Capital adequacy measurement a case study of an binh commercial joint stock bank

In 2005, SBV issued the Decision 457/2005 promulgating the regulation on safety assurance ratio in activities of credit institutions and they continued to grant the Decree number 141/200

UNIVERSITY OF ECONOMICS HOCHIMINH CITY

FALCUTY OF BANKING

MBA PROGRAM

A CASE STUDY OF AN BINH COMMERCIAL

JOINT STOCK BANK

To achieve this thesis, I would like to convey my sincere thanks and appreciation to the Economics University of Ho Chi Minh City , MBA program officers who have facilitated and helped me with all their kindness and assistance

My special thanks to Ms Pham Thanh Thuy, Director of Treasury Division of An Binh Commercial Joint Stock Bank, Mr Vo Van Nhuan, Vice Head of Financial Accounting Department, of ABBank, Mr Nguyen Cong Anh and Ms Tuy Loan, Expert of Financial Accounting Department of An Binh Commercial Joint Stock Bank who created favorable conditions, gave me relevant data and helped me to carry out significant analysis and CAR measurement jobs during the time I had been doing this research dissertation

From DHL- VNPT Express Ltd., I appreciate Mr Do Huu Anh, Deputy General Director, Ms Dao Thi Ngoc Anh who have supplied me valuable data, information and edited this research All of us have had good cooperation during the time of this thesis being done

Apart from the above mentioned, Mr Nguyen Huu Nhan, Mr Ngo Tran Kien Quoc- members of MBA Banking class, Dr Truong Tan Thanh- lecturer of Investment analysis and portfolio management and my wife having encouraged and helped me with all their hearts made me more confident and delighted to carry out this research dissertation

I would like to say that a lot of thanks are owed, in particular, to the assistance and guidance from Assoc Prof., Ph.D Tran Hoang Ngan, Vice Rector of Ho Chi Minh City Economics University Ph.D Tran Hoang Ngan, the tutor has encouraged and given me a lot of advice on doing this thesis Without Ph.D Tran Hoang Ngan‘s advice, a lot of difficulties would surely arise during my performance on this task

Once again, all assistance helping me with this thesis is highly appreciated

In current age, globalization of financial institutions is a characteristic point and unavoidable trend that make each country have to establish a banking management system to protect against financial risks, to reinforce transparency in the banking payment system and to tighten regulation on capital adequacy

In order to conduct the opening door policy and integrate intothe world economy, implement commitments of the WTO, Vietnam has many efforts to apply international standards in capital banking management In 2005, SBV issued the Decision 457/2005 promulgating the regulation on safety assurance ratio in activities of credit institutions and they continued to grant the Decree number 141/2006 date the January 1st, 2006 required Vietnamese commercial banks to have

a chartered capital of 3,000 billion VND at the end of 2010 which were seen the interest of SBV in capital fund of commercial banks The research problem of the thesis is to examine the adequacy of bank capital in Vietnamese banking system through a case study of An Binh Bank

In term of structure, the research study has six chapters Chapter One and Two review research background, scope of work, methodology, significance of the study, risk in banking operation and banking capital adequacy Chapter Three introduces research methodology is carried out in the thesis Chapter Four and Five present an overview of CAR measurement in Vietnamese banking system and survey results obtained from a real model Chapter Six provides some conclusions and recommendations from the research

With the finding as presented above, the dissertation provides many implications to

be able to improve in banking capital adequacy management in Vietnamese commercial banks

SBV State bank of Vietnam

SOCBs State owned commercial banks

JSCBs Joint stock commercial banks

SPBs Social policy bank

JVBs Joint-venture banks

FBBrs Foreign bank branches

FFOBs Fully foreign owned banks

VAR Value at risk

ORM Operational Risk Management

ALM Asset Liability Management

ALCO Asset Liability Committee

ABB An Binh Commercial Joint Stock Bank

FRB the Federal Reserve Board

FRS the Federal Reserve System

FDIC Federal Deposit Insurance Corporation

OCC The Office of the Controller of the Currency

RWAs Risk- weighted assets

US the United States

OECD The Organization for Economic Co-operation and Development

BIS Bank for International Settlements

CAR Capital adequacy ratio

GDP Gross domestic product

IBRD International Bank for Reconstruction and Development

EBRD European Bank for Reconstruction and Development

ADB Asian Development Bank

AfDB Africa Development Bank

ACB Asia Commercial joint stock Bank

STB Saigon Thuong Tin Commercial Join Stock Bank

VCB Vietnam Foreign Trade Commercial Join Stock Bank

Vietinbank Vietnam Joint Stock Commercial Bank for Industry and Trade EAB Eastern Asia Commercial Joint Stock Bank

TCB Technological and Commercial Joint Stock Bank

EIB Export Import Commercial Bank

OCB Orient Commercial Joint Stock Bank

NAB Nam A Commercial Joint Stock Bank

SCB Saigon Commercial Joint Stock Bank

HDB Hochiminh City Housing Development Joint Stock Bank

VBSP Vietnam Bank for Social Policies

VDB Vietnam Development Bank

BIDV Bank for Investment and Development of Vietnam

MHB Mekong Housing Bank

VBARD Vietnam Bank of Agriculture and Rural Development

DAB Dong A Bank

VIB Vietnam International Bank

ROA Return on Assets

ROE Return on Equity

EPS Earning per Share

PCC Primary capital components

TA Total assets

AfL& LL Allowance for loan and lease losses

ATRR Allocated transfer risk reserves

SCC Secondary capital components

Acknowledgements i

Abstract ii

Glossary of terms and abbreviations iii

Table of Contents v

List of Tables ix

List of Figures x

Chapter One: Introduction 1

1.1 INTRODUCTION 1

1.2 RESEARCH BACKGROUND 1

1.3 RESEARCH PROBLEMS 3

1.3.1 RESEARCH OBJECTIVES 3

1.3.2 RESEARCH QUESTIONS 4

1.4 SCOPE OF WORK AND LIMITATION 4

1.5 METHODOLOGY 5

1.6 SIGNIFICANCE OF THE STUDY 5

1.7 STRUCTURE OF THE STUDY 5

Chapter Two: Literature survey 7

2.1 INTRODUCTION 7

2.2 RISK IN BANKING OPERATION 7

2.2.1 BANKING RISK OVERVIEW 7

2.2.1.1 Credit risk 7

2.2.1.2 Market concentrate risk 8

2.2.1.5 Foreign currency risk 8

2.2.1.6 Economic risk 9

2.2.2 BANKING RISK MANAGEMENT ORGANIZATION 9

2.3 ADEQUACY OF BANK CAPITAL 10

2.3.1 REGULATIONS OF ADEQUATE CAPITAL 11

2.3.1.1 Uniform capital requirements 12

2.3.1.2 Risk- adjusted capital requirements 14

2.3.2 REGULATORS’ VIEW POINTS 16

2.3.3 BANKERS’ VIEW POINTS 17

2.4 CONCLUSIONS 17

Chapter Three: 18

Research methodology 18

3.1 DEFINE RESEARCH PROBLEM AND ESTABLISH RESEARCH OBJECTIVES 18

3.2 DETERMINE AND COLLECT DATA 18

3.3 EVALUATE AND ANALYZE DATA 19

3.4 RECOMMENDATIONS AND CONCLUSIONS 20

Chapter Four: 21

An overview of CAR measurement in Vietnamese banking system 21

4.1 VIETNAMESE BANKING STRUCTURE 21

4.2 REAL ACTIVITIES OF VIETNAMESE COMMERCIAL BANKS 23 4.2.1 ACHIEVEMENTS 23

4.2.1.1 Number of commercial banks increased annually 23

4.2.2 SHORTCOMINGS 27

4.2.2.1 Bank- based financial system 27

4.2.2.2 Bad debts of state owned commercial banks 28

4.2.2.3 Small equity capital 28

4.2.2.4 Traditional and mono banking services 29

4.3 CAR REGULATIONS IN VIETNAMESE BANKING SYSTEM 32

Chapter Five: 35

Capital adequacy ratio measurement analysis in ABBank 35

5.1 ABBANK OVERVIEW 35

5.1.1 CORPORATE INFORMATION 35

5.1.2 MILESTONE AND VISION 35

5.1.3 BANK’S ORGANIZATION, PRODUCTS AND SERVICES 36

5.2 ROLE OF ALCO 37

5.2.1 TARGETS OF ALCO 38

5.2.2 TASKS OF ALCO 38

5.2.3 CONTENTS OF THE REPORT SUBMITTED TO ALCO 39

5.3 CAPITAL MANAGEMENT IN ABBANK 39

5.3.1 REGULATIONS IN SAFETY 40

5.3.2 SUPERVISION 42

5.3.3 DEBIT CLASSIFICATION AND RISK PREVENTION 42

5.3.4 FOREIGN EXCHANGE STATUS 43

5.3.5 DEPOSIT INSURANCE 44

5.4 ABBANK’S CAPITAL ADEQUACY 44

5.5 CAR CALCULATED ACCORDING TO SBV IN COMPARISON WITH PRIMARY CAPITAL TO ASSET RATIO (FRB) 49

6.2 INCREASING THE CURRENT CAR 52

6.3 APPLYING STANDARDS OF BASEL II IN VIETNAMESE COMERCIAL JOINT STOCK BANKS 52

Conclusions 54

Bibliography 56

List of appendices 58

4.1 Number of commercial bank 2004- 2008 23 4.2 Chartered capital of Vietnamese commercial banks 27 4.3 CAR of Vietnamese commercial banks from 2003 to 2008 33

5.2 Total assets and capital in ABBank from 2006 to 2009 45

5.4 Calculating CAR in accordance with different ways 50

2.1 Asset/ Liability management structure 10

4.2 Fund mobilization and loan outstanding from 2001 to 2008 by

Vietnamese commercial banks

25

4.3 Growth rate of fund mobilization and loan outstanding 25

5.3 Capital adequacy ratio of some commercial banks from 2006 to

2008

48

5.4 Owned adequacy/ Total asset of commercial banks 48 5.5 Chart of CAR according to different calculation 51

Chapter One: Introduction

1.1 INTRODUCTION

Banks undertake a variety of functions which assists the operation of the economy and the general community The most important function of these is the provision of payment service and it acts as financial intermediaries between savers and borrowers In this role, banks pool the community’s saving, thereby increasing liquidity and avoid the risk of investing funds with a few borrowers- household or businesses when approaching banks or other financial intermediaries do not face the cost of approaching a large number of small savers to meet borrowers’ finance needs Lending and borrowing activities make banks take many risks caused by from external and internal factors such as business risk, financial risk, liquidity risk, exchange risk and country risk as well That requires banking managers to consider about the risk management The risk management in financial institutions is sophisticated and its purpose is to optimize the uncertainty and to create the value by maximizing return available for a given level of risk

Banking business activities are sensitive and highly spread into a whole system Any social volatilities which affect on banking the downturn of banking system are able

to make bad results on national economy Thus, with the role as a central place of national payment system, banking management, especially capital management is crucial to absorb the volatility of economy affected in banking system and build in the confidence on the customers Bank capital must be sufficient to protect a financial organization’s depositors and counterparties from the risks of the institution's on- and off-balance sheet risks

1.2 RESEARCH BACKGROUND

Vietnamese banking system has been executing a careful process of reform which has resulted in the restructure of its large monobank The process has created four public sector banks including state owned commercial banks (SOCBs), joint stock commercial banks (JSCBs), foreign banking and credit cooperatives JSCBs only

account for 15% of banking sector assets, but they are considered more rapid growth than SOCBs Their operations are concentrated on major urban areas and focus on providing credit to small and medium sized companies and retail banks JSCBs’ services are various and new technologies have been applied in operation and management on the purpose to give the best service to consumers JSCBs’ banking activity are supervised by SBV and board of management The reform has made Vietnamese banking system operated better and contributed significantly in economic growth With the role of financial intermediary, Vietnamese banking system has been contributed positively to maintain high economic growth continuously in last years With the outstanding loan of economy making up 35%

to 37% of GDP, annually, banking system has contributed over 10% of overall Vietnamese economic growth rate

Business downturn has occurred since the end of year 2008 with the bankruptcy of big banks in the world such as Lehman Brother and Citibank that have been the signals of financial regression In the year 2009, the business overview in the world has become more serious as American business has fallen in crisis which has caused the financial crisis in most of countries In this context, Vietnamese commercial banks which have low level of management and weak capital base are able to be impacted by global crisis influences In order to deal with the downturn, SBV is not only to maintain a tighten monetary policy but also to grant many regulations to maintain the banking operation system and limit the credit risk Vietnamese commercial banks are concentrated on two main targets: increasingly lending and borrowing operation but assure capital safety

Moreover, the integration process requires Vietnam have to be aligned with international treaties and global standards in banking management that will ensure the safety and soundness of global financial system Capital fund of commercial banks in total assets and deposits have become an issue regarding to adequacy of bank capital

1.3 RESEARCH PROBLEMS

Bank regulators in most countries and international bank supervisory agencies have taken into account of capital adequacy by setting up many regulations of bank capital, in which, Basel I and Basel II proposed by the Basel Committee have been aligned with member states To do opening- door and integration policy, Vietnam has made many efforts to renovate economy and implement the WTO’s commitments, in which banking service is the area of deeper integration and the widest Vietnamese banking system has just aligned with a part of standards in the Basel I about credit risk and forecast to do fully the standard in 2010 Vietnamese commercial banking system will have to prepare in long time before applying the Basel II Therefore, being aware of bank capital and capital adequacy problem are key factors in management for Vietnamese regulators and banking managers The problem to be addressed in the thesis is the capital adequacy in Vietnamese commercial banks through studying a case study in An Binh Joint Stock Commercial Bank (ABBank)

The case study has been done in An Binh Joint Stock Commercial Bank which adequate capital is so high, its operation is not so complicated as more than 90% of its income mainly come from credit activity Scale of total capital in ABBank is average and it will not encounter with the pressure of increasing capital over three billion Vietnamese dong in 2010 This is one of Vietnamese commercial banks having big ambitious strategy to extend banking market share and the most important is that the research can find quite enough data for the research purpose

SBV with standards of Basel I before Vietnam has to apply new international standards such as the Basel II

- How does ABBank measure capital adequacy ratio under SBV’s regulations?

- Is there the significant difference between the measurement of CAR according to SBV’ rules with primary capital to asset ratio?

- What action can improve capital adequacy in Vietnamese commercial banks?

1.4 SCOPE OF WORK AND LIMITATION

Completing the dissertation combines aspects theory with practice For theory, this study replies on main contents of the Basel I and current regulations of SBV relating

to capital management and assurance of safety ratio in activities of credit institutions

in Vietnam The research also uses theory of FDIC’s Capital Adequacy Act to discuss on primary capital to assets method In addition, utilizing data collected from ABBank to calculate CAR and analyze capital management in the thesis Moreover, data of commercial banks in HCMC area published in the public media such as newspapers, magazine, internet being utilize in the study

As presenting on the research problem, Vietnam needs to have more conditions about expenses, qualified human resources, system guidelines to apply the Basel II

in Vietnam Therefore, the dissertation focuses on standards of the Basel I are implemented in Vietnamese banking system via ABBank’s case study Some of data collected such as CAR are gathered at the end of year when they can differentiate from data at the point to publish information popularly Analytical data are collected

in 3 years and because of being problems in accessing and collecting information of the entire banking system, the research just compares the data from commercial banks doing business in Ho Chi Minh City area

1.5 METHODOLOGY

The researcher determines the research methodology depending upon their research question The thesis is designed to describe characteristics of adequacy capital practice of Vietnamese commercial banks Thus, descriptive research is chosen for this study The research study uses the qualitative method combined with quantitative method Data collected from multiple sources including direct reports,

surveys, interviews, documentation review and observation

1.6 SIGNIFICANCE OF THE STUDY

The research is significant for capital management practice in Vietnam Results will point out a real model doing adequate capital management in Vietnamese banking system Through a real case of ABBank applying the Basel I in capital adequacy management, Vietnamese regulators and banking managers learns useful lessons in banking capital management and strongly implements the Basel II which have been updated and renovated more better than the Basel I in capital adequacy measurement

in future

1.7 STRUCTURE OF THE STUDY

This research study is structured as follows:

Chapter One: The introduction provides the general introduction of the research

study, rational of the research, problem statement, objectives, research methodology, scope and limitations

Chapter Two: The Literature Survey reviews details, definition, secondary data

and industry reports about banking risk management, capital adequacy management and capital adequacy ratio calculation based on international standards Then the research study come to the review of the research process, industry and SBV’ regulations in order to have the right technique to carry out this research

Chapter Three: The Research methodology mentions the methodology data

analysis finding, in which the research study defines the research study, how to

collect primary and secondary data Both qualitative and quantitative research methods are also mentioned in this chapter

Chapter Four: An overview of CAR measurement in Vietnamese banking system introduces general characteristics of banking system in Vietnam In addition,

good and bad point of Vietnamese commercial banks is also highlighted in this chapter

Chapter Five: CAR measurement analysis in ABBank presents the survey results

in one of Vietnamese commercial bank about the adequate capital, measurement of CAR

Chapter Six provides some recommendations to increase the capital management

of An Binh Joint Stock Bank and to strengthen the capital adequacy management in Vietnamese Commercial Join Stock Banks

The last section is the conclusions to make a brief summary of the results achieved

Chapter Two: Literature survey

2.1 INTRODUCTION

Banking system is very important role in the economy at most countries Commercial banks, one type of banks are the heart of paymenst system which control and settle customers financial transactions Besides major role of commercial banks in payment settlement, other financial institutions such as saving and loan, saving bank, credit union, money market mutual funds and brokerage firms offer transaction account, as well Role of bank in payment system takes on an important social dimension because an efficient payments system is vital to economic stability and growth (Benton and James, 2005) In addition, banking system keeps a role of financial intermidiary obtain fund from surplus fund of depositors and investors and lend the loans to borrowers Banks mobilise deposits by offering instruments with wide variety denomination, interest rate, and maturities This role is very important because the stability and growth in nation’s economy depend on the large volume of saving and the effective allocation of loan Last but not least, banks would provides other financial services to customers including off

balance sheet activities, Insurance and securites related activities and trust services

The health of banking system has influenced on the development of economy

2.2 RISK IN BANKING OPERATION

2.2.1 BANKING RISK OVERVIEW

Bank is a risky business The nature of banking is such that risks are inherent in almost every aspect of banking business (Budge, 1988) Bankers have faced with various uncertainties that can make negative effects in banking operation Basically, the banking activities have been impacted the following risks:

2.2.1.1 Credit risk

This is the main risk threaten stability of bank as that is posible loss of principal and interest because of default of borrowers Credit risk arisen by counterparty can not meet the contractual payment and that is influenced directly on the bank or on the

third party where the bank has guaranteed the primary borrowers performance (Budge, 1988)

2.2.1.2 Market concentrate risk

The risk is an extension of credit risk which is interested in banking risk management Individual or interprises did not diversify their portfolio investment in banking product when they invest in one banking product or service As a result, when dificulties or failures of the customers threaten the stability of banks It does not place too many eggs in one basket and this is the best investment way to avoid this risk

2.2.1.3 Interest rate risk

Interest rate risk is the risk impacts on the balance of bank’s balance sheet due to a mismatch between booking value assets and liabilities The mismatch can be negative or positive which depends on when assets are repriced and the fluctuation

of floating interest rate exits in financial market A negative profit happens if bankers reprice asset later than liabilities and interest rates increase or the liabities are repriced later than later than its asset and interest rate decrease

2.2.1.4 Funding risk

Funding risk or liquidity risk reflects the situation in which banks are not enough liquid fund to meet the demand to withdraw fund due to a mismatch between assets and liabilities maturites This risk causes problems if the bank does not have surplus liquidity or the ability evaluate the fluctuation on the market that affect on the withdrawal of fund

2.2.1.5 Foreign currency risk

In reality, banking business in countries occurs in the global market that mean they deal in a great of currencies thus they disclose themselves to potential foreign currency risk The foreign exchange risk is the risk that the value of assets and liability will change because the exhange rate is fluctuated by the international obligation of foreign curency There are two types of foreign exchange risk The former happens in trading transaction as the fluctuation exchange rate impacts on the settlement value by foreign currency at a future date at a pre-contracted rate The

risk araise where there is either a mistmatch of buying or selling contracts or one

side of trading contract fail to delivery on a counterparty (Budge, 1988) The later is

of a structural nature that involves a dispropotion of long term assets and liabilities between forein currencies

2.2.1.6 Economic risk

Economic risk or enviromental risk is the risk concern with appreciating and understanding how nation’s economy and financial market will change in the future which create uncetainties to the banking system and impact, as a result, on the customer’s benefit The bankers only minimize the risk by sound analysis of the business environment and predict the broad trend affecting directly or indirectly on the business of bank in future

Even through banking business always encounters with many risk are inherent in all aspect of it activity, banks still maintain their activities effectively through their ability to control the risk they face

2.2.2 BANKING RISK MANAGEMENT ORGANIZATION

The core ALM function is the control and management of the bank’s assets, liabilities and capital base The balance sheet can be controlled through defensive or aggressive asset/ liability management The purpose of defensive or aggressive asset/ liability management is to separate the net interest income out of the impact of changing interest rate ALM unit establishes the ALM process to control risk and return management

A well definition of ALM process is considered that ALM function involves planning, directing and controlling the flow, level, mix, cost& yield of the consolidated funds of the corporation These responsibilities are interwoven with and overall objectives of achieving the corporation’s financial goals and controlling

financial risks (John and Goddard,1992 )

In bank’s management, a committee consist of the senior executive thoroughly familiar with finance and interest rate theory will be responsible for the asset and liability management The task of ALCO including:

Studying the trend of loan demand and interest rate to set up the base rate

Discussing market shares and performance of various banking groups

Maintaining and enhance the institution’s capital position

Reviewing and making the change gradually in banking business

Figure 2 1: Asset/ Liability Management structure

(Source: John W Bitner with Robert A Goddard (1992), successful bank asset/

liability management)

2.3 ADEQUACY OF BANK CAPITAL

Generally, bank capital is described as shareholder’s funds in the commercial banks and serves significant functions Firstly, bank capital acts as a buffer against unidentified losses occurring in future that banks may incur A bank must hold enough capital to cushion both depositors and senior lenders against losses, while leaving the bank able to meet the needs of its customers (William, 1999) The

Board of Directors

Chief Executive Officer

Asset/ Liability Committee Chief Executive Chief Financial Officer Treasure

Senior Lending Officer Senior Liability (Deposits) Senior Investment Officer

second function of capital in bank is a source of funds to buy tangible assets The final function of bank capital relating to the question of adequate capital This is a difficult concept because the ratio of capital on asset is small while banks need to cover all potential losses in future to protect creditors and to guarantee the safety and the soundness in financial system Karlyn (1984) states that the capital adequacy issue arose because bankers who try to maintain capital adequacy to attract deposits and operate profitably while bank supervisors try to maintain capital adequate to protect the depositors and promote a sound financial system.

2.3.1 REGULATIONS OF ADEQUATE CAPITAL

The history of development in banking sector showed that many capital adequacy standards have been established and changed those standards many times to fix with the variability of financial system in the world

In the early 1900s, when the deposit running is the major reasons to threaten the strength of bank, the Office of the Comptroller of the Currency (OCC) concentrated

on bank’s capital to deposit ratio to measure capital adequacy

During World war II, a capital to risk asset ratio is utilized by regulators, where the term losses on risky asset was considered to the main cause for bank risk

Over the last fifty years, a large of methodologies has been applied to assess capital adequacy For instance, in the 1950s, the Federal Reserve Board (FRB) used Form for Analyzing Bank capital (FABC) to divide assets into six risk categories and each

of categories is required a different percentage of capital With small banks, capital requirement was higher because of the perception that the diversification of their portfolio less than large banks By contrast, strict instructions in the early 1960s in favor of more subjective evaluation based on many components such as management quality, asset liquidity, ownership, operating expenses and deposit composition were abandoned by the OCC The guidance relative to capital requirement is nonintegrated make banks become confusing in compliance with those regulation Another issue with capital standard has been their enforceability and fairness In the past, banking regulations were not supported by force of law in most countries that make financial system operated unsuitable not only in national

territory but also in the globalization This problem was solved by the International Lending Supervision Act of 1983 under which act, regulators set up a minimum capital requirements and enforce them Moreover, the implementation of guidelines

is unfair when the small banks were applied a restrictive capital requirement than large bank because according to regulators, small bank usually encountered with future uncertainty greater than large bank

2.3.1.1 Uniform capital requirements

The discrimination in compliant with capital requirement has been occurred in every country and across countries In the United States, unfair discrimination treats people such as African American, Hispanics and other minorities, foreign born person and females As trade has become globalization that make regulators to standardize capital regulation in region and across nation as well A uniform capital requirement for international banks has been devised and adopted by those developed countries with largest economies Uniform capital standard has been proposed for securities firm as well International corporation by banking securities regulators has been attempted and harmonization of domestics regulator has been urged In the United States, ratio of minimum primary capital to asset has been established by federal bank regulators, in which FRB and OCC adopted specific ratio of primary capital The Board of Governors of the FRS has established a minimum level of primary capital to total assets of 5.5 percent and a minimum level

of total capital to total assets of 6.0 percent Accordingly, banking institutions are expected to operate above the minimum primary and total capital levels Those organizations whose operations involve or are exposed to high or inordinate degrees

of risk will be expected to hold additional capital to compensate for these risks Under Capital Adequacy Act applied with bank holding companies and state member banks, the Board has established the capital measurement including

Primary Capital Components

- Common stock,

- Perpetual preferred stock (preferred stock that does not have a stated maturity date and that may not be redeemed at the option of the holder),

- Surplus (excluding surplus relating to limited-life preferred stock),

- Undivided profits,

- Contingency and other capital reserves,

- Mandatory convertible instruments

- Allowance for possible loan and lease losses (exclusive of allocated transfer risk reserves),

- Minority interest in equity accounts of consolidated subsidiaries,

- Perpetual debt instruments (for bank holding companies but not for state member banks)

Secondary Capital Components

- The components of secondary capital are:

- Limited-life preferred stock (including related surplus) and

- Bank subordinated notes and debentures and unsecured long-term debt of the parent company and its nonbank subsidiaries

(Appendix B—Capital Adequacy Guidelines for Bank Holding Companies and State Member Banks: Leverage Measure)

Based on the common guidelines the Board has given the instruction of primary and total capital asset ratio for both bank holding companies and state member banks

a) The primary and total capital ratios apply for bank holding companies

PCC

Primary capital ratio = -

TA + AfL& LL (exclusive of ATRR)

PCC + SCC

Total capital ratio = -

TA + AfL& LL(exclusive of ATRR)

b) The primary and total capital ratios for state member banks are computed as follows:

PCC - Goodwill

Primary capital ratio = -

Average TA + AfL& LL (exclusive of ATRR) - Goodwill

(PCC + SCC) - Goodwill

Total capital ratio = -

Average TA + AfL& LL (exclusive of ATRR) - Goodwill There are more improving uniformity in capital management by regulators since

1985 tending to settle a basic capital ratio for all banks so that capital standard were monitored and protected capital from financial risk However, the uniform capital/ asset ratio measuring capital sufficiency make undercapitalized bank raised capital, cut off operating cost, increase services price and make riskier loans These changes can offset the benefit of increment capital in many cases and so defeated to some extent the capital adequacy objectives of regulators (Benton and James, 2005)

2.3.1.2 Risk- adjusted capital requirements

During the 1980s, regulator in the US and other industrial countries became concern that capital- to- asset ratio established simple that required too much capital for safe assets but deficient for riskier assets Another relation was that the regulation did not required any capital for portfolios of off- balance sheet which were growing rapidly in operation of banking institution These issues led to the development of the risk based capital framework which was adopted by the Basel Committee on Banking Supervision in 1988 and implemented at the end of 1992

The First Basel Agreement (the Basel I) was signed in June 1988 under the sponsorship of the BIS, in which the Agreement provided the international capital standards and methods of measuring capital The Basel I has clarified concepts concerning core capital, supplementary capital, undisclosed reserves, asset revaluation reserves, general provisions, general loan-loss reserves, hybrid debt capital instruments, subordinated term debt, deductions from capital (Nguyen, 2006) Assets of banks were classified and grouped in five categories according to credit risk, carrying risk weights of zero (for example home country sovereign debt), ten, twenty, fifty, and up to one hundred percent (this category has, as an example, most

corporate debt) Banks with international presence are required to hold capital equal

to 8 % of the risk-weighted assets

Since 1988, this framework has been progressively introduced in member countries

of G-10 and other countries have also adopted, at least in name, the principles prescribed under Basel I The efficiency with which they are enforced varies, even within nations of the Group of Ten

of banks collapse In practice, Basel II attempts to accomplish this by setting up rigorous risk and capital management requirements designed to ensure that a bank holds capital reserves appropriate to the risk the bank exposes itself to through its lending and investment practices Generally, these rules mean that the greater risk to which the bank is exposed, the greater the amount of capital the bank needs to hold

to safeguard its solvency and overall economic stability

Tier 2 or supplemental comprised of undisclosed reserves, asset revaluation reserves,

g eneral provisions or general loan-loss reserves, hybrid (debt/equity) capital instruments, and subordinated debt

The sum of tier 1 and tier 2 elements will be eligible for inclusion in the capital base, subject to the following limits

-The total of tier 2 (supplementary) elements will be limited to a maximum of 100% of the total of tier 1 elements

-Subordinated term debt will be limited to a maximum of 50% of tier 1 elements

- Where general provisions/general loan-loss reserves include amounts reflecting lower valuations of asset or latent but unidentified losses present in the balance sheet, the amount of such provisions or reserves will be limited to a maximum of 1.25 percentage points, or exceptionally and temporarily up to 2.0 percentage points, of risk assets

- Asset revaluation reserves which take the form of latent gains on unrealized securities will be subject to a discount of 55%

Goodwill is deducted from tier 1 and total capital base will takes away

- Investments in unconsolidated banking and financial subsidiary companies

- Investments in the capital of other banks and financial institutions (at the discretion of national authorities)

According to the Basel I, banks are required to hold capital adequacy ratio (CAR) at least 8% to offset risks and absorb losses so that they are not affect the depositors CAR is calculated by the formula:

Capital base CAR = -

Risk weighted assets

2.3.2 REGULATORS’ VIEW POINTS

Financial risks are major increase the probability of bank insolvency Interest and non interest expenses are likely to rise and exceed bank earning when earning after taxes change variable Thus, banks will face with insolvency if their capital do not absorbed potential losses However, the problem of regulators is that they tend to

require higher capital to maintain lower financial risk that may restraint the efficiency and competitive in banking system With the role of financial intermediary, commercial banks mobilize deposit and lend to the borrowers, if the capital requirement to exceed unregulated levels, the lending operation of banks may constrain because loan funds do not allocate efficiently to institution which need to borrow money Therefore, the productivity of economic sector is lessened due to lack capital to invest and open business activity Regulatory restriction on banking capital could also inhibit their competitive concerning to other sellers of financial services Thus, regulatory policy relate to capital adequacy must weigh the potential advantages of safety and strength of financial system against the potential costs of efficiency and competitive

2.3.3 BANKERS’ VIEW POINTS

The objective of bankers being as agents of bank’s shareholders tend to seek an optimal mix capital structure in order to maximize the value of their common stocks Karlyn (1984) said that bankers usually preferred lower capital ratio because they do not consider the social cost of a bank failure Bankers’ decision are made by choosing the optimal tradeoff between expected return and risk and expected return normally increased by decreases in a bank’s capital ratio while increasing in capital ratio tends to reduce risk because that will rise bank’s ability to absorb losses Bankers balance these opposing effects in adjusting capital ratio

2.4 CONCLUSIONS

Banking operation is implicit in uncertainty and despite banking regulators have made afford to control banking risks by establishing many standards to require capital ratio, determining the size of a bank’s capital is not easy Standards of the Basel Committee required a minimum of capital is necessary to ensure the safety and soundness of the financial system Under specific circumstances, each countries should study and apply the Basel’s Standards (the Basel I or II) to be accordance with its condition so that commercial banks have to be adequate enough capital to absorb losses in banking operation

Chapter Three:

Research methodology

As presented briefly in Chapter Introduction the research methodology that is applied to carry out this research is the qualitative method using in-depth, open-ended interviews, direct observations and written documents combined with quantitative methodology through market surveys, existing business reports, and business statistics

3.1 DEFINE RESEARCH PROBLEM AND ESTABLISH RESEARCH OBJECTIVES

The problem of this research is capital adequacy in Vietnamese banking system when financial market is inherently more risk Involving the research problem, the dissertation has the following objectives:

- To collect specific evidence of capital adequacy practice in Vietnamese commercial banks

- To develop case study as a model of adequate capital management in Vietnamese banking system

- To contribute to knowledge of practical banking management in Vietnam

3.2 DETERMINE AND COLLECT DATA

The survey data will be gathered in a proper way The data and information from external sources were collected through internet, government’s policies, SBV’s regulations, annual reports and internal sources of the ABB such as administrative reports, agendas, letters, minutes, and available news clippings of banking magazines The research also collects data from reports in the seminar, workshop holding by Ho Chi Minh City State Banks Branch or other banks Documents reviews can be done with management grades for example treasury manager, head

of financial department in ABB or the Board of Director (if any) A list of financial indicators will be built to collect data

Investigators first arrange to visit the Board of Directors of the ABB as a group and ask for copies of the organization’s mission, news clippings, brochures, and any other written material describing the organization and its purpose The investigator reviews the purpose of the study with the entire Board, schedules individual interview time with as many Board members as possible, confirms key contact data, and requests that all Board members to respond to the written survey which will be mailed later Investigators will contact with relevant departments or individuals to suggest to supply analysis data through soft copies or hard copies

Investigators take written notes during the interview and record field notes after the interview is completed The interviews, although open-ended, are structured around

the research questions defined at the start of the case study

3.3 EVALUATE AND ANALYZE DATA

Raw data will be categorized, cross reference checked and examined by using many interpretations in order to find linkages between the research object and the outcomes with reference to the original research questions to assure the correct information The reliability of data is classified in priority order from the ABBank’s data to internal banking system and finally this is external data gathering from media

In cases of data is unclear or some points of the survey need to interpret, the investigator conducts follow-up focused interviews to confirm or correct the initial data in order to tie the evidence to the findings and to state relationships in answer

to the research questions

The research uses both cross case examination and within case examination to analyze collecting data

Within-case analysis is the first analysis technique used to sharpen, sort, focus, discard, and organize collecting data in a way that allows for final conclusions to be drawn and verified

Cross-case analysis is following step to examine pairs of cases, categorizing the similarities and differences in each pair As patterns begin to emerge, certain evidence may stand out as being in conflict with the patterns In those cases, focused interviews are conducted follow-up with relevant individuals or departments to confirm or correct the initial data in order to tie the evidence to the findings and to state relationships in answer to the research questions

3.4 RECOMMENDATIONS AND CONCLUSIONS

A brief summary of the obtained results will be present in this section and some recommendations also puts aside if any

Figure 3.1: Chart of Research Framework

Internal Environment Analysis

Strategy formulation and Recommendations

Chapter Four:

An overview of CAR measurement in

Vietnamese banking system

4.1 VIETNAMESE BANKING STRUCTURE

For two years, business currency - bank of Vietnam has developed powerfully The attractiveness of currency trading - banks rated as higher than other economic sectors Return on own capital of banks reached 9-10%, higher than the 1-2% of the industry The biggest challenge for commercial banks in Vietnam is internal forces

of the bank, with a small scale, limited human resources, the level of technology progress is still slow in comparison with other countries in the region The historical development of Vietnamese banking system has associated with the growth of Vietnamese economy when it was a planned economy transformed to a market oriented economy The economic transformation has occurred since 1986 and resulted in tremendous economic growth for Vietnam In order to mobilize, allocate capital and contribute to the macroeconomic stability of an economic, Vietnamese banking system has been also restructured from a mono banking system to commercial, two tier banking system Generally, the restructure consists of three periods

- The first reform of Vietnamese banking system (1987- 1990)

Two outstanding points of this transition are that the first, the fund management unit

of state budge was removed from the State Bank to establish the State Treasury system which performed the responsibility of fund management for government budget The second point is that the banking system shifted from a mono banking system to a two tier banking system, separated the responsibility of banking operation from the State Bank It retained the responsibility of the central bank which functioned the monetary policy

- The Second reform of Vietnamese banking system (1990- 2000)

The requirement of reforming Vietnamese banking system stemmed from the need

to transform the concentration management mechanism to the market oriented economy On the 23rd, May, 1990 the Vietnamese State Council granted the Ordinance concerning to Bank and Credit cooperative institutions Two ordinances marked the second reform of Vietnamese banking system on the purpose to establish the Vietnamese banking system as nearly the same as the banking system

of other countries where there has been the market economy

- The Third renovation of Vietnamese Banking system (2000 until

now)

The banking structure reform in Vietnam to two tier systems began from 1990 and needed a legal and regulatory framework On 1st, October, 1998, Vietnamese National Assembly passed the Law on the State Bank of Vietnam and Law on the Credit Institution which repealed the Ordinance on State Bank of Vietnam and Ordinance on Bank Credit Co-operatives and Financial Companies According to the Law, Vietnamese banking structure consisted of The Vietnamese State Bank playing the central bank and Credit Cooperatives were the role of financial intermediaries The responsibility of Vietnamese State Banks were as follows

- Conduct state management of monetary and banking activities, aimed at stabilizing the currency and securing the safety of banking activities

- Print, cast, recall, replace and destroy national currency issues

- Issue and revoke the establishment and operations licenses and credit institutions

- Inspect and supervise banking activities

- Provide banking services for the State Treasury

- Manage foreign loans granted to and the repayment of foreign loans made by enterprises

- Take the lead in formulating and monitoring the balance of payments

- Control foreign exchange and gold trading operations

- Research and apply bank science and technology

(Le Minh Lam,1999)

The transformation in Vietnamese banking system was an important significance in the development of financial structure, especially, commercial banking system By shifting a two- tier banking system, Vietnamese government created a competitive banking system which had a commercial bank network doing quite well the role of financial intermediaries to meet the demand and supply credit of individuals and business units on financial market Those were crucial pre-conditions for the economic growth in Vietnam to overcome difficulties and obtain later achievements

4.2 REAL ACTIVITIES OF VIETNAMESE COMMERCIAL BANKS

4.2.1 ACHIEVEMENTS

4.2.1.1 Number of commercial banks increased annually

At the end of 2008, Vietnamese banking system had a total of 95 types of bank including 5 stated owned commercial banks, 1 social policy bank, 40 joint stock commercial banks, 5 joint venture banks, 39 branches of foreign bank and 5 fully foreign owned banks Five fully foreign owned banks consisted of Standard Chartered, HSBC, ANZ, Shinhan Vina and Hong Leong

Table 4.1: Number of commercial bank 2004- 2008

Figure 4.1: Chart of commercial bank types

In comparison with 2004, in the year 2008, the number of banks rose up more than 28% that has been seen a potential market of financial banking services developing

in future after Vietnam has joined in the WTO However the quality of commercial banks needs to be improved to prevent risks from banking operation

4.2.1.2 Mobilizing and supplying a large amount of funds

Vietnamese commercial banks have mobilized and supplied a large amount of capital to the economy, estimated at about from 16% to 18% of annual GDP, nearly 50% of social capital The total of fund mobilization increased annually and the growth rate of Vietnamese credit institution as whole reached 22.9% in the year of

2008, much lower than the rate of 47.6% in 2007 In 2008, fund mobilization by SOCBs rose by 18.78% while that of JSCBs, join- venture banks, foreign bank branches and non- banks credit institution combined was 29.92% Credit growth continued to increase during the years and met the demand of funds for economic development The loan outstanding of a whole banking sector reached 25.4%, lower than the rate of 53.8% in 2007, in which VND and foreign currency credit increased

at 27.56% and 17.61%, respectively

Fund mobilization Loan oustanding

Figure 4.2: Fund mobilization and loan outstanding from 2001 to 2008 by

Vietnamese commercial banks (Source: SBV’s annual reports)

Growth rate of fund mobi l iza ti on Growth rate of l oan ousta nding

Figure 4.3: Growth rate of fund mobilization and loan outstanding

(Source: SBV’s annual reports)

4.2.1.3 Increasing chartered capital

According to Decree 141/2006/ND-CP dated 22/11/2006, at the latest 31st of December, 2008, credit institutions must have a chartered capital being actually contributed or allocated at least to be equivalent level of legal capital including with the SOCBs is 3,000 billion VND and 1,000 billion VND for JSCBs until the end of

2008 and have up to 3,000 billion at the end of 2010 Therefore, commercial banks has been running to increase their chartered capital

At the end of 2009, the chartered capital of Vietnamese commercial banks nearly exceeded the level of 3,000 billion VND (table 4.2), two banks including Southern Bank and VP Bank were lower than 3,000 billion VND and 19 joint stock commercial banks which had the chartered capital lower than 2,000 billion VND Even though Vietnamese commercial banks try their best to increase the chartered capital but scale of Vietnamese banks capital is still much lower than other banks of regional countries Vietnamese commercial bank having the biggest chartered capital is 1,200 million USD which is so low in comparison with the Singaporean biggest bank (DBS) which chartered capital is 4 billion USD or Maybank which is one of the biggest Malaysian banks having 15 billion USD of chartered capital In the other hand, pressure of increase capital has impacted on financial ratios of Vietnamese commercial bank such as ROA, ROE, EPS

Table 4.2: Chartered capital of Vietnamese commercial banks

(exchange rate 17,500 VND/USD)

Order

Number Bank names

Chartered capital (billion VND)

Chartered capital (millions USD)

4.2.2.1 Bank- based financial system

The Vietnamese banking system has been many crucial contributions on the growth and stabilized the economy in last years The Banking system has mobilized and supplied a large amount of capital to Vietnamese economy, estimating figures around from 16 to 18 per cent of GDP and making up approximately 50 per cent of investment capital of total society The credit growth rate rose continuously annually, such as in 2006: 25.4%; in the year 2007: 51.39%; in 2008 from 21% to 22% and the ratio forecasted to reach to 30% in the year 2009

However, mobilizing capital channel for the economy primarily has done through the banking system to fund middle term and long term capital that has disclosed the unbalance of financial system In addition, there is around 50% of total mobilizing capital in short term transfer to lend in middle term and long term which will create risk for the entire banking system

4.2.2.2 Bad debts of state owned commercial banks

Bad debt situation has tended to reduce the uncertainty, in which it is notably the state credit institutions Some reasons lead to debts overdue increase in the state-owned commercial banks such as the loan is primarily based on collateral, while the real estate market and commodities market is not developing and much fluctuation complex; analyzing the ability of using capital and repaying debt is so week, so has brought capital into the business of ineffective will lead to overdue debts,

outstanding debts; liberalization of interest rates tend to make in the domestic

interest rate rise, create conditions to attract more savings into the banking system Otherwise,the deposit interest rate increases so high in commercial banking system make lending rate also increased, creating additional cost burden to enterprises which are depended heavily on loans from banks As a result, banks continued lending to feed debt, lead to the growing losses

4.2.2.3 Small equity capital

Although the charter capital of banks has increased dramatically over the past but still small compared to the world and the region CAR of almost commercial banks were met the standard of rate as required by the SBV and international practice (8%) but the average level of own capital of ten state-owned commercial banks is 0.5 billion, total own capital of five state-owned commercial banks is only equivalent to

a medium-sized banks in the region System-owned commercial banks account for 75% to the market to mobilize capital and 73% on credit markets Apart from system state-owned commercial banks had registered capitals ranking average in comparison with the disciplines of regional countries, joint stock commercial banks has small capital and need rising capital to meet business requirements This made the liquidation and stability of the system not to be high

Quality and efficiency of assets can lower (less than 1%), and again must deal with the risk difference is double the risk period and exchange rate risks

According to Vietnamese banking specialist, if it has to extract the full deduction for the debt and fold the bad debt, state-owned commercial banks in Vietnam, especially state-owned commercial banks, can be in the negative situation

4.2.2.4 Traditional and mono banking services

Banks’ services in Vietnam were monotonous, its quality was not high, yet oriented customer needs and focused on traditional banking services Banks raising capital primarily as a deposit account for 94% of capital mobilization and credit is the main activity of banks, accounting for over 80% of total income

The Marketing Saigon Newspaper has done a customer research survey about commercial banks and banking services which have satisfied customers in 2007 and quarter 1/2008 The survey has been done on the top ten commercial banks which

Figure 4.4: Credit market share of commercial banks

(Source: VnEconomy, 12/2007)

Financial companies and people credit Fund, 2.16%

Foreign banks, 15.85%

SOCBs, 35.09%

Local JSBs,

46.90%