LV Thạc sỹ_Improving the quality of credit appraisal for individual customers in VIB

Objective factors...29 CHAPTER 2: THE REALITY OF CREDIT APPRAISAL ACTIVITY FOR INDIVIDUAL CUSTOMERS IN VIETNAM INTERNATIONAL BANK – LIEU GIAI TRANSACTION OFFICE 31 2.1.. Indicators refle

initial to the final phase of my thesis

Additionally, I also sincerely thank Mr.– Director of Vietnam InternationalBank – Lieu Giai transaction office and Mr.– Credit officer of Credit managementdepartment for their encouragement and valuable instruction during my internship

at the bank

Lastly, I expose my regards to other people especially my classmates inadvanced finance class intake 50 for their help in the completion of this thesis

ABBREVIATION v

LIST OF TABLES vii

LIST OF FIGURES viii

INTRODUCTION 1

CHAPTER 1: THEORETICAL FRAMEWORK OF CREDIT APPRAISAL FOR INDIVIDUAL CUSTOMERS IN COMMERCIAL BANKS 4

1.1 Credit for individual customers in commercial banks 4

1.1.1 Credit activities in commercial banks 4

1.1.1.1 Bank credit definition 4

1.1.1.2 Classification of bank credit 5

1.1.1.3 Roles of bank credit in the economy 7

1.1.1.4 Bank credit risk 8

1.1.2 Credit for individual customers 9

1.1.2.1 The concept of credit for individual customers 9

1.1.2.2 Classification of credit for individual customers 11

1.1.2.3 Roles of credit for individual customers 13

1.2 Credit appraisal for individual customers in commercial banks 14

1.2.1 Concept and characteristics of credit appraisal 14

1.2.1.1 Concept of credit appraisal 14

1.2.1.2 General characteristics of credit appraisal 14

1.2.2 Credit appraisal for individual customers 17

1.2.2.1 Objectives of credit appraisal for individual customers .17

1.3 The quality of credit appraisal for individual customers in

commercial banks 21

1.3.1 The concept of appraisal quality for individual customers in commercial banks 21

1.3.2 Indicators reflecting the quality of credit appraisal for individual customers in commercial banks 22

1.3.2.1 Qualitative indicators 22

1.3.2.2 Quantitative indicators 24

1.3.3 Factors affecting the quality of credit appraisal for individual customers in commercial banks 27

1.3.3.1 Subjective factors 27

1.3.3.2 Objective factors 29

CHAPTER 2: THE REALITY OF CREDIT APPRAISAL ACTIVITY FOR INDIVIDUAL CUSTOMERS IN VIETNAM INTERNATIONAL BANK – LIEU GIAI TRANSACTION OFFICE 31 2.1 Overview of Vietnam International Bank – Lieu Giai transaction office 31

2.1.1 Foundation and development history 31

2.1.2 Organizational structure 34

2.1.3 The reality of business activity 34

2.1.3.1 Financial result 34

2.1.3.2 Product and service development 37

2.2.2 Appraisal system for individual credits in VIB Lieu Giai 42

2.2.3 An example of credit appraisal process for individual customers in VIB Lieu Giai 43

2.2.4 Indicators reflecting the quality of credit appraisal activity for individual customers in Vietnam International Bank – Lieu Giai transaction office 50

2.3 Evaluation of credit appraisal activity for individual customers in Vietnam International Bank – Lieu Giai transaction office 55

2.3.1 Achievements 55

2.3.2 Drawbacks and reasons 58

CHAPTER 3: SOLUTIONS TO IMPROVE THE QUALITY OF CREDIT APPRAISAL FOR INDIVIDUAL CUSTOMERS IN VIETNAM INTERNATIONAL BANK – LIEU GIAI TRANSACTION OFFICE 62 3.1 The development orientation of credit appraisal for individual customers in Vietnam International Bank – Lieu Giai transaction office 62

3.1.1 The business target 62

3.1.2 The orientations of credit appraisal for individual customers 64 3.2 Solutions to improve the quality of credit appraisal for individual customers in Vietnam International Bank – Lieu Giai transaction office 65

3.2.1 Completing the appraisal process, content and method 65

3.2.2 Modernizing appraisal technology 68

3.2.3 Enriching the quality of human factor 69

3.3.2 To State Bank of Vietnam 713.3.3 To Vietnam International Bank 72

APPENDIX 75

VIB Lieu Giai Vietnam International Bank – Lieu Giai

transaction office

Table 2.3: Collateral asset information

Table 3.1: Score system in a bank in the U.S

Figure 2.3: Growth in profit before tax

Figure 2.4: Growth in capital mobilization

Figure 2.5: Outstanding credit for individuals versus total assetsFigure 2.6: Ratio of outstanding credit for individuals over total assetsFigure 2.7: Overdue debts

Figure 2.8: Ratio of profit from credit over outstanding credit

Figure 2.9: Outstanding credit for individuals

Figure 3.1: Targets for 2012

Figure 3.2: Targets for credit appraisal for individual customers

1 Rationale

In Vietnamese financial market, commercial banks normally thrive on theloans and services they provide to businesses For example, offering funds for newbusinesses or expansion of some existing business, managing inter-city orinternational transactions involving large sums, or offering financial advice, etc.However, no bank can completely ignore the individual consumers, as theyconstitute a large part of the market and are considered an important source of fundsfor the banks

As the time is passing by, the number of individuals seeking loans from thebanks is increasing day by day The demands and needs of the consumers areincreasing at a higher rate and so more and more consumers are opting for loans tosatisfy their needs They seek loans for each and every need and the banks areadvantaging this fact Doesn’t matter what the requirements are whether they want

to gain loan for a small scale business or want financial aid for houses construction

or even if they want a brand new vehicle, they knock the door of these banks tosolve each and every purpose and hence are falling under debt day by day Theseloans differ in sizes and characteristics, ranging from long term huge mortgageloans to small loans taken out for shopping through credit cards

Moreover, loans for individuals are different from business loans in manyways Even though the business loans are borrowed by individuals as well, butpeople tend to think differently when borrowing for the business as compared to theborrowing for personal use Consumer loans are thought to be the more risky onesthan business loans because individuals defaults (fails to payback) more often thanthe businesses, that's why consumer loans normally have higher interest rates thanthe business loan and also need to be appraised carefully

In the year 2012, the lending interest rates for individual loans are still highdue to some economic reasons, resulting potentially bigger amount of bad debts for

commercial banks Thus the appraisal for individual loans is considered the mostessential phrase that has to be improved and advanced.

Interested in this concern, during more than two months doing internship inVietnam International Bank – Lieu Giai transaction office, I have taken my chance

to do research and experience appraisal activities for individuals and finally

conducting this bachelor thesis in finance: “Improving the quality of credit appraisal for individual customers in Vietnam International Bank – Lieu Giai transaction office”.

2 Research questions

This thesis intends to achieve answers for these following questions:

- What are bases that credit appraisals for individual customers incommercial banks are developed from?

- How are appraisal activities for individual credits performed in VietnamInternational Bank – Lieu Giai transaction office?

- What recommendations can be applied to improve the quality of creditappraisals for individual customers in Vietnam International Bank – Lieu Giaitransaction office particularly and commercial banks generally?

3 Research objectives

This thesis mainly focuses on assessing the status of appraisal activities forindividual credits in Vietnam International Bank – Lieu Giai transaction officethrough indicators related to individual credit and real experience during internshiptime From the result of assessment, numerous proposals are raised to improve thequality of credit appraisals for individual customers in the bank

4 Research methodology

Method of collecting information and data: reports and data in VietnamInternational Bank – Lieu Giai transaction office, information in newspapers,internet, reference books, etc

Method of processing information and data:

- Describing and synthesizing

- Comparing: trend, proportion, structure

- Analyzing and evaluating (absolute and relative value)

Besides, the research also uses consultancy of VIB Lieu Giai’s credit officers

to have a more realistic look

5 Research scope

The thesis focuses on appraisal activities for individual credits in VietnamInternational Bank – Lieu Giai transaction office All data used to analyze the bankactivities in general and the bank’s appraisal activities in particular is extracted fromVIB Lieu Giai’s annual reports for the period 2008 – 2011

6 Research structure

This thesis research comprises of three main parts:

Chapter 1: Theoretical framework of credit appraisal for individual customers in commercial banks

This chapter presents an overview on credit activities and appraisal activitiesespecially for individual credits in commercial banks The quality of credit appraisalfor individual customers is also discussed with concept, indicators reflecting andfactors affecting it

Chapter 2: The reality of credit appraisal activity for individual customers in Vietnam International Bank – Lieu Giai transaction office

This chapter introduces about Vietnam International Bank – Lieu Giaitransaction office with its basic banking activities like capital mobilization, lendingand other products and services Here, the thesis assesses quality of the bank’sappraisal activities for individual credits, evaluating its achievements anddrawbacks as well

Chapter 3: Solutions to improve the quality of credit appraisal for individual customers in Vietnam International Bank – Lieu Giai transaction office

This last chapter aims at raising recommendations and solutions to enhancethe quality of credit appraisal for individual customers not only in VIB Lieu Giaibut also in Vietnamese commercial banks in general

CHAPTER 1: THEORETICAL FRAMEWORK OF CREDIT APPRAISAL FOR INDIVIDUAL CUSTOMERS IN

COMMERCIAL BANKS 1.1 Credit for individual customers in commercial banks

1.1.1 Credit activities in commercial banks

1.1.1.1 Bank credit definition

a Credit definition

Credit is the trust which allows one party to provide resources to anotherparty where that second party does not reimburse the first party immediately butinstead arranges either to repay or return those resources (or other materials of equalvalue) at a later date The resources provided may be financial, or they may consist

of goods or services Credit encompasses any form of deferred payment Credit isextended by a creditor, also known as a lender, to a debtor, also known as aborrower

Credit, in commerce and finance, is a term used to denote transactionsinvolving the transfer of money or other property on promise of repayment, usually

at a fixed future date The transferor thereby becomes a creditor, and the transfer, adebtor; hence credit and debt are simply terms describing the same operationviewed from opposite standpoints

According to Vietnamese Law on credit institutions:

“Credit extension” means an agreement allowing an organization orindividual to use a sum of money or a commitment allowing the use of a sum ofmoney on the repayment principle by such professional operations as lending,discount, financial leasing, factoring, bank guarantee and other credit extensionoperations

b Bank credit definition

More specific than definition of credit, bank credit is the borrowing capacityprovided to an individual or a business by the banking system, in the form of credit

or a loan The total bank credit the individual/business has is the sum of theborrowing capacity each lender bank provides to the individual/business

1.1.1.2 Classification of bank credit

Banks and their principal competitors make a wide variety of credits to widevariety customers for many different purposes Although there are numerous criteria

to classify bank credit, following are some common categories used by banks inevaluating and analyzing:

 In terms of maturity:

 Short–term credit: has maturity of less than one year, is often used to

supplement the temporary shortage of working capital of business or

to finance for personal consumption

 Medium-term credit: has maturity of one-to-five years, is often used

for purposes of fixed assets, purchasing, technical improvement andinnovation, construction and expansion of small, fast capital-recoveryprojects

 Long-term credit: has maturity of more than five years, is often used

to finance the construction of new factories, mortgage projects,infrastructure developments Together with medium-credit, long-term-credit forms long term capital and a part of working capital

 In terms of economic scale of borrowers:

 Credit for corporations and big enterprises

 Credit for small and medium enterprises

 Credit for individuals

 In terms of purpose:

Credit may be divided into some broad categories, declined by theirpurposes:

 Real estate loans: are secured by real property – land, buildings, and

other structures – and include short-term loans for construction andland development and longer-term loans to finance the purchase offarmland, homes, and apartments

 Agricultural loans: are extended to assist in planting and harvesting

crops and supporting the feeding and care of livestock

 Commercial and industrial loans: are usually granted to businesses to

cover purchasing inventories and some other business payments

 Loans to individuals: include credit to finance the purchase of

automobiles, apartments, and retail goods, to repair and modernizehomes and other personal purposes

 Miscellaneous loans: are other credit not listed above, including

securities’ loans

 In terms of credit objects:

 Working capital credit: is used to build up the working capital of

enterprises including inventories and receivables Term of this kindcredit is usually short or medium

 Fixed capital credit: is used to form fixed assets, for instances,

purchasing fixed assets, improving technology, executing newprojects The term of this kind credit is commonly medium or longterm

 In terms of currency:

 Credit in domestic currency: is often employed for investments and

transactions domestically

 Credit in foreign currency: is often employed to make payments for

foreign suppliers and partners and other foreign-currency-related businesses This credit is heavily affected by currency risk caused by exchange rate fluctuation and the home government’s economic policy regarding foreign currencies

1.1.1.3 Roles of bank credit in the economy

Lending to businesses, governments, and individuals is one of the mostimportant economic functions banks and their competitors provide, and it is alsoamong the riskiest as our Vietnamese economy has demonstrated through bad creditcrisis recently

Fist of all, bank credit activity plays an important part in the growth andstability of a national economy The increase rate of credit directly relates to GDP

of one nation and other crucial ratios reflecting health of the economy like: growthrate of total payment and inflation rate Hence, if bank credit has a reasonablegrowth rate, it would help develop the whole economy as expected, lessen thepressure of incrementing total payment and limit factors causing inflation

Moreover, bank credit is recruited by Center Banks to control the volume ofmoney circulation For instance, by controlling the credit growth rate of each bankgroup, State Bank of Vietnam has been achieving the objectives of its monetarypolicy, controlling market fluctuation and preventing some market risks

In implementing other economic programs of the Government including:enhancing export and manufacture sectors, supporting education and agriculture,bank credit also servers as a useful and effective tool Especially, in some projectssuch as transportation constructions, technological innovations and researches inbasic sciences, bank credit is considered as key sponsor beside other internationalfunds

Because credits support the growth of new businesses and jobs within thelenders’ market area, how well a lender performs in fulfilling the lending functionhas a great deal to do with the economic health of its region Borrowing operationsbridge the gap between the expenditure requirements and income receipts in theproduction economy As in any voluntary exchange, a credit transaction benefitsboth parties to a transaction The borrower may use the proceeds to buy someconsumer goods or services A business firm may borrow to put the loan proceeds

to work in income-producing assets such as raw materials, inventories, machinery

or securities which are expected to earn in due course more than the amountborrowed The lender in turn receives the interest as remuneration for his expensesand for bearing the risks that unforeseen developments may cause payment ofprincipal or interest or both to be delayed or defaulted

Finally, bank credit frequently conveys information to the market place aboutborrowers’ credit quality, often enabling a borrower whose credit is approved toobtain more and somewhat cheaper funds from other sources as well

1.1.1.4 Bank credit risk

Credit risk is most simply defined as the potential that a bank borrower orcounterparty will fail to meet its obligations in accordance with agreed terms Of allthe risks banks encounter in their intermediation processes, credit risk poses greaterthreat to their vulnerability and sustainability It has got two distinct facets:

 Risk from the macro credit portfolio management perspective; and

 Risk inherent in the individual loan account

Banks nowadays are increasingly facing credit risk (or counterparty risk) invarious financial instruments other than loans, including acceptances, interbanktransactions, trade financing, foreign exchange transactions, financial futures,swaps, bonds, equities, options, and in the extension of commitments andguarantees, and the settlement of transactions However, for most banks, loans arethe largest and most obvious source of credit risk

Since exposure to credit risk continues to be the leading source of problems

in banks world-wide, banks and their supervisors should be able to draw usefullessons from past experiences Banks should now have a keen awareness of theneed to identify, measure, monitor and control credit risk as well as to determinethat they hold adequate capital against these risks and that they are adequatelycompensated for risks incurred

The goal of credit risk management is to maximize a bank’s risk-adjustedrate of return by maintaining credit risk exposure within acceptable parameters.Banks need to manage the credit risk inherent in the entire portfolio as well as the

risk in individual credits or transactions Banks should also consider therelationships between credit risk and other risks The effective management ofcredit risk is a critical component of a comprehensive approach to risk managementand essential to the long-term success of any banking organization

Although specific credit risk management practices may differ among banksdepending upon the nature and complexity of their credit activities, acomprehensive credit risk management program will address these four areas:

 Establishing an appropriate credit risk environment;

 Operating under a sound credit granting process;

 Maintaining an appropriate credit administration, measurement andmonitoring process; and

 Ensuring adequate controls over credit risk

These practices should also be applied in conjunction with sound practicesrelated to the assessment of asset quality, the adequacy of provisions and reserves,and the disclosure of credit risk

1.1.2 Credit for individual customers

1.1.2.1 The concept of credit for individual customers

a Definition

Credits for individuals also called personal credit or personal lending is anamount of money lent to an individual (both on secured and unsecured basis) forpersonal, family, or household purposes It is commonly to finance the purchase ofautomobiles, mobile homes, appliances and other retail goods, to repair andmodernize homes, and to cover the cost of medical care and other personalexpenses, and are either extended directly to individuals or indirectly through retaildealers

Personal loans are monitored by government regulatory agencies for theircompliance with consumer protection regulations The credit score of the borrower

is a major component in underwriting and interest rates (APR) of these loans The

monthly payments of personal loans can be decreased by selecting longer paymentterms, but overall interest paid increases as well.

b Characteristics of credit for individual customers

 High interest rate risk

Most types of personal credits have grown explosively in recent year, fed by

a growing economy and intense competition among banks By and large, banksregard credits for individuals and entrepreneurs profitable with “sticky” interestrates That is, they are typically priced well above the cost of funding them, buttheir contract interest rates often don’t change readily with market conditions as dointerest rates on most business loans This means that many personal credits areexposed to significant interest rate risk

 High lending interest rate

Personal loans are usually priced so high (with a large risk premium builtinto the loan rate) that market interest rates on borrowed funds and defaults rates onthe loans themselves would have to rise substantially before most personal creditswould become unprofitable

 Cyclical sensitivity

Personal loans are among the most costly and most risky to make per dollar

of loan-able-funds committed to them It also tend to be the cyclically sensitive.They rise in periods of economic expansion when consumers are generally moreoptimistic about the future On the other hand, when the economy turns down, manyindividuals become more pessimistic about the future and reduce their borrowingaccordingly

 Interest inelastic borrowers

Household borrowings appear to be relatively inelastic, that is, individualcustomers are often more concerned about the size of monthly payment required by

a loan agreement than the interest rate charged (though, obviously, the contract rate

on a loan influences the size of its required payments)

 Influences of education and income levels

While the level of interest rates is often not a significant conscious factoramong household borrowers, both education and income levels do materiallyinfluence consumers’ use of credit Individuals with higher incomes tend to borrowmore in total and relative to the size of their annual incomes Those households inwhich the principal breadwinner has more years of formal education also tend toborrow more heavily relative to their level of income For these individualsborrowing is often viewed as a tool to achieve a desired standard of living ratherthan as a safety net to be used only in emergencies

1.1.2.2 Classification of credit for individual customers

We can classify personal credits by purpose – what the borrowed funds will

be used for – or by type – whether the borrower must repay in installments or repay

in one lump sum when the loan comes due Commonly, loans to individuals andfamilies my be divided into two groups, depending upon whether they finance the

purchase of new homes with a residential loan or whether they finance other, housing activities through nonresidential loans.

non- Residential loans:

Credit to finance the purchase of a home or fund improvements on a private

residence comes under the label of residential mortgage loans The purchase of

residential property in the form of houses and multifamily dwellings usually givesrise to a long-term loan, typically bearing a term of 15 to 30 years and secured bythe property itself Such loans may carry either a fixed interest rate or a variable(floating) interest rate that changes periodically with a specified base rate or anational mortgage interest rate A commitment fee, typically 1 to 2 percent of theface amount of the loan, is routinely charged up front to assure the borrower that aresidential loan will be available for a stimulated period

 Nonresidential loans:

Within the nonresidential category, personal loans are often divided into

subcategories based on type of loan – installment loans (such as auto or education

loans); non-installment loans (such as cash advance); and revolving credit loans

(including credit card loans)

 Installment loans:

They are short-term to medium-term loans, repayable in two or moreconsecutive payments (usually monthly or quarterly) Such loans are frequentlyemployed to buy big-ticket items (automobiles, furniture and home appliances) or toconsolidate existing household debts

 Non-installment loans:

Short-term loans individuals draw upon for immediate cash needs that arerepayable in a lump sum are known as non-installment loans Such loans my be forrelatively small amounts and include charge accounts that often require payment in

30 days or some other relatively short time period It may also be made for a shortperiod (usually six months or less) to wealthier individuals and can be quite large;for example, the loans to finance the cost of vacations, medical care, the purchase ofhome appliance, auto and home repairs

 Revolving credit loans:

One of the most popular forms of personal credit today is accessed via credit

cards issued by VISA, MasterCard, Discover, and many other card companies.

Credit cards provide convenience and a revolving line of credit the customer canaccess when ever the need arises Credit cards offer their holders access to eitherinstallment or non-installment credit because the customer can charge a purchase onthe account represented by the card and pay off the charge in one billing period,escaping any finance charge, or choose to pay off the purchase price gradually,incurring a monthly finance charge based on an annual interest rate usually rangingfrom about 10 percent to 24 percent and sometime more Today, majority number ofcredit cards has variable rates of interest

Card companies find that installment users of credit cards are far moreprofitable due to the interest income they generate than are non-installment users,who quickly pay off their charges before interest can be assessed Card providers

also earn discount fees from merchants who accept their cards That is the reasonwhy a rapidly increasing number of the acceptance of charge cards is opened today

1.1.2.3 Roles of credit for individual customers

 For individual customers

With personal credit, individuals can enjoy wealthier lives while they havenot saved enough money, especially for expensive and emergent expenses such asmedical care and education

For the youth and low income people, personal credit helps them finance fornecessary consumptions to stabilize lives Therefore, they have conditions todevelop themselves and contribute more to the society

However, if personal credit is overused, maybe it causes over-expense andreduces savings and future consumption

 For commercial bank

Personal credit is one of crucial tools for banks widening their relationshipswith customers, resulting bigger volume of individual deposits and higher profitfrom other services for individual customers

Banks diversify their risks from wholesale banking to retail bankingactivities which serve individuals and families and have more opportunities tobroaden their market share

 For the economy

If personal credit is employed as a useful financial tool to finance theconsumption of domestic goods and services, it can stimulate national demand andthe growth of the economy as a whole Otherwise, it may reduce the nationalsavings and cause some troubles

On the enterprises’ view, personal credit pulls future demand back ward,helps for the purchase of finished goods, so then raising the scale and scope ofmanufacturing, increasing the quality and quantity of products Thus, the economy’sproduction, distribution and consumption are moving faster and more effectively,which is base of the economic growth

Personal credit also clears out the cycle: low income – low level of savings –low productivity which leads to the decline of unemployment rate and higherstandard of livings.

1.2 Credit appraisal for individual customers in commercial banks

1.2.1 Concept and characteristics of credit appraisal

1.2.1.1 Concept of credit appraisal

Credit appraisal is the process by which a lender appraises the technicalfeasibility, economic viability and bankability including creditworthiness of theprospective borrower Credit appraisal process of a customer lies in assessing if thatcustomer is liable to repay the loan amount in the stipulated time, or not

Each bank has their own methodology to determine if a borrower iscreditworthy or not It is determined in terms of the norms and standards set by thebanks Being a very crucial step in the sanctioning of a loan, the borrower needs to

be very careful in planning his financing modes However, the borrower alonedoesn’t have to do all the hard work The banks need to be cautious, lest they end upincreasing their risk exposure All banks employ their own unique objective,subjective, financial and non-financial techniques to evaluate the creditworthiness

of their customers

1.2.1.2 General characteristics of credit appraisal

Credit appraisal is an important phase in the origination cycle as decisionsmade here affect the health of the portfolio Incorrect decisions increase the risk andmay add to bad debts affecting the portfolio performance

The techniques for credit appraisal can broadly be classified into two

categories: Traditional approaches and Modern approaches

 Expert System or Five C's of Credit

Every credit proposal, howsoever, small or big, is backed by an entrepreneur.Every project which may be considered technically feasible, economically viableand financially sound may run into difficulties if it is not backed by a competentperson who understands the risk and is willing to take and manage them Thus, theman behind the project is always the key to understanding the risk in a creditapplication Confidence is the basis of all credit transactions This is cornerstone ofevery credit application A lack of confidence in the management leads to anoutright rejection of the credit proposal The basis of this confidence is generallyderived from the 5 ‘C’s of the borrower: character, capacity, capital, collateral andconditions In addition to the 5C's reliability, responsibility and resources are alsolooked into for gaining the confidence

 Character

Character is the greatest and the most important asset, which is assessed first

It is the character of the borrower, which indicates his intention to repay and is key,even if a borrower has the capacity and capital to repay a loan A questionableintegrity would make every banker shun him, even if backed by sufficientcollaterals Character of a borrower is constituted by honesty, sobriety, good habits,personality, the ability and willingness to keep his word under all circumstances,reputation of the people with whom he deals etc

 Capacity

It deals with the ability of the borrower to manage an enterprise or venturesuccessfully with the resources available to him The management team’seducational, technical and professional qualifications, antecedents/the past trackrecord of the enterprise, present activity, experience in the line of business,experiences of the family, special skill or knowledge possessed by him/thecollective knowledge base of the enterprise, his past record etc would give a insightinto his capacity to manage the show successfully and repay the loan

 Capital

It is the amount of owned funds involved in the business as well as his ability

to meet the loss, if any, sustained in the business or venture from his owninvestment or capital without shifting it to his creditor or banker Unless a borrowerhas some stake in the business, he may not take much interest in its success

 Collateral

Collateral refers to the security provided by the borrower in a credittransaction The fact that the collateral may be seized by the bank acts as amotivator to the borrower to repay the loan as per the terms and conditions of theloan agreement

 Conditions

Conditions mean the external factors which are beyond the control of theborrower but which may affect his ability to repay the loan These includeeconomic, social, political, competitive and technological conditions Though theseare not under the control of the borrower, it helps to judge the sensitivity of theborrower to changes in these conditions If the borrower is too sensitive to any ofthese conditions his repayment capability may be adversely affected as a result ofadverse changes in conditions

b Modern Approaches

The modern approaches for credit appraisal are statistical in nature Theseapproaches are more objective as they are based on some statistical model One ofthe commonly used approach is credit scoring

 Credit Scoring

Traditionally banks were using the method of analyzing the financialstatement of the applicants by which the bank was able to evaluate the applicant’scapacity to pay back the loan Though the applicant may be financially sound topay, it was very difficult to identify whether he or she has the willingness to pay theloan When the demand for personal credits in retail market is fast increasing, banksmust have a system by which they are able to process the credit applications

professionally and at the same time to identify the potential default risk of theborrower

Most of the banks presently use credit-scoring model to evaluate the loanapplications they receive from consumers Banks, credit card providers, mortgagelenders and other loan providers develop their own internal credit-scoring model onretail lending and use these models to evaluate their applicants With theintroduction of credit scoring models in the banks, often the customer can phone inwith a loan request and within the shortest possible time, bank can convey theirdecision calling back the customer Usually the credit scoring systems are based ondiscriminated models or related techniques in which variables are used jointly toestablish a numerical score or ranking for each credit applicant If the applicant’sscore exceeds the prescribed and defined cut off level, the loan application is likely

to be approved for credit If the credit scoring is below the cutoff level, credit islikely to be denied

1.2.2 Credit appraisal for individual customers

1.2.2.1 Objectives of credit appraisal for individual customers

The main purpose of credit appraisal for individual customers is to answersufficiently three questions followings, so then assess the ability of repayment of theborrowers

1 Is the borrower creditworthy? How do you know?

2 Can the loan agreement be properly structured and documented so thelending institution is adequately protected and the borrower has a high probability

of being able to service the loan without excess strain?

3 Can the lender perfect its claim against the assets or earnings of theindividual customer so that in the event of default, the lender’s funds can berecovered rapidly at low cost and with low risk?

1.2.2.2 Significance of credit appraisal for individual customers

Credit appraisal plays a vital role in economic growth by helping expandaccess to credit markets, lowering the price of credit and reducing delinquencies anddefaults In general, it is to help solve three specific economic problems:

 Improving the efficiency of the financial sector;

 Expanding private sector lending which has been relatively stagnant;and

 Reducing the risk of financial crises, which often stem in part fromadverse selection and moral hazard problems in the banking sectorFor the national economy, credit appraisal helps smooth consumption duringcyclical periods of unemployment and reduces the swings of the business cycle Byenabling loans and credit products to be bundled according to risk and sold assecuritized derivatives, credit scoring connects consumers to secondary capitalmarkets and increases the amount of capital that is available to be extended orinvested in economic growth Especially, credit reporting and credit scores can alsofuel economic growth, increase consumer access to essential resources and enablemore efficient allocation of risk, costs and financial reserves

For businesses, especially small and medium-sized enterprises, creditappraisal increases access to financial resources, reduces costs and helps managerisk

And for individuals, credit appraisal is the key to homeownership and

consumer credit It increases competition among lenders, which drives down prices,makes credit affordable Decisions can be made faster and cheaper and moreconsumers can be approved It helps spread risk more fairly so vital resources, such

as insurance and mortgages, are priced more fairly

1.2.2.3 Process of credit appraisal for individual customers

Each loan type will go through the some phases with some variations.Consumer loans are generally small ticket and thus low risk loans; the process forcredit appraisal may be minimized to adopt auto sanction On the other hand, home

loans are generally high-ticket long-term loans with high risk and may go throughmultiple appraisals before sanction Similarly consumer loans may have singledisbursement, where as loans for under construction homes may have multipledisbursements Consumer and auto loans have assets to back the loan where assome personal loans have no asset Risk is typically mitigated with collateral.

A process of credit appraisal for individual customers basically includesthese steps followed:

 Step 1: Analyzing character of the borrower and his ability to pay

The first step in getting a personal loan is customers fill out the bank’sapplication and submit all the necessary documents required by that particular bank.After submission of documents in bank, the bank field investigator will visit thecustomer’s home and office in to verify whether the information provided is correct

or not If the verification officer is not able to locate the borrower’s office/home, theapplication can be rejected

Key factors in analyzing any personal loan application are the character of the borrower and the borrower’s ability to pay The appraiser must be assured that

the borrowing customer feels a keen sense of moral responsibility to pay on time.Moreover, the borrower’s income level and valuable assets (such as holdings ofsecurities or savings deposits) must be sufficient to reassure the lender that thecustomer has the ability to repay the loan with a comfortable margin for safety

Often, in this step, the bank appraiser can assess the credit history of the

applicant on national or regional credit bureaus for more reliable information This

reference check happens both on the borrower’s any default on loans/credit cardsand also what score on his credit profile If the borrower is not having anyloans/credit cards then his score is likely to be zero which does not mean that he has

a bad score In case his score is satisfactory and no default is listed then his chances

of the loan approval increases

 Step 2: Analyzing purpose of the credit

The appraiser analyzes purpose of the loan to ensure that it is legal, suitableand meets the bank’s quality standard The appraiser can verify the purpose of theloan to understand some questions like: Has the customer clearly stated what heplans to do with the money? Is the stated purpose of the loan consistent with thebank’s loan policy? Is there evidence of a sincere intention to repay any fundsborrowed?

 Step 3: Analyzing other factors

Other factors considered are debt to income ratio, disposable income,stability of employment, deposit balances, length of residence, suit, garnishment,credit references, full disclosure and integrity of the application, etc

 Income levels:

Both the size and stability of an individual’s income are consideredimportant The appraiser generally prefer the customer to report net salary, or take-home pay, as opposed to gross salary, and with large loans, may check with thecustomer’s employer to verify the accuracy of customer supplied income figuresand length of employment

 Deposit balances:

An indirect measure of income size and stability is the daily average depositbalance maintained by the customer, which the loan officer may verify with thedepository institution involved

 Employment and residential stability:

Among the factors considered by lenders is duration of employment Many

lenders are not likely to grant a sizable loan to someone who has held his or her

present job for only a few weeks or months Length of residence may also be

considered because the longer a person stays at one address, the more stable his orher personal situation is presumed to be

 Pyramiding of debt:

Lenders are especially sensitive to evidence that debt is piling up relative to a

consumer’s income Pyramiding of debt – where the individual draws credit at one

lending institution to pay another – is frowned upon, as are high or growing creditcard balances and frequent returned checks drawn against the customer’s account.These items are viewed as indicators of the customer’s money management skills

 Home ownership:

Owner ship of any form of real property, such as land or buildings conveysthe impression of stability and good money management skills, even if suchproperty is not posted as collateral behind a loan

Last but not least, the most important thing to do is verify whether theborrower answers the loan officer’s questions truthfully A lender may look forinconsistencies as a sign the borrower is untruthful or, at best, forgetful

 The challenge of appraisal for personal credit:

Often, personal credit is not easy to evaluate For one thing, it is often easierfor individuals to conceal pertinent information bearing on the payout of a loan(such as their health or future employment prospects) than for most businesses(whose loan applications are frequently accompanied by audited financialstatements) Moreover, a business firm usually can more easily adjust to ill health,injury, or financial setbacks than can individuals Thus the default rate on consumerloans usually is several times higher than that for many types of business loans Thekey features of consumer loans that help lenders hold down potential losses are thatmost are small in denomination and often secured by marketable collateral

1.3 The quality of credit appraisal for individual customers in commercial banks

1.3.1 The concept of appraisal quality for individual customers in commercial banks

Credit appraisal in general and credit appraisal for individual customers inparticular have direct and decisive impact on value of loans and then contribute tothe development of credit activities and the whole operation of banks as well Thus,

enhancing the quality of credit appraisal is an urgent and regular duty for anycommercial banks and credit institutions.

The appraisal quality is often not easy to assess until the end of the loanduration when the payments come due It is even more for difficult in case ofpersonal credit where the information can be concealed and depend on thecreditworthiness of individuals A high quality appraisal should result in a goodloan in which borrower repays both principal and interest amount on time.Moreover, a quality credit appraisal should verify correctly the character ofborrower, the purpose of loan and make sure that bank still gets back its loanthrough marketable collateral even in case the borrower has not enough ability torepay the loan

Thus, the quality of credit appraisal represents the accuracy, integrity andflexibility in assessing the value of a credit High quality of credit appraisal willmitigate the risk of capital loss, ensure the reasonableness of loan making, boostprofit and enrich banks and the whole economy as well

1.3.2 Indicators reflecting the quality of credit appraisal for individual customers in commercial banks

1.3.2.1 Qualitative indicators

 Quality of individual credit provided

The quality of credit appraisal is firstly evaluated through the quality ofcredit itself One requirement for quality of personal loans is to ensure the existenceand development of the bank In other words, lending to individuals must providebank incomes to cover the costs involved, so then make profits and minimize risks

A loan can only be regarded as effective if the lending rules are adhered andcustomers use the loan properly and effectively and repay principal and interest ontime

 The actual purpose of the personal credit

The purpose of loans used in the contract signed by both bank and customer

is thorough assessment in terms of effectiveness, feasibility, legality and relevance

to economic policy the industry, local and nationwide Thus if the customer’s use ofloan is correctly matched with the purpose initiated in the loan agreement, it is one

of the conditions to ensure the achievement of credit appraisal Using borrowedcapital as committed with bank will create conditions for clients to achieveinvestment efficiency Consequently the customer can fulfill repayment obligations

to ensure the existence and development of the bank

 Consultancy resulting from appraisal process

The economy and volatile market with fierce competition requires banks todynamically conduct good appraisal for individual loans to meet growing demand

of both quality and quantity of customers

To achieve that, in addition to rapid response and timely capital providing,banks need to actually become friends who are willing to help and share difficultieswith customers For example, in a loan appraisal process if the purpose of personalloan is irrational, not feasible, instead of rejecting the loan application, banks maycomment, advise their clients to review appropriately Furthermore, banks are alsoable to provide useful information on markets and on scientific and technologicaladvances to customers Having done so, the new personal credit really plays itsroles of economic leverage for both banks and customers

 Bank’s prestige

The quality of credit appraisal for individual customers also depends on thebrand name of bank in the financial market A prestigious bank of course can attractmore customers, and vice versa if a bank has numerous clients and does business ingenuine, should that bank has high quality in appraising personal credit

 Appraisal time

Appraisal time is considered when evaluating whether a personal creditappraisal is good or not Time for appraising should be shortened to save costs, timeand especially not to miss a good investment opportunity for both bank andcustomer but still enough to ensure the quality of the credit.

 The health of the economy

More broadly, a requirement for individual credit appraisal activity of banks

is to contribute to the socio-economic development of industrial area, local andnationwide This is an inevitable result gained when both individual customers andbanks together achieve efficiency in their activities It is expressed in the financialstability of the national economy; it helps improve production capacity, solveunemployment problem, increase incomes and improve living standards of eachindividual in society However, evaluating this criterion should base on specificcircumstances in each period rather than a common assessment

To summary, qualitative indicators in assessing the quality of appraisal credit

for personal are very general and evaluated on the views of: banks, customers andthe economy However, they are the only overview basis for assessing the quality ofappraisal for consumer loans What about issues related to the economy is verydifficult to measure, so in fact we use qualitative criteria as above to consider

individual customers The higher the ratio is, the more concentrative the bankoperates in retail banking activities.

The second indicator reflects the size of credit for individuals relative to totalassets of banks; and allows an assessment of bank’s reasonableness in using assets.This ratio is high shows personal credit represents a large share in total bank assets.Normally banks prefer to distribute risks by diversifying their profitable assets thanfocus on a property with high profitability, but implicit a big risk

 Overdue debts rate

Overdue debts are those debts when payment deadline plus loans extended time (ifany) come due but the customer has not paid the debt In this case, the customer will

be subject to higher interest rate which is higher than the interest rate agreed in thecredit agreement However, not visible that banks eager to get this high interest inthese overdue debts

Overdue debts are one of the most important criteria in assessing the quality of bankcredit appraisal It reflects the risks that banks are facing In addition, to evaluate in-depth, overdue debts were usually divided into categories including: collectableoverdue debts, bad debts and uncollectible overdue debts Criteria to divide theoverdue debts normally are overdue time, the cause of overdue debts, prestige ofborrower, etc The indicators used to assess overdue debts include:

Indicator 3

Overdue-debts from individualsOutstanding credit for individualsIndicator 4

Bad debts from individualsOutstanding credit for individuals

Indicator 5

Uncollectible overdue debts from individuals

Outstanding credit for individualsThe indicator 3 reflects the general situation of bank’s overdue debts in totalcredit for individuals Clearly, banks are all keen to lower this rate down to itslowest level since the high level of this rate proves that banks are likely to facemany risks.

This indicator is only reflecting the general situation of overdue debts ofbanks but to evaluate more precisely we should use the next two indicators: thepercentage of bad debts for individuals and uncollectible overdue debts forindividuals over total outstanding credit for individuals Bad debts are less likely torecover but they are still better than uncollectable debts which mean capital loss Ifboth later indicators are low, whether the indicator number 3’s high or not is notsomething so bad for banks Conversely, if these two indicators are at high level,especially indicator reflecting proportion of uncollectible debts, that clearly meansthe bank's activities are likely to face risks Maybe it can not directly threaten theexistence and development of bank; it does prove for the low quality of creditappraisal for individual customers

 Profit from credits for individuals over profit from credit activities

Because banks are considered as financial intermediaries in the economy,acting as a lever to promote economic development, banks in the business processmust not only pay attention to economic efficiency but also pay attention to socialeffects However, most of the enterprises when conducting investment or businessactivities are directed to the most important goal: profit and commercial banks isalso not an exception Profit is a necessary factor to ensure the survival anddevelopment of banks so that it can not be ignored when assessing the quality ofcredit appraisal for individual customers The quality of this appraisal can not say to

be good if profit brought by credit activities for individuals is low Specifically, wemay use the following criteria:

Indicator 6

Profit from credit for individualsOutstanding credit for individualsIndicator 7

Profit from credit for individuals

Total profitThe indicator number 6 reflects the profitability of bank’s credits forindividuals It shows the profit provided by a contract for personal loans The higherthe rate is the more profitable credit for individual customers is So then, thisindicator is also used to assess the quality of personal credit appraisal

The seventh indicator says about the importance of personal lendingactivities relative to all activities of the bank This ratio is high means that most ofthe bank's profit is gained from personal lending However, this also shows thatbanks must accept to face the potential risk caused by retail banking activities.Therefore, banks are required to manage the personal credit activities in scientificand rigorous ways

1.3.3 Factors affecting the quality of credit appraisal for individual

customers in commercial banks

1.3.3.1 Subjective factors

a Information

For credit appraisal in general and credit appraisal for individual customers

in particular, information plays an important role in appraisal process as well as inevaluating the quality of an appraisal

The common way for banks to collect necessary information for a creditappraisal is through loan application with documents attached and throughinterview with borrower; it is the very first primary source of information for banks

to go to appraisal step Beside that banks also consider other secondary sources like

information of that client in Official Information Center and in credit institutionsthat client already has transactions

The concern for banks is not only how to obtain relevant information but alsohow to obtain accurate information which has the decisive value to the quality of acredit appraisal and a loan also Normally, information provided by borrower isfeasible and subjective in order to be favored by banks For corporate customers, thecredit application file includes financial statements that are already audited by anindependent auditing firm, so the accuracy of information can be relied Theappraisal for a personal loan application is even more challenging becauseinformation filled in is all subjective and quite hard to verify In this case, thetruthfulness of applicant is significant factor affecting the quality of the appraisal

In summary, a complete and accurate information system in local andnational level is vitally necessary not only for quality of credit appraisal and creditactivities but also for the development of the whole economy

b Credit officer

The quality of credit appraisal for individual customers partially depends onhuman factor The person who directly involves in appraisal process does occupy avery crucial role in the quality of appraisal is of course credit officer or also calledappraiser in specific What information to require, how to obtain it and what criteria

to use are entirely decided by credit officer And if the loan is under his decidinglimit, he can be the person who approves it As a result, to enhance the quality ofcredit appraisal for individual customers, first and foremost, bank should increasethe quality of its credit officer

The credit officer must possesses a broaden knowledge of not only bakingoperation but also related fields like tax, manufacturing, environment, technology,etc Technical, scientific, social and economic knowledge of a credit officer can bebuilt through both training and self-motivating; experience and skills are cultivatedthrough practical jobs and tasks

Moreover, the characteristics of a credit officer are essential to ensure thequality of credit appraisal in general and credit appraisal for personal loans inparticular To be more specific, features of the job often require integrity,independence and profession in a credit officer.

c Appraisal methodology

Appraisal methodology, which is stated clearly in bank’s credit policy andmay be owned by each experienced credit officer, has crucial effect on quality ofcredit appraisal for individual customers

Like corporate loan application and investment project loan application, eachpersonal one owns its unique characteristics, so then each should be treated in acustomized way Nonetheless, bank should develop and apply uniform criteria inappraising those personal credits, and on the other hand, choose the most efficientmethods and criteria for appraisal processing in each particular loan case

d Bank organizational governance

Credit appraisal for individual customer comprises of many related activitiesand its quality depends on the bank’s organizational governance, management andcoordination between units during the evaluation process Reasonableorganizational governance will help avoid overlaps, promote strengths and reduceweaknesses, and decrease costs and time of appraisal process

1.3.3.2 Objective factors

a The clients

Credit appraisal is processed based on information client has provided, so itsquality is resulted from an objective factor called the creditworthiness of clients.The more accurate information provided is, the more probably credit appraisal isassessed as high quality On the other hand, in case the information in personal loanapplication is not true for some reasons, the appraiser would have a pool ofdifficulties in doing his job, resulting wrong decisions and poor quality of creditappraisal

b Technology

Recently, banks employs more and more advanced technologies to apply intheir operations to improve economic efficiency and raise profit Not be exception,credit activities also recruit a modern science technology system especially in creditappraisal for both corporate customers and individual ones Technology helps creditofficer assess and handle a lot of information in seconds, thus save time and cost inappraisal process With official information center where holds credit information

of almost creditors and advanced software and appliance, technology does affectsignificantly on the quality of credit appraisal in general and credit appraisal forindividual customers in particular

c Government’s regulation

Government sets up regulatory agencies to control the whole banking system

on behalf of them The government’s regulations and these regulatory agencies’administration and policies directly impact banks’ operation and credit activities.Commonly, controlling credit activities is one method of the government to controlthe currency circulation and inflation rate of the national economy Additionally,quality of credit and credit appraisal has a lot influences on the macro economy;therefore government often pays attention on this area

CHAPTER 2: THE REALITY OF CREDIT APPRAISAL ACTIVITY FOR INDIVIDUAL CUSTOMERS IN VIETNAM INTERNATIONAL BANK – LIEU GIAI TRANSACTION

OFFICE 2.1 Overview of Vietnam International Bank – Lieu Giai

transaction office

2.1.1 Foundation and development history

a Vietnam International Bank (VIB)

 Foundation

International Joint Stock Commercial Bank of Vietnam, abbreviated asVietnam International Bank (VIB) was established according the decision number22/QD/NH5 of President of State bank of Vietnam dated January 25, 1996 Thebanking license was issued by the State Bank of Vietnam and was valid for 99 yearsfrom the date of the banking license

• Successfully implemented the Banking Technology Modernization Project

• The charter capital was increased to more than VND 1,000 billion

• Became an official member of the International Organization for Visa andMasterCard cards

• Established VIB Card Centre, and independently issue the local debit card,VIB Values