Foreign exchange risk management of vietnam bank for agriculture and rural development (agribank)

ABSTRACT Thesis Title: Foreign exchange risk management of Vietnam Bank for Agriculture and Rural Development Agribank Pages: 55 University: Vietnam National University - Hanoi Graduat

VIETNAM NATIONAL UNIVERSITY, HANOI

INTERNATIONAL SCHOOL

NGUYEN THI QUYNH AN

FOREIGN EXCHANGE RISK MANAGEMENT OF VIETNAM BANK FOR AGRICULTURE AND RURAL

DEVELOPMENT (AGRIBANK)

MASTER THESIS

HA NOI,2021

ABSTRACT

Thesis Title: Foreign exchange risk management of Vietnam Bank for Agriculture and Rural Development (Agribank)

Pages: 55

University: Vietnam National University - Hanoi

Graduate School: International School

Date: January.2021 Degree: Master

Graduate Student: Nguyen Thi Quynh An Supervisor: Dr.Mai Anh

Keywords: Bank, Exchange Rate Risk Management, Foreign Currency, Policy, Trading

The demand for foreign currencies of corporate customers as well as the development of foreign currency business operations of commercial banks in the integration process is huge Consequently, Vietnamese banks in general as well as Vietnam Bank for Agriculture and Rural Development (Agribank) in particular must have the right direction in the current development trend to achieve high efficiency in business activities The general objective of the study is to assess the current situation of exchange rate risk management at Agribank, thereby proposing directions and solutions to enhance exchange rate risk management at the bank in the near future With the suitable methods and continuous efforts in exchange risk management at Agribank, a number of certain achievements have been obtained Profits from foreign exchange trading activities have continuously met the set targets, increased and stabilized over recent years Agribank does not face heavy losses due to exposure to risks in general and exchange rate risks in particular The bank’s foreign exchange trading operations also contribute to meeting customers’ diverse foreign currency payment needs, thereby promoting the bank’s other business activities such as national payment, foreign currency loans, guarantee, etc

to attract more customers, limit risks and increase profits for the bank As a reputable bank with strong brand name in the banking industry in Vietnam, Agribank has obtained remarkable achievements However, there are still some shortcomings, such as the bank’s management system has not been clearly defined, there is no specific regulation on the coordination between front office and back office departments, there is no department to perform the function of analyzing and managing risks in foreign exchange trading The bank also lacks a system of managing transaction limits and management limits for customers, banking employees, and controllers, so the risks in foreign exchange trading are very high Based on those shortcoming, the author also gives some recommendations to improve exchange rate risk management at Agribank With the solutions given by the research to contribute to further completing and improving the efficiency of foreign exchange trading risk management at Agribank, the author hopes that in the coming years, Agribank will have significant changes in foreign exchange trading activities as well as risk management of these foreign exchange trading activities to contribute to bringing practical benefits to the system and a small part to the growth rate of the whole system of Agribank

ACKNOWLEDGEMENT

I would like to express my deep gratitude to my teacher, Dr Mai Duc Anh, who enthusiastically guided and helped me throughout the process of studying, researching and completing this research I would like to thank the teachers and lecturers at Vietnam National University - Hanoi, International School for their valuable comments to help me in the process of researching and completing the research I would like to express my sincere thanks to the leaders and officers working at Agribank for facilitating me to complete this research

I hereby declare that this research is my own research work, not yet published anywhere All data used in this research are authentic information, subject to school regulations and academic integrity regulations Word count of the research is 13,968

words I accept all responsibilities for my declaration

TABLE OF CONTENTS

ABSTRACT i

ACKNOWLEDGEMENT Error! Bookmark not defined TABLE OF CONTENTS v

LIST OF TABLES viii

SYMBOL MEANING ix

LIST OF ABBREVIATIONS x

CHAPTER 1: INTRODUCTION 1

1.1 Rationale of the study 1

1.2 Subject and scope of the study 2

1.2.1 Subject of the study 2

1.2.2 Scope of the study 2

1.3 Objectives of the study 2

1.3.1 General objective 2

1.3.2 Specific objectives 2

1.4 Significant contributions of the thesis 2

1.4.1 Theoretical contributions 2

1.4.2 Practical contributions 3

1.4.3 New contributions of the thesis 3

1.5 The structure of the thesis 3

CHAPTER 2: THEORETICAL FRAMEWORK OF EXCHANGE RATE RISK MANAGEMENT IN THE BANKS 4

2.1 Foreign exchange trading by commercial banks 4

2.1.1 Concept of foreign exchange trading 4

2.1.2 Role of foreign exchange trading for commercial banks 4

2.1.3 Risk classification in foreign exchange trading 5

2.2 Overview of exchange rate risks of commercial banks 8

2.2.1 Concepts of exchange rate risk 8

2.2.2 Classification of exchange rate risks by commercial banks 9

2.2.3 Factors affecting exchange rate risks of commercial banks 9

2.3 Exchange rate risk management of commercial banks 9

2.3.1 Concepts of exchange rate risk management 9

2.3.2 Role of exchange rate risk management for commercial banks 9

2.3.3 Content of exchange rate risk management 10

2.3.4 Exchange rate management tools 11

2.4 Factors affecting exchange rate risk management of commercial banks 13

2.4.1 Objective factors 13

2.4.2 Subjective factors 15

CHAPTER 3: RESEARCH METHODOLOGY 18

3.1 Data collection 18

3.1.1 Secondary data 18

3.1.2 Primary data collection 19

3.2 Data processing 20

CHAPTER 4: RESULTS AND DISCUSSION 21

4.1 Current situation of exchange rate risk management of Agribank in the period of 2017 - 2019 21

4.1.1 Process of exchange rate risk management 21

4.1.2 Details of exchange rate risk management 23

4.2 Factors affecting exchange rate risk management of Agribank 29

4.2.1 Objective factors 29

4.2.2 Subjective factors 30

4.3 Assessment of exchange rate risk management for the period of 2017 - 2019 of Agribank 33

4.3.1 Achievements 33

4.3.2 Shortcomings and causes 35

CHAPTER 5: CONCLUSION AND RECOMMENDATIONS 41

5.1 Conclusion 41

5.2 Recommendations to improve exchange rate risk management of Agribank 42

5.2.1 Completing the system of departments in charge of exchange risk management 42

5.2.2 Strengthening the work of building and implementing a correct and effective customer policy 43

5.2.3 Improving professional qualifications of foreign exchange trading officials 44

5.2.4 Developing the information technology system to modernize the banking and information network 45

5.2.5 Enhancing banking operations related to foreign exchange trading 46

REFERENCE LIST 50

APPENDIX 1: SURVEYS FOR BANKING EMPLOYEES 53

APPENDIX 2: SURVEYS FOR CUSTOMERS 55

LIST OF TABLES

Table 3.1 Sources of secondary data collection 18

Table 4.1 Agribank’s foreign exchange status for the period of 2017 - 2019 24

Table 4.2 Credit risk classification by grade and rating of Agribank 25

Table 4.3 Sales of spot trading foreign currencies in the period of 2017 - 2019 26

Table 4.4 Revenue from forward transactions in 2017 - 2019 27

Table 4.5 Rate of risk provisioning 29

Table 4.6 Evaluation of the impact level of environmental factors 30

Table 4.7 Evaluation of the impact level of foreign exchange policy of the bank 30

Table 4.8 Evaluation of the impact level of banking organization 31

Table 4.9 Evaluation of the impact level of employee quality 32

SYMBOL MEANING

LIST OF ABBREVIATIONS

Agribank : Vietnam Bank for Agriculture and Rural Development EUR : Euro Dollar

GBP : Great Britain Pound

JPY : Japanese Yen

L/C : Letter of Credit

USD : United States Dollar

VaR : Value at Risk

VND : Vietnam Dong

CHAPTER 1: INTRODUCTION

1.1 Rationale of the study

In the current economy, one of the main causes of economic crises is the weakness of the banking system The close relationship between banks - customers

- the economy, requires banks to be proactive in every situation; to forecast and predict the probability of occurrence, quantify risks, thereby taking prevention measures to minimize the impact of risks In addition to traditional business activities, banks are increasingly developing new business activities, including foreign exchange trading For banks, this banking operation serves a variety of purposes (Tran, 2015) On the one hand, it helps meets foreign currency demand for import and export payment, on the other hand, this is also an independent business operation that brings a significant profit for the bank It has the function of providing foreign currencies in international trade transactions and also providing exchange rate hedging tools for export earnings, import payments, investments or loans in foreign currency Therefore, the demand for foreign currencies of corporate customers as well as the development of foreign currency business operations of commercial banks in the integration process is huge However, this is a risky banking operation and the level of its risks is very high because it is influenced by many factors such as economic development, exchange rates, interest rates, etc (Nga et al 2013) Consequently, Vietnamese banks in general as well as Vietnam Bank for Agriculture and Rural Development (Agribank) in particular must have the right direction in the current development trend to achieve high efficiency in business activities

Therefore, the author has chosen the topic: “Foreign exchange risk

management of Vietnam Bank for Agriculture and Rural Development (Agribank)” to make a small contribution to solving the above issues

1.2 Subject and scope of the study

1.2.1 Subject of the study

The subject of the study is exchange rate risk and exchange rate risk management by Agribank

1.2.2 Scope of the study

Research content: The study focuses on exchange rate risk management

activities of Agribank, thereby finding the causes and solutions to improve exchange rate risk management at the bank

Regarding time: Research data were collected in the period of 2017 - 2019 Regarding space: The research was conducted at Agribank - Headquarter at 2

Lang Ha, Thanh Cong, Hanoi

1.3 Objectives of the study

1.3.1 General objective

The general objective of the study is to assess the current situation of exchange rate risk management at Agribank, thereby proposing directions and solutions to enhance exchange rate risk management at the bank in the near future

1.4.2 Practical contributions

- Analyze and assess the current situation of exchange rate risk management of Agribank in the period of 2017 - 2019 to find out the limitations that need to be overcome

- Propose a number of suitable solutions to perfect exchange rate risk management at Agribank

1.4.3 New contributions of the thesis

The thesis on “Foreign exchange risk management of Vietnam Bank for

Agriculture and Rural Development (Agribank)” has shown the current situation

of exchange rate risk management of Agribank in recent years, the shortcomings and limitations in the bank’s exchange rate risk management, from which many solutions have been proposed to improve exchange rate risk management at the bank, thereby contributing to developing business activities, improving both quality and quantity in the foreign exchange trading activities of Agribank in particular and the banking system in general

1.5 The structure of the thesis

In addition to introduction, conclusion, tables, figures, reference list, etc., the study has five chapters as follows:

Chapter 1: Introduction

Chapter 2: Theoretical Framework of Exchange Rate Risk Management in the Banks

Chapter 3: Research Methodology

Chapter 4: Results and Discussion

Chapter 5: Conclusion and Recommendations

CHAPTER 2: THEORETICAL FRAMEWORK OF EXCHANGE RATE RISK MANAGEMENT IN THE

BANKS

2.1 Foreign exchange trading by commercial banks

2.1.1 Concept of foreign exchange trading

According to Tin (2013), foreign exchange trading in a broad sense includes buying, selling, borrowing and lending foreign currencies to ensure the balance of foreign currency demand for the bank and seek to profit through exchange rate and interest rate differences between different currencies In a narrow sense, foreign exchange trading is merely the foreign exchange trading activities of commercial banks when banks participate in the domestic and foreign markets in order to ensure the foreign currency demand of customers and earn some profit for the bank

2.1.2 Role of foreign exchange trading for commercial banks

Foreign exchange trading helps commercial banks improve their competitiveness in the banking system, as well as their competitiveness In any business industry in the market, a business that wants to survive and thrive must have products with differentiation and quality, and banks are not an exception In the current context, the banking industry is increasing in both quantity and quality due to the process of liberalization, globalization and strong integration into the financial and monetary market In order to survive and compete strongly, banks not only provide the products they currently have, but also have to know how to grasp the needs of corporate customers to offer the products that they wants (Tin, 2013) This not only increases the competitiveness of banks, but also increases the value and diversification of their products to attract more customers to them Thus, foreign exchange trading has a great influence on other banking operations such as international payment, guarantee, foreign currency loans, L/C, etc., contributing to diversifying business activities of commercial banks

Foreign exchange trading activities contribute to enhancing the position of commercial banks in the international market through foreign exchange trading with foreign banks, other financial and non-financial institutions In addition, this activity also brings a significant amount of profits to commercial banks, especially banks whose foreign exchange trading activities develop when commercial transactions involve the purchase and sale of foreign currencies (often with high risk level) while the measures of hedging for exchange rate risks for import-export corporate customers and investors are not absolutely safe Through derivative products and transactions in foreign exchange trading activities, banks seek profits through interest rate difference trading channels and exchange rate speculation in the foreign exchange market In fact, banks hope to make a profit by taking the risk of buying a currency today and reselling it at a later time in the future to trade for differences If the bank is a speculator that takes advantage of financial leverage and predicts the future market trend, it will get a huge profit, but if the prediction is wrong, the level

of risk that the bank must bear is extremely serious With increasingly diversified products in foreign exchange trading activities, banks can use them as a method of capital generation to help quickly meet the shortage of foreign currency capital needs (Trinh, 2013)

2.1.3 Risk classification in foreign exchange trading

Foreign exchange trading is increasingly playing an important role in the business activities of commercial banks This is a business activity that brings a significant source of income for the bank The measurement and calculation to come up with solutions to minimize risks in the banks’ business operations is very important Foreign exchange trading contains many risks as follows

a Exchange rate risk

Exchange rate is the price of one currency expressed in terms of another Exchange rate risk is the risk that occurs due to exchange rate fluctuations leading

to a loss in a transaction In other words, exchange rate risk is the uncertainty of the value of an income or payment caused by a fluctuation in exchange rates, which can

damage the expected value of a contract There are two main activities that give rise

to exchange rate risk for a commercial bank, including on-balance-sheet activities through borrowing and investing in foreign currencies, off-balance-sheet activities through foreign exchange trading for customers and for the bank itself (Köhler, 2015) In the globalized financial - monetary - banking environment today, bank managers are increasingly facing exchange rate risks They make derivative transactions rapidly develop, become diversified and complexly used in trading and

to hedge exchange rate risks

b Operational risks

Risks arising from the bank’s foreign exchange trading activities are the possibilities of loss caused by non-financial factors Operational risks include human risk, operational risks and organizational risks

c Counterparty risks

According to Berger et al (2010), counterparty risks occur when a counterpart bank or customer does not have the ability to transact or does not want to fulfill the financial obligations as committed in foreign exchange trading contracts and the time of rising those commitments In this case, real risks for the bank include costs

of canceling the contract with the current partner To limit those risks, it is necessary to have warnings assessing the reliability of the partners, their operations

as well as their reputation, thereby building a suitable limit for each partner, corresponding to each type of transaction In case they are not reputable enough and

do not have financial capacity to fulfill the committed obligations, there must be a preventive measure to limit risks such as requiring customers to deposit, make deposit, and apply standard reserving regulations under which partners maintains deposit accounts in banks’ account systems, etc

d Liquidity risks

Liquidity risks are the inability of a bank to fail to meet its financial obligations immediately or to raise additional capital at high costs or to sell assets at low prices Liquidity risks occur causing the bank to stall operations, face losses, and lose

credibility, and if serious, it can lead to bankruptcy In such a case, the bank is forced to make loans to supplement the payment capital, or sell its assets to fulfill financial obligations such as the depositors’ need to withdraw money, etc In the context of increased costs for additional capital mobilization, banks were forced to sell off immediately, even the hard-to-transfer assets at low prices because there was not enough time to find buyers or to negotiate (Vu, 2012) Due to the urgent sale of assets at low prices, banking solvency is threatened In the case liquidity risks ae more serious, bank will definitely have to face up with bankruptcy

e Political risks

Political risks occur when a trading partner abroad cannot fulfill the obligations committed to in the contract of purchase and sale of foreign currencies at the time incurring obligations commitments The cause may be war or riot, causing unexpected changes in financial market conditions, stock market crashes, external risks, or macroeconomic factors such as rising inflations, fluctuations in commodity prices, unemployment, which all affect the volatility of interest rates, exchange rates, and liquidity (Tran et al., 2019)

In general, in foreign exchange trading, banks always face up with many types

of risks, but the most serious risk that brings the most loss to the bank is exchange rate risk The banking industry’s history has seen many major losses or even led to serious collapses due to exchange rate risks in treasury departments’ operations The fact that the bank does not have effective risk management measures suitable to the development of foreign exchange trading will lead to huge potential risks of exchange rate This means that with the unsuitable level and method of risk management for foreign exchange trading, the bank can still operate normally and profitably under favorable conditions Only when the exchange rate fluctuates, then potential risks are realized by unexpected huge losses Therefore, the management

of exchange rate risks is very important in order to help banks prepare for adverse changes in exchange rates in foreign exchange trading activities, to avoid unexpected damages and losses in foreign exchange trading for banks when the

exchange rate fluctuates unexpectedly, and ensures high profitability for banks with the lowest level of risk, reducing sensitivity to changes in the exchange rate environment, enhancing competitive advantages for banks

2.2 Overview of exchange rate risks of commercial banks

A commercial bank is characterized by a financial intermediary, so its basic and thorough operation is to transfer capital (domestic currency, foreign currency) from people with surplus capital to under-capitalized people, creating efficiency in using higher capital, increasing socio-economic efficiency The Bank uses its professional skills to establish a portfolio of services to the society such as: mobilization, lending, domestic guarantee, international guarantee, domestic payment, international payment , consulting In addition, banks must also maximize profits by diversifying investment portfolios: investing in bonds, stocks, foreign currencies

It can be said that banking activities face many the most risky In addition to the normal risks faced by other activities such as interest rate risk, credit risk, liquidity risk, technical risk, operational risk, legal risk, reputation risk, and strategic risk… the banking operations also incur an additional special risk, which is the exchange rate risk Due to frequent fluctuations of exchange rates, exchange rate risk is considered a permanent risk associated with banking operations

2.2.1 Concepts of exchange rate risk

Risk is the possibility of an instability or uncertainty that can predict the probability Exchange rate risk is the type of risk that is caused by exchange rate fluctuations affecting the expected value in the future Exchange rate risk may arise

in many different activities of the bank as well as of customers (Lepetit et al., 2008) However, not whenever the exchange rate fluctuates, commercial banks will face exchange rate risk The volatility of the exchange rate is only a necessary condition to expose the bank to exchange rate risk because if the commercial bank's business only involves domestic currency and takes place domestically, the exchange rate risk is now zero In fact, commercial banks do business in the monetary sector including domestic and foreign currencies, so the next section will

study the eligibility or the main reasons for a bank Commercial goods are exposed

to exchange rate risk when conducting business transactions

2.2.2 Classification of exchange rate risks by commercial banks

Exchange rate risks of commercial banks include foreign exchange risks and swap rate risks, status risks, risks in the implementation of the transactions, risks of payment and credit, sovereign risks, etc (Lepetit et al., 2008)

2.2.3 Factors affecting exchange rate risks of commercial banks

According to Poghosyan and Cihak (2011), the subjective cause is due to disproportionate foreign exchange status, that is, there is a difference in the value of assets and liabilities or a difference between the revenue from buying and from selling of a foreign currency The objective cause is due to the exchange rate fluctuation in an unfavorable direction for banks The causes of this fluctuation are the supply and demand of foreign currencies in the market, the difference in interest rates and inflation among countries, in addition there are other factors such as government policies, expectations and sentiment

2.3 Exchange rate risk management of commercial banks

2.3.1 Concepts of exchange rate risk management

Exchange rate risk management is a scientific, comprehensive and systematic process of approaching exchange rate risks to identify, measure, control and minimize the adverse effects of exchange rate risks The ultimate purpose of exchange rate risk management is to ensure that risks are controlled within banks’ ability, while maximizing the value the bank expects to achieve under variable conditions of the business environment (Lepetit et al., 2008)

2.3.2 Role of exchange rate risk management for commercial banks

Well-implemented exchange rate risk management will contribute to improving the quality and efficiency of commercial banks’ business operations Good exchange rate risk management contributes to reducing risks in foreign exchange trading Good exchange rate risk management also contributes to enhancing the competitiveness and international integration of commercial banks

2.3.3 Content of exchange rate risk management

The issue of managing foreign exchange risk is of great concern to everyone participating in the foreign exchange market Risk management includes risk analysis and control In which risk analysis plays an important role, by using statistical economic tools to analyze prediction, systematically quantify the level of risk associated with the forecast capital project, from which the cost compensation can be calculated to have the basis for the best decision Risk control is based on analysis results providing instrumental measures to limit and offset risks

to a bank when there is an open foreign currency position (Nguyen, 2019) Thus, any foreign exchange trading activities that create an open foreign currency position are exposed to the risks caused by exchange rate fluctuations

b Risk measurement

The commonly known method of measuring exchange rate risks is Value at Risk (VaR) VaR is the bank’s expected loss on exchange rate fluctuations The limit of risk value is the maximum expected loss that the bank can withstand

Value at risk = Foreign exchange position - Estimated volatility of exchange rate - Closing rate

c Risk control

Risk control is the implementation of measures to minimize risks before risks occur such as: avoiding, preventing, minimizing, neutralizing risks, etc Specific measures that banks take include limit on foreign exchange positions (this can be seen as a measure of risk avoidance and risk prevention because, in principle, if customers need to transact beyond the limit, the bank will refuse), balancing net foreign currency position regarding term and size, use of derivative tools, and diversification of currencies (Brown, 2001)

d Risk financing

Risk financing is the implementation of financial measures to minimize the adverse effects of a risk when this occurs, for example: self-remedy by contingency, with available resources, or transfer of risk through insurance contracts, etc In addition to a number of methods to limit risks, banks need to deduct a portion of their profits to be used as a risk financing fund for foreign exchange trading Just like credit activities, every year, a part of profit must be deducted to compensate and prevent bad debts In foreign exchange trading, risks always occurs concurrently with open trading, which means that the foreign currency position does not need to be equal Setting up risk financing fund can be 10% -20% profit of that year on foreign exchange trading (Honohan, 2007)

2.3.4 Exchange rate management tools

a Forward

A forward transaction is a transaction in which two parties commit to buy and sell together an amount of foreign currency at a certain exchange rate and the payment will be made at a specified time in the future Forward contract is the oldest instrument, and because of that, it is very complex A forward contract is an agreement between two parties to buy or sell a certain amount of foreign currency,

at a fixed exchange rate and at a specified time in the future It can be understood that a forward contract is an agreement between the buyer and the seller at this point that the buyer will pay the seller at the agreed term price and the seller will deliver the goods to the buyer at the time the contract expires Forward contract rate is

determined at the time of signing the contract but applies to a specified time in the future (Honohan, 2007)

b Future

Futures transaction is a transaction standardized in the type of foreign currency traded, transaction turnover and transaction date Future transaction is done centrally through an exchange broker A future contract is an agreement to buy or sell a fixed amount of foreign currency in the future at a fixed exchange rate on the contract date (Mishkin, 2004)

The trading mechanism of futures contract is that all futures contracts trade at the Exchange and the Exchange controls the activities of members Members of the Exchange are individuals, which can be representatives of companies, commercial banks or individuals with separate accounts Individuals, companies, and banks send orders to buy or sell a specified amount of foreign currency to brokers or members

of the Exchange At the Exchange, buy orders, also known as in long position, are compared with sell orders, also known as in short position A clearing company at the Exchange guarantees both buying and selling sides that orders after being confirmed to match with each other will surely be executed

Clearly, if using future contracts as a hedge against exchange rate risks, they still contain potential exchange rate risks; while forward contracts completely eliminate those risks Future contracts are always the speculators’ choice as a hedge against exchange rate hedging because the gains arising from futures contracts are received in cash and on the same day, transaction costs are very low, the Exchange can set a limit on the future price by specifying how much the settlement price of today is increased or decreased from the previous day’s settlement That is, the daily rate fluctuation can be limited by the Exchange (Allayannis et al., 2001)

c Swap

Swap transaction is a double exchange transaction consisting of two operations: spot exchange and forward exchange, these two transactions are carried out at the same time, with the same amount of foreign currency or gold in two opposite

directions A swap is the simultaneous buying and selling of a certain currency, where the buying value date and the selling value date are different Like a forward contract or a spot contract, a swap contract also has a buy and sell contract Suppose

a contract to buy and sell a currency is signed simultaneously at the same time today,

if there is no other agreement, buying a currency means that the bank buys the base currency, and selling a currency means that the bank sells the base currency (Matousek et al., 2017)

d Option

Option transaction is a transaction between the buyer and the seller, in which the buyer has the right but not the obligation to buy or sell a specified amount of foreign currency at a specified exchange rate/price for a period of time/prior agreement A currency option contract is a financial instrument that gives the contract buyer the right (but not the obligation) to buy or sell one currency for another at a pre-agreed fixed rate and at a certain time in the future

There are certain risks to options trading The option buyer is exposed to the risk of losing all or part of the cost paid to buy the option If the holder does not resell his option on the secondary market and does not exercise it before it is due, he loses the full amount of the premium For the seller of the option, the seller is obliged to perform the contract at any time during the contract term requested by the buyer, and at the same time they risk losing their profit opportunities when the exchange rate is delivered right at the time the contract expires, higher than the rate for the option (Dinh & Kleimeier, 2007)

2.4 Factors affecting exchange rate risk management of commercial banks

2.4.1 Objective factors

a Legal basis

Legal basis is a decisive condition to the effectiveness of exchange rate risk management in the bank’s foreign exchange trading activities With legal documents such as laws, ordinances, decisions, etc., the State creates a legal

condition for foreign exchange trading, as well as exchange rate hedging operations, but not ever These policies are also consistent with the laws of the market When that polices are not appropriate, they will limit the effectiveness of exchange rate risk management For example, the State Bank sets the forward exchange rate equal

to the spot rate plus a percentage of the spot rate, regardless of the interest rate of two exchange currencies Therefore, when the exchange rate increases sharply, banks do not dare to take risks to offer forward or option contracts (Dufhues, 2003) Every year, the State promulgates many new policies to supplement and change the old legal provisions that are no longer suitable for the market conditions in the new period Foreign exchange trading transactions are not only done for a few days but many transactions in several years, or transacted not only domestically but also with other countries, for example, the transactions of mobilizing and lending in gold Once the government policy changes and the bank does not fully anticipate it, it will create many difficulties for the process of managing risks in banking business The State’s policy changes bring policy risks to banks As recently, the State Bank has issued a policy to settle gold deposits and loans, which has brought losses to commercial banks

In general, in order to create conditions for banks to apply foreign exchange trading operations and to hedge exchange rate risks effectively, it is necessary to have favorable conditions suitable to the level of market development and the level

of development of each bank

b Market conditions

Foreign exchange trading activities are always in a volatile environment both at home and abroad, although banks have many preparations in their business plans, they cannot anticipate all the difficulties the market will bring For that reason, the bank’s business activities are always potentially risky and changes in the external business environment often cause many difficulties for the bank’s business risk management (Kousted et al., 2005)

A bank can only apply exchange rate hedging instruments when the foreign exchange market has developed to a certain extent If the market develops with a full range of institutions and financial instruments to operate foreign exchange transactions, capable of meeting all transactions of foreign currency derivative transactions, then the bank’s management of exchange rate risks will get better results At that time, the bank will have more complete information to help forecast exchange rate fluctuations more accurately and easily in assessing the market On the contrary, if the foreign exchange market is underdeveloped, the implementation

of foreign exchange trading operations and risk prevention is very limited, and banks will also find it difficult to manage their exchange rate risks

c Customers

Customers’ business capacity is weak They are not good at making business plans, budget planning, estimating all expenditures, which results in incorrect determination of income for bank debt repayment The use of capital is not effective and for wrong purposes, the purpose of applying for loans and business efficiency has not been brought into full play, so when due, it is impossible for corporate customers to pay debts to the bank, or they lose their liquidity (Nguyen & Stewart, 2013)

2.4.2 Subjective factors

a Badly compliance with banking risk management policies and procedures

Although the bank has in place a risk management system for business operations, improper compliance with the regulatory system creates many risks for the bank’s overall operations Failure to comply with the provisions of this policy may arise from the side of the leaders who do not manage risks according to the regulations or may arise from the side of the implementers who are not follow strictly the regulations or intentionally violate the regulations for a certain reason The improper implementation of the regulations in the risk management system in business operations can bring a lot of damage to the bank and make it more difficult

for the policy to be enforced for the general purpose of the bank (Stewart et al., 2016)

b The facilities, technical and technological conditions

The application of exchange rate risk prevention tools in foreign exchange trading is not easy, banks need a system of technical equipment with advanced technology For banks that operate actively trading foreign exchange, the team of professional banking employees can be hundreds of people, each of them needs to

be fully equipped with modern equipment and technology, charging up to many millions of dollars And in general, these equipment are often not going to be used for long, because advanced technology develops very quickly, so they are susceptible to invisible depreciation and become obsolete within a few years As such, not all banks are eligible and able to purchase technological equipment Only banks that are developed at a certain level, strong enough in finance, can afford to procure modern and fully equipped equipment to serve for risk management Big banks often accept high costs to have the most modern equipment and technology, which helps to transfer and process data quickly and efficiently, increase the ability

to analyze and retain data reliably and systematically, etc Although the cost for technology is high, but in return the bank’s business becomes more competitive, the management of exchange rate risks is more effective and the profit will be earned more (WB, 2014)

The bank needs to expand cooperation relationships with foreign banks in the international market to take advantage of the support in knowledge, technology, and risk management analysis system for derivative instruments, FX option, futures When purchasing equipment, it is necessary to pay attention to whether it is suitable for the organization model, the level of the bank, applying this system of machinery and equipment is in accordance with the bank’s bookkeeping or not

c Organizational work of the bank

If the organizational apparatus of the bank is not arranged and organized scientifically, the departments do not have a cooperation to promptly meet the needs

of customers as well as promptly handle the risks arising, which will lead to unpredictable consequences in the management of exchange rate risks (Vietnam News, 2019)

d Human resource conditions

In exchange rate risk management, human is the manager and transactions related to foreign currencies are the subject of management, so the capacity and qualifications of the managers are very important factors affecting directly effective risk management in general and exchange rate risk management in particular Limiting exchange rate risks is not easy, requiring certain professional training and qualifications Managers’ competence is not only reflected in their in-depth knowledge of exchange rate risk management, but also in their experiences, sharp judgment, and management skills through market volatility and the process of implementing foreign exchange trading operations as well as foreign exchange risk prevention operations In particular, they should be able to quickly absorb modern scientific technology At the same time, they should regularly update policies related to the management mechanism and foreign exchange trading to make suitable market adjustments (Stewart et al., 2016)

CHAPTER 3: RESEARCH METHODOLOGY

In order to achieve the specific objective of clearly analyzing exchange rate risk management at Agribank, secondary and primary data were carefully collected, processed and analyzed

3.1 Data collection

3.1.1 Secondary data

Secondary data are data always available, aggregated and published (Bryman, 2012) In order to conduct research on the topic, the author collected secondary data from documents such as:

- Summary reports on activities from 2017 - 2019 of Agribank

- Relevant documents, curriculum, guiding information of the finance and banking industry, magazines, etc

Table 3.1 Sources of secondary data collection Information Type of document Data collection source

Theoretical basis of the

study, figures and

+ Books and lectures: Activities

of commercial banks, exchange rate risk management;

+ Articles from magazines related to the topic;

+ Documents from websites;

+ Dissertations, reports related to the research topic

+ Library of National Economics University; + Online library, information on the website;

+ Textbook of the Academy of Finance and National Economics University - Hanoi

- Data on human

resources;

- Data on the general

situation of the bank,

+ The number of human resources working at the bank and the general level of human resources of the bank;

- Department of Human

Administration;

- Financial statements of

exchange rate risk

management at the

bank

+ Reports on the bank’s production and business results over the years;

+ Performance of exchange rate risk management;

+ Development policy of the bank in the coming time and exchange rate risk management policy in particular

the bank, reports on implementation of annual plans;

- Reports of business development plan and foreign exchange policy

of the bank

Source: Collected by Author (2020)

3.1.2 Primary data collection

Primary data are those used for calculating analytical indicators to carry out research (Bryman, 2012) Primary data were directly conducted through a survey on the basis of identifying survey samples thanks to random sampling method

- Survey location: Agribank’s Headquarter at 2 Lang Ha, Thanh Cong, Hanoi

- Content of questionnaire includes: Criteria and requirements related to factors affecting exchange rate risk management of Agribank

- Respondents:

+ Banking employees in charge of foreign exchange trading

+ Individual customers and corporate customers that are engaged in banking foreign exchange activities

+ By the end of 2019, Agribank had 440 employees working on foreign exchange trading Therefore N = 440 Accordingly, n = 440/(1 + 440 x 0.05 x 0.05)

= 210 It means that the minimum sample size must be 210 In the study, the author took 300 samples to study

+ Agribank has 500 customers including individual customers and corporate customers having foreign exchange relations with banks Therefore N = 500, n = 500/(1 + 500 x 0.05 x 0.05) = 223 It means the minimum sample size must be 223

In the study, the author took 300 samples to study

- Data collection implementation: Based on the list of officials and customers, the author deployed data collection as follows:

Step 1: Develop the questionnaire

Step 2: Conduct the survey

Step 3: Receive responses and sum up the answer results In other words, from the collected data, the author analyzed and selected the necessary factors to synthesize into reasonable data with scientific basis

3.2 Data processing

For this research, content analysis was applied Microsoft Excel was also used

to make descriptive analysis

CHAPTER 4: RESULTS AND DISCUSSION

4.1 Current situation of exchange rate risk management of Agribank in the period of 2017 – 2019

The risk management of Agribank is still quite simple and primitive, but in general it still maintains stable operations for the bank in the context of the current market is stabilizing Agribank has made certain progress on the roadmap towards international standards

Agribank has taken the first steps in building a risk management apparatus according to international standards (Basel II standards) In addition to the establishment of research teams to build mechanisms and processes, Agribank also invites international experts with extensive experience to advise and guide Agribank also has regulations on the roles and responsibilities of the Board of Members and the Board of Management on risk monitoring of the whole system in Agribank's organizational charter structure Specifically, the Board of Members is responsible for approving the risk management strategy and process and monitoring the implementation of risk prevention methods The Risk Management Committee assists the Board of Members in the development of risk management policies and procedures and advises the Members' Council in the decision-making process The roles and responsibilities of the Risk Management Committee are set out in Decision No 856 of the Members' Council on the terms of operation and organization of the Risk Management Committee Finally, the Executive Board ALCO committee was established even though it was in its infancy

4.1.1 Process of exchange rate risk management

Agribank has used very closely the limits to control the level of risks in foreign currency trading, including quite a full range of limits such as foreign currency status limit, transaction limit, and loss limit The above limits are placed directly

on the bank's core banking system, helping to control both operational errors and

the risk of intentional over-limit transactions of foreign currency traders Agribank

is the first commercial bank in Vietnam to build and develop a core banking system, allowing centralized data management, minimizing risks in business operations Agribank's core banking system also ensures the rapid assessment of profit and loss from foreign currency trading, the status report, transaction report and foreign currency business result report are automatically supported help a lot for risk management Agribank's sales of derivative transactions including forward transactions and swaps are increasing, showing that the importance of derivative transactions is gradually improving Not only to prevent risks, derivatives are also playing a great role in taking advantage of idle capital to bring profits to the system Agribank has focused on professional training for foreign currency traders, for staff

to study and train short-term courses at home and abroad so that each officer can receive quick, clear risk awareness and effective response Foreign currency trading process is also increasingly being completed, tightly controlled through many steps, both before and after the transaction This also helps to minimize risks arising from professional mistakes of each individual, which must be extremely sensitive and accurate when participating in domestic and international transactions Agribank's payment security is also guaranteed Documents are also checked by the back office

to ensure that correct data is entered into the system for all transactions Statistical reporting mode provides complete and timely information for administrators, policymakers at all levels, maximum support for monitoring, controlling and handling arising risks

In the market economy as well as in foreign exchange trading, the risks encountered are inevitable Due to fluctuating and unpredictable exchange rate, exchange rate risk is considered a permanent risk and becomes a specific characteristic of foreign exchange trading A good risk management process will greatly limit the damage to the bank Understand that problem; Agribank always attaches great importance to exchange rate risk management The bank’s exchange rate risk management process consists of four steps as follows