127 Credit risk management at bank for investment and development of Vietnam (BIDV) - Thanh Do Branch,Master''''s Thesis

Limits and challenges...63 4.5 Solutions to improve credit risk management at BIDV Bank - Thanh Do branch ..... The fact that, it requires BIDV Bank - Thanh Do Branchhas to focus on and

ɪ 1 Dissertation submitted in partial fulfillment of the

Requirement for the MSc in Finance

The dearest appreciations are directed to our families and friends, for giving us greatsupport and help during these months Without them, my thesis would not be finished.

September 2018Student’s Signature

Duong Thi Thanh

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on profitability in banks The study is limited to identifying the relationship of creditrisk management and profitability of BIDV - Thanh Do Branch The results of the studyare limited to the bank in the sample and are not generalized for the all the commercialbanks in Vietnam Furthermore, my study uses both Secondary data collection methodsand quantitative research by analyzing the logistic regression model (Binary logistic)was selected with the dependent variable is the binary variable (1 The enterprise fallsinto the risky situation, 0 The business is not risky).

Key words: credit risk management, profitability, banks, regression model.

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ABBREVIATIO NS

TABLE OF CONTENTS

ACKNOWLEDGEMENT ii

ABSTRACT iii

ABBREVIATIONS iv

LIST OF TABLE, DIAGRAM viii

1 INTRODUCTION 1

1.1 Background 1

1.2 Problem Discussion 2

1.3 Research purposes and tasks: 3

1.4 Delimitation 3

1.5 Disposition 4

2 METHODOLOGY: 5

2.1 Research approach 5

2.2 Data collection and description 7

2.3 Tested Results of the research model 10

2.3.1 Correlation Matrix of thevariables in the model 10

2.3.2 Determination of research results 13

3 FRAMEWORK 16

3.1 Previous studies 16

3.1.1. Liturature review 16

3.1.2 credit risk management Indicators 21

3.1.2.1 Credit size 21

3.1.2.2 Loan porfolio structure 21

3.1.2.3 Overdue debt 22

3.1.2.4 Non-performing loans 22

3.1.2.5 Credit risk provision 23

3.2 Theories 24

3.2.1 Risk in Banks 24

3.2.2 Credit risk managementin banks 25

3.2.3 Credit risk classification 25

3.2.4 Loan porfolio structure 27

3.2.5 Overdue debt 27

3.2.6 Non-performing loans 28

3.3 Credit risk provision 29

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3.4 Regulation 30

3.5 Credit risk measurement 31

a Qualitative model of credit risk management 31

b Quantitative model of credit risk management 32

c Credit risk measurement model in Basel II 36

3.6 Lessons 37

4 EMPIRICAL FINDING AND ANALYSIS 39

4.1 An overview of BIDV and Thanh Do Branch 39

4.1.1 Establishment and development of BIDV Joint Stock Commercial Bank 39

4.1.2 The formation and development of BIDV Thanh Do Branch 40

4.2 Business performance of BIDV Bank - Thanh Do Branch 41

4.2.1 Capital mobilization 41

4.2.2 Lending 43

4.2.3 Business performance 44

4.3 Credit at BIDV - Thanh Do branch 45

4.3.1 Loans structure of BIDV- Thanh Do branch 45

4.3.2. Credit risk of BID V - Thanh Do branch 48

4.3.3 Credit risk management of BIDV- Thanh Do branch 50

4.3.3.1 Risk management models of BIDV- Thanh Do branch 50

4.3.3.2 Credit risk management policy of BIDV- Thanh Do branch 53

a Credit risk management policy for customers 53

b Credit allocation policy 53

c Jurisdiction 54

d Classifying debt, establishing and using credit loss provision policy 54

e Regulations on reporting and checking credit risk 54

4.3.3.3 Credit Risk Management of BIDV - Thanh Do branch 54

a Identification of credit risk: 54

b Credit risk measurement: 56

c Risk control process: 59

d Risk management operation: 60

4.4 General evaluation of BIDV - Thanh Do branch in risk management 62

4.4.1. Achievements 62

4.4.2. Limits and challenges 63

4.5 Solutions to improve credit risk management at BIDV Bank - Thanh Do branch 65

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4.5.1 Building an effective credit policy 65

4.5.2 Diversify credit portfolio to decrease credit risk 68

4.5.3 Improve the quality of loan appraisal and analysis 68

4.5.4 Reinforcing internal credit supervision and inspection 69

4.5.5 Improve the quality of human resources 70

4.5.6 Use derivatives 72

4.6 Recommendations 72

4.6.1 Recommendations to the SBV 72

4.6.2 Recommendations to Head Office of BIDV 73

CONCLUSION 75

REFERENCES 76

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LIST OF TABLE, DIAGRAM

Table 1: Descriptive Statistics Business Credit risk 8

Table 2: Describe the indicators of financial ability and effectiveness in the operation of enterprises 10

Table 3: Correlation coefficient matrix 11

Table 4: Summary table of the model 12

Table 5: Summary of credit risk ratings by Standard & Poor's 13

Table 6: Conclusion of model results 14

Table 7: Capital mobilization results from 2015 to 2017 41

Table 8: Several targets for credit activities in 2015 - 2017 43

Table 9: Results of business activities in 2015 - 2017 44

Table 10 Loans structure of BIDV - Thanh Do branch in 2015 - 2017 45

Table 11: Overdue and bad debt of BIDV - Thanh Do branch in the period of 2015 to 2017 Fingure 1: Lending model without risk appraisal process 50

Fingure 2: Lending model with risk appraisal process 51

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In this chapter, I present the background of the thesis followed by the problem statement The discussion also contains the motivation for our thesis Finally, we present the literature review, the methodology, the purpose of this thesis and limit the area of the study.

1.1 Background

The world has experienced remarkable numbers of banking and financial crises duringthe last thirty years Caprio and Klingebiel (1997) have identified 112 systemic

banking crises in 93 countries since the late 1970s (Ibid.) Demirguc-Kunt and

Detragiache (1998) have identified 30 major banking crises that are encountered fromearly 1980s and onwards Though most of those were experienced in the developingcountries, the authors have noted that Vietnam has also gone through similar crises inthe late 1980s and early 1990s1 2 Interestingly, the majority of the crises coincided withthe deregulatory measures that led to excessively rapid credit extension In the long run,continuous increases in asset prices created bubble3 At some point, the bubble burst andthe asset markets experienced a dramatic fall in asset prices coupled with disruption.Finally, widespread bankruptcies accompanied by non-performing loans, credit lossesand acute banking crises were observed

Ironically, the frequency of crises did not decrease despite the introduction of successivereforms Why? There are many contributing factors, mainly, political and economicalconditions It can thus be self evident that the improved risk management does notimprove the banking business Moreover, Jean-Charles Rochet (2008) states that keyfactors to successful reform are independence and accountability of banking supervisors

As long as banking supervisors represent political and economical interests of theirrespective countries, it is not possible to implement international regulation successfully.The current global financial crisis indicates that risk management of the financialinstitutions is not adequate enough This leads to the failure of the banks in highlychallenging financial market Furthermore, the discussion of financial crisis in massmedia and among scholars mentions the risk management as omissions or neglect of riskmeasurement signals They state that more attentive participants could avoid thetremendous affect of the financial meltdown4 Therefore, Risk Management as adiscipline is being taking seriously nowadays5 Nevertheless, the financial storm teachesseveral key lessons which can assist to improve the risk management in future As aresult, risk has become a very challenging area of studies This has motivated me toconduct my thesis on this area of interest

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1 INTRODUCTION

1Systemic risk is the risk of collapse of an entire system or entire market and not to any one individual entity or component of that system.

2Steigum (1992) and Vihriala (1997) discusses on the Norwegian and Finnish cases

3Englund P (1999), The Swedish Banking crisis: Roots and Consequences, Oxford review of Economic Policy, Vol 15, no.3, pages 80-97.

4Joe Nocera, “Risk management and financial crisis”, Herald Tribune, January 4, 2009

5A.E Feldman Associates, Inc., US Consulting firm report “On financial crisis and its effect”

http://www.aefeldman.com Accessed February 9,2009

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In the trend of liberalization, economic globalization and internationalization offinancial flows have fundamentally changed the banking system; with the opening of thefinancial market, the appearance of banks with investment capital, modern technology andadvanced management level are major challenges for domestic banks Thus, the businessactivities become more complex and the competitive pressure between the banks is largerand along with it, the level of risk increases Risks are almost present in each bankingoperation A bank wants to make a profit; it must have risky, meaning that it must livetogether with the risks that arise in each of its operations In the context of competition andfinancial market integration and the financial services industry - the banking sector isgrowing; it demands strong reforms to reduce operational risk.

Credit activities bring high income but also the riskiest Over time, the nature ofcredit risk also changes when Vietnamese enterprises are increasingly under pressure fromglobalization and international integration Therefore, the issue of improving credit riskmanagement to improve operational efficiency and competitiveness in the current period is

a serious problem for commercial banks

BIDV Bank is a Joint Stock Commercial Bank with a wide network spreadingthroughout the country and also reaching out to neighboring countries in the region as well

as having representative offices of some countries in the world Thanh Do branch is anaffiliated unit is located at 463 Nguyen Van Linh Street, Phuc Dong Ward, Long BienDistrict, Hanoi The branch has 04 sub-branches Over time, BIDV Thanh Do has madesignificant contributions to the socio-economic development of Hanoi City in general andfor the development of BIDV in particular Apart from the achievements, credit activitiesstill face many difficulties and challenges, the situation of overdue debts and bad debtstend to increase due to the impact of the economic recession storm in the last period; itrequires BIDV Thanh Do to focus and improve risk management, especially credit risk, toensure the safety of the system, contributing to competition capacity building in the newstage

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In addition to the achievements, credit activities still face many difficulties, thesituation of overdue debt and bad debt still exist and tend to increase due to the impact ofeconomic recession in the past The fact that, it requires BIDV Bank - Thanh Do Branchhas to focus on and improve risk management, especially credit risk management to ensuresafety, contributing to improving competitiveness that is an urgent requirement for JSCBs

in the current context However, during the study, the author found there has not beenresearch work on credit risk management at BIDV Bank - Thanh Do Branch in the period2015-2017 and suggested the direction to improve credit risk management quality.Therefore, the author selected the topic “The Credit risk management at BIDV Bank -Thanh Do Branch”

1.3 Research purposes and tasks:

- This research is focused in period 2015-2017

- Research on credit risk management was conducted at BIDV Thanh Dobranch

- The process includes: analyzing the credit risk management situation,assessing the weaknesses of credit risk management and proposingsolutions to improve the credit risk management in BIDV - Thanh Dobranch

1.4 Delimitation

The research is limited on identifying practical activities of credit riskmanagement in Thanh Do Branch and some features of other typical branches in theBIDV system Due to the unavailability of information in annual reports, my sample onlycontains information of BIDV - Thanh Do branch Considering the above mentionedcircumstance, the results of the study are limited to one commercial bank in the sample andare not generalized for the commercial banks in Vietban

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1.5 Disposition

Chapter 1

INTRODUCTION: In this chapter, I present the background of the thesis

followed by the problem statement The discussion also contains the motivation for our thesis Finally, we present the literature review, the methodology, the purpose

of this thesis and limit the area of the study.

Chapter 3

METHODOLOGY: In this chapter, I widely describe the HOW part of our study.

The chapter comprises research approach, sampling, data collection, data anyzing instruments and the description of applied regression model The chapter

is finalized by reliability and validity and limitation of my study.

FRAMEWORK: In this Chapter, I provide theoritical foundation to my study by

presenting relevant literature

E MPRICAL FINDING AND ANALYSIS: In this chapter, I present overview of

BIDV - Thanh Do branch and the results of my regression model, sollutions and recommendation for the bank.

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2 METHODOLOGY:

In this chapter, I widely describe the HOWpart of our study The chapter comprises research

approach, sampling, data collection, data anyzing instruments and the description of applied

regression model The chapter is finalized by reliability and validity and limitation of my study.

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2.1 Research approach

My study is conducted by using Logistic regression model; Data collection, datadescription and results of the test model including: correlation Matrix of variables in themodel, regression results, relevance of the model This is to explain the credit risk of thebusiness through the expected variables into the model

The method of our study is Logistic regression.

Logistic regression is a special regression model where the dependent variable is a binaryvariable that accepts only two values of 0 and 1 This regression model is used to predictthe probability of occurrence of an event based on information of Independent variables inthe model

(1) Probability: The probability that something happens, denoted by P(2) Odds is the ratio between two probabilities: probability of occurrence and probabilitydoes not occur Or more specifically the ratio between success and failure

When we have two dependent variables: Y = 1, Y = 0, and the probability that it happens

is denoted by P (Y = 1) = P Statisticians often use a familiar quantity as Odds

Odd = P/1-P (3.1)Thus, according to the formula, Odds is a function of P Odds> = 0, and Odds will not bedetermined when P = 1

We have: P is the probability of occurrence of the event, then (1 - P) is the probability of

no event occurrence, probability P is measured as follows:

1 - Pi 1 + ezi

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Meaning: When Xk changes a unit, the probability that Y = 1 (also Pi) will change

Pi * (1 - Pi) * βk Probability change according to this interpretation depends on twofactors The first factor is the sign of the coefficient βk If the coefficient is positive,the increase in Xk will increase the probability of Y = 1 and vice versa The secondfactor is the probability change for Y = 1 when the change in Xk is again dependentand the value of Xk means that the probability increase (decrease) Pi when thechange Xk is not fixed but will change corresponds to the value of the variable Xkand this change falls within the domain of the probability condition of 0 ≤ Pi ≤ 1.The relationship between the marginal effect of the variables depends on probabilityincreases from P0 to P1 when change one unit of Xk:

Evaluating the factors that affect the riskiness of the business, the model of assessingbusinesses classified as risk, or not risk is used as the logit model (Binary logistics) Usedfor the case where the dependent variable has only two values, usually these values areencoded as "1" or "0" In which, each value represents a specific value of the dependentvariable The definition of "1" or "0" belongs to any object, the value of the dependentvariable does not affect the results of the model.

The results of the above model building were conducted and concluded after the validation

of the model's usability, the verification of the collinearity between the explanatoryvariables in the model, the evaluation of the level of interpretation of the model At thesame time, research also aims at the feasibility of the model and the most accurateassessment of the research objectives

2.2 Data collection and description

Data collection method: Based on the selected research model, the collected datawas accessed and aggregated from the secondary data source at BIDV head officeand BIDV Thanh Do branch Of which, 253 data of enterprises were collected andprocessed for analyzing, clarifying the objectives of the topic on Credit RiskAnalysis of Vietnamese Enterprises, case study in banking system BIDV Thanh Do

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Cumulative

% Valid Non-risk

On the basis of collected data are enterprises, taking sources from the bank andassessments of banks' ability to repay Credit risk of enterprises in the thesis alsouses the view of credit risk for enterprises in view of the bank According to theabove assessment, credit risk for enterprises classified as enterprises is difficult torepay the bank's interest Serving the ability to assess credit risk, the thesis uses a

set of indicators related to (i) the financial ability of the client and (ii) the

effectiveness of the client's operations This information is described in detail as

follows:

The sample was conducted on 253 enterprises, 176/253 enterprises were ranked atrisk level, accounting for 69.6% of total surveyed enterprises The number ofenterprises classified as risky is 77/253 enterprises, accounting for 30.4%

Table 1: Descriptive Statistics Business Credit risk

At the general average level, enterprises are classified as non-risk indicators havingfinancial ratios at high level compared to enterprises classified as risk indicators Inparticular, the group of indicators of enterprises ranked in the form of no higher riskthan the group of risk indicators are classified as follows:

Group 1: The target of the non-risk group is higher than the group of risk indicators

are 9 indicators including retained earnings / total assets (X1), retained earnings /

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net revenues (X2), working capital / Total Assets (X3), Net profit margin (X4), NetProfit / Equity, Net Revenues / Short-term Debt (X6) and Short-term liquidity ratio(X7)

Group 2: The target of the non-risk group is lower than the risk group is Net sales /

of risky group

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Non-risk Risk Total Diff

N Avera ge

Standarddeviatio

N Avera ge

Standarddeviation

,0 80

1 76

,011 ,124 253 ,027 ,115

5.9 X

2

7

7

,1 58

2,6 56

1 76

-,015 ,258 253 ,037 1,476

-10.1 X

3

7

7

,2 52

,1 97

1 76

,080 ,193 253 ,133 ,210

3.1 X

4

7

7

,0 41

1,5 42

1 76

,008 ,137 253 ,018 ,854

5.2 X

,051 ,451 253 ,058 ,381 _

1.5 X

6

7

7

2,8 57

3,1 85

1 76

2,3 68

1,920 253 2,517 2,381 _

1.2 X

7

7

7

2,3 79

2,1 52

1 76

1,3 05

,859 253 1,632 1,468 _

1.8 X

8

7

7

,7 66

,8 57

1 76

1,1 06

,949 253 1,003 ,933

0.7 X

1 76

Source: Survey and synthesis of the author

2.3 Tested Results of the research model

2.3.1 Correlation Matrix of the variables in the model

Correlation of variables in the model is expressed through correlation matrix (Pearson,Karl, Yule, G., Blanchard, Norman, Lee, Alice, 1903) Observing the pearson correlationmatrix, the relationship between the variables is relatively low The maximum correlationcoefficient of the variables in the model is 0.707 which is the correlation between thevariables X6 and X8 The correlation between the independent variables in the model israther low, the degree of collinearity between the variables in the model is not high Thus,the expected independent variables are introduced into the modeling process

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Table 3: Correlation coefficient matrix

** Correlation is significant at the 0.01 level (2-tailed).

* Correlation is significant at the 0.05 level (2-tailed)

The result of logistic regression model (Binary logistic)

The research model with explanatory variables is that the indicators describing thefinancial viability and efficiency of the model are concretized by the nine independentvariables (X1 to X9) mentioned in the preceding section which are further advanced Thelogistic regression model is designed to study the factors that impact on business risk Theresults of the modeling are specified in the following table:

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Step 1a

X2

-.03 7

.1 23

.0

.7 63

.96 4

.02 6

53

.2 11

.5

.4 69

1.16 5

26

.7 00

.0

.8 58

1.13 4

0

.1 33

7.7

.0 05

.69 1

8

.1 32

.1

.6 59

.94 3

3.90 0

4

.0 87

4.0

.0 45

.84 0

15

3.5 00

5.3

.0 20

3345.835

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Table 4: Summary table of the model

a Variable(S) entered on step 1: X1, X2, X3, X4, X5, X6, X7, X8, X9.

Source: Summary from analytical data

The audited results with explanatory variables affect the model's credit risk show that with

9 expected variables affecting the model The results can be divided into the two groups ofimpact

The Group has less impact on the ability to forecast credit risk of the business include:Retained Earnings / Total Assets (X1), Retained Earnings / Net Revenue (X2), Net Profit /Net Income (X4), Net Profit / Equity (X5) and Short-term Liquidity Ratio (X7)

Variable groups are likely to impact the Company's credit risk including variable capital /total assets (X3), net revenue / current liabilities (X6), turnover Net / Total Assets (X8) andChanges in Total Assets (X9)

Based on the results of the study, the results of the credit risk classification are based onStandard & Poor's According to Standard & Poor's, 60.08% of enterprises surveyed andforecasted according to the results of the high quality model of risk index, meaning that it

is impossible to fall into credit risk, 15.42% enterprises achieves average quality, 15.42%

of enterprises are below average quality and 9.09% of enterprises are in bad condition, theyare likely to default in short time

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5 Ba Medium quality, with speculation factor 7 2.77

15.42

9.09

Table 5: Summary of credit risk ratings by Standard & Poor's

Source: Summary from the results of the analys

2.3.2 Determination of research results

Based on the model results, the conclusions from the model can be summarized in thefollowing table Of these, 9/ 9 variables are expected to be included in the model, 4 out

of 9 variables are able to explain the enterprise risk in the study and 5 out of 9 variables

do not show clear explanations, not significant in explaining the credit risk of theenterprise Specific results are as follows:

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No. Variable

symbol

Input variables model Results from the

1 X1 RE/TA= Retained Earnings / Total Assets Not statistically significant

2 X2 RE/NR= Retained Earnings / Net Revenue Not statistically significant

3 X3 WC/TA= Working capital / Total assets Statistical significance

4 X4 NPM= Net profit margin Not statistically significant

5 X5 ROE=Return on Equity Not statistically significant

6 X6 NR/STD= Net revenue / Short-term debt Statistical significance

7 X7 CR: Short-term liquidity ratio Not statistically significant

8 X8 NR/TA= Net revenue / Total assets Statistical significance

9 X9 (Log(TA): Log(Total assets)) Statistical significance

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Table 6: Conclusion of model results

Source: Summary from the results of the analysis

The results of the study are consistent with trends in relationships according to studies

by Le Tat Thanh (2012) and Altman (2000), Lo Ka Wan (2005), Ciaran Walsh (2006).The relationship between Total Net Sales / Total Assets (X8) still shows the impact, butthe opposite is also true of the actual performance of Vietnamese enterprises bothgeneral and corporate loans in the Sacombank system in particular

The results also show that the retained Earnings / Total Assets (X1), Retained Earnings /Net Revenue (X2), Net Profit / Net Revenue (X4) After-tax profit / owner's equity (X5)and short-term ratio (X7) in terms of Vietnam in general and businesses accessing credit

at BIDV - Thanh Do branch in particular are less affected and create the ability toinfluence the credit risk of the business

The factors that create the greatest risk of enterprise in the context of the study showthat the indicators of the profit factors of enterprises have not clearly reflected the

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Thus, the turnover targets, changes in the assets of enterprises in the direction ofexpanding the size of enterprises in the course of operation of enterprises reflect thestate of trade of enterprises in the process of moving from The goal of improvingprofitability is to increase revenue and maintain business performance in difficulteconomic conditions The above criteria were according to the author is quite consistentwith the current condition of Vietnam economy

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Risks related to credit management, related to the skill of the officers, the author haslisted a lot of shortcomings of banking officers, the human factor is always important ineach agency, the organization and the need to improve the qualifications and quality for thestaff of bankers are concerned by the author From the real situation of commercial banks,the author has made some useful and practical recommendations such as: (i) The bankmust determine the credit development strategy depending on the target market and takeadvantage of their ability, strength, avoid spontaneous (ii) enhancing the capacity ofmanagement and operational staff in the credit sector; (iii) utilizing existing facilities andtechnologies; (iv) make a risk provision in accordance with the nature of the loan, (v) applythe tools to prevent credit risk.

The author outlines the risk factors related to credit in a very authentic and scientific way,shows the causes and determines what the root cause is and makes the suitablerecommendations However, the article also has some limitations because the practice ofcredit development in recent years at commercial banks is a matter that needs to beanalyzed in depth In addition, there are credit risk factors that not all people point to andfind solutions to immediately solve such as cross-ownership situation between commercialbanks and the benefits of these “interest groups”"

(2) Assoc Prof Dr Nguyen Thi Mui (2006), Commercial Banks Management,Finance Publishing House: The author presents a general overview of commercial bankmanagement that spends a lot of time discussing credit management issues and derivativeworks from credit where the author has introduced credit concepts, processes and

The advantages are that the author has helped readers understand the banking managementpractices, management practices and interrelationships of the activities identified in asystem

that gives an overview of banking operations and understands the activities related to creditmanagement and credit risk However, as a scientific work, it still has nature of researchand

theory in order to apply to the practice of banking management, especially themanagement

of our credit risk, it is necessary to cooperate more relevant processes and regulations.(3) Prof Dr Nguyen Van Tien (2002) “Risk Assessment and Prevention inBanking Business”, Statistical Publishing House: In this work, the author has updated thelatest knowledge with advanced content about banking management that are widelyapplied in the world and shows the applicability and implications for commercial banks inVietnam In this book, the author listed the main risks in banking operations - specialbusiness type The author also incorporates typical case studies and exercises for readers tounderstand the theory and can be practiced and applied in real work This is a work that hasmany practical elements and it is close to the processes and regulations of modern andadvanced finance Useful exercises case studies as a “miniature bank” so that theadministrator can measure the risk factors and provide the suitable methods and solutions.However, the works are still inevitably limited and need to be improved in order to bettermatch the business practice of Vietnamese commercial banks

(4) The State Bank of Vietnam (2013), the Regulations on AssetsClassification, the level of deductions, the method of setting up risk provisions and the use

of provisions to deal with risks in the credit organization's operations, foreign bank branch,issued in conjunction with the State Bank of Vietnam's Circular No 02/2013 / TT-NHNNdated January 21, 2013: This is a legal document which includes the procedure for assetclassification and risk provisioning is mandatory, requiring all credit institutions,

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as well as ensuring the safety of the system and will be of great help to commercial banks

in credit risk management as well as financial balance to have appropriate investmentstrategies However, it is a legal document, so it has a lot of administrative elements,commands and to maximize the effect as desired, it also needs to be revised, improved tofit and to be more realistic, avoid factors with nature of coping

(5) Nguyen Anh Tuan (2012) “Credit Risk Management of Bank forAgriculture and Rural Development in Viet Nam” Doctoral dissertation, Hanoi University

of Economics: The dissertation has given basic signs to identification and early warning ofrisk as well as methods of measuring credit risk, the biggest advantage of the project is that

it provides a relatively sufficient qualitative and quantitative criteria to evaluate theeffectiveness for Credit risk management of the Bank for Agriculture and RuralDevelopment of Vietnam, as well as suggestions for other commercial banks

The dissertation has shown many weaknesses and limitations in the credit riskmanagement in Agricultural Bank such as backward risk management model, creditscoring system for credit customers is not suitable, it still has a qualitative factor, it doesnot attach much importance to the quantitative factors, the classification of debts as well asthe provision for risks are still inadequate and inaccessible to existing regulatory advancedprocedures, making bad debts in banks tends to increase and decline in profits

Since then, the author has provided key solutions to improve the credit risk management atbanks and make practical recommendations However, the drawback of this study is thatsuggestiveness, application for credit risk management in general is not high as we alreadyknow that the Bank for Agriculture and Rural Development is a relatively subsidized bankand old-dated in technological modernization as well as the access to and integration withinternational finance and banking is low

(6) Nguyen Duc Tu (2012), “Credit risk management in VietinBank”, PhDdissertation, Hanoi University of Economics: The dissertation proposed new concept ofcredit risk difference with the view of many economists and managers in Vietnam, itemphasizes the possibility of unexpected discrepancies between actual and expectedreturns, full receipt of principal and interest, credit risk will lead to financial losses i.e netreduction in net income and decrease in market value This concept is an importanttheoretical basis for identifying the specific content of credit risk management

Moreover, the dissertation has developed the credit risk management theories applied

to the bank with the content of building credit risk management model in the approach of

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current risk management methods Applying credit risk management models, enhancingthe efficiency and transparency of credit risk management, and recommending banks todevelop new credit policies from post- and loan decision management based on the creditanalysis and review system From theoretical point of view, the author has pointed out themain causes leading to risks and proposed many useful solutions and directions as well assuggestions for the Industrial and Commercial Bank of Vietnam as well as commercialbanks The Bank is also committed to strengthening the Bank's credit risk managementframework and enhancing the Bank's ability to integrate into the international financialsystem

(7) Basel II: Basel II is the second version of the Bassel treaty which lays downthe general principles and banking rules of the Basel Committee on Banking Supervision,Basel II is limited by market risk measurement and basic measurement of credit risk,which introduces a series of complex and risky credit approaches that focus on operationalrisk Basel II uses such concepts as: Minimum capital requirements:

Mentioning the maintenance of a legal capital amount is calculated for the three riskcomponents that banks face: market risk, credit risk and operational risk, with credit riskcomponents; it can be calculated in three different ways of complexity change namely thestandardized approach The standardized approach is the simplest of Basel II credit scoringmethods

Accordingly, to measure credit risk, banks should have the support of external ratingagencies (such as Moodys', S & P, Fitch) and from there, determine the risk factor asrequired In some countries, the central bank's supervisory and supervisory bodies onlyapprove this method during the Basel II application period

By this method, Basel II provides a list of consumer credit assets divided into seven mainasset classes, including: (i) National loans; (ii) loans to banks; (iii) loans to enterprises; (iv)Loans for Retail; (v) Loans secured by housing assets; (vi) Loans secured by commercialreal estate; and (vii) other types of assets The relative weighting of each asset class will beappropriate for each level of risk sensitivity, or in other words, based on the rating of theindependent rating agency

While Basel I set the risk weight for corporate loans at 100%, Basel II places different riskweights according to customer ratings Risk weighting for firms in the rating scale hasdeclined significantly (e.g., 20% for AAA to AA-), while the customer segment is not

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it can be seen to be particularly limited for small and medium enterprises due to thesignificant costs of obtaining an independent rating agency.

At the same time, for enterprises are not ranked in credit, how to handle? This is the reality

of the banking sector, especially in the banking markets of developing countries Due tothe borrowers of these banks are usually small and medium enterprises, the trend is notrated credit

In addition, the author also reviews some of the legal documents relating to bankingcredit and credit risk management such as the Law on Credit Institutions, guiding circulars

of the ministries and departments, industries on banking credit risk management

Credit activity is the main business activity and brings the bank's main profit.However, this is also a very risky business Credit risk accounts a large proportion ofbanking activity Although banking activity has shifted in the structure of profit, creditincome tends to decrease and service income tends to increase, however, the rate of returnfrom credit activity still accounts a large proportion of total bank income Credit risk is one

of the major causes of loss and seriously impacts on the business quality of the bank

It is possible to generalize that the risk is unexpected incident, as they occur, resulted

in loss of bank assets, a reduction in actual profits against the expectation or an additionalexpense to accomplish a certain financial business

If credit is regarded as "trusting", then giving the customer a present value with theexpectation of receiving a greater value in the future, the credit risk is the ability that thatdesire is not met, or in other words, the likelihood of the unwanted occurrence betweenactual results and expectations

At present, credit risk has been researched by a lot of scientists and put forward anumber of different views:

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- The Banking Supervisory Board defines credit risk as "the likelihood that aborrower or counterparty of a bank will fail to perform its obligations under the terms ofthe agreement."

Under Clause 1, Article 3 of the State Bank Governor's Circular No 02/2013 / NHNN of January 21, 2013 about prescribing assets, deduction levels and methods ofsetting up risk provisions and the use of provision to deal with risks in the operation ofcredit institutions and foreign bank branches: “Credit risk in banking activities of a creditinstitution is the potential loss of a financial institution or branch of a foreign bank becausecustomers cannot perform or are unable to perform part or all of their committedobligations

TT-3.1.2 credit risk management Indicators

3.1.2.1 Credit size

Credit size is not a direct indicator of credit risk, however, if the scale of creditgrowth has bloomed, does not correspond to the control of the bank then the scale of creditwill reflect credit risk, expressed in these aspects:

- If the scale of credit is too large, beyond the management capacity of the bank, this

is reflected by the increase in the ratio: outstanding loans to total assets, outstanding loans

to total loans of banks then the level of risk increases

- If the bank extends the credit line towards loosening credit for each customer:lending in excess of customer demand, lending in excess of the allowable asset, it will lead

to the result that customers use the capital for the wrong purpose, cannot control thepurpose of using the loan this will put the bank in risk

3.1.2.2 Loan porfolio structure

This factor, like the credit size, does not directly reflect the level of risk, whichreflects the degree of credit concentration in a sector, field, time If the credit structure istoo biased in the risk areas, it will reflect the potential credit risk Credit structure can bedivided into groups as follows:

Loan structure by sector: If we focus on high risk industries, the risk of not payingbank debt is high When the credit structure focuses too much on one sector, the level ofrisk will be high when that sector is degraded or affected by another sector

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Loan structure by asset-backed: The percentage of loans with collateral is low, thebank faces a potential risk when the customer defaults.

3.1.2.3 Overdue debt

Overdue debt is the basic indicator reflecting credit risk Overdue debt is the result ofpoor credit relationships, which violate the basic characteristic of credit that is timelinessand full repayment When making a credit, the factor that should always be taken intoaccount is: repayment period and amount of value to be repaid Overdue loans will accrue,the borrower is unable to repay in full or in part the principal and / or interest to the lender

on the repayment term

Overdue debts can be determined at any time through the system of books and creditrecords at the bank

Overdue debts are reflected in the following two criteria:

Overdue debtOverdue debt ratio = - x 100%

Total loansThe ratio of overdue

Number of overdue debt customersdebts customers to total = -x 100%

Total number of outstanding loans customersoutstanding loan

When the bank has large overdue loans and the big number of customers withoverdue debts, the bank has a high level of risk and vice versa

3.1.2.4 Non-performing loansNon-performing loans is amount of money lent to the borrower and cannot berecovered due to loss or bankruptcy of enterprises, increased liabilities, enterprises losingtheir solvency Debt lasts longer than a year and is difficult to resolve

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- According to the International Monetary Fund (IMF)

The definition given by the IMF is as follows:

"A loan is considered to be unprofitable (Non-performing loans) when interestpayments and / or principal is overdue for at least 90 days, or interest payments of up to 90days or more have been restructured or renewals, or payments of less than 90 days butthere are grounds to suspect the full repayment "

Basically, Non-performing loans, according to IMF, is defined based on two factors:(i) overdue more than 90 days; or (ii) suspected repayment capacity With this view, baddebt is approached based on overdue debt repayment time and customer repaymentcapacity Debt repayment capability can be either completely unpaid, or inadequaterepayment

- According to the State Bank of Vietnam (SBV)

According to Decision No 493/2005 / QD-NHNN of the Governor of the State Bank

of Vietnam dated 22 April 2005 on loan classification, provisioning and use of provisions

to deal with credit risk in banking activities of credit institutions and the Circular No.02/2013 / TT-NHNN on the classification of assets, the level of deduction, the method ofdeduction for risk provisions and the use of provisions to deal with risks in the operation ofcredit organizations, foreign bank branches, replacing Decision No 493/2005 / QD-NHNN, Non-performing loans are defined as follows:

Non-performing loan is in group 3 (substandard debt), group 4 (doubtful), group 5(bad debt)

3.1.2.5 Credit risk provisionThe risk provision assesses the bank's ability to compensate for loss in its creditactivity when the risk arises When the bank has to use a reserve fund, it means that thebank is facing a risk of losing capital, so the risk provision is an indicator reflecting the risk

of losing capital The provision for risk under Circular 02/2013 / TT-NHNN dated 21January 2013 is defined as follows:

"Risk provision is the amount of money to be set up and accounted into operatingexpenses to cover the possible losses for debt incurred by credit institutions and foreignbank branches Provision for risk includes specific provisions and general provisions

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= Total loans

This ratio reflects the ability to offset the risk from credit activities A lower rateindicates better credit quality

Ratio of Provision

covering the risk = -x 100%

Losing capital debt

Risks are the uncertainties that can make the banks to loose and be bankrupt According to

the Basel Accords, risks the banks facing contain credit risk, market risk and operational

risk Credit risk is the risk of loss due to an obligator's non-payment of an obligation in terms of a loan or other lines of credit The Basel committee proposes two

methodologies for calculating the capital requirements for credit risk, one is to measurethe credit risk in a standardized manner and the other is subject to the explicit approval of

the bank’s supervisor and allows banks to use the IRB approach Market risk is defined

as the risk of losses in on and off-balance sheet positions arising from movements in market prices The capital treatment for market risk addresses the interest rate risk and

equity risk pertaining to financial instruments, and the foreign exchange risk in the

6 Basel II (2006) International Convergence of Capital Measurement and Capital Standards, A Revised Framework Comprehensive Version.

7 Basel II (2006) International Convergence of Capital Measurement and Capital Standards, A Revised Framework Comprehensive Version.

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trading and banking books The value at risk (VaR) approach is the most preferred to be

used when the market risk is measured Operational risk is defined as the risk of direct or

indirect loss resulting from inadequate or failed internal processes, people and systems or from external events There are three approaches applied to the operational risk

measurement: Basic Indicator Approach (BIA), Standardized Approach (SA), andAdvanced Measurement Approach (AMA)

3.2.2 Credit risk management in banks

Bank loan is a debt, which entails the redistribution of the financial assets between thelender and the borrower The bank loan is commonly referred to the borrower who got anamount of money from the lender, and need to pay back, known as the principal Inaddition, the banks normally charge a fee from the borrower, which is the interest on thedebt The risk associated with loans is credit risk

Credit risk is perhaps the most significant of all risks in terms of size of potentiallosses Credit risk can be divided into three risks: default risk, exposure risk and recoveryrisk As the extension of credit has always been at the core of banking operation, thefocus of banks’ risk management has been credit risk management It applied both to thebank loan and investment portfolio Credit risk management incorporates decision makingprocess; before the credit decision is made, follow up of credit commitments includingall monitoring and reporting process8 9 The credit decision is based on the financial dataand judgmental assessment of the market outlook, borrower, management andshareholders The follow-up is carried out through periodic reporting reviews of the bankcommitments by customer Additionally, “warning systems” signal the deterioration ofthe condition of the borrower before default, whenever possible

3.2.3 Credit risk classification

Depending on purpose, research requirements, we have different ways of classifyingcredit risk Depending on the classification criteria, credit risk is divided into differentcategories

- Based on the risk reason, credit risk can be divided into two groups:

+ Ethical risk is the risk caused by inadequate information after the transaction.+ Risks of opposite choice are due to inadequate information created before thetransaction

- Based on the level of loss, credit risk can be divided into two groups:

+ The risk of capital accumulation is the risk that occurs in the case when the bankhas not recovered the loan, resulted in funds frozen, less liquid and affected the bank

8Basel I http://www.bnm.gov.my/guidelines/01_banking/01_capital_adequacy/02_basel1 pdf accessed 2009-03-14

9Joel Bessis (1998) Risk Management in Banking

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+ The risk of losing money is a risk when the borrowers are unable to repay theirdebts under the contract, including principal and / or interest, at that time they can recovertheir loans only because of customer’s asset liquidation

- Based on the users, risk can be divided into three main groups:

+ Individual customer risk: Credit risk occurs in individual clients

+ Risks of companies / economic organization, financial institutions: Credit riskoccurs in customers that are companies, economic organizations, financial institutions.+ National or geographic risk: Credit risk occurs in each country for debt and aidoperations

- Based on the overall nature of the risk: risk can be divided into Transaction and

portfolio risk

+ Transaction risk is the risk that is caused by the limitations in the transactionprocess, loan approval, customer rating, including the risk of selection, security risk andoperational risk

+ Portfolio risk is the risk that the cause is due to restrictions on the bank's portfoliomanagement, divided into internal and centralized risks

- Based on risk period, risk can be divided into three groups:

+ Risk before loan: occurs when the bank misjudges the customer, resulted the loan

to customers who are not eligible to ensure the ability to repay in the future

+ Risks during the loan: occurring in the credit granting process, can be attributedfrom a number of reasons as follows: disbursement in wrong progress, not updatinginformation regularly to customer, unpredictable hidden money risk

+ Risks after the loan: occur when credit officers do not grasp the situation of usingloans, the future financial ability of customers

- Based on the range of risk: Credit risk can be divided into two groups:

+ Individual credit risk is the risk that occurs for only a loan or a portfolio of banks.Causes can be attributed to a number of reasons as follows: characteristics of business type

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3.2.4 Loan porfolio structure

This factor, like the credit size, does not directly reflect the level of risk, whichreflects the degree of credit concentration in a sector, field, time If the credit structure istoo biased in the risk areas, it will reflect the potential credit risk Credit structure can bedivided into groups as follows:

Loan structure by sector: If we focus on high risk industries, the risk of not payingbank debt is high When the credit structure focuses too much on one sector, the level ofrisk will be high when that sector is degraded or affected by another sector

Loan structure by loan term: This factor is based on the bank's capital structure If thebank has a large short-term capital structure, low long-term capital while the long-termcredit structure is large, this means that the bank has used too much short-term capital formedium and long term loans, then the bank may face liquidity risk When the bank focusestoo much on medium and long-term credit, the risk level will be higher

Loan structure by asset-backed: The percentage of loans with collateral is low, thebank faces a potential risk when the customer defaults

3.2.5 Overdue debt

Overdue debt is the basic indicator reflecting credit risk Overdue debt is the result ofpoor credit relationships, which violate the basic characteristic of credit that is timelinessand full repayment When making a credit, the factor that should always be taken intoaccount is: repayment period and amount of value to be repaid Overdue loans will accrue,the borrower is unable to repay in full or in part the principal and / or interest to the lender

on the repayment term

Overdue debts can be determined at any time through the system of books and creditrecords at the bank

Overdue debts are reflected in the following two criteria:

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Total loansThe ratio of overdue

Number of overdue debt customersdebts customers to total = - x 100%

Total number of outstanding loans customersoutstanding loan

When the bank has large overdue loans and the big number of customers withoverdue debts, the bank has a high level of risk and vice versa

3.2.6 Non-performing loans

Non-performing loans is amount of money lent to the borrower and cannot berecovered due to loss or bankruptcy of enterprises, increased liabilities, enterprises losingtheir solvency Debt lasts longer than a year and is difficult to resolve

- According to the International Monetary Fund (IMF)

The definition given by the IMF is as follows:

"A loan is considered to be unprofitable (Non-performing loans) when interestpayments and / or principal is overdue for at least 90 days, or interest payments of up to 90days or more have been restructured or renewals, or payments of less than 90 days butthere are grounds to suspect the full repayment "

Basically, Non-performing loans, according to IMF, is defined based on two factors:(i) overdue more than 90 days; or (ii) suspected repayment capacity With this view, baddebt is approached based on overdue debt repayment time and customer repaymentcapacity Debt repayment capability can be either completely unpaid, or inadequaterepayment

- According to the State Bank of Vietnam (SBV)

According to Decision No 493/2005 / QD-NHNN of the Governor of the State Bank

of Vietnam dated 22 April 2005 on loan classification, provisioning and use of provisions

to deal with credit risk in banking activities of credit institutions and the Circular No.02/2013 / TT-NHNN on the classification of assets, the level of deduction, the method ofdeduction for risk provisions and the use of provisions to deal with risks in the operation of

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3.3 Credit risk provision

The risk provision assesses the bank's ability to compensate for loss in its creditactivity when the risk arises When the bank has to use a reserve fund, it means that thebank is facing a risk of losing capital, so the risk provision is an indicator reflecting the risk

of losing capital The provision for risk under Circular 02/2013 / TT-NHNN dated 21January 2013 is defined as follows:

"Risk provision is the amount of money to be set up and accounted into operatingexpenses to cover the possible losses for debt incurred by credit institutions and foreignbank branches Provision for risk includes specific provisions and general provisions.Specific provision is the amount of money that is set up to reserve for incident lossesspecific debt

General provision is the amount of money that is set up to reserve for incident butundefined

Losing capital debt

This ratio indicates the percentage that risk reserve fund can offset for performing loan when they moved to losing capital debt (Group 5)

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+ Develop an appropriate credit environment

The Basel Committee requires the Board of Directors to approve and periodicallyreview (at least once a year) credit risk strategies and credit risk policies This strategyshould include the level of risk tolerance and the likely response to any type of credit risk.Basing on this basis, the Board of Directors is responsible for implementing the credit riskmanagement strategy and developing policies and procedures to detect, measure, monitorand control credit risk in every activity, at the level of credit and also the portfolio Banksshould identify and manage credit risk in all their products and activities

+ Carry out a healthy credit

Banks should clearly define healthy credit criteria (target markets, customers, terms,credit terms ) Banks should develop credit limits for each type of customer and relatedgroup of borrowers in order to cover different types of credit risk but can be compared andmonitored on an internal credit rating for customers in different sectors The bank shouldhave a clear credit approval process with the involvement of marketing departments, creditanalysts and credit approval departments, as well as the clear responsibilities of theparticipants At the same time, it is necessary to develop an experienced andknowledgeable credit risk management staff in order to make prudent assessments in creditrisk assessment, approval and management

+ Maintain an effective management, measurement and monitoring process

The Bank should have an effective credit portfolio management system, themonitoring system for the conditions that related to each credit, including determining theappropriate size of reserves, constructing and using the internal risk rating system in creditrisk management The rating system should be appropriate to the nature, scale andcomplexity of banking operations

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+ Ensure adequate control with credit risk

The Bank should establish an independent and continuous review system for theBank's credit risk management process and these results should be reported to the Board ofDirectors and senior management

The credit process must be strictly managed, and the level of lending must be withinsafe and acceptable limits Internal controls should report timely to management at alllevels except in policies, procedures and limits

Banks should have early warning systems for deteriorated credit, problematic creditmanagement, and similar situations

3.5 Credit risk measurement

Risk measurement is the next step after risk identification Currently, many banksaround the world have used many recent and advanced methods and models to measure therisks

a Qualitative model of credit risk management

Qualitative model of credit risk is a model of traditional borrower-based assessment

of banks According to this model, banks mainly use different information about borrowersusing the 5C method or the 6C model to make their own comments

+ Cash flow: determine borrower’s source of repayment

+ Collateral: A second source of income that can be used to repay a loan to a bank

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+ Control: Assess the effects of changes in laws, regulations, the ability of customers

to meet the standards of the bank

The use of this model is relatively simple, but its limitation is dependent on the level

of accuracy of the information source, the ability of forecast as well as the level of creditofficers’ analysis and evaluation

b Quantitative model of credit risk management

□ Z score model

This model was developed by E.I Altman to give credit scores to US companies Z

is an aggregate measure to classify borrowers’ credit risk and depends on: (i) Borrower'sfinancial indicators - X; (ii) the importance of these indices in borrower default probability

in the past, the model is described as follows:

Z = 1,2 X 1 + 1,4 X 2 + 3,3 X 3 + 0,6 X 4 + 1,0 X 5

Where:

X1 = Net working capital of total assets

X2 = retained earnings of total assets

X3 = Profit before tax, interest on total assets

X4 = stock value to long-term book value

X5 = revenue to total assets

The higher the Z-score, the lower customer’s probability of default and vice versa(the Z-value may be negative) Thus, when the Z value is low or a negative number it will

be the basis for placing customers into high risk groups

Z <1.8: High risk customers

1.8 <Z <3: Unspecified

Z> 3: Customers cannot repay

Any company with a score of <1.81 should be classified as a high risk group

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