Luận văn improving credit risk control through reforming business customer assessment methodology the case of vrb’s hanoi office

Table 3-3: Four most critical factors that exist in the creation, registration, and enforcement of security and collateral 0.00.00 ose 26 Table 3-4: Adequacy of current interna

5 ‘Emad ATONAL ARS, MAY UNIVERSITE DE NANTES

—the case of VRB’s Hanoi office

Author: Le Hong Quan Supervisor: Nguyen Phu Hung

Hanoi, June 2017

1.6.1 Methodology of the research

1.62 Variables and Indicators

1.6.3 Description of Data, Population, and Sample

1.6.4 Tools of strvey andanalysis

1.7 Conclusions and Roadmap of Dissertation

18 Planof implementation

CHAPTER 2 LITERATURE REVIEWS

2.1 Operations of commercial bank

2.1.1 Function of commercial Banks

2.1.2 Credit activities of commercial banks

23

24

2.2.3 Key ckmonts oferedit risk

2.2.4 ‘The causes and effects of credit risk

3.2.5 Faclors driving credil exposure

Credit Risk Managammert

2.3.1 Risk maragemond process

2.3.2 elaterabzed

3.3.4 Mensuing Oredit Risk ceoseeeecee

2.3.5 Measures toConEolrisk coeoeeeore

CHAPTER 3 SURVEY RESULTS OF THE CURRENT STATUS OF RISK

SITUATION AND CONTROL OF VRB ILANOL

Survey results of cwxent VRB’s risk situation and control,

3.11 Bad debts status,

3.1.3 Opinions in ereditreeavery and crvdil risk management

3.1.4 Opinions on the measures to reduce credit rEk

Findings

3.2.1 Worsening credil risk

3.2.2 Credit risk management system need enliarieing uc co

3.2.3 The seriousness of credit sia are inadequate

3.2.4 Qullyofcredit stafR is inadeqwade

3.2.5 Worsening economic situation is one of major causes of worsening

3.2.6 The intcrml system tay be over rigid te react w busine:

3.2.7 Problems of cwrent credit risk management

3.2.8 Objective af eredil risk management reform of VRB HANOT

3.2.9 Attributes of a viable credit risk management model in case of VRB

Summary of creditrisk management issues of VRB-Tanot

Summary of credit risk management requirements

Principal bases ariting developing meastres to enhance credit risk mana gene

Credit risk management policy reform recommendation erento

44.1 Tighten credit policy

4.4.1 Adjust kending policy appropriate to current economic situation

4.4.2 Enforoe the compliance to credit assessment procedures and regulation 45

44/4 Re-price loans for each customer group to reflect accurately new

4.4.6 Increase the degree of monitoring and inspection of active loats

4.4.1 Unbanced the role of inspection and internal control

4.5 Improving Credit Risk Control through reforming Business Customer

4.5.2 Improve internal audit operations 4.5.3 Improve credit risk forceasting

4.5.4 Tmprove transparency to promote accountability 52 4.5.5 Application of information technologies to improve maragement data

system 52

461 Innovation in organizational stuctwe and improvement in human

LIST OF TABLE

Table 1-1: Variables and Indicators

Table 2-1: The causes and effects of credit risk abe canssvcaranancosesvavassestentincisc EL Table 3-1: The magnitudes of credit risk

Table 3-2: What is the most critical risk category?

Table 3-3: Four most critical factors that exist in the creation, registration, and

enforcement of security and collateral 0.00.00 ose 26

Table 3-4: Adequacy of current internal credit risk management system, procedures,

Table 3-5: The major factors affecting the quality diign gu ến assessment 28

Table 3-6: Compliance of credit officers with standardized procedures for handling

Table 3-9: The need of keeping documented records au

Table 3-10: Ability for organization to adapt to changes in business environment 34 Table 3-11: Implementation oftechnology ee)

LIST OF FIGURES

Figure 1-1: Organizational Structure of the VRB

Figure 2-1: Four levels of credit risk based on the risk level

Figure 2-2: Factors driving credit r&k

Figure 2-4: 4 steps of Rk managemeri pIOCeS§ -

ACKNOWLEDGEMENT

First of all, I would like to express my sincere gratitude to my supervisor, Dr Hung Nguyen for his instruction and help for me to complete this dissertation Thanks for his support and his patience with my slow progress,

Moreover, I would like to give special words to all lecturers of the program who

always supported, inspired and guided me to carry on sucha challenging project

And moreover, I want to say thank you to my entire family member, classmates in FAB7 who give me the best time during I attended the course.

ABSTRACT

During the past two years, Vietnam’s economy has suffered a severe recession due to

a financial crisis, The bankruptcy of various enterprises has had a negative impact on the performance of the banking sector Thus, during this time, the primary objective

of commercial banks become risk management, especially activities regarding credit

risk management

The types of risks associated with banking activities are diverse, complex and uswally hidden They can present fiom the cards, deposits and trade finance business to investment and foreign exchange business and often at many different levels So far,

the most serious and far-reaching impact that risks can have is on credit This is

because credit is considered the basic operation and usually produces the bank’s

largest amount of profit as well the largest amount of potential loss Not only that this phenomenon has been predicted in theories, it has been considered true in the

practices of the banking sector

This thesis focuses on meastes to ensure the saféty of banking activities in the midst

of increasing complexity and breadth of risks in credit, such as the traditional policy

of management focusing oninereasing revenue and decreasing cost, credit risk

VRB because it help to reduce potential losses

CHAPTER 1 PROBLEM STATEN

1.1 Introduction of the VRB

The Vietnam-Russia Joint Venture Bank (VRB) was established in 2006 The establishment of

VRB is the result of the economic co-operation of the Vietnamese and Russian Governments

and the two Central Banks

VRB is a joint venture between the two leading banks in Vietnam and Russia, Bank for Investment and Development of Vietnam (BIDV), accounts for 50% and Bank for Foreign

Trade of Russia (VTB) with 50% of chartered capital

VRB opens new opportunities for co-operation of the two economies and the financial systems The opening ceremony was attended by the President of Vietnam Nguyen Minh

‘Triet and of Russian President Vladimir V Putin

VRB’svision is to be the leading bank to finance for bilateral trade and investment activities

between Vietnam and Russia VRB will develop to become a multi-functional business bank

with modern banking model under the principles of sustainable, effective, secure, and

integrative development, meeting all safety indexes of normal operations of international

© VRB arranges investment capital, directly give loans or co-finance projects.

© VRB provides guaaniee servioss, suoh as guarantee for payment, bid, contact fulfilments

* VRB makes direct investments through provision of capital to by shares in the two countries’ firms; indirect investments through activitics on inter-bank markets or financial markets,

b, Trade promotion

© VRB does financial and trading promotion activities;

* VRB provides support on sharing information of markets and customers;

© VRB cooperates with customers in assessing their partners as well as investment projects

to promote bilateral business activities between Vietnam and Russia

VRB’s products and services include

Consumer banking-Doposit; Individual account; Cards; Individual lending, Money tramsfér in both domestic and oversea, direct transiér between Vietnam and Russia inthree curencies: VND, RUB, and EURO

Gi) Business banking:Deposil, Account, Loars, Guaranice; Moncy transfer: damestie

and oversca; Trade sponsor: import, export, Forcign curencics wading, and

Others

Overall structure of VRB is shown in the picture below

maintain their loyalty All commercial banks have regarded customers much like a top

priority at all times in all their activities VRB is in a hard time of competition to retain

customers fom a number of newer banks VRB needs a strategictool to identify the bank's

mpst profitable customers and prospects, and devotes time and attention to expanding account

relationships with those customers through individualized marketing, repricing, discretionary

decision making, and customized service-all delivered through the various sales channels that

the bank uses

Today, many businesses such as banks, insurance companies, and other service providers

realize the importance of credit risk management A close focus on risks involved customers

will require astrong coordination between sales and marketing departments to provide a long-

term retention of selected customers.

1.3

1.4

‘This thesis is dedicated to the credit risk management which is a primarily lead to the fillen into a serious financial crisis in Vietnam economy recently The National Assembly blames that the financial crisis in banking sector arose largely because credit had been too lack to fund the mational economic rapid expansion during 2007-2011, which resulted in growing uncontrollable bad debts, that in tum makes the Government to suddenly becoming too restrictive in financial and baking policies

Being a newer bank, VRB has many common risks, such as interest ratio exposure, credit

exposure, exchange rate exposwe, liquidity exposure, and operational exposure Among these exposures, credit exposure is the most important and impacting In order to control credit risk,

as well as other financial issues, VRB needs to have particular risk management tools,

especially an appropriate credit risk control

This is the reason that this thesis will study the“Improving Credit Risk Control through reforming Business Customer Assessment methodology”

1 What are the status-quo of VRB and how CRM is critical to the survival of VRB

2 How has the VRB managed CRM?

3 Does the current methodology and managerial policy perform well? What are the advantages and disadvantages of current CRM methodology?

4, How to enhance the performance of managing credit risk?

Scope of research

Indeed, risk management covers many types of risk but credit risk is the one this thesis

focuses on The dissertation will limit its attention on the matters of CRM in the Hanoi office

of the VRB.

1.6 Methodology and Data

1.6.1 Methodology of the research

In order to find the answers for the questions given above, the proposed approach is designed

as below

First, identifying problems of credit management facing VRB-Hanoi through a survey designed to credit staffs;The thesis will survey involved stakeholders to get to know the current situation of CRM challenging VRB

Second, review literate on problems identified above to learn lessons/experience of successes and failures from similar financial institutions in dealing with credit risks, based on that speciffy potential solutions The literature review of credit risk management (CRM) is for building an critical analytical framework of CRM at VRB-Hanoi

Finally, analyze the applicability of specified potential solutions in case of VRB Hanoi, and select the most applicable one to propose to management board

All the values are in likert scale of 5

1.6.2 Variables and Indicators

‘The paper uses the following indicators:

Creditrisk management | Humanresowce Likert scale

Credit policy Likert scale

Table 1-1; Variables and Indicators

1.6.3 Description of Data, Population, and Sample

The thesis also analyzes secondary data collected fiom academic journals, websites, and

governmental offices to draw a comprehensive picture of the whole banking industry and

5

1.8

assess the comparative competence of the VRB’s CRM in this context Lessons drawn from

literature will serve as basis for recommending solutions to enhance the CRM performance

© Survey in paper form

Conclusions and Roadmap of Dissertation

Afier the first chapter of introduction, we review literatures on the credit risk management in

Chapter 2 The Chapter 3 describes analytical results from the survey and discuss the findings Finally, the Chapter 4proposes measure to enhance the situations

Plan of implementation

5/2017 First Draft of thesis

7/2017 “Tum in final thesis

21

CHAPTER 2 LITERATURE REVIEWS

This chapter provides a brief review on literature of Credit Risk Management, which will be

served as a basis to develop recommendations in the next Chapter

Operations of commercial bank

Commercial Banks are financial institutions providing a wide range of diversified financial

services - especially credit, savings, and payment service — for profit “A bank is an institution

whose current operations consist in granting loans and receiving deposits from the

public” (Rochet, 2008; Gestel & Baesens, 2008)

The basses of commercial banks’ operation are () Activities to raise capital, (ii) Capital we

activities, and (iii) Credit activities

2.1.1 Function of commercial Banks

Commercial banks perform various basic functions; some of them are as followed (Rochet,

2008; Gestel & Baesens, 2008):

© Raising capital: Commercial banks can increase their capital by some methods such as: raising capital fiom stakeholders by put more money in to the bank, through borrowing shareholders, lending from financial markets, fiom government, ete

© Using capital: Commercial banks use the capital to supply many products and services concerning to credit such as: overdraft services, discount by bill, loans ete

© Creating credit: Credit creation is the most significant function of commercial banks The Joan provided to a customer is not available in cash, banks open a deposit account from

which the borrower can withdraw.

2.1.2 Credit activities of commercial banks

Bank credit is the process in which the lender must identify the specific legal borrower,

independently define the borrower's credit needs to ensure that the credit offered by the bank matches the borrower's need

2.1.3 Risks of banks

The Basel II Capital Accord (Gestel & Baesens, 2008, p 23) identifies three majority reasons

of risk: operation risk, market risk and the most important is credit risk Like any other firm,

banks are exposed to classical operational risks such as infrastructure breakdown, supply problems, environmental risks, etc However, the most typical and critical risks that a bank

can face are financial risks (Hefiérnan, 2005) Financial risks can be split in three main

categories: (i) credit risk, (ii) interest rate risk, and (iii) liquidity risk

© Credit risk occurs when a borrower can’t able to payback fulfill his loan, including

interest, original debt and other obligations This is also the focus of this paper

© Liquidity risk is the situation when a bank lack of finds or feasible short-term assets to

response the demand deposit, withdraw, credit of customers, especially in deposit because

this is a kind of account which allows customers can demand anytime, When a large number of withdrawals occur during a short time, which maybe lead to a liquidity

exposure for the bank

Interest rate exposure: incurred when interest rate is fluctuate between lending interest rate

and interest rate which the bank has to pay to the borrowers which leads to decrease the

profit of bank This risk is the result of changes in interest rates In the economy, the

interest rate is the very sensitive factor to economic fluctuations, moreover, it is a tool in

the implementation of fiscal and monetary policies of the Government Therefore, interest

rate risk is the risk that appears frequently in the banking business

‘© Systemic risk: systemic risk is the risk that a sole event can trigger the loss of economic

value causing the increase in uncertainty to a substantial portion of the whole financial

system and in turn leads to significant adverse effects on the real economy

Credit risks ate the focus of this paper and explained in the next sections.

2.2 Credit risks of commercial banks

2.2.1 The origins of risk

Nowadays, when the enterprises need more and more equity to develop, so the relationship

between banking and enterprises become to coordinate closely Moreover, in the violent

competitions among too much the banks in the finance market, it leads to many banks accept

high risk or lack of stringent controlling and responsibility Banking faces to a serious risk

and lead to bankruptcy Business in banking has the giant impacts to the stability of economic

and society It is cause of crisis psychological, people have a panic about losing money and they want to withdraw money on the same time, cause of the mass collapse system

As any company or other organizations, a commercial bank earns money that they accept the tisk in business In some cases, the bank could face with bankruptcy because risks, and

uncontrolled risks So, we could see the business of banking contains many potential risks, more risk more profit, that’s feature of Banking as well as other businesses

‘The risk that unexpected events leading to loss of the bank's assets, decline the actual profit

than expected or have to add an expense to be able to complete a career financial services

2.2.2 Credit risk

In the banking operation, credit is profitable mainly activity but also is the big risk latent

activity, The statistics and research shows that credit risk accounts for 70% of total banking

risks

Credit risk is the potential loss that can arise because the borrowers cannot afford or do not

have enough capacity to implement their contractual obligations (repay money) in full or on

time as committed to the lending institutions Corporate lending offen is highly exposed to

credit risk due to the size of the loan involved, while retail lending risk offen arises from

constrained access to data (Heffernan, 2005) Credit risk has many impacts: reducing the

profitability of banks; reducing the solvency of banks; reducing the bank's reputation,

credit risk is one of the main reasons causing losses and affecting seriously the quality of the banking operations

Credit risk following the basic definition is the risk of loss due to failure of a borrower to meet its contractual obligation to repay a interest and a debt in accordance with the agreed

terms

Credit risk probably has been prevalent and the most important risk type in banking sector Credit risk has wide and potentially detrimental financial impacts to economic transactions, thus must be under close control such that it will not result in social impacts (Gestel &

Baesens, 2008, p xii)

© Credit risk can arise in typical cases below (Bessis, 2003; Gestel & Baesens, 2008):

¢ when the borrower is in a financially stressed situation and may be facing a bankruptey procedure;

© When the borrower refuses to comply with its debt service obligation, ¢.g,, in the case of a fraud or a legal dispute

© When the bank invests in debt of a historically high-quality borrower but his risk profile deteriorating over time When liquidating the debt of this borrower, the price at which the debt is sold on the market is lower than the cost at which the bank bought the debt, thus resulting ina net loss

‘The financial loss in the case of default depends on the percentage that one can recover from

the defaulted counterpart and the total exposure to the counterpart The recovery depends on the presence of collateral and guarantees A good risk management tries to avoid large

exposures on high-risk counterparts

2.2.3 Key elements of credit risk

Credit risk is not only limited to lending activities It can also present in many credit activities

of commercial banks such as underwriting, finance leasing, ete

According to the current method of credit risk management, the credit risk is divided into four levels based on the risk level

- Not collecting earned interest on time: This is the lowest level of risk, when a borrower

cannot repay interest on time This type of risk is classified as low level because except for

the case of criminal activities, the reasons are mostly from the imbalance between debt collection and debt repayment

- Not collecting principal on time: the situation can becone serious if'a large of credit fund is lost The bank will move this debt to overdue debt resulting in delays the customers’ scheduled business plan

- Not collecting enough interest: this situation ocews when the client’s business is not efficient enough to be able to pay interest to the bank It can lead to adverse impact since the bank can lose its entire interest and principal

Figure 2-1: Four levels of credit risk based on the risk level

Some causes of credit risk are objective, while others are subjective

Table 2-1: The causes and effects of credit risk

Borrowers s Capital used for the wrong

purposes; unwilling to pay the debt

resulting ina financial

shortage to fulfill the

obligation

The bank's credit policy ‘Some banks loosen credit policy to

attract more customers

Many unqualified customers may still get credit, resulting in

potential loss

The madequacy of credit Wrongly rating a loan request, (ims Tnadequate price leads to low

officers setting a too low price recovery if credit loss actually happens

Lack of supervision and | Lack of continuous efforts on| Bank is caught by surprise due management after loan, | monitoring loans to low awareness of the

local banks

Lack of inter- | Weak cooperation between] Information of borrowers are

organizational cooperation | commercial bank loose, the role of | not updated system-wide, thus with other financial | the CIC is meffective a bad customer from a bank

2.2.5 Factors driving credit exposure

First reason arise from loopholes internal procedures of the bank for some reasons:

© Incomplete credit information (bank has no comprehensive vision of customers well

as the their financial situation);

¢ Limitation in professional qualifications and ethics of credits officers (lack of capacity

to handle the credit information, appraisal loan documents to protect and monitoring loans);

¢ The banks too focused on profits and income, they set the income expectation in higher priority than healthy loan So that, there was strong competition with other

banks and non-banking institutions to approach more propotion of loans;

® Lack of knowledge of the market, lack of information or analysis incompkte information loading lo the kerting aml investing unreasonable;

© Relaxing in the process of inspecting and monitoring after lending not lead to timely detect the phenomenon using loans for improper purposes:

* Overconfidence in collatcral, gusranioas and insumancy, as il is rmatcrial fo prSưe the

recovery of the Toan principal and interest

* Focusing on the quantitics (according to plan), neglect the quality of the loan optimistic and confident in the success of the business plan

© Tack of the dspartinent is responsible for monitoring and managing risk credil on cach customer, cach branch, cach product and scrviccs to diversify risk, sct up frccasts in each period

» Competition between banks is becoming increasingly fierce; banks eased the conditions required for Toans to attract mors eustornecrs,

The second group of reasons relate to customers

* Customers delibcratcly make the fake documents in order to cheat the bank;

* Customers have some legal problems;

«= Incusiomers are cnlerprises, they sudderily have lo change the marngers, leader, or

© Customers use the loan dor wrong purposes because they accept the high risk, they hope that it will bring higher profit but the resuit is not good On other hand, some customers can’t afford repay the Ioan ina difference bank and they find many ways to Joan in another bank to swap the loan

‘Other external reasons:

* Volatile economic environment: ‘Ihe fluctuation and unpredicted of the market is the

majority reasons impact to the activity ofthe loaner Vietnam’s economic still belong

13

to the agriculture and many low value sectors It's very sensitive with the weather, price, policy and other bartiers to entry It directly impact to The Vietnam enterprises

as well as the activity ofbanks

» During the finance ffee process, Vietnam takes part in the international market, which lead to the fierce competitions among the enterprises, that make almost enterprises face lo Toss of equity and bankrupt

© Nalural Disasters which ars the Botors cart bs predicted when they have credil, the

customers are difficult thal ead fo the expose eredil im Bank,

Credit Risk Sources

Tnepankstootocuses | | [Lakothnowledgeotthe| | levtemerstegalprobiens| (| Natural Disasters

Laity in theproessof Tw canfidentin Sudden changes of

Imsecirgemd mantrngl | |kalnterl girankerand| t~fnanages leader, or board afer ening Tae Sidrecrs

Focusing en the Lack of the department quantities), neglect the ‘ually er thetoan responsible nd mangingrse for mori toring] High-risk occupations

Lacking of management ability, imit of monitoring}

‘experience,

|Customers use the loan fo

Wrong purposes

Figure 2-2: Factors driving credit risk

2.3 Credit Risk Management

2.3.1 Risk management process

Credit Risk Management is a well-designed process aiming to detect new potential risks and

improve overall performance of existing systems The process involves (i) the identification

15

of potential risks, (ii) the measurement of these risks, (iii) the appropriate treatment, and (iv) the actual implementation of risk models (Gestel & Baesens, 2008)

Figure 2-3: Risk management process

(Source: Gestel & Baesens, 2008, p 42)

‘This is a continuous task that evaluates relevant indicators to reveal potential threats so that

the bank will not encounter any surprising loss

16

¢ identification of potential risks

¢ measurement of these risks

¢ Appropriate treatment

* actual implementation of risk models

Figure 2-4: 4 steps of Risk management process

2.3.2 Collateralized

2.3.2.1 Collateralized versus uncollateralized netting sets

Collateralization (or margining) is the way to reduce credit expose beyond the benefit

achieved with netting and the other methods In the fact of it is an essential condition between lender and borrower when break clauses in the contract Collateral can be used to pay

for the lender in the case the borrower losses of solvency

‘The idea of collateral management is cash or other secwities which belong to counterparty or

third party to protect the loans, and the credit risk Although collateral can be used to reduce credit exposure, however it may be added new risks, such as market, legal, operational and liquidity, Until now the collateral managements are still the best way to decrease the credit tisk, including:

® It's not only to reduce credit exposure, but also able to broaden more customers The bank

can opencredit however still ensure secure credit ratio

© To allow to corporate with a special counterparty For instant, scoring credit system may

not enable to make credit lines with some customers without collateral

‘© To depreciate capital requirements Basel regulatorycapital rules give capital relief for

collateralized exposures

¢ To diversity competitive pricing of counterparty credit risk

17

2.3.2.2 Valuation

‘The valuation agent is normally the party calling for delivery or retum of collateral and thus must handle all calculations The role of the valuation agent in a collateral calculation is as follows (Gregory, 2012 b, pp 64-65)

© To compute credit risk under the effect of netting;

¢ =Tocompute the market value ofthe collateral before loan;

© To compute the uncollateralized exposure;

* To compute the delivery or return amount (the amount of collateral to be posted by either

counterparty)

2.3.23 Types of collateral

In normally, the collaterals are the more liquidity the more preferred such as cash, or government secwities (for example, Fannie Mae and Freddie Mac) and Triple-A MBS securities are also used for high-quality assets with minimal price volatility (Gregory, 2012 b,

pp 64-65)

However, in some cases, cash is in limited provided and securities have additional volatility from the price uncertainty of collateral posted If the market value of collateral decreases

below the value in the mortgage contracts, it’s necessary to make a new agreement about the

value of collateral between counterparties immediately

When the local curency of two counterparties are different, one party will have to take FX

exposureconcerned to the collateral posted, even when it is the cash Some collateral are

various kind of currency securities may be allow in some banks FX exposure can be

prevented and decreased by taking part in the derivatives market, using some tools such as

swap, option, future and spot

Other collaterals also preferred are the real estates; it’s very popular in Vietnam as well as in over the world Nonetheless, when the bank accepts real estates are collaterals to protect the Joans, they also fice to some potential risk fiom the legal regulations, the decrease price of real estate, the bubble ofthe market,

In the fact of some banks accept collaterals are the goods and the right to collect the debt

from other counterparties; however the guarantee rate is very low About the essence, the

banks accept give unsecured loans to the customers because it’s very difficult to liquidation these collaterals

23.2.4 Coverage of collateralization

Collateral contracts will be made base onthe reference valuefiom the netted value of some or

all sector or with some particular customers To decrease the risk, the conditions value should

be based on the estimation of maximum number of the sectors however it’s also should be

balanced against the demand of customers and some specific sectors

Some kind of product and services frequently are affected by region that is the important factor has to notice in the collateral contract Collateral contact don’t require to transfer of the

undisputed amount immediately, which means that the main of products should still be

collateralized even when there are disputes regarding a minority

2.3.2.5 Disputes and reconciliations

Collateral management relies on physical process and data standards, leading to significant

disputes between counterparties due to a number of factors like trade population; trade

valuation methodology; application of netting rules; and valuation of previously posted

collateral,

In case, the valuation or disputed amounts of collaterals are difference with these in the

collateral contract, parties may "divide the difference" In another way, it needs to clarify the reasons of the distinction

In case of a dispute, counterparties will try their best to solve the contention within the shortest time The disputing party (i) is required to notify its counterparty reason for the

dispute, it expects to litigate the risk or collateral computing no later than time of business day following the collateral call; then (ii) agrees to transfer the undisputed amount if the counterparties can't solve the conflict in the certain time, they can ask for help fiom one third

party to make a reasonable agreement, or due to court for resolution

Instead of being reactive and focusing on dispute resolution, banks should be proactive and aim to prevent disputes in the first place Reconciliations are to minimize the chance of

dispute, thus it is better to perform reconciliations weekly or monthly so as to minimize

differences in estimation between parties, pre-empt later problems Reconciliations should

also be detailed and highlight differences that otherwise may be within the dispute tolerance

or that by chance offset one another

19

Collateral management is developing, because a simplification a type of collateral (e.g the bank just accepts collateral is money) This is also concerning to assess the value of collateral

2.3.3 Tools

Efficient credit risk management tools are vital in fostering the growth in consumer credit In order to minimize credit risk, financial institutions establish a risk management system to monitor retail and corporate lending through reviewing a number of performance indicators (eg probability of default, exposure at default and loss given default), The system allows the

financial institutions to detect borrowers’ potential operational and financial risk and to give

necessary appropriate responses The risk management system assesses credit risks before

deciding whether to grant a loan using qualitative or quantitative methods

Credit scoring system

The most well-known quantitative method and one of the earliest successful financial risk

management tools are credit scoring The digitalization of data, computers, and application of

advanced statistical modeling technique have supported with this credit risk measurement

However, under many circumstances, due to the unavailability of information (such as the credit bureau cannot find a credit report for a particular applicant), the bank may switch to a

qulitative approach This implies checking elements constituting the risk profile of the

borrower such as how long the borrower has been with the bank, their employment history, or

their financial asset

Market standards for credit risk management include:

Capital cushion: The Basel II establishes a level of capital adequacy for banks that plays as a cushion to absorb credit and other losses The bank should match the capital cushion with the portfolio risk of individual transactions, their concentration, and comelation, and optimally allocated capital in relation to the selective investments made (Gestel & Baesens, 2008)

Risk quantification: Complementary to other tools of modern risk management

2.3.4 Measuring Credit Risk

2.3.41 Credit Valuation Adjustment

According to the “Basel committee on Banking Supervision”, Credit Valuation Adjustinent (CVA) is “an adjustment to the fair value (or price) of derivative instruments to account for counterparty credit risk (CCR)” (Basel Committee on Banking Supervision, pp.1, 2011), They

20

further suggested that CVA depends on counterparty credit spreads as well as other the market risk factors influencing derivatives’ values and exposure CVA is calculated as the difference between the risk-fiee and the true portfolio value, taking info account the possible

tisk of default It is also considered the market value of counterparty credit risk

2.3.4.2 Implementation Challenges

© Data challenges: Acquiring standard and exact data is a hard challenge for any banks Almost banking system just has the data fiom their cwrent customers and reference from

CIC

¢ Technological management system challenge: in order to building the modern and useful

technology system requires the huge investment and the many time to experience and

improve

© Human resource competency challenge: because banking system is too much complicate

arid highly potential risks, so the qualification and competency of staf is noticed priority

2.3

A case study of Credit risk - Methodologies for credit risk quantification of BBVA

‘The risk measurement and management models used by BBVA have made it a leader in best

practices in the market and in compliance with Basel II guidelines The following summary is

taken fiom its website!

‘The Bank quantifies its credit risk using two main metrics: expected loss (EL) and economic capital (EC) ‘The expected loss reflects the average value of the estimated losses (ie the cost

of the business) and is associated with the Group’s policy on provisions, while economic capital is the amount of capital necessary to cover unexpected losses (i.e if actual losses are

higher than expected losses)

These risk metrics are combined with information on profitability in value-based management, including the profitability-risk binomial into the decision-making process, fom the definition of business strategy to the approval of individual loans, price setting, assessment of non-performing portfolios, incentives to the different areas in the Group, ete

‘http //shareho ldersan investors bbva.con/TLBB/micros/Finan cialReport2011/en/Riskmanagement/CreditriskM ethodologiesforcreditriskquantification html

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‘There are three risk parameters that are essential in the process of calculating the EL and EC meastrements: the probability of default (PD), loss given default (LGD) and exposure at default (EAD) They are generally estimated using the available historical information and are assigned to operations and customers according to their particular characteristics In this context, the credit rating tools (ratings and scorings) assess the risk in each transaction/customer according to their credit quality by assigning them a score This score is then wsed in assigning risk metrics, together with additional information such as transaction seasoning, loan to value ratio, customer segment, ete The increase in the number of default

events in the current economic situation contributes to reinforce the soundness of the risk

parameters by adjusting their estimates and refining methodologies The incorporation of data fiom the years of economic slowdown is particularly important for refining the analysis of the cyclical behavior of credit risk The effect on PD estimates and the credit conversion factor (CCF) is immediate, An analysis of the impact on LGD, however, requires waiting for the outcome of the recovery processes associated with those default events

3.5 Measures to Control risk

‘Typically, financial institutions manage risks through five ways (Heffernan, 2005)

1, Computing loan pricing according to the level of risk: calculating all factors that can

lead to financial loss and risks involved with the loan This means charging a higher

interest rate and loan fee for borrows who are more likely to default

2 Customer rating: the credit score system is based on many elements such as the

financial status of the customer, purpose of the loan, credit rating principles, loan to-

value ratio, the customer’s business plan and estimated effect on yield or credit spread

3 Using collateral: collateral is offered to secure repayment of the loan in case of financial loss

4 Diversification portfolio: decreasing unsystematic risks, limiting potential risks within major sources and thereby reducing the possibility of default

5 Asset securitization and the use of credit derivatives

Other ways to mitigate credit risk include transferring from the lender to the insurer via credit insurance, hedging credit risk and tightening credit while broadening other services to reduce the proportion of income fiom credit Credit risk can be assessed based on criteria such as

credit score, credit structure, overdue or provision for credit losses (Gestel & Baesens, 2008)

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2.4

Furthermore, some banks also mitigate credit risks by imposing limits on the transacted notional amounts, central clearing and netting

Conclusion

In this Chapter, the thesis has reviewed relevant literature relating to credit risk management

In the next Chapter, the thesis will present the results of'a survey which is used to assessment

current situation of the VRB Ha noi

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CHAPTER 3 SURVEY RESULTS OF THE CURRENT STATUS OF RISK SITUATION AND CONTROL OF VRB HANOI

This section provides results of the survey and discuss the implications of the survey results to the Credit Risk Management of the VRB

Survey results of current VRB’s risk situation and control

‘The surveys were responded by 15 key staffs and executive relating to credit services The

answers are anonymous to promote honest answers and sharing The answers appear to support the paper’s reasoning

3.1.1 Bad debts status

For 15 surveyees, 13 stated that he/she has customers’ bad debt, account for 87% Almost

50% of surveyees have over 5% of his/her customers’ borrowings fall into bad debt category,

of which the proportion of “over 10%” is terribly high, about 1/3 (Table 3-1) Compared with

the statutory limit of bad debt of under 5%, this indicator show VRB HANOI OFFICE is in

high risk of credit

Table 3-1: The magnitudes of credit risk

3.1.2.1 Most critical risk category

Half of staffs contended that credit risk is the most critical to bank financial health, while 1/3 think it is the liquidity risk (Table 3-2)

The most critical risk category

Foreign exchange risk Market risk

3.1.2.2 Four most critical factors that exist in the creation, registration, and

enforcement of security and collateral

When asked to select four most critical factors out of total 8 factors that exist in the creation,

registration, and enforcement of security and collateral, the Customer's capacity and the

Collateral to the loan contract are the most selected (ticked by 60% of surveyees), then the

capital resource and the size of the loan are the next critical (Table 3-3),

Table 3-3: Four most critical factors that exist in the creation, registration, and enforcement

of security and collateral

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* Collateral to the loan contract

= The purpose of the loan

8 Amountof the Loan

= Obligation Repayment of customer

3.1.3 Opinions in credit recovery and credit risk management

3.1.3.1 Adequacy of current internal credit risk management system

Almost 30% (4 out of 15) of surveyees stated that a proportion of their corporate lending is

not secured by adequate collateral

Around 70% of surveyees think that the cwent internal credit risk management system, procedwes, and regulations of VRB HANOI OFFICE are adequate to control the risks it is facing (Table 3-4)

Table 3-4: Adequacy of current internal credit risk management system, procedures, and