CREDIT RISK MANAGEMENT AT MILITARY BANK – THANG LONG BRANCH

Vietnam’s existing regulations on debt classification, provisioning and use of provisions for settlement of credit risks...20 CHAPTER II : ANALYSIS OF CREDIT RISK MANAGEMENT OF SMALL AND

TABLE OF CONTENTS

TABLE OF CONTENTS i

ACKNOWLEDGEMENTS iii

ABBREVIATION iv

LIST OF TABLES v

LIST OF FIGURES vi

STATUTORY DECLARATION vii

ABSTRACT 1

CHAPTER I : BASIC ISSUES OF CREDIT RISK AND CREDIT RISK MANAGEMENT 3

1.1 Overview of credit risk 3

1.1.1 Definition of credit risk 3

1.1.2 Causes of credit risk 3

1.1.3 Consequence of credit risk 5

1.2 Overview of credit risk management 6

1.2.1 Definition of CRM 6

1.2.2 Process of CRM 6

1.3 Credit Risk Management – According to Basel 15

1.3.1 Basel I Banking regulations 15

1.3.2 Methods of credit risk approach according to Basel II 17

1.3.3 Criteria for development of a modern risk management model as per Basel Committee 18

1.3.4 Vietnam’s existing regulations on debt classification, provisioning and use of provisions for settlement of credit risks 20

CHAPTER II : ANALYSIS OF CREDIT RISK MANAGEMENT OF SMALL AND MEDIUM ENTERPRISES AT MILITARY BANK- THANG LONG BRANCH 22

2.1 Overview of Military Bank – Thang Long Branch 22

2.1.1 Foudation and Development of Military Bank- Thang Long Branch 22

2.1.2 Organizational structure 22

2.1.3 Ranges of service for customer 23

2.1.4 Performances from 2011-2013 24

2.2 Analysis of credit risk for SMEs at Thang Long Branch 27

2.2.1 Classification of outstanding loan by risk: 27

2.2.2 Overdue loan ratio 30

2.3 Credit risk management at Thang Long Branch 31

2.3.1 Credit Risk Recognition 31

2.3.2 Credit Risk Measurement 32

2.3.3 Credit Risk Controlling 32

2.3.4 Credit Risk Solving 32

2.4 Evaluate the results achieved credit risk management at the branch over 3 years from 2011 to 2014 33

2.4.1 Results achieved 33

2.4.2 Shortcomings and limitations 33

2.4.3 Main reasons caused credit risk in Milirary Bank 36

Chapter III: SOLUTIONS TO IMPROVE CREDIT RISK MANAGEMENT AT THANG LONG BRANCH 40

3.1 Finish credit operation and risk management structure 40

3.2 Finish credit procedures 44

3.3 Improve the quality of human resources 47

3.4 Customer classification and assessment procedures 49

3.5 Develop customer policies in credit activities from Military Bank: 51

3.6 Credit policies 51

3.6.1 Set out practical ratios in credit activities: 51

3.6.2 Widen loans secured by collaterals 52

3.6.3 Dissipate credit risks 53

3.7 Book procurements to counterbalance dangers 54

3.8 Put resources into current data innovation 55

CONCLUSION 57

REFERENCES 58

First and foremost, I want to use this opportunity to thank my parents whoalways trust on me whenever I make them disappointed Thanks to their unconditionallove and support that I can complete my four years in the university

Thank you lord, for bringing all good friends and family who are always with methrough my up and down, especially Khanh, who helps me understand how theoriesare applied in the real world and the business activities as well Thank you my friends,Hang, My and Diep, who are always there to suppport and encourage me no matterwhat happens

A heartfelt thanks to my supervisor Assoc.Prof - Ph.D Dang Ngoc Duc for hisenthusiastic guidance and useful advices during the time I conducted this thesis

I would also like to send my great thanks to my colleagues at Military Thang Long Branch for giving me the chances to do my internship and support methroughout the internship period Without their advice and guidance, I would not beable to complete this thesis

LIST OF FIGURES

Figure 2.1 : Total capital mobilization of Thang Long Branch in 2011, 2012,

and 2013 25

Figure 2.2 : Structure of Oustanding loans of MB Thang Long 26

Figure 2.3: Classification of loans in 2012 - 2014 30

Figure 2.4: Overdue loan of Thang Long Branch in 2012 - 2014 31

STATUTORY DECLARATION

I herewith formally declare that I myself have written the submitted Barchelor’sThesis independently I did not use any outside support except for the quoted literatureand other sources mentioned at the end of this paper

Hanoi, 31/05/ 2016

Do Thu Ha

Credit activity is one of the basic activities and primarily generating profits forcommercial banks in Vietnam nowadays On the other hand, credit risk (CR) alwaysbrings unpredictable consequences for the economy as well as the commercial banks(CBs) The statistics show that the risk of lending activities account for 70% of totalrisk of commercial banks Although there has been restructuring in profits forcommercial banks, the revenues from credit tends to decrease and revenues fromservice tends to increase, but in Vietnam, operating income for loans still account for60% - 70% of the total income of the commercial banks Loans are primarily lucrativesource but it also contains many risks, determining the existence and development ofthe commercial banks

Nowadays, financial and monetary markets suffering from complicateddevelopments and it directly affects the lending activities of commercial banks, therisk of lending activities is incresing and becoming hard to control than before Inparticular, during the financial liberalization and international integration, risks inlending activities increased due to the unpredictable fluctuations of the world’seconomy Risks in lending activities not only affect the commercial banks but also theeconomy Therefore, controlling the risks in lending activities becomes more and moreimportant in each credit operations

Small and medium enterprises in Vietnam develop very dynamic and powerful inboth quantity and quality in recent years It contributes significantly for the nationaleconomic This kind of enterprises is particularly concerned and given good conditions

by the government With the specific characteristics of the scale there which consistentwith management capabilities and operational orientation of MB, SMEs are focused oninvesting credit and becoming mainstream customers

From the awareness of the effects of credit risk and the reality in credit riskactivities for SMEs in Military Bank – Thang Long Branch , the author has chosen thetopic: " CREDIT RISK MANAGEMENT AT MILITARY BANK – THANG LONGBRANCH ".The goal of thesis is to concretize general theory of credit risk, solutions

to limit credit risk, using theory into practical in order to assess the limitations of creditrisk activities and make recommendations to limit credit risk in Military Bank – ThangLong Branch

Acknowledging the important role of MB- Thang Long branch in the operation

of the bank, I have spent my internship time at the branch to research and investigatedeeply characteristics CRM of the branch To be detailed, the general result of myinvestigation includes:

+ Basic issues of credit risk and credit risk management

+ Analysis of credit risk management of SMEs at the branch

+ Strength and weakness of CRM in the branch; reason for current situation anddirection of development in the future

Data within the report is collected from a wide variety of official sources, such asbank websites and other data provided by the branch During the paper,the authordecides to apply some theories and real-life findings to analyze, compare andgeneralize the data

CHAPTER I : BASIC ISSUES OF CREDIT RISK AND

CREDIT RISK MANAGEMENT

1.1 Overview of credit risk.

1.1.1 Definition of credit risk

Bank credit is the credit relationship between banks, credit institutions andeconomic organizations, individuals on the principle of repayment The principalrepayments of credit means that the implementation of the value of goods on themarket, and the interest repayments of credit is the realization of surplus value in themarket Therefore, credit risk can be viewed as business risk, but in view of banksAccording to Thomas P.Fitch, credit risk is the type of risk occurs when theborrower fails to repay the debt under a contractual agreement Apart from interest raterisk, credit risk is one of the primary risks in credit (Dictionary of Banking Terms,Barron’s Edutional, Inc., 1997)

Credit risk, according to the most basic concept, is the risk of loss of principal orloss of a financial reward stemming from a borrower's failure to repay a loan orotherwise meet a contractual obligation

1.1.2 Causes of credit risk

1.1.2.1 Commercial banks

Arranging unethical and unprofessional staff which lead to the failure inevaluating financial situation, collateral and business plans of customers Lack ofethics, leading to process credit left to pursue personal interests; appraisal sketchy,records matter, lacking control checks, assessment of collateral values are not rightwith the actual value On the other hand, the distinguish between rights andresponsibilities in the credit granting decision is unclear, the manager is not boundtightly to their responsibilities as a result the doubtful loans continued to rise

Credit approval process and lending process are lack of discipline; not focus onannalysing customers, abusing mortage assets For SMEs and personal loans, thebank's lending decisions primarily based on experience but the analysis was limitedand inaccurate, lending decisions lack of scientific basis and it does not reflect thesituation as well as the possibility of using the capital

Lack of supervision and management after loan Banks often focused on theverification and loose the control of capital after lending Inspecting debt is an

important responsibility of loan officers banks, partly due to troubling aversion tocustomers, not provide timely and adequate information that banks require.

Lack of customers’ information or reliable credit information to analyze beforegranting credit Partly because of limited collecting channels to analyze informationefficiently The cooperation between banks is too loose, the role of the CIC is notreally effective In financial management, repayment capacity of a customer is aspecific figure, with its maximum limit Without exchanging information, as aconsequence, a client can lend at many banks which exceeds this maximum limit

Lack of compliance with accounting standards as banks will be difficult toestimate the financial situation of enterprises The appraisal reports are impractical,therefore banks have always considered part of collateral severe as the last solution toprevent credit risks

1.1.2.3 Others factors

 Unstable economic environment

With fast and unpredictable changes in the world market: Economy of Vietnammostly relies on imported raw materials such as steel, petroleum, fertilizers,etc as well

as the major exported items such as textiles, agricultural,etc

Liberalization of trade and international integration increases the competitivepressure on firms and banks Due to limited capital, technology, management skills,many companies and banks are not strong enough to create competitive products, thenthey lose customers which lead to losses and bankruptcy

Economic development lack of direction, assigning, specialization labor and regulation of the state led to the spontaneous development of the industry, companies andbanks caught up in the economic syndrome Therefore, when market becoming satiation orbeing back to the balance of supply and demand , the excess occurred, causing difficultiesand losses for these investments, lending of banks and enterprises

macro- Political risk

Political risks such as a military coup, new elected government discontinuingcertain policies and programmes, wars, terroism, international isolation , etc, canseverly impact the quality of a credit asset and may lead to losses

 Disaster risk

Disaster risks such as natural disaster, fire, epidemic diseases,etc.These are risksthat both customers and banks had anticipated for their credits, customers sufferdifficulties which affect the ability to repay loans for banks For customers with strongfinancial status, it also takes time to stabilize the business processes to be capable ofrepaying debt, and with potential customers, the credit can highly transform to baddebts Although this type of risk can be limited by insurance, however, when this type

of risk occurs, clients and banks would take much time to take money from insurancecompanies to fulfill the obligations to repay loans for banks

1.1.3 Consequence of credit risk

1.1.3.1 Impact on bank

 Lowering the prestige of commercial banks

With the trend of intense competitive nowadays, almost all commercial banks inVietnam try to open branches throughout the territory of Vietnam, and bringing thebest service for their customers Banking activities are always placed the prestige ontop, they always try to minimize all bad news in mass media affecting the bank'soperations If a commercial bank has high ratio of bad debt, or it was placed underspecial control by State bank, then the reputation of the bank will be reduceddramatically At that time there will be no individuals or organizations using the bank'sservices because they do not know the capital they put in the bank safe and profitable

or not

 Reducing the solvency of commercial banks

To have sufficient funds to provide credit for customers, the banks must raisefunds from organizations and residents, in other words the banks borrow money frominstitutions and residents to sponsor credit If the credit risk due to irrecoverable debts,the bank will limit the ources to pay deposit for creditors which are residents and othereconomic organizations

 Bankruptcy.

As mentioned above, credit risk affects the credibility, liquidity and profitability

of the bank If this proportion continues to extend and corrosion on the bank's owncapital, bankruptcy is inevitable

1.1.3.2 Impact on economy

Most banks now are using short-term funds to finance long-term debt, whichmeans that the time banks collect debts from customers can not as fast as the timecustomers withdraw money Thus, banks are faced with liquidity risk Once credit riskoccurs , it will lead to the prestig and solvency of the banks, people and organizationswill rush to withdraw money and terminate the relationship It will cause a chain effect

to the economy as follows:

Firstly, when the liquidity of banks reduces, banks will not be able to continuefunding for legal person and natural entity Thus, the funding recipients were greatlyaffected

Secondly, chain reaction to other commercial banks.When faith of public forbanks drops, customers will lose confidence in banks, thereby causing a chainreaction withdrawal at other banks

Finally, it is the chain reaction to other economic sectors Banking collapseleading to economic recession, reduced purchasing power, rising unemployment andsocial instability

1.2 Overview of credit risk management

1.2.1 Definition of CRM

Credit risk management is the practice of mitigating those losses byunderstanding the adequacy of both a bank’s capital and loan loss reserves at any

given time – a process that has long been a challenge for financial institutions.The goal

of credit risk management is to maximise a bank's risk-adjusted rate of return bymaintaining credit risk exposure within acceptable parameters

1.2.2 Process of CRM

1.2.2.1 Credit Risk Recognition

Credit risk recognition includes the steps of:

Monitoring

Researching environmental activities and the lending process to classified creditrisk forms

Forecasting underlying causes

To identify risks, the administrators must make a list of all the types of risk havebeen and will be able to appear in the future by these methods:

Establishing research questionnaires

Conducting investigations

Analysising credit records

Investigating the records that had problems

The analytical wil lresult for the signs, manifestations, causes

from which to find effective measures to prevent risks

1.2.2.2 Credit Risk Measurement

To measure the risks, it is necessary to collect data and analyze the level of riskbased on the criteria set out Entities need to assess the level of risk includes clients,loans and investment portfolio

Estimating borrowers risks:

Basel II allows banks choose between "Benchmarking" and "method based oninternal assessment" also known as "internal classification" There are two basic toolswhich are credit rating for enterprises and credit scoring for individual customers.These tools have made the task of credit grading, the main difference is thatcredit scoring only applies in banks system to estimate credit risk for loans of smallenterprises and individuals Credit scoring is mainly based on non-financialinformation, the information required in the loan application along with otherinformation about customers collected by banks will be imported to computers,through the system of credit information for analysis These results will give a number

- credit score - only the level of credit risk of the borrower This high technicalefficiency help risk management for small businesses and individuals effectively.Because these clients do not often have financial report or, lack of 0

Credit rating applies for large enterprises, with financial reports, statistical data ofaccumulated period are very helpful for classification Applied more widely, not only inthe banking activities, securities trading business, but also in trade, investment

Each banks may have different ways in implementation but always have commonpurpose which is to determine the ability, the attention of the customers in repayingloans, credit contractual interest signed application Thereby determining the riskpremium and limit maximun credit safety for customers as well as a provision forrisks There are 2 types of analysis:

• Non-financial analysis:

Quality models based on factors 6C:

Character

Character is the resposibility to start & finish the debt successfully

It is about customers’ personal, professional capacity to execute the debtssuccessfully roficient ability to execute the obligations effectively Character will beassessed uniquely in contrast to various individuals, including loan specialists Someindividuals will think a firm handshake is an indication of solid character Others willneed to see a decent acknowledge record and a stable job history The financial record

is a record demonstrating your past obtaining execution Loan specialists will take agander at past execution deliberately and assess the borrower on his or her potential forfuture insolvency Contingent upon your strategy for success and the advance you askfor, the moneylender may take a gander at the record of loan repayment of thebusiness, the individual borrower, and any co-signors, underwriters, or financialspecialists

It is imperative that you recognize what is on your credit record precedingapplying for an advance A terrible imprint on your credit record does not as a matter

of course keep you from getting an advance In any case, it is essential that you havefound a way to address any negative blemishes on your credit record and that you candisclose to your loan specialist why you got those imprints in any case

Capacity

Capacity is the ability of enterprises can pay the loan or not Capacity depends onlaws of each country The borrower must have civil legal and civil act capacity

o The legal documents proving the legal capacity of business loans

o Describe the operation of the business to the current time including theownership structure, owners, nature of activities, products, key customers, suppliers of

Credit officers use income to figure out if a business can meet month to monthadvance installments Income articulation is utilized to infer a proportion regularlycalled a base obligation administration scope (DSC) proportion prerequisite The creditofficiers will need to see that you have more trade turning out every month from wagethan you have going out from costs and advance reimbursement Loan specialists usediverse methods for figuring DSC proportions, however a decent general guideline is

to shoot for a DSC proportion of 1.2 to 1.25 That implies that for each $1,000 ofobligation reimbursement you need to make every month, you ought to have $1,200 to

$1,250 of money after costs You will make a cushion that ensures you (and your loanspecialist) from the surprising like increasing expenses or falling costs by having morecash than you have to pay costs

Collateral

Collateral is the security for loans Credit officers will need to consider all potentialoutcomes, and must arrangement for the most dire outcome imaginable In the event that theborrower can't reimburse the advance, how does the loan specialist get back their cash?Security is the domain, hardware, houses, autos, and other profitable things that a bank canhold as insurance for an advance if the advance is not reimbursed

The estimation of the property being held as security is an essential component:Lenders will probably require their own particular evaluation of the property ordifferent resources Frequently, resources are not esteemed by worth, but rather atwhat a loan specialist can get for the thing on the off chance that they need todispossess or sell That frequently implies the most minimal product cost for yieldsand domesticated animals and a serious rebate on gear Keep in mind loan specialistsare not in the matter of working the ranch business and/or purchasing and offering

ranch items, so the bank may not get the best cost on live creatures, crops in the field,perishable, or repossessed products

Likewise, most banks have arrangements with respect to advance to esteemproportions For instance, banks may just advance 80% of the estimation of a package

of property, or 25% to half of the estimation of a specific bit of hardware Differentbanks require 150% insurance in light of the expenses and misfortunes brought about

in a liquidation of the security The sort of guarantee is vital, as well: Lenders may askthat you secure the advance with your home, on the hypothesis that you will be lessinclined to default if your house is at danger

Control

It evaluates the impact of changes in laws, regulations operate to the ability tomeet customer needs of customers

• Laws, regulations, current rules relating to credit are being considered

• Enough paper records serve for control

• Profile loan documents and disbursement must be completed and signed by theparties

• Coverage of the loan for the rules and regulations of the Bank

• Comments by economic experts, environmental technicians of the sector, theproduct, the other factors can affect the loan

Bank focuses on issues such as changing laws and regulations related activitiesare adversely affecting customers or not, credit needs of customers who meet thecriteria of budget line or not

In addition, there are other assessment models such as 5P ( based on thefollowing factors: Purpose, Payment, Protection, Pilicy, Pricing) and CAMPARI(based on the following factors: Character, Ability, Magin, Purspose, Amount,Repayment, Insurance)

• Financial analysis:

For loans of enterprises, besides non-financial factors, banks also use financialindicators to evaluate the repayment capacity of enterprises This is curent financialanalysis, overview capital management capabilities and business activities through thenumbers in the financial reports of companies Some indicators of financial analysiswhich are often applied:

Z – credit scoring model

The Z-score is the output of a credit-strength test that gauges a publicly tradedmanufacturing company's likelihood of bankruptcy The Z-score, is based on fivefinancial ratios that can be calculated from data found on a company's annual report.The Altman Z-scoreis calculated as follows:

Z = 1.2X1 + 0.6X4 1.4X2 + + + 1.0X5 3.3X3

X1: Current assets – Current liabilities / total assets

X2: Retained Earnings / Total Assets

X3: Earnings before interest and taxes / Total Assets

X4: Market value of equity / Total Liabilities

X5: Sales / Total Assets

The lower/higher the score, the lower/higher the likelihood of bankruptcy

A score below 1.8 means the company is probably headed for bankruptcy, whilecompanies with scores above 3.0 are not likely to go bankrupt Any company with Zscore <1.81 must be classified as at risk of high credit risk

 Loan risk evaluation

Basel II can also calculate the expected loss according to the probability ofdefault, loss given default exposure and exposure at default as the formula:

EL = EAD x PD x LGD

If a loan is considered as a test, if any risk statistics complete, we can determinefairly accurately the probability of risk of each bank's assets in each period , each type

of credit, every investment sector

 Portfolio risk evaluation : Value at Risk (VAR)

Value at risk (VaR) is a statistical technique used to measure and quantify thelevel of financial risk within a firm or investment portfolio over a specific time frame.Value at risk is used by risk managers in order to measure and control the level of riskwhich the firm undertakes The risk manager's job is to ensure that risks are not takenbeyond the level at which the firm can absorb the losses of a probable worst outcome

1.2.2.3 Credit Risk Controlling

Risk control is the use of measures, techniques, tools, strategies and operational

programs for preventing, avoiding and minimizing risks Based on the level of riskwhich was calculated, the safety of the financial system, and the ability to take risks,then there are several preventive measures to reduce the extent of damage, such as : Passively accept the risk: with small loans, sometimes the costs of preventingare higher than accepting losses Or if the probability of risk is too high, banks willavoid risk by limiting or refusing to grant credit

For the remaining loans, whereas the risk prevention tool is particularly effectivefor preventing, avoiding or minimizing the likelihood of risks and losses Themeasures include: preventing risks, sale debt, spread risk and derivative instruments

Sponsor Risk: including insurance, asset disposal to ensure the recovery of debts

and lawsuits, a provision for risks to process these items can not be recovered

To ensure that these methods are carried out smoothly and efficiently, the banksneed to conduct simultaneously these steps:

Based on the current situation as well as the bank's forecast of economicdevelopment situation, from which issued the policy, specific documents, as well asstrategic planning is apparent

Identify the resources required to implement the goals, including humanresources, material and technical base as well as minimum initial capital

Develop plans to allocate labor resources, distribution of financial resources,design and construction of apparatus functions for operating, set the development of

banks Thereby, leadership labor force and step by step

set out targetss in short term and in long term

Having credit granting process, testing internal controls, including theobservance of the principles and procedures for granting credit (including the contents

of separation between responsibility and delegated powers), warning systems effectiveinternal report, risk prevention plan, etc

1.2.2.4 Credit Risk Solving

 Diversify portfolio

This is the best and most proactive method in dispersion of credit risk Banksshould divide their money into various types of credit investments, different industries

as well as customers in diffirent areas This has expanded the scope of credit activities

of banks, strengthen their reputation and achieving the purpose of risk diversification

To do this task ,the bank should indicate some appropriate business strategies based on

a thorough study of the following issues:

Investing in different economic sectors to avoid competition from other creditinstitutions in spending snatching market share in narrow range of developing career aswell as to avoid the risk faced by the government policies with the aim of limitingactivities of a certain number of lines in the plan to restructure certain economic sectors Invesying in manufacturing business objects, different types of goods to avoidcentralized lending produce some types of products, especially the non-essentialproduct categories that the government does not encourage to appear in the market.Avoid excessive lending for a customer, always ensure a certain proportion oflending activity in the capital costs of the customer to avoid the customer’sdependence and unpredictable risk The State Bank has also issued regulations onlending products due to the Decision No 1627/2001 / QD-NHNN of which stated "The total outstanding loans to a single client may not exceed fifteen (15) per cent ofthe equity of the credit institution, except in cases of loans funded by capital sourcesentrusted by the Government, by organizations or by individuals If the capitalrequirements of a client exceed fifteen (15) per cent of the equity of the creditinstitution or if a client wishes to raise capital from a number of sources, creditinstitutions may enter into a syndicated loan in accordance with regulations of theState Bank."

Loans with different types of time limits to guarantee a balance between the

short-term , medium term, long term loans and to ensure steady growth as well as toavoid credit risks due to changes in interest rates

Create an appropriate ratio between loans in VND and foreign currency toensure the needs for loans of customers avoiding credit risks due to changes inexchange rates

Diversify portfolio has the advantage of enabling banks to spread risk in activeways, however, the diversification of the credit portfolio will also have disadvantagessuch as: dificult in management, increase the cost of inspection and surveillance,etcand decrease profitable opportunity

 Co-financing loans

In fact, there are enterprises with massive demand for loans that banks can notserve, it usually needs to invest in major projects and difficult to determine the level ofrisk that may occur In this case, banks will link together to evaluate projects, lendingand risk sharing ensure the rights and obligations of each party

This form of credit is not really popular with commercial banks in Vietnam.Partly because of the complexity of this form, others due to problems in the bankingcompromise between the rights and responsibilities of the link This is also drawback

of this measure

Currently, the State Bank of Vietnam has issued regulations on the issue ofco-financing loan is the premise legally basis for promoting such activities Toimplement effective this form of credit, banks must have a sense of cooperation andbanks need to have a chair for compromise between them, this role can be assigned

to the State Bank

 Credit Insurance

In social life, "insurance" is a common definition used to refer to one of the mosteffective methods to disperse risks Credit insurance is also an important method toshare risk in credit activities of banks For example Vietcombank and Vietcombank-Cardif Life Insurance (VCLI) has cooperated continuously and distributed the product

"Security Credit" for borrowers since 2009 After more than 6 years of implementingthe credit security products, VCLI paid insurance benefits for compensatio up tobillions in many cases which borrowers unfortunately died or were injuredpermanently Some cases have received benefits from the first year of the contract.VCLI has also created impression to customers with quick processing and timely

payment of insurance benefits Moreover, in order to encourage borrowers toparticipate this integration, Vietcombank has adopted preferential policies such asshopping voucher worth up to 2 million, the system used in supermarkets and othershopping systems Credit insurance can be implemented in various forms such asinsurance for lending, property insurance, mortgage insurance

Customers buy credit insurance When customers fall into unemployment,bankruptcy and unable to pay loan, the insurance company will pay This is amethod of credit risk management should be concerned, especially in conditions ofbanks operating in Vietnam So far, only a handful of banks in Vietnam to usecredit insurance to manage risk prevention for themselves and especially forindividual customers

Banks buy insurance directly from insurance professional organization and will

be compensated for losses

Insurance of loan collateral

Advantage of using credit insurance is that when credit risk happen, it can be thebest way to overcome the consequences of such risks

Thus, every business activities contain potential risks, if we do not take risks, we cannot create new investment opportunities Business activities of commercial banks as well

as other enterprises activities are inevitably risks Thus risk management is anindispensable requirement set out in the existence and development of the bank So tomanage risk effectively banks should use the flexibility of risk management methods toachieve the goals of the bank as well as limited to the lowest level possible risks out

1.3 Credit Risk Management – According to Basel

1.3.1 Basel I Banking regulations

Credit granting criteria and credit monitoring process (Standard 7): The mainpart of controlling system is to assess policies, practices and procedures related tocredit granting, implementation of investment and management of current portfolio.Credit and investment functions of banks are objective based on healthy principles It

is necessary for banks to maintain prudential lending policies, purposes and procedures

in compliance with reasonable lending documents The bank should have a process tomonitor the existing credit relations of customers Database is an important factor forthe information management system because credit portfolio is determined.Consequently, it is important that banks grant credit to such parties on an arm’s-length

basis and that the amount of credit granted is monitored Such controls are most easilyapplianced by requiring that the terms and conditions of such credits not be morefavourable than credit granted to non-related borrowers under similar circumstancesand by imposing strict limits on such credits Another method of control is the publicdisclosure of the terms of credits granted to related parties The bank’s credit-grantingcriteria should not be altered to accommodate related companies and individuals.

Asset quality assessment and provisions for debt loss (Standard 8):Bankinspectors should be all aware that the bank establishes and maintains policies, habitsand procedures appropriate with asset quality assessment and provisions.The bankshould develop a process to identify problematic debts and filter past-dues.Inimplementation of guarantees or receipt of mortgages, the bank must assess reputation

of the guarantor and evaluate the mortgaged asset.In the events of problematic debts,the bank promotes its lending activities on the basis of credit granting and overallfinancial strengths For the various components of credit administration to functionappropriately, senior management must understand and demonstrate that it recognisesthe importance of this element of monitoring and controlling credit risk

Risk centralization and huge risks (Standard 9):The bank need to develop acredit monitoring system, which allows determination of notable points in theinvestment portfolio and set up prudential ratios to restrain a trend that the bankcentralizes on particular customers or a group of customers Specific individualsshould be responsible for monitoring credit quality, including ensuring that relevantinformation is passed to those responsible for assigning internal risk ratings to thecredit In addition, individuals should be made responsible for monitoring on anongoing basis any underlying collateral and guarantees Such monitoring will assist thebank in making necessary changes to contractual arrangements as well as maintainingadequate reserves for credit losses In assigning these responsibilities, bankmanagement should recognise the potential for conflicts of interest, especially forpersonnel who are judged and rewarded on such indicators as loan volume, portfolioquality or short-term profitability

Relationship lending (Standard 10):To prevent the abuse that may arise fromrelationship lending, credit relations should be based on the principle of “undercontrol”, so that credit expansion can be assessed effectively for risk control andmitigation Relationship lending often results in special risks to the bank, so it should

be approved by Board of Directors Internal risk ratings are an important tool inmonitoring and controlling credit risk In order to facilitate early identification, thebank’s internal risk rating system should be responsive to indicators of potential oractual deterioration in credit risk Credits with deteriorating ratings should be subject

to additional oversight and monitoring, for example, through more frequent visits fromcredit officers and inclusion on a watchlist that is regularly reviewed by seniormanagement The internal risk ratings can be used by line management in differentdepartments to track the current characteristics of the credit portfolio and helpdetermine necessary changes to the credit strategy of the bank Consequently, it isimportant that the board of directors and senior management also receive periodicreports on the condition of the credit portfolios based on such ratings.

1.3.2 Methods of credit risk approach according to Basel II

There are two methods for calculation of bank credit risks:

The first method: measures credit risks by the standardized approach based onexternal credit assessments

The second method: the banks use their own internal ratings-based system (IRB)

 The Standardized Approach (SA):The standardized approach means thatbanks classify credit risks based on observable features of risks (such as risks from acompany loan or from a loan secured by collateral being a house) The standardizedapproach classifies fixed ratings for each type of risks supervised and bases onexternal assessments to enhance the sensitivity of risks The standardized approachprovides inspectors and supervisors with guidelines to decide whether externalassessments are appropriate to apply in banks or not An important change of thisapproach is that loans are classified as past-dues if their credit rating is 150%, exceptwhen provision has been booked for such loans

When banks expand their credit derivatives such as mortgage, guarantee, Basel IIconsiders such tools as factors to mitigate credit risks The standardized approach widensthe scope of eligible collaterals beyond the nation’s issues and simultaneously introducesseveral methods to assess the level of capital decrease upon market risks of collaterals The standardized approach also consists of specific handling with retail risks.Ratings of risks in loans mortgaged with houses will be reduced together with otherrisks of loans to non-rated firms Besides, some loans to small and medium-sizedenterprises may be processed as retail risks in case of meeting certain criteria

To help banks and supervisors in case there are not many options, BaselCommittee developed “the simple standardized approach” consisting of the simplestoptions to calculate risk-weighted assets Banks applying the simple standardizedapproach should comply with requirements of market inspection, monitoring and

discipline equivalent to the new Basel agreement

 The Internal Ratings-Based Approach (IRB):Banks must have independentcredit risk supervision units specializing in designing and implementing their owninternal rating systems Such units are independent in terms of functions frommanagement units who are responsible for creating potential risks Aspects ofsupervision include:

- Check and follow up the internal ratings;

- Prepare and analyze summary reports from the rating system of the bank,including historical data on cases of failures in repayment classified at the time ofoccurrence and one year prior to this occurrence, analyze measures to mitigate risks,monitor trends in major rating criteria;

- Implement processes to inspect whether rating definitions are uniformly used

by Departments, Boards and regions or not;

- Assess on and record all changes in the rating process and reasons thereof

- Consider rating criteria to assess if they are still of any effects for riskanticipation Changes in the rating process, criteria or parameters must be made intowritten records and archived for supervisors’ consideration

- The credit risk supervision unit should be proactively involved in thedevelopment, selection, implementation and determination of valid values of ratingmodels, undertake the supervision and monitoring of all models used in the ratingprocess and bear the highest responsibility for frequent assessments and changes ofrating models

1.3.3 Criteria for development of a modern risk management model as per Basel Committee

Basel Committee says: Weaknesses in the banking system of a country, whetherdeveloped or developing, threaten the stability of both its finance and internal affairs.Therefore, Basel Committee pays much attention to strengthening the power of thefinancial system Basel Committee has issued principles on management of defaultswhich are by nature principles on credit risk management, ensuring the efficiency andsafety in credit granting Such principles focus on the following contents:

• Develop a fitting credit environment: Accordingly, Basel Committee requiresBoard of Directors to routinely affirm credit hazard strategies, survey credit dangersand develop an exhaustive system in the bank's operations (terrible obligation rate,hazard acknowledgment level, and so forth) Upon such premise, Board of

Management embraces to actualize such bearings and create approaches and strategies

to distinguish, measure, screen and control awful obligations in all operations at thelevel of every credit and the entire financing portfolio Banks need to decide andoversee credit dangers in each item and action Particularly, new items must beendorsed by Board of Directors or Committees under control of Board of Directors

• Healthily allow credits: Banks need to plainly characterize criteria for soundcredit conceding (target markets, qualified clients, terms and states of credit giving,and so forth) Banks ought to develop credit lines for every sort and gathering ofborrowers to recognize distinctive sorts of credit dangers, which can be thought aboutand caught up upon inside appraisals of clients in different perspectives and segments.Banks ought to issue clear procedures of acknowledge giving, credit changes forinvestment of showcasing division, credit investigation division and creditendorsement division, and also unmistakable obligations of members At the sametime, banks ought to build up a group of experienced and educated dangeradministration staff to convey prudential choices on evaluation, endorsement andadministration of credit dangers Credit conceding ought to be led upon reasonableexchanges among gatherings Particularly, there ought to be prudential and sensibleevaluations on relationship clients

• Maintain a reasonable credit postliminary, observing and administrationprocess: Banks ought to be outfitted with cutting-edge administration frameworktowards the venture portfolio with potential dangers, including upgrading creditrecords, gathering current money related data, archive drafts, for example, creditcontracts, and so forth upon the banks' degree and level of multifaceted nature In themeantime, the framework ought to have the capacity to handle and control clients'money related circumstance, duty consistence, and so on to auspicious distinguishrisky obligations Banks ought to have a framework to opportune adapt to awful anddangerous obligations Credit hazard arrangements ought to elucidate strategies foroverseeing risky credits Obligations towards such attributes might be relegated to thepromoting division or obligation recuperation division or the blend of such divisions,contingent upon the degree and nature of every credit Also, Basel Committee urgesbanks to create and develop an inside rating framework for danger administration,empowering to recognize levels of credit dangers for possibly hazard weightedresources of the bank.Inconclusion, to develop the credit risk management model,Basel principles include the following significant contents:

Analyzing the credit granting system by division of marketing, credit analysis

and credit approval.

Improving the quality of risk management staff

Developing efficient information management and updating system to maintain

a proper credit monitoring and measuring process, coming close with the requirements

of credit assessment and risk management

1.3.4 Vietnam’s existing regulations on debt classification, provisioning and use of provisions for settlement of credit risks

After more than four years of implementing Decision No.488/2000/QĐ- NHNN5dated November 27th 2000, the regulations turned out to have some shortcomings anddid not comply with the international standard In order to further more fit with theinternational standards, the SBV issued Decision No 18/2007/QĐ-NHNN dated April

25th 2007 on supplementing and amending a number of articles of Decision No 493

Debt classification by the quantitative method:

Group 1

Debts that are not due and assessed by credit institutions as fully and timely recoverable both principal and interest Debts that are overdue for less than 10 days and assessed credit institutions as fully and timely recoverable both principal and overdue interest

Group 2 Debts that are overdue for 10 up to 90 days, and the repayment term is

first time restructured

Group 3 Debts that are overdue for 91 up to 180 days; the repayment term first

time restructured; debts that are waived or reduced for interest

Group 4 Debts that are overdue from 181 up to 360 days

Group 5 Debts that are overdue for more than 360 days

Debt classification by the qualitative method:

Group 1 Debts with timely recoverable principal and interest

Group 2 Debts with recoverable principal and interest but with signs of the

clients’ decrease in repayment capability Group 3 Debts incapable of timely recoverable principal and interest with

possibility of partial loss Group 4 Debts assessed by credit institutions as high possibility of debt loss

Group 5 Debts assessed by credit institutions as irrecoverable

Provisioning ratios applicable to debt groups:

CHAPTER II : ANALYSIS OF CREDIT RISK

MANAGEMENT OF SMALL AND MEDIUM

ENTERPRISES AT MILITARY BANK- THANG LONG

BRANCH

2.1 Overview of Military Bank – Thang Long Branch

2.1.1 Foudation and Development of Military Bank- Thang Long Branch

On December 24th 2009, MB - Thang Long Branch officially opened its newhead office at 34 Lang Ha , Dong Da District, Hanoi The branch was formerly LeTrong Tan Branch, which was established in 2003 at 164 Le Trong Tan, Thanh XuanDistrict, Hanoi From November 2008, Le Trong Tan Branch was officially renamedThang Long Branch and become level-1 branch of MB system The new officesituated right in the center of the capital city Easy traffic, high density of population,along with the appearance of many banks will create a competitive environment sothat Thang Long Branch can uphold its strength in funds and profession activities, aswell as other banking services and many new customer-aimed products

Up to this time, this branch owns total assets of over 4,500 billion and has thefastest growth rate in MB system For nearly seven years of operation , the branch hasreached many achievements and gained prestige from customers and become one ofthe most well-performed units of MB

2.1.3 Ranges of service for customer

 Bank Savings

With a payment account (current account), customers can receive and keeptheir deposited money (VND, USD, EUR, etc) as well as use the money in theiraccount for daily spending and payment Current account is unlimited for thetimes of deposit or withdrawal

 Remittance services

Asan official authorized agent of Western Union money transfer service inVietnam, MB is a reliable partner offering express remittance money transferringservices to over 200 countries and territories MB’s application of modern technologyenables customers to experience safe and sound remittance services Customers canreceive money within a few minutes from their relatives being half a world away inVND or USD depending on position of currency at the transferred No fee is chargedfor receiving money

 Loans services

 The maximum loan limit: up to 80% customer’s financial demand

 The maximum loan tenor: 180 months

 Simple and convenient loan application procedures: processing within 1-3working days

 Flexible repayment alternatives : installment, principal in arrears, diminishingprincipal balance

 Collaterals accepted in various forms: real estate, valuable papers, vehicles.

 Grace period can be up to 12 months

 Cards services

 Withdrawing cash at more than 8,000 ATMs which display a Banknetvn,Smartlink and VNBC logo nationwide

Making payment for goods and services at all card acceptance points

Making account transfer/account balance inquiry/account statement inquiry, etc,directly on MB’s ATMs

Using modern banking services: HomeBanking, eMB, Mobile Banking, etc

Making online payment via websites: Baokim.vn, pay.zing, vio.com.vn

Being more active by debiting directly from customers’ accounts

Enjoying customer service 24/7

Table 2.1 : Capital mobilization of Thang Long Branch in 2011, 2012, and 2013.

Unit: Billion Dong

Source: Bussiness performance report of Thang Long Branch in 2013

Based on Table 1 , we have the comparison charts of capital mobilization of Thang Long Branch in 3 years , from 2011 to 2013

Figure 2.1 : Total capital mobilization of Thang Long Branch in 2011, 2012, and 2013.

Unit:Billion Dong

Capital mobilization activities of Thang Long Branch have relentless growth in 3years and achieved very high sales It reached 1,019.49 billion in 2011, 2012 was3,829.23 billion and was very high in 2013 -8,537.57 billion We can see that in 2012 ,

it increased 3.76 times compared to 2011 In 2013 was 2.23 times increased compared

to 2012 and increased 8.37 times compared to 2011, nearly a dozen, which was apositive and good result To obtain high growth rates like that, MB Thang Long hasadopted effective policies to raise capital such as applying flexible interest rate policyfor deposit, good customer service to attract customers,…

The overall proportion of deposits increased stable year by year, especially in

2013 the proportion of deposits increased sharply We can notice that non-termdeposits accounted for a small proportion compared to term deposits, but tends toincrease The increase in non-term deposit was due to the increasing of corporatecustomers, the balance on the account was very well It helped the branch becomemore proactive in using capital and profits increased significantly

2.1.4.2 Credit activities

The Branch focuses on promoting personal and SME loans Outstanding loansreflect the total amount of the bank to the borrower at a specific time Therefore, weexplore the outstanding loans of individuals and corporate customers at the end of eachyear to evaluate the credit performance of Thang Long Branch

Table 2.2 : Oustanding loans of MB Thang Long in 2011, 2012, 2013

Unit: Billion Dong