LV Thạc sỹ_Credit risk management in BIDV branch in hai phong

Research Objective This thesis is set out to characterize credit risk management operation forbusiness customers in a BIDV branch located in Dien Bien Phu Street, Hai Phong city.The stud

ADVANCED EDUCATIONAL PROGRAM

*****************************

Bachelor Thesis

Credit Risk Management in

Bank for Investment & Development

of Vietnam branch in Hai Phong

This report is the result of my internship in the Risk Management Department ofBIDV – Dien Bien Phu, Hai Phong branch By that time, I have worked with a greatnumber of people whose contribution in the research It is a pleasure to convey mygratitude to them all in my humble acknowledgement

In the first place, I would like to express my thank to Mr… for his supervision,guidance, and encouragement I appreciate all his time and effort in helping me duringthe time of my internship

I gratefully acknowledge all lecturers and officers from Advanced Program fortheir shared knowledge and experiences

I would like to deliver my gratitude to all my friends in Advanced Class intake

50 Their support is one thing making this report possible

Last but not least, many thanks go to all of staffs in the BIDV branch in HaiPhong generally, and in the Department of Risk Management particularly, for theirwarm treatments during my internship I am very grateful to Mr Hung, my supervisor

in the office, for his encouragement and guidance

TABLE OF CONTENT

ABSTRACT 5

ABBREVIATION 6

LIST OF TABLES 7

LIST OF FIGURES 8

CHAPTER I: INTRODUCTION 9

1.1 Rationale 9

1.2 Research Objective 9

1.3 Methodology 10

1.4 Research Scope & Constraints 10

1.5 Thesis Structure 11

CHAPTER II: THEORETICAL BACKGROUND 12

2.1 Overview About Commercial Bank 12

2.1.1 Definition of Bank 12

2.1.2 Services Provided by Commercial Banks 13

2.1.3 Risks in Banking 15

2.2 Credit Risks In Banking 17

2.2.1 Definition of Credit Risk 17

2.2.2 Impacts of Credit Risks 17

2.2.3 Causes of Credit Risks 18

2.2.4 Reflecting Factors for Possible Credit Risks 19

2.3 Credit Risk Management 21

2.3.1 What is Credit Risk Management? 21

2.3.2 How does the Government Regulate about Credit Risk Management? .22

2.3.3 Is There Any Specific Method to Evaluate Credit Risks? 25

Financial ratios analysis 26

Credit analysis 26

Internal credit rating system 29

Credit review 30

2.3.4 Is There Possible Way to Hedge against Credit Risks? 31

CHAPTER III: CURRENT SITUATION OF CREDIT RISK MANAGEMENT FOR ORGANIZATIONS IN BIDV – HAI PHONG BRANCH 32

3.1 Profile Of BIDV And BIDV Dien Bien Phu, Hai Phong branch 32

3.2 Organizational Structure Of The Branch 34

3.3 Business Results Of BIDV – Hai Phong Branch During 2009-2011 37

3.3.1 Profitability Analysis 37

3.3.2 Capital Mobilization 39

3.3.3 Credit Activities 42

3.3.4 Services Activities 44

3.4 Credit Evaluation System Of BIDV 45

3.4.1 Steps in Credit Granting in BIDV 45

3.4.2 Internal Credit Rating Process 47

3.4.3 Credit Granting Policies & Collateral Requirements 53

3.4.4 Credit Review Policy under BIDV 55

3.4.5 Connection between BIDV’s Credit Evaluating System and the Model of 6 Cs of Credit Analysis 55

3.5 Performance Of Credit Risk Management In BIDV Branch 57

3.6 Evaluating Of Credit Risk Management In BIDV – Hai Phong Branch 63

3.6.1 Achievements in Credit Risk Management of BIDV branch 63

3.6.2 Shortcomings in Credit Risk Management of BIDV branch 65

CHAPTER IV: RECOMMENDATION 68

4.1 Recommendation To BIDV & The Branch 68

4.1.1 To Improve Qualification of Credit Officers 68

4.1.2 To Build Internal Information System 69

4.1.3 To Enhance Internal Supervision on Outstanding Debts 70

4.1.4 To Refer to Different Methods to Access Credit Ratings 72

4.1.5 To Diversify Borrowers Pool & Hedging Strategies 73

4.2 Recommendation To The Government & SBV 75

CONCLUSION 78

APPENDIX A: The Model 6 Cs of Credit Analysis 79

APPENDIX B: Z-score Model 81

REFERENCE 83

The goal of this internship thesis is to characterize performance of BIDV – HaiPhong branch in credit risk management and to highlight possible related problemsduring the 3-year period 2009-2011 The paper is going to analyze internal credit ratingsystem of BIDV as well as to discuss its connection to international standards The realsituation of credit risks in the branch will be determined basically through examiningoutstanding loans structure The results from this study helps to understand about thecompany’s business operation, focusing on credit risk management for organizationcustomers, and to identify any shortcoming existing in the company’s management, sothat suggestible actions should be undertaken

 BIDV Bank for Investment and Development of Vietnam

 SBV Stated Bank of Vietnam

 Dep. Department

 Div. Division

 FDIC Federal Deposit Insurance Corporation

 FTP Fund Transfer Pricing

 EBIT Earnings Before Interests and Taxes

 ROE Return on Equity

 ROA Return on Assets

 D/E Debt to equity ratio

 C&R Vietnam Credit Information and Rating Company

 CRC Enterprise Credit Rating Appraise Science Center

 CIC Credit Information Center

 VAS Vietnamese Accounting Standards

 IAS International Accounting Standards

LIST OF TABLES

Table 2.1: Risk Classification in Banking 16

Table 2.2: Debt Classification under Article 7 of Decision no.493 23

Table 2.3: Maximum Rate to Calculate the Value of Collateral 24

Table 2.4: Credit Risk Minimization Methods 31

Table 3.1: Credit Rating for BIDV in 2010 33

Table 3.2: Operational Results of BIDV – Hai Phong branch during 2009-2011 37

Table 3.3: Capital Mobilization of BIDV – Hai Phong branch in 2009-2011 41

Table 3.4: Distribution of Annual Average Outstanding Debts by Customer Type 43

Table 3.5: Average Outstanding Debts Classification by Currency 44

Table 3.6: Financial Indicators in Credit Rating of BIDV 49

Table 3.7: Coefficients for Nonfinancial Indicators 51

Table 3.8: Credit Rankings under BIDV System 52

Table 3.9: Credit Policy in BIDV 54

Table 3.10: Debts Classification for BIDV branch under Decision no.493 60

Table 3.11: Provision for Loan Losses in BIDV branch 61

Table 3.12: Calculation for Expected Provisions for Loan Losses 62

LIST OF FIGURES

Figure 2.1: Six Basic Cs of Lending 27

Figure 3.1: Organizational Structure of BIDV – Hai Phong branch 35

Figure 3.2: Revenues Structure of BIDV branch in 2009-2011 39

Figure 3.3: Capital Mobilization of BIDV branch in 2009-2011 40

Figure 3.4: Credit Structure by Instruments in BIDV branch in 2009-2011 42

Figure 3.5: Net Income by Service Lines in 2009-2011 45

Figure 3.6: Credit Granting Process in BIDV System 46

Figure 3.7: Internal Credit Rating Process for Corporate Customers in BIDV 47

Figure 3.8: Nonperforming loans in BIDV – Hai Phong branch 58

Figure 3.9: Overdue Debt Ratio 60

Figure 3.10: Charge-offs & Recovery in 2009-2011 63

CHAPTER I: INTRODUCTION

1.1 Rationale

Credit activities have grown significantly for recent years, due to high demand

of capital for investment However, it is also associated with increasing risks of losingmoney The economy generally and enterprises particularly has experienced manydifficulties arising Banks are facing problems with possible credit default In fact,recently, the Stated Bank of Vietnam have adopted a new policy of classifying banksinto different groups of credit lines in order to minimize credit risks for the wholeeconomy Thus, credit risk management is the most critical issue for banks and otherfinancial institutions nowadays

1.2 Research Objective

This thesis is set out to characterize credit risk management operation forbusiness customers in a BIDV branch located in Dien Bien Phu Street, Hai Phong city.The study is descriptive, and is not intended to develop new theory or to extendexisting theory For more specific, two research questions need to be answered:

- How is the performance of credit risk control for business customers in BIDVDien Bien Phu, Hai Phong branch during the period of 2009-2011?

- Is there any success or problem existing in credit risk management, as well assuggestion of solutions?

1.3 Methodology

In order to serve the goal of the paper as stated, the contribution of the study lies

in assembling secondary data The data collected includes financial statistics which

represent the performance of BIDV in credit risk management during the researchperiod The thesis will focus mainly in indicators related directly to credit riskmanagement of the branch, such as loans structure, loans quality, and provisions.Several other financial figures are included to give understand about how well thebranch did in their overall business operation In addition, available documents related

to credit rating process and credit management policies in BIDV will be obtained toprovide more understanding about how the branch manages its credit activities in bothqualitative and quantitative ways

1.4 Research Scope & Constraints

The thesis is based on internship research undertaken in BIDV - Dien Bien Phu,Hai Phong branch Because of limitation of time and collectible data, it will benarrowed down to a three-year period analysis of the branch’s performance in creditrisk management The period chosen is from 2009 to 2011, which is considered to bethe most up-to-date available data

The drawback of the research comes from limitations of accessible data Timeconstraints as well as high information security requirement in banks create significantdisadvantages to access to primary data As a result, secondary data will be the majorsource used for the analysis The lack of primary data may somehow affect theaccuracy and update of the thesis’s conclusion in the studying topic The list ofreferences collected can be checked at the end of the paper Furthermore, the paperfocuses on qualitative analysis, due to limited time causing difficulty to collectsufficient sample data to conduct a meaningful quantitative model

Lastly, there is lack of official meaningful industry benchmarks to evaluateperformance of a bank, including its credit risk management Therefore, it may be notabsolutely efficient and practically accurate in evaluating the business results of thebranch

1.5 Thesis Structure

The paper’s content is organized in 4 main parts as follows

- Chapter 1: To introduce the topic of the thesis

- Chapter 2: To present theoretical backgrounds to serve research of the report

- Chapter 3: To analysis and evaluate operation of BIDV and its branch on Dien BienPhu Street, Hai Phong in credit risk management This part also highlight strengthsand weaknesses that may exist in operation of the branch, focusing on mattersrelated to credit risk control

- Chapter 4: To recommend a number of suggestions in solving existing problems

CHAPTER II: THEORETICAL BACKGROUND

2.1 Overview About Commercial Bank

2.1.1 Definition of Bank

Banking is one of the key drivers of the national economy Among all types offinancial institutions, banks are the oldest and most familiar There are many ways todefine what a bank is It can be stated in terms of the economic functions it serves, theservices it offers its customers, or the legal basis for its existence

In history, banks are often identified for the scope of services offered Typically,the menu contains accepting deposits, making commercial loans, offering trustservices, managing cash or portfolios

According to functional classification, a bank is a financial institution and afinancial intermediary that accepts deposits, and channels those deposits into lendingactivities, directly or through capital markets It performs fund transference fromsavers to borrowers, and payment function for goods or services

However, the economic as well as financial market have changed greatly fromtheir origins, both domestically and internationally For the centuries, their competitorshave invaded banking business by trying to make their products as similar as possible

to banks’ offers Those are savings and thrift associations, credit unions, money marketfunds, investment banks, security brokers and dealers, investment companies, mutualfunds, hedge funds, finance firms, insurance companies, and financial-serviceconglomerates Pressured by its financial-service competitors, banks have faced anhuge evolvement of expanding into new market Banking service menu and increasinginterference of other financial institution create confusion arising in differentiatingbetween banks and other financial institutions Thus, a legal definition of banks must

be required to make clear recognitions Under the United State’s law, the Congressdefined a bank as any institution that could qualify for deposit insurance administrated

by the Federal Deposit Insurance Corporation (FDIC) In Vietnam, according to Article

20 of Law of Credit Institution 2004, banks are regulated to be a credit institutionpermitted to conduct all banking activities and other related business operations In

2010, the new law is changed into the concept of “a credit institution that is able tocarry out all of banking activities” Those activities are regulated to be 3 main ones:accepting deposits, granting credit, and offering payment services through accounts.Commercial banks, as the concentrated subject in my study, are defined as a form ofbank allowed to conduct all banking and other business activities for profitablepurposes, prescribed by Article 4, Credit Institution Law 2010

Until the end of June, 2011, Vietnam has more than 100 domestic banks andbranches of foreign banks In specific, there are 5 state-owned banks, 1 policy bank, 37joint-stock banks, 53 fully-foreign-owned banks or branches of foreign banks, and 5joint-venture banks

2.1.2 Services Provided by Commercial Banks

One of the goals of any commercial banks is to encourage individuals andorganizations to save and transfer those savings to those individuals and organizationswho is demanding money for investment Besides of that, banks also provide a variety

of supporting services essential to modern living In this sector, we will examine anoverview of products served by commercial banks nowadays Here are several possibleservices as regulated for commercial banks by Law of Credit Institution 2010:

- To accept deposits, including demand deposits, term deposits, saving deposits, etc

- To issue certificate of deposits, promissory notes, bills, bonds

- To grant credit under following methods:

+ Lending: This is the traditional and most popular debt instrument issued by

creditors to borrowers In a loan, the borrower initially receives an amount ofcash, called the principal, from the lender, and is obligated to pay back the

money at appointed time The payment generally includes the principal plus acost of borrowing, referred to as interest on the debt.

+ Discounting or rediscounting valuable and commercial notes: The bank

purchases valuable or commercial papers initially owned by the borrower beforematurity

+ Guaranteeing: The bank commits to implement financial obligations to other

party on behalf of its customers if customers are unable carry out properly

+ Issuing credit cards: As a type of revolving credit, credit line is gaining wide

use in recent years When the bank issues credit card, a revolving account iscreated, and the borrower is granted a line of credit from which the user canborrow money for payment to a merchant or as a cash advance to the user

+ Factoring: The borrower sells its rights to collect money from its holding

accounts receivable to the bank at a discount

+ Other methods of offering credit accepted by SBV

- To open payment accounts for customers

- To offer means for payments

- To provide payment services (including cheques, overdrafts, bank acceptances,payment orders, letters of credit, cards, etc)

Besides, currently, banks are able to indirectly perform new services which wasoriginally provided by other types of financial institutions, through acquisition andsubsidization

- To support government activities with credit facilities

- To offer trust and financial advisor services

- To safeguard properties and valuables

- To offer equipment leasing, and venture capital loan

- To sell insurance policies and retirement plans

- To deal with securities: brokerage and investment banking services

- To offer hedging strategies, such as derivative contracts

2.1.3 Risks in Banking

In business context, risks may be defined as the perceived uncertainty associatedwith a particular event In other words, risks can be understood to be differencebetween what people expect and what occur in the reality Risks may be divided intoqualitative and quantitative risks Quantitative risks are found using the numbers from

financial statements or statistical reports, for instance cash generating ability or thedegree of marketable assets held by the borrowers In other hand, qualitative risks areidentified based on ability of human resources as well as influences of nonfinancialconditions Examples for qualitative risks can involves fields like competence ofemployees, government regulations, rules, market conditions, or any external andinternal factors involved

For banking management, there is a number of key risk types listed in table 2.1below Among them, the most frequently concerned issues should be credit risks,liquidity risks, interest rate risks and market value risks

Table 2.1: Risk Classification in Banking Type of risk Definition

Credit risk

the probability that some of the financial firm’s assets will decline in value and perhaps become worthless resulting from nonpayment or delayed payment on loans and securities

Liquidity risk

the probability the financial firm will have sufficient cash and borrowing capacity to meet demand of deposit withdrawals and other cash related requirements

Operational risk the uncertainty regarding a financial firm’s earnings due to failures in

external and internal environment, working condition or human resources Legal risk the probability that variability can occur due to actions taken by the legal

systemRegulation risk the uncertainty associated with negative publicity toward the organization

and its stakeholdersStrategic risk the variations created by adverse business decisions, implementation of

decisions, or responsiveness to industry changesCapital risk

the probability related to possibility of the institution’s long run survival, which may be caused by the value of its assets decreasing below the level

of its total liabilities

(Source: Banking Management & Financial Services)

2.2 Credit Risks In Banking

2.2.1 Definition of Credit Risk

The risk of loss that an investor can suffer arising from a borrower whose failure

to make payment as promised is called credit risk The potential losses include lostprincipal and interest, decreased cash flow, or increased collection costs When such anevent happens, it is a default, and it is unfavourite for any investors because they losemoney in this situation Credit risk is found in all activities in which success depends

on counterparty, issuer, or borrower performance Thus, other terms for credit risks aredefault risks, or counterparty risks

2.2.2 Impacts of Credit Risks

Managing credit risk is extremely vital for any business Since banks’ main andoriginal functions are to accept deposits and to lend money to borrowers, cash flowsfrom credit activities play major proportion in their main business income Indeed, if abank cannot collect their principal and promised interests in timely manner, the bankwill not receive any future anticipated cash flows, and a loss may have to berecognized Lack of cash results in the bank’s potential failure to fulfill its ownliabilities: repay their customers as well as meet other requirements A higher record incredit risk measurement indicates inefficiency in management and weak performance

of banks Liquidity problems appear to be closely associated to likelihood of creditrisks the bank is exposed Furthermore, default on debts happening in credit activitiescan lead to significant probability of lenders’ bankruptcy In fact, some businessresearchers believe credit risks take approximately 70% of entire risks that a bank mayexperience in its business cycle

In the economy, each bank connects and contributes to others in a system.Under the circumstance when growing credit risks exists, the economy can sufferdespairingly due to not just weak performances from enterprises, but also banks wholose their money because of their borrowers’ inability to fulfill their obligations, as well

as the banks’ own obligations to pay back their customers Serious situation of default

risks can contribute to a financial crisis In fact, the financial crisis in 2007 wastriggered by increasing defaults and losses on subprime mortgage loans, which broughtabout serious negative impacts on global market.

A bank should therefore establish a holistic approach to assess credit risks andensure that credit risk management is a part of an integrated approach to management

of all financial risks The institution should establish a risk management framework toadequately identify, measure, monitor, and administrate credit risks Adequate capitalshould be held to against credit risk assumed Relevant rules, regulations andprudential requirements are also necessarily conducted

2.2.3 Causes of Credit Risks

Credit risk is unavoidable in banking business The minimum effect can be thatbanks may have to forgo opportunities to conduct some defensive strategies againstpossible “rainy-day” situations This is referred as trade-offs between returns and risks.There are many reasons to explain why such kind of risks can be happen to financialinstitutions We can classify them into three basic groups

- Causes from customers Mainly, risks arise from uncertain of lenders’ ability to

fulfill their obligations in the future Lack of legal power and authority, mis- orineffective use of borrowed funds, weak or inappropriate management, losses comingfrom low performance of business activities, etc are common mistakes oforganizational clients, which leading to a insufficient financial inflows to fulfill theirpromised returns to the banks

- Causes from the bank’s ability to manage and control An adequate credit policy

conducted can result in serious damages suffered by the bank itself Institutions need topay attention closely to their process of evaluating, estimating, predicting, reviewing,and adjusting their credit contracts to minimize probability of risks Lastly, employeeswith low quality of competences or violations of the organizational regulations andnorms can make the bank exposed more to risks as well

- Causes from external conditions These conditions can be market circumstances,

which are about competition, legal support or constraint environment or impacts from

international financial market Additionally, customers will force to default their loans

if catastrophes, such as diseases, natural calamities, wars, riots, etc, occur, makingoutcomes derived from expectation of both banks and borrowers

2.2.4 Reflecting Factors for Possible Credit Risks

Firstly, credit risk is closely tied to potential return of an investment Generally,the higher the perceived credit risk, the higher the rate of interest that investors willdemand for lending their capital This is a fundamental principle, referred as trade-offbetween returns and risks, for any investor to keep in mind

Checking symptoms of credit risks requires the understanding aboutcreditworthiness of the borrowers It is calculated based on clients’ collateral assets,income generating ability, taxing authority, and credit history The sources forinformation collection are be either of financial reports, copies of board of directors’resolutions or partnership agreements, business publications, the company’s and relatedworld wide websites, or credit granting and using biography Among financial figurescollected from the customers, revenues, net profit, plan of investment, and value ofcollateral assets used to pledge to the loans should be the most notable factors

Thirdly, estimating the risky of loans also involves in managing and controllingover total debts hold by the banks Credit risk must be controlled not only based onindividual transactions but also based on the bank's lending portfolio as a whole Thefollowing indicators, as appropriate, should be used when assessing the quality ofcredit risk management:

- Debts’ quantity and structure: This is the most useful and popular way of credit

management implemented by banks since it provides clear view over situation ofloans Classification focuses mostly on checking quality, term, type of customer andpunctuality of payments

- Credit growth rate: Although this ratio does not tell clearly quality of current loans,

but, by observing this indicator, the bank can predict risks of its whole loans

portfolio Unappropriate credit growth can lead to either inefficiency of creditactivities or high risk exposures.

- Total loans/Total assets: This ratio shows how much of outstanding loans is held by

a bank As this ratios grows, an examiner may become more concerned becauseloans are usually among the riskiest of all assets for depository institutions

- Nonperforming loans/Total loans: This ratio estimates the proportion of

nonperforming loans among outstanding loans held by the banks A high resultindicates high chance of credit risk problems arising

- Net charge-offs/Total loans: Measuring the ability of a bank in recovering its

written-off bad debts, a high ratio is favorite to the bank

- Allowance for loan losses/Total loans: Allowance, or provision, is a reserve balance

made by the bank in protecting itself from impacts of possible defaults events.Generally, a sufficient amount of allowance guarantees adequate degree of safetyfor the bank

- Allowance for loan losses/Equity capital

- Nonperforming loans/Equity capital

Lastly, credit risk is a vital component of fixed-income investing, thus ratingagencies such as S&P, Moody’s and Fitch attempt to evaluate the default risks ofcorporate issuers and municipalities on an ongoing basic These rating are available,standardized and reliable sources to check for credit worthiness of many businessentities However, because they are international rating organizations, it is impossible

to find the information and credit risk rating for SMEs since to access data forinformation of those companies is difficult, especially when Vietnamese economy hasbeen not in advanced development level yet

2.3 Credit Risk Management

2.3.1 What is Credit Risk Management?

Credit risk management is the lending institution's primary line of defense toprotect itself against customers who fail to meet the terms of the loans or other creditthat was extended to them

Effective credit risk management is an important aspect of a lending institution'ssuccess as it ensures the institution will not take on more risks than it can handle, andprotects its rate of return Conceptually, risk management ensures that the amount andtype of credit exposure remains within appropriate limits for the size and goals of thebank Inadequate credit risk management can result in severe consequences for banks

as well as customers In other hand, a sound credit risk management program ensuresthat a corporation's risk identification and reporting controls in credit processes areadequate and functional

Simply put, credit risk management is a two-step process - determining whatrisks exist in an investment and then handling those risks in a way best-suited to yourinvestment objectives Four key pillars in credit analysis include credit policy, creditrating, line of credit and ability to make repayment for the loan

2.3.2 How does the Government Regulate about Credit Risk

Management?

Under Vietnamese circumstance, as the domestic financial market have beenexpanding increasingly, SBV issued many legal statues stating about managing andcontrolling credit risks in banking business Those documents provide the base forbuilding credit risk management system in each bank Due to constrains of time andthesis’ objectives, we will only examine a number of noticeable rules in the mostimportant document, Decision no.493/2005/QD-NHNN dated April 22nd, 2005 released

by the Central Bank, as well as briefly taking a look at fundamental principles in creditrisk management stated by Basel Committee on Banking Supervision as an sufficientinternational standard to evaluate credit risk management system in the bank

 Debt classification: According to articles 2, 6 and 7 of Decision no.493, debtliabilities in banks are divided into five categories Every credit institution are subject

to estimate and identify the structure of their credit items, based on the those fivestandardized groups, and loss provisioning requirements However, it should be notedthat there is a significantly difference between debt classification under two Articles 6

and 7, which represent to quantitative and qualitative approach to classify the loansrespectively Under Article 6, commercial banks usually classify debt items based onthe length of time that loans are overdue Meanwhile, Article 7 states that banksclassify debts mostly based on results from customer ratings on the internal creditrating system which is based on an overall assessment of their financial and non-financial situation, and their business performance This is also the methodology used

by banks worldwide when making decisions on lending Nonperforming loans, or baddebts, are defined to be those in group 3 (subprime loans), 4 (doubtful loans) and 5(irrecoverable loans) Under the context of Vietnamese economy, a credit institutionwith nonperforming loan rate less than 5% is considered to be in safe zone

Table 2.2: Debt Classification under Article 7 of Decision no.493

Group Features Required

provision

1 Standard loans Loans that the borrower is able to pay the principal

and interest for in a full and timely manner

0%

2 Noticeable loans Loans that the borrower is able to pay the principal

and interest for in full, but there exists a sign of decreasing payment ability

5%

3 Subprime loans Debts that the borrower is not able to pay the

principal and interest for in a timely manner, and some losses of principal and interest is possible

(Source: Decision no.493/2005/QD-NHNN)

 Provision requirement for loans: Article 6 and 7 requires a bank to establish

standardized reserve required for each category The loss provisioning aims tocompensate for credit losses of credit institutions The ratios for applying are 5% forgroup 2, 20% for group 3, 50% for group 4, and 100% for group 5 Meanwhile, SBVrequests each bank to conduct a general reserve for the whole system with 0.75% of thevalue of loans of group 1 to 4 For the purpose of calculating specific amount ofallowance, a formula is set up as follow:

R = max {0; A-C} x r

with R: amount of allowance for loan losses

A: the value of loan

C: the value of collateralr: ratio for setting allowance for each type of debt, according toArticle 6 and 7 of Decision no.493

Table 2.3: Maximum Rate to Calculate the Value of Collateral

Type of pledged assets Maximum

rate

Balance of deposit accounts in VND at credit institutions 100%

Treasury bills, gold, balance of deposit accounts in foreign

currencies at credit institutions

95%

Government bonds

With less than 1 year until maturity date 95%

With more than 5 years until maturity date 80%

Commercial notes, valuable notes from other credit institutions 75%

(Source: Decision no.493/2005/QD-NHNN)

 Value of collateral: Collateral assets are important in credit activities because

they act in the manner of a financial defensive shield against default risk likelihood toarise during the term of the outstanding loan When default event occurs, banks canseize and sell the pledged assets to recover partially or entirely what the borrower didnot pay back Besides, collateralization gives the lender a psychological advantageover the borrower Borrowers should be more incentive to return money as they feelobligated to work hard to avoid losing their assets For those reasons, examiningcollateral with respect to the value of debts is required In the light of Article 8 ofDecision no.493, the value of pledge, denoted as C in the above formula is determinedbased on market value of gold, par value of government bonds and bills, commercialnotes, market value of securities, or market value of collateral properties or financialleasing contracts A designated rate is assigned to each type to calculate to final value

of collateral

 Principles for credit risk management by Basel: The Basel Committee

formulates broad supervisory standards and guidelines and recommends statements ofbest practice in banking supervision in the expectation that member authorities and

other nations' authorities will take steps to implement them through their own nationalsystems, whether in statutory form or otherwise According to the Basel 75thpublication published in September 2000, there are totally 17 core principles for theassessment of banks’ credit risk management, focusing on 5 main matters:

- To establish an appropriate credit risk environment

- To operate under a sound credit granting process

- To maintain an appropriate credit administration, measurement and monitoringprocess

- To ensure adequate controls over credit risk

- To identify the role of supervisors

2.3.3 Is There Any Specific Method to Evaluate Credit Risks?

In this session, we will examine possible ways used to estimate degree of creditrisks contained in each customer and their loan requests There is both qualitative andquantitative methods

Financial ratios analysis

This method is mostly consist of quantitative calculations based on accountingfigures Several financial indicators are derived from financial statements of thecustomer to find out how financial health of the firm is good enough to handle withadditional obligation of the loan requested Normally, its strong point is simplify andresulting in quite clear results However, it overlooks many other essential factors inassessing credit risks, such as credit history, collaterals, proposal of business plans,purpose of loan requests, and so on It searches for credit worthiness solely based onfinancial conditions Though using financial ratios analysis is not perfect tool to givesubstantial evaluation about a company’s abilities, capacities and potentials, it is stillrecommendable The method concentrates on ratios related to the companies’ potentials

of profitability, coverage capacity, leverage level and liquidity of assets Severalfrequently used indicators can be EBIT, ROE, ROA, profit margin, interest coverage,debt ratio, leverage ratio, current ratio, quick ratio, cash ratio, average collectionperiod, inventory turnover, etc

Credit analysis

How does a institution qualify for credit? As a part of a bank’s lendingprocedures for making a loan, credit analysis is the method by which one estimates andpredicts the creditworthiness of an individual or organization It is to determine thelikelihood that the borrower will live up to his/her obligations In other hand, a bank

may analyze the financial statements as well as other related factors of a businessbefore making or renewing a commercial loan

Carrying out a credit analysis for a customer involves finding sufficient andsuitable answers for three major questions:

1) Is the borrower creditworthy? How do you know?

2) Can the loan agreement be properly structured and documented so the lendinginstitution and those who supply it with fund are adequately protected and theborrower has a high probability of being able to service the loan without excessivestrain?

3) Can the lender perfect its claim against the assets or earnings of the customer sothat, in the event of default, the lender’s fund can be recovered rapidly at low costand with low risk?

Figure 2.1: Six Basic Cs of Lending

(Source: Bank Management & Financial Services)

To know the answers, a credit grantor gathers information, primarily fromborrower’s credit application and credit bureau reports, to determine whether you will

be able and willing to repay your debt in the expiration date The information requiredcan be summarized through six key Cs of the model, which refer to character, capacity,cash, collateral, conditions and control They are center elements in attempting toestimate credit reliability and to gauge the chance of default of the borrower Figure 2.1illustrates how the 6 Cs model contribute to classify the ability to fulfill creditobligation of the borrower Detailed of the model can be found in appendix A

To summary, a banker consider multiple issues in approving or denying eachloan requests They fall under six categories Character is determined by analyzingwhat purpose of borrowing is, and how the company has handle past obligation as well

as its honesty and responsibility Capacity is to check if the company demanding fundshas sufficient legal authority and standing to sign a binding contract The characteristiccalled Cash concentrates on finding ability to generate enough cash to repay the loan.Also, it involves understanding about the capital structure and the nature of assets hold

Carrying out a financial analysis is frequent action in describing Cash element of a loanrequest In assessing the collateral, the bank searches for adequate assets to defenseagainst the case of default arising The common examples of assets pledged in businessare accounts receivable, factoring, inventory, real and personal property, andguarantees Good collateral requires to be durable, easy to identify, marketable, stable

in value, and standardized Condition of six Cs requires loan officers and creditanalysts to be aware of recent movements of environment and economic conditions.Finally, the control element is associated with the questions “does the loan meet writtenloan policy, and how would loan be affected by changing laws and regulations ?” Itshould be noted that regulation in control is different than in condition Examiningregulation in condition means checking influences of legal environment in businessperformance of customers and their ability to repay debts Otherwise, in condition,credit officers consider relations of related legal documents in lending process, creditpolicies and procedures

Although the model seems to be simple, applying it is not a easy job because itsresult and accuracy depend heavily on accuracy of information collectible as well asability of analysts to evaluate

Internal credit rating system

In present modern financial management, credit institutions have beenincreasing building and applying their own credit rating system This approach is themost favorite because of two main reasons The first is to facilitate ability to meetrequirements of external conditions and the institution’s own objectives It is moreappropriate to adapt not only with features of a bank and its targeted customers, butalso with national legal and culture backgrounds and potentially, internationalaccounting standards Therefore, it increases correctness of evaluation process.Secondly, a distinctive but standardized credit rating system stimulates competition inthe market

In fact, the Stated Bank of Vietnam has recently increased interests inmotivating and regulating internal credit rating system in commercial banks, regarding

to Article 4 of Decision no.493 Started from 2006, with the advices of Earns & Young,the state-run BIDV announced that it has started to carry out an internal credit ratingsystem This was regarded as a step forward in making its operations transparent before

it started the equitization process In fact, BIDV has become the pioneered commercialbanks in implementing the internal credit ratings under the Article 7 of Decision no.493

in line with international standards that has been recognized by the SBV The system isapplied to corporate and individual customers, and also to credit institutions We willdiscuss in details about the internal credit assessment system of BIDV as well as howwell it is in gauging and managing credit risks in organization customers in the chapter3

Credit review

After a loan agreement has been endorsed by the borrower and the lendinginstitution, it must not be ignored until the loan expiration date comes, and theborrower makes the final payment Credit rating is not constant at all In fact, the creditworthiness level of a loan request as well as a corporation can change, at differentdegrees, over time as conditions change Fluctuations happen all times in economy,which affecting the borrowers’ financial strength and their ability to repay their debts.Therefore, the lending institutions must be sensitive to these movements Loan review

on outstanding debts must be required to be done periodically and carefully until theyreach expiration

There are several general principles for loan review procedures that arefollowed by most of banks and other institutions

- To conduct reviews of all types of outstanding loan items on periodic basic, forinstance, per year, per 6 months, per quarter, or per month

- To design the loan review process carefully to ensure quality of the investigation

- To focus largely on checking the loan with the most credit line because a possibledefault event on those loans can cause serious damages to the bank

- To carry out more frequent reviews of troubled loans, criticized loans and overdueloans to address closely problems arising and to find out solutions to recoverpotential losses as soon as possible

- To accelerating the schedule of loan review in the case of economic or industrialdownturns

2.3.4 Is There Possible Way to Hedge against Credit Risks?

The following table 2.4 lists some common methods investors use to mitigateimpacts of credit risk, according to en.wikipedia.org

Table 2.4: Credit Risk Minimization Methods

No Method Characteristics

1 Risk-based pricing Lenders charge higher interest rate as risk perception increases

2 Covenants Bankers write stipulations on the borrower in loan agreements

3 Credit insurance &

derivatives

Lenders hedge their hold credit risks by entering credit insurance or credit derivative contracts (CDS, credit option)

4 Tightening Banks reduce the amount of credit extended

5 Diversification Lenders decrease its concentration risks by diversifying the

borrower pool

6 Deposit insurance Lenders purchase deposit insurance to receive guarantee from

government protection

(Source: en.wikipedia.org)

CHAPTER III: CURRENT SITUATION OF CREDIT RISK MANAGEMENT FOR ORGANIZATIONS IN BIDV DIEN BIEN PHU, HAI PHONG BRANCH

3.1 Profile Of BIDV And BIDV Dien Bien Phu, Hai Phong branch

In accordance of the direction of the Decision no.177/TTG, Bank for Investmentand Development of Vietnam, denoted as BIDV, was found on April 26th, 1957, as astate-owned organization As a long-established bank, it has funded many investmentprojects and key economic areas of the country It has also built the largest enterprisecustomers, while confirming the implementation of prestigious items, objectives,economic programs and social security of the country It is believed that BIDV earnsthe number one bank in revenues, which was approximately 70 million USD in 2007.Locating its head office in 35 Hang Voi, Hoan Kiem District, Ha Noi, the bank is alsoranked as the second biggest bank in the domestic financial industry, behind Agribank

As of 31st December, 2007, the bank’s total assets reached about 10.48 billion USD.Until the end of 2011, the bank system has included 114 branches, 373 transactioncounters, 142 saving funds, 1,295 of ATMs and more than 16,000 employees with.Furthermore, BIDV has actively implemented the transparency and publicity of thebusiness, leading to be the pioneered bank in applying of international standards.Acknowledge the contribution of BIDV through the periods, the Party and the SocialistRepublic of Vietnam have given to BIDV many noble titles and rewards OnNovember 30th, 2011, following the equitisation process planned, BIDV has hold asuccessful initial public offering (IPO), with the average sale price was about 18,583VND and mobilized capital of over 1.5 trillion VND Besides, in 2010, three well-known global credit rating agencies Moody’s, S&P and Fitch did give great impressiveoutlooks on credit worthiness and management of BIDV, shown in table 3.1

Table 3.1: Credit Ratings for BIDV in 2010

1 Moody’s

Long-term deposits in local/foreign currency B1/B2

Long-term issuer in local/foreign currency B1/B1

(Source: Annual Report of BIDV 2010)

With about 55 years of experiences in the domestic financial market, BIDV haswitnessed a profound transformation with several name changes Its original name wasthe Bank for Construction of Vietnam, under which it operated from 1957 to middle of

1981 Afterwards, the name was changed to the Bank for Investment and Construction

of Vietnam, in the implementation of direction accomplished by the Government andthe SBV for the whole nation during this period Finally, it adopted its present name onNovember 14th, 1990, in order to adapt with the orientation of innovation and modernbanking services development

Previously being on Bien Binh Street, BIDV – Hai Phong branch is currentlylocated in 68-70 Dien Bien Phu Street, Hong Bang District As Hai Phong is among thebiggest cities in Vietnam, and one of key economic areas, the branch has a long-history

of operation in Vietnamese financial market generally, and in the market of the cityparticularly Maintaining a strong relations with the headquarter in Ha Noi, BIDV –Hai Phong branch has been acting as authorized leader for all of other branches and

transaction counters in the city’s extent Eventually, the branch has become a functioned, diversified, universal and comprehensive bank It provides a wide range ofcommercial banking services and investment banking in four main product lines:mobilization, credit activities, payment services and others Until the end of 2009, thenumber of customers coming to the bank’s services achieved 75,163, including 73,019enterprises (97.1%) and 2,144 individuals, meaning a growth rate of 15% compared tothe previous year

well-To simplify, in the context of this to, if there is any mention of BIDV withoutfurther explanation, it is implied to be about the branch located in Dien Bien PhuStreet, Hai Phong as the subject of my internship

3.2 Organizational Structure Of The Branch

Upon its establishment, BIDV was a state-owned institution, but currently, it hastransformed into a joint-stock bank with 78% capital owned by the Government.Following the general guidance of the Head Office, the model of organizationalstructure of the BIDV – Hai Phong branch is divided into five major divisions, asillustrated in the diagram 3.1 The functions of each division are described briefly asfollows in regard to Decision no.4589/QD-TCCB2 dated September 4th, 2008 Alldivisions and departments co-operate and connect closely with each other inadministrating and managing business activities in the branch By 2012, there are 157staffs working in the office of the branch, including one director and three vice-directors

- Customer Relations Division (3 departments):

+ To promote and do marketing banking products to potential customers

Figure 3.1: Organizational Structure of BIDV – Hai Phong branch

(Source: BIDV - Hai Phong branch)

+ To foster and maintain customer relations

+ To carry out and manage credit activities

+ To examine the market conditions (information, competitors’ services, etc)

- Internal Administrative Division (4 departments):

+ To administrate daily operations of the office

+ To collect information and propose operational and developing plans

+ To control and evaluate plan implementing processes as well as performance ofthe branch

+ To perform accounting and financing activities

- Risk Management Division (1 department):

+ To carry out credit management activities (policy proposing, risks estimatingand supervising on outstanding loans, debt classification and provisionestablishment monitoring, collateral evaluating, bad debts processing)

+ To manage credit risks in granting or extending credit for customers

+ To manage operational risks

+ To prevent money laundering activities

+ To develop and manage ISO quality evaluating system

+ To implement internal control and investigation

- Operational Division (5 departments):

+ To directly perform transactions with customers

+ To administrate credit activities, including loan appraisal, credit grantingprocedure, allowance for loan losses estimation, loan documents storage, etc+ To manage directly accounts, vaults, and funds in the bank

- Transaction Office Division (4 transaction offices):

+ To conduct transactions directly with customers in the region located

3.3 Business Results Of BIDV - Hai Phong Branch During 2009-2011

3.3.1 Profitability Analysis

The table 3.1 highlights operational results of BIDV during the period of 2009

-2011 Had been increasing each and every year, revenues of the branch were proved to

be extremely favorable From 2009 to 2010, revenues grew at a very rapid rate,approximately 58.81% Although the growth became quite slow down under negativeeffects of economic downturn, annual revenue still managed to reach around 1,480.68billion VND It was corresponding to an annual growth of 39.43%, which was stillcommendable result Meanwhile, net income seems to fluctuate through years In fact,the branch’s income did make a big increase of 30.07% in 2011 after decreasing11.62% visibly in 2010

Table 3.2: Operational Results of BIDV – Hai Phong branch during 2009-2011

(Source: Database of BIDV – Hai Phong branch)

Profit margin also received positive results As a crucial indicator in assessingprofitability, profit margin measure a business’s ability to generate earnings afterderiving its expenses and other relevant costs incurred A high and increasing profitmargin indicates the company is doing well, and is always expected by any investor In

2009, BIDV - Hai Phong branch earned a 2-digit margin for income before taxes, at13.59% Unfortunately, the number then fell nearly half to 7.56% in the next year Thegoing-down trend continued in 2011, but at a lessen level, when a profit margin of7.05% was recorded The reason might be impacts of global and domestic economic,which affecting both performances of the bank and its customers to repay their loanspunctually Interest rate raising also caused difficulties for enterprises to fulfill their

obligations or utilize debt financing Meanwhile, the SBV did have several restrictions

in credit activities to deal with credit risks increasing in the whole national system aswell as to reduce inflation As a state-owned bank, BIDV and its branch did have to bethe pioneer to implement policies adopted by the Government However, consideringthe disadvantageous conditions, the business outcomes achieved by BIDV turned out to

be great results, despite its decreasing movement It proved how efficient of BIDVbranch in operating its business

As a credit institution, BIDV shared similar characteristic in income structurewith many other banks The branch’s earnings came heavily from interest earned,which estimated to be about 93.71% of total revenues earned in 2011 Among that,39.81% was interest earned by credit extended by the branch itself, and the rest, 53.9%was obtained from FTP (Fund Transfer Pricing) This could be explained as the branchhas been operated as an authorized sub-head office to manage every branches andtransaction counters in Hai Phong Furthermore, BIDV has recently opened a newoffice located on Le Hong Phong Street of the city, then required Dien Bien Phu branch

to support actively its newly operation Meantime, incomes generated from services feesources shown slightly decreasing trend during the period Service fees played 7.87%,6.19% and 4.14% of total revenues in 2009, 2010 and 2010 respectively

Figure 3.2: Revenues Structure of BIDV branch in 2009-2011

(Source: Database of BIDV – Hai Phong branch)

Figure 3.3: Capital Mobilization of BIDV

The graph 3.3 points out a

illustrative overview on capital

raising It seemed that capital

raising activities faced significant

fluctuation during this period In

2009, mobilization brought

averagely 4,487 billion VND to the

BIDV branch, then increasing

slightly, about 4.7%, to 4,697

billion VND However, this

number declined drastically in

2010, at the rate of 24.8%

compared to the previous year It

appeared to result from effects of

downturn in domestic financial market, when there were disadvantageous conditionsprevented many enterprises from investing and made it difficult to generate income.High inflation caused households to have careful outlook about their budget As aresult, there were unstable growths in businesses and individuals’ deposits during2009-2011 Besides, many restrictions and requirements by SBV and the Governmentshould be another reason It is demonstrated by table 3.3, in which deposits of financialinstitutions suffered noticeable drop

In spite of that, those numbers did exceed the estimations planned by thebranch Moreover, in accordance to the regulation about rating for branch of BIDV

under the guidance of Decision no.1059/CV-TCCB.1, the amounts of capital raisedwere sufficient enough to earned maximum points for mobilization activity Therefore,

we may consider those results are considerable

Table 3.3 also shows the structure of the branch’s capital In term of customers,

it appears that BIDV relied mostly on individuals and business organization’s deposits

In fact, individual-type customers always played a large percentage in the bank’s fundportfolio, while business-types also contributed significantly and potentially, proved by

a growing trend from 30.19% in 2009 to 43.81% in 2011 As the branch of a owned institution, most of capitals was under VND currencies Additionally, BIDVseemed to focus on term deposits, with averagely 52.81% short-term and 29.09%medium & long-term

state-Table 3.3: Capital Mobilization of BIDV – Hai Phong branch in 2009-2011

Figure 3.4: Credit Structure by

Instruments in BIDV branch in

Syndicated loans were another high-volume credit instrument of the branch,with approximately 19.8% in two consecutive years, 2010 and 2011 This type of loan

is a form of lending funds or capital to a business with a group of lenders Participation

of two or more credit institutions facilities credit granting and sharing default risksacross multiple lenders

Under classification by customer type, we can see that business enterprises werethe most important clients for the branch Loan granting for this sector of customersdominated in credit activities, with more than 95% in average of the whole period Forinstance, in 2011, the outstanding loans for business entities accounted for 96.86% ofwhole debts This is understandable since demands in capital for business are usually at