Solutions to improve credit risk management of vietnam bank for agriculture and rural development (AGRIBANK)

xi LIST OF ABBREVIATIONS ACB Asia Commercial Bank AGRIBANK Vietnam Bank for Agriculture and Rural Development ALCO Asset Liability Committee BIDV Bank for Investment and Development of

VIETNAM NATIONAL UNIVERSITY, HANOI

SCHOOL OF BUSINESS

HOANG NGOC LINH

SOLUTIONS TO IMPROVE CREDIT RISK MANAGEMENT

OF VIETNAM BANK FOR AGRICULTURE AND RURAL

vi

TABLE OF CONTENTS

ACKNOWLEDGEMENTS i

ABSTRACT ii

TÓM TẮT iv

TABLE OF CONTENTS vi

LIST OF ABBREVIATIONS xi

LIST OF TABLE xii

LIST OF FIGURES xiii

INTRODUCTION 1

1 Thesis necessity 1

2 Research Objectives 2

3 Research Scope 2

4 Data sources 2

5 Research Methods 2

6 Contributions of the research 2

7 Limitation 3

8 Structure of the thesis 3

CHAPTER 1 4

THEORETICAL FOUNDATION 4

1.1 Commercial banks 4

1.1.1 Main types of Risk in the bank operation 4

1.1.1.1 Liquidity risk 4

1.1.1.2 Credit risk 5

1.1.1.3 Interest rate risk 6

1.1.2 Other types of risk 6

1.2 Bank credit & Credit Risk 8

1.2.1 Bank credit 8

1.2.2 Classification of credits & credit risk 9

1.2.2.1 Classification of credits 9

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1.2.2.2 Classification of credit risks 11

1.2.3 Root causes of credit risk 12

1.2.3.1 External reasons 12

1.2.3.2 Risks due to borrowers 14

1.2.3.3 Risks due to the bank internally 14

1.2.4 Damages caused by credit risks 15

1.2.4.1 To the bank 15

1.2.4.2 To economy and society 16

1.3 Credit risk management 16

1.3.1 Concept 16

1.3.2 Identification of credit risks 16

1.3.3 Preventive and corrective measures against groups of risk signs 18

1.3.3.1 Preventive measures: 18

1.3.3.2 Corrective actions: 19

1.3.3.3 Measures on debt recovery 20

1.3.3.4 Measures against bank officers and relevant bodies: 21

1.4 Risk management from the viewpoint of Basel Committee and criteria for development of a modern risk management model 21

1.4.1 Basel I Banking regulations 21

1.4.2 Methods of credit risk approach as per Basel II 23

1.4.3 Criteria for development of a modern risk management model as per Basel Committee 24

1.4.4 Vietnam’s existing regulations on debt classification, provisioning and use of provisions for settlement of credit risks 26

CHAPTER 2 28

ANALYSIS Of AGRIBANK’S CREDIT RISK MANAGEMENT 28

2.1 Overview on Agribank and its loan system 28

2.1.1 Milestones 28

2.1.2 Organization structure 30

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2.1.3 Operation networks 30

2.2 Overview of Agribank’s business performance in period of 2005 - 2009 and in first 6 months of 2010 31

2.2.1 Business environment in period of 2005 - 2009 and in first 6 months of 2010 31

2.2.2 Business performance during 2005 - 2009 34

2.2.2.1 Total Assets 34

2.2.2.2 Treasury 36

2.2.2.3 Some indicators to assess financial performance 40

2.2.2.4 Trends of capital adequacy of AGRIBANK 42

2.2.2.5 Business results of 2010’s first half 44

2.3 Loan structure and quality during 2005-2009 46

2.3.1 Loan structure: 46

2.3.1.1 Loan structure by economic regions 46

2.3.1.2 Structure of lending by economic sectors in the years 2005-2009 47

2.3.1.3 Loan structure by terms: 47

2.3.1.4 Loan structure by currencies: 48

2.3.1.5 Loan structure by economic industries: 48

2.3.2 Credit quality 49

2.3.2.1 Credit quality by terms 49

2.3.2.2 Credit quality by economic regions 49

2.3.2.3 Credit quality by enterprise types 49

2.3.2.4 Credit quality by branches 49

2.3.3 Assessment on provision for impairment loss and methods to deal with bad debts 52

2.3.3.1 Provision for impairment loss 52

2.3.3.2 Methods to deal with bad debts 53

2.4 Status quo of credit risk management in Agribank 54

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2.4.1 Credit organization structure and risk management: 54

2.4.2 Credit processes 56

2.4.3 Regulations on customer classification as currently applied 58

2.4.4 Some shortcomings in credit risk management 59

2.4.4.1 Shortcomings in provisioning and risk processing: 60

2.4.4.2 Shortcomings in credit policies, customer policies and customer classification. 60

2.4.4.3 Shortcomings in credit procedures and credit risk management. 61 2.4.4.4 Shortcomings from Staff’s qualification and career ethics 62

2.4.4.5 Shortcomings by insufficient information management system 63

2.4.5 Main reasons caused credit risk in Agribank 64

2.4.5.1 External reasons 64

2.4.5.2 Reasons caused by borrowers 65

2.4.5.3 Internal reasons 66

CHAPTER 3 69

SOLUTIONS AND RECOMMENDATIONS TO IMPROVE AGRIBANK’S 69 CREDIT RISK MANAGEMENT 69

3.1 Agribank’s development goals and orientation in terms of credit activities and credit risk management towards 2015 and 2020 69

3.2 Measures to improve the efficiency and effectiveness of credit risk management in Agribank 71

3.2.1 Strengthening financial conditions 71

3.2.2 Complete credit operation and risk management structure 72

3.2.3 Complete credit procedures 77

3.2.4 Improve the quality of human resources 79

3.2.5 Customer classification and assessment procedures 82

3.2.6 Develop customer policies in credit activities: 84

3.2.7 Credit policies 85

3.2.7.1 Set out prudential ratios in credit activities: 85

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3.2.7.2 Expand loans secured by collaterals 85

3.2.7.3 Disperse credit risks 87

3.2.8 Book provisions to offset risks: 89

3.2.9 Invest in modern information technology 89

3.3 Policy recommendations to improve commercial bank’s credit risk management 91

3.3.1 To the Government 91

3.3.2 To State Bank 92

CONCLUSION 94

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LIST OF ABBREVIATIONS

ACB Asia Commercial Bank

AGRIBANK Vietnam Bank for Agriculture and Rural Development

ALCO Asset Liability Committee

BIDV Bank for Investment and Development of Viet Nam

CAR Capital Equity Ratio

CEO Chief Executive Officer

CIC Credit information center

CIs Commercial Institutions

DBS Development Bank of Singapore Limited

GDP Gross Domestic Product

IAS International Accounting Standards

IRB Internal Ratings - Based Approach

NPLs Non performing loans

OCBC Oversea Chinese Banking Corporation LTD

SBV State Bank of Viet Nam

UOB United Overseas Bank

VAS Viet nam Accounting Standard

VCB Bank for foreign trade of Vietnam

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LIST OF TABLE

Table 2.1: CBs’ total assets from 2007 to 2009 35

Table 2.2: Treasury growth rates over the years 36

Table 2.3: Agribank's structure of deposits in the years 2005-2009 38

Table 2.4: ROA, ROE & some indicators of Agribank in the years 2007-2009 41

Table 2.5: ROA, ROE of CBs in 2009 42

Table 2.6: Agribank’s capital adequacy ratio (CAR) is as follows: 43

Table 2.7: Loan structure by economic industries: 48

Table 2.8: Agribank’s loan classification in the year 2006-2009 period 50

Table 2.9: Ratios of NPLs of CBs in 2009 51

Table 2.10: Agribank’s provision for impairment loss 52

Table 2.11: Agribank’s Risk handling in the year 2007-2009 period 53

Table 2.12: Agribank’s debt recovery in the year 2005-2009 period 53

Table 3.1: Structure of capital in the year 2006-2009 period 71

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LIST OF FIGURE

Figure 2.1 GDP Growth over the year 2005-2009 (%) 31

Figure 2.2 Agribank’s total assets from 2005 to 2009 35

Figure 2.3 Deposits of some big credit institutions (billion VND) 37

Figure 2.4 Agribank's break-down of deposits in the year 2009 by economic sectors 39

Figure 2.5 Agribank’s deposits in terms of currencies from 2005 to 2009 (billion VND) 40

Figure 2.6 Agribank’s owner equity from 2006 to 2009 41

Figure 2.7 Agribank’s profit before tax from 2006 to 2009 41

Figure 2.8 CAR of some commercial banks in Vietnam & in the region 44

Figure 2.9 Credit growth through years (2005 – 2009) (billion VND) 46

Figure 2.10 Agribank’s loan structure by economic regions in the year 2009 46

Figure 2.11 Structure of lending by economic sectors (billion VND) 47

Figure 2.12 Agribank’s loan structure by terms in the years 2005-2009 47

Figure 2.13 Agribank’s Outstanding by currencies from 2005 to 2009 48

1

INTRODUCTION

1 Thesis necessity

60-70% of commercial banks’ profit comes from credit operations, or even up

to 90% elsewhere The credit monoculture is a vital issue in risk management of the banking industry Among existing risks, credit risk covers the biggest proportion in commercial banks, which account for up to 80% of fundamental risks and cause great impacts on banking operations Due to such impacts, risk management has become a focus and attracted special attention of the entire banking system

In addition, credit operations are now among the most severe competition with foundation of joint stock commercial banks Commercial banks have taken advantage of their advantages to have brand names and hold big market shares in the local financial market Despite being established later, joint stock commercial banks have affirmed themselves with state-of-the-art technology, powerful human resources and marketing strategies, etc, step by step obtaining a firm position in the absolutely potential market of Vietnam It is not to mention foreign banks operating

in Vietnam now

Regardless of developed or developing banks, under completion procedures or scope expansion, risk management, especially credit risks, plays a significant role while profits from credit activities, in practice, account for a large portion of total revenues Therefore, good risk management secures banking operations and prevents potential risks in the future

The financial environment is providing banks with a huge number of opportunities to enhance profits, as well as challenges of competition and risks Thus, risk management becomes one of the most efficient weapons of the industry The credit operations of Agribank over the last period also indicate that credit risk management of the whole system has not been controlled efficiently and risks are in a more and more increasing trend Consequently, it is now an urgent requirement that credit risks must be controlled and monitored methodologically and efficiently, ensuring credit activities to be under an acceptable risk scale,

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assisting better and more effective distributions of capital in credit operations, minimizing any damages caused by credit risks, increasing profitability for the bank’s business results, contributing to the improvement of the bank’s reputation and competitive advantages

2 Research Objectives

The main objectives of the thesis are to

- Clarify and contribute to the debate over credit risk management

- Analyze the situation of credit activities and credit quality, point out reasons for risks and methods of credit risk management in Agribank

- Based on the discussion and practical analysis of credit risks, propose several measures on credit risk management in Agribank

3 Research Scope

To study from the theory to practices of reasons for credit risks, situation of credit risk management so far in Agribank, accordingly recommend measures on credit risk management

4 Data sources

The main sources of secondary data are books, newspapers, internal and external reports (annual reports, financial statements, official releases of Agribank and other banks) and internet The primary data was gathered from direct interviews and discussion with officials and managers of Agribank

5 Research Methods

I apply the method of relative and absolute comparison, statistical analysis method, interview some key managers

6 Contributions of the research

In terms of theory: Clarify definitions and analytical framework related to bank credit activities, credit granting; credit risks, risk management

In terms of practice: Through research on lending activities and credit risk management in Agribank, reflect the practices of such two contents Accordingly, reasons for arising of credit risks are to be stated

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Upon the theory and practices of the research, recommend how to cope with stated issues, what are feasible solutions to achieve the best research efficiency, contributing to improve credit quality and risk management of Agribank

7 Limitation

The thesis focuses on clarification of credit risks and credit risk management

in Agribank and identification of key reasons for credit risks and corrective actions However, due to the limited time and capability, the thesis does not detail the analysis and comparisons of credit targets or credit risk management models of other fellow banks

The financial and economic situation changes hour by hour, and along with that are also the fast changes of credit policies and credit risk management policies The thesis bases much on statistics of previous periods, so the assessment may not

be updated

8 Structure of the thesis

The thesis is presented into three chapters, not including the introduction part , the conclusion part and reference part

Chapter 1 Theoretical foundation

Chapter 2 Analysis of Agribank’s credit risk management

Chapter 3 Solutions and recommendations to improve credit risk management

of Agribank are also suggested in this chapter

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CHAPTER 1 THEORETICAL FOUNDATION 1.1 Commercial banks

According to Credit Risk Management Book is published by Oxford

University, a commercial bank is a financial intermediary which collects credit

from lenders in the form of deposits and lends in the form of loans

Commercial bank: An organization trading in currency major in and

frequently to receive deposit from the customers with the responsibility to refund and use that money to loan, carry out discount operation and make payment means

(Source: Vietnam’s Banking Ordinance dated 23, May 1990)

1.1.1 Main types of Risk in the bank operation

A bank has many risks that must be managed carefully, especially since a bank uses a large amount of leverage Without effective management of its risks,

it could very easily become insolvent If a bank is perceived to be in a financially weak position, depositors will withdraw their funds, other banks won't lend to it nor will the bank be able to sell debt securities in the financial markets, which will exacerbate the bank's financial condition even more The fear of bank failure was one of the major causes of the 2007 – 2009 credit crisis and of other financial panics in the past

Although banks share many of the same risks as other businesses, the major risks that especially affect banks are liquidity risk, credit default risks and interest rate risks

1.1.1.1 Liquidity risk

Liquidity risk is considered a major risk It is often defined in different ways: extreme illiquidity, the safety cushion provided by the portfolio of liquid assets, or the ability to raise funds at a “normal” cost

The main problem in liquidity management for a bank is that, while bills are mostly predictable, both in timing and amount, customer demands for funds are highly unpredictable, especially demand deposits (checking accounts)

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Finally, liquidity risk also means having difficulties in raising funds Liquidity risk relates then to the ability to raise money at a reasonable cost Such ability is actually the outcome of two types of factors: the market liquidity which varies over time, and the liquidity of the bank Both interact to determine the conditions of funding

Liquidity risk is a normal outcome of standard transactions These generate a maturity gap between assets and liabilities Often, the bank collects short term sources and lends long term Given this gap between maturities, there exists always

a liquidity risk and a cost of liquidity The cost of liquidity can be defined as any cost generated by locking in liquidity for the horizon of the loan

1.1.1.2 Credit risk

Credit risks play an extremely important role in potential losses Credit risks may refer to losses arising from the customer who fails to fully repay the principal and interest of the loan or does not comply with due repayment of principal and interest after the credit extension (both on and off-balance sheets)

Pursuant to Clause 01 Article 02 of the Regulations on classification of debts, provisioning and use of provisions for settlement of credit risks in banking operations of credit institutions (issued under Decision No 493/2005/QĐ-NHNN dated April 22nd 2005 by the Governor of the SBV), “Credit risks in the banking activities of credit institutions are potential losses that may arise in the banking activities of the credit institutions due to the failure of their customers to perform or their not being able to perform their obligations in accordance with their commitments.”

It can be accordingly said that credit risks may arise in relationships in which the bank is the creditor and the debtor fails or is unable to perform their repayment obligations at maturity, which may be referred as risk of repayment incapability and late repayment, those related to the quality of the bank’s credit activities

Credit risks are not only limited to lending activities but also include other credit-natured operations such as guarantees, commitment to payment, trade

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finance acceptance, inter-bank lending, valuable securities (bonds, stocks, etc), claims, Swaps, hire/purchase credit, club deals, etc

1.1.1.3 Interest rate risk

A bank's main source of profit is converting the liabilities of deposits and borrowings into assets of loans and securities It profits by paying a lower interest

on its liabilities than it earns on its assets - the difference in these rates is the net interest margin

However, the terms of its liabilities are usually shorter than the terms of its assets In other words, the interest rate paid on deposits and short-term borrowings are sensitive to short-term rates, while the interest rate earned on long-term liabilities is fixed This creates interest rate risk, which, in the case of banks, is the risk that interest rates will rise, causing the bank to pay more for its liabilities, and, thus, reducing its profits

All short-term and floating-rate assets and liabilities are interest-rate sensitive-the interest received on assets and paid on liabilities changes with market rates Long-term and fixed-rate assets and liabilities are not interest-rate sensitive Interest-rate sensitive assets include savings deposits and interest-paying checking accounts Long-term CDs are not interest-rate sensitive

So for a bank to determine its overall risk to changing interest rates, it must determine how its income will change when interest rates change Gap analysis and duration analysis are 2 common tools for measuring the interest rate risk of bank portfolios

1.1.2 Other types of risk

 Foreign Exchange Risk

International banks trade large amounts of currencies, which introduces foreign exchange risk, when the value of a currency falls with respect to another A bank may hold assets denominated in a foreign currency while holding liabilities in their own currency If the exchange rate of the foreign currency falls, then both the

in an attempt to conserve the more valuable currency when the native currency is declining in value

 Political Risk

Political risk represents the financial risk that a country's government will suddenly change its policies This is a major reason why developing countries lack foreign investment

 Market Risk

This is the most familiar of all risks Also referred to as volatility, market risk

is the day-to-day fluctuations in a stock's price Market risk applies mainly to stocks and options As a whole, stocks tend to perform well during a bull market and poorly during a bear market - volatility is not so much a cause but an effect of certain market forces Volatility is a measure of risk because it refers to the behavior, or "temperament", of your investment rather than the reason for this behavior Because market movement is the reason why people can make money from stocks, volatility is essential for returns, and the more unstable the investment the more chance there is that it will experience a dramatic change in either direction

 Systematic risk

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It occurs due to some external factors such as direct competition, govt policies, inflation, interest-rate, change in legal structure & tax etc This type of risk cannot be reduced & predicted It affects the entire market This is also known as uncontrollable or undiversified risk

 Unsystematic Risk

Unsystematic risk is sometimes referred to as "specific risk" This kind of risk affects a very small number of assets An example is news that affects a specific stock such as a sudden strike by employees Diversification is the only way to protect yourself from unsystematic risk

1.2 Bank credit & Credit Risk

1.2.1 Bank credit

- Credit: According to the Decision No.1627/2001/QĐ-NHNN dated

December 31st 2001 by the Governor of the State Bank of Vietnam, credit means an asset transaction (money or goods) between the lender (banks and other financial institutions) and the borrower (individuals, enterprises and other entities), in which the lender gives the borrower right to use the asset in a certain period of time as agreed by both parties, and the borrower undertakes to unconditionally repaying both principal and interest to the lender at maturity

- Lending: Pursuant to Clause 01 Article 03 Regulations on lending to

customers by credit institutions (issued under Decision No.1627/2001/QĐ-NHNN dated December 31st 2001 by the Governor of the State Bank of Vietnam (SBV)),

“Lending means a form of extension of credit whereby a credit institution provides

a client with an amount of money to be used for a certain purpose and within a fixed period of time as agreed on the basis of the principle of repayment of both principal and interest.”

- Credit activities: Pursuant to Article 20 of the Laws on credit institutions

No.07/1997/QHX passed by the X Legislature of the National Assembly of Socialist Republic of Vietnam in its second session on December 12th 1997 and effective as of October 01st 1998, “Credit activities mean the use of equity and

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funds mobilized by credit institutions to grant credits”

- Extension of credit: Pursuant to Article 49 of the aforesaid laws on

“extension of credit”, Credit institutions shall be entitled to extend credit to organizations and individuals in form of loans, discounting commercial and other valuable papers, issuing guarantees, finance leasing and others as permitted by the SBV

1.2.2 Classification of credits & credit risk

Next, in order to be more aware of banking credits and credit risks, we further more specify the classification of credits

1.2.2.1 Classification of credits

Classification of credits means the arrangement of loans upon certain categories The classification of credits indicate a scientific base as a premise to set out appropriate lending processes and enhance the efficiency of credit risk management Credits are classified by the following categories:

 Purposes:

+ Loans for production and trading

+ Loans for personal consumption

+ Loans for real estate trading

+ Loans for agricultural production

+ Loans for import and export trading, etc

 Lending types:

Credit institutions consider granting loans to customers in the following modes:

+ Short-term: loans with tenor of up to 12 months

+ Medium-term: loans with tenor of between over 12 and 60 months

+ Long-term: loans with tenor of more than 60 months

 Level of trustfulness towards customers:

+ Fiduciary loans: mean lending without collaterals mortgaged or pledged by customers, or guarantees by others but approval is fully based on the customers’

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reputation

+ Secured loans: mean lending basing on collaterals such as mortgage, pledge,

or guarantees by the third party

 Lending methods:

+ Separate lending: On each occasion that a loan is granted, the client and the credit institution shall carry out the necessary procedures and enter into a credit contract

+ Credit line: The credit institution and the client shall determine and agree on

a credit facility to be maintained for a fixed period of time

+ Investment project financing: The credit institution shall provide a loan for

a client to implement an investment project for development of production, business and services or an investment project for servicing living conditions

+ Syndicated lending: A group of credit institutions shall provide a loan for the loan project or loan plan of a client, whereby one credit institution acts as the focal institution for making arrangements and coordinating with the other credit institutions Syndicated lending shall be carried out in accordance with these Regulations and with the regulations on co-financing by credit institutions issued

by the Governor of the SBV

+ Lending on installment repayment: When providing the loan, the credit institution and the client shall determine and agree on the amount of loan interest to

be paid in addition to the amount of principal which shall be divided into repayment terms during the loan tenor

+ Lending pursuant to a reserve credit line: The credit institution shall undertake to make loans available to a client within the limit of a fixed credit line The credit institution and the client shall agree on the period of validity of the reserve credit facility and the fees payable for the reserve credit facility

+ Lending via issuance and use of credit cards: The credit institution shall approve the use by a client of a loan amount within the limit of a credit facility to pay for purchasing goods and services or to withdraw cash at automated teller

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machines or at the cash advance agencies of the credit institution For lending via issuance and use of credit cards, credit institutions and clients must comply with the regulations of the Government and of the SBV on issuance and use of credit cards + Lending by overdraft limit: The credit institution shall agree in writing with the client on making payments in excess of the account balance of the client, consistent with the regulations of the Government and of the SBV on payment operations by credit institutions providing payment services

Along with the above mentioned lending methods, banks also perform their guarantee operations upon their own reputation

(Source: Decision No.666/QĐ-HĐQT-TD dated June 15 th

2010 of Vietnam Bank for Agriculture and Rural Development)

1.2.2.2 Classification of credit risks

Upon root causes of risks, credit risks may be divided into the following types:

 Transaction risk: is a kind of credit risks resulting from shortcomings in

the duration of transactions, loan approval and customer assessment Transaction risks consist of three main components being selection risks, security risks and operational risks

+ Selection risks are those related to the credit assessment and analysis processes when a bank selects profitable loan schemes to approve credit granting + Security risks arise from security standards such as terms and conditions in credit contracts, types of collaterals, security entities, security modes and lending amounts with higher values than those of collaterals

+ Operational risks are those related to the management of loans and lending activities, including the use of risk rating and techniques of processing problematic debts

 Portfolio risk: is a kind of credit risks resulting from shortcomings in

management of the bank’s credit portfolio, divided into intrinsic risk and concentration risk

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+ Intrinsic risk: originates from distinctive features and factors inside the borrower or the economic industry and sector It comes from the features of the borrower’s operations and loan use

+ Concentration risk may occur when the bank centralizes its lending to some key clients, to a lot of enterprises operating in the same economic industry or sector; or in a certain geographic region; or on the highly risky lending type

1.2.3 Root causes of credit risk

1.2.3.1 External reasons

 Fast and unpredictable changes of the world market:

Vietnam’s economy still much relies on agricultural production and industry for agriculture (aquaculture, food processing and materials), crude oil, garment, etc which are naturally sensitive to the weather and the world’s prices So it is at ease

of encountering impacts in the event of the world market’s bad turbulences

 Inevitable risks of the financial libertization and international integration process:

The process of financial liberalization and international integration may result

in an increase of bad debts because, in the context of a severely competitive environment, most of banks’ customers face the risks of loss and the harsh selection rules of the market Besides, competition itself among both local and foreign commercial banks in the economic integration environment also pushes local banks with weak governance systems to be in danger of increasing bad debts as most customers with powerful financial capability will be attracted by foreign banks

 Surplus investment in some industries led by shortage of reasonable investment planning and distribution:

Market economy inevitably brings about competition In our country over the recent time, competition has, however, spontaneously risen under the helpless of associations’ roles and macro-control of the State, absolutely unassociated with rational planning, labor cooperation, allocation and specialization This leads to an excessive increase of investment in some industries, causing a crisis of excess and a

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waste of national resources

 Inefficiency of local legal agencies:

Over recent years, the National Assembly, Standing Committee of the National Assembly, the State Bank and relevant agencies have issued a variety of laws related to banking credit activities Despite the availability of laws and legal documents, the implementation in banking operations is still slow and suffers from various shortcomings such as documents regarding judicial debt recovery

 Inefficiency of the State Bank’s inspection and monitoring:

Besides the achieved efforts and results, banking inspection and system security have not gained qualitatively fundamental improvement Inspectors’ capability has not fitted with requirements; some inspectors even have not kept pace with state-of-the-art business operations and technology Inspection contents and methods are still old-fashioned and slow to innovation The role of auditing has not been promoted and the information system has not been efficiently organized On-site inspection is still the main method; ability of monitoring entirely operations

of the monetary market and risks is weak Bank inspectors work passively by mainly coping with already arisen issues but are less likely to stop and prevent risks and violations There are still a number of shortcomings in the organization structure of bank inspectors Thus, mistakes of commercial banks are not warned

by the State Bank’s inspectors for preventive actions from the beginning but intervention comes only after severe damages have been recognized

 Inadequate information management system:

The State Bank’s Credit Information Center (CIC) has been operating for more than a decade and has achieved encouraging initial results in timely supply of information about credit activities But this is not yet an agency to assess the creditability of enterprises independently and efficiently Information provided by the center is still simple and out of date, which has not fully met banks’ needs of information search

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1.2.3.2 Risks due to borrowers

 Wrong use of loan, unwillingness in repayment:

Most customers applying for loans with banks have specific and feasible business plans There are just a small number of enterprises using loans wrongly and intentionally defrauding banks to appropriate assets However, arisen incidents are too serious and cause bad impacts on reputation of bankers and other customers

as well

 Weak business management ability:

When applying for loans with banks for expansion of business scope, the majority of customers focus the investment on physical assets Hardly do any enterprises bravely renew their management manner by investing in systems of management, finance, accounting as per standards The much faster and wider expanding scope than the managing thought is a reason for bankruptcy of excellently feasible business plans which should have been a success in practice

 Weak and opaque financial situations:

A small scale of assets and treasury is a common characteristic of most borrowers in Vietnam In addition, the habit of fully, clearly and accurately recording accounting books has not been closely and trustfully complied with by customers Thus, accounting books provided by customers seem to be of display purposes only Financial analysis prepared by bank officers upon such given statistics is therefore impractical and unauthentic This explains why banks rely more on collaterals as the final basis to avoid credit risks

1.2.3.3 Risks due to the bank internally

 Staff in shortage of career ethics and professional qualifications:

Some remarkable economic cases recently related to commercial banks all existed the abetment of some bankers, together with customers, to counterfeit loan applications, or raise collateral values and pledge rates to appropriate the bank’s money

 Lack of post-disbursement monitoring and management:

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Banks tend to focus more of their efforts on pre-granting assessment and loosen the processes of post-disbursement inspection and monitoring Once granted, a loan must be actively monitored and controlled to ensure the possibility

of repayment Loan follow-up is one of the most important responsibilities of credit officers in particular and the bank in general However, this has not yet been well conducted so far, which is partially due to bankers’ fear to make customers annoyed Another reason is because of the customers’ old-fashioned information management system, so information required by commercial banks is not timely and sufficiently provided

 Cursory cooperation among commercial banks and inefficiency of CIC’s roles:

Banking business is a special job in which deposits are used to grant to customers as loans, or in other words, borrowing is used for lending Thus, risks in credit activities are unavoidable Banks should closely collaborate with each other

to eliminate any possible risks Such collaboration is much required for risk management when one customer applies for loans with different banks

1.2.4 Damages caused by credit risks

1.2.4.1 To the bank

In case of arising credit risks, the bank may not collect the granted amount and interest thereof, while deposits must be still refunded plus interest thereof at maturity This leads to the imbalance of revenues and expenditures, reduces the credit capital return, resulting in less profitability and higher expenses than expected

In case of any irrecoverability of a loan, the bank shall have to use its equity

to depositors, and to a certain extent, the bank shall not have enough fund to pay depositors back and be pushed into the state of insolvency, which may result in liquidity risks Consequently, business scope is narrowed; financial power is declined; reputation and competitiveness are reduced in not only the local market but foreign countries as well; the bank’s business results are worse and worse,

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resulting in losses or bankruptcy if no timely corrective measures are triggered

1.2.4.2 To economy and society

By nature, a bank functions as an intermediary financial organization who specializes in mobilizing unemployed funds in the economy to finance needy organizations, enterprises and individuals Accordingly, loans are under ownership

of depositors of the bank Thus, in case of any arising credit risks, damages are born to not only the bank but depositors as well When a bank suffers from serious credit risks or goes bankrupt, depositors of other banks will also panic and rush to those banks for withdrawals, causing harshness to the entire banking system Banks’ bankruptcy will also affect the production and trading of enterprises No wages to be paid by enterprises make workers’ lives hard Moreover, banks’ turbulences give severe influences on the whole economy, resulting in the economic recession, price increases, low consumption, high unemployment, and instable society

In addition, credit risks also affect the world economy as the economy of each country now depends on the regional and world economy

* To sum up, a bank’s credit risks occur at different levels: As the lightest, the bank’s profitability is decreased due to uncollectibility of loan interest As the heaviest, there will be irrecoverability of principal and interest at a high rate, resulting in losses If the situation lasts a long period of time, the bank will go bankrupt, causing serious consequences to the economy in general and the banking system in particular Therefore, it is necessary that bank managers should be very careful and set out reasonable measures to mitigate credit risks

1.3 Credit risk management

1.3.1 Concept

Credit risk management is the process that banks impact credit activities via management systems and tools to prevent, warn and set out measures to optimally avoid failures in full recovery of a loan principal and interest or late repayments

1.3.2 Identification of credit risks

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Business hardly fails after one single night, so failure is normally implied by some warning signs Some signs are very blurred while others are clearly shown Banks should be able to recognize initial signs of problematic loans and apply necessary actions to prevent or deal with such loans But it should be noted that: signs are sometimes identified through a process but not a single point of time Hence, credit officers should know to identify them systematically Signs of a bad credit are summarized as follows:

1 Abnormal and unreasonable delays in providing financial statements and repaying according to the schedule as agreed; or delays in contacts with credit officers

2 For corporate credits, any abnormal changes in depreciation, compensation and benefit plans, inventory values, collaterals and income

3 For corporate credits, any debt restructuring or restraints of dividend allocation, or changes in creditability ratings

4 Delays or raising difficulties for banks in regular/ extraordinary inspections

of loan use, financial situation, business operations without any transparent and convincing explanation

5 Net income decreased in one or a number of years, especially indicators of return on assets (ROA), return on equity (ROE), earnings before interest and taxes (EBIT)

6 Unfavorable changes in capital structure (equity on outstanding), liquidity (current ratio), or performance level (e.g return on inventories)

7 Gaps of revenue or cash flows in comparison with plans on which credit was granted

8 Sudden, unexpected and unreasonable changes in deposit balance of the customer’s account with the bank

9 Frequent proposals for credit restructuring and extension

10 Identified with history of loan reverses (principal to be partially reduced upon receipt of a new loan)

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11 Frequently increasing loan demands, loan demands higher than expected

12 Abnormal increase of receivables and inventories, equity increase based

15 Accept expensive loans on all conditions

(Sources: FDIC, Bank Examination Policies, Washington, D.C., selected year)

1.3.3 Preventive and corrective measures against groups of risk signs

1.3.3.1 Preventive measures:

When a customer’s business suffers from any signs of risks due to any reasons, in order to prevent risks to occur, the bank must firstly conduct every compulsory inspection and monitoring In principle, all loans with signs of risks must be downgraded and put into the status of special monitoring

In the event of any downgraded loans, the bank must consider and choose preventive actions:

+ Monitoring the loan

Monitor the loan and collect the most updated financial statements of the customer as well as information about financial situation and other necessary information to monitor the loan closely to check whether the borrower has any signs

of improvement If the situation is found disadvantageous, the bank must require customers to provide financial statements more regularly and check those reports specifically; even if signs of disadvantages are not clear enough, study and analysis must be still implemented

On clarifying the disadvantageous trend of the customers’ business operations, the bank must immediately determine its strictness, reasons for such instability must

be considered and assessed whether it was temporary or due to weak finance; due to

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the market or weaknesses of management work

+ Review and re-evaluate collaterals

In case a loan is downgraded, the bank must review and re-evaluate collaterals Re-evaluation of collaterals should be practical and prudential to assess how to process them in a normal business situation and also in an abnormal business situation

+ Complete legal documentation:

The bank should review all legal documents of the loan to supplement any missing documents in case of any insufficiency

1.3.3.2 Corrective actions:

When loans are downgraded to group 4 or 5, the following measures should

be applied:

+ Require additional collaterals

As soon as a loan is identified to be problematic, the bank must apply any measures to have more collaterals; financial statements and other information must

be checked carefully to define what kinds of collaterals may be added It is important to determine whether collaterals may be sold or transferred to cash without any serious impacts on the business operation of the debtor

+ Define restructuring plans

This method is applicable to customers whose credit relations are approved to

be maintained Once restructuring has been conducted as the bank wishes to maintain credit relations, the loan must be closely monitored This measure should

be applicable only when the borrower manages to prove his repayment capability of both principal and interest at rescheduled maturity The bank should analyze ro make decisions in the orientation of restructuring or extension Restructuring by the bank should be approved only when the following issues have been considered:

a) Capable of repayment from ordinary cash flows;

b) Capable of repayment by sales of assets or future revenues

In all cases of restructuring, the borrower must fully submit applications for

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restructuring to the bank, including:

Restructuring request, including proposed tenor and amounts of principal and interest to be repaid;

Repayment plan and measures:

Estimation of income, profit and cash flows for repayment as rescheduled; Detail reports on liabilities and assets of the borrower, including the market prices of each asset; names and addresses of creditors; amount of each debt and equivalent collateral;

Mortgaged assets are required to be used as collaterals or supplementary collaterals to secure the repayment

The restructured loan must be kept in the list of bad debts until it is repaid as prescribed In case the minimum repayment is performed, this loan shall be reviewed and equivalently upgraded

+ Recover debts

After reviewing and concluding that the loan is unrecoverable, the bank shall apply measures of debt recovery to reach the following goals:

Recover the debt as much as possible

Minimize costs during debt recovery; diminish reactions from customers;

1.3.3.3 Measures on debt recovery

When the loan is downgraded to the highly risky level, the bank may apply the following actions:

+ Sales of collaterals: the bank should convince the customer to sell their assets voluntarily In case of unwillingness from the customer, the bank may put collaterals into auctions under the supervision and approval of legal agencies

+ Repayment performed by the third party: Require the guarantors to repay instead of the borrower

+ Prosecution: In case of compulsory prosecution, the bank must complete all legal procedures to prosecute the customer

+ Debt trading: sales of the whole company or part of the company One of the

+ Provisioning: In principle, this measure should be only applied for bad debts, i.e it is impossible to recover the debt after application of all corrective actions, or for debts whose collaterals have been sold out encountering with a minus gap (both principal and interest included); or for irrecoverable debts caused by force majeures

Provisions are used to offset credit risks and purify the bank’s finance, but not entirely cancel customers’ debts All the debts processed by provisioning shall be booked in off-balance sheets After being provisioned, such loans shall be monitored to be recovered off Corrective actions are still used for recovery;

Currently, in terms of risk processing, banks must comply with Decision 493 and Decision 18 issued by the Governor of the State Bank providing regulations on debt classification, provisioning and use of provisions in banking operations of credit institutions

1.3.3.4 Measures against bank officers and relevant bodies:

Besides all the corrective actions as above mentioned, upon the risk level and mistake of each officer, the bank may choose a suitable method for settlement (pursuant to regulations on organization and human resources of the bank):

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 Credit granting criteria and credit monitoring process (Standard 7):

A crucial part of the inspection system is to assess policies, practices and procedures related to credit granting, implementation and management of investment and current portfolio

Credit and investment functions of banks are objective based on healthy principles It is necessary for the management of the bank’s lending functions to maintain prudential lending policies, purposes and procedures in compliance with reasonable lending documents The bank should have a process to monitor the existing credit relations of customers Database is an important factor for the information management system, in which credit portfolio is specified

 Asset quality assessment and provisions for debt loss (Standard 8):

Bank inspectors should be all aware that the bank establishes and maintains policies, habits and procedures appropriate with asset quality assessment and provisions

The bank should develop a process to identify problematic debts and filter past-dues

In implementation of guarantees or receipt of mortgages, the bank must assess reputation of the guarantor and evaluate the mortgaged asset

In the events of problematic debts, the bank promotes its lending activities on the basis of credit granting and overall financial strengths

 Risk centralization and huge risks (Standard 9):

The bank must develop a management information system, which allows determination of notable points in the investment portfolio and set up prudential ratios to restrain a trend that the bank centralizes on particular customers or a group

of customers

 Relationship lending (Standard 10):

To prevent the abuse that may arise from relationship lending, credit relations should be based on the principle of “under control”, so that credit expansion can be assessed effectively for risk control and mitigation Relationship lending often

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results in special risks to the bank, so it should be approved by Board of Directors

1.4.2 Methods of credit risk approach as per Basel II

There are two approach methods for calculation of bank credit risks:

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

The second method: the bank uses its own internal ratings-based system (IRB)

 The Standardized Approach (SA):

The standardized approach means that banks classify credit risks based on observable features of risks (such as risks from a company loan or from a loan secured by collateral being a house) The standardized approach classifies fixed ratings for each type of risks supervised and bases on external assessments to enhance the sensitivity of risks The standardized approach provides inspectors and supervisors with guidelines to decide whether external assessments are appropriate

to apply in banks or not An important change of this approach is that loans are classified as past-dues if their credit rating is 150%, except when provision has been booked for such loans

When banks expand their credit derivatives such as mortgage, guarantee, Basel II considers such tools as factors to mitigate credit risks The standardized approach widens the scope of eligible collaterals beyond the nation’s issues and simultaneously introduces several methods to assess the level of capital decrease upon market risks of collaterals

The standardized approach also consists of specific handling with retail risks Ratings of risks in loans mortgaged with houses will be reduced together with other risks of loans to non-rated firms Besides, some loans to small and medium-sized enterprises may be processed as retail risks in case of meeting certain criteria

To help banks and supervisors in case there are not many options, Basel Committee developed “the simple standardized approach” consisting of the simplest options to calculate risk-weighted assets Banks applying the simple standardized

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approach should comply with requirements of market inspection, monitoring and discipline equivalent to the new Basel agreement

 The Internal Ratings-Based Approach (IRB):

Banks must have independent credit risk supervision units specializing in designing and implementing their own internal rating systems Such units are independent in terms of functions from management units who are responsible for creating potential risks Aspects of supervision include:

- Check and follow up the internal ratings;

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

- Implement processes to inspect whether rating definitions are uniformly used by Departments, Boards and regions or not;

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

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

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

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

Basel Committee says: Weaknesses in the banking system of a country, whether developed or developing, threaten the stability of both its finance and internal affairs Therefore, Basel Committee pays much attention to strengthening the power of the financial system Basel Committee has issued principles on

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management of defaults which are by nature principles on credit risk management, ensuring the efficiency and safety in credit granting Such principles focus on the following contents:

 Develop an appropriate credit environment: Accordingly, Basel

Committee requires Board of Directors to regularly approve credit risk policies, assess credit risks and build up a thorough strategy in the bank’s operations (bad debt rate, risk acceptance level, etc) Upon such basis, Board of Management undertakes to implement such directions and develop policies and procedures to identify, measure, monitor and control bad debts in all operations at the level of each loan and the whole financing portfolio Banks need to determine and manage credit risks in every product and activity Especially, new products must be approved by Board of Directors or Committees under control of Board of Directors

 Healthily grant credits: Banks need to clearly define criteria for healthy

credit granting (target markets, eligible customers, terms and conditions of credit granting, etc) Banks should build up credit lines for each type and group of borrowers to identify different types of credit risks, which can be compared and followed up upon internal ratings of customers in various aspects and sectors Banks should issue clear processes of credit granting, credit adjustments with participation

of marketing division, credit analysis division and credit approval division, as well

as definite responsibilities of participants Simultaneously, banks should develop a team of experienced and knowledgeable risk management staff to deliver prudential decisions on assessment, approval and management of credit risks Credit granting should be conducted upon fair transactions among parties Especially, there should

be prudential and reasonable assessments on relationship customers

 Maintain a suitable credit follow-up, monitoring and management process:

Banks should be equipped with up-to-date management system towards the investment portfolio with potential risks, including updating credit files, collecting current financial information, document drafts such as credit contracts, etc upon the banks’ scope and level of complexity At the same time, the system should be able

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to grasp and control customers’ financial situation, commitment compliance, etc to timely identify problematic debts Banks should have a system to timely cope with bad and problematic debts Credit risk policies should clarify methods of managing problematic credits Responsibilities towards such credits may be assigned to the marketing division or debt recovery division or the combination of such divisions, depending on the scope and nature of each loan In addition, Basel Committee encourages banks to develop and build up an internal rating system for risk management, enabling to distinguish levels of credit risks for potentially risk-weighted assets of the bank

To sum up, in developing the credit risk management model, Basel principles include the following remarkable contents:

- Clarify the credit granting system by divisions of marketing, credit analysis and credit approval as well as clear responsibilities of participants thereof

- Improve the capabilities of risk management staff

- Develop an efficient information management and update system to maintain

a reasonable credit monitoring and measuring process, meeting the requirements of credit assessment and risk management

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

After more than four years of implementing Decision NHNN5 dated November 27th 2000, the regulations turned out to have some shortcomings and did not comply with the international standard In 2005, the SBV issued regulations on debt classification, provisioning and use of provisions for settlement of credit risks in banking operations of credit institutions as per Decision

No.488/2000/QĐ-No 493/2005/QĐ-NHNN dated April 22nd

2005 Two years later, in order to further more fit with the international standards, the SBV issued Decision No 18/2007/QĐ-NHNN dated April 25th 2007 on supplementing and amending a number of articles of Decision No 493

Debt classification by the quantitative method:

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Group 1

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

timely recoverable both principal and overdue interest

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

is first time restructured

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

first time restructured; debts that are waived or reduced for interest

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

Group 5 Debts that are overdue for more than 360 days

Debt classification by the qualitative method:

Group 1 Debts with timely recoverable principal and interest

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

clients’ decrease in repayment capability

Group 3 Debts incapable of timely recoverable principal and interest with

possibility of partial loss

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

Group 5 Debts assessed by credit institutions as irrecoverable

Provisioning ratios applicable to debt groups:

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CHAPTER 2 ANALYSIS OF AGRIBANK’S CREDIT RISK MANAGEMENT 2.1 Overview on Agribank and its loan system

2.1.1 Milestones

On March 26, 1988, the Council of Ministers (currently the Government) promulgated Decree No.53/HDBT to establish specialized banks including Vietnam Bank for Agricultural Development In this period, Credit activities were mainly subsidized, most of the loans were directed to the state – owned and collective sectors However, the bank started shifting its activities towards an independent commercial bank Its focus on lending to the food industry in the Mekong River Delta; granting loans directly to farming households piloted in An Giang, Vinh Phu,

Ha Son Binh branches

On Nov 14th 1990, the Chairman of the Council of Ministers (now the Government) signed the Decision N0 400/CT on the establishment of Vietnam Bank for Agriculture replacing Vietnam Bank for Agricultural Development It was

a multi- function commercial bank focusing mainly on rural and agricultural sector, was an independent legal entity responsible for its operation

Since 1992, Agribank has involved in the external business activities including lending in foreign currencies and international payments and became the first bank

to have implemented international projects In 1992, Agribank began to apply positive interest mechanism even to farming households in which the lending interest is higher than mobilizing interest Thanks to this, the business has been profitable since 1993

On Nov 15th 1996, authorized by the Prime Minister, the SBV Governor issued Decision N0 280/QĐ-NHNN to change the current name to Vietnam Bank for Agriculture and Rural Development Agribank is a special-class State-owned enterprise, governed by the Law on Credit Institutions and placed under the direct authority of the SBV Agribank operates mainly in the rural, agricultural sectors and for farmers’ benefits In 1998, Agribank focused on the improvement of credit

In February 1999, the Chairman of the Board issued Decision 234/HDQT-08 governing the administration of foreign exchange activities in Agribank system under which NOSTRO accounts were centralized at the Operations Center

Agribank proactively expanded international relations and foreign business It was granted funding from international financial institutions such as WB, ADB, AFD, etc

The year 2001 marked the institution’s first year of implementation of its structuring project which emphasized the re-structuring of debts, financial clean-up, improvement of asset quality, reform of existing accounting system to match international standards, reshuffle of organization under the model of a modern bank, intensification of training and re-training of banking technology, and building fo a sophisticated management information system

re-Agribank accelerated the progress of the re-structuring project in order to develop its activities to a great proportion with high quality In 2003, Agribank has been conferred Title of Labor Hero of the Doi Moi (Renovation) Period

Agribank was ranked the number one among top 200 Vietnamese biggest enterprises by UNDP in 2007, got the title of Top 10 Vietnam gold star award in

2008, also got TOP 5 best correspondent service bank award; Corporate Sustainable (CS) Award, The Chairman of Board of Directors was awarded with the title

"Outstanding Vietnamese Businessman" ……

The current Agribank system consists of:

- 03 representative offices: 01 in central region, 01 in the south, and 01 in PhnomPenh - Campuchia

- 03 centers including: Information Technology Center, Training Center, Card Center

2005 2006 2007 2008 2009

- 02 Operations Center: Settlement Center and Risk Prevention and Handling Center

- 08 subsidiaries including: Finance Lease Company N0 I, Finance Lease Company N0.II, Securities Co., Ltd, Commercial Banking Service and Printing Company, Jewelry Trading Company, Ho Chi Minh City Gold, Silver and Gemstone Company, Trade and Tourism Company, Food investment and trading Company

- 22 Departments, 01 Transaction center, - 72 level-1 branches and 85 level-2 branches and 776 level-3 branches

2.2 Overview of Agribank’s business performance in period of 2005 -

2009 and in first 6 months of 2010

2.2.1 Business environment in period of 2005 - 2009 and in first 6 months

of 2010

 Business environment in period of 2005 - 2009

Figure 2.1 GDP Growth over the year 2005-2009 (%)

(Sources : General Statistics’ Press releases from 2005 to 2009)

The year of 2007 highlighted the highest GDP growth over the last decade but

in 2008, the world economy entered the period of many uncertainties, especially the witness of the consequences of the U.S’ real estate market collapse, resulting in the breakdown of financial institutions and spreading to commercial banks, even those considered to be reputable and powerful in finance, seriously affecting the global financial market Inflation rose up in most countries worldwide Oil prices were