Credit risk management at the branch of china bank in hochiminh city vietnam

l[ji+,~iiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiii.'t HCMC UNIVERSITY OF FOREIGN LANGUAGES AND INFORMATION TECHNOLOGY DEPARTMENT OF INTERNATIONAL BUSINESS ADMINISTRATION GRADUATION PAPER l CREDIT -RISK MANAGEMENT AT THE BRANCH OF CHINA BANK IN HOCHIMINH CITY~VIETNAM \ Student's Name: Ly Le Lan Class: KD0207 JULY 2005 I • Ho Chi Minh City July 6,2006 ADVISOR'S COMMENTS Student's Name: LY Li; LAN - KD0207 Paper Title: CREDIT-RISK MANAGEMENT AT THE BRANCH OF CHINA BANK IN HOCHIMINH CITY - VIEJNAM Practicality Credit activities are in fact the major activities of any banks However, these activities also contain a lot of risks The paper that focuses on the credit-risk management of the branch of China bank in Vietnam meets the practical requirement of a research paper for graduation fj'om university Content Apart from the introduction and conclusion, the paper consists of chapters that are arranged in a logical way The first chapter provides the general concept of credit activities 'and the risk that is involved The second chapter introduces the' branch of China bankin Ho Chi Minh city and its credit-risk management including assessing risk, measuring risk and controlling risk The last chapter offers two groups of suggestions: one for credit-risk management and another for developing the bank: The two are intel.twined and seem to be.feasib)e Presentation The paper is ilh.istrated clearly The techniques references are acceptable General of paging, making footnotes and Assessment In terms of applying financial knowledge harvested from university into a specific case, the paper is successful in making the analysis on the way a specific branch of bank manages its credit risk, and in making some feasible recommendations to control the credit risk it is facing The presentation of the paper is good and made in an acceptable way Suggested Grade: Excel/eTl/ • Dr TRAN DUYEN ElJNH .r COMMENTATOR'S ASSESSMENT r • ACKNOWLEDGEMENT After four years of studying, I would like to express my gratitude to all professors ofHUFLIT who have taught and provided me valuable knowledge and • experience Also, I would like to send my special thanks and show my deep gratitude to my advisor-Dr Tran Duyen Dinh, who has devoted to give me advices, guidance and encouragement so that I can complete this paper with the best utmost I also thank all of the staff of the Branch of China Bank who have created all good conditions and supplied me necessary documents to finish my paper , , After all, from the bottom of my heart, I am really grateful to my parents, my brothers and sisters, as well as all my friends who have helped and encouraged me • to continue studying this paper Thank you so much again! Ly Le Lan II ABSTRACT Nowadays, the economy is getting more and more competitive, especially when Vietnam is preparing to become a member of WTO, a world-wide business environment In order to survive, companies need to improve its productivity as well as its capacity They need more capital to develop their companies They can raise their capital by issuing stocks, capitalizing, or some other forms Among them, banks seem to be an important and popular source of providing credit loans for them The credit activities are major activities that bring back much revenue for banks However, the higher the return is, the more risks banks have to face Banks should consider the relationships between credit risks and other banking risks The effective management of credit risk is a critical component of a comprehensive approach to risk management and essential to the long-term success of any banking organization As we know, exposure to credit risk continues to be the leading source of problems in banks So, banks should have a keen awareness of the need to identifY, measure, monitor, and control credit risk as well as to determine that they hold adequate capital against these risks and that they are adequately compensated for risks incurred iii CONTENTS Page • • A ckno wIedgem ent - - 11 • Abstract - 111 • Contents IV • List of figures - IX INTFtOl)lJCllION I Objectives of the Topic - I Scope of the Topic Research Method Contents - CHAPllEFt GENEFtAL CONCEPll OF CFtEI>Ill ACllIVIllY ANI) mSKS AI Credit and Classification of Credit - 1/ What is Credit? - 2/ Classification of Credit 2.1- Purpose of the Loan ~ 2.2- Tenor/Maturity - 2.3- Customer's Creditworthiness IV 2.4- Payment Method - BI Credit Risks Management and Major Types of Risks in Banking 10 1I Definition - 10 1.1- What is Credit Risk? 10 1.2- What is Risk Management? 12 21 Maj or Types of Credit Risk - 12 31 Other Types of Major Risks in Lending 12 3.1- Liquidity Risk 13 3.2- Market Risk 15 3.3- Interest Rate Risk 16 3.4- Earning Risk 17 3.5- Solvency (or Default) Risk - 18 41 Major Causes that make Banks Fail - 18 4.1- Subjective Causes - 18 4.2- Objective Causes -~ 21 51 Damages Caused by Risks 22 5.1- To the Banks 22 5.2- To The Economy 23 Summary -~ ~ ~ 23 v CHAPTER CREDIT RISK MANAGEMENT AT THE BRANCH OF CIDNA BANK IN HOCHIMINH CITY AI An Overview of the Branch of China Bank in Hochiminh City 24 24 1/ Establishment - 24 21 Scope of Activities - 25 31 Products and Services 25 41 Organizational Chart of the Branch of China Bank in Hochiminh City - 27 BI An Overview of the Credit Activities at the Branch of China Bank in Hochiminh City - 31 CI Risk Management at the Branch of China Bank in Hochiminh City 34 1/ Assessment of Credit Risk - 34 1.1-"Credit Policy 34 1.2- Credit Granting Criteria 36 1.3- Credit Administration and Monitoring Process 38 21 Measurement of Credit Risk - 39 2.1- General Credit Process - 40 2.1.1- Credit Granting Proposal Letter 40 2.1.2-Credit Analysis 41 2.1.3- Credit Decision - 46 2.1.4- Money Issuance - 47 vi 31 Control of Credit Risks - Summary - 47 49 CHAPTER SOME RECOMMENDATIONS FOR CONTROLLING THE BRANCH OF CHINA BANK IN HOCHIMINH AI Recommendations for Credit Risk Management CREDIT RISKS AT CITY - 50 - 52 1/ Diversification - 52 21 Have a Clear "Definition" of Target Customers 53 31 Set Provision Fund for Loan Losses 54 41 Set a Sensible and Structured Credit Policy - 54 51 Establish a Group of Legal Officers 55 61 Self-Insurance - 56 71 Credit Insurance - 56 BI Recommendations for Developing the Bank 57 1/ Build Website for the Bank 58 21 Issue a More Specific Brochure or Booklet about the Credit Granting - 59 31 Organize Meetings to Launch New Services or PR about the Bank -~ - 60 41 Invest in Banking Industry - 61 51 Monetary Trade 61 VII 6/ Establish a Group of Professional Internal Auditors - 62 7/ Training and Developing Employees ~ 62 Summary - 63 CO N CL USI N 64 ~IC~~NC~ 65 viii I , I creditors, board members, etc So, managing risks, eventually, are reducing losses, protecting their profits, and developing their business In general, credit is the major activity of the bank that contributes a significant amount of profits for the bank More than 70% of the bank's revenue comes from loans In return, the more the rate of return is, the higher the risks the bank will face We all know that credit risk is the risk due to an uncertainty in the borrower's ability to meet its obligations In actuality, there are many types of borrowers, from individual, company, to sovereign government body And there are many different types of obligations as well So, credit risk takes many forms Banks manage it in different ways Each bank will, of course, have its own risk management policy and principle Here, I would like to suggest some recommendations that I could learn from many sources and from the bank itself Due to limited knowledge, I hope that these recommendations are helpful for the bank - 51 - A- Recommendations for Credit Risk Management 1/ Diversification Diversification of risk is a key percept in banking This idea comes from the principle ofInvestment, it is "Never put all your eggs in one basket" As we have known, the quantity of customers of the bank is not much large Most of them are nearly in the same industry This is nota sound thing for.the safety of the bank's credit activities, because whenever there is one fluctuation of the economy of the world domestically or internationally, they will be affected and, therefore, there will be a strong impact to the bank's revenue from those loans In addition, the major revenue of almost every bank comes from granting credits, more than 70% of the total revenue So, managing risks in granting credits plays an important role in the bank's activities It is vital that the bank should prevent all exposures from granting credits as much as possible One of that prevention is to diversify the business of counterparties who want to get ~redit loans from the bank The aim of this prevention is to avoid the "domino effect" in the customer portfolio from credit loans, which will be in stuck in the receipt of repayment when there are fluctuations of the economy We can enhance our customer portfolio from credits to other various types of industries Moreover, diversifying helps the bank has more choices in finding more new counterparties from other businesses In conclusion, diversifying the bank's portfolio is one way of preventing risks - 52- 2/ Have a Clear "Definition" of Target Customers As we know, the majority customers of the bank are Chinese and Taiwanese companies It is somewhat general, not really specific It is just about Chinese and Taiwanese companies Unfortunately, there are many Chinese and Taiwanese firms in Vietnam When they apply for credit granting policy, we have to spend time analyzing them, short-listing them and then after that, if they are unqualified, we have to say sorry to refuse them This thing, to some extent, will affect the relationship between counterpartiesand the bank It is wisely that we first have a clear set of requirements or conditions for t~e counterparts who want to get credit loans, and then just compare their conditions and accept to continue to deeply analyze or not Moreover, market segmenting about target customers is also very important We should choose which segment of customers we will enter Because, segmenting customers like this way will help us much more quickly in finding and accepting customers who want to get credit loans at the bank In addition, segmenting customers like this way will also help us know which market the counterparties are in, middle market lending or highly developed market, which sizes of operations they take, etc - 53- I f I 3/ Set Provision Fund/or Loan Losses In order to manage risks in credit activities, a bank should prepare for loan losses by building up loan-loss reserves (the allowance for loan losses) through annual charges against current income (the provision for loan losses) This can be considered another source to cover loan-loss amounts from bad quality credit contracts However, we should consider the proper percentage of this prOVISIOnfund Because if this amount of provision was too high, it is not good, it could appropriate the bank's capital Resources spent on risk management like this could be instead spent on other more profitable activities We could use such resources for investing into other projects so that we could gain much more profits instead of letting it idle in the safe of the bank So, the question here for the bank is how we I spend the least amount of resources in ~he risk management process while reducing the effects of risks as much as possible It depends on the policy of the bank about stipulating the percentage for the fund 4/ set a Sensible and Structured Credit Policy It is vital that the bank should set a sensible and structured credit policy to maintain the loyal customers and to make relationship with new truly customers A sensible credit policy helps credit officers have a clear policy to make flexible - 54- decisions about some credit conditions, for example, the credit officers can offer a preferential interest rate policy for both loyal customers and new truly customers, (or a longer repayment period for new customers, or easy procedure, etc.) So, the bank's credit officers should update informatiOn frequently in order to make proper decisions and use up-to-date methodologies to have a sound credit policy for the right counterparty In general, this sensible credit policy can attract more new customers and maintain loyal customers for the bank It is one of the ways to enlarge the revenue for the bank 5/ Establish a Group of Legal Officers • This group will help the credit department When the bank wants to expand its scope of activities, it is necessary to establish a group of legal officers These officers must master laws, especially the laws relating to banking industry, such as banking law, credit law, contract law, corporate law, etc Their main duties are helping credit department in examining credit contracts, valuing asset securities, making and maintaining relationships with Government and local authority because a larger number of business and Government contacts tend to be better equipment to access credit risk We can also get some confidential information easily So, the bank can, to some extent, prevent credit risks - 55- I 6/ Self-Insurance Self insurance is a risk management method whereby an eligible risk is retained, but a calculated amount of money is set asid~ to compensate for the loss This type is somewhat similar to the type of setting provision fund for loan loss as we mentioned above The credit officers have to use all information to calculate the I f I estimated amount of money in order that the amount set aside is enough to cover the potential loss in the future However, any risk where potential risk is too large to afford to pay the potential loss is not worth being insurable The bank then should refuse to give credit loan for that counterparty because we are sure that we cannot have enou.gh money to afford the potential loss 7/ Credit Insurance This is the type of credit insurance that the insurance company (insurer) will pay damage of the loan to the bank (the lender) when the loan is not paid or paid late With this type of insurance, the bank can be protected against various financial risks, especially credit risks For example, insurance company might also cover failure of a creditor to pay the money it owes to the insured Credit insurance pays some or all of a loan back when certain things happen to the borrower like unemployment, disability, or death - 56- B- Recommendations for Developing the Bank Reputation and brand name of a well-known bank plays an important role in the activities of a bank, not only in the services but also in the credit activities as well A highly appreciated bank can get much more attention from lots of customers They will feel safe when doing business with the bank, for example, depositing their saving into the bank or making credit relationship with the bank They have no fear that this bank will not repay them their money Moreover, a well~known bank with high reputation will easily get credit relationship with highly creditworthy customers, because those who the business truly will tend to find a reliable bank to make relationship Moreover, with a high reputation brand name, there will be more and more people coming to make relationship with the bank, the bank will then have a wide customer portfolio; they can choose the best highly creditworthy customer to give credit loan So, building a strong brand name with a high reputation for the bank plays an important role for the bank right now or at least in next year, because Vietnam is now preparing to join WTO, a really big playing field for every business, including banking business There will be more and more foreign companies, foreign banks -investing in Vietnam This will create a more competitive, more challenging business environment for both domestic and foreign companies who have already done business in Vietnam So I think that being ready when the market becomes more and more challenging is a good - 57- I , I I I ' choice to follow With the above reasons, I would like to recommend some suggestions to develop the image of the bank 1/ Build Website/or the Bank Accelerating technology renovation in preparation for integration into world markets, especially when Vietnam is going to become a member of WTO, is so important to intense competition in the banking system So, I think that building website for the bank is one of the emergency actions to right now The Head Bank in China has already had its own website, but the branch here has not established a website yet How can customers access to know more clearly information about their accounts, the exchange rates, banking services, etc, It is not denied that Internet is now a tool for advertising a product effectively; it is also an endless source of information Through Internet, we can find information we want to know or we can access to know about one company if that company has a website Why don't we take advantage of that usefulness? We can build a website to develop an information system for our customers to keep in touch with the bank Here are some advantages of establishing a website • It is a tool for Advertising • People can access this website to know more about the bank, as well as the services, the activities, etc - 58- I • Existing customers can check the outstanding balance through the website, or transfer their account to the other party or to pay for their bills, etc • They can also keep up-to-date information about the bank's activities I I I • We can inform them our new services through this website, for example, when we have a promotion or some special discount, we can inform them in order that they can join with us Or when we want to sell shares to the public, existing customers are prior, we can inform them, In addition, to perform the banking technology modernization, the bank should invest on upgrading new technology system to help to the banking activities faster and more exact 2/ Issue a More Specific Brochure or Booklet about Credit Information As far as I know, the brochure, leaflet about the bank on the credit section is too general, it is not specific It does not provide much information about how to get a credit loan from the bank, who can get the credit loan, what conditions the bank requires, etc It is not good for the credit activity because it prevents potential ~ustomers from finding information about the credit loan granting So, advertising about the bank, as well as its services, especially credit information, as clearly as possible plays a crucial role in building brand for the bank Among them, brochure and leaflet are one of the tools for this type of Advertising But it is vital that the - 59- • bank should describe about the credit information as clearly as possible, such as its conditions, its target customers, its requirements, etc building website for the bank, as I mentioned above, also has the similar aim as issuing brochure and leaflet They all help customers know more clearly about the bank and how to r transactions with the bank I I I 3/ Organize Meetings to Launch New Services or PR about the Bank Diversifying and developing new products and services to provide customers with a wider range of utilities is also important for the bank to compete with others However, the bank should launch them publicly in order to introduce them to the public So, organizing meetings or PR events broadly to the' public or with a focused group of customers is important Its aim is to firmly assert its position, status and role in the banking system of Vietnam It can help to "polish" the bank's brand mime and we can build our bank's brand name as a good, healthy and prestigious brand name, so the bank can increase its reputation in the public's trust Moreover, it can help to find more potential customers for the bank who are aware of the existence of the bank.' - 60- ' a 41Invest in Banking Industry Select the right commercial bank to be partner and purchase their shareholders, As I know, there are many foreign banks coming to invest in Vietnam, from Asia, Australia, to America, such as Citibank from America, HSBC from Hongkong, ANZ from Australia, Tokyo Mitsubishi from Japan, OCBC from Singapore, etc Almost all of them now are partners of some commercial banks in Vietnam They purchase shares of those commercial banks and provide new techniques about management, technology, etc., in order to help to develop the operations in retailing banking of those banks When the business of those banks increases, the revenues will increase, too And of course, their profits will also increase • I think this is a good way to make more profits for the bank, or at least the bank can have another source of income to compensate for the loan~loss accounts 51Monetary Trade Purchasing and selling some types of foreign currencies to get the capital gain are another way of managing the risk from exchange rate variation It is also a source for the bank to get more revenue - 61 - r 6/ Establish a Group of Professional Internal Auditors This group will take responsibility of checking all documents from all activities of the bank, from credit activities, banking services, to accounting activities, etc in order to discover disguises or mistakes from the bank officers, so that the bank can have prompt actions to modify it in time With prompt actions, the bank can avoid a significant loss 7/ Training and Developing Employees Last but not least, developing and updating !he knowledge as well as the skills for • employees, especially the credit officers, plays a critical role for the developing of the bank Why I recommend that? As we know, human resource plays an important role not only in the bank, but also in other business sectors Every day, almost every activity is carried out by employees So, the more knowledge as well as experience, and skills employees have, the better they in their jobs They will, of course, know how to avoid as much as mistakes as possible Especially in credit granting activity, we need employees who are really expertise in credit granting, as well as other essential knowledge, such as, laws including credit law, investment law, corporate law, bankruptcy law, skills to keep update information about the business of relevant credit customers, etc., in order to analyze and recognize potential risks lying in the credit facilities Maybe at the first time, the - 62- • business of that counterparty looks very sound and wealthy, but, in fact, the internal business situation of the firm is getting worse and worse So, if the credit officers not have enough competency, as well as knowledge, experience and skills, how can they recognize those potential risks in issuing credit facility for that counterparty? And, if, unfortunately, the credit facility is accepted due to incompetence of credit officers, the bank has to suffer a lot of losses This will lead to many other related damages as we mentioned above So, I think that training for the employees of the bank regularly is really important and necessary for the development and survive of the bank This will help to provide necessary information • in order that they can keep up with the changing economic environment So, this will increase the productivity of the business Moreover, through training, the management can inform the bank's employees the newly reviewed credit risk strategy or credit risk policies of the bank or the new procedures of identifying, measuring, monitoring, and controlling credit risks In one word, the idea of managing credit risks goes along with developing the bank in general As a matter of fact, my seven recommendations for managing credit risk must be made along with seven recommendations for developing the bank •• - 63- CONCLUSION There is a majority of risks in lending Credit activities involve many risks Most banks fail just because of failing in the credit activities However, in return, it is the major source of banks' revenue It brings back to banks the highest amount of income in comparison with other services More than 70% of banks' revenue comes from credit activities With such a high return of revenue, banks must have a proper credit risk management policy and process in order to identify, assess, monitor and control credit risks Banks should strictly follow all procedures approved by the board of directors There are three main parts They are assessment of credit risk, measurement of credit risk and finally, control of credit risk They all are necessary in an effective system to identify, measure, monitor, and control credit risk as part of an overall approach to risk management Going deep into each part, there are numerous criteria that must be followed All things contribute in order to prevent as much risk as possible, so as to reduce as much loss as possible , - 64- REFERENCES I/BOOKS al In Vietnamese I ~ I ~ r TS Ho Dieu, Tin Dung Ngan Hang Tp Ho Chi Minh: NXB Thong Ke, I t 2001 I Pham Vu Dinh, Tim Hieu Ve Tin Dung & Hoi Doai Tp Ho Chi Minh: I I NXBTre Tp Ho Chi Minh, 1998 TS Nguyen Van Tien, Danh Gia va Phong Ngua Rui Ro trang Kinh Doanh Ngan Hang Tp Ho Chi Minh: NXB Thong Ke, 2003 ' bl In English Peter S Rose, Commercial Bank Management USA: Irwin McGraw-Hill (41h edition), 1999 III WEBSITES www.bambooweb.com www.bis.org www.sei.cmu.edu - 65-