The inter-island ship MCY went down within a minute, police said.
They added charges are likely to be brought as the vessel was overloaded, Radio Australia reported.
Rescuers pulled 37 people from the water, but a 10-month-old baby and a crew member remained missing.
The ferry was travelling from Malekula to the capital, Port Vila, when it capsized.
Some hours before, its engines had reportedly failed several kilometres out at sea.
