Photos from the scene showed the blackened multi-storey building in western Hanoi mostly destroyed by flames, and piles of twisted metal strewn nearby.
Police said they received reports of a fire at 11:00 pm Wednesday (1600 GMT) "with many people trapped inside".
Rescue workers rushed to the scene and managed to bring out seven people alive, two of whom were rushed to hospital. Eleven others were found dead, they said.
"The police suspect that the cafe was (deliberately) burned down and ... have arrested the perpetrator," Hanoi police said in a statement.
Witnesses said the fire was so large that no one dared to attempt to rescue those trapped inside. The building's balconies were enclosed with metal bars, likely making escape difficult.
Tran Duc Tuan told AFP that he ran out of his home and saw 5-6 motorbikes burning fiercely, blocking the entrance to the building.
"We saw one flash light from a mobile phone on the balcony of the third floor... that's when we knew that there were some survivors inside," he said.
Tuan told how nearby residents desperately attempted to extinguish the fire, pouring water over the flames for more than an hour.
"This was the biggest fire I have ever witnessed... (and) there were no exits at all," he said.
"Everything I saw was very painful. When (people) were brought down, I saw some signs of life but later, there were just several (dead) bodies."
Suspected arrested
More than 10 fire trucks and ambulances sped to the scene, according to local media.
The fire reportedly began on the first floor, before quickly spreading through the building. State media said CCTV footage from a nearby house showed a man carrying a bucket entering the premises shortly before the fire broke out.
A suspect was arrested around midnight, police said.
The man had gone to the karaoke bar to drink beer before arguing with staff, they added. He then allegedly bought petrol and poured it close to an area with many motorbikes, which burst into flames.
The incident comes after six people, including four police officers, were jailed in October over a fire that ripped through a karaoke bar two years ago, killing 32 people.
The blaze in a province close to business hub Ho Chi Minh City shocked Vietnam and led to the closure of thousands of karaoke bars nationwide for failing to meet fire regulations.
More than two-thirds of the country's approximately 15,000 karaoke bars were forced to close, according to state media, citing police sources.
