The overview of credit risk and credit risk management in
Credit risk in banking activities
Credit risk is the likelihood of financial loss when a borrower fails to meet their debt obligations by not making payments on the due date In this context, the lender, typically a bank, bears the responsibility of credit risk within a credit agreement.
In banking activities, credit risk is the most frequently risk and induces the most severe consequences including leading to bankruptcy of banks
Credit risk in banking activities is divided into 4 main types: a Capital loss risk:
Credit risk occurs when banks are unable to recover debts from customers, significantly impacting their capital and business assets With over two-thirds of bank assets tied up in loans and investments, any irrecoverable lending can result in substantial losses of both principal and interest Additionally, late payment risk further exacerbates these financial challenges.
Customers often face challenges in gathering sufficient capital to repay bank debts by the maturity date, leading them to request an extension of the repayment period If banks do not accept the reasons for the delay, customers may incur penalty interest This slow recovery of funds can disrupt banks' business plans and pose a risk of potential capital loss, highlighting the importance of managing interest risk effectively.
In the market economy, interest rates fluctuate, and this may pose a risk to the operation of commercial banks
When a bank signs a contract for a term loan with a fixed interest rate, it risks incurring losses if market interest rates rise Conversely, if market interest rates decline, banks face potential damage when borrowing capital at fixed rates Additionally, banks are exposed to exchange rate risk, which can further impact their financial stability.
Exchange rate risk arises from fluctuations in currency values, impacting business profitability When the selling exchange rate exceeds the purchase price, businesses gain, but losses occur when the opposite is true For instance, if an Australian bank provides a loan to a UK company in British pounds, a decline in the pound's value against the Australian dollar results in lower returns when converting principal and interest back to Australian dollars Consequently, the bank may not recover sufficient funds to mitigate its risk.
1.1.3 Characteristics of credit risk: a Being indispensable
Credit risk is an inherent aspect of banking activities, making its management crucial for financial institutions Banks must assess business opportunities by weighing the potential risks against the benefits to identify advantageous prospects that justify the associated risks Effective banking operations rely on maintaining reasonable and controllable risk levels.
In credit relationships, banks grant customers the right to utilize loans Credit risk arises when customers face challenges in managing their bank loans, primarily due to the inherent risks associated with their business operations.
Credit risk arises from a complex interplay of various factors and their subsequent effects To effectively manage credit risk, banks must pay close attention to all signals stemming from these factors and their consequences, enabling them to implement appropriate solutions.
1.1.4 Signals to recognize credit risk:
Many banks globally are currently experiencing credit issues, which can vary based on specific circumstances However, there are common indicators of credit risk that can be identified across different situations.
- Customers delay to repay bank loan unusually without any reason of financial statements and agreed repayment schedule
- The restructured liabilities are arisen
- The stock price changes in a negative way, net income falls in one or more years
- The disadvantage of the capital structure, liquidity or operational level arises
- The sudden changes in the balance of deposits in banks alter in a downward trend
Risks due to inevitable reasons such as: natural calamity or competitiveness market
Inadequate legal frameworks and an unhealthy business environment can lead to significant risks stemming from government macroeconomic policies, resulting in congestion and severe repercussions for the overall banking system and its credit activities.
Information asymmetry in financial markets poses significant risks, such as adverse selection and moral hazard, which can jeopardize banks Additionally, the economic environment can influence a borrower's financial stability, potentially leading to detrimental consequences for lenders.
Customers pose various risks to banks, including financial instability and misuse of funds Instances such as using loan proceeds for inappropriate purposes or submitting fraudulent documentation and forged collateral can significantly impact lending decisions and overall financial security.
Weaknesses in governance administration stem largely from the human factor, which is critical in an increasingly internationalized business environment Many administrators lack the necessary qualifications to effectively manage banks, struggle to quickly adapt to changing information, and may not fully comprehend legal requirements, leading to inappropriate personnel allocation.
Many commercial banks have established comprehensive lending processes that align with market mechanisms and regulations to ensure loan safety However, credit officers often overlook these processes for various reasons, leading to significant shortcomings in loan evaluations, including issues with loan guarantees and letters of credit (L/C) opening guarantees, as highlighted by internal inspections and controls within the banks.
Moral degradation and self-interest of bank staff: In some cases, loan officers or leaders colluded with customers which leads to high possibility of risk to that loan
Credit risk seriously affects the activity of the involved parties in a credit relationship
To borrowers: they face the loss of ability to pay and even bankruptcy
When banks experience capital loss due to credit risk, they are compelled to increase provisions for bad debt, leading to higher expenses and potential losses This situation complicates the recovery of principal and interest on loans, while banks must still meet their obligations to pay principal and interest on mobilized funds at maturity This imbalance between revenue and expenses can create liquidity risks and erode customer trust, prompting customers to withdraw funds en masse, which poses significant challenges for the entire banking system.
Credit risk management
1.2.1 The goals of credit risk management:
- Establish a reasonable, lucrative and less risky credit portfolio to support liquidity risk by securitization
- Create activeness and enhance sense of responsibility of the operational departments to seek loans with high profitability and low risk
- Implement transparent stages in the lending process, with the specified logical regulation in structure and proportion of provision
- Ensure a transparent and accurate reflection in credit portfolio, set up an appropriate provision to offset the risks arising in the lending process
- Have an effective checking system to detect, prevent and promptly handle the risks incurred to credit portfolio
1.2.2 The process of credit management
Credit risk management is an ongoing process that begins with evaluating potential borrowers before loan approval and continues through disbursement, monitoring loans for early warning signs, managing problematic debts, and handling bad debt recovery strategies to minimize losses, ultimately culminating in capital collection.
Banks need to establish a policy and procedure by document After that, banks should evaluate the customer’s financial situation before lending If the
Control after lending financial situation of customers can meet requirement of banks, they will decide for a loan approval
Banks must establish a credit agreement with customers and manage the disbursement process effectively Following this, it is crucial for banks to monitor the distribution of funds to mitigate potential credit risks.
Banks must regularly assess loans post-lending to identify early indicators of credit risk Additionally, it is essential for banks to track customers' repayment schedules and reassess their credit policies accordingly.
1.2.3 Measurements to manage credit risk
Risk is inevitable course of business Thus banks always accept a given level of risk and establish policies to control the level of risk in the proposed permission
Banks must regularly control the loan portfolio, especially in bad debt, problematic debt to take solutions promptly when risks happen
Banks categorize debts into five groups: pass debt, special mention debt, substandard debt, doubtful debt, and irrecoverable debt It is crucial for banks to manage substandard, doubtful, and irrecoverable debts effectively, as these represent bad debts that can negatively impact financial stability.
The bank must prioritize special mention debt, as adverse fluctuations in lending activities can quickly transform this category into bad debt.
Banks implement strategies to manage bad loans and problematic debt by classifying loans and analyzing their causes and current status This proactive approach is essential for maintaining the overall credit quality of financial institutions.
If borrowers have temporary financial difficulties, however there is still the ability and will to pay the debt, banks adopt a policy to support such as debt restructuring, remission rates
If borrowers defraud or have no ability to repay the debt the banks adopt a policy to sell the collateral or blockade deposit account
Management of the loan portfolio may include:
- It is necessary to describe the target credit market of bank in loan portfolio so that the bank can seek for potential customer groups easier
- The bank needs to determine the powers and responsibilities of the officers involved in the credit providing procedure to make it easier for managing loan portfolio
- Loan portfolio should contain policies and methods of determining the interest rate, fees, credit term and the repayment schedule
- Another important step in loan portfolio management is evaluating collateral as well as detecting, analyzing and processing the problematic debts
1.2.3.2 Prevent credit risk a Credit risk management policy of banks:
The primary goal of credit risk management is to minimize risk while maximizing income for the bank Key risk management policies, including collateral, guarantee, and syndicated policies, are essential in mitigating credit risk These policies serve as the foundation for establishing an effective credit process, ensuring thorough credit analysis and informed decision-making.
Credit analysis involves evaluating a customer's current and potential capacity to utilize and repay loans Its primary goal is to assess both the willingness and ability of customers to repay their debts, identify potential risks that could affect lending decisions, and forecast the bank's risk management capabilities Additionally, effective credit analysis enables banks to implement strategies to mitigate potential losses and ensure robust credit monitoring and control.
Moral hazard is a key factor contributing to credit risk in lending relationships To mitigate this risk, banks typically implement monitoring mechanisms that involve regular assessments of loan usage and periodic evaluations of borrowers' operations and business activities after funds have been disbursed.
Credit agreements typically mandate that borrowers supply comprehensive and timely operational information Additionally, banks utilize monitoring systems, including credit information databases, stock market data, and insights from competitors and regulatory agencies, to oversee how customers utilize their loans and manage associated risks effectively.
To mitigate credit risk, banks should avoid concentrating capital in a single customer or a group of customers Instead, they must diversify their loan portfolios, which will help lower the overall credit risk, especially during times of financial difficulties faced by these clients.
Banks also should not make centralized credit to a sector or a region which can leads to capital loss when this sector changes in a negative way
It is crucial for banks to diversify credit products to spread risk if one of the credit products is ineffective
Banks need to make syndicated loan to share risk with their cooperator e Derivative instruments
Credit swaps are a common type of credit derivative instrument, where two lending institutions agree to exchange payment obligations under their respective credit contracts This process is facilitated by an intermediary, who ensures that the contract is fulfilled in exchange for a service fee.
Credit options serve as a safeguard for banks against potential losses in the value of credit assets, effectively mitigating the increased borrowing costs associated with declining credit quality This agreement ensures full loan repayment in cases where the loan's value significantly decreases or defaults occur If borrowers fulfill their repayment obligations as scheduled, the bank will receive the expected payments, and the credit options will remain unused.
1.2.4 The consequences limitations of credit risk
Loan classification and provision are essential for enhancing credit risk management in commercial banks, facilitating corrective credit actions, and improving overall financial stability This process enables banks to proactively address outstanding loans, thereby strengthening their financial capacity and competitiveness within the Vietnamese banking sector.
According to Decision No 02/2013/TT- NHNN of the State Bank of Viet Nam, loans are classified in two methods: Quantitative method and qualitative method
+ Loans classification according to quantitative method:
Category 1 (pass debt) includes debts that borrowers can repay completely and on time, or those that are less than 10 days overdue and are deemed likely to fully recover both principal and interest throughout the remaining term.
Category 2 (special mention debt): This includes the overdue debts from 10 days to 90 days or the debt adjusting repayment period for the first time
The real situation of credit risk management in Vietcombank- Ngo
The overview of Vietcombank- Ngo Quyen branch
On October 30, 2008, Vietcombank, the Joint Stock Commercial Bank for Foreign Trade of Vietnam, inaugurated its new operational headquarters located at 31-33 Ngo Quyen, Hang Bai Street, Hoan Kiem District, Hanoi, alongside a customer conference for the year 2008.
The new branch is strategically situated between the city center and convenient transportation routes, benefiting from high population density and a robust enterprise ecosystem This location, coupled with the presence of numerous banks, enhances competitive advantages and promotes improved performance The branch will leverage strong capital and specialized expertise from foreign banking, while also offering retail banking services and innovative products tailored for individual customers.
Nguyen Hoa Binh, Chairman of Vietcombank, stated that despite being officially independent from the main office for nearly six years, the branch has rapidly established itself as a leader within the Vietcombank family in recent years.
The new branch of Vietcombank in Hanoi not only holds a significant market share but also leads in implementing the bank's policies and testing new products It excels in capital mobilization, even during challenging times, and stands out as one of the top contributors to Vietcombank's overall profitability.
There are 5 main groups in Ngo Quyen branch
2.1.3 The duties of Ngo Quyen branch
According to the decision 50/QD-NHNT.SGD of the chairman of Ngo Quyen branch, the duties of this branch include:
- Providing information about services of Vietcombank for every customer coming to the branch
- Receiving savings mobilization, issuing valuable papers in foreign currency and VND, carrying out operations related to saving accounts and valuable papers
- Opening, managing and implementing operations related to VND and foreign accounts of individuals and organizations according to regulations of Vietcombank
Vietcombank serves as the broker for issuing credit and debit cards, overseeing all operational requirements and ensuring the efficient liquidation of transactions related to the cards it issues.
Small and medium enterprises room
Capital and Foreign currency trading room transaction accounting room
- Accepting cash payment with international credit card and other ones
- Implementing operations related to trading foreign currency
- Transferring travel cheques by foreign currency within regulations of Vietcombank
- Paying foreign currency which is transferred to individuals
Credit activities in Ngo Quyen branch ( 2012-2014)
2.2.1 Total mobilized capital from 2012 to 2014
The Ngo Quyen branch experienced a steady increase in total capital mobilization, rising from 35,200 billion VND in 2012 to 56,100 billion VND in 2013 While deposits from residents showed a positive trend, contributions from economic institutions declined Short-term deposits consistently outpaced long-term ones, reflecting an upward trajectory throughout the period Additionally, although VND accounted for a larger share compared to foreign currency, its overall proportion decreased over the same timeframe.
Table 2: outstanding loan by term
Figure 1: outstanding loan by term
(Source: Annual report of Vietcombank- Ngo Quyen branch)
The graph indicates that short-term outstanding loans consistently outnumbered long-term outstanding loans, although short-term loans exhibited a declining trend over the observed period Notably, in 2014, the gap between the two categories narrowed to approximately 7.2%, a significant decrease from 30% in 2012.
2.2.3 Outstanding loan by economic sectors
Table 3: outstanding loan by economic sectors
Small and medium size enterprises
Figure 2: outstanding loan by economic sectors
(Source: Annual report of Vietcombank- Ngo Quyen branch)
Small and medium size enterprises
Wholesale lending consistently held the highest share of outstanding loans by sector, demonstrating a steady upward trend In contrast, the small and medium enterprises sector saw a decline from 13.2% in 2012 to 6.3% in 2014, while the individuals and households sector faced an opposite trend, indicating a growing demand for personal loans.
2.2.4 Outstanding loan by debt category
Table 4: outstanding loan by debt category
Figure 3: outstanding loan by debt category
(Source: Annual report of Vietcombank- Ngo Quyen branch)
2012 2013 2014 category 1 category 2 category 3 category 4 category 5
The graph illustrates that debt categories 1 and 2 constitute the majority of outstanding loans, showing a steady increase over three years In contrast, the proportion of bad debt, which includes categories 3, 4, and 5, remains relatively small and has gradually declined during the same period.
Table 5: outstanding loan by currency
Figure 4: outstanding loan by currency
(Source: Annual report of Vietcombank- Ngo Quyen branch)
The bar graph depicts the outstanding loan distribution by currency at the Ngo Quyen branch from 2012 to 2014 Notably, VND loans comprised a significant majority, dropping sharply from 83.2% in 2012 to 71.2% in 2014 In contrast, the share of outstanding loans in foreign currency experienced a substantial rise, increasing from 16.8% in 2012 to 28.8% in 2014.
Credit risk management in Ngo Quyen branch
According to the decision 118/QD-VCB.CSTD on 18 th March 2010 of chairman of Vietcombank, Ngo Quyen branch applies two main policies to manage credit risk
- Basing on internal credit rating result, the debt classification of Ngo Quyen branch is illustrated as follow:
Total grades Credit rating Debt classification
From 88 to under 94 AA+ Category 1
From 83 to under 88 AA Category 1
From 70 to under 73 BBB Category 2
From 67 to under 70 BB+ Category 2
From 64 to under 67 BB Category 2
From 58 to under 60 CCC Category 3
From 54 to under 58 CC+ Category 3
From 51 to under 54 CC Category 3
- Provision which must be set up for each debt and off-balance sheet commitments is calculated by the following formula:
C: The discount value of security assets r: Provision rate
- The provision ratio according to debt category:
2.3.2 Real situation of bad debt and provision in Ngo Quyen branch
The situation of bad debt (including debt in category 3, 4, 5) in Ngo Quyen branch is illustrated as follow:
The NLP ratio or the bad debt ratio is calculated as the following formal:
NPL ratio = (NPL loans/ Gross loan) ×100%
NPL ratio: non-performing loan ration
NPL loan: no-performing loan (bad debt)
Total amount of bad debt
(Source: Annual report of Vietcombank- Ngo Quyen branch)
The table and the bar chart present the changes of bad debt from 2012 to
2014 in Vietcombank- Ngo Quyen branch in a positive direction As can be seen from the table, the bad debt decreased steadily from 840 billion VND in 2012 to
In 2014, the non-performing loan (NPL) ratio significantly decreased to 4.9% of gross loans, down from 8.4% in 2012, reflecting the effectiveness of credit risk policies implemented in the sector.
The number of provision which is set up in Vietcombank- Ngo Quyen branch increased significantly despite the fact that the amount of bad debt decreased:
Non-performing loan Gross loan
(Source: Annual report of Vietcombank- Ngo Quyen branch)
The line chart shows the amount of provision set up over the period from
From 2012 to 2014, the financial figures for the branch surged from 152 billion VND to 601 billion VND However, this sharp increase coincided with a significant reduction in the branch's profits The decline is attributed to the challenging conditions faced by both the banking sector and the broader economy, which ultimately resulted in decreased income for the branch.
Assessment of credit risk management in Ngo Quyen branch
Since 2012, there has been a steady annual increase in total capital mobilized and outstanding loans For example, total capital mobilized rose from 35.200 billion VND in 2012 to 56.100 billion VND in 2014.
Between 2012 and 2014, the financial sector experienced remarkable and consistent growth, with total capital mobilized increasing by 160% and outstanding loans rising by 120% This substantial growth highlights the thriving operational conditions within the industry during this period.
The outstanding loan classified by terms, sectors, debt categories and currency went up at a stable growth every year from 2012
The credit risk management policies at the Ngo Quyen branch are straightforward and easy to implement, leading to a significant reduction in bad debt from 2012 to 2014 Consequently, the non-performing loan (NPL) ratio remained at a manageable level during this period.
The standard loans always occupied the vast majority percentage in total outstanding loan
The risk provision was established using a comprehensive formula, enabling the credit staff at the Ngo Quyen branch to efficiently calculate the appropriate provision amount for each individual customer.
Households and individuals is a potential customer group which can increase total outstanding loans for the branch, however the growth of outstanding loan in this group reduced over the period
Since 2012, the annual provisions have increased significantly, even as bad debt has sharply declined, resulting in diminishing profits for the branch.
To turn to management policies, the debt classification policy is too detailed which induces difficulties in evaluating financial situation of customers
The limited capacity of credit staff hinders their ability to promptly update and respond to complex market movements, ultimately affecting the efficiency of credit activities granted to customers.
The challenging economic climate is causing numerous enterprises to face bankruptcy, which in turn prevents the sector from recovering loans from these clients Consequently, this situation necessitates the establishment of higher provisions to mitigate financial risks.
Many customers with debt in category 3,4,5 expressed uncooperative attitude to bank staff which makes it difficult to recollect loans
The Ngo Quyen branch of Vietcombank plays a crucial role in the bank's operations Between 2012 and 2014, the branch demonstrated positive credit management through increased mobilized capital and outstanding loans, alongside a reduction in the non-performing loan ratio However, the rise in provisions has negatively impacted the branch's profitability This period highlighted both opportunities and challenges in the credit activities of the Ngo Quyen branch.
Solutions to enhance the quality of credit risk management in Ngo
3.1 The orientation of Vietcombank- Ngo Quyen branch in 2015
In 2015, Vietcombank's Ngo Quyen branch aims to maintain stability and growth in resident deposits while actively seeking new credit customers to enhance credit activities Additionally, the branch will evaluate and expedite the disbursement of medium and long-term contracts signed with large clients.
In term of bad debt and loan sale, the branch is oriented to take drastic measures in processing bad debts and to urge for recovery of the debt sale
The ATM system did work really effectively in 2014, so that the branch will set up solutions to improve the performance of ATM system
3.2.1 Improving the quality of assessing and analyzing credit
Credit risk arises from inaccurate credit assessments, resulting in poor lending decisions To effectively mitigate credit risk and minimize losses, it is crucial to conduct thorough assessments and analyses This process should prioritize careful evaluation based on profit and risk analysis while also meeting customer service quality standards.
To effectively manage customer risk, banks should conduct a comprehensive analysis and evaluation of each client's overall financial health by periodically assessing their credit line every six months to a year This approach provides insights into the customer's financial situation and business quality, enabling banks to better understand potential risks and evaluate future growth prospects Consequently, banks can establish a well-informed and appropriate credit line that aligns with the assessed risks of the business.
To effectively manage potential risks and enhance control capabilities, the branch must integrate both qualitative and quantitative analysis A key component of this approach is the establishment of a customer credit rating system, which should be regularly updated to align with Vietnam's economic conditions rather than strictly adhering to international standards Through quantitative analysis, the branch can identify potential risks, assess the risk levels of anticipated loans, and develop strategies to mitigate credit risk prior to extending credit to customers Additionally, this analysis will involve examining both macro and micro environments, the internal dynamics of enterprises, and their relationships with the branch, enabling more informed credit granting decisions.
Based on the approved credit line, the branch must prioritize risk analysis for each lending option, assessing potential risks, the branch's capacity to manage them, and developing strategies to address adverse situations effectively.
In investment project evaluations, some customers inflate project values to secure larger loans, which increases risk due to their low actual capital ownership This situation raises concerns about their repayment capacity and diminishes the branch's debt collection ability Consequently, it is crucial for the branch to engage an independent and trustworthy appraisal organization to thoroughly assess the project's true value and accurately verify the customers' capital.
To ensure that profits align with risk levels in credit contracts, it is essential to combine factors such as interest rates, equity proportions, and collateral Financial institutions should increase the equity proportions of borrowers and select collateral with high liquidity, particularly for clients with lower credit ratings Additionally, implementing stricter legal conditions in credit contracts not only protects the rights of the lending institution in the event of risks but also reinforces the borrowers' accountability in managing their loans.
3.2.2 Managing, monitoring and controlling the process of disbursement and after lending
The branch must ensure that disbursements align with credit regulations, requiring a thorough reconciliation of the borrowing purpose, requested disbursements, and the client's capital needs It is essential that all loan uses are backed by valid documentation Cash disbursements should be restricted, except in special circumstances typical of the customer's business, such as purchasing agricultural and forestry products or paying workers Furthermore, only transfer payment methods should be utilized to effectively control the use of customer loans.
Credit risks frequently arise post-lending due to ineffective business plans or improper fund utilization by customers Additionally, a lack of cash flow oversight can result in customers misusing funds for inefficient or non-transparent purposes To mitigate these risks, banks must enforce stringent controls and monitoring after the lending process.
The branch must ensure the appropriate use of loans by considering the unique characteristics of each loan and the quality of the customer It is essential to develop an inspection plan that balances the need for security with the facilitation of business operations and relationships between parties Utilizing the customer's credit rating as a basis, the branch should determine the frequency of loan usage checks—customers with higher credit ratings may undergo less frequent assessments, while those with lower ratings should be monitored more closely For clients with bad debts, regular examination and classification are crucial to closely track their situations, allowing the branch to implement effective identification, analysis, and solutions to minimize risks.
To effectively assess capital usage, the branch must thoroughly analyze the actual situation regarding fund allocation and collateral This proactive approach will enable timely risk detection and the implementation of necessary measures, preventing mere theoretical compliance.
Effective risk management in banking requires the analysis and timely evaluation of warning signs, such as customer repayment difficulties, sudden changes in the business environment, adverse market conditions, and potential legal violations By utilizing a robust system of early warning signals related to credit risk, banks can proactively identify and address these potential threats, ensuring a more resilient business strategy.
The branch must diligently oversee customer funds by monitoring various loan types, including verifying the dispatch date for export loans, assessing the progress of construction loans, and reviewing the inventory, monthly outstanding balances, and utilization of revenues for commercial loans This proactive approach will enable the bank to collect debts promptly while minimizing risks.
3.3 Measures to offset when credit risk happened
3.3.1 Enhancing the efficiency of processing problematic debt
Bad debt is an inevitable challenge for banks, making effective debt settlement essential To mitigate potential losses, it is crucial to clearly define the roles and responsibilities of relevant departments in addressing issues that arise during the debt management process.
In handling the problematic debt, the branch should take steps sequentially and carefully, avoid adverse impacts on those relationships which have been established with customers, especially the traditional customers
- Clarify the status of business, collateral, customer attitudes: analyzing the resilience of business situation, debt repayment ability, customers’ collaboration, status and processing collateral capabilities
When selecting a method for managing customer accounts, businesses should consider either a workout or liquidation approach This decision must align with the specific characteristics and payment capabilities of each customer to ensure optimal performance while maintaining manageable costs.