LUẬN văn THẠC sĩ solutions to improve credit risk management of vietnam bank for agriculture and rural development (AGRIBANK)

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, 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.

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.

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.

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.

Research Methods

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

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

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.

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.

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

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

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)

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

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

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

Bank credit & Credit Risk

- Credit: According to the Decision No.1627/2001/QĐ-NHNN dated December 31 st 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 31 st 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 12 th 1997 and effective as of October 01 st 1998, “Credit activities mean the use of equity and 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

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:

+ Loans for production and trading

+ Loans for real estate trading

+ Loans for import and export trading, etc

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’ reputation

+ Secured loans: mean lending basing on collaterals such as mortgage, pledge, or guarantees by the third party

+ 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 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)

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

+ 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:

Credit risk management

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

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)

11 Frequently increasing loan demands, loan demands higher than expected

12 Abnormal increase of receivables and inventories, equity increase based on assessment of assets

13 Frequent changes of the management organization, or presence of conflicts or disputes

14 Signs that customers expect other abnormal income sources rather than the major production and trading, repayment performed on the basis of abnormal sources (e.g sales of factory or machines and equipment)

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

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 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

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

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

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 restructuring to the bank, including:

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

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;

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 most important decisions is to check whether the new owner may make the company profitable or supplement capital to help the company survive in the future

It depends on each particular case to decide to sell the whole company or part of the company only

+ Repayment simulative measures: exemption or reduction of interest, recalculation of interest, cancellation of penalty interest, etc should be applied for customers with willingness of principal repayment

+ 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:

Risk management from the viewpoint of Basel Committee and criteria

 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

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 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 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 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 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 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

Overview on Agribank and its loan system

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,

On Nov 14 th 1990, the Chairman of the Council of Ministers (now the Government) signed the Decision N 0 400/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 15 th 1996, authorized by the Prime Minister, the SBV Governor issued Decision N 0 280/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 quality, recovery of outstanding debts, tight management of due diligence and loan granting as well as the reduction of past-due debts

On March 30 th 1999, the Prime Minister promulgated Decision No.67/1999/QD-TTg on some banking credit policies for agricultural and rural development in order to promote and expand credit for farming households

Agribank promoted the raising of deposits both at home and abroad, paying attention to the proper implementation of entrusted foreign projects, project financing

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 re- 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

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

To expand and develop business activities as well as creating resources (capital resource, profit, etc) for rural and agriculture investment, Agribank has focused on network expansion at urban areas as well as establishing payment and credit relationship with big Corporations

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

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

- 08 subsidiaries including: Finance Lease Company N 0 I, Finance Lease Company N 0 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

Overview of Agribank’s business performance in period of 2005 - 2009

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 constantly up and reached more new records The world stock market witnessed a dramatic and continuous decline Gold prices therefore tended to increase again

In such a context, Vietnam’s economy encountered severe impacts such as the constantly high increase of inflation, the Government’s implementation of tightening interest rates in the continuously increasing monetary market, resulting in some races of interest rates Also, there appear deficits of liquidity in most of commercial banks

In 2009, our economy encountered a lot of difficulties and challenges due to impacts of the world economic crisis and severe damages from natural disasters

According to the assessment of the General Department of Statistics, the GDP growth rate of 2009 was still lower than the figure of 6.18% of 2008 but over- fulfilled the target of 5% as planned in the context of the world economy’s depression While many economies got a minus growth, such a result was a great success

In early 2009, the Government issued the economic stimulus package, contributing a big part for banks to improve liquidity and maintain customers’ repayment capabilities, restraining deficits of the economy Besides such positive results, the stimulus package, however, indicated a number of shortcomings and consequences Firstly, there arose the unfairness between enterprises granted with subsidized loans and ungranted ones, creating an unequal business environment

Secondly, the implementation of interest rate subsidy along with fiscal expansion and loosened monetary policies made total means of payment and credit highly increase leading to the danger of reinflation and turbulences in the forex, gold and real estate markets

Movements of exchange rates in 2009 were relatively complicated In late

2009, there witnessed the huge turbulences and devaluation of exchange rates, the constantly tightened indications of forex markets, surplus of credit USD and shortage of commercial USD Banks did not have enough foreign currencies to sell to enterprises and if any, the exchange rates were higher than the ceiling rates stipulated by the State Bank Unequabilities in the forex market and exchange rates continued to cause difficulties to the import and export activities

In 2009, the situation of Vietnam import and export encountered a lot of difficulties due to the global economic depression, resulting in the production stagnancy and consumption restraint in countries deemed as big export markets of Vietnam such as the U.S, Japan, EU, etc The total export turnover of 2009 was estimated to reach about 56,5 billion USD, down by 9.9% against 2008

The total import turnover of 2009 was expected to reach 67,5 billion USD, down by 16.4% against 2008 This reflects difficulties of local production due to the economic depression

However, it can be said that under the huge impacts of the world economic crisis, the decline of Vietnam economy did not last long and had growth drive recovered

 Socio-economic situation of the first 6 months of 2010:

The world economy experienced the year of 2009 with full of difficulties Up to now, the world financial depression has been controlled thanks to governments’ timely intervention by a variety of positive solutions to make the global economy more optimistic

According to General Department of Statistics over the first half of 2010, GDP increased by 6.16% against the same period of last year and equivalently rose in the three sectors There was an increase of 3.31% in the agricultural-forestry-fishery sector, 6.50% in the construction sector, and 7.05% in the service sector The GDP growth rate of the first half of 2010 followed the trend that the latter quarter was higher than the former one and there was an increase in all the three sectors, indicating that our economy is now in a fast-pace recovery trend and is able to achieve a higher growth rate in the coming time

In April 2010, inflation increased by only 0.14% against March, but money continued to be attracted via the open market with a net worth of 6,700 billion VND The mechanism of negotiable interest rates was initially applicable for short terms only Credit increase of the first 4 months was only 6% higher than the end of

2009 Banks were not much interested in credit development, partially because of the low gap between the input and output interest rates, the other part comes from enterprises’ not desiring to borrow In stead of lending, the bank focused more on buying government bonds, decreasing the interest rate for 3-year bonds to just 10.6% p.a This rate was about 1% p.a lower than the deposit rate and 2.7% p.a lower than the average lending rate of 12 big banks as collected and announced by the State Bank in late May 2010 of 13.3% p.a

Since April 2010, the supply and demand of foreign currencies has returned to its balance, liquidity of the market is high, credit institutions can balance their foreign currencies themselves and no longer desire to buy foreign currencies from the State Bank, some credit institutions can even buy an excessive amount of foreign currencies from customers and sell them to the State Bank

During the first half of 2010, the growth drive of deposits and credit balance gradually increased, fitting with goals of economic growth and inflation control As compared to the end of 2009, deposits from credit institutions were estimated to increase by 10.82% and outstanding was estimated to increase by 10.52%

In recently years, especially 2008 and 2009, Vietnam’s commercial banks in general and Agribank in particular faced a lot of challenges due to the adverse influences in the business environment However, with the objectives of maintaining sustainable development and preparing for the conversion of Agribank into one member limited liability Company which 100% state owned, Agribank has made attempts to achieve the targets The analysis below shows its performance in terms of capital, assets quality, profitability and liquidity

Agribank’s total assets increased with a reasonable structure In 2009, Agribank had total assets of 480,937 billion VND, which made it hold the first rank in Vietnam, followed by BIDV (292,298 billion VND)

Figure 2.2 Agribank’s total assets from 2005 to 2009

[Sources: Agribank’s Annual Report from 2005 to 2009]

Total assets of AGRIBANK increased by 21.1% against 2008 and slightly decreased as compared to the average growth rate of 25% during 2006 - 2009 due to the increasing trends of total assets and disadvantageous impacts of fluctuated business environment over the past year However, the growth drive has been maintained since 2006, among which credit activities made up the biggest proportion of 76% of total assets Such activities bring the bank major income

Below comes the table of total assets of some senior banks of Vietnam during

2007 – 2009, indicating that Agribank is always the bank with highest total assets nationwide

Table 2.1: CBs’ total assets from 2007 to 2009

[Source: Agribank’s Annual report from 2007 to 2009]

Total outstanding including lending to credit institutions and subsidiaries was

Loan structure and quality during 2005-2009

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

[Source: Agribank’s Annual report from 2005 to 2009]

Credit over the years has witnessed sharp increases The credit structure is evolving positively and credit quality has been obviously improved As at Dec 31 st

2009, the total credit balance stood at 354,112 bn VND, up by 24.4% against 2008 and up 2.2 times against 2005 and up by 46.2% against 2007

Credit analysis is detailed as follows:

2.3.1.1 Loan structure by economic regions

Big proportions of outstanding belonged to key regions such as Hanoi, HCM city, Southwest region The credit balance rate by regions did not change too much

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

[Source: Agribank’s Annual report in 2009]

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

Loans to State-owned were down from 11% in 2005 to 7.5% in 2009

Meanwhile, loans to non-state businesses and co-operatives increased from 29.2% in 2005 to 40.4% in 2009

Household financing over the year has covered the biggest proportion out of the total outstanding In 2009, household and individual outstanding was 183,472 billion VND, up by 27,787 billion VND (17.8%), covering 51.8% of total outstanding

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

(Source: Agribank’s Business Summary Report for the years 2005 to 2009) 2.3.1.3 Loan structure by terms:

The rate of short-term loans/total outstanding as compared to that of medium and long-term loans over the years has been relatively stable at 60/40 Agribank in the coming time targets to reduce the outstanding of medium and long-term loans and expand short-term loans to mitigate risks By the end of 2009, AGRIBANK’s short-term rate covered 60,3%,

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

Credit balance in local currency made up over 90% of the total balance and was nearly stable over the years

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

2.3.1.5 Loan structure by economic industries:

Table 2.7: Loan structure by economic industries:

The credit balance for labor export covered 144 billion VND with bad debts accounting for 10.4 % while the common bad debt rate was 2.6% This high rate of bad debts resulted from the number of laborers forced to return prematurely (50%), late repayment of customers (20%), and other reasons (30%)

The agricultural and rural market continued to be the major market with million household borrowers

2.3.2 Credit quality 2.3.2.1 Credit quality by terms

Short-term bad debts: 5,164 billion VND, covering 2.42% of total short-term outstanding and 1.46% of total outstanding

Medium and long-term bad debts: 4,102 billion VND, making up 2.92% of total medium and long-term outstanding and 1.16% of total outstanding

2.3.2.2 Credit quality by economic regions

Regions such as mountainous and bordering areas, formerly Region 4, HCM city suffer from bad credit quality due to the high rate of bad debts over total outstanding

2.3.2.3 Credit quality by enterprise types

Bad debts of enterprises: 5,160 billion VND, covering 55.6%/ total bad debts of the system and 2.8%/ total enterprises’ outstanding, up by 2,076 billion VND against December 31 st 2008

Bad debts of households and individuals: 4,100 billion VND, in which bad debts of group 3 included 1,414 billion VND, covering 45% of total group-3 debts; bad debts of group 4 covered 2,432 billion VND, covering 43% of total group-4 debts; bad debts of group 5 made up 1,644 billion VND, covering 44% of total group-5 debts

The increase of bad debt rate and a high proportion coverage in financing households and individuals resulted from constantly force majeures occurring in

2009 (natural disasters, diseases) in agricultural, forestry and fishery production in the Central, Central Highlands and Mekong river delta

Some branches had low bad debt rates of less than 1% such as Southern Hanoi, Hoàn Kiếm (0.3%), Hưng Yên, Sài Gòn (0.5%), Nghệ An (0.6%), …

As at December 31 st 2009, there were 21 branches all over the system holding the past-due rate of more than 5%/total outstanding Some of thems are: Tân Bình

(9.1%), North of Hanoi (10.2%), West of Hanoi (10.4%), Branch 11 (11.7%), Branch 10 (12.2%), especially Đông Anh (19.7%)

Below is the table of debt classification by groups over the years to more insightfully demonstrate the debt classification and credit quality of Agribank

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

In 2008, under the negative impacts of the economic crisis, the ratio of NPLs stood at 2.71% of total credit balance In 2009, NPLs decrease lightly at 2.62%

However, as can be seen from the above statistics, the bad debt rate over total outstanding of 2009 reduced a little bit against 2008, but from an absolute calculation, it increased 1,567 million dongs Comparing with previous years

(2007, 2006), the bad debt rates over the years considerably increased in terms of both relative and absolute figures In 2009, rates of debts classified in groups 2 and

5 increased as compared to 2008, in which debts of group 2 covered 13% of total outstanding

In addition, in terms of bad debt rate increase as compared to the outstanding growth, it can be seen that the defaults of 2009 increased by 20% against 2008, which is a pretty high rate, nearly equal to the outstanding growth (24%) Thus, there should be measures to improve credit quality in Agribank

Although Agribank carried out some uniform implementation of measures to control and mitigate bad debts such as: accurately assessing customers and classify debts, closely monitoring credit quality for each loan and each customer; restraining loans to customers with bad debts; actively instructing debt recovery; handling with collaterals for recovery; restructuring loans, risk handling and debt trading, etc., the bad debt is increasing

Agribank will continue to ensure credit quality at targets: bad debts of less than 5%, reduction of debts classified in group 2 over total outstanding

The bad debt rate of 2009 stood at the permitted level (less than 5%)

However, as currently analyzed, there are signs of some highly risky loans such as loans to Finance Leasing II & I Company, Vietnam Shipbuilding Industry Group (Vinashin) Such loans have not specifically classified and will raise the ratios of bad debts after classification

The result of loan classification reflects quite clearly the quality of loan quality because it can be seen that loan classification and provision for impairment loss are made based on quantitative criteria on overdue time, but it can be sure that it does not reflect completely and correctly quality of each loan It is the warnings that Agribank should pay more attention to the credit quality

Comparisons of bad debts with other banks in VN & Regional banks as below:

Table 2.9: Ratios of NPLs of CBs in 2009

CBs in Vietnam NPLs (%) CBs in region NPLs (%)

Industrial & Commercial Bank of China Limited ICBC 2,29

(Sources: annual reports of those banks in 2009)

As above analyzed, it can be seen that Agribank’s bad debts cover a high proportion as compared to other local banks Regional banks have very low ratios of bad debts except for Bangkok bank

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

Table 2 10: Agribank’s provision for impairment loss

Agribank has been complying with SBV’s regulations and closely followed international practices in debt classification and setting aside of provisions It has also taken actives steps in recovering outstanding corporate debts under the directions of the Government and the SBV Since 2005, Agribank has made provision for credit loss in accordance to Decision 493/2005/QĐ-NHNN In 2008, the provision increased to 7,410 billion dong, a rather high provision to be made because of the financial crisis It can be seen that Agribank’s financial capacity of

Provision/ NPLs 117.01% 136.61% 96.25% 81.4% controlling risk was enhanced In 2009, the bank set aside 7,551 bn VND of provisions, up against the 7,410 bn VND of the year 2008

Agribank tried to fully book provisions as prescribed with provisioned amounts increasing over the years The insufficiently accounted provisions have decreased over the years From 2006 till 2009 Agribank fully booked the provisions However, the general reserve has not fully accounted by Agribank

However, as per Article 9 Decision 493, banks are allowed to book general provisions within 5 years since the effectiveness of this Decision (May/2005)

2.3.3.2 Methods to deal with bad debts

+ Risk handling: in 2009: 4.183 billion VND, accounting for 45.1% of total bad debts

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

+ Debt recovery over the years:

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

+ For irrecoverable debts, AGRIBANK strongly determines to classify them in group 5 to refresh the asset balance sheets

+ For state-owned enterprises under the equitization process facing difficulties in balancing sources for repayment of debts, the bank may consider cancellation of debt interest but the principal outstanding must be still repaid by the takeover or transferred to share contribution of the bank upon prior negotiation

+ Debt trading: AGRIBANK has strongly and aggressively sold off bad debts and suspectedly irrecoverable debts to its Debt and Asset Trading Company and others, partially reducing bad debts accounted in balance sheets and best recovering off-balance sheet debts, considerably increasing the bank’s profits

+ Exemption from and reduction of suspension interest is used as a solution to encourage customers to pay principals off to purify the bank’s finance.

Status quo of credit risk management in Agribank

2.4.1 Credit organization structure and risk management:

* At the Head Office: The credit risk management organization structure at the

Head Office is as follows:

Internal Audit Committee (Independent credit inspection and monitoring) is a unit under control of internal inspection and audit board, operating independently from operational credit units in order to manage credit risks objectively

Credit Board functions to provide consultancy to Board of Directors, CEO in management and instruction of local guarantees, short and long-term investments, market expansion, study and propose recommendations on improving lending

Deputy General Director in charge of credit

- Departments related to credit activities procedures in the direction of facilitating customers in order to develop business safely and profitably

Risk Prevention and Handling Center assists Board of Directors and CEO in collection, provision, archive and analysis of risk prevention information, collection and recovery of risks in business operations of the whole system

The risk management system in branches consists of three major sectors directly joining the risk management process

- Independent credit inspection and monitoring team

Branch Director is responsible for governing business operations in general and credit approval in particular under his delegated power; reviewing assessments submitted by Credit Department for consideration of approval, signing credit contracts and loan security contracts; deciding over measures on debt recovery: debt extension, restructuring of repayment terms, past-due classifications, corrective actions towards customers

Credit Department: undertakes to study and develop customer credit policies, classify customers and propose priorities for each type of customers; collect information about and analyze credit activities on a quarterly and annually basis; frequently classify debts, analyze past-dues, trace reasons and propose corrective actions; draft preliminary and summary reports; act as the key contact to prevent and handle with credit risks; prepare business strategies, assess and propose lending as delegated; cooperate with Internal Audit Department in internal inspection of branches in the area, topic-based reports and inspections as prescribed

The independent credit inspection and monitoring team operates under the control of the Internal Inspection and Audit Department of Branches independently from Credit Departments This team is responsible for assessing the risk degrees of credit portfolios and risk management procedures from the commercial viewpoint of each operational department; frequently inspecting and assessing the compliance with laws, provisions of the State Bank and regulations and policies of Agribank in terms of credit aspects in Branches to timely detect violations, discrepancies and shortcomings in credit activities and accordingly propose corrective actions; inspecting and assessing credit activities of Branches on a regular basis; setting out preventive measures to avoid new violations; making recommendations to improve policies, regulations and procedures to the Operations Center for research and implementation; acting as the contact person and collaborating with inspection and audit teams of Operations Center, externals and inspectors of the State Bank; preparing reports in accordance with its functions and tasks regularly or extraordinarily at the request of Directors and Operations Center

One of the most efficient measures to manage credit risks is to set out a standard and appropriate credit process and to fully, precisely and strictly comply with that process Lending process in branches is subject to the one described in Agribank’s credit handbook, regulatory documents issued by the Government, the State Bank and Agribank such as:

- Decision No.1627/2001/QĐ-NHNN by the Governor of the State Bank dated December 31st 2001 on lending regulations of credit institutions to clients

- Decision No.286/2002/QĐ-NHNN by the Governor of the State Bank dated April 03rd 2002 providing regulations on co-financing of credit institutions

- Decision No.666/QĐ-HĐQT-TD dated June 15th 2010 regarding lending regulations to customers in the system of Vietnam Bank for Agriculture and Rural Development and relevant documents

- Decision No.1300/QĐ-HDQT-TD dated December 3 rd 2007 on loan security

Credit procedures in branches are conducted in the following steps:

Step 1: Credit officers directly receive loan applications from customers, undertake to compare with the application portfolio as prescribed, check the legality and validity of each application and report to Credit Department Manager or Head of credit team

Step 2: Credit Department Manager or Head of credit team assign officers to assess conditions of loan applications

 Capacity for civil legality, civil acts and civil liabilities in accordance with regulations of the laws

 Financial capability to secure due repayments as committed

 Feasible and profitable investment projects/ business plans or feasible investment projects/ business plans for serving lives in line with a feasible repayment solution

 Compliance with regulations on loan security as prescribed by the Government, Governor of the State Bank and guidelines of Agribank

Step 3: Credit Department Manager or Head of credit team is responsible for checking loan applications, legality and validity thereof and assessing reports submitted by credit officers, reviewing and re-assessing (if necessary) or directly assessing in case of any pluralism as a credit officer, giving comments in assessment reports, reassessing (if any) and submitting to Director for approval after credit officers have completed assessment reports and submitted to Credit Department Manager

Step 4: Branch Director, basing on assessment/ reassessment reports (if any) submitted by Credit Department, decides to approve or refuse the credit granting and transfers to Credit Department

Step 5: Loan applications approved by Branch Director are then sent to accountants for accounting and payment operations or to Vault to make disbursements (in case of lending in cash)

Step 6: After disbursements, credit officers perform inspection of loan use

Above are general regulations and processes applied in Agribank However, the compliance with credit procedures on branches may vary

2.4.3 Regulations on customer classification as currently applied

Currently, credit rating and customer classification procedures of Agribank are subject to guidelines as per Decision No 1406/NHNo-TD dated May 23 rd 2007

The purpose of such provisions is to classify customers by quantifying customers’ risk degrees via an evaluation process with a uniform scoring grid upon customers’ financial and non-financial information Credit rating and customer classification are conducted to assist the bank in:

- Classification for filtering and development

- Credit granting decision-making, determination of credit lines, loan tenor, interest rates, service fees, collaterals thereof

- Monitoring and assessment of the customers’ outstanding for anticipation of loan quality and set-out of corrective actions; Improving Agribank’s management capability in lending, debt collection and risk handling

According to these regulations, based on different features of customer groups, Agribank classifies customers in 2 groups: corporate and individual (individuals and households)

The model of customer classification applied now in Agribank’s system is quite simple: For corporate customers, there are 5 basic indicators, including 4 quantitative indicators to reflect customers’ financial situation and reputation in credit relations with the bank:

+ Positive profit, equal to or more than the previous year: rated A + Positive profit, less than the previous year: B

Owner’s Equity/ Total Equity Level

- Bad debt ratio with AGRIBANK:

- Qualitative indicator reflecting the enterprise’s compliance with laws

+ Enterprises with no law breakings: A + Enterprises concluded by competent authorities to break the existing laws but not to the level of a fine penalty: B

+ Enterprises breaking the laws to the level of criminal liability: C For households and individuals, classification is made via 2 indicators namely the bad debt ratio with Agribank and level of compliance with current laws

A-rated customers are given more priviledges to be granted with credits without collaterals or priorities of interest rates or service fees as per regulations of Agribank

B-rated customers may also be granted with partial credit unsecured by collaterals The proportion of credit unsecured by collaterals must not exceed 50% of total granted amount Priorities of interest rates and service fees can be considered

For C-rated customers, outstanding must be graduallu reduced and loans must be secured by collaterals No priorities of interest rates and services shall be applicable

2.4.4 Some shortcomings in credit risk management

2.4.4.1 Shortcomings in provisioning and risk processing:

The bank deals with risks by transferring irrecoverable debts with annually increasing outstanding to off-balance sheets Even though it indicates the bank’s activeness in coping with credit risks, it also reflects that credit risks in Agribank are still at a high level The increase of provisioning amount and risk processing over each year raises the bank’s capital costs and reduces its profits

The default rate of less than 3% throughout the system but too high rates in some branches as above analyzed show that credit risk management has not been uniformly deployed, the bad debt rate is low but not sustainable In the first half of the year, the bad debt rate of the whole system is 4.1% while it was only 2.67% in late 2009 It is still a situation in some branches that in order to reach the financial targets, irrecoverable debts are not paid enough attention to be recovered but focus is paid much more on recoverable ones, then efforts are made to clear up off- balance sheet loans If this method is abused for a long time, it will create a bad antecedent and will not reflect the nature of credit risks and risk processing

2.4.4.2 Shortcomings in credit policies, customer policies and customer classification

Agribank’s development goals and orientation in terms of credit

Agribank set out its strategic orientation of credit management and risk mitigation as at 2015 and vision up to 2020 as follows: “Growth must go hand in hand with quality control and security assurance in credit activities, credit increase must go in line with: development of banking services, fostering of trade finance, deposits, and expansion of service scope to private enterprises and inhabitant businesses in accordance with the market economy Be initiative in determining types of investment and sectors to finance to create an appropriate and stable structure for the operations of the whole system”

In order to adapt to capital demands for economic development in general and for agricultural, forestry, fishery and salt production, and rural economy, household production in particular, Agribank defines its strategy to be still holding its prime role in the rural credit market (70%), which has long been regarded as the traditional market of Agribank; Simultaneously, improve its position in he market of industrial and open economic zones On implementing the objective of safe and efficient capital supply, Agribank continues to make a comprehensive restructure with reasonable customer policies which secure all rational benefits of both the borrowers and the lenders In the customer policy, more focus is paid to agricultural export enterprises; small and medium-sized enterprises, farming economics, as well as producers and farmers in general

Agribank also continues to foster its network development to communes, metropolitan areas for the convenience of credit transactions with farmers The mechanism of partially fiduciary lending via groups of socio-economic- professional organizations continues to be improved to facilitate credits to farmers

Reinforce the synergy of the whole system; attach much more importance to frequently improving the quality of existing operations, especially traditional credit and payment services; comprehensively strengthen the cost-accounting regime and thrift practices At the same time, create every favorable condition to expand new types of business, initiated with trading of real estate, foreign exchange, pledge, production joint venture, international settlements, safe box, remittance, trading of gold, silver and fine arts, insurance, securities, etc.; achieve the profit targets, improve discipline and solidarity, efficiently fight against and prevent bureaucracy, embezzlement, waste of labor and money, maintain the business reputation

Build up the independent and centralized Risk Management system in accordance with international standards, consolidate the system of internal inspection and audit Have Asset Liability Committee (ALCO) and Risk Management Committee established Foster partnership with other commercial banks to set up risk distant forecast agencies

Continue to maintain the treasury growth rate of 15-20% per year and capital use of 16-18% per year; diversify and enhance the quality of credit products and banking services as well as customer segments to increase the proportion of income from services The focus on improving the quality of credit growth must be associated with safety and profitability in order to increase competitiveness, meet the requirements of economic restructuring, innovate banking activities, promptly adapt to the new business environment with affordability for competition and development

Continue to hasten the schedules of training and developing human resources to meet the short-term as well as long-term needs of business operations in general and credit activities and risk management in particular, such as: standardize qualifications of each operation so that measures on training and developing human resources as well as policies to attract talents may be set out; provide management levels with training courses to improve the governance and risk management capability all over the network; focus more on upgrading educational levels and professional operations of the bank’s management and staff.

Measures to improve the efficiency and effectiveness of credit risk

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

Chartered capital supplement reserve fund 159 239 325 414

Other debt instruments with maturity of 10 years 4,043 4,376 4,376 4,376

(Sources: Agribank’s report from 2006 to 2009)

Equity capital plays an important role for CBs as it helps boost a CB’s financial capabilities to international standards Although it is a financially powerful Commercial ban, Agribank’s capabilities remain modest compared with regional peers Under the Law on Credit Institutions, a CB’s investments in fixed assets cannot exceed 15% of its equity capital Besides, there are also restrictions on credit extension, guarantee, etc Therefore, it is important for Agribank to increase its capital, which can be done by a number of measures as follows:

- First, increase tier-1 capital This can be done by requesting additional funds from the State budget; recovering debts which are either outstanding debts or have been accounted for as off-the-balance-sheet items and in respect of which funds for handling have been provided by the Government

Increase funds which are included in tier-1 capital such as reserves for additional charter capital, financial reserves, operational development and investment funds

- Second, increase tier-2 capital Continue to issued bonds at competitive interest rates to increase tier-2 capital;

Re-value fixed assets: this is an active, fast and efficient way to increase tier-2 capital as most of Agribank’s fixed assets are real estates If this is done properly, the bank’s tier-2 capital will increase significantly

3.2.2 Complete credit operation and risk management structure

Currently in AGRIBANK, credit operations and risk management have not been separated Loans are all approached, validated, as well as supervised and managed by credit officers That credit officers collude with, pay bureaucracy to, harass, require loan sharing with customers has occurred and are only identified once risks have already arisen Accordingly, the present credit organization of AGRIBANK reduces the close supervision of credit risk management

In order to mitigate credit risks, the credit activity organization from the Head Office to branches should be built upon the principles of: clearly defining functions, tasks, rights and responsibilities of relevant units and individuals involved in the process of credit assessment, approval, and debt monitoring, management and recovery

- So as to efficiently manage credit risks systematically, the bank should complete its management and risk monitoring system in the following structure:

 Board of Directors Board of Directors via Risk Management Committee is responsible for approving the bank’s risk management policies and monitoring the implementation of such policies

 Risk Management Committee Risk Management Committee is founded by Board of Directors and is responsible for reporting to Board of Directors on key issues related to all different types of risks Risk Management Committee undertakes the review and approval of the bank’s risk management scope including security policies, risk limits and measures on credit risk management

 Board of Management and management levels Board of Management and management levels play key roles in definition and assessment of risks related to the bank’s operations and effective implementation of risk monitoring

Risk management board is a tool of Board of Management and is responsible for management and monitoring of the bank’s risks This board is independent from business units of the bank and is not involved in creation of risks, but holds the key responsibility for establishment of credit limits for the entire system with coverage of all aspects such as credit risks, market risks and operational risks

Risk management board holds key functions to identify and detect risks, analyze, evaluate and measure risk levels, and at the same time set out measures on mitigating risks

Credit management board is an instrument of Board of Management and is responsible for credit management including: setup of credit and guarantee mechanism, policies and processes, credit and guarantee limits; management and recovery of the bank’s bad debts

Internal supervision board is an instrument of Board of Management and is responsible for immediate direction and internal inspection of the bank on all operational aspects including credit operations

Credit organization structure must be developed under the orientation of: separating the functions of credit decision-making with those of credit management on the basis of clearly allocating responsibilities and functions among units of credit assessment, credit approval, credit management, credit risk management

Divide credit units into specialized departments as follows:

Units of credit risk rating, portfolio reporting and policy under credit management department shall respectively have the following functions:

Customer relation department Risk management department

- Focus on doing the marketing, approaching, receiving demands of customers, then guide them to complete loan applications

- Provide the risk management department with information

- Inspect and monitor customers’ compliance with commitments (loan use, collateral)

- Define credit limits (credit rating, sector analysis, development ability), anticipate possible risks of the loan

- Analyze and assess loans independently, and give comments on credit granting

Submit to authorized levels for credit approval

- Monitor the implementation of credit decisions of customer relation department

- All credit applications must be archived to ensure the uniformity and subjectivity of credit files to avoid any possible amendments of credit files after approval

- Classify debts and define bad debts

- Report risk, loan classification, credit quality

- Rate credit risks and prepare a portfolio report

 Risk rating and portfolio reporting unit:

- Review ratings applicable for all loans and report on requirements of loan ratings and provisioning

- Maintain the rating system, supporting and management instruments

- Assess risks of new products

- Monitor the quality and components of loan portfolio, especially the highly sensitive or risk-weighted areas

- Develop mechanisms, texts (credit risk management policies, debt classification policies, provision policies), join the development of credit policy, customer policy, credit processing procedures, etc

- Review, improve and adjust the credit assessment procedures of the bank

- Approve sector limits and regional limits

- CIC: maintain relations with CIC and collect information

 Establish a team for macroeconomic study, analysis and forecast under risk management department

As aforementioned, a big proportion of credit risks results from shortage or inaccuracy of information from customers or careless processing of market information To avoid risks caused by this reason, Agribank should establish a team for macroeconomic study, analysis and forecast, who will work on all channels and sources of research and forecast to give out:

Macroeconomic research/ analysis and forecast team

Credit risk management strategy, customer strategy and credit capital investment strategy

Analyze and assess the scale, structure and credit profitability of economic industries and rural and urban sectors

 Establish the Legal team and Recovery team under credit management department

The Legal team is responsible for providing Risk management department and recovery team with consultancy of legal issues

The situation of a huge number of balance-sheet bad debts and provisions of Agribank indicates that one of the reasons for this situation comes from the bank’s unfulfillment in loan management and recovery, so provisions have been booked for settlement In order to solve this situation and mitigate arising bad debts, Agribank should deal with the following issues:

- Firstly, there should be specialized staff in level-1 branches to process and recover problematic debts (including both balance sheet and off-balance sheet ones) They may be called Recovery team so that problematic debts can be recovered thoroughly Staff of this team should not be assigned to engage other jobs but fully spend their time on debt collection and recovery (there should be an excellent lawyer in settlement of economic disputes in such a team)

- Secondly, as debt collection and recovery are different from the fundamental lending and assessment, the bank should send staff of debt recovery team to specialized training courses to upgrade their knowledge and experiences Along with deeply grasping knowledge of credit regulations and procedures, staff of this team should also have in-depth knowledge of laws and ability to analyze customers’ psychology and convince them

- Thirdly, debt recovery team should review loans carefully as per monthly credit reports prepared by credit officers, then analyze and classify loans in groups 1,2,3,4 and 5 Group 1 includes performing debts, group 2 consists of watched debts, group 3 contains sub-prime loans, group 4 includes doubtful debts and group

5 is comprised of potentially irrecoverable debts

- Fourthly, Agribank should delegate power to this team to apply any remedies as prescribed by existing laws to recover debts in the most efficient manner

Policy recommendations to improve commercial bank’s credit risk

Support from the Government, and relevant levels and industries is of great importance The Government should have strong supporting measures on legal regulations so that commercial banks in general including Agribank expand their business activities, mitigate risks, purify the financial and monetary market, ensure the sustainable development of the economy to integrate into the world economy

The thesis proposes the following recommendations:

Firstly, the Government should improve the legal system and law enforcement agencies should be more aware of their responsibilities for enterprise management, business management, cooperate with banks in prevention of defrauds and intentionally using borrowings with wrong purposes, share with banks the risks that are pushed into banks by the economy

Secondly, the Government should issue regulations on cooperation among tax agencies, audit offices, consultancy companies and banks in clarifying and transparenting customers’ financial statements to avoid the situation that an enterprise creates a number of statements to apply for bank loans

Thirdly, the Government, the State Bank, relevant ministries and authorities should have more definite and determined directions to help commercial banks including Agribank to quickly recover hundreds of billion of bad debts Up to now, a great number of assets being real estates related to legal cases have been declared by courts to be transferred to Agribank for debt recovery, but in fact, execution has not fully performed due to procedural obstacles The Government and relevant ministries and agencies are kindly requested to enable commercial banks and enterprises to perform loan security obligations, process collaterals for debt recovery, especially assets owned by state enterprises

Finally, the debt trading market in Vietnam has not much developed, which results in the uncompetitive prices and limited number of transactions Legal documents should be improved so that debt trading companies are put into operations and relieve the accumulatively blocked funds over the years and assets mortgaged or pledged with the bank Financial organizations transfer the assets to such companies under the commission form on the basis of transfer contract as agreed by parties to help commercial banks including Agribank to recover the debts and exploit such blocked funds effectively Foundation of debt trading companies is of great necessity to cope with blocked funds for commercial banks, Agribank, which accordingly may diversify credit contracts

The State Bank plays a huge role in introducing the general strategy to commercial banks The thesis proposes some recommendations to the State Bank as follows:

Firstly, the State Bank should build up and improve strategies of risk management policies properly A comprehensive reform of factors affecting the risk management capacity, including planning and developing risk management strategies and policies should be performed There should be directions and guidance to credit institutions to systematically develop indicators and forewarned limits of potential risks in credit activities to restrain or prohibit lending because the risk is too high or at the cut-off point (i.e reaching the maximum limit for each specific sector or enterprise)

Secondly, the State Bank should coordinate with other ministries and agencies to complete the system of international accounting standards (IAS)

Measures on improving internal inspection and audit methods among commercial banks should be developed and proceed to the international practices Because the accounting system applicable to Vietnam’s credit institutions only complies with about 50% of international accounting standards, there are differences in indicators of provisions to be booked in the context of supervision as per Vietnam accounting standards (VAS) and IAS Therefore, to prevent commercial banks from conducting the audit in both VAS and IAS, the State Bank should propose the Finance Ministry to urgently promulgate Vietnam accounting standards with presentation, recognition and measurement of financial instruments in compliance with IAS

Thirdly, the State Bank should issue regulations on management of lending to the same customer by commercial banks to support and cope with issues that regulations on syndicated lending have not covered

Finally, the State Bank should clearly and strictly force credit institutions to provide information such as outstanding status, repayment capability, bad debts, collaterals of customers including organizations and individuals to CIC CIC should be required to exploit various sources of information about enterprises and frequently give warnings bout problematic customers for recognition and prevention of commercial banks

Credit risks are complicated and diversified, consisting of both controllable and uncontrollable ones Credit risks may originate from subjective and/or objective reasons Consequences of credit risks are often severe So the seeking and applying appropriate preventive measures to mitigate risks and minimize damages are of great importance

In its credit activities Agribank has been applying a number of active measures on prevention and management of risks to minimize any damages caused by credit risks and increase profitability However, Agribank’s bad debt is increasing, the credit risk management shows some shortcomings The question of how to handle NPLs and create a strongly healthy credit environment in Agribank is a big question that needs time to answer

All the analyzed findings about the current situation in credit risk management practices in Agribank , together with knowledge I grasp during my study and research as well as experience as a credit officer over the last 5 years, I would like to recommend some measures to improve the efficiency of credit risk management in Agribank for sustaining its viability and competitive advantages in the banking market as well as in the country’s international integration process

Research’s shortcomings are unavoidable It would be my honor to receive any of your contribution and comments Thank you very much!

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5 Univ.Doz.Mag.Dr Josef Christl and Dr Kurt Pribil (2004), “Credit Approval Process and Credit risk Management, guidelines on credit risk management, Oesterreichische National Bank (OeNB) in co-operation with the Financial Market Authority (FMA)

6 Tran Dinh Dinh (2008), Credit risk management in banking according to standard, international rules and Vietnam regulations, judiciary publisher

7 Dr Nguyen Huu Thuy, “Some measures to improve the control of creit activities in commercial banks”, PhD Thesis, 2007

8 Vietnam Bank for Agriculture and Rural Development, “Credit handbook”, 2004’

9 Vietnam Bank for Agriculture and Rural Development, “Annual report”,

10 The State Bank, “Reports on Deposits”, 2009

12 Commercial banks’ annual reports for 2009

13 State Bank of Viet nam, “Decision No 493/2005/QD-NHNN on issuing regulations on making loan classification, making impairment loss and using provision to handle credit risk in banking operation”, 22/4/2005

14 Websites of Commercial Banks, including: