh Hoang, a senior analyst at Vietcombank Securities.
An amended law allowing foreign shares of up to 60 percent in some listed firms could soon be approved, according to a draft seen by Reuters that is awaiting executive approval.
However, the draft says restrictions will still apply on sectors "in which the state needs to control foreign capital".