Luận văn credit risk management in viet nam development bank vdb ha nam branch

In this research, the author has systematized the literature reviews of the credit risk management, analysed and evaluated the real situation in investment lending al the Gia Lai Branch

Credit risk management in Viet Nam

Development Bank (VDB) — Ha Nam Branch

Graduate student: Chu Tat Thang

Supervisor 1: Assoc Prof., PhD Nguyen Van Dinh

Supervisor 2: Assoc Prof., PhD Tien-Tsai Huang

Ha Noi, 2017

Lunghwa University of Science and Technology

Approval Certificate of Master's Degree Examination Board

This is to certify thal the Master

University : Lunghwa University of Science and Technology

Graduate School ; Department of Business and Management

Date :December, 2016 Degree : Master

Graduate Student : Chu Tat Thang

Advisor 1: Assoe Prof, PhD Nguyen Van Dinh

Advisor 2 : Assoe Prof, PhD Ticn-Tsai Huang:

Keywords: Banking and Finance, Credit Risk Managemenl, Vietnam Development

Bank Ha Narn Branch

In a market economy, lending is one of most important activities off a bank

However, the hank’s credit activities are always exposed to many risks such as: Interest rate

risk, forcign oxchangs risk, liquidity risk, customers’ defaull risk, and so on Utilization is the largest and most complex type of risk, When the bank falls into serious financial difficulties, the cause usually arises fiom the bank's credit activities From this fact, expecially the importance of risk management in (he process of financial restruckuring of the bank is urgent and practical to solve the challenge that banks Vietnamese goods are facing

Based on the synthesis of theory on credit risk, oredit risk management and credit risk management models in banking business, This thesis focuses on in-depth investigation Assessment of credit risk management in Ha Nam Development Bank in recent years, achievements, difficulties and obstacles encountered in oredit risk management at Ha Nam Developmanl Rank Since thin, the tyne bas provided practical solutions lo Ñmthơr

improve the effectiveness of credit risk management in the context of the economy being restructured Credit risk is an urgent and priority conecrn,

Mifie research methods: methods of data collection,

ACKNOWLEDGEMENTS

It is hereby to acknowledge that this thesis is carriod truthiully by inysclf All the figures and numbers in this thesis are fom seliable sources and are cited according to the standards ‘The conclusions are honestly resulted ftom the real activities of the examined subject

T would Tike to expross iny sineore gratitude lo the IecLurcs from Ihe International School of Vietnam National University, Hanoi tor their enthusiasm and guidance which has brought

to me valuable knowledge and experiences [ also would like to say a special thanks to Associate Professor, Doclor Nguyen Van Dinh for your care and thoroughly guidance

during my time working on this thesis Besides, | want to cxpress the warmest thanks to all

the managers and the staff of VDB — Ha Nam Branch who created favourable environment for me lo colicel data and information lo cornplete this thesis

Despite my bes! cffort to the accomplishment of his thesis, the Timilation and iwisiakes arc unavoidable, Therefore, I am open to reccive all the valuable suggestion and advice from the lectures to improve the resuits of my thesis and make it become more applicable in the Tny work and practice

Chu Tat Thang

1.2.1 Credit risk — TH nh HH HH thư,

1.2.2 Credit risk management

CTIAPTER 2 METHODOLOGY

2.1 Methodology

2.2 Seoondary data collection method HH n0 0e rre

2.3, Secondary data processing method (data anaÌysis) osec

2.3.1 Aggregate analysis method

2.3.2 Comparative and statistical method

2.3.3 Methods of evaluating and analysing policy documents

2.3.4 Method of gathoring information in official channels

CHAPTER 3 CREDIT RISK MANAGEMENT AT VDRB —- HA NAM BRANCH

3.1 Overview of Vick Development Bank - Ha Nam Branch

3.1.2 Organizational Structure of Vietnam Development Bank - Hla Nam

3.1.3 Some key performance indicators of Viet Nam Development Bank Ha

3.2 Curent silualion of credit risk management al the Vicuxam Development

3.2.1 Credit policy of VDB-Ha Nam Branch,

3.2.2 Crodil procedure

3.3.2 Achievements

3.3.4, Reasons for problems

CHAPTHR 4 PROPOSED SOLUTIONS TO IMPROVE CRUDIT RISK

MANAGEMENT AT VIETNAM DEVELOPMENT BANK-HA NAM BRANCH

4.1 Credit development orientation at Ha Nam Development Bank

4.1.1, General direction

4.1.2 Specific direction

4.2 Proposed solutions to improve credit risk management al the Vichran

Development Bank 1a Nam branch

4.2.1 inprove the quality of credit appraisal and analysis,

4.3.2 Inprovemeont the managomont ad monitoring oŸ dcbt

4.2.3 Dealing with overdue đebts and NPLa, is coe

4.3.4 Tnmoving the moniforing o[ loạn security assets

4.3.5 Hnhanee the role of Internal inspoction and control

4.2.6 Improvement of the quality of credit staff

4.2.7 Improvement of the cfficicney of processing credit information systems

4.3 Some recommendations to the Vietnam 1)evelopment I3arik

43.1 Developing credit scoring and internal customer ratings

43.2 Measures to support debt recovery and debl recovery for affiliates

4.3.3 Strengthening the Debt Recovery Facility

38

CONCLUSION REFERENCES APPENDIX.

LIST OF TABLE

Table 1.1 The maximum deduction rates of the collateral 23

'Table 2.1 Term loan struciure coentnnhnHrehreHerrec 38 Table 2.2 Business Performance from 2013-2016 39

Table 2.3 Structure of outstanding loans by group of Buterprises cuslorers under VDB Ia Nam on Decernber 31, 2015 — 2016 is 4 Table 2.4 Credit risk allowance on December 31*, 2013-2016 at VIDB Ha

‘Table 2.6 Details of general provision for debt groups as of December 31",

Table 2.7 Sourees of Bad Debts of VDB Ha Nam sec 52

‘Table 2.8 Bad debt and bad debt ratio of VDL La Nam from 2013 201653 Table 2.9 Branches with a high non-performing loan ratio as of 31/12/201 54

‘Table 2.10, Credit classification at Ha Nam Development Bank 2013-201657

LIST OF DIAGRAM Diagram 1 Credit risk management procedure

Diagram 2, Organization chart of Ha Nam Development Bank

Diagram 3 Loan providing procedure at VDB

vũ

INTRODUCTION

1 Rationale

Nowadays, the highly development of the economy aml the actively economic markets has been expanded among the relationship between the domestic and international economy It is the beneficial environment for the development of the

in gencral andl the barking industry specifically However, along with this development, there are highly risks associated with the opportunities that the integration of the intemational financial markets has brought about

In the banking industry, there is a close relationship between customers and the economy through the banking services, Le borrowing and lending activilies, Therefore, the risks associated with these activities are compheated and could show up at variety of forms and at different levels Among the risks, in case of happening, credit risk could

have cnormous cffecis and dircelly infucnee the development of thesc financial

institutions At the higher |

be affected seriously because of the special features in the credit providing activities and other banking services

, i is possible thal (he banking system in general conld

The Vietnam Developrnsnt, Bank — Tla Nam Branch is a financial institution without

focusing on the profils The m

i1 objectives of the bank is to provide the loans for projects at industries and areas with difficulties, for the programs which have direct effects on the transformation of the economic structure and to foster the sustainable development of the coonomy Due to the aims of the Joms which ar to cneouege investment and increase the efficiency of the society, the above projects and programs are granted a lot of benefits such as long-term loan, collaterals ftom the assets which are crealed from the loan ilself As a resull, the loans are aecompanicd with many risk factors, P Volcker, the former chaxman of the Federal Reserve of the United States (PED) believed that: “A bank which do not have the bad debis is not doing business” Thus, credit risk is always in existence and is an obvious faclor of any bank Hawever, the difference between banks with good and bad credit risk management system lies in the control of the acceptable bad debt ratio due to the efficient and suitable management

to Timnit the crodt risks which are derived ftom the personal views and other controllable

credit risks,

Because of all the problems discussed above, 1 choose to focus my research on the

“Credit Risk Management in Vietnam Development Bank (VDB) — Ha Nam

Branch”

2.The objectives of the thesis

According to the summarization of the literature review and different models of the credit risk management, this thesis focuses on the analysis and evaluation of the credit rik management al VDB —Tla Nam Branch including the achievements and difficulties After that, this thesis will suggest some feasible solutions in order to increase the efficiency of the credit risk management procedure in the cưrzni economic environment wheu the implementation of the banking systern Tustrueluring al, which credit risk management is highly emphasized and is the main priority

‘Owing to the above objcctives, the thesis will bring togcther the following contents

= Systematizing the Htcralure reviews of the credit risk and Ihe management of the credit risk in banking industry

- Defining the real situation including the achievements, the limitations and the issues in the credit risk management procedure in VDB — Ila Nam Branch

- Suggesting the solutions in order to strengthen the credit risk management system applied in tho VDP — Ha Nam Branch

3 Scope uf the thesis

Research subject:

The main subject of this thesis is the credit tisk numagement procedure in

Vietnam Development Bank Ha Nam Branch,

Research scape:

This thesis focuses on the management of credil risk in VDB — Ta Nam Branch and the suggested solutions in order to improve the efficiency of the credit risk management procedure in VDB — Ha Nam Branch

4.Methodology

‘The thesis acguiras diffarent methods in order to take advantages of the strengths of

each method including collecting the data, summarizing, analysing and comparing the

results, Besides, statistics method is also applied along with the experiences of the

author and other researchers,

§ Expected cuntribution of the thesis

The thesis is projected to cvaluate (he real business aclivilies al VDB — Hà Nam

Branch so thal it could

st the managers of the branch in impraving the cfficicney of

the credit risk management procedure and the business activities in general

6 Thesis structure

Apart from the content, lists of tables and abbreviations, introduction and

conclusion, the thesis is divided into 4 main parts:

- Chapter 1-'Pheoritieal background and literature review

- Chapter 2: Methodology of the research

- Chapter 3: Credit risk management at VDB — Ha Nam Branch

- Chapter 4: Proposed solutions to improve credit risk management at Viet Nam

Development Bank — [Ja Nam Banch.

CHAPTER 1 LITERATURE REVIEW AND

THEORITICAL BACKGROUND

1.1, Literature review

Nowadays, despite the unfavourable condition of the financial market, the commercial banks in Vietnam is still expanding the scope of their business, the list of the investment portfolio and increasing (he quantity of their products and services as well as loosen the requirements for the borrowers in order to keep their former customers and attract more potential customers Consequently, the risks associated with the bariking business are inercasing significantly, ospocially Iho credit risk Thoreforg, it

is undeniable that there has been a lot of research which are carried out on the topic of the credit risk management in banking sector For example:

‘The Doctoral dissertation “Yhe credit risk management in Vietnam Bank for Agriculture and Rural Development of the research student Nguyen Anh Tuan,

majoring in the Finance Banking Economies, supervisor Professor, Doctor Cao Cu

Boi, which is defended at the judgement council of national level thesis and dissertation

at the National Economics University The research made new contribution to the

academic view of the credit risk and the management of the credit risk al the current

international integration banking industry In details, the dissertation has brought about

the fimdamental factors to identify credit risk in Vietnam, including the early-

recognition fielors and the snethod to measure (hese faclars TL also proposed the model,

which can be used in measuring the credit nsk factors in the present and in the fuature, to

establish the rating and ranking system depending on the customers’ database in comply

with the intemational standard By combining the eredit risk managcment principles of BASEL Committee and of Viemamese standards, the dissertation has set up a relatively

adequate rating system in order to evaluate the credit risk management procedure in

Vielmam banking seetor— which used to be the linrtation of previous rescaych in

Vietnam It could be said that the results from this dissertation is an important principle

to bring and ensure the success of a completed credit risk management strategy in Viet conumercial banks in general and al the VieIam Bank for Agriculture and

Rural Development specifically

‘he Master dissertation in Finance and Banking “Credit risk management in invesiment-purpose loans wi VDB — Gia Tai Branch” (2014), which is carried out by Vo Hoang Thach In this research, the author has systematized the literature reviews of the credit risk management, analysed and evaluated the real situation in investment lending

al the Gia Lai Branch of VDB in 2011-2013 period, Morcover, the author identified the achicvement and limitation of the credit risk management procedure at the examined entity and proposed some solutions for improving the procedure as follows (1) Entumcing the quality of the loan especially af the slages of assessment, disbursenent and debts recovery, establishing the bad debt classification system in conformity with the business practice of VDB, the procedure for setting up the Allowance for credit los

s und the resolutions for recovering the bad deb in order to reduce the rate of general non-performing loans to under 7% in 2015, 4%-5% m 2020, 3% during the period of 2020-2030 (2) Credit institutions, except the branches of foreign banks, should maintain the minimum capital adequacy ratio 9% which is the rate of owner’s

equity and the risk weighted asscts

The article “Credit risk management models in Vieinan commercial banks” of Master Nguyen Duc ‘It — lecturer of the Human resource development and training

school, on the official website of the Vietnam Banks Association on 25 November

s of 2 credit tisk

2011 The article focused on analysing the strengths and woakry

management models including concentration model and dispersion model which are applied in Vietnam In addition, the article also suggested the direction for establishing the adequate model which could be applied in Vietnam commercial banks in the near future

The article “Reduce the credit risk in Vienam commercial banks” of the author

Duong Thi ‘hanh Hai on Financial Market Reviews Issue 7 in April, 2013 The article

emphasized thal the banks should understand clearly the risks associated with banking business, especially the credit risk, Moreover, the evaluation of credit risk in order to propose the suitable solutions is the mam prority to ensure the safety and efficiency of

banking busine:

the current banking system,

The mticle also suggested some solutions to reduee the credil risk of The above mentioned research and articles relates directly or indixactly to the thesis topic However, depending on each period of time, the management of credit risk

should be reviewed and then propose more adequate policy in accordance with the

updaled situation Thersfore, the new rescareh should be conducted to

ist the banking sector with the more feasible solutions 1 choose this thesis topic with the ams of contribution to the improvement of the credit risk management procedure in VDI — la

‘Nam Branch,

1.2 Theoritical background

1.2.1 Credit risk

12.44 Definition of credit and credit risk

Lending is one of the most important business activities of a bank because the majority of the bank’s income derives fiom this activity According to the statistics,

about 60% to 75% of the bank’s profits comes from the credit providing However, it

also the source of enormous potential risks Some resgarch shows thal credit risks make

up about 70% of the lotal risks in barking business, TL eanmot he dented that maximizing, profit with acceptable rate of risk is the nature of banking business, The fonner chairman of HD, P Voleker believes that “A bank which do not have the bad debis is

not doing busin

is still considered as the main source of the assets losses and could lead to the bankruptcy of a bank There are different definitions of credit risk

* Allhough there is a lol of innovation in banking sector, credit risk

According to ‘Thomas P Fitch: “Credit risks happen when the borrowers are

incapable of paying the loan at the maturity of the credit contract” Along wilh the

interest sisk, credit risk is one of the main source of risk in the lending activity of a

bank

Sanders and H Lange also define “Credit risk is the potential losses when a hank provides loans for a customer, ie expected profit from this activity is infeasible

when it comes to the quantity and the deadline for payment as well”

In the item | Articl: 3, Circular 02/2013/TT-NHNN, in effect from 21° January, 2013, detines: “Credit risk in banking business (known as risk in abbreviation) is the possible

losses which could accur ta the lon of a credit institution, a branch of the foreign bank

due to the non-performance or incapability of customers to pay the partial or total amount of their ebligations as commitment”

In this thesis, credit risk could be understood as the potential losses that might

happen in case the counterparty és unable to fulfill his/her obligation on time as being speerfied on the credit contract

124.2 Characteristics of credit risk

From the view of the nature of credit relationship, the definitions as well as the signs

of credit risk, it can be scen in the following features:

- Credit risk has the indirect nature

This feature comes from the consideration of credit relationship between the bank and its customer When the loans is provided to the customer for the pre-determined period, it is possible that losses can happen during this time, However, because the use

of the loan is depended on the intention of the customer, i is difficult for the bank to recognize these losses in the most accurate and completed way when the business of their customers are in trouble

- Credit risk are complicated and naultiform

‘This feature can be seen in the complicated and multiform nature of the sources, appearances ant consequences of credit risk IL could be considered as the unavoidability of lending activity because of the intermediary role of banking system in monetary market This feature is also seen as the result of the first feature because the indirect nature of credit risk, in tum, enables it to become more and more feasible to

experience the complicatcd and mulliform characteristic of credit risk

- Credit risk is unavoidable and always comes logeiher with the lending activity

of a bank

Asymmetric information could be seen as the mam reason that the experts and bankers as well consider banking business as managing the acceptable rate of risk in

proportion Io the profits Because it is impossible lo achicve the slate of symmetric

information in lending activity, any loan is exposed to the risk of capital losses

12.1.3 Credit risk classification

There arc varicty of critcria to classify crodit risk so that which factors could be used depends on the objectives and requirements of the researchers If the sources of

credit risks are used to consider, it could be categorize as below

Transaction Risk is the type of credit risk that derives from the limitation of the transaction and assessment of the customers and the loans It comprises of 3 main parts: Selection risk, Underwniting risk and Operation risk

+ Selection risk involves the assessment procedure and credit analysis in order

to select the efficient lending projects to provide loans

+ Underwriting risk comes from the insurance provisions in the credit contract

such as the collateral, subject, method and the credit limit calculated on the

value of the collateral,

+ Operation risk is the risk that accompanies with the loan management and

lending activity including the use of ctedit rating system and the mechanism to

handle the doubtful debts

Portfolio risk is a type of credit risk which comes from the limitation in managing the lending portfolio, including two parts: intrinsic risk and

concentration risk

+ Intrinsic risk itself derives from the internal characteristic of each borrower or the specific features of each industry and economic sector In particular, it

depends on the business practice and the usage of the loan of the borrowers

+ Concentration risk occurs in the case of over-concentrated lending portfolio,

ie the bank providing loans to too many companies operated in one specific

industry or area or the same high-risk loans.

Apart from the sources, credit risk is also categorized by other criferia such as

objective/subjective featwres of the loam, structure of cach type of risk or the

classification of borrowers,

1.2.2, Credit risk management

L224 Credit risk management in commercial banks

Overview of credit risk management in commercial hanks Definition of credit risk management

Credit risk is an incvitable factor in banking business If it is known elcarly then

the risk could be accepted in with full awareness and be controlled under suitable method In addition, it is possible to measure and predict the credit risk so that it can be

lackled efficiently

Credil risk mramagemenl is a procedure thal involves the managing mechaniste of

a bank to predict, to issue warming and to propose solutions in order to keep the

potential losses at the mininmm level

According to the Basel Committee, credit risk management is a course of action

including setting up the mechanism to identify the risk, to quantify, to tackle and to

contiol the current and potential losses in lending activity at the most completed way in order to maxirnize the profit in proportion to the risk-adjusted factors by maintaining the

aceaptable level of credit risk

As a result, credit risk management can be understood as the commercial banks

take advantages of their professional skills and knowledge to control the lending

activity and to minimize the potential losses that could in tum directly affect other risks

in banking business, leading to the bankruptcy

the necessity of credit risk management

It is undeniable that the credit providing activity is the most profitable part in

banking business Towever, this also means (hal il can be seen as the highest risk

activity which could lead to the devastating consequences in not only the banking

system but also the economy and society

Meanwhile, credit risk is unavoidable that exists in unbiased form along with the lending activity Managing the credit risk plays an important rote in ths maintenance of

an acceptable level of credit losses to ensure the highest level of safety and efficiency of

the banking business with sustainable growth vale

The objectives of credit risk management

The management of eredit risk should be considered in relation with the lending, business and the administration in general, The main objective is to ensure the efficiency of lending activity and continuous improvement of the loan quality even in the case of market fluctuation with high potential rate of risks In more specific, credit risk management involves reducing the ratc of risk while improving the safcty level if banking business by acquiring the effective policies and supervising techniques

Basel credit risk management principles

Basel is also known as the Basel Conmnittee of Banking Supervision, established by the central banks of G10 countries since 18 century under the sponsoring of the Bank for International Sctticment (BIS), Basel Il is a comprehensive sct of reform measures replacing the Basel I reform which was in effect since 1988 in order fo assist commercial banks in managing risks more effectively Particularly, there are 17 principles about bad debis management which ean be scen as the sot of regulation in managing credit risk to ensure the efficiency and safety in lending activity The key features of these principles are described as follows:

* Establishing adequate lending environment (3 principles)

- Prineiple 1: Approval and examination of credil poticics periodically, review the acceptable level of risk and profitability ratio,

- Principle 2; The process of implementing credit policy, establishing lending procedure for individual loans and the credit portfolio as a whole in order to idowify, evaluate, manage andl eontrol Ibe credit risk

- Principle 3: Identifying and managing credit risk in all products and services, assuring that they should go through all the stages of controlling procedure and are supervised carefally

* Performing healthy lending policy (4 principles)

- Principle 4: Tending activity shoud depend on healthy crileria with clear identification in borrowers, objectives, credit structure and sources of payment

Prinsiple 5: Setting up the credit lines for each types of customers and groups of borrowers to identify the different types of eredit risk that could be tracked on

the business accounts, on- and off-balance sheet accounts

Principle 6; There should be a clear procedure for approval of credit lines as well as modification, extension of the loan term, restructuring and refunding

policy of the curren loans

Principle 7: The credit business should be conducted in the fair basis among

Principle 9: There should be Iacking system to supervise the condilion of

individual loan, including the measure of the allowance for credit losses

Principle 10: Enoouraging the bank to develop and apply the internal credit rating system in managing credit risk procedure

Principle 11: Commercial banks should acquire the information system with analysing Lcehrriques lo tacasure the credit risk in all om and off-balana sheot

accounts

Principle 12: There should be a special system to track down the structure and quality of the lending portfolio

Principle 13: Commercial banks should consider the effects of economics

changes on their lending activity

Ensuring the completed conrolling system (4 principles)

Principle 14: Establishing the independent credit rating system which could be used contimously and reported regularly to the Board of Directors and Senior

Managers

Principle 15: Loan providing procedure should be monitored in the most completed method, in particular, it must comply with the cautious standards and acquite the internal contzol process with any violence of the credit policy being,

1

- Improvernent of credit risk mamagetent stall,

- Fstablishing the managing system with updated information in order to identify, measuring and tracking the loans at the adequate level which can meet the requirement of credit risk management procedure,

+ Credit policy and the procedures

* Credit policy and procedures

‘The credit policy und procedures is considered nol only as the guidance for the daily lending business but also the method to manage the credit risk which is curently applied at commercial banks ‘Thanks to these documents, the development of the credit

business is under control it assists to orientate the growth of the credit business,

- Assigning the level of management, prioritizing the customers according to the

12

geographical areas and the bank’s policy Clearly defining ths situations to

promote or la restrict lending

- Bstablishing the safe, efficient and comprehensive credil policy for individual or group of customers, In order to enter the credit contuact with the particular kind

of borrowers, it is essential that the banks examine the creditworthiness of their customers in the mast comprehensive way which depends on ths credit portfolio

of the bank including types, terms, sizes of the contract and the quality of the provided loans

- Assigning the responsibilities to each credit staff ie, not all the credit staff are possible to be in charge of and lo manage the large-scale loans In addition, the managers should divide their staff into separated groups and allocate the credit lines to them, Moreover, the allocation should be determined on the ability and the current working condition of each group,

- Within each group, there should be clear intemal procedure to assign responsibilities and 10 report,

- Bach admission, examination and delorminalion stages of loan providing

procedure should be reasonable and can minimize the potential losses

- The lists of acceptable and inacceptable collatcral

* Credit risk management policy

In order to meet the objectives of credit risk management, commercial banks should

ealaHish the adsquale policy which includes the lists of viewpoint, solution, instruments proposed by the Board of directors on the general director's suggestion to manage outstanding loan and credit risk It is essential that the credit risk should be recognized

and measured al carly stage and roported promptly to the board of directors,

board and the executive committee

‘Once being defined, credit risk should be analysed, measured and proposed the suitable solutions in order to manage and track down easily Meanwhile, the management system should bs able lo identify the potential risks then repeating the

management procedure

Credil tisk management policy includes the operation policy, lending activity policy, creditworthiness assessment policy, measurement policy and bad debts handling

13

policy

+ Credit risk management models

Credit risk management model can be seen as the group of sub-model including the mmagemenl model, theasurcrncnt modest and tisk control model which are sel up and operated in the comprehensive and continuous system, It reflects the fundamental parts of credit risk management such as the policies and procedure in order to maintain credit risk within acceptable level or the measuring instruments and supervising activities in order to identify the risk and apply timely and suitable solutions

It is vital that the risk model should ensure the efficiency and continuity of the lending business while raising the level of credit quality even in the fluctuation of the market At current time, there are 2 popular models which are applied at the commercial

‘banks in Victnatn: the concentration

pode] and the dispersion madct

¥ Concentration credit risk management model

The most distinctive feature of ths concentration modet is that the customer assessment stage and the sisk management stage are the responsibility of the head office

ot depend on the geographical areas Branches of the commercial banks are only

responsible for the sean and skim of the customer's profits then deliver it to the head office, It allows the scparation of cach function, iv the operation, conduction of business and risk management which all aims at the main priority to minimuze the potential fosses and to maximize the abitity of each credit staff in a bank

+ Strengths of the model:

The concentration model allows the overall risk management in banking system and assure the long-term competitiveness of the bank Meanwhile, it creates and maintains the comprehensive cnvironinen which is suitable for the activity of all the departments, enhancing the contro! of the credit risk, establishing the nnified risk management policy which is completely separated between business function and operation function

head office under specific set of criteria Moreover, the credit staff should acquire particular skills and knowledge and arc capable Le apply theories in the real practices

* The concentration credit risk management model ix suitable for the large

commercial banks

Dispersion credit risk management model

‘The dispersion model requires the assessment of customer and risk management being conducted at branches instead of the head office as the conccniration model Therefore, the head office is only responsible for the general orientation and are in charge of the special customers that the branches are unable to take care of As a result, the 3 main fimetion of a barik, ic risk mmagement, conduction af business: and operation are all taken by the credit department

* Strengths of the dispersion model

‘The dispersion model only requires simple and orderly operating system so that documents humdled by the customers are processed quickly and the establishment, and operation of the model do not take times and effort

* Weaknesses of the dispersion madel

‘The model lacks of specialization because of the concentration of the 3 fimctions of lending business within Ï departrront ofa branch The distant roports Lo the head office depends on the subjective of each branch and the head office only manages the loan indirectly which can be resulted in the difficulties in risk management

* The dispersion credit risk model can he applied in meditmn- and small

commercial bunks,

Y The orientation of credit risk model application

According to the real practice in lending business, the recommendation of the Basel Committee and international standards as well as the regulations and technology

systorn and Tumnan resources in Vietnam, the concentration credit risk management

model should be applied,

At the head office; the lending decisions and the risk management fiction should

be scparated acvording to the assigned resporsibilily of cach department including the assessment, approval, credit management and credit risk management

15

Ai the branches: to split up the sales fiinction (marketing and customer services),

The ercdit analysis department, in tum, should be abic to process the information, collecting additional information through the interbank sources, CIC questioning and on the media, The department then conducts analysis and overall assessment of the customer’s creditworthiness from the general aspects to financial ability, loan projects and collaterals After that, they will report the results directly to the supervisor who can make the approval decision The results then wilt he telumed 1 the credil, amalys

department for storing and be dativersd to the customer services department to undertake the next stages

+ Credit risk management procedure

The credit risk management procedure can be described as follows:

Diagram 1 Credit risk management pracedure

Measure credit risk

Control and prevent credit

risk

Process ¢ credit

Source: Chrinko R.S Guill (2000 "A framework for assessing credit risk in

depository institution” [60]

Lach stage is described in detail as follows:

Adentify the credit risk

Identifying the credit risk is an important aspect in credit risk management I is

undeniable that the potentiat losses should be identify at the early stage to propose the suitable solution and minimize the potential losses It is believed that credit risk only occurs whion the loans are approved and provided However, if the assessment stage is not comprehensive enough, it could lead to the losses not only the income ftom interests but also the bank’s capilal, Therefore, Ihe thesis defines : “Tdentify risk is ths continuous process fiom the loan assessment stage until all the debts are recovered including interests and capital payments, the credit risk appears in the ease customers are predicts to be unable to return the loan to the bank on time”

+ Firsily, pre-lending identifying credit risk

Identifying oredit risk before lonting car be seen through the loan appraisal This is

an important step when making a loan decision, The assessment of loans includes

financial information and non-financial information of the customers

- Non-financial indicators: ‘This is a set of non-quantifiable oriteria reflecting the customers’ stalus including: legal capacily, repayment of customers in previous borrowings, Noz-financial factors help the bank in assessing the partial of the potential risks in each loan, Although the bank might consider many criteria for providing loans tơ their customers, they usually focus an 6 fundamental criteria which are called "éC” including: Character, Capacity, Cash flow, Collateral,

Conditions and Control According to the 6 mentioned criteria, credit staff

should be able to answer 3 questions before continuing wilh the disburscient stage: (i) Is the client cligiblc? (ii) Is the credit contract adequate and valid; G1) Can the credit institution are able to recover the debts by collateral or income

when the borrower defaults?

+ Finaneial indicators: In ordcr to calculate and cvalnale the Gnancial indicators:

credil staff should be able to perform the following sleps:

Step 1: Collecting information and analysing the financial status of the customer

Solvency ratios such as current ratio, quick Taio, cash ratio If the solvency ratios are too low, it can be seen as a sign that the repayment capacity of the business is

a problem and are possible to result in the credit nsk

Debt ratio shows as one unit of assets is in proportion to how many unit of debts

The use of debt will boost the income of the business but also cause financial risks, On the bank’s perspective, the debt ratio of the business should be as low as possible because it is safer when one unit of assets is in proportion to as many as possible unit of dchis

Performance ratios such as inventory tumover, receivables tumover which reflects the length of an inventory or receivables cycle depending on the characteristics

of each industry However, if the cycles of inventory and receivables are too long compared to the average figure of the industry, it can be undersload that the capital cannot be used efficiently in investment leading to difficulties in production and other business activities of enterprises and affecting the ability to repay the principal

Profitability ratios suggest that if the profitability of the business is high compared to the overall calculation of the industry, this partly ensures the ability to pay

inlerest as well as Ue: principal for the company

Step 2: Processing information

Aller collccting information, credit staff arc in chirge of screening these information to analysc and cvaluate the financial ability of customers Based on that, the credit staff will identiffy the risk to provide loan or to refizse Joan and other conditions to limit risks

Step 3: Identify the risks of the customer to recognise (he credil risk

+ Secondly, identify after-lending risk

For after-lending monitoring, banks need to regularly review their loans so that tunely detection of potential risks can helps to prevent and to reduce the credit risk Tere are some signs of a problem bank loan:

- Customers avoid or credit staff cannot contact with customers

- Frequently violating finaneial terms under the agreed credit contract

- Revenue increases abnormally

- Customers have large purchascs without legitimate causcs or unsuitable

financial resources.

- The companies do not provide timely, completed, truthful related information

- Having difficulties in borrowing money at other banks! Less favourable terms on

the credit contract

- Changing kcy positions in the company board of managars

- Revenme fiom sales deercaszs or incrcases abnonnally

- Unreasonable sales price and sales price potiey

- The increase in debt/investment for subsidiaries, joint ventures’ associates or

individuals involved in the business,

+ Tnercase in the payables account

Credit risk assessment

Risk measurement is an important stage after identifying and detecting credit risk The mcasurement of credit risk helps the bark ta clitninate the Joan ta Tigh risk

customers and to recognise the potential risks

‘At present day, the world is beginning to pay close attention to quantify credit risk and to apply of modem methods and models of risk management Here are some of the

credit risk incasurciment models which ars currently in asc:

* Credit risk measurement under Base! H framework

Commercial banks will use the models which are based on their internal data systems to determine the possibility of credit losses ‘Ihe commercial banks will define

the following variables:

PD (Probabitily of Default): probabitily of customers cammol pay the debt;

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LGD (Loss Given Default): estimated loss ratio;

EAD (Exposure at Default): total outstanding debt of customers at the time the customer are insolvency

Depending on the above variables, commercial banks will determine EL (Expected Loss) For each specified term, estimated losses can be calculated based on the following, foruzula:

FL=Ph * LGD * FAD

That is

PD: The basis of this probability is the historical past ligbililics af the custorners, including paid debts, in-term debts and inrecoverable debts

LGD is the proportion of the losscs on the total outstanding loans at the time of

default The estimated loss ratio can be calculated using the following formnla:

LGD = (EAD - Amount recoverable) / EAD

EAD: total outstanding loans of cusotmer at the tite the customer cannot repay the debt The Basel Committee required the LAD to be calculated as follows:

EAD = average outstanding debt + LEQ x Average umsed credit line

In particular, LEQ (Loan Equivalent Lxposure) 1s the proportion of unused

capital is likely to be withdrawn more at the time of default

* Measurement of credit risk by internal credit rating system

The internal credit rating system is a combination of procedures for classifying customers by industry, size, ownership, financial indicators and non-financial indicators for scoring purposes, The internal credit rating sysiern is an important tool in managing and monitoring the quality of loan to each customer as well as the entire loan portfolio

“The good intemal credit rating system are able to tell the difference between the levels

of tisk in lending activities of commercial banks Tl also allows a more precise definition

of the characteristics of the loan portfolio, the level of problem Joans and the adequacy

allowance of Joan losses

‘The internal credit rating system must be developed specifically for the three targeted groups: corporate customer, individual customer ard business household of the

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credit institution, ‘The total score of the program is determined on a maxinmm scale of

100 divided by Gimeial indicators and non-financial indicalors al a certain propention Highly rated customer can be understood that the bank's good judgment on the customer and its ability to recover the lending, the provision for loan interest rates and other conditions will be more favourable than those wilh fowcr scores Currently, this zacthod

is used by many commercial banks in Victnam and has obtained certain results in the process of screening and selecting good customer for providing loans

* Measurement of credit risk by Z-Score model

7-Scora model (%-Crotlit scoring model) is set by ETAltman to oblain the credit

scores for US mamafacturing companies Z-Score is measured to classify credit risk for borrowers which is depends on

+ ‘The numeric vatue of the borrower's financial factors (Xj)

+ ‘The importance of these indicators in determining the probability of a borrower's dofaull in the past The model is described as follows

Z=12K%1 [4X21 33X51 06X41 LOXS

“That is:

XL: "Net Working Capital / Total Assets"

X2: "Cumulative Profits / Yotal Assets”

X3: "Earnings before tax and Interest / ‘Total assets"

X4: "Stock price / book value of long-term debt"

X5: "Revenue / Total Assets"

The higher the Z-score, the lower the probability of a default, So when the Z value

is too low or a negative munber, it will be the time for classifying customer in the high- Thk group

Z.<1.8: Thọ cusotirer is likely to be at high risk,

1.8 <7, <3: Unspecified

3: The customer is untikely Lo default

Any company with a Z-score of <1.8 must be classified as high credit risk

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Control and prevention of credit risk

Checking and controlling credit risk helps to detect errors in the credit providing Procedure Tt can also help to prevent risk According ta Basel IT framework, commercial banks must establish credit control department which is independent in

design, implementation and operation of ifs internal rating systems ‘Chis department

should also be separated to tha mamager who must take [he tesponsibilily for ereating potential risks This is to ensure the unbiased and accuracy during the regular credit control and credit risk management control procedure In order to perform well the credit risk tmanagemen! procedire, the bank should enhance the following duties

- Credit monitoring: ‘he bank supervises the customer through account activity, periedic Rmameial ømalysis, loan guarantce and information fom cxternal

sources

- Loan insurance: The implomentation of any form of loan inswance depends on the particular status of the client and the internal policy of the bank, In order to

minimize the credit risk, loan insurance should:

+ Loans insured by assets: Accurately assess the ownership of assets, whether they

are in dispute or not? Assuss the markel value of cusront and future asscis, determining the level of the devaluation of the asset within the guaranteed term

‘The procedure must be in accordance with the regulations of the authority and of

the specific industry

+ Loans insured by # guarantee: Rivaluats the legal abilily, financial capacity and willingness of the guarantee, Ensure the guarantee procedures

The table below shows the maximum discount rales which arc used (o determmne the

deductible value of collateral assets in accordance with the latest regulation of the State Bank of Vietnam - Circular 02/2013-NIENN on the basis of comparison with the

deduction rates of the same type of collateral under former regulations, Decision

493/2005-NHNN and Decision 18/2007-NHNN

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‘Table 1.1 The maximum deduction rates of the collateral

Maximum Maximum | deduction rate

rate (%) former

regulation

Gold ingot, except the gold that is invalid in listing, gy, 95%

other type of gold, deposits in foreign currency we oo

Government bond, transferable _ instruments,

certificated sceuritics issued by the credit institutions Applied to the themselves; savings book, deposit certificate, treasury government notes, Dill of cxchange issucd by the crcdiL ‘bond only

inshiutians and forcign banks

Securities issued by the different credit institutions agg, 20%

Securities issued by the different companies which ca, 65%

Unilisted securities, certificated securities issued by

the listed company, except the certificated securities

issued by the same oredit institutions; savings book, 50% 50%

CDs, treasury notes, bill of exchange issued by the

credit institutions and foreign banks

Unilisted securities, certificated securities issued by

the unlisted company, except the certificated

securities issued by the same credit institutions, 390% 50%

savings book, CDs, treasury notes, bill of exchange

issucd by the credit institutions and forcign banks

Unilisted securities, certificated securities issued by

the company which already applied for listing in the 30q 30%

Exchange

Unilisted securities, certificated securities issued by

the company which have not applied for listing inthe 10% 30%

Exchange

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(Source: Circular 02/2013- NHNN effected on 21/01/2013)

Table 1 indicates the maximum deduction rate under the new regulation much tighter and the discount rate has been significantly reduced for some types of collateral against the former regulations This also means that the value of the eollatcral asscts under the new regulations will be reduced accordingly and the specific provisioning for the loans using these collateral assets of the bank should be increase

Handlling the losses in case credit risk occurs

Solutions for dealing with this situation are implemented when the loan cannot be

recovered, so that the hank rust lake slurdy measures lo recover the maximum amourtt

of debt The solutions include:

* Debt recovery

Bank decides to recover the debt by terminating the loan agreement to reduce

further costs incurted duc to loan losses The bank recevers the debt by asking the

customer to pay the debt to them If custorner has fully repaid the amount owed to the

bank, the contractual relationship between the bank and the customer is terminated If customer fails to return the fiili amount or not repay the bank's total debts, the hank will

continuc to apply the following measures to recover the mazdmum amount of capital

such as asset sales or debt repayment, litigation, selling the debt

Compulsory sales of the collateral: ‘The bank will try ta persuade the customer to

voluntarily sell their assets If the customer refuses to do so, the bank will proceed to

sell tnorigages under the supervision and judgment of the law enforacment

Debt repayment by guarantee: The bank will require the guarantee to repay the loan on behalf of the customer because the loan is guaranteed by a third party ‘The guarantee is obliged lo repay the debl on behalf of the enstomer for the outstanding

umommL

Court actions: Tn case the collateral and the guaranice do not mel the payment

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obligations with the bank, the bank can use the lawsuit to recover all the money Bank

must preparc the necessary legal procedures for the lawsuit

Sales of debt: When the bank cannol recover ils debl, the bank can use he debt sales method, ie, selling the debt and the value of debt to another organization Collected debts are often much smaller than the former value of the debt, but this is also

4 way of recovoris a portion of tha debl, Debt sales is oflen applied to larga valuable businesses that sell the entire business or part of an enterprise for the purpose of replacing the board of managers with the new leaders, which might be able to recover the business aetivity of the company

Tncenlives for debt recovery: Partial inlerest vale exemption, interest reimbursement,

no interest penalty, which can be applied to the customer intending to pay back the

loan

* Tandling by the reserved find

Using a reserved fund to rmke up for credit, losses only exacerbates the fimmecial situation of the bank It does not mean completely eliminating debt for the plan For debts covered by the reserved fimd, it will be transferred to the off-balance sheet tor fall collection, banks still have to take measures to recover the debts

+ Measures for bunk officers and related departments in the bank

In addition to the above solutions, based on the Icvel of risk and the responsibility of

the staff, the bank will choose the level of penalty (this should be based on the internal

regulations of each bark) ax: To take responsibility, to pay compensation, to handle the

review, to dismissal or be fined according to the regulations of the bank

~ Credit risk management assessement

To assess credit risk management, there arc many indicators, However, within the framework of this thesis, the following indicators may be giver:

Firstly, the growth rate of the outstanding loans

Outstanding debls at year t—

Outstanding debts at year (t-1)

Growth rate of the

Normally, the growth rate of the outstanding debts is stable and in corresponding with the ccanomy’s conditions, which implics thal crodil risk management of commercial banks is effective

Secondly, the structure of outstanding debts

A commercial bank with effective credit risk management will have a reasonable credit balance structure to minimize the risks and to maximize the profit to

NPL ratio is one of the indicators thal reflccls the quality of the loans, If the rale

of bad debt over the years tends to decrease, it implies that the management of credit risk of commercial banks also tends to improve In contrast, if bad debt ratio tends to increase significantly over those years, the bank's credit risk management activities need

to be reviewed, However, if only based on the bad debt ratio over years, the assessment

of credit risk management is nel accurate because of many other objective factors such

as the sharp decline in the economy condition which could rise the bad debt rates Therefore, it is necessary to combine multiple indicators to evaluate, not only a single

indicator

At the stage of assessing bad debts, commercial banks should compare their conclusion with the branches in the same banking system This is a measure of credit risk management of this branch compared to other branches in the same banking system In order to have an accurate assessment of a bank credit risk management If the bad debt ratio of cornmercial banks compared lo other commercial banks is lower {han that, it shows that credit risk management of these commercial banks is better and vice versa In addition, the ratio of bad debts of commercial banks compared to the whole system should be considered alsa TLis likely that the rale of bad debt over the yours of a bank increase due to objective or subjective reasons, Therefore, to be better in evaluating the management of credit risk, commercial banks should compare with the rate of the whole system Ifthe bad debt ratio of commercial banks is lower than that of

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the whole banking system, it shows that credit risk management of commercial banks is

more

fective than the systsm Ifthe had debt ratio of commercial banks is higher than that of'the whole system, then commercial banks should consider and propose solutions

to improve their credit risk management

Fourthly, debt collection after handling the risk

Debt recovery proceeds after handling the risk indicate the ability to control the loan after it has been dealt with The higher the debt collection for the loans, the greater contol it made over commercial bank loans

Pifthly, recoverable debts ratio

When the bad dzbt is Ti

while combining the interests of deposilors, banks and borrowers

The credit procedure

a sound credit procedure will improve the efficiency of the risk management

Credit risk management content

Credit risk management is a systematic reflection of regulatory, policy, and operational issues to establish safe operating limits and risk control points in a process including measuring, tisk detection instruments, monitoring activities for compliance and limely identification of new type

of risks arising as well as the options and

aneasures to actively prevent and to cope with the risks arise.

Internal control system

Internal control should be considered as the bank's “imme” system, The larger the barik is, the more effective il is to protect the bank against the risk A good internat control system with a team of professional supervisors acquired great training will quickly detect and adjust the lending procedure as soon as problems arise to help to Tim crodit risk ofa bank

Qualification of credit officers

Peopits are aways the decisive factor to success in all business activities in general and of course it does not exclude from the operation of a bank In order to improve etliciency in business, or the quality in credit activities in general, the bank needs to have a good team of credit staff who are trained systematically, and have broad

knowlcdge about the market

Information technology applications in banking

Information tochmology is an important factor in improving the bank's operational capacity The technology will clearly help the bank in the field of management, in the expansion of products and services, and to meet the strict needs of

the banking system In addition, the technology also allows banks lo be bottler at tisk management, thus providing supportive instruments to help banks make the right decisions

+ Objective factors

Customer factor

- The use of the loan and the sense of repayment of customers: Most customers when borrowing bank loans have business plans, specific consumption plans which arc feasible In facl, duc to the number of products and sorvices are limited compared to actual needs of individuals and businesses, customers are prone to be forced to use the fimds for the incorrect purposes to meet their needs This affects significantly the ability to repay the loans of the customer

- Business ability to generate income, value of collaterals: Borrowers with strong financial capacity having feasible and offective business projects are loss likely

to be at risk, Therefore, when tisk occurs, losses to banks are minimized However, if the customer uses the joan for the tight purpose, but the repayment

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capacity is not well enough, or other unpredicted events could deteriorate the Topayinent capacity, so (hat the customer carmol guarantee the repayment

and viec versa

«Political enviromnent

The political environment plays an important role in business, especially for banking business, Polifical stability in the country will be one of the most favourable factors for businesses Io operate effectively If mmpredielsd events such as war, riols, demonstrations, strikes, etc, occur, it is possible to lead to damages in businesses and the economy as a whole And so, the loans will be difficult to be recovered filly on

time

+ Regulatory environment

An incomplete legal environment, lack of uniformity and consistency between laws, sub-law documents will cause businesses to encounter difficulties In addition, the lack the necessary flexibility might pul the business al risk Therefore, building a sound legal environment will facilitate the improvement of business efficiency of enterprises including banking system,

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CHAPTER 2 METHODOLOGY

2.1 Methodology

The dissertation approaches the research subject basically depending on using dialectical materialism method as gencral methodology The approaching method of the dissertation is that comment, evaluation, and analysis are given based on the theoretical and practical basis of the research subject, finally solution is proposed to improve banking risk managing mission, Besides, fiom reality survey and summary, comparing with credit risk management theory of national and intemational credit agencies, the dissertation proposes as the way to create credit risk management model of ‘Ihe

Vicunam Development Bark (VDR) — Ha Nam Branch

2.2 Secondary dala collection method

experiment observation and performance) is a vital step in science research for the purpose of being basic science reasoning, finding out the ground of hypothesis demonstration, and addressing the research issue

In scope of rescarch lopic, the method of collecting data from reference is mainly used It depends on both primary and secondary information sources which are gathered from previous research documents in order to build ground basis for hypothesis demonstration In banking sector, the process of collecting and processing infortvalion cricauniers obstacle bovause of slrict sceurity as well as close risk managing operation, leading public information to verify carefully

In this topic, secondary data which needs collecting and analysing is about business operation, credit operation, credit risk management of VDB — Ha Nam Branch

in (he period of 2013-2016 through the audited annual and Gnancial reporls, bricl reports, announcements, and internal documents of'the branch

Moreover, secondary data source of the branch is also published: on the Internet, newspapers, magazines, and annual reports of the State Bank;

2.3 Secondary data processing method (data analysis}

Secondary database is also used selectively and processed carefully to create the most cbjcctive anafysis and evaluation in the disscrtation, After analysing and

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