The credit risk management of agribank’s bien hoa branch

Figures Figure 2-1 Categorizing Risks in The Banking Business ...5 Figure 2-2 The Steps of Managing Risks in Operation of Bank...6 Figure 2-3 Credit form Shows in the Following Exhibit .

MEIHO UNIVERSITY Graduate Institute of Business and Management

MASTERS THESIS

The Credit Risk Management of Agribank’s Bien Hoa Branch

In partial fulfillment of the requirements for the degree of

Masters of Business Administration

Advisor: Dr Ching-Wen Mo Co-advisor: Dr Pham Duy Hieu Graduate Student: Nguyen Hoang Thanh Phi

December, 2010

ACKNOWLEDGMENTS

I am very grateful indeed to the Ho Chi Minh city Industrial University’s the managing boards, and Meiho University, Taiwan My thanks to Ph.D Ching-Wen Mo in Meiho University, Taiwan for instructing me during the time of doing my research Thanks to Ph.D Pham Duy Hieu to give me valuable experience Thanks also to the professors in Meiho University and in Ho Chi Minh city Industrial University

As ever, I am grateful to all the staff in the Agricultural and Rural Development Bank in Bien Hoa City Thanks to all my classmates of EMBA2 class to give me helpful advice to finish my research

The Credit Risk Management of Agribank’s Bien

Hoa Branch ABSTRACT

Banks play an important role as the channel of mobilizing and circulating capital and become financial intermediaries in the market economy The process of globalization has strengthened the inter-dependence among the economies in the world In 2008, the credit crisis in the USA affected the global economy crisis, the financial fields suffered sharply from this event as well as banking sector Nowadays, one of the risks which the banks need to consider is the credit risks, since the credit system is such important, complicate but vulnerable

By combination of theories and practical operation, we have collected the real data as many banks through questionnaires and then used comparison and analysis methods to have comments to evaluate and true credit activities and credit risk management tasks From the empirical results, we have suggested some realistic solutions

to improve the quality of credit risk management tasks And the banks may apply these solutions to control risks as lowest rate as possible Moreover, we learned from the research that credit growth is very necessary; however it needs to be linked with safety and effectiveness On the other hand, besides the outside causes, the subjective causes are more important to credit risks Although banks gained success in the process of managing credit which there is still limitations and slots left to make room for credit risks to sprout

Here are some our suggestions developed during the time of investigating the credit risks management tasks

- Building an effective credit operational procedure

- Upgrading the quality of checking tasks inside the banks

- Managing and supervising credit risks in and after the time of offering loans

- Setting up and upgrading the IT system inside the banks

- Improving the quality for the human resources

- Building an internal credit risks control department

- Considering all environmental factors in loans regulations

We believed that if banks implement these solutions properly, they will avoid most

of credit risks problem at the lowest rate as they can

Keywords: Financial Intermediaries, Credit Risks, Internal Control

The Credit Risk Management of Agribank’s Bien

Hoa Branch Contents

ACKNOWLEDGMENTS I ABSTRACT II Contents IV Tables VI Figures VIII

Chapter1 Introduction 1

1.1 Motivation 1

1.2 Research Objective, Research Questions 2

1.2.1 Reasearch objective 2

1.2.2 Research questions 2

1.3 Research Scale, Objects for Research and Limit Research 3

1.4 New Characteristics of the Thesis 3

Chapter2 Reasoning Basis in Managing Credit Risks 4

2.1 Managing Risk in the Banking Business 4

2.1.1 Generalizing about risk 4

2.1.2 Risks and managing risks in the banking business 4

2.1.3 Influence of risks to banking operations and social economy 8

2.2 Overview of Managing Credit Risks of the Bank 8

2.2.1 Credit concept 8

2.2.2 Credit risks 9

2.2.3 Credit risk management 14

2.3 Introduction of the Bien hoa Agribank and Rural Development 19

Chapter3 Research Methodology 21

3.1 Research Process 21

3.2 Research Methods 23

3.3 Designing the Questionnaire Structure 23

3.4 The Accuracy of the Data 26

3.5 Validity and Reliability of Research Data 27

Chapter4 Research Results and Analysis 28

4.1 To Analyze the General Information of Investigated Persons 28

4.2 To Analyze the Causes of Credit Risk in Banks 29

4.2.1 The reasons causing credit risk (the outside causes) 29

4.2.2 The credit risk be caused from customers 30

4.2.3 The credit be caused from the weakness of risk management of bank 31

4.3 Comparisons Analysis 36

4.3.1 Comparing three groups of causes of credit risk among the size of credit deposit 36

4.3.2 Comparing three groups of causes of credit risk among working experience in bank 41

4.3.3 Comparing three groups of causes of credit risk among professional degree 46

4.4 Multiple Regression 48

Chapter5 Implications, Conclusions and Recommendations 51

5.1 Orientation Development of Agribank’s Bien Hoa Branch in 2010 51

5.2 Solutions to Increase Efficiency of Credit Risk Management in Agribank’s in Bien Hoa Branch 51

5.2.1 Setting up the effective credit policies 51

5.2.2 Improve the quality of checking tasks inside the banks 52

5.2.3 Manage and supervise the credit risk in and after loans offer 53

5.2.4 Building and upgrading the it system internal 53

5.2.5 Improve the quality of human resources 54

5.2.6 Building risk managing culture 54

5.2.7 Consider environmental factors in terms of loans 54

5.3 Recommendations 55

5.3.1 The recommendations to Agribank Vietnam 55

5.3.2 Recommendations to state banks 56

5.3.3 Recommendation to the state 58

5.4 Conclusion 60

References 61

Tables

Table 2-1 Results of the Bank’s Business Activities during the Years 20

Table 3-1 Reliability of the Questionnaire 27

Table 4-1 The Size of Credit Deposit 28

Table 4-2 About Your Working Experience in Bank 28

Table 4-3 Professional Degree 29

Table 4-4 The Reasons Causing Credit Risk 29

Table 4-5 The Credit Risk Be Caused From Customers 30

Table 4-6 The Credit Risk Be Caused From the Weakness of Risk Management of Bank (1) 31

Table 4-7 The Credit Risk Be Caused From the Weakness of Risk Management of Bank (2) 32

Table 4-8 The Credit Risk Be Caused From the Weakness of Risk Management of Bank (3) 33

Table 4-9 The Credit Risk Be Caused From the Weakness of Risk Management of Bank (4) 34

Table 4-10 ONE – WAY ANOVA – Descriptives of the 3 Group of Causes among the Size of Credit Deposit 36

Table 4-11 Test of Homogeneity of Variances – among the Size of Credit Deposit for Each Group of Causes 36

Table 4-12 ANOVA 37

Table 4-13 ANOVA 38

Table 4-14 Multiple Comparisons 38

Table 4-15 ANOVA 39

Table 4-16 Multiple Comparisons 39

Table 4-17 ANOVA 40

Table 4-18 Multiple Comparisons 40

Table 4-19 ONE – WAY ANOVA – Descriptives of the 3 Group of Causes among Working Experience in Bank 41

Table 4-20 Test of Homogeneity of Variances – Among Working Experience in Bank for Each Group of Causes 41

Table 4-21 ANOVA 42

Table 4-22 ANOVA 43

Table 4-23 Multiple Comparisons 43

Table 4-24 ANOVA 43

Table 4-25 Multiple Comparisons 44

Table 4-26 ANOVA 44

Table 4-27 Multiple Comparisons 45

Table 4-28 ONE – WAY ANOVA – Descriptives of the 3 Group of Causes among Professional Degree 46

Table 4-29 Test of Homogeneity of Variances – Among Professional Degree for Each Group of Causes 47

Table 4-30 ANOVA 47

Table 4-31 Correlations Matrix of the Predictors and Predicted Variable 48

Table 4-32 Model Summary for Credit Deposit Regression 49

Table 4-33 ANOVA(b) of the Credit Deposit Model 49

Table 4-34 Coefficients(a) of Predictors for Credit Deposit 49

Figures

Figure 2-1 Categorizing Risks in The Banking Business 5

Figure 2-2 The Steps of Managing Risks in Operation of Bank 6

Figure 2-3 Credit form Shows in the Following Exhibit 8

Figure 2-4 Credit Risk Pattern 9 Figure 3-1 The Process of Research Themes Can Express Through the Following Steps 22

The Credit Risk Management of

Agribank’s Bien Hoa Branch Chapter1 Introduction

Contents of Chapter1 includes: (1) Motivation; (2) Research objective, research questions; (3) Research scale, objects for research and limit research; (4) New characteristics of the thesis

http://www.vinacorp.vn/news/thu-hep-tin-dung-ca-nhan/ct-362519) However, this operation always potentiate high risks, especially in the developing countries such as Vietnam, because the information system lack of the clearness and adequateness, the level

of managing risks is limited and the profession of the banking staffs are not high

In credit field, the potential risks cannot eliminate; they can only identify and control strictly to restrict the risks to the lowest losses when they occur In 2008, fast increasing circumstance in credit had many high risks in the operation of banks In 2009, the increasing in credit went down a little; however, the bad effects of the fast increasing

in credit of the year 2008 appeared and they created the pessimistic signals In the operation of the bank, the operation of monetary and credit business field has a close

relationship with the customers and the economy through the process of doing the business transactions

Credit risk always remains unsettled and non-performing load (thereafter, NPL) is

an obvious practice at any bank, including the top banks of the world because there are some risks out of the control of the human If the credit risk occurs, there will be a huge effect and direct influence to the existence and development of every credit organization,

or in higher level, there will be influence to the entire banking system, financing structure and economic development However, the basic difference among the banks is the ability

to managing NPL at an acceptable ratio based on the constructing an effective managing credit risk pattern which is suitable to the operation environment to eliminate the subjective credit risks coming from the human factor and other manageable credit risks Realizing the important role in the credit operations, evaluating the level of risks, identifying the cause to suggest the effective solution, constructing a credit risk-managing pattern that is appropriate with Vietnamese conditions are urgent demands to guarantee the restriction of risks in the operation of providing credit, to incline towards international standards of managing risks Therefore, we chose the thesis "The credit risk management

of Agribank’s Bien Hoa branch" as the researching purpose

1.2 Research Objective, Research Questions

From the above causes, suggesting the whole and suitable solutions to the operations of Bien Hoa Agribank to improve the effectiveness of managing credit risks at Bien Hoa Agribank

1.2.2 Research questions

(1) How to reduce the possible risks to ensure credit activities?

(2) What are the measures to improve of using capital to increase profits for the banks based on “safety, effectiveness, and stable development”?

(3) What are the necessary abilities to handle credit risks on time in order to avoid the bank’s loss?

(4) How to improve the quality of doing business of the banks to strengthen the competition in the global integration trend?

1.3 Research Scale, Objects for Research and Limit Research

Due to limited time, the writer has only done a survey on 100 staff and experts in Agribank Bien Hoa and in other banks in Bien Hoa and the writer collected information

to analyze, evaluate about the credit activities and credit risk management to find out many practical solutions to improve the quality credit risk management tasks in Agribank Bien Hoa

1.4 New Characteristics of the Thesis

The thesis of managing credit risks is a rather new thesis to economical researchers

in Vietnam and now Vietnam is going international The thesis will clarify the basic reasons of credit, credit risk, and identifying and managing credit risk

Based on the basic analysis of the credit operations of Bien Hoa Agribank, we will proposes some signals showing the problematic debts sooner, detects some causes to suggest the effective and possible solutions

The most important here is that the thesis researches in details in credit risks, gives out the criteria of managing credit risks at Bien Hoa Agribank, which has not researched previously

Chapter2 Reasoning Basis in Managing

Credit Risks

Contents of Chapter2 includes: (1) Managing risk in the banking business; (2) Overview of managing credit risks of the bank

2.1 Managing Risk in the Banking Business

2.1.1 Generalizing about risk

2.1.1.1 Risk concept

In general, risk can define as the possibility that actual future returns will deviate from expected returns In other words, it represents the volatility of returns Risk can define as the volatility of the unexpected outcomes, generally the value of assets or liabilities of interest Firms can expose to various types of risks, which can broadly classify into business and non-business risks (Philippe Jorion, 2000)

Unsystematic risks (dividable risks): result from the accidental or uncontrollable events, which only affect some companies or some industries These elements can be changed of labor force, managing ability, bringing a legal action, regulating policy of the government Most of the investors who have the minimum understanding of this field can eliminate the dividable risks by holding an enough big portfolio, which has from tens

to hundreds of stocks

2.1.2 Risks and managing risks in the banking business

2.1.2.1 Risks in the banking business

2.1.2.1.1 Concept

In the banking business activities, risks are the unexpected events, which lead to the loss to the assets of the bank, reduce the real profit compared to the budgeted one or

spend a further amount of expense to finish a certain finance practice when they occur (Phan Thi Cuc, 2009)

Operational Risk: According Basel (1998d) and Jorion (2000), the operational risk generally can be defined as arising from human and technical errors or accidents This

RISK IN ACTIVITIES

OF BANK

Operational Risk

Credit Risk

Liquidity Risk

Legal Risk Market

Risk

includes Freud, management failure, technical errors and inadequate procedures and controls Operational risk also can lead to market and credit risk

Liquidity Risk (unable liquidity): occur in the case that the bank losses the liquidity, convertibility of assets to cash, or borrowing power to meet the need of a settlement contract (Phan Thi Cuc, 2009)

Legal Risk: Customers and other people can take legal actions to the bank Reason

of taking legal actions comes from the common operational processes For example, according to the customers, the rejecting of providing the credit limit again is unreasonable However, some cases can come from the reasons, which are not from the business activities of the bank such as financing the customers who polluted the environment and the bank can take a legal action by the third party suing When solving the legal action of a bank, for example, the contract of leasing and the guaranteeing asset standard have problems, or the government suddenly changes the macro policy in economic structure, prior field, etc These things can create the risk of loss for the bank (Le Thi Tuan Nghia, 2007)

Market Risk: arises from movements in the level or volatility of market prices Value at risk tools now allow users to quantify market risk in a systematic fashion (Philippe Jorion, 2000)

2.1.2.2 Managing risks in banking business

Managing risks is the process of approaching risks scientifically, entirely, and systematically to identify, control, prevent, and reduce the damage, loss, bad effects of risks Managing risks includes the steps shown in the following exhibit:

Figure 2-2 The Steps of Managing Risks in Operation of Bank

(Phan Thi Cuc, 2009)

IDENTIFY

-ING

RISKS

ANALYZ -ING RISKS

EVALUAT -ING RISKS

CONTROL LING AND PREVENT- ING RISKS

FINANC -ING RISKS

* Identifying risks:

About the managing risks, Phan Thi Cuc (2009) has to identifying risks; it is the process of identifying continuously and systematically Identifying risks include the work of observing, considering, researching operational environment and entire activity

of the bank to list all kinds of risks, not only eliminate the occurred and occurring risks but also forecast the forms of risks, which newly occur at the bank Based on the above basis, the appropriate solutions in controlling and financing risks suggest

Besides, Phan Thi Cuc also purposes that to identifying, managers have to compile the list of the occurred, occurring and potentially appearing risks of the bank by the following methods: preparing the research questionnaire about risks and continuing investigation, analyzing the financial statements, flow of chart method, inspecting the real field, analyzing the contract, working with related governmental agencies

* Analyzing risks:

Phan Thi Cuc (2009) points out to analyze risks is to identify the causes making risks This is a complicated work, because not every risk comes from the only cause but from many causes

To analyze risks is to find effective methods to prevent risks When the cause or the influence affecting the change find, we can prevent risk effectively (Phan Thi Cuc, 2009)

* Evaluating risks:

Phan Thi Cuc (2009) also considers that to evaluate risks, we need to collect, analyze and estimate the data Based on the result, we prepare the matrix to evaluate risks To evaluate the important level of risk to the bank, we use both criteria: the frequent occurrence of risk and the margin of risk - the serious level of damage Between the two, the second plays the determining role

* Controlling and preventing risks:

The main work of administration is controlling risks Controlling risks is using the methods, skills, tools, strategies, the operational programs to prevent, avoid, and eliminate the damage, loss, unexpected influence occurring at the bank There are many risk controlling methods such as avoiding risks, preventing loss, eliminating loss, transferring risks, diversifying risks, information management (Phan Thi Cuc, 2009)

* Financing risks:

Phan Thi Cuc (2009) points out when the risks occur, firstly we need to observe, identify accurately the loss of assets, human resources, legal value Then we need to have

appropriate financing ways to risks These ways can divide into two categories: risk overcoming and transferring

self-2.1.3 Influence of risks to banking operations and social economy

In the banking operations, the first influencing risk can cause loss to the assets of the bank The frequent losses are losing the principle of loan when lending, increasing the operation expenses, decreasing profit, and asset value Besides, risks make the reputation of the bank and the trusts of the customers go down, and the bank can loss its goodwill A bank operating with loss result continuously, with insufficient liquidation making a large number of customers withdraw their deposits, which obviously causes the bank to go bankrupt Thus, it influences thousands of depositors, and businesses which need the capital, and makes the economy recess, prices increase, purchasing power decrease, unemployment decrease, order of society confuse, and moreover a lot of domestic bank collapse (Phan Thi Cuc, 2009)

Besides, risks of the banks also influence the world economy because in the circumstance of going international and globalization now, every country's economy depends on the area and world's economy On the other hand, the relation of currency, investment among the developed countries is close so the risks of the banks in one country will affect directly to other related countries' economies These have shown by the financial crisis of 1997 in Asia, of 2001-2002 in South America and of 2008 in the U.S

2.2 Overview of Managing Credit Risks of the Bank

Figure 2-3 Credit form Shows in the Following Exhibit

2

1 Loan

Refund capital and interest

2.2.2 Credit risks

According Basel (1998b) and Jorion (2000), Credit risk originates from the fact that counterparties may be unwilling or unable to fulfill their contractual obligations The effect of credit risk is measured by the cost of replacing cash flows if the other party defaults However, the risks of the bank mainly focus on credit portfolio This has the hugest risks, and risks frequently occur When a bank encounters a very serious and difficult situation in finance, the cause usually comes from the credit operations of the bank (Le Thi Tuan Nghia, 2007)

2.2.2.1 Concept of credit risks

Credit risks are the risks, which occur during the providing credit process, shown

in the situation that customers do not have the ability to return the debts or pay debts not

in time to the banks (Le Thi Tuan Nghia, 2007)

Hence, credit risks are said to appear in the relation that the bank is the creditor, while the debtor does not or cannot carry out the obligation of paying debt when it matures It occurs during the process of lending, discounting the transferring tools, and the valuable documents, financial leasing, guaranteeing, insuring settlement of the bank

2.2.2.2 Categorizing risks

We can diversify credit risks shown in the following exhibit:

Figure 2-4 Credit Risk Pattern (Source:Le Thi Tuan Nghia, 2007)

CREDIT

ATTENTION RISK

LIST RISK

CHOOSING

RISK

INSURANCE RISK

SKILL RISK DOMESTIC

RISK TRANSACTION

RISK

Based on the above exhibit, credit risk can divide into risk in transaction and risk

in portfolio (Le Thi Tuan Nghia, 2007):

Risk in transaction: is the form of credit risk whose cause comes from the limit in the process of transaction, considering and approving the loan, evaluating the customers

It includes:

Risk in choosing: is the risk related to the process of evaluating and analyzing credit when the bank chooses the effective ways of lending money to suggest the lending decision

Risk in guaranteeing: comes from the guaranteeing standards such as the terms in the lending contract, guaranteeing properties, subjects, ways and lending amount based

on the collaterals

Risk in practice: is the risk related to process of lending and managing loans including using the risk ranking system and processing technically the problematic loans Risk in portfolio: is the form of credit risk whose cause comes from the limit in managing lending portfolio of the bank, divided into two types: intrinsic risk and concentration risk

Intrinsic risk comes from its own element, characteristics, has the inside distinctiveness of every lending subject or from economic industry, field, from the characteristics of the operation or using capital of borrowing customers

Concentration risk: is the case that the bank concentrates too much lending capital

on some customers, lends too much to many businesses operating in the same industry, economic field, certain geographical area, or form of lending which has high risk

2.2.2.3 Ratio of evaluating credit risk

2.2.2.3.1 Overdue debt ratio

Overdue debt is the most important yardstick evaluating the health of the institution It influences all of the main operational fields of the bank The way of determining this criterion with low result indicates that the credit amount of the bank guarantees quality; risk in providing credit of the bank is low On the contrary, if this ratio is high, it indicates the ability of using the bank's working capital low (Le Thi Tuan Nghia, 2007)

Overdue debt ratio = (Overdue debt balance / Total lending loan balance) x 100%

2.2.2.3.2 Bad debt ratio (Le Thi Tuan Nghia, 2007)

Bad debt ratio = (Allowance for compensating risk / Total debt balance) x 100%

2.2.2.3.3 Risk circumstance of losing capital (Le Thi Tuan Nghia, 2007)

Credit risk allowance ratio = (Allowance for credit risk deducted / Debt balance for preparing period) x 100%

2.2.2.3.4 Credit risk factor

This factor shows the density of credit amount in the assets If the credit amount in the total assets is high, the profit will be high, but meanwhile credit risk will be high, too (Le Thi Tuan Nghia, 2007)

Credit risk factor = (Total lending loan balance / Total assets) x 100%

2.2.2.4 Some signals of realizing credit risks

2.2.2.4.1 Some financial signals (Nguyen Van Tien, 2007)

- Liquidity ratios show weak points

- Return ratios show weak points

- Operational turnovers show weaknesses

- Capital structure is unreasonable

2.2.2.4.2 Some non-financial signals (Nguyen Van Tien, 2007)

* Signals relate to the banks:

- Deposits reduce significantly

- Debts increase

- Borrowing amount frequently increases

- Needs of borrowing amount is in excess of budgeted demands

- Using the financing source with high interest rate is acceptable

- Slow payment of principle and interest of debt to the bank

* Signals relate to managing ways with customers:

- There are changes in human resource structure in the administrating system

- There are conflicts in the managing system

- Little experience, much appearance

- Transferring employees too often

- Dispute in the managing process

- Illegal administrative expenses

- Nepotism management

* Signals in technical and commercial problems:

- Difficulty in developing new products, having no substitution products

- Changes in the governmental policies

- Seasonal products

- There is an indication of cutting expenses

- Changes in the market about interest rate, exchange rate, losing customers, taste, etc

* Signals in processing financial information:

- Increase in ratio of debt unbalance

- Prepare insufficient financial data, delay in submitting report

- Cash balance decreases

- Increase rapidly in accounts receivable and period of paying debts

- Loss in income result

- Deliberate to make the balance perfectly with intangible assets

* Other non-financial signals:

- Degradation of business premises

- Inventory increases due to not sold goods, damage, and obsoleteness

- Discipline the leading officers

2.2.2.5 Cause of credit risks

- Disaster, fire, epidemic pull the business and manufacturing processes down

- Domestic and international social and economic circumstances

- Environmental factors

- Changes in policies of the government

- Legal environment is disadvantageous, loosing in macro-management

2.2.2.5.2 Subjective cause

* From customers:

This is one of the main and most traditional causes of credit risks Borrowers can

be intentionally or unintentionally unable to pay loan to the bank just in time In general, this cause can be controllable, deal able if the bank supervises, controls and manages the customers well before, within, after distributing the loan to customers (Nguyen Van Tien, 2007) This cause can be considered in the following aspects:

- Because the borrowing customers lack legal capacity

- Using the borrowing capital with wrong purpose, ineffectiveness

- Due to continuous loss in business, unconsumed goods

- Inappropriate way in managing capital causes lacking liquidity

- The business owner borrowing loan lacks managing ability, embezzles, cheats

- Because the subjective intention of the borrowers, they do not want to return the debt to the bank

- Due to the disunity in the internal of the Board of Directors

* From the bank:

Apart from the cause of overdue debt from borrowers, subjective cause includes shortcoming, defect from the bank (Nguyen Van Tien, 2007):

- Judging ability of the lending project of the bank is still weak so the bank lent to the projects, which are unfeasible, risky, unrecalled in a loan while the bank cannot predict the reserve source to amend risks

- In addition to the problem being short of and weak in managing ability, there is also a group of bank staff who lack moral quality taking advantage of their working positions to seek self-interest, embezzle, corrupt, lend intentionally with wrong rule This

is also the cause of increasing overdue debt

- The bank believes subjectively in the collaterals, sponsoring and insuring property, considers them as certainly insuring things for recalling principle and interest

of loan and looks down the check, control of doing projects, prevention of risks The bank does not know the way of using the loan of customers so there is no method of preventing, processing quickly when the loans have the bad signals in the using process

so it makes the debt returning ability unsecured, and debts overdue

- The bank lacks a department that specializes in observing, managing risks, managing maximum credit limit for each customers of different industry, products, and regions to scatter risks

- Bank's control system is too weak and loose, which makes a lot of credit amount concentrating too much on a few borrowers so the peril of losing credit of the bank increases depending on these customers' business operations

2.2.2.6 Effect of credit risks

According Basel (1998b) and Jorion (2000), the effect of credit risk is measured

by the cost of replacing cash flows if the other party defaults However, when we focus

on the credit risk of the bank, we can cite Nguyen Van Tien (2007) supposes bank is the mental centre of the entire economy and a regulating tool of government's macro-economy Thus, if the bank has risk in any operations, especially credit risk; it will cause

not only damaging effects to the bank itself but also serious influence to bank system and national economy

* To the bank having risks (Nguyen Van Tien, 2007)

In the financial sector: due not to recall in the debt (including principle, interest of the loan and other expenses), it makes the capital of the bank stuck so it cannot create interest, while the bank has to pay interest for the deposits mobilized; so the bank's profit decreases, source of working capital is narrowed If this situation becomes serious and last in a long time, it will make the bank unliquidated and go bankrupt

In the social sector: Bank's credit risk can make the bank lose the liquidity due to losing the depositors' confidence and withdrawing money in large quantity of them The circumstance of withdrawing the deposits with large quantity occurs not only at one bank but also at other banks, which causes panic and instability in society

* To the bank system (Nguyen Van Tien, 2007)

The operations of one bank of one country relate to the bank system and many economic and social organizations and individuals in the economy Thus, if one bank has bad operational results or even loses liquidity and goes bankrupt, there will be some bad linear influence to other banks and economic sectors, the thought of losing money will spread to depositors and they will withdraw money at the same time at other banks It can make other banks encounter the situation of unliquidated

* To the economy (Nguyen Van Tien, 2007)

Bank has a close relationship with other economic components, is a channel attracting and providing money to invest in developing business process, and is vital to every economic component Therefore, credit risk causes bankruptcy to a bank or even influences badly other banks and it makes the national economy confused, economic activities unstable and standstill, the relation of supply and demand unstable, the inflation, unemployment and social evils increase, security and political situations unstable

2.2.3 Credit risk management

2.2.3.1 Concept

Credit risk management is the way of using professional measures to control credit qualitity, limiting bad effects in credit activities, reducing loses not to let bank activities fall into dissolution status (Credit Manual, 2010)

2.2.3.2 The necessity of credit risk management

Ngo Quang Huan (2007) points out to limit the risk, it is necessary to work well from prevention to solving bad effects due to risk occurring:

Forecasting, identifying potential risks, detecting disadvantageous occurrence, preventing unbeneficial situations, which happened or are happening and can be spreaded to a widespread area To solve the effect of risks can prevent the loss to property and income of bank This is a logical process so it is necessary to have management to secure the unification

Preventing risks is done by the staff, leaders of the bank At the bank, the thought and action of the staff can be different, or obstruct the others so we need to have management to make everyone to act unifiably

Management suggests detailed goals to help the bank develop in the correct direction and we must have detailed plans and suitable results to the suggested goal

2.2.3.3 Tools of managing credit risks (Le Van Tu, 2005)

2.2.3.4 Method of managing credit risks

Le Van Tu (2005) points out to perform these above tasks well; first, credit risk management has to secure the general steps of management including planning, organizing, disposing, examining and controlling Besides, in addition to the significant characteristics of credit risks considered at different aspects, the method of managing credit risks is considered and done coordinative

2.2.3.4.1 Managing credit risks with influencing factors

Le Van Tu (2005) also considers that it is the method of identifying and managing many factors, which affect and influence to credit risks It includes the following factors: Factors of the bank: credit policy, risk managing pattern, human resource quality, credit evaluating work, supervising and controlling after work, credit increasing speed, customers, loan maturity, lending subject, credit rating, collateral, portfolio diversification, risk in moral, human resource management policy, etc

Market factor: economic cycle, inflation, interest rate, exchange, price and market, risk in policy, etc

Policy of customers: possibility, effect of lending project, collateral, liquidity, profitability, leverage, effect of managing capital, cash flows, moral of business owner, manageability, prospect of industry, competitiveness, business diversification, etc

Other factors: accurateness and availableness of information, legal way, supervising role of central bank, etc

2.2.3.4.2 Credit risk management with segmentation of credit rank

Credit managing work can do differently at every segment of credit rank (Le Van

Tu, 2005) It includes:

Before providing money: it includes from planning policy to developing evaluation and providing credit decision This is the decisive stage to the whole process (although other after segments of providing credit process cannot be considered lightly While providing money: it include set up records and control during providing process Work in this process has high formality and legality

After providing money: risk causes can potentates in the two first segments (before and while providing money; however, credit risk is only exposed and occur after providing money Thus, controlling, supervising loan and classifying debt are attached special importance in this segment

2.2.3.4.3 Credit risk management with period of occurring credit risks

* Before occurring risks:

- Identifying and evaluating risk

- Determining level of risk

- Grasping and doing the forecast steps

- Getting rid of big risks

- Financing acceptable risks by choosing method of self-financing, guaranteeing and disposing risks

* After occurring risks:

- Managing loss

- Planning restoration

In short, the duties of credit risk management is forecasting, detecting potential risks, detecting disadvantageous events, preventing disadvantageous situations which happened and are happening and are spreading widely, solving effect of risk to prevent loss to the property and income of the bank This is logical process and to prevent credit

risk, managers has to perform well from forecasting, preventing stage to stage of solving bad effects due to risks (Le Van Tu, 2005)

2.2.3.5 Measuring credit risks

One of the basic characteristics of modern finance is riskiness so all modern financial patterns are set in risky environment Thus, it is necessary to construct a tool to measure it These patterns are diversified including quantitative and qualitative models (Nguyen Van Tien, 2005)

2.2.3.5.1 Quantitative model of credit risk - Model 6C

Nguyen Van Tien (2005) points out the first question of bank to every loan are whether customer wants or has the capacity to repay the loan when it matures This relates to researching details "6 aspects - 6C” of customers These include:

- Character of borrower: Credit staff must make sure that borrower has clear credit goal and serious intention of paying debts when maturing

- Capacity of borrower: Borrower of loan must have legal and behavioral capacity

of citizen, must be the legal representative of the business

- Income of borrower: Bank has to identify the source of repaying loan of borrower from the cash flows of business

- Collateral is the second source used to repay loan to the bank

- Conditions: Bank sets up conditions depending on the credit policy of each period

- Control: means to assess the influence from change of law, operational regulation, and customers’ ability to adapt the bank's criteria

Using this model is rather simple but the limit of this model is that it depends on the accuracy of information source collected, forecasting ability as well as analyzing, and evaluating ability of credit staff

2.2.3.5.2 Qualitative model of credit risk

Nowadays, most of the banks approach to modern method of assessing risks There are some qualitative models of credit risk following mostly used

™ Z point model (Le Van Tu, 2005):

This model was set by E.I.Altman depending on:

(i) Ratio of financial element of borrower - Xj

(ii) The importance of these ratios in identifying bankrupt possibility of borrower

in the past

Z = 1.2X1 + 1.4X2 + 3.3X3+ 0.6X4 + 1.0X5X1: Net working capital / Total assets ratio X2: Retained earnings / Total assets ratio X3: EBIT / Total assets ratio

X4: Market value of share / Book value of long-term liabilities ratio X5: Sales / Total assets ratio

Z value is high so the borrower having bankrupt possibility is low When the Z value is low or a negative number, it is a base to classify the customer into the group who has high bankrupt risk

If Z < 1.8: customer has high risk

If 1.8 < Z < 3: unidentified

If Z > 3: customer does not have the ability of bankruptcy

Any company which has Z value < 1.8 is classified into a group of high credit risk and the bank will not provide credit

Advantage: measuring technique of credit risk is rather simple

Disadvantages: This model can use to classify into customer groups, which have risks or no risks However, in reality, every customer's credit risk level is different from low level as low or unable payment of interest to level of losing both principal and interest of loan There is no persuasive reason to demonstrate that parameters reflecting the importance of ratios are invariant while the business conditions as well as financial markets are changing continuously

™ Ranging model of Moody, Standard & Poor (Le Van Tu, 2005):

Credit risk in lending and investing usually indicates by ranging bond and loan Moody, Standard & Poor is one of the businesses providing these services best Moody, Standard & Poor ranges bond and loan into 9 ranges and descends by quality Which is belonging to four first ranges, bank will lend but other ranges, and bank will not lend or invest

In short, the work a bank evaluate risk possibility of one borrower and based on that base, how to assess loans and debts correctly depends on investment portfolio and expenses of collecting information These related factors leading to investment decisions include:

* Factors relating to borrowers:

Borrower's prestige: indicates by lending - borrowing history of customers If during the borrowing process, the customer always pays sufficient money and in time, it will create confidence to the bank

Customer's capital structure: indicates by working capital/capital ratio The higher this ratio is, the bigger the risk possibility is

Fluctuation level of income: with any capital structure, income influences largely

to ability of returning debts of borrowers Hence, the company which has frequently stable history of income will attract more investors

Collateral: is the main condition in any lending decision to encourage using capital effectively and improving the duties of customer in returning debt to the bank

* The factors relating to the market:

Economic cycle has affected strongly to business activities So the bank needs to analyze the economic cycle to make a decision on time and to invest in which fields have the low risk rates

Interest rate: the high interest rate is applied to show a tight currency policy relating to the high risk rate, many investors who are attracted by high profit projects but

to forget that the interest rate seems to face possible risks

2.3 Introduction of the Bien hoa Agribank and Rural Development

Office: 1A Highway 1, Binh Da Ward, Bien Hoa City, Dong Nai Province

The Bien hoa Agribank was established by Decree No: 430/QD/HDQT-TCCB dated November 07th, 2001 and Decree No.145/QD/HQT-TCCB dated April 27th, 2004

of the board of director of Bank for Agriculture and Rural Development of Vietnam Main office of Bien hoa Agribank is located at convenient conditions for bank to easily communicate with people living in the province In addition, it can service to vicinity residents Bien Hoa Agribank has formed a network defense system-wide transactions

Comparing to the first day of establishment, Bien hoa Agribank now has some achieved development, products and services are accepted and confided by large organizations and foreign economy, businesses, small business and individuals

There are a lot of changes in the financial markets recent years but the bank have made great efforts and achieved that are encouraging results, in particular:

Table 2-1 Results of the Bank’s Business Activities during the Years

Unit: Billion VND 2008/2007 2009/2008 Standard

Mobilizing

Total debt 814.46 882.94 1142 68.48 8.41% 259.06 29.34%Include:

bad debt 11.403 7.064 4.568 -4.339 -38.05% -2.496 -35.33%Total

income 141.336 176.686 219.446 35.35 25.01% 42.76 24.20%Total

Agribank is Vietnam's the largest bank in terms of capital, assets, personnel staff, operation networks and customer amount

The Bien hoa Agribank and Rural Development is spacious, cool, is invested the new systems and modern equipment Leadership is a highly qualified and experienced The staff is young, dynamic, creative, dedicated to customer and highly qualified

Customers wishing to use the products and services of bank are increasing Products and services of the bank are trusted by customers It is a solid prop for survival and development banks

Chapter3 Research Methodology

Contents of Chapter3 includes: (1) Research process; (2) Research methods; (3) Designing the questionnaire structure; (4) The accuracy of the data

Step 4 - Theoretical grounds of managing credit risks: After studying the relevant documents, since researching on the state of credit risk management of bank, offering appropriate solutions to improve efficiency in credit risk management of the bank To solve the problem, we consult experts Ho Chi Minh University of Industry and Meiho University, to construct a questionnaire opinion survey of more than 100 employees in the bank

Step 5 - Constructing questionnaire: using the questionnaire after referring materials research, surveying of essays, designing appreciatively with the goal of this topic, then consult of specialists and complete the questionnaire, send it to the advisable professor to comments and approve of the questionnaire

Step 6, 7 - Distribute and collect questionnaire: after the questionnaire was gone through by a advisable professor, choosing the auxiliary person, training on

how to write and hand the questionnaire to person is selected surveys and unite time with returning questionnaires After distrusting the questionnaire, people who support and conduct survey calls to remind people surveyed have chosen to invest more to answer the questionnaire By the time of appointment to receive back the questionnaire, which came to support directly, check and collect questionnaires Step 8 - Analyzing of data collected: after collecting the questionnaire survey, classification and data entry, general results and graphs used for analysis Since then remarked evaluation of survey results

Step 9 - Solutions, Recommendations and Conclusions: on the basis of reference material and comparison with survey results, offer solutions and recommendations to improve effect of credit risk management Finally concludes the overview of the topic

1 Identifying research problem

2 Determine research motivation

3 Identify the purpose of research

4 Reasoning basis in managing credit risks

5 Develop Questionnaire

6 Deliver Questionnaire

7 Collect Questionnaire

8 Analysis of data collected

9 Suggestions, Recommendation and

Conclusions

Consultation from experts

3.2 Research Methods

Subject in this study is that the staff is working in the departments of bank currently Conducting a survey of 100 subjects are employees of the bank Thus, the number of sample survey of 100 samples We conducted survey the questionnaire and collect 100 valid votes Then proceed to enter data and analysis

3.3 Designing the Questionnaire Structure

Based on research material and what present in Chapter 2, combined with the opinions of experts, we designed a questionnaire based on the following groups:

* The reasons causing credit risk

* The credit risk be caused from customers

* The credit risk be caused from the weakness of risk management of bank With the group of factors, we have determined the detailed questions and put

in content to the survey questionnaire Specifically:

to manage credit risk in our bank well

Full name: Position: Workplace:

Part one: General information about the surveyors

* The size of credit deposit in your department:

Less than 100 billions From 100 to 500 billions Great than 500 billions

* About your working experience in bank:

Less than 3 years From 3 to 6 years Great than 6 years

* Your professional degree:

Senior high school Intermediate vocational College University Graduated University

Part two: The group of causes of credit risk

Group 1: The reasons causing credit risk

1 The change of economic such as crisis, depression and stag-inflation

Did not occur Occur less Occur common

2 Irresistibility causes such as natural calamity (earthquake, flooding and drought)

Did not occur Occur less Occur common

3 The change of the Government’s policies

Did not occur Occur less Occur common

4 The regulator modifies regulation makes the bank system synchronous

Did not occur Occur less Occur common

5 The credit information system translate occur time-lag

Did not occur Occur less Occur common

Group 2: The credit risk be caused from customers

6 The loan procedure too looses (few regulations and few relevant data) can’t exactly execute the risk control

Did not occur Occur less Occur common

7 The amount of loan of customer exceed the payment of his ability

Did not occur Occur less Occur common

8 The customers intentionally deceive

Did not occur Occur less Occur common

9 Customers do not perform a credit contract after borrowing money from the bank

Did not occur Occur less Occur common

10 The customers change initial purpose after borrowing money

Did not occur Occur less Occur common

11 Customer offer the truthful financial reports

Did not occur Occur less Occur common

Group 3: The credit risk be caused from the weakness of risk management of bank

12 The lack of customer’s information when evaluating conditions for offering loan

Did not occur Occur less Occur common

13 The lack of information of CIC (Credit Information Center)

Did not occur Occur less Occur common

14 The difficulty in verifying information from customer

Did not occur Occur less Occur common

15 Bank regulations are not suitable

Did not occur Occur less Occur common

16 The loan procedure of bank is not suitable

Did not occur Occur less Occur common

17 For evaluating and analyzing risk of customer, credit staffs often only do based on company’s financial report

Did not occur Occur less Occur common

18 The reducing in loan terms of stipulation to attract customer

Did not occur Occur less Occur common

19 The cheating by both staff and customers

Did not occur Occur less Occur common

20 The low qualification and uncompleted training of credit staff

Did not occur Occur less Occur common

21 The credit staff is overload of working

Did not occur Occur less Occur common

22 The working tools can not compatible with the demand of management Did not occur Occur less Occur common

23 The loan of bank too much focuses on same kind of customer

Did not occur Occur less Occur common

24 The lack of collateral information about its market price

Did not occur Occur less Occur common