Moral hazard in vietnamese commercial banks and solutions,graduation thesis

MINISTRY OF EDUCATION STATE BANK OF VIET NAM AND TRAINING BAKING ACADEMY OF VIETNAM FOREIGN LANGUAGE FACULTY -**** - GRADUATION THESIS Topic: Moral Hazard in Vietnamese Commercial Banks and Solutions Student’s name Nguyen Thi Le Ngoc Class ATCB – K13 Supervisor Dr Pham Thi Hoang Anh Student number 13A7510128 Hanoi, May 2014 TABLE OF CONTENTS ACKNOWLEDGEMENT LIST OF ABBREVIATION LIST OF FIGURES AND TABLES INTRODUCTION Rationale of the study Research objectives Scope of the study Research methodology Thesis structure CHAPTER 1: THEORETICAL FRAMEWORK FOR MORAL HAZARD IN COMMERCIAL BANKS 1.1 1.2 1.3 Commercial banks 1.1.1 Definition 1.1.2 The role of commercial banks in VN’s economy Asymmetric information in commercial banks 1.2.1 Concept and nature of asymmetric information 1.2.2 The inefficiency of information asymmetry 1.2.3 Cases of asymmetric information Moral hazard problem in commercial banks 1.3.1 Definition 1.3.2 Causes of moral hazard 10 1.3.2.1 Internal cause 10 1.3.2.2 External cause 11 1.3.3 Consequences of moral hazard 12 1.3.4 Popular measures to prevent moral hazard 13 CHAPTER 2: ACTUAL SITUATION AND IMPACT OF MORAL HAZARD PROBLEM ON VIETNAMESE BANKING SYSTEM 2.1 Some well-known cases of moral hazard in Viet Nam 15 2.1.1 Moral hazard caused by customers 15 2.1.1.1 Facts and causes 15 2.1.1.2 Adopted measures 18 2.1.2 Moral hazard caused by staff 2.2 19 2.1.2.1 Facts and causes 19 2.1.2.2 Adopted measures 24 Current preventions 27 2.2.1 Government actions 27 2.2.2 Banks’ actions 28 CHAPTER 3: RECOMMENDATIONS TO DEAL WITH MORAL HAZARD PROBLEM IN VIETNAMESE COMMERCIAL BANKS 3.1 3.2 Bank’s solutions 31 3.1.1 Staff management 31 3.1.2 Customer management 32 Government’s solutions 34 CONCLUSION 36 REFERENCES 37 ACKNOWLEDGEMENT I would like to express my deep appreciation to those who facilitate the completion of this graduation thesis A special gratitude I give to my supervisor, Ms Pham Hoang Anh for her continuing support during my process With her profound academic knowledge, professional working manner and strictness, she has offered me a great deal of valuable and constructive advice, which have improved the presentation and the content of this dissertation significantly Furthermore, I would also like to extend my thanks to the lectures in Foreign Language Faculty, Banking Academy, who have help build up my knowledge and necessary skills over the past four years I hope that this foundation will contribute to my future career and life Last but not least, I would like to offer sincere thanks to my family and friends for their consistent support Their assistance, experience and encouragement are truly important for me to fulfill this demanding task LIST OF ABBREVIATIONS CBs Commercial Banks VND Vietnam Dong US United States VDB Vietnam Development Bank VIB Vietnam International Bank OCB Oriental Commercial Bank Agribank Vietnam Bank for Agriculture and Rural Development Vietin Bank Vietnam Bank for Industry and Trade Exim Bank Vietnam Export Import Bank Vietcombank Joint stock commercial Bank for Foreign Trade of Vietnan ACB Asia Commercial Bank Navi Bank Nam Viet Bank JSC Joint Stock Company M&E Mechanical and Electrical HCMC Ho Chi Minh City SBV State Bank of Vietnam LIST OF TABLES AND FIRGURES Figure The inefficiency of asymmetric information towards buyers Figure The inefficiency of asymmetric information towards sellers Table The internees and their sentences pronounced at the trial for Huyen Nhu’s case INTRODUCTION Rationale of the study Over the past twenty years of innovation, the banking system has been extended with a total of approximately 70 banks in which 60% are commercial banks In recent years, these commercial banks have evolved into large-scale and professional organizations It can be clearly seen that on the one hand, with a variety of services and the availability of modern channels, they attract more and more customers On the other hand, banks are in need of a bigger number of qualified staff However, the quantity is not associated with the quality when banks are unable to control the growing volume of both clients and human resources Among them exists the people who intentionally risk doing activities beneficial to themselves but harmful to the bank This is called moral hazard which arises from the imbalance of information between the parties involved in a contract Moral hazard has become a serious problem as it brought about intensely unwanted consequences not only to individuals but also organizations and even the macroeconomy suffers without much preparation Being aware of how alarming this matter is, the author of this thesis expects that after looking into the situation, the recommendatons offered can contribute partly to the prevention of the moral hazard issue in order to facilitate the operation of commercial banks and banking system Research objectives This work aims at the following objectives: - Systematize the theoretical framework for moral hazard problem - Analyze some noticeable cases of moral hazard in Viet Nam and seek causes - Provide suggestions to minimize the impact of moral hazard in Vietnam banking sector Scope of the study The thesis studies the reality of moral hazard in Vietnam in recent years and offer solutions to improve this situation for the coming years Reasearch methodology In order to find out the most logical and reasonable answer to the problem, this thesis will retrieve information resources from books, lectures, newspapers, magazines, and the Internet Thus, by collective method, deduction, analysis, statistics, this thesis will present and analyze the real state caused by moral hazard in Vietnam commercial banks and propose some suggestions Thesis structure Apart from Introduction and Conclusion, the thesis consists of chapters: - Chapter : Theoretical framework for moral hazard problem in commercial banks - Chapter 2: Actual situation and impacts of moral hazard problem on Vietnamese banking system - Chapter 3: Recommendations of solutions to deal with moral hazard problem in Vietnamese commercial banks Chapter Theoretical framework for Moral hazard problem in commercial banks 1.1 Commercial banks 1.1.1 Definition According to US laws, a bank is any business offering deposits subject to withdrawal on demand (such as writing a check or making an electronic transfer of funds) and making loans of a commercial or business nature Particularly, commercial bank is a type of bank which sells deposits and makes loans to businesses and individuals A bank links together deficit entities – an individual or entit that spends more than it currently earns and then must borrow money and surplus entity – an individual or entity that spends less than it currently earns and therefore can save money and invest in different channels One party would like to mobilize fund in the least expensive and efficient way while another wants to ensure the best return on investment In Vietnam laws, commercial bank means a type of credit institutions which may conduct all banking operations and other business activities under Law No.47/2010/QH12 of June16, 2010 on Credit Institutions for profit Banking operations can be defined as the trading in and regular provision of one or some of the following services: deposit taking, credit extention and via-account payment Banks generally have offerred services throughout history which are carrying out currency exchanges, discounting commercial notes nad making business loans, offering saving deposits or demand deposits, safekeeping of valuables, supporting government activities with credit, and offering trust services Recently, they have evolved and offerred even a wider range of services such as granting consumer loans, offering equipment leasing, selling insurance policies, selling retirement plans, making venture capital loans, etc 1.1.2 The roles of commercial banks in the economy CBs, due to their specialness, play some basic and vital roles in all countries all over the world though its level of influence may range in terms of the development of those nations Whether in a developed economy or a developing one, the roles of CBs can be listed as below The first role of CBs is to be an intermediate which encourage individuals and institutions to save and then transfer their savings to the individuals and institutions planning to invest in new projects as well as satisfy the need for liquidity and reduce the risks and transaction costs not only for surplus entities but also for deficit ones Previously, significant transaction costs, especially information cost used to impede small and invividual investors’ participation in the financial market, but the presence of commercial banks as information-producing bodies gradually decrease transaction costs thanks to their economies of scale and specialization Therefore, the fund flows become more smooth well-oriented when potential savers and borrowers are indirectly connected by commercial banks through the fund mobilizing and allocating process Secondly, the process of making payment would not be executed safely and conveniently without CBs as they carry out payments for goods and services on behalf of the customers They act as payment agents by opening checking or current accounts for customers, paying cheques drawn by customers on the bank, and collecting cheques deposited to customers' checking accounts Banks also allow customers to make payment via other channels such as automated clearing house (ACH), wire transfers or telegraphic transfer, electronic funds transfer at point of sale (EFTPOS - an electronic payment system based on the use of payment cards, such as debit or credit cards, at terminals located at points of sale) and automated teller machine For example, nowadays, people can pay electricity, water or phone bills and paying salaries using bank services.These services are very easy and gives the users a sense of security and comfort Additionally, CBs support international goods, servicers and capital Moral hazard does originate from those people who directly deal with credit activities The current credit mechanism after a great deal of adjustment and revolution really accommodates the business makers However, there is no guarantee that their projects will be effective and successful when put into practice In fact, when these plans fail, naturally there will be no profit which means the ability to repay the loan is undoubtedly limited Loans will then be classified as over due and, after a fixed period of time, loss loans Here, what causes moral hazard is contributed by the insufficient standard of credit officers in assessing and supervising process and partly by the immoral and irresponsible behaviors rooting deep in personal-related incentives like earning self-interest when they pass the business plans with moderate possibility and efficiency Furthermore, it cannot be denied that the unbelievable loose and weak management of the banks aided and abetted the criminals in the lasting and large-scale fraud It was illustrated by the fact that they created forged documents and withdrew money with almost no obstacles In the bargain, when we look into the root, we can see that the conduct of the cheaters cannot be completed without the demand of the customers including individuals, enterprises and commercial banks They did have one thing in common which is the desire for high interest rate offered by the offenders Individuals and corporations simply wanted that appealing high profit but banks, knowing that it was wrong to deposit their money into another bank for interest difference, intentionally did it 23 2.1.2.2 Adopted measures The chairperson of the instance trial announced the punishment for Huynh Thi Huyen Nhu and her accomplices at around 11.30 am on the 27th of January Accordingly, Huyen Nhu got a life sentence for cheating and appropriating”, 6year sentence for “forging stamps, documents of organizations” and therefore a life sentence is concluded Moreover, she should be responsible for 4000 billion VND appropriated from organizations and individuals However, the representative of People’s procuracy claimed that Vietin bank should take no responsibility in this case for the money Huyen Nhu occupied though plaintiff asked for that Many people believe that Huyen Nhu could make fraud without much difficulty owing to the internal monitoring phase of Vietin bank As for the other internees, the punishment seems lighter compared with the proprosal of the procuracy Internee Count Proposed sentence Pronounced sentenced Vo Anh Tuan Cheating and appropriating properties life 20 years Cheating and appropriating 17 - 18 years 14 years Cheating and appropriating usry 10 - 12 years for cheating, years months - years for usury years Cheating and appropriating 17 - 19 years 14 years Cheating and appropriating and usury 16 - 18 years 12 years Huynh My Hanh Nguyen Thi Lanh Tran Thi To Quyen Dao Thi Tuyet Dung 24 Pham Anh Tuan Tran Thanh Thanh Pham Thi Tuyet Anh Tong Nguyen Dung Bui Ngoc Quyen Hoang Huong Giang Doan Le Du Vu Nguyen Xuan Tien Huynh Trung Chi Nguyen Thi Phuc Ngan Huynh Huu Danh Making use of position and authority in on actve service Violating lending regulatons in credit institutions’ activities 13 - 15 years 14 years 14 - 16 years 10 years Violating lending regulatons in credit institutions’ activities 16 - 18 years 15 years Violating lending regulatons in credit institutions’ activities 16 - 18 years 15 years Violating lending regulatons in credit institutions’ activities 14 - 16 years 14 years Violating lending regulatons in credit institutions’ activities 10 - 12 years years Violating lending regulatons in credit institutions’ activities 18 - 20 years 17 years Violating lending regulatons in credit institutions’ activities 14 - 16 years 11 years Violating lending regulatons in credit institutions’ activities 16 - 18 years 15 years Violating lending regulatons in credit institutions’ activities 16 - 18 years 15 years Violating lending regulatons in credit 18 - 20 years 17 years 25 institutions’ activities Luong Thi Viet Yen Ho Hai Sy Le Thi Ngoc Loi Nguyen Thien Ly Lack of responsibility resulting in serious outcomes - 10 years years Violating lending regulatons in credit institutions’ activities - years years Violating lending regulatons in credit institutions’ activities - years years Usury years months and years for illegal currency transfer years Huynh My Phuong Usury 2- years Pham Van Chi Usury - 12 years years months 10 days Set free after the pronunciation year Table The internees and their sentences pronounced at the trial for Huyen Nhu’s case (Source:http://laodong.com.vn) 26 2.2 Current preventions 2.2.1 Government actions The instructions on reducing moral hazard are based on the principles of BCBS – IADI According to principle 2, by ensuring the compatibility of the deposit insurance, moral hazard can be controlled Examples of this is setting insurance limit, applying the cost calculating system in terms of the level of risk The legislature body found ways to direct market discipline by giving out characteristics which affect the attitude of depositors It is limiting the scope of deposit insurance including controlling the limit of deposit insurance, types of documents and the depositing objects In order to minimize the loss, deposits without insurance can choose to put their money into the healthy and reliable organizations participating in deposit insurance or those are unlikely to go bankrupt In my experience, it is really important to maintain an effective limit to protect the majority of depositors while leaving a reasonable percentage of the total value Besides making the deposit insurance match up with the bank, the other factors of financial safety network may help lessen this type of risk like building and intensifying suitable promotion policy through corporate administration and risk management for each bank or the principle of efficient market and legal frames, safe and sustainable regulation In normal conditions, policy planners try to balance between the objective of financial stability and moral hard limit However, in critical time, planners, the goal of maintaining and recovering the finance is priotized, thus protection policies for depositors and lenders are often disregarded inspite of moral hazard In a financial depression, most depositors have insufficient information about the bank use of money and there are not not enough banking sanctions for those who participate in deposit insurance 27 2.2.2 Banks’s actions Commercial banks in Vietnam nowadays have been applying two main credit risk management models which are the focus and the dispersion models Each of them have pros and cons; nontheless, the credit risk management focus mechanism is preferred and recommended by Committee BaseI to be compatible with the reality and the general conditions about legality, market, technology and human resources Following this method, there is clear distinction among the three functions including risk managing, business making, and operating The separation is designed to minimize risk and at the same time ultilizing professional skills of every single credit officer The advantge of this method is that the bank will have a synchronous risk management environment and united risk monitoring policies for the entire system At the headquarter, two functions namely credit determination and credit management are separated and the tasks and responsibiliy are distinctly assigned to asessing department, credit approving, credit management and credit risk management departments Meanwhile, at branches there are three main units for three functions Customer relationship division seek and care for clients, help them complete the loan documents and submit information to the credit analysys division Later on, the credit analysys unit will check the information about customers (financial ability, business projects or plans….) Next, the results shall be sent to the approver then he releases the final decision to the credit analysys division for information storage and simultaenously to the customer relations unit to implement the other steps All of the things help prevent moral hazard; however, this method is seemingly suitable for big banks and it requires a considerable degree of monney, time and effort To take an example, VCB has succeeded to some extent in employing this model According to the annual report by the board of VCB directors released on the 8th of April, 2014, VCB has deployed many reality assessing project and built the model of credit risk measuring turning towards the standards set in Base II Agreement on the safety banking operation It also examined and adjusted the credit monitoring process, set aside appropriate provisions 28 to meet the requirements from SBV As a result, the rate of bad debts in 2013 was controlled at 2.73% This figure surpassed the expectations of its own shareholders (3%) and it is worth recording that this ratio is lower than the average level of the banking sector The capital adequacy ratio (CAR) of VCB is 13.37 % which fulfilled the minimum CAR of % prescribed by SBV However, there are still shortcomings in VCB’s using this model since the model has not yet been implemented thouroughly in some fields such as monitoring target customers of the system The debt collection activity witnessed dramatic improvement compared to the previous years but broadly speaking, it needs reinforcing To reduce moral hazard in doing business, various banks set up their own moral standards for bankers to conform to But the positive outcome of these set of rules has not yet been recognized on account of the vagueness of the regulations Whereas, the nature is not clearly expressed and described Having little knowledge and consciousness of the dreadful results if their performance is discovered can make someone more a law unto his self To take an example, VietinBank, as well as many other banks, issued regulations on moral standard, living style for staff and members of VietinBank’s party committee following President Ho Chi Minh as a model Accordingly, all staff working in VietinBank’s system and benefiting from VietinBank’s salary fund must obey basic rules VietinBank attempted to raise calidre’s awareness of preventing behaviours such as misappropriation, mercenariness, etc Most common mistakes were listed in the regulations but there appeared to have no specific punishment or level of penalty or such activities To sum up, recently, there have been big and serious crimes which drew the attention from both insiders and outsiders, and the loss adds up to unbelievably trillions of VND One notable thing is that criminals made use of a broad range of simple but cunning tricks to cloud the system In addition, it can be clearly seen that the corelation between staff and clients occurred in most major cases Generally, moral hazard is attributed to customers and staff’s financial desire and banks’ weak 29 management Nevertheless, after these cases were discovered, the involved had to receive punishment equivalent to their illegal acts 30 Chapter Recommendations to deal with moral hazard problem in Vietnamese commercial banks 3.1 Banks’ specific solutions 3.1.1 Staff management In recent years, the moral standards for banking staff have been somehow lowered When the interest is higher and the loans become due, corporates have to pay debt though the financial abitlity is limited, it is a good chance for the bank staff to cooperate with companies to share the money when loan is approved This fact is drawing a dull scenario for both banks, the banking system and the corporate community in general Thus, banking activities need to be transparent and as professional as possible on account of its vital role in the the economy It is essential that the qualities of banking calidres who constitute every cell of a working body should be raised Weak human resources in any kind of corporates will surely bring the firms down Especially in banking industry, the low quality of the working force creates the restriction on bank management, lower revenue but results in the bank’s unstability or even pushes it to the verge of collapse The first suggestion is that banks should put more concentration on the recruitment and training progress which aim at high quality and morally educated members It is necessary that credit institutions raise the collective consciousness of the officers by showing the potential negative effect they may cause to the banking operation Working for bank’s profit instead of personal earnings should be a slogan for all staff Actually, history facts showed that some staff did not care much about bank’s asset as they approved the unsatisfactory loan requests or ignored the truth that customers misused the fund provided then they quited their jobs for another company to hide the evil actions Besides warning, banks ought to have treatment mechanism for staff of different value and working results as an incentive for them to make the best of 31 themselves The credit division or exactly credit officers should receive more focus as in almost any cases, credit officers played an important part in guaranteeing the success of the crime New staff recruited each year are often post graduates who are young and inexperienced but in charge of a transaction center These newcomers are likely to be affected by the direction of the manager and cause problems though the lending process is composed of many steps taken by other divisions The reevaluation division should also be strengthened and covered by excellent and experienced members, not the merely experienced Furthermore, it is urgent to build corporate culture, establish a special managing system on banking activities and put it into practice since vague rules and regulations on the behaviours are the base for the intentional actions of banking staff In reality, the managing system exist but how it works and influences banking operation is still of little knowledge More specifically, an exceptional supervising system in mobilizing and lending is necessary to be founded Additionally, the decentralization needs to be more strictly managed For example, depending on the model of management and the bank’s own policies, it may only allow the director of branch to decide on a loan of 500 million VND and below If the amount stated in the loan request exceeds the limit, the documents must be sent to the head quarter for more proper decision However, some banks allow the director of a branch to approve a loan of huge amount like tens of billions of VND Given that risk occurs, the loss is uncountable In fact, this happened at a state-owned commercial bank, a branch manager intentionally violated the lending regulations because he was offered the power determine the loan up to the limit of 70 billion VND His conduct caused the bank to suffer hundreds of billion VND 3.1.2 Customer management 32 To start with, credit offcers should have a marking scheme for assessing both customers as corporates and individuals The scheme for corporations may be based on annual financial reports while that for individuals on consuming coefficient, age, income, asset conditions, etc to set up a credit frame policy What is more, banks should tighten the loan policy by asking for mortgages Theoretically, collaterals are crucial in preventing moral hazard and limit the loss when risk occurs The rate of loans with collaterals should be increased The outstanding loan needs to be reduced if customers cannot meet the collateral requirements After accepting mortgages, every branch should pay regular attention to the validness, legalness and price of those assets On the otherhand, it is true that collaterals banks receive are land use right, machines and equipment, etc whose value deteriorate over time so they may require more valuable assets with the higher rate of their value over the loan value It is also important for the existence of an agent collecting information and determining the financial transparency of the parties involved The information needs to be supplied regularly, constantly and without fee Once the information asymmetry is lessened, there will be more accurate decisions on making loans For the disbursement, there has to be a center listing and rating the credit worthiness of clients The more detailed, sufficient information it provides, the less risk lenders will take For instance, knowledge about clients such as age, occupation, income, religion, the repayment rate for the previous loans, etc helps a lot in making lending decisions Only when the measures are applied, is moral hazard gradually minimized and the tendency that banking staff are more and more being prosecuted will be reduced Thus, banks in this condition, will be able to develop healthily and sustainably 33 3.2 Government’s general solutions The Government, though not being directly blamed for the damage caused by moral hazard but as a managing agency, it should be responsible for these affairs to a certain extent In fact, the gaps in the business laws create chances for the depraved staff and dishonest customers to grab and spleen the law Therefore, the first suggestion is that the government strengthens the current legal barriers and gives credit institutions clear and detailed directions for how to deal with internal and less serious moral hazard - related problem For example, it will be a good idea if credit institutions are required to provide not only basic but adequate necessary information about customers to the Credit Information Center of State Bank Thus, the center will be capable of supplying additional evidence and give regular and timely warnings of customers who are under suspicion Secondly, there should be some steps to raise people’s awareness of this problem To prevent any social members from starting such moral hazard, severe punishment for banking criminals is critical That is to say, it is an effective way to repulse the intention of violating the laws Also, there are many ways to disseminate information about credit problems to the general pubic The government’s representatives, which are electronic or paper newspapers apart from television or radio, will certainly prove their impact on the public in carrying this mission Moreover, the government ought to restrict the act of saving “too big too fail” enterprises, especially some state-owned companies which cover the close relationship between the state members and the companies’ executives as well as the mutual benefit The truth that these firms play an essential role in the macro-economy or bring some social benefits does not mean that the government should always help them to recover This will only drive to higher rate of people’s causing moral hazard 34 In summary, current years have witnessed the rapid degradation of banking moral standard That is the reason why CBs should focus more on the recruiting, training and supervising process At the same time, there is probability of limiting customer’s immoral activities through marking scheme and loan policies It is an endurable procedure so that the Government’s role is indispensable It is recommended that the State offer guidance to banks as well as spread information to increase consciouness and take into account the necessity to rescue big corporations 35 CONCLUSION Commercial banks, as explicitly proved, play an important part in the economy thanks to a wide range of servces they provide In fact, the functions and roles of this type of intermediaries are irreplaceable That is to say, a deficiency or problem relating to banking performance could result in serious outcomes for the system itself, in particular and the economy as well, on balance Thus, it is necesaary that we take immediate action in the alarming situation of moral hazard in Vietnamese commercial banks Handling the consequences of moral hazard problem in the banking system cannot be completed by commercial banks alone but it unquestionably requires the cooperation of both banks and the government Only when the necessary conditions are satisfied and appropriate measures are taken, is moral hazard controlled and prevented Then, the banking system will benefit from a more secured environment to operate Therefore, the domestic economy will no long suffer from the malfuntion of the banking system and the possibility of development will be more certain and sustainable 36 REFERENCES http://en.wikipedia.org http://www.khoahockiemtoan.vn/ http://www.cbsnews.com/ http://laiboni.wordpress.com/ http://gafin.vn/ http://laodong.com.vn/ http://vietinbank.vn/ Peter S.Rose, 2008, Bank management & financial services, 7th edition, McGraw-Hill Irwin Frederic S.Mishkin, Economics of Money, Banking, and Financial Markets Law No.47/2010/QH12 of June 16, 2010, on credit institutions Law No.46/2010/QH12 of June16, 2010, on the State Bank of Vietnam 37