FACTORS AFFECTING CREDIT RISK MANAGEMENT EFFICIENCY OF AGRI BANKS IN HANOI

CERTIFICATE OF ORIGINALITY This is to certify that the research work entitled “Factors affecting Credit risk Management Efficiency of Agri banks in Hanoi”orally defended/presented under the DBA program jointly offered by Southern Luzon State University of the Republic of the Philippines and Thai Nguyen University of the Socialist Republic of Vietnam, embodies the result of original work carried out by the undersigned. This thesis does not contain words or ideas taken from published sources or written works by other persons which have been accepted as basis for the award of any degree from other higher education institutions, except where proper referencing and acknowledgement were made. _______________________ FULL NAME OF STUDENTS: TRACY Date Orally Defended: ……………..

THAI NGUYEN UNIVERSITY

Socialist Republic of Vietnam

SOUTHERN LUZON STATE UNIVERSITY

Republic of the Philippines

FACTORS AFFECTING CREDIT RISK MANAGEMENT EFFICIENCY OF AGRI

BANKS IN HANOI

A RESEARCH PROPOSAL PRESENTED TO THE FACULTY OF GRADUATE SCHOOL SOUTHERN LUZON STATE UNIVERSITY LUCBAN, QUEZON, PHILIPPINES

THAI NGUYEN UNIVERSITY S.R VIETNAM

IN PARTIAL FULFILLMENT OF THE REQUIREMENTS FOR THE DEGREE

DOCTOR OF BUSINESS ADMINISTRATION

By Pham Thi Tuyet (Tracy)

SLSU-DBA 2

November, 2017

This thesis does not contain words or ideas taken from published sources or written works

by other persons which have been accepted as basis for the award of any degree fromother higher education institutions, except where proper referencing andacknowledgement were made

_

FULL NAME OF STUDENTS: TRACY

Date Orally Defended: ………

APPROVAL SHEET

In partial fulfillment of the requirements for the degree of Master of Business Administration,

this research paper entitled “Factors affectingCredit risk Management Efficiency of Agri banks in Hanoi ”has been prepared and submitted by Tracy (Pham Thi Tuyet) who is

hereby recommended for oral examination

FULL NAME OF ADVISERS

Research Adviser

Nguyen Khanh Doanh

Approved in partial fulfillment of the requirements for the degree Docter of BusinessAdministration by the Oral Examination Committee

Accepted in partial fulfillment of the requirements for the degree of Master of BusinessAdministration

Chairperson

JOANNA PAULA A ELLAGA, DBA

Dean, College of Business AdministrationDate

ACKNOWLEDGMENTS

In grateful recognition and sincerest thanks for the encouragement, guidance and unselfishsharing of their knowledge, time, effort and skills, and for the untiring motivation that leads tothe completion of this study, the researcher acknowledges the following:

Prof Nordelina B.llano, Ph.D Dr, OIAA of Southern Luzon State University, Republic of thePhilippines, for her untiring effort and belief that this collaboration is possible thus enabling us topursue the DBA degree;

Prof Dang Kim Vui, Ph D., Director of International Training Center, Thai NguyenUniversity, Socialist Republic of Vietnam, for his enormous pursuit to provide the Vietnamesepeople an opportunity to grow through education;

Assoc Prof PhD Nguyen Khanh Doanh for his support and supervision throughout mygraduate study program His kindness and daily instructions in the last three years are greatlyappreciated and this dissertation is as much his work as mine;

Mr Tran Luu Hung, Deputy Head of International Faculty, Thai Nguyen Universityfor hisassistance and encouragement to pursue this study;

To all the SLSU and TNU Professors, for their support and guidance extended throughout thegraduate studies in Thai Nguyen University, Vietnam;

To the research adviser, for her selfless guidance and assistance thereby making this paper ascholarly work;

PROFESSORS , CHONA V.CAYABAT, CATHERINE R.GONZALVO,

who composed the written Defense Committee, for their suggestions, comments andcorrections to improve this study;

ITC STAFF, for providing me the necessary research materials provided to us;

Respondents, for their patience and cooperation in answering the questionnaire and for other datagiven;

My family and friends, for the love and support in one way or the other; and to all who havecontributed to make this study a success

DEDICATION

This piece of work is humbly dedicated to my colleagues and fellow instructors, my students,

my family and my relatives, my friends, my husband, and my children

Pham Thi Tuyet (Tracy)

LIST OF ABBREVIATIONS

TABLE OF CONTENTS CERTIFICATE OF ORIGINALITY

APPROVAL SHEET

LIST OF ABBREVIATIONS

TABLE OF CONTENTS

LIST OF TABLES

ABSTRACT 1

CHAPTER 1: INTRODUCTION 2

1.1 Background of the study 2

1.2 Objectives of the Study 5

1.3 Significance of the study 7

1.4 Scope and limitations of research 8

1.5 Research questions 8

1.6 Research Hypotheses 9

1.7 Definition of terms 10

CHAPTER 2: REVIEW OF RELATED LITERATURE 11

2.1 Theory of credit risk in commercial banks 11

2.1.1 Credit risk definition 11

2.1.2 Credit risk classification 14

2.2 Credit risk management efficiency of commercial banks 16

2.2.1 The definition of credit risk management 16

2.2.2 The definition of risk management efficiency 18

2.2.3 Criteria of credit risk management indicators at Agribanks 21

2.2.3.1 Risk assessment 25

2.2.3.2 Overdue Debts, Bad debt 29

2.2.3.3 Provisioning Risk Rate 32

2.2.3.4 Ratio Profit from credit 34

2.3 Factors affecting the efficiency of credit risk management in commercial banks 35

2.3.1 The efficiency of employees in the Bank credit 35

2.3.2 The instructions of the Central Bank 36

2.3.3 Agri banks' credit policies and procedures 39

2.3.4 Credit control before procedures 42

2.3.5 Credit control in borrowing procedures 44

2.3.6 Credit control after procedures 44

2.3.7 Information asymmetry between customers and banks 46

2.3.8 Agribank'scredit risk management model 50

2.4 Credit risk management in terms of levels of efficiency 53

2.5 Conceptual framework 54

CHAPTER 3: RESEARCH METHODOLOGY 55

3.1 Research design 55

3.2 Locale of the study 58

3.3 Sources of Data 58

3.4 Population, Sample and Sampling Technique 58

3.5 Determination of sample size 58

3.6 Research Instrument 60

3.7 Data Gathering Procedure 71

3.8 Statistical Treatment 71

CHAPTER IV: RESULTS AND DISCUSSION 75

4.1 Background characteristics of Agribanks 75

4.1.1 Overview of Bank for Agriculture and Rural Development of Vietnam 75

4.1.1.1 Organizational structure of the Bank for Agriculture and Rural Development of Vietnam 75

4.1.1.2 The network of Agribank system 77

4.1.1.3 Overview of business results of Agribank Vietnam period 2014 - 2016 78

4.1.2 Effectiveness of credit risk management in the Bank for Agriculture and Rural Development in Hanoi 83

4.1.2.1 Overview of Bank for Agriculture and Rural Development in Hanoi 83

4.1.2.2 Capital and debt ratios of Agri banks in Hanoi for the period 2014-2016 86

4.1.2.2.1 Indicators reflect the effectiveness of credit risk management of Agri banks in Hanoi period 2014 - 2016 86

4.1.2.2.2 Credit rating in credit risk management in Agri banks in Hanoi 88

4.1.2.2.3 Overdue debt ratio of Agri Banks in Hanoi 92

4.2.2.4 Provision for risk provisioning, risk management and debt recovery of Agri banks in Hanoi 2014 - 2016 96

4.3 Assessment of respondents on factors affecting credit risk management 100

4.4 Assessment of respondents on credit risk management in term of levels of efficiency 112

4.5 The evaluation of factors affecting Credit Risk Management in Agricultural Bank 113

4.5.1 Scale reliability 113

4.5.2 Results of the EFA analysis 126

4.5.3 Confirmatory factor analysis - CFA 130

4.5.4 Determine the significant differences on factors that influence the efficiency of credit risk management at Agri banks 133

4.6 The indentified limitations 136

4.7 Conclusion 139

CHAPTER V: SUMMARY OF FINDINGS, CONCLUSION AND RECOMMENDATIONS 141

5.1 Summary of the Findings 141

5.2 Conclusions 145

5.3 Recommendations 145

5.4 For further research 153 REFERENCES

APPENDIX

LIST OF TABLES

Table 2.1: Moody’s corporate rating 27Table: 3.4 Scale factors affecting credit risk management effective of Agri Bánks 62Table 4.1.3 Business results of Agribank VietnamPeriod 2014 - 2016 79Table 4.1.4 Statistics of transaction centers and branches of type I of the Vietnam Bank

for Agriculture and Rural Development in Hanoi 83Table 4.1.5 Capital and debt balance of Agri banks in Hanoi for the period 2014-2016 87Table 4.1.6: Aggregate debt classification of Agri banks in Hanoi Period 2014 - 2016 93Table 4.1.6: Agri banks in Hanoi compared with Agribank in the period 2014 - 2016 97Table 4.1.7 Agribank's debt recovery performance in Hanoi compared to Agribank's

period 2014 - 2016 98Table 4.2.1: Characteristics of Research Subjects 99Table 4.3.1 Mean distribution of one-sample T-test in term of the efficiency of

employess in the Bank credit 102Table 4.3.2 Mean distribution of one-sample T-test in term of the instructions of the

Central bank 104Table 4.3.3 Mean distribution of one-sample T-test in term of the credit policy and

procedures of the Bank 106Table 4.3.4 Mean distribution of one-sample T-test in term of Credit Control before

borrowing 107Table 4.3.5 Mean distribution of one-sample T-test in term of Credit Control in

borrowing proceduces 108Table 4.3.6 Mean distribution of one-sample T-test in term of Credit Control after

borrowing 109Table 4.3.7 Mean distribution of one-sample T-test in term of Information asymmetry 110Table 4.3.8 Mean distribution of one-sample T-test in term of the Risk management

model 111Table 4.4.1 Mean distribution of one-sample T-test in term of Credit Risk Management 112Table 4.5.1.1 Result of the Cronbach's Alpha coefficient of The efficiency of employee in

the Bank credit (1st) 114

Table 4.5.1.2 Result of the Cronbach's Alpha coefficient of The efficiency of employee in

the Bank credit (2nd) 115

Table 4.5.1.3 Result of the Cronbach's Alpha coefficient of The instructions of the Central bank (1st) 116

Table 4.5.1.4 Result of the Cronbach's Alpha coefficient of The instructions of the Central bank (2nd) 117

Table 4.5.1.5 Result of the Cronbach's Alpha coefficient of The credit policy and procedures of the Bank (1st) 117

Table 4.5.1.6 Result of the Cronbach's Alpha coefficient of The credit policy and procedures of the Bank (2nd) 118

Table 4.5.1.7 Result of the Cronbach's Alpha coefficient of The credit policy and procedures of the Bank (3thd) 119

Table 4.5.1.8 Result of the Cronbach's Alpha coefficient of The credit Control before borrowing 119

Table 4.5.1.9 Result of the Cronbach's Alpha coefficient of the credit Control in borrowing proceduces 120

Table 4.5.1.10 Result of the Cronbach's Alpha coefficient of credit Control after borrowing 121

Table 4.5.1.11 Result of the Cronbach's Alpha coefficient of the Information asymmetry (1st) 122

Table 4.5.1.13 Result of the Cronbach's Alpha coefficient of Risk management systems (1st) 123

Table 4.5.1.14 Result of the Cronbach's Alpha coefficient of The risk management systems (2nd) 124

Table 4.5.1.15 Result of the Cronbach's Alpha coefficient of Credit Risk Management (1st) 125

Table 4.5.1.16 Result of the Cronbach's Alpha coefficient of The credit Risk Management (2nd) 126

Table 4.5.2.1 KMO and Bartlett's Test 127

Table 4.5.2.2 Total Variance Explained 127

Table 4.5.2.3 Pattern Matrixa 129

Table 4.5.3.1 Factors’ covariances 131

Table 4.5.3.2 Composite Reliability and Average Variance Extracted of factors 133

Table 4.5.4.1 Results of hypothesis test (Hi) 135

Table 4.6.1 Problems encounted in Credit risk management 138

Table 5.3 Introduce solutions to improve the weakest point from the research results of the author 150

LIST OF FIG Figure 2.1: Continuous credit control process 43

Figure 2.2: Conceptual framework 54

Figure 4.1.1 Structure of the Bank for Agriculture and Rural Development of Vietnam 76

Figure 4.1.2 Agribank's network of organizations 77

Figure 4.1.3 Organizational structure of Agribank Dong Anh, Hanoi 84

Figure 4.1.4 The process of marking for corporate customers 89

Figure 4.5.3.1 Result of CFA testing for the second time (standardized) 130

Figure 4.5.4.1 The results of analyzing by SEM model (standardized) 134

Figure 5.1 Credit risk management model at Agribank 147

Figure 5.2 Proposed model of credit risk mangement in type I branch 148

LIST OF GRAP Graph 3.1 Research Process 57

LIST OF CHART Chart 4.1.5: Bad debt ratio/total outstanding loans at Agri banks in Hanoi period 2014 -2016 compared to Agribank Vietnam 94

Adviser: Nguyen Khanh Doanh

This study was conducted to determine Factors affecting Credit risk Management Efficiency

of Agri banks in Hanoi Research done on the basis of theoretical practice of FactorsAffecting Credit Risk Management Efficiency In the research process is divided in two partstudy of qualitative research in order to adjust the variables and additional observations forthe scale Regarding quantitative study using coefficient method reliability Cronbach 's alpha,factor analysis exploring EFA, CFA correlation analysis and regression with the number ofsamples surveyed 307 full-time employees working in Vietnam Bank for Agriculture andRural Development to evaluate the research model The author uses the SEM network model

to measure reliability, validity as well as the relationship between independent variables anddependent variables The result found that the Before borrowwing factor was the strongestfactor to affecting Credit risk Management in Agribanks Ha Noi According to the result, thisstudy give some recommendations for Credit risk Management such as: training humanresoucrces; applying technology into the work, connecting two way between Central andoutside banks; controlling in all procedures including before, in, and after the borrowingprocess; supervising and reviewing the operations and results regularly; applying the creditrisk management efficiency model

CHAPTER 1: INTRODUCTION

In the context of the world there are many changes with complicated developments andunpredictability of financial markets, political problem in the world plus production -domestic business more difficult; bad debt ratio of some commercial banks is not really at thecontrolled level; Banks have to compete hard against each other, as a result the marginalinterest spread is decreasing,…Compared with international rules and regulations on themanagement of information, risk management, internal control system of credit organizations

in Vietnam are still gaps need to continue to improve.One of the problems posed for existenceand sustainable development of commercial banks is the capacity to manage operational risk,especially credit risk Credit risk in banking business is often difficult to control and if ithappens, its consequences are unpredictable, by the extent of its influence spread to allorganizations in society, especially affecting operating macroeconomic policies of thegovernment Therefore, the identification of factors affecting the effectiveness of credit riskmanagement in commercial banks it requires intensive research in the context of the changingbusiness environment today

1.1 Background of the study

Bank is a typical type of financial institution and its main function is trading in money.During the 1980s and 1990s in Vietnam, there were only several state-owned banksparticipating in the banking industry so the competition was quite insignificant The centrallyplanned subsidized economy (1975-1986) had created monopoly power for the state-ownedbanks As a result, the banks served their customers in a bureaucratic and red-tape mannerwith a deep rooted attitude existing in a considerable part of the banking staff that thecustomers need them rather than they need customers Thus, people used to have greathesitation in working with banks Since Vietnam opened the economy, then became a member

of WTO, a lot of joint stock commercial banks have been established, along with some 100%foreign invested banks and a number of foreign bank’s representative offices This makes thecompetition within the banking industry become more and more intensive To stay firmly andkeep thriving in the new business environment, it is necessary that the state-owned banksundertake comprehensive reforms in terms of four aspects: increase capital capability, offercompetitive services (regarding quality, variety and distinction), build effective brandingstrategy in response to the requirements of a more open economy

The process of globalization forces the Vietnamese banking industry to overcome itself and toembrace the tendency of corporatization, groupization, demonization and multi-ownership.These trends require more rigorous reform of the legal environment and restructuring of thebusiness operations, leading to a restructuring of the entire banking system In this context,Vietnam's commercial banks with limited resources are facing a variety of risks in whichcredit risk is one of the most risky types of all to the operation of each commercial bank if itoccurs It is time for credit risk management to be identified by commercial banks as a keystrategic task, to force banks to actively manage the loan portfolio to mitigate losses and gainprofit Credit risk management is an integral part of the loan process It maximizes bankexposure by adjusting the rate of return risk by maintaining exposure to credit risk to protectbanks from the negative impact of credit risk Credit risk management is simply a practicalactivity of systematic selection of efficient methods to minimize the impact of theimplementation of the threat to the insitution All risks are unavoidable or partially mitigatedsimply because of financial and practical constraints (Moteff, 2005)

Date 26/03/1998, the Council of Ministers of the Socialist Republic of Vietnam issuedDecision No.53/HDBT, establishment of the Vietnam Agricultural DevelopmentBank.Vietnam Bank for Agriculture and Rural Development is a State-owned enterprise of

special grade, operating under the Law on Credit Institutions and under the direct management ofthe State Bank of Vietnam Apart from the functions of a commercial bank, the Vietnam Bank forAgriculture and Rural Development has further defined development investment tasks for ruralareas by expanding medium- and long-term capital for construction The material and technicalfacilities for agricultural, forestry and fishery production contribute to successfully implementingthe cause of industrialization and modernization of rural agriculture.

According to the Decision No 214 / QD-NHNN dated 30 January 2011 of the Governor ofthe State Bank of Vietnam, Agribank was transformed into a one-member limited liabilitycompany owned by the state In November 2011, Agribank was approved by the Government

to supplement VND 8,445.47 billion, raising the total chartered capital of Agribank toVND29,605 billion As of 31/12/2016, the total assets of Agribank are VND 1,001,204,753billion In addition to its capital size, Agribank is also the largest bank in terms of number ofemployees and the largest network of commercial banks in Vietnam Staff of nearly 40,000people; Nearly 2,300 branches and transaction offices, Cambodia branch; Agencyrelationships with more than 1,000 banks in nearly 100 countries and territories; trusted bymillions of clients Agribank is also the leading bank in Vietnam to receive and deployforeign projects, especially projects of the World Bank, Asian Development Bank…

In recent years, Agribank has been also wellknown for its reputation of a leading bankproviding state-of-the-art and convenient service packs Since 2010, due to the impact of theglobal financial crisis and the government's macroeconomic management policies, Agribankhas faced many difficulties According to audited data, Agribank's outstanding debt is VND23,652 billion, accounting for 59.23% of total outstanding loans, equal to 89% of chartercapital Thus, Agribank's total bad debt reached approximately 40,000 billion, higher than thechartered capital of about 10,000 billion (Hoai, 2014)

Some officials and employees of Agribank violated professional ethics standards and wereprosecuted for "irresponsibility in economic management causing serious consequences",which greatly affected the prestige and reputation of Agribank Credit risk is defined as theprobability in which a client will not be able to pay back the stated amount to the bank inaccordance with the terms agreed in the credit agreement Credit risk occurs in relation to thepotential return on an investment that makes the bank face the risk of bankruptcy Bothdomestic and foreign studies confirm that the most tremendous risk for banks is credit risk.The purpose of this study is to identify the factors that influence the efficiency of Agribank'scredit risk management in Hanoi.

Moreover, the intensified global competition and the liberalization of banking rules andregulations have also changed the modern banking system by providing greater opportunitiesfor banks’ risk diversification Consequently, the purpose of this study to find out the factorsthat will affect the banks’ risks taking in the industry The recognition of these factors would be

of assistance in constructing valuable risk management strategies in the banks and to minimize

a loss in income Besides, an understanding on the relationship of risk involved in the bankingindustry will also aid banks to formulate suitable strategy that will rise optimistic and reducepessimistic shock of linked risks Identifying and accepting these influential factors will be akey step in the development of valuable strategies and methods for credit risks management at

Agri banks For the abovementioned reasons, I have chosen to study the subject: "Factors affecting Credit Risk Management of Agri banks in Hanoi" with a view to contributing to the

improvement of credit risk management, helping Agribank to develop sustainably

1.2 Objectives of the Study

The general objective of the study is to find thefactors affecting credit risk managementefficiency of Agri banks in Hanoi In order to reach that goal, the specific objectives of thestudy are as follows:

1 Background characteristics of Agribanks

1.1 Overview of Bank for Agriculture and Rural Development of Vietnam

1.2 Effectiveness of credit risk management in the Bank for Agriculture and RuralDevelopment in Hanoi

1.3 Assessment of respondents on factors affecting credit risk management

2 Demographic characteristics profile of respondents in terms of:

3.1. The efficiency of employees in the Bank credit

3.2. The instructions of the Central bank

3.3. The credit policy and procedures of the bank

3.4. Credit Control before borrowing

3.5. Credit Control in borrowing proceduces

3.6. Credit Control after borrowing

3.7. Information asymmetry

3.8. Risk management systems

4 Assess the credit risk management in terms of level of efficiency

5 The relationship between factors affecting credit risk management and the levels of efficiency of CRM

6 Develop a model for credit risk management

1.3 Significance of the study

This is the very first study on the factors affecting the efficiency of credit risk management inthe Vietnam Bank for Agriculture and Rural Development (Agribank) and as a result, thisresearch is of both theoretical and empirical significance

This study will provide valuable information to help Agri banks identify the factors thatinfluence the efficiency of credit risk management Accordingly, the leaders’ outlook oncredit risk management will be more comprehensive and they will attach more specialimportance to it The empirical result of the survey is a proof of the need to focus on creditrisk management, to gradually regain the reputation of Agribank in the domestic and regionalcurrency trading market

The study has proposed a system of feasible solutions to help Agribank leaders complete anddevelop a credit risk management framework consistent with bank resources and the trend ofrisk governance of financial institutions worldwide with a desire for sustainable development.This is also a valuable resource for the Agribanks Training Center to refer to Staff internaltraining on credit risk management in the economy of high competitiveness

The results help the author to apply the empirical figures and result into the lectures so thatthe learners have a more comprehensive and profound view on credit risk management aswell as factors affecting the efficiency of credit risk mangement in banking industry Thisresearch process helps the author to improve her knowledge, skills and gain a morecomprehensive understanding of credit risk management as well as its influential factors onthe sustainable development of commercial banks;Research helps the author have theopportunity to gain experience and enhance ability in studying scientific works from lecturers,scientists at home and abroad

This research is provided as a valuable reference for researchers involved in the management

of credit risk in banking industry Finally, the methodology, theoretical basis and conclusions

in the research are useful references for individuals who want to study economics, finance andbanking

1.4 Scope and limitations of research

 Research content

- Risks in the money trading business are manifold and often manifest in 6 basic risks such ascredit risk, liquidity risk, market risk, exchange rate risk, interest rate risk and finallyoperational risk In this research, the author focuses on the efficiency of credit riskmanagement in some Agribank branches of type I in Hanoi

- Credit activities of Agribank have many different types of service packs and the clients arevarious as well Therefore, in this study, the author focuses on the factors affecting theefficiency of credit risk management in medium and long term lending services to individualclients and business households Individuals and corporate loans (excluding loans to othercredit institutions)

 Research Area: The author focuses on 34 type I Branches of Agribank in Hanoi,Vietnam.Of which, 34 branches are divided into two groups: (i) group 1: includes brancheslocated in the counties of downtown Hanoi.(ii) group 2: includes branches located indistricts,suburban districts of Hanoi

 Survey respondents: 307 managers and credit officers are working at branches of Agribanks in Hanoi

 Implementation period: April 2013 to December 2017

1.5 Research questions

(1).How are Hanoi Agri Banks' branches applying in credit risk management?

(2) How are agricultural bank branches in Hanoi controlling credit risk?

(3) Which factors affect the effectiveness of credit risk management at Agribank branches inHanoi?

(4) Instructions from the central bank affect effective credit risk management at branches ofAgribank does not?

(5) What are the differences in the effectiveness of credit risk management between branchesbased in downtown Hanoi and branches located outside the city of Hanoi of the Bank forAgriculture and Rural Development of Vietnam?

(6) It is possible to use a credit risk management model suitable for credit activities ofbranches of the Bank for Agriculture and Rural Development in Hanoi

1.6 Research Hypotheses

H1: The efficiency of employee in the bank credit officers has a positive impact on the

effectiveness of credit risk management

H2: There is a significantly positive relationship between the instructions of the Central Bank and the efficiency of credit risk management

H3: The credit policy and procedures of the Bank has a positive impact on the efficiency of credit risk management at Agri banks

H4: Credit control before borrowing of the Bank has a positive impact on the efficiency of credit risk management at Agri banks

H5: Credit control in borrowing proceduces of the Bank has a positive impact on the

efficiency of credit risk management at Agri banks

H6: Credit control after proceduces of the Bank has a positive impact on the efficiency of credit risk management at Agri banks

H7: Information asymmetry has a significantly positive impact on the efficiency of credit risk management in medium and long-term loans at Agri banks

H8: Agribank's credit risk management has a significantly positive impact on the efficiency ofcredit risk management in medium and long-term loans at Agri banks.

- BANK: A bank is a financial institution which collects and from dividends or organization,safeguard them and undertakes to surrender them to their owners which required but also at acertain time, lends some of these funds to those who needs to borrow it and pay back withinterest

- CREDIT RISK MANAGEMENT: is the process of planning, organizing, implementing andmonitoring all credit operations to maximize bank profitability and minimize losses aboutwhich credit risk brings

- EFFICIENT CREDIT RISK MANAGEMENT: Efficient credit risk management in bankingactivities reflects the level of utilization of bank resources, expressed in the results achievedagainst expenditure bank charges for a specified period of time

CHAPTER 2 REVIEW OF RELATED LITERATURE

In this chapter, the author focuses on analyzing and synthesizing theory and models of factorsaffecting the effectiveness of credit risk management in commercial banks On this basis, theauthor proposes the variables used in the study; Conceptual framework and Researchparadigm

2.1 Theory of credit risk in commercial banks

2.1.1 Credit risk definition

According to Broll, Pausch and Welzel (2012), (Broll et al., 2012) one of the most importanttypes of risk faced by commercial banks is credit risk This is the type of risk that a borrowercan not afford to repay principal and interest If commercial banks fail to control this type ofrisk, very easily lead to loss of capital Catherine (2009) defines credit risk as the prospectivethat a borrower from a bank will fail to meet its obligation in agreement with agreed term andconditions (Catherine and Yusoff, 2009) The risk of monetary losses due to debt issuers who

do not honor contractual debt payments is commonly referred to as credit risk (Lindset et al.,2014) Funso, Kolade and Ojo found that when bank expose more to credit risk will make thebank have high tendency to experience the financial crisis and vice-versa (Funso et al., 2012) Vogiazas and Nikolaidou defined credit risk as the ratio of loss and doubtful loans to totalloans (LLP ratio) in their research (Vogiazas and Nikolaidou, 2011) The authors, Funso,Kolade and Ojo (2012) used the ratio of Non-performing loan to loan & Advances (NPL/LA),ratio of Total loan and Advances to Total deposit (LA/TD) and the ratio of loan loss provision

to classified loans (LLP/CL) as the measurement of credit risk However, the most commonindicator of credit risk is non-performing loans (NPLs) which is the ratio of non-performingloan to total loans, because nonperforming loans (NPL) is directly affect the bank’s financial

performance which is the contributing factor to the credit risk in the banking system A largenumber of credit defaults will be suspect in a high probability when NPL increase in the bank(Thiagarajan, 2013)

According to Somoye (2010), non-performing loans (NPLs) reduces the liquidity of banksbecause increase credit will decelerate the growth on the bank performance when bank is indefault and will affect the whole economy (Somoye, 2010) Espinoza and Prasad (2010) alsofound that the NPL ratio worsens when economic growth becomes lower, therefore large banksand banks that spend less would have lower NPLs, but high NPLs in the future might cause bythe high credit growth in the past (Espinoza and Prasad, 2010) Besides, Karim, Chan andHassan (2010) indicate that higher non-performing loan reduces cost efficiency which meanswill make the bank efficiency drop, in other words, lower cost efficiency of the bank increasesnon-performing loans (Karim et al., 2010) As a result, credit risk that represent by non-performing loans not only affect by the economic condition and economic factors, it also affect

by the internal factors which will affect the bank efficiency at the same time

Credit risk in the operation of banks is always among tops concern of policymakers and bankmanagers Credit risk is addressed in various aspects such as:

Thomas P Fitch (1997) states that "Credit risk is the type of risk that occurs when borrowersfail to pay their debt under a contractual agreement that results in a default in the repaymentobligation." (Fitch, 1997) In view of this, it seems that Thomas P Fitch is narrowing thescope of credit risk which is misleading, as the author argues that credit risk can occur in thecase of a late payer (both principal and interest) or to pay part of the principal and interest tothe bank

In the view of the Basel Committee, "Credit risk is the possibility of a borrower or itscounterpart to fail to comply with an agreed commitment" (Basle Committee on Banking

Supervision, 2000) In this view, credit risk is broadly understood not only in the creditrelationship between the banks and the clients, but also in other activities such as investmentand other derivative transactions.

According to Broll, Pausch and Welzel, one of the most important forms of risk faced bybanks is credit risk This is the type of risk that the customer is unable to repay the loan andinterest as committed to the bank (Broll et al., 2012) Catherine (2009) defines credit risk asthe prospective that a borrower from a bank will fail to meet its obligation in agreement withagreed term and conditions (Catherine and Yusoff, 2009) The risk of monetary losses due todebt issuers who do not honor contractual debt payments is commonly referred to as creditrisk (Lindset et al., 2014) Funso, Kolade and Ojo (2012) found that when bank expose more

to credit risk will make the bank have high tendency to experience the financial crisis andvice-versa (Funso et al., 2012)

However, as presented in the research area of the thesis, the thesis only focuses on the creditrisk in the credit granting activities of the bank According to Clause 1, Article 1 of Decision

No 493/2005 / QD-NHNN dated April 22, 2005 of the State Bank of Vietnam: "Credit risk isthe probability of losses occurring in banking operations of a credit institution due to thefailure of the clients to do so or the inability to perform their obligations under thecommitment " From our point of view, even if the client fails to repay the loan principal andinterest on a loan, it is still necessary to be added to and regarded as the damage to the bank(The State Bank of Vietnam, 2005) "Risks in lending are the losses incurred when grantingcredit to clients, but the bank could only collect a portion of principal and interest or couldcollect the principal or interest overdue or when the principal or interest can not be collected."said Nguyen Kim Anh (2010) This view points out that credit risk only occurs when a clientperforms only part of his or her obligations under a bank guarantee or fails to make a

commitment (the bank loses both principal and interest) (Anh, 2010) Article 3 of the StateBank of Vietnam's Circular No 02/2013 / TT-NHNN dated January 21, 2013 also states:

"Credit risk in banking operations (hereinafter referred to as risk) is the probable loss to acredit institution or a foreign bank branch of a bank failing to perform, or is unable to performpart or all of its obligations under the" (SBV, 2013) This view is taken on a wide range ofcredit risks To some extents, credit risk arises when there is an unexpected differencebetween actual and expected returns, with sufficient principal and interest in credit activity.Credit risk will lead to financial loss, ie, decrease net income and decrease the market value ofcapital

From the above analysis, the author argues that: Credit risk is the type of risk that arises in the credit granting process of the bank, whether the client defaults on principal or interest or fails to repay it The due date for the bank as committed in the credit agreement This is the

approaching view in the study by the author as well

2.1.2 Credit risk classification

For the commercial banking system, credit risk classification is of vital importance inestablishing policies, procedures, and governance models Credit risk classification also helpscommercial banks to identify risk factors and clearly distinguish responsibilities amongdepartments, among stages in the assessment process, credit monitoring debt collection anddebt processing if there are abnormal signals

Based on the causes, credit risk is divided into two groups: (i) Moral hazard: risks due toasymmetric information occur after the transaction takes place (ii) The risk of counterattackdue to asymmetric information occurring prior to the transaction

Based on the level of loss, credit risk is divided into two groups: (i) Risk of capitalaccumulation is a risk that occurs when the bank still has not recovered the loans, resulting in

frozen funds and accordingly affects the bank's capital distribution plan and faces difficulties

in payment for clients (ii) The risk of losing money is a risk when the borrower is unable torepay the loan, including principal or interest The risk of loss of capital will increase the cost

of bad debt, management costs, monitoring costs and reduce profits due to increasedprovisions for lost capital

According to clients, can be divided into three groups: (i) Individual client risk: Credit riskoccurs to individual clients (ii) Risks of companies, economic organizations, financialinstitutions are the type of credit risks that occur to clients who are companies, economicorganizations, financial institutions (iii) Country or geographical risk: the type of credit riskthat occurs in each country for debt and aids

Based on the overall risk, credit risk is divided into two categories: (i) Transaction risk is thetype of risk that is caused by restrictions in the process of transaction and loan approval,assessment of repayment capacity of clients Transaction risks include the risk of selection,security risk, and operational risk (ii) Portfolio risk: the risk that the cause is due torestrictions on the management of the bank's loan portfolio, classified into internal risk andconcentration risk

Based on the arising period, credit risk is divided into three groups: (i) Risks prior to lending:Risks arise when the bank analyzes misrepresentation of clients resulting in the inability ofthe borrower to secure future repayment (ii) Risks during Loans: This risk occurs in the creditgranting process The reason for this risk is due to the disbursement is not timely, do notupdate client information regularly and do not forecast the potential risks (iii) Risks afterlending: This type of risk occurs when credit officers do not understand the state of loandistribution and the future financial capacity of clients

2.2 Credit risk management efficiency of commercial banks

2.2.1 The definition of credit risk management

Credit risk management is the process of establishing and executing strategies, policies, andcredit business to maximize profitability within an acceptable level of risk Control of creditrisk at acceptable level is demonstrated by the commercial banks' strengthening methodology

to prevent, limit and reduce the overdue debt and bad debts in order to increase creditrevenues, reduce the cost of risk offsetting, achieve high efficiency in the credit business both

in the short and long term The management of credit risk of credit portfolios is therefore onethe most important tasks for stability of banking (Kiseľáková and Kiseľák, 2013) The mostsignificant impact on performance of the enterprise has just financial risk The unsystematicrisks have a higher impact on performance of the enterprise as systematic risks (Kiseľáková etal., 2015) The determination of each individual loan, or borrower, risk assessment techniquesplays a primary role in the management and minimization of the credit risk It is only afterdetermining the risk represented by each individual borrower and byeach individual creditservice that one can begin to manage the loan portfolio as a whole

According to Nguyen Van Tien (2005): "Credit risk management is the process ofestablishing and implementing credit management policies and methods aimed at achievingsecurity, efficiency and sustainable development" This authors view is approaching themacro direction from the development of policies and methodology of credit riskmanagement Authors Tran Trung Tuong (2011) asserted that: "Credit risk management is theprocess by which managers include identifying, assessing the potential level of risk faced bythe bank simultaneously take appropriate measures / tools to deal with credit risks ofcommercial banks " From this point of view, credit risk management is the activity of themanagers and must follow a certain process from risk identification to risk management In

the practice of commercial banks, however, risk management is not a mere managementactivity by the leaders themselves, it is a common activity that requires all individualsinvolved in the grant process to abide by Moreover, it sometimes does not comply with theorder of the process as the author stated; However, under the same control operation, it cantake place in all activities related to credit granting and it appears even when the capital issufficient for the client as committed.Peter S.Rose (2001) argues that "risk management is anorganized, targeted process of bank executives targeting managers and business stakeholdersfor risk prevention, reducing and minimizing in the business, thereby enhancing the level ofsecurity, profitability and achieving the growth target of each commercial bank " PeterS.Rose identified the actors involved in the implementation of the credit granting and statedthat risk management should play a role of "risk prevention, mitigation and reduction" ratherthan aiming to overcome the consequences when credit risk has occurred (Rose, 2001).Author Phan Thi Cuc (2009) also acknowledges that credit risk management is a systematicprocess of managing four basic activities: risk identification; risk measurement; riskassessment; and risk financing The results of each stage will be the premise for the nextstage "Credit risk management is a holistic, scientific and systematic approach to riskidentification, control, prevention and mitigation of loss and damage caused by the risks" saidthe author (Cuc, 2009).

Credit risk management activities of commercial banks closely linked to the operation ofcredit Credit risk management is the process of establishing and implementing creditmanagement policies and methods aim at achieving security, efficiency and sustainabledevelopment In a narrower viewpoint, it is understandable that risk management in lending isthe process of developing and executing strategies, policies of lending business to maximizereturns within the acceptable risk levels Risk controlling prior to lending, while lending and

post-lendings at acceptable levels means that commercial banks strengthen measures toprevent, minimize and reduce overdue debt or bad debt in lending business It aims to increaselending revenue, reduce risk-offset costs and achieve efficiency in both short-term and long-term lending Risk management in lending business is a vital part of the overall risk approachand is considered to play the most important role in the long-term success of the bank

To summarize, the notion of credit risk management is addressed from different viewpoints,but they are essentially similar and on the standpoint of management, the notion is understood

as: "Credit risk management is the process of planning, organizing, implementing and monitoring all credit operations to maximize bank profitability and minimize losses about which credit risk brings" Credit risk management is the process by which the bank utilizes the

overall methods to impact credit performance through its machinery and management tools toprevent and control credit risk which can occur at a predictable level and minimize losses, iebelow the estimated amount of loss

2.2.2 The definition of risk management efficiency

Management is defined as the process of coordinating tasks so that they can be completedwith the highest efficiency and productivity by other staffs Efficiency is a scientific categorythat reflects the comparative relationship between results and costs to achieve that result Inall situations, the cost can be measured by material or non-material In credit activities ofcommercial banks, the bank uses labor resources, material facilities, finance for lending andinvestment activities Thus, the efficiency of credit risk management must ultimately bereflected in the preservation of capital, the bank profits gained after deducting the input costsand ensure the social benefits in providing credit to clients for the purpose of production,business and life This is the basis for evaluating the efficiency and factors affecting theefficiency of commercial banks in general and Agribank in particular

In the study of bank operation, some authors stand on the production approach, in which theyregard the bank as the production unit (Benston, 1965; Ferrier et al., 1990; Shaffnit et al.,1997; Zenios et al., 1999), some authors take an intermediary approach, regarding banks asfinancial intermediaries (Sealey and Lindley, 1977; Maudos and Pastor, 2003; Casu et al.,2003), and some other modern approaches are that banks play both roles as production unitsand as financial intermediaries (Frexias and Rochet, 1997; Denizer et al., 2000;Athanassopoulos and Giokas, 2000) Efficient credit risk management can be approached frommany different perspectives altogether According to Tran Cong Hoa (2007), the efficiency ofcredit risk management is considered in terms of economic efficiency and social efficiency Inwhich economic efficiency is a category that reflects the comparative relationship between thedirect and indirect economic outcomes that economic agents earn with direct and indirect coststhat the economic operator must get out to achieve those results In term of qualitative method,economic efficiency reflects the close0 link between the achievement of economic goals andthe socio-political requirements and objectives (Hoa, 2007).

According to the abovementioned author, the efficiency of credit risk management inthis study is considered on two sides, namely the economic efficiency and the socialefficiency (i) Economic efficiency: manifested at the levels of implementation of financialand non-financial economic indicators to satisfy the material needs of the society Economicefficiency can be measured qualitatively or quantitatively, through a system of measurementnorms such as profitability, levels of profitability, efficiency of business capital distribution,etc Such as competitiveness, customer loyalty, the position of the bank (ii) Social efficiency:The efficiency of credit risk management is reflected in the implementation of socio-economic indicators However, the social benefits of commercial banks' credit activities aredifficult to quantify, but are primarily quantitatively assessed through the indirect assessment

of customer's efficiency How does it help to create more jobs, contribute to equal economicdevelopment, and pay taxes to the Government? How can the management and operation ofbranches and transaction offices be improved? We must distinguish between businessefficiency and socio-economic efficiency Efficiency demonstrates the relationship betweenresults and costs Business performance is a measure to consider choosing investmentsolutions, deciding on investment in development or halting service provision Businessperformance can be qualitative and quantitative

According to wikipedia.org: Efficiency is the (often measurable) ability to avoid wastingmaterials, energy, efforts, money, and time in doing something or in producing a desiredresult In a more general sense, it is the ability to do things well, successfully, and withoutwaste In more mathematical or scientific terms, it is a measure of the extent to which input iswell used for an intended task or function (output) It often specifically comprises thecapability of a specific application of effort to produce a specific outcome with a minimumamount or quantity of waste, expense, or unnecessary effort Efficiency, of course, refers tovery different inputs and outputs in different fields and industries

From the above analysis, the author proposes the notion: "Efficient credit risk management in banking activities reflects the level of utilization of bank resources, expressed in the results achieved against expenditure bank charges for a specified period of time".

Thus, with this viewpoint, it is necessary to consider the efficiency of credit risk management

on the following perspectives:

First, the expenditure of resources: Expenditure includes labor costs, equipment, materialsthat commercial banks spend in the process of creating products, credit services and obtainingthe corresponding results Resources include resources for personnel, facilities, machines,software, intellectual resources, operating costs, risk management processes, and capital

Secondly, the results achieved at the cost of the bank: the resources and costs that the bankpays for the business can produce a variety of results There will be results consistent withbusiness objectives, but also results inconsistent with business goals, even against the goals.Therefore, it should be understood that this result should be a useful result for the bank andthe entire national economy and socially recognized, in accordance with social ethicalstandards The results can be expressed in quantitative numbers according to specific criteriasuch as output, value of use, turnover, profit or qualitative, abstract results such ascontributing reducing poverty, boosting per capita income, contributing to a greener, cleanerenvironment

The effect is a reflection of the ultimate result after a period of work or after a business cycle ofthe banks in particular and other businesses in general The efficiency of credit riskmanagement can be expressed in a completed workload, a secure service quality system, orsales revenue, profitability, capital security Accordingly, "Credit risk management efficiency is

an important part of the overall risk approach and is considered to play a critical role in thesuccess of the banks in long - term period." (Basle Committee on Banking Supervision, 2000)

2.2.3 Criteria of credit risk management indicators at Agribanks

The methods used to quantify credit risk are accompanied by a special transparencyrequirement, including a quantitative assessment of the methods’ accuracy and a statisticalmethod property known as robustness The transparency of the credit risk methodologypresents an opportunity to view a given phenomenon not only as a whole but also in detail.Transparency has become the most important characteristic of credit risk assessment methodsthanks to the need for the most thorough identification of both credit risk and the credit riskmodel itself Methodological transparency refers to the precision of the employedmathematical methods, the reduction of the element of subjectivity in expert assessments, the

clarity of the results of risk assessment and analysis, the bank employees’ thoroughunderstanding of these results, and the accessibility of the given methods to regulatoryauthorities and borrowers In order to analyze, forecast, and manage credit risk, each bankmust be able to quantify relevant credit risk factors, to analyze the risk involved, and topermanently monitor credit risk factors (Andrianovа and Barannikov, 2013)

The bank’s decisions about granting, or refusing to grant, a loan, about the interest rate, andabout the level of loan default provisioning will depend on the accuracy of risk recognitionand assessment The accuracy of risk factor assessments is evaluated relative to the number oferrors in the recognition of "bad" and "good" loans and their average number The accuracy ofrisk factor assessments is determined in a similar manner when loans are classified into morethan two classes Furthermore, the stability of risk assessment methodologies is characterized

by the property of statistical methods known as robustness Different methodologies of riskassessment, yield dissimilar classifications of loans into "good" and "bad".The application ofdifferent methodologies may result in the categorization of one and the same loan as either

“good” or “bad” Such instability in loan classification may affect the assessment of 20% oftotal number of loans (Solojentsev, 2004) Banks need to adapt their crediting-relatedactivities to the changing conditions of the nation's developing economy and to the changes inthe standard of living The methods used to quantify and analyze credit risk are of greatimportance for the smooth functioning of a bank Each bank develops its own risk probabilityassessment model in order to quantify and analyze credit risk, taking into account the generalrecommendations of the Basel Committee on Banking

Supervision, the high accuracy of credit risk assessment helps to minimize the bank’s losses,

to reduce the interest rate, and to enhance the competitiveness of the bank (Basle Committee

on Banking Supervision, 2006) Creating an effective risk assessment model and managing

credit risk successfully is possible only thanks to continuous quantitative analysis of statisticalinformation on credit success There are such different approaches to the determination of thecredit risk posed by a particular borrower as the bank experts’ subjective evaluation andautomated risk assessment systems (Konovalova, 2009) Global experience shows, however,that credit risk assessment systems based on mathematical models are more efficient andreliable than any others In order to build a credit risk assessment model, first those clients ofthe credit institution are selected who have already proved themselves to be either good or badborrowers.

Some argue that the banks look into their borrowers to figure out the potential risks throughwarning signals However, by empirical research, the author disagrees with the aboveviewpoint The bank has to look into two sides, first on the bank side, and then on the client's

in order to be able to identify early warning of possible risks Efficient credit riskmanagement will be considered from 2 sides: from the bank and from the customer (i) On thebank side: Credit risk is assessed on credit size, credit structure, overdue debt, bad debt, andrisk provision When these factors tend to be disproportionate: the scale of credit increases tooquickly beyond the bank's management capacity, or the credit structure is over-concentrated

in a particular industry or risky area, or overdue debts, bad debts have signs of exceeding theallowed threshold or risk reserves are used up, the bank is facing the risk It is also possiblethat credit risk arises from a weak internal control system in addition to the morality of asmall part of the bank staffs (ii) On the customer side: When customers have signs of hardlyable to pay debts, bad financial condition, risk will occur To identify the potential risk, thebank needs to analyze the clients' assessment in order to detect the risk in each customer,specific loans Clients' analysis is conducted from the beginning of client contact, duringlending and post-lending process Gathering clients' information has a direct impact on

lending decisions Currently, the exploitation of information about customers usually rely on:financial statements in recent years of clients (for corporate customers); Information fromclients' partners; From competitors; From the Center of risk prevention CIC of the StateBank Data of clients' analysis in terms of the quantitative and qualitative criteria is of vitalimportance to make accurate conclusions about the status of clients (i) Qualitative indicators:The criteria are not quantified by numbers but only reflect the nature and characteristics ofclients These criteria are clearly demonstrated by the 6C method: (1) Character: The creditofficer must assess the appropriateness and justifiability of the purpose of the loan, determinewhether it is compatible with the current credit policy of the bank or not Even if the purpose

of the loan is reasonable, the credit officer must also determine if the borrower showsresponsibility for using the loan, haves goodwill and attempt to repay the loan by the due date

In fact, there are many firms as well as individuals who are able to pay their debts but do notwant to pay for the bank and occupy the amount as their own capital to gain profits via otherinvestments (2) Capacity: The credit officer must ensure that the borrower has complete civilact and legal capacity to sign a credit agreement, The signatory must be a legal person andlegally authorized by the company (3) Cash flow: Borrowers have three possibilities formaking money, which is money from sales or earnings; proceeds from liquidation of assets;Money from debt securities or equity securities The bank prioritizes the repayment capacity

of its customers by the amount of the first loan, as the liquidation of the asset will weaken thecustomer's capacity and be a manifestation of unfairness in the business , making creditrelations "problematic" (4) Collateral: Clients are granted credit based on the value ofcollateral, mortgages, pledges, or guarantees from third parties If the borrower does not repaythe loan in accordance with the agreement, the bank will liquidate the property to recover thedebt and bind the borrower to take more responsibility for repayment To repay loans for the

recovery of their security assets (5) Conditions Credit officers and credit analysts must beaware of the recent trends in customer behavior and the industry in which they operate Theimpact of change in the economy on the loan (6) Controlling: credit officers and appraisalsshould note the changes in the law whether to affect the borrowers or not? Whether theborrower's credit requirements meet the bank's and credit quality standards or not? The bankcan collect information from a variety of sources, from the clients, the CIC credit informationcenter, from the customer's partner, from the media to help the bank obtain moreinformation about the borrowers, accordingly overcome the risks caused by asymmetricinformation

In fact, banks often coordinate various methods to identify credit risks The application ofmethods depends on the specific conditions of each bank and the flexible and efficient utilization

of credit officers In order to efficiently identify credit risks, the credit risk management activities

of a commercial bank must ensure two issues: the perception and views of management at themanagement level credit risk; and the information requirements

There are different views when considering the efficiency of the credit risk management of acommercial bank However, with the author's point of view, the author focuses on a number ofindicators that reflect the efficiency of commercial banks' credit risk management activities

- PD (Probability of default): The probability of default of the client/category

- LGD (Loss Given Default): The percentage of bank credit defaults will be lost when clientsdefault

- EAD (Exposure at Default): Loan balance (and equivalent) of client / category when occursinsolvency

With PD, LGD and EAD, two of the most important factors that commercial banks payattention to first and to take into account carefully are their ability to repay and theirrepayment needs have been quantified prior to deciding to grant credit And thanks to PD,LGD and EAD, the factors that affect customers as well as the credits given to them arereflected in the three risk components mentioned above

Based on the results of the calculations of PD, LGD, and EAD, banks will develop and apply

in credit risk management in many respects The main applications include: (i) Credit EL(Expected Loss) and UL (Unexpected Loss) (ii) The Z rating model This model wasdeveloped by E.I.Altman to give credit scores to US companies Z is a composite measure toclassify credit risk for borrowers and depends on the value of borrower's financial ratios (Xј),ј),),the importance of these indicators in identifying the probability of default of borrowers in thepast Accordingly, Altman developed the following rating model:

Z = 1,2Xј),1 + 1,4Xј),2 + 3,3Xј),3 + 0,6Xј),4 + Xј),5

Xј),1 = The ratio of net working capital to total assets

Xј),2 =The ratio of retained earnings to total assets

Xј),3 = The ratio of profit before tax to total assets

Xј),4 = Market-value coefficient of total equity / total cost of debt

Xј),5 = The ratio of return to total assets

In the Altman Z model, the higher the Z-score, the lower the probability of default and vice

versa (The Z-value may be negative.)

Z <1.81: Highly risky clients

1.81 < Z <3: Unidentified

Z > 3: Clients are not likely to default

According to this conclusion, the bank will not grant credit to clients until the Z score isgreater than 1.81

 Moody’s rating model

This model ranks the business activity status based on the annual risk rate Firms are rankedhigh when the risk ratio is less than 0.1%

Table 2.1: Moody’s corporate rating

Source: Moody's report

 Portfolio Risk

The portfolio risk is assessed through Value at Risk (VAR) model, the Return on Risk onCapital (RAROC) model, and the Basel II internal credit rating model (IRB)

- VAR Model: VAR is developed on a variety of perspectives and theories It is represented

by four major models: Credit Metrics J Morgan, Credit-Portfolio (Mckinsey), Credit-Restore(CSFG)(Bank Committee on Banking Supervision (1999) The VAR of an asset portfolio isdefined as the maximum loss for a given period of time The VAR model evaluates the