Moral hazard problem in vietnamese commercial banks from 2014 to 2017,graduation thesis

ABSTRACT In economics, moral hazard and adverse selection are two possible consequences of asymmetric information or ineffective information pricing.. In banking field, not only moral h

BANKING ACADEMY Faculty of Foreign Languages

BANKING ACADEMY Faculty of Foreign Languages

ACKNOWLEDGEMENTS

First and foremost, I would like to express my heartiest appreciation to Ms Nguyen Thi Hien Hanh, my thesis supervisor, for her great guidance, useful advice, invaluable suggestions and comments in helping me complete the graduation thesis

I also would like to give thanks to all my lecturers in Faculty of Foreign Languages - Banking Academy of Vietnam, who have provided such huge supports and instructed me throughout my four - year learning process Without their help, I would not be able to finish this thesis

Special gratitude also goes to my beloved family and my friends for always supporting, caring, loving, and encouraging me during the process of doing this thesis

Due to time constraints and my limited capacity, this graduation thesis may not

be free from certain defects Therefore, I hope to receive feedbacks from the lecturers as well as the readers to improve my thesis

ABSTRACT

In economics, moral hazard and adverse selection are two possible consequences

of asymmetric information or ineffective information pricing Moral hazard occurs when the party with more information about its actions or intentions has a tendency

to behave inappropriately from the perspective of the party with less information

In banking field, not only moral hazard can cause financial losses to businesses and customers, but can also create an alarming situation for the banking system particularly and the economy generally This can be seen as one of the most serious threats to all banks since the root of the matter could lie on the inside as well as the outside of the bank Although many banks have recognized the gravity of this issue, they are still unable to find radical measures to successfully prevent moral hazard Moral hazard can lead to severe damage especially for some developing country like Vietnam, where the banking system is incomplete, and its operation still contains many defects This type of risk may occur in every stage and no matter where in the banking system, can seriously impact on the bank’s assets as well as its reputation

The number of moral hazard cases is increasing rapidly and uncontrollably in Vietnamese commercial banks Some of them are still in the process of investigation and prosecution In most cases, the amount of loss money cannot be returned nor recovered To cope with this situation, banks as well as the Government have come up with various solutions, and in this study, more recommendations will be suggested as well The aim of this thesis is to study moral hazard theories in the perspective of the author, provide readers with more knowledge by analyzing Vietnamese realistic cases, and giving suggestions to help banking system in the fight against moral hazard problem

TABLE OF CONTENT

DECLARATION 1

ACKNOWLEDGEMENTS ii

ABSTRACT iii

LIST OF TABLES AND FIGURES vi

LIST OF ABBREVIATIONS AND ACRONYMS vii

CHAPTER 1: INTRODUCTION 1

1.1 Significance of the study 1

1.2 Research purposes 2

1.3 Scope of the study 2

1.4 Research methodology 2

1.5 Research structure 3

CHAPTER 2: THEORETICAL BACKGROUND OF THE STUDY 4

2.1 Commercial banks 4

2.1.1 Definition of commercial bank 4

2.1.2 The role of commercial bank 5

2.2 Asymmetric information in commercial banks 7

2.2.1 Concept of asymmetric information 7

2.2.2 Cases of asymmetric information 8

2.3 Moral hazard problem in commercial banks 11

2.3.1 Concept of moral hazard problem in commercial banks 11

2.3.2 Causes of moral hazard 12

2.3.3 Consequences of moral hazard 15

CHAPTER 3: MORAL HAZARD PROBLEM IN VIETNAMESE COMMERCIAL BANKS FROM 2014 TO 2017 17

3.1 Current situation of moral hazard in Vietnamese commercial banking system17 3.2 Vietnamese moral hazard cases from 2014 to 2017 21

3.2.1 Cases caused by customers 22

3.2.2 Cases caused by banks 29

3.2.3 Consequences of these cases 40

3.3 Addressing the actual problems of moral hazard 41

3.3.1 Current preventions in Vietnam 41

3.3.2 The unsolved issues 43

CHAPTER 4: RECOMMENDATIONS TO DEAL WITH MORAL HAZARD PROBLEM IN VIETNAMESE COMMERCIAL BANKS 45

4.1 Recommendations for banks 45

4.1.1 Staff management 45

4.1.2 Customer management 47

4.2 Recommendations for those charged with governance 49

4.3 General solutions needed from the Government and the State Bank of Vietnam 50

CONCLUSION 52

REFERENCES 53

LIST OF TABLES AND FIGURES Figure 1: The number of cases involving enforcement of judgments in relation to

credit institutions and banks 19

Figure 2: The number of cases involving enforcement of judgments in relation to credit institutions and banks in some provinces 20

Figure 3: The number of cases in some banks 21

Table 1: Penalties for a 31 billion VND appropriation case 26

Table 2: Penalties for a 422 billion VND appropriation case 27

Table 3: Penalties for a 600 billion VND appropriation case 27

Table 4: Penalties for a 1,600 billion VND case 27

Table 5: Penalties for Huynh Thi Huyen Nhu case 37

Table 6: Expected penalties for Pham Cong Danh case after the first trial 37

LIST OF ABBREVIATIONS AND ACRONYMS

ABBank An Binh Commercial Joint Stock Bank

ACB Asia Commercial Joint Stock Bank

Agribank Vietnam Bank for Agriculture and Rural

Development

BaoVietBank Bao Viet Joint Stock Commercial Bank

BCBS - IADI Basel Committee on Banking Supervision -

International Association of Deposit Insurers

BIDV Joint Stock Commercial Bank for Investment and

Development of Vietnam

Eximbank Vietnam Export Import Commercial Joint Stock

Bank

HDBank Ho Chi Minh City Development Joint Stock

Commercial Bank

LienVietPostBank Vietnam Postal Union Commercial Joint Stock

Bank

MSB Vietnam Maritime Commercial Joint Stock Bank

Nam A Bank Nam A Commercial Joint Stock Bank

Navibank Nam Viet Commercial Joint Stock Bank

Sacombank Saigon Thuong Tin Commercial Joint Stock Bank

Techcombank Technology Commercial Joint Stock Bank

TPBank Tien Phong Commercial Joint Stock Bank

VDB Vietnam Development Bank

Vietcombank Bank for Foreign Trade of Vietnam

VNCB Vietnam Construction Commercial Joint Stock

Bank

Vietinbank Vietnam Joint Stock Commercial Bank for Industry

and Trade

CHAPTER 1: INTRODUCTION 1.1 Significance of the study

The development of the Vietnam’s banking system has closely linked with the

national cause of revolution and construction The establishment of the Vietnam

National Bank on May 6th, 1951 was a significant milestone in the evolution of

Vietnam’s monetary and banking systems Since the Reformation in 1986,

Vietnam’s banking sector has changed fundamentally along with the economy,

contributing an important part in the socio - economic development of the country

Important changes were accomplished both in the structure, the regulation and the

operations of the banks Vietnam’s banking industry has grown tremendously from

a mono - banking system to a huge network of banks and financial institutions

Throughout nearly thirty years, Vietnam’s banking system has been extended

and improved incredibly both in quantity and quality There are 43 banks in active

in which approximately 90% are commercial banks Besides performing the usual

commercial banking functions, banks in developing countries play an effective role

in their economic development Furthermore, banks also take responsibilities for

providing many other services in order to support the establishment, and the

operation of other economic entities

In the course of their operations, banks are invariably faced with various types of

risks that may have a potentially negative effect on their business The risk arises

from the occurrence of some expected or unexpected events in the economy or the

financial markets While having to take care of their customers, banks also need to

pay attention to their own staffs Many serious situations in daily banking activities

can be created if their employees are not well - qualified, and this could easily lead

to further awful aftermaths On the other hand, banks have to deal with risks from

their customers since some of them may intentionally or unintentionally want to

benefit themselves by doing something harmful to banks

The risk mentioned above is called moral hazard which appears from the

imbalance of information between the parties involved in a contract This type of

risk is gradually becoming a serious danger to banks as the economy and the

banking system are developing every single day This can bring about dreadful

consequences and unwanted severe damage not only to many individuals,

organizations, banks, but also the entire economy of the country

Being aware of how important this problem is, the author of this thesis expects

that this work could help readers have a deeper understanding and a better view

about moral hazard situation in Vietnamese commercial banks in recent years

Moreover, some recommendations will be offered in this thesis with the hope of

contributing partly to the prevention of the moral hazard problem in banking

system

1.2 Research purposes

The objective of this study is to provide readers with theoretical background of

moral hazard issue in commercial banks Also, the main target of the thesis is to

analyze some noticeable cases of moral hazard in Vietnam’s banking system, as

well as identify main causes, consequences, and current solutions of responsible

parties to deal with the existed problem Finally, the author would like to provide

some more possible recommendations to prevent moral hazard problem and

minimize its impacts on Vietnam’s banking sector

1.3 Scope of the study

The study mainly concerns moral hazard problem in the context of banking

system As well as this, the paper specifically aims at studying the causes and

consequences of moral hazard in banking field, its reality in Vietnam in recent

years, and offer solutions to cope with this situation at the present and in the years

to come

1.4 Research methodology

The thesis is based on a wide range of information resources from books,

lectures, newspapers, journals, breaking news, previous researches, and the Internet

Hence, this study will represent and analyze the actual condition caused by moral

hazard in Vietnamese commercial banks by collective method, deduction, analysis,

and statistics

1.5 Research structure

The thesis consists of 4 main chapters: (1) Introduction, (2) Theoretical

background of the study, (3) Moral hazard problem in Vietnamese commercial

banks from 2014 to 2017, (4) Recommendations to deal with moral hazard problem

in Vietnamese commercial banks

 In the first chapter, the author explains why the main topic is chosen, what it

was for, and how it was completed

 In the second chapter, the author will give a clear, comprehensible and

sufficient theoretical knowledge about commercial banks, moral hazard and

its main causes as well as effects in banking industry

 In the third chapter, the author will provide the readers with a thorough

overview of moral hazard issue in Vietnam’s banking sector in recent years

by analyzing numerous cases and identifying hidden obstacles

 In the last chapter, some feasible recommendations will be suggested to

prevent moral hazard problem and minimize the harmful impacts on

Vietnam’s banking system

CHAPTER 2: THEORETICAL BACKGROUND OF THE STUDY

2.1 Commercial banks

2.1.1 Definition of commercial bank

According to The banking system: Commercial banks by Stephen D Simpson,

the banking system is an essential component of the global economy and accounts

for trillions in assets worldwide The health of an economy and the health of its

banks have been interrelated for so many years Therefore, banks are a huge part of

our lives, and can be seen as one of the most heavily regulated businesses in the

world A banking system is a group or network of institutions that provide financial

services such as operating a payment system, providing loans, taking deposits, and

helping with investments

According to US laws, a bank is any business offering deposits subject to

withdrawal on demand (such as by writing a check or making an electronic transfer

of funds) and making loans of a commercial or business nature More specifically,

commercial bank is a type of bank which sells deposits and makes loans to

businesses and individuals

According to the Law No47/2010/QH12 of June 16th, 2010 on Credit

Institutions, in Vietnam, commercial bank is legalized to be a type of credit

institutions which conducts all banking operations including deposit taking, credit

extension and payment services, along with other business activities

From my own exploration of those researches, the traditional commercial bank is

a brick and mortar institution with tellers, safe deposit boxes, vaults and ATMs A

commercial bank is a financial institution that provides various financial services,

such as issuing business and auto loans, accepting deposits and mortgage lending

Moreover, a wide range of investment products such as savings account, checking

accounts and certificates of deposit can be also offered to their customers

Throughout the history of banking system, banks have been carrying out some

fundamental services such as exchanging currencies, making loans, accepting

deposits, discounting several kinds of valuable paper, and supporting the business

activities of the government and other corporations by providing credit services

The world’s economy as well as the banking system have been developing

astoundingly in recent years Therefore, banks started to expand and offer more

services with the hope of successfully satisfying their customers, namely: leasing

equipment, selling insurance policies and retirement plans, trading securities,

underwriting, etc

2.1.2 The role of commercial bank

According to the textbook “Ngan hang thuong mai” by Assoc Prof., Dr To

Ngoc Hung of Banking Academy, commercial banks are open to the public and

serve individuals, institutions, and businesses by offering a wide range of services

Besides performing the usual commercial banking functions which are acting as an

intermediary, providing payment services, managing risks, and other functions,

banks in developing countries play an effective role in their economic development

Since commercial banks are the oil for the wheels that keep the economy turning,

the roles which are described in the slides of Commercial Banking subject of

Banking Academy will show how important the presence of commercial banks is in

modern economies

First of all, commercial banks play an exceptional role as an intermediary in

the financial system By encouraging individuals and institutions to save and then

transfer their savings to those who plan to invest in new projects, the need for

liquidity of many individuals and economic entities in the market will be satisfied

Moreover, the risks and costs during transactions will also be reduced with this role

of commercial banks More specifically, commercial banks will accept deposits

from customers, raise capital from investors or lenders, and then use that money to

make loans, buy securities and provide other financial services to customers These

loans are then used by people and businesses to buy goods or expand their business

operations, which in turn leads to more deposited funds that make their way to

banks Commercial banks do a variety of other things, such as helping corporations

with their, often more complex, financial needs This can range from the various

ways to gain access to capital for growth and investments, to assisting in mergers

and acquisitions, as well as to converting currencies Not only can commercial

banks bridge redundant funds with in - need customers, but they also play the role

of a brokerage In this situation, commercial banks will act as investors’ agent, help

them attract or raise funds and re - invest to gain more profit Due to the information

advantage which helps manage fund more efficient and minimize the risk of using

funds, both commercial banks and customers can receive many benefits

Furthermore, the cost of transactions might be reduced when commercial banks

participate in the business because they have the economies of scale to screen and

supervise borrowers

The second important role of commercial banks is to provide a safe and

convenient way in order to execute the process of making payment for and on

behalf of customers With commercial banks, customers no longer need to keep

large amounts of currency on hand because transactions can be handled with

checks, debit cards or credit cards instead Commercial banks also act as payment

agents within a country and between nations, and they perform the payment via

various channels through the current account or checking account system

Customers can make payment by using tele - transmitting method where money is

transferred directly from one account to another Moreover, commercial banks

allow account holders to pay for goods with the swipe of a card Customers can use

electronic card such as ATM card or MASTER CARD, VISA OR PAYPAL to

automatically pay at the point of purchase These services give users a sense of

security and comfort Additionally, since the international banking system is

developing rapidly, commercial banks can transfer currencies among different

countries They could also help in financing both internal and external trade

Furthermore, commercial banks can provide all types of facilities such as

discounting and accepting bills of exchange, providing overdraft facilities, issuing

drafts, etc Commercial banks are responsible for bringing the money from the

importer to the exporter more quickly, easily and safe Consequently, foreign

business transactions increase, and this will boost the domestic economy

Other roles of commercial banks can be named as agency role, policy role, or

in general, policy transmitting role In fact, commercial bank is an indirect channel

through which the Government interferes in the macro - economy For instance, in

order to implement a loose currency policy, the central bank generally buys

securities from commercial banks As a result, this action will make the interest rate

drop and create propitious conditions for investors, and the domestic economy will

indeed benefit In another way, the central bank can reduce or increase the money

supply by affecting the ability of commercial banks to create demand deposits

Commercial banks serve as an empowered monitor who allows the Government to

regulate the financial market in particular and the economy in general without

imposing too many administrative measures on the whole country, which is often

attached with negative attitude, dissident thoughts, and stubbornness

2.2 Asymmetric information in commercial banks

2.2.1 Concept of asymmetric information

Do Quy Toan (2003) analyzed in his research that asymmetric information,

sometimes referred to as information failure, is presented whenever one party, in an

economic transaction, possesses greater material knowledge than the other party

This normally manifests itself when the seller of a good or service has more or

superior knowledge than the buyer, although the reverse can happen regularly as

well This could create to an imbalance of power in transactions, and almost all

economic transactions involve information asymmetries Potentially, asymmetric

information may lead to undesirable and serious consequences because one party

can easily take advantage of the other party’s lack of knowledge to satisfy their own

needs Likewise, in banking field, asymmetric information is asymmetric

distribution of material information which could be influential in decision making

by both parties to the loan agreement Suppose an entrepreneur comes up with a

business idea, and is looking to raise capital for the actualization of his dreams

Ordinarily, he will approach a bank with his business plan Nevertheless, even

though the bank will try to do due diligence before disbursing the loan, the investor

will always have a clearer understanding of his financial condition, the prospective

returns as well as the risks of the business than the bank Information asymmetric

can cause problems both before the transaction is closed (adverse selection) and

after the transaction has been closed (moral hazard)

2.2.2 Cases of asymmetric information

If information is not only imperfect but also asymmetric, inefficient results may

be the consequences Mishkin, F.S (2010) mentioned in his book (The Economics

of Money, Banking, and Financial Markets) that the presence of asymmetric

information leads to adverse selection and moral hazard problems All of these

economic weaknesses have the potential that could lead to market failure which is

any scenario where an individual or firm’s pursuit of pure self - interest leads to

inefficient results

According to an article of William C Spaulding about information asymmetry,

the term “Adverse selection” is used in economies to describe a risk exposure that

exists before the money is lent or invested It happens when there is a lack of

symmetric information prior to a deal between a buyer and seller The uneven

knowledge may cause the price and quantity of goods or services in a market to

shift This results in “bad” products or services being selected

Laiboni, M (2012) analyzed in his blog (Asymmetric Information in the Banking

sector: How adverse selection & moral hazard affect our banking system) that

adverse selection occurs because of information asymmetries and the difficulties in

selecting customers For example, bad credit risks (firms which have poor

investment channels and high inherent risks) are usually more probable to acquire

loans than good credit risks (firms with better investment opportunities and less

inherent risks) Due to information asymmetry, lenders tend to have a difficult time

discriminating between good and bad credit risks Therefore, they usually demand a

blanket premium over and above the existing rates as compensation for the risk

arising out of the inability to determine who indeed should be lent to As a result,

the good firms might stop borrowing from these lenders because the high rates have

depreciated their strong credit history On the other hand, the bad firms tend to be

very eager to borrow from such lenders since they know that judging by the strength

of their cash - flows, they should be charged an even higher interest rate

Consequently, lenders end up with a loan portfolio comprising almost entirely bad

credit risks However, it is also possible that sellers will have better information

than buyers, and sellers only sell product when it is favorable to them For instance,

in a secondhand car market, the seller may know all about an invisible defect and

charge too much to the consumers who are badly informed

Conversely, the case in which the information asymmetry occurs after an

agreement obtained between individuals is called “moral hazard” Saul Perez

(2014) defined that moral hazard refers to a situation where a person, a group (or

persons), or an organization is likely to have a tendency or a willingness to take a

high - level risk, even if it is economically unsound Economist Paul Krugman once

described moral hazard as “any situation in which one person makes the decision

about how much risk to take, while someone also bears the cost if things go badly”

in his research (The Return of Depression Economics and the Crisis of 2008)

Specifically, in relation to asymmetric information, moral hazard may happen if

one party is insulated from risk and has more information about its actions and

intentions than the party paying for the negative consequences of the risk For

instance, moral hazard occurs in employment relationships involving employees

and management When a firm cannot observe all of the actions of employees and

managers, there is a chance that selfish and careless decision making may occur

Similarly, Laiboni M also mentioned that in banking field, moral hazard may

happen after the money has been disbursed to the borrower, and it arises out of the

fact that the borrower may have an incentive to breach the loan covenants by

investing in “immoral projects”, which are unacceptable in the perspectives of the

lenders The reason is that while they have a high possibility of gain to the

borrower, they also have a high possibility of failure This will create the most

detrimental effect on the lender Once again, moral hazard is caused due to the

lender’s lack of knowledge about the borrower’s activities

To sum up, the differences between adverse selection and moral hazard need to

be clarified These two are both concepts widely used in the field of insurance as

well as banking They are quite distinct to each other even though they are normally

misinterpreted Moral hazard and adverse selection always result in one party

benefiting over the other mainly because they have more information or they bear

lower levels of responsibility which make way for acting recklessly The difference

between the two is that: adverse selection occurs when the party providing service is

unaware of the full length of the risk because all information is not shared when

entering into the contract; moral hazard removes socially beneficial consequences

that results from a lack of necessary information to encourage good behavior or

discourage bad behavior In most situations that do not involve insurance,

warranties, legal liabilities, renting services, or any form of continued contract and

obligation, moral hazard is unlikely to occur On the other hand, adverse selection

can happen for any experience good which is a good for which a buyer cannot

determine the total value and total cost without actually purchasing the good There

is a case when both adverse selection and moral hazard happen together at the same

time However, it is quite challenging to declare whether this is true or not Since

banks only know about their customers at a moderate level, it is hard for them to

find out what the customers are going to publish even when banks have tried their

best to gain access to information This seems to be unfair if banks are blamed for

not being aware of every single detail about their clients While in fact, customers

are the ones who can intend to play some trick to the bank at the beginning There

are many ways for them to mislead the bank such as making fake documents,

bribing the bank’s officers, etc In this situation, the bank might give credit wrongly,

but they do not make fault This case of asymmetric information is usually regarded

as moral hazard in reality

Asymmetric information considerations have encompassed all fields of

economic and finance, and the presence of information asymmetries could be the

source of large economic efficiencies Although the technology has been advanced

more strongly as well as many solutions have been carried out, commercial banks

could not solve this problem thoroughly Especially, for moral hazard, wangle tends

to be extremely harder to cope with Therefore, in the next part, the author will

present more clearly about this problem in commercial banks to help readers have a

better understanding and realize how serious moral hazard is nowadays

2.3 Moral hazard problem in commercial banks

2.3.1 Concept of moral hazard problem in commercial banks

According to contract theory, moral hazard results from a situation in which a

hidden action occurs Bengt Holmström said in his research (Moral Hazard and

Observability Bell Journal of Economics, 1979) that: “It has long been recognized

that a problem of moral hazard may arise when individuals engage in risk sharing

under conditions such that their privately taken actions affect the probability

distribution of the outcome” The term “moral hazard” was widely used by English

insurance industry by the late 19th century, but it can be applied to several

situations Insurance companies worried that while they were trying to protect their

customers from risks like motorbike accidents or fire, their clients might be

encouraged to behave in riskier ways such as not wearing helmets or smoking inside

their houses This can lead to the fact that these insurance companies may not want

to protect their clients as much as the clients would like to be protected anymore

This term is also heard frequently in discussions about how to reform the health

care system and the financial system Federal Reserve chairman Ben Bernanke said

in his speech about regulating the financial system: “As we try to make the financial

system safer, we must inevitably confront the problem of moral hazard” Moral

hazard is a risk that occurs when a big bank takes risks, knowing that someone else

will have to face the burden of those risks This situation happens when one party

holds more information that is significant to a contract or outcome than the other

For example, a firm selling investments will probably know that there is a good

chance that the firm cannot make it another year due to some recent non - disclosed

projections The investors who have less information may assume that the company

is in good condition and its future is hopeful

Arne Rogde Gramstad and Jacopo Bizzotto (2015) analyzed in their research

about Social costs from Moral hazard in Banking that moral hazard also arises in a

principal-agent problem, whereby one individual - the principal - wants to hire

another party - the agent - to perform a given task However, once the contract has

been signed, the agent can either take an action that is non - observable for the

principal, or obtain information about some characteristics of the environment that

the principal cannot acquire The agent usually has more information about his or

her actions or intentions than the principal does, because the principal usually

cannot completely monitor the agent Therefore, the agent may have an incentive to

act inappropriately from the viewpoint of the principal if the interests of the agent

and the principal are not aligned

2.3.2 Causes of moral hazard

The cause of moral hazard can be classified into 2 categories: internal causes

which are caused by the banking operation itself, and external causes in which

customers are mainly involved

a Internal causes

Vu Thanh Ha and Tran Thu Huong of Banking Faculty in Banking Academy

analyzed in their research that there are four main internal causes

First of all, the flaws in bank’s policies are the main reasons which lead to

moral hazard These defects may include the looseness in supervising auditors and

creditors, recruiting and training bankers, monitoring customers, the lack of clear

standards in lending policies, as well as the lack of effective and strict control of

funds Inside the banking system, moral hazard can occur in any chances especially

when banks do not manage their employees closely Although auditors play an

important role in identifying fraud from their clients, some of them may accept

bribe from firms to cover all the mistakes and make the financial reports become

better Moreover, moral hazard activities can happen due to the neglect of banks in

the process of selecting bankers Professional ethics are one of the most important

and integral standards in recruiting bank’s staffs Therefore, having irresponsible

and unreliable bankers may bring about serious outcomes for banks In most

transactions, it is the fact that the borrowers tend to have more information as well

as knowledge than the lenders when it comes to the use of loan If banks do not

supervise strictly, customers can easily conceal or forge the information, and they

can even accomplish inappropriate actions that could lead to serious consequences

for the fund raised

Secondly, the ignorance of administrators can also lead to moral hazard

problem in banking industry An expert once said that banking is a business which

is closely related to money, a huge amount of money Therefore, it is obvious that

moral hazard or ethical issue encircles this area The key to this problem is finding

ways to manage and control moral hazard Nevertheless, this does not seem to be

easy when commercial banks in some developing countries are still weak in

controlling, and the shortage in knowledge of banking executives is still remained

as a serious shortcoming Since the financial market has been developing rapidly

nowadays, various new forms of financial products which are more complex such as

derivatives or securitization has appeared The administrators must update and

understand the nature and risk of each product in order to apply appropriate risk

management policies as well as find ways to guarantee the health of the business

However, not all banks have the ability to do this because of the ignorance from the

management board

Thirdly, bank bailouts and moral hazard are sometimes closely related to each

other There are at least two reasons for why an intervention of the Government

may worsen the problem of moral hazard The first is the expectation of the

Government saving banks in trouble If a manufacturing company goes bankrupt,

the Government will not intervene Therefore, they have an incentive to avoid

taking unnecessary risks However, in some situation, the Governments have to bail

out “too big to fall” banks to prevent catastrophic consequences for the entire

economy in general and a collapse in confidence of the banking industry in

particular This also means that those banks effectively have government insurance

against losses The expectation of a safety net in case of trouble may lead banks to

act recklessly, and give them an incentive to change their behavior and take more

risks The second is the existence of Deposit Insurance against systematic liquidity

risk to conserve public confidence in the financial system The bailouts might lead

to risky lending in the future if those people who are willing to take risks think that

they will not have to take full responsibilities for potential losses anymore

Fourth, moral hazard can happen due to the weak supervision of the

Government, shareholders, investors, and depositors In most cases, banks are

fully trusted by investors, shareholders, and depositors with their liquidity and

credibility Therefore, these people may lose the supervision on the funds Some

banks may take advantage of this neglect and try to gain more profit by allowing

borrowers to get more loans With deposit insurance, depositors may also be more

careless about where they deposit their savings They usually have no incentive to

care about how banks invest their saving because they thought that the deposits are

insured Furthermore, bank’s activities will be impossible to control, and moral

hazard problem may become even more severe if the Government does not manage

the system properly

b External causes

PhD Nguyen Minh Phong (2016) investigated that customers can be seen as one

of the most common reasons that could lead to moral hazard although they usually

could not finish their plans without the help from the inside of the banking system

No one can deny the fact that borrowers have every right to determine where to

pour the funds into, and lenders, on the other hand, know too little about the usage

of their money This explains why the information asymmetry is unavoidable In

banking field, moral hazard may include wrong uses of funds which are not stated

in the investment portfolios or lending contract at the beginning In some cases,

customers can associate with bank’s employees to reach their evil purposes, which

is even harder for banks to find out

Customers tend to perform various and different types of tricks in order to

violate the terms of the lending contracts For instance, they can submit fake

documents, forge dealing contract or mortgage one asset for multiple times

However, not all customers are well aware of the definition of moral hazard since

they do not have a clear understanding about this aspect Sometimes, borrowers

may execute wrong activities with the fund but they actually do not realize that their

action is unacceptable and illegal

These major causes from above could lead to moral hazard, and then could easily

bring about severe damages and create a dangerous threat for the banking system as

well as the whole economy of the country In the next segment, the author will give

a more detailed understanding about numerous consequences which may be caused

by moral hazard problem

2.3.3 Consequences of moral hazard

As previously discussed, in banking industry, moral hazard in mainly caused by

wrong activities of the customers as well as the commercial banks That explains

why they are the ones who have to suffer from the risk Vu Thanh Ha and Tran Thu

Huong (Banking Faculty of Banking Academy) also analyzed the consequences of

moral hazard in their research

For commercial banks, moral hazard can lead to credit risk This may happen

because commercial banks play an important role in being a financial intermediary

who specializes in mobilizing idle capital for business entities, and funds are

basically owned by people depositing or investing money in the bank Once credit

risk occurs and goes public, banks have to deal with a lot of serious issues Many

customers of the banks might watch the news on media such as newspapers,

television, radio and the Internet As they realize the seriousness of the situation, the

“domino” effect among customers will be created Customers will definitely be

worried and wondered whether they should keep using the services of this bank or

not Some will be afraid that the banking system is not stable like it used to be This

situation could drive depositors to withdraw their money all at once Since moral

hazard can create a panic not only for the banks themselves but also for their

customers, commercial banks must realize the fact that they are critically at huge

risks The prestige which they have spent so many years building as well as

maintaining is about to be collapsed Although loyal customers are the most

potential subjects of many commercial banks in making profit, they can easily

decide to leave if their banks are no longer worth their trust anymore

Moreover, even though sometimes commercial banks are not able to collect the

principal as well as the interest on loans disbursed, they are obliged to pay

depositors and investors in due as a part of their responsibility As a result, this

causes the imbalance in the flow of money, the ineffective turnover of capital, and

over - expected real expenditure In addition, banks may have to use their funds to

pay for depositors when that a loan is classified as bad debt or loan loss At a more

specific and serious point when the fund cannot meet the paying demand which also

means that their provisions are technically not sufficient, banks will fall into

liquidity risk Consequently, the business scale must be narrowed by banks, and

reliability as well as the competitiveness in both domestic and foreign markets will

also decrease If there are no immediate and appropriate actions to cope with these

difficulties, the scenario will become even worse when banks face bankruptcy

Being on the edge of bankruptcy, these banks are more willing to risk literally

everything they have left with the hope of surviving through the severe situation

Additionally, bank failures may lead to contagion to other banks The failure of

one reckless bank may have adverse effect on other potentially prudent banks If the

financial sector does not have the right incentives, failed investments can have

serious effects on the entire economy This could create panic not only for the

banking system but also for the whole country as well There will be no stable

funding for purchasing materials, and the prices will be fluctuated Thus, the rate of

unemployment as well as the instability of the society may increase

Furthermore, moral hazard can be seen as one of the major causes for some

international crises such as the Asian financial crisis in 1997, the South American

financial crisis from 2001 to 2002, and today’s crisis resulting from sub - standard

loans in the USA

CHAPTER 3: MORAL HAZARD PROBLEM IN VIETNAMESE

COMMERCIAL BANKS FROM 2014 TO 2017 3.1 Current situation of moral hazard in Vietnamese commercial banking

system

Recently, information and news from media as well as the Internet have been

causing anxiety and worrying about the degradation of moral problem in banking

business Authorities have detained and interrogated a series of bank officers with

high position as well as employees for intentionally wrongdoing involving moral

hazard in this field Some of them were prosecuted for violating the law and

professional ethics They use different and more complicated tricks to steal money

from customers, such as withdrawing money from banks to play securities and trade

real estate, withdrawing the "savings book" tens of billions as in Nghe An case,

asking for "kickbacks", harassing customers when lending money, intentionally

misrepresenting important documents, misusing power and authority, making false

papers, false signatures, and blank vouchers, colluding with organizations or

individuals to appropriate others’ property and trying to escape with stolen money,

collaborating with customers to raise the value of collateral to overpay collateral

value or revolving collateral to borrow multiple times in different banks, etc These

above behaviors could seriously cause losses of hundreds and even thousands of

billion, and make the public skeptical of an industry which is supposed to keep the

word "trust” to survive

It can be seen in chapter 2 that moral hazard involves the wrong behaviors of

employees and even of customers No one can exclude the possibility of bad

customers who deliberately and fraudulently prepare fake papers to cheat the bank

A very serious scam can be listed is Huynh Thi Huyen Nhu’s bank fraud which has

caused damage to trillions This is the sign of collusion and alliance, and that moral

hazard of customers and employees is closely connected This situation is the

consequence of relationship in banking business A longtime credit expert has

confided, perhaps because of the subjectivity that led to the cases in which the

director of Agribank Hong Ha branch was willing to sign a guarantee of up to a

hundred billion with no hesitation, and the director of Agribank Tan Binh still

agreed to loan even though those customers did not have the financial capacity and

owned no asset These banks would have avoided losses if correct rules in business

processes had been applied

According to an article by Hong Phuc in the Saigon Times website, the image of

commercial banks has been worsened over the past time, and the mutual trust

among banks is diving The management level and capacity of credit institutions

had yet to keep pace with their growth, development demand and economic

uncertainties The quality of human resources at banks remains low, resulting in

risks for themselves and negatively affecting their operational efficiency

The banking system is an economic segment in dire need of high - level

transparency and professionalism Therefore, the quality improvement of staffs is a

vital duty A substandard work force both downgrades banking governance and

adversely influences business effectiveness of the system Moral hazard is therefore

serious

“Shareholders of some banks have managed to spur their investments by

borrowing money from other banks, which is known as multiple - gearing, and by re

- assessing to keep upsizing total assets of the banks Meanwhile, leaders of credit

institutions under high pressure to make profits have invested heavily in numerous

risky projects and areas, especially in property schemes, stock trading and even

unofficial credit activities,” vice chairman Ha Huy Tuan of the National Financial

Supervisory Committee once told a seminar held in Hanoi “Certain banks are being

controlled by a number of shareholders, and this has led to an ambiguous

relationship between the industry players and local companies The ownership rate

of a shareholder at some banks is much higher than that allowed by law, giving

them power to manipulate banks This means the banking operation largely depends

on the targets and interest of such individuals The fact shows that weak banks tend

to favor those corporate borrowers having close relationship with their shareholders

These enterprises, in reality, are inclined to use the bank loans to invest in real

estate, securities trading or subsidiaries,” cited a report at the seminar

Reviewing business results of domestic banks over past time, many experts said

that the immature risk management system, particularly credit and liquidity risk

control, and the ineffective internal supervision system have given rise to

increasingly growing operational and moral hazard Moreover, the most important

but hardest to control was professionalism and ethics in the banking industry The

hot growth of the banking system, the scarcity of high-level human resources with

business ethics, coupled with the absence of proper recruitment and training

programs, have also led to moral hazard problem These can be seen in the cases of

Huynh Thi Huyen Nhu and Pham Cong Danh as well as many other cases which

will be analyzed later on

Figure 1: The number of cases involving enforcement of judgments in relation

to credit institutions and banks

On April 17th, 2017, the General Department of Civil Judgment Enforcement -

Ministry of Justice held a summation meeting of judgment execution in the past 6

months Le Thi Kim Dung, Head of Department of Civil Service 1, General

Department of Civil Judgment Enforcement (MOJ) said that civil judgment

enforcement results in the past six months increased compared to the same period in

However, there are still many limitations compared to the requirements which

were set out As reported at the conference, from October 1st, 2016 to March 31st,

2017, the total number of cases and the amount of money to be enforced which are

related to credit institutions and commercial banks across the country is enormous,

including: approximately 18,800 cases, which is equivalent to over 76,000 billion

VND However, the number of unfinished cases still remains as the majority, which

is over 17,000 cases, corresponding to nearly 65,500 billion VND Deputy Director

General of the General Department of Civil Judgment Execution (MOJ), Mai Luong

Khoi said that although the credit and banking sectors only account for 3.25% of the

cases, they made up 55.8% of the total amount of money

Figure 2: The number of cases involving enforcement of judgments in relation

to credit institutions and banks in some provinces

Particularly, some provinces have a great number of cases and a huge amount of

money which must be enforced for credit institutions and commercial banks such as

Ho Chi Minh City (2,300 cases, over 29,300 billion VND), Hanoi (more than 2,900

cases, 11,000 billion VND), Dong Nai (nearly 700 cases, over 1,700 billion VND),

Long An (approximately 900 cases, over VND 2,200 billion), An Giang (over 700

cases, about 1,800 billion VND), and Hai Phong (more than 400 cases, nearly 3,200

billion VND)

Moreover, according to statistics, there are five commercial banks that have a

large figure of cases and a huge quantity of money which need to be executed

Specifically, Agribank with nearly 4,000 cases (over 17,000 billion VND),

VietinBank with 1,239 cases (nearly 7,200 billion VND), BIDV with 1,608 cases

(about 5,660 billion VND), Techcombank with 1,236 cases (over 5,400 billion

VND), and Vietcombank with 561 cases (nearly 4,200 billion VND)

Figure 3: The number of cases in some banks

In addition to these five banks, there are about 60 other credit institutions and

banks also have cases that are being executed by the civil judgment enforcement

agencies

3.2 Vietnamese moral hazard cases from 2014 to 2017

There are thousands of cases in Vietnamese commercial banks which are related

to moral hazard problem Most of them were just discovered in 2017 although the

cheating process had started for years Due to time pressures and limited ability, the

Agribank Vietinbank BIDV Techcombank Vietcombank

The number of cases in some banks

writer could only mention some cases from small to big ones in which customers

and banks are the main defendants

3.2.1 Cases caused by customers

 Director cheated 3 banks, appropriated 31 billion VND

On January 9th and 10th, 2017, the Hanoi People's Court opened the first trial of

Nguyen Manh Hung (former director of Manh Hung Ltd.), Nguyen Thi Thanh

Xuan, and Dao Thi Lien for property fraudulent appropriation

According to the first instance, in addition to being the director of the company,

in 2010, Hung set up two other companies and asked Dao Thi Lien to be the

director and chief accountant of Vietnam Metal Mechanics Ltd., and Nguyen Thi

Thanh Xuan (Hung's younger sister) to be the chairman of Vietnam Environment

Equipment Manufacturing Joint Stock Company These two companies did not

operate the business, and the management was all controlled by Hung According to

the allegation, to complete the loan application for BaoVietBank, Nam A Bank, and

HDBank, Hung made up the economic contract and erected the “ghost” partners

After that, Hung directed Lien and Xuan signed a sales invoice

In order to use goods as collateral, Hung hired workers to make 90 concrete

pieces shaped like steel rolls which were armored, strapped and baled Hung

himself printed import and export stamps with parameters and pasted on these rolls

of counterfeit steel Later, he put the goods in a warehouse to prove with banks’

staffs As expected, the staffs of these three banks came to appraise collateral did

not find out about this In two years (2011 - 2012), banks have disbursed more than

31 billion VND to Hung His fraudulent behavior was disclosed in early March

2013 by BaoVietBank and then HDBank and Nam A Bank

At the end of the trial, the Panel determined that, in this case, the defendant

Hung plays the role of mastermind Two accused Lien and Xuan actively helped

Hung carry out the crime Moreover, they have to compensate the entire amount of

money appropriated for all three banks