Handling bad debts in vietnamese commercial banks the real situation and solutions,graduation thesis

THEORETICAL FRAMEWORK

Non-performing loans

Non-performing loans (or bad debts), under the decision 493/2005 promulgated by the

The Governor of the State Bank of Vietnam has classified loans into three categories: group 3 (sub-standard), group 4 (doubtful), and group 5 (loss) Non-performing loans typically exhibit several key characteristics that define their status.

- Customers cannot fulfil their repayment obligation at the due date

- Customer’s financial status is getting worse and the bank might not be able to recover the loan as well as interest

- Regarding time, these loans are normally overdue at least 90 days

1.1.2 The causes of non-performing loans

Non-performing loans (NPLs) often arise due to some following causes:

Firstly, it is due to the unstable macro-economic environment It is widely believed that customers’ business operations are greatly influenced by the economic environment

A stable and healthy economic environment enhances customer operations and ensures ample cash flow, making it easier for them to meet their loan commitments Conversely, during economic recessions and crises, the purchasing power and solvency of all entities decline due to reduced income and net profit.

Student Vu Thi Hong The_ATCBK12 Page 12

Inappropriate macroeconomic policies can lead to increased bad debts, as effective monetary and fiscal strategies are crucial for fostering a conducive business environment For instance, supportive measures like lowering lending interest rates and implementing tax cuts can help businesses sustain and enhance their operations However, it is essential to evaluate all circumstances carefully to formulate suitable policies; otherwise, the economic environment may become chaotic and unstable.

Financial liberalization, while crucial for economic development, introduces significant risks that can lead to bad debts It fosters opportunities for global cooperation but also exposes domestic economies to heightened competition As enterprises navigate this selective environment, those unable to meet market demands risk losses and insolvency, contributing to the rising non-performing loan (NPL) portfolios in banks.

Finally, it is due to unforeseen causes such as: disasters, floods, epidemic… or the so- called force majeure which are out of banks’ control

Many individual customers take out loans primarily for consumption, relying on their monthly income to repay these debts Consequently, any factor that affects this income can lead to an increase in bad debts Key contributors to this issue include economic fluctuations, job instability, and unexpected expenses.

- Customers are suddenly sacked off, leading the expected monthly income increases

- Customers or their family members suffer from unexpected incidents like diseases or death

- Customers could not estimate unexpectedly arising expenses

- Customers intentionally swindle banks by making fake documents

- Customers intentionally delay in repaying the principal and interest with the purpose to appropriate banks’ funds

The root factor causing bad debts from enterprises is ineffective operation The ineffectiveness may be as a result of some reasons as follows:

The board of directors often lacks sufficient business management skills, leading to ineffective responses to market fluctuations This can result in impractical business plans where materials, outputs, and selling prices are poorly calculated As a consequence, companies may struggle with a surplus of unsold products and face financial difficulties in meeting their loan obligations.

Companies often face significant risks due to their financial status, especially when they rely heavily on borrowed funds rather than owner’s equity This unbalanced financial structure can lead to insufficient income from business activities, making it challenging to cover the high costs associated with borrowing Additionally, companies that are mismanaged or poorly appropriated may exacerbate these financial challenges.

Student Vu Thi Hong The_ATCBK12 Page 14 partners are obviously passive in repaying loans to banks when their partners are in trouble

Many customers misallocate borrowed funds, initially intending to use them for specific business plans as outlined in their loan contracts However, once the loan is secured, they often divert these funds towards high-risk ventures in pursuit of greater profits When these risky endeavors fail, banks are left to bear the financial consequences.

Fourthly, customers intentionally make fake financial documents, and take advantage of legal gaps to evade the obligation to repay principal and interests

The discord between the board of directors and the management team leads to disjointed operations, hindering the effective implementation of the business plan and fund utilization outlined in loan agreements As a result, the company struggles to meet its loan repayment deadlines.

Hereunder are some essential factors in banks causing bad debts:

A well-defined credit policy is essential for guiding all credit activities within a bank When a bank adopts a vague or lenient credit policy, it risks allowing credit officers to approve loans for unsuitable customers, ultimately jeopardizing loan recovery and increasing the likelihood of bad debts Moreover, banks that prioritize profit may recklessly approve substandard loans, further elevating the risk of financial losses.

Many banks adopt a risky credit policy by allocating a significant portion of their funds to lend to a single corporation or industry This approach can lead to substantial bad debts when these borrowers face financial challenges.

In a highly competitive banking environment, institutions are compelled to raise interest rates to attract customers, leading to increased lending rates necessary for maintaining profitability Consequently, customers facing financial difficulties have no choice but to accept these high borrowing costs, ultimately struggling to repay both the principal and interest on their loans.

Bank managers set targets for credit officers to enhance productivity and develop their skills However, this approach can backfire, as some credit officers may feel pressured to approve risky or unreasonable credit proposals.

In the lending process, the collection of information, credit analysis, and ongoing monitoring are crucial steps that demand knowledgeable and professional credit officers These professionals must stay informed about economic and social trends to accurately assess customers' creditworthiness, business plans, and collateral Failure to do so can lead to a decline in credit quality Additionally, some credit officers compromise professional ethics by colluding with customers for personal gain.

Many credit officers do not attach importance to monitoring customers after loans are made Therefore, they cannot promptly detect early problems and take corrective action

Collateral serves as a security measure for lenders in the event of borrower defaults or unexpected situations This is why banks are willing to extend loans to individuals with valuable collateral, even if their repayment sources are uncertain However, since most collateral consists of real estate, which is subject to market fluctuations, selling these assets can be challenging and time-consuming As a result, banks continue to face issues with bad debts.

1.1.3 The signs to identify non-performing loans:

During monitoring customers after loan disbursement, credit officers should continuously update information about customer as well as their operations, then detect early problem base on following signs:

Theory of bad debt management in commercial banks

1.2.1 The concept of bad debt management

Effective bad debt management involves developing and implementing strategies and credit policies aimed at achieving financial stability and security It also encompasses proactive measures to prevent and minimize bad debts, as well as efficient methods for addressing existing bad debts.

1.2.2 The objectives and the importance of bad debt management

Bad debts will be a great hindrance of banking activities and the economy if they are not carefully considered

Bad debt significantly impacts banking operations, posing a serious risk to the stability of the banking system A high level of bad debt reduces bank profitability by restricting credit extension and growth opportunities Additionally, banks incur expenses related to loan loss provisions and the management of bad debts, further contributing to a decline in profits.

Secondly, high rate of bad debt lessens bank’s reputation due to it breaks the international security limitation

Bad debt negatively impacts a bank's liquidity and business strategies, as commercial banks primarily focus on accepting deposits and issuing loans By mobilizing funds from the community, banks lend to those in need; however, if they fail to recover the full principal and interest from these loans, they risk facing cash flow issues This inability to meet their obligations to depositors leads to illiquidity, posing a significant threat to the stability of banks.

Finally, bad debt is an obstruction for banks to compete with one another in the context of globalization and development

Commercial banks play a crucial role in distributing funds and offering banking services within the economy Consequently, the issue of bad debts in banking operations poses significant challenges for all economic entities.

Effective bad debt management aims to establish and execute a suitable customer policy that minimizes credit risk while achieving the bank's profit objectives.

1.2.3 The content and process of bad debt management (Figure 1.1)

Setting up and implementing credit policy effectively

A credit policy serves as a strategic framework for commercial banks in offering loans to individuals and businesses, guiding credit officers in their operations and establishing a consistent banking mechanism This framework is crucial for effectively managing banking activities and plays a vital role in preventing bad debts through well-defined lending practices.

This is a very important preventive measure of bad debts Only by keeping close control of credit does bank reduce the possibility of making mistake during the lending activity

Figure 1.1: The process of bad debt management

Assessing ability to repay loans

Loan classification and loan loss provision

Loan classification involves organizing bank loans into categories based on shared characteristics, enabling effective management and providing a framework for assessing potential future risks that banks may encounter.

In most regulations on loan classification all over the world, loans are classified into 5 groups: Standard, Special attention, Sub-standard, Doubtful, and Loss

Under Vietnam Law, Decision 493 and amended Decision 18 allows credit institutions to apply both qualitative and quantitative methods to classify loans

The five-category system classifies bank loans is mainly based on the period which payments of principal and interest are overdue

- Debts that are not due and the borrower is able to pay the principal and interest of debts in full and in a timely manner

Debts that are overdue for less than 10 days can be fully covered by the credit institution, which assesses the ability to recover both the principal and interest in accordance with the remaining term.

- Debts are overdue for 10 or 90 days, and

- Debts with the repayment term to restructure for the first time and rescheduled debts are not due

- Debts that are overdue from 91 to 180 days,

- Debts with the repayment term to be restructured for the first time, except for those classified into group 2, and

- Debts, of which interests are exempted or reduced because customers are not capable of making full payment of interests under credit facility

- Debts are overdue from 181 to 360 days,

- Debts with the repayment term to be restructured for the first time, which are overdue for less than

90 days under the restructured repayment term,

- Debts with the repayment term to be restructured for the second time

- Debts are overdue for more than 360 days,

- Debts with the repayment term to be restructured for one time that are overdue for 90 days and more under the restructured repayment term,

- Debts with the repayment term to be restructured for two times, which are overdue under the restructured repayment term,

- Debts with the repayment term to be restructured

Student Vu Thi Hong The_ATCBK12 Page 23 for three times, including those which have not yet been overdue or have been overdue,

Table 1.1: Loan classification by the quantitative method Source: Decision 493 and amended Decision 18 by SBV Qualitative method

This method is based on banks’ internal credit rating systems and their provisioning policies as approved by the SBV There are also five groups as follow:

Customers demonstrate a strong capacity to repay debts, consistently meeting both principal and interest payments on time There are no indicators suggesting a decline in their ability to fulfill financial obligations, reflecting a stable business and financial situation.

Unresolved debts can significantly impact the ability to repay principal and interest on time, potentially leading to a decline in business and financial stability However, it's important to note that such debts do not necessarily impair overall repayment capabilities if addressed promptly.

Debts with clear signs of reducing business and financial situation affecting the ability to repay the debt in full

Debts with serious signs of reducing business and financial situation leading to a high risk of loss or inability to recover the debt in full

5 Loss Debts with sufficient basis to determine the inability to recall or recall negligibly

Table 1.2: Loan classification by the qualitative method Source: Decision 493 and amended Decision 18 by SBV

Loan classification is essential for determining adequate loan loss provisions, which help commercial banks mitigate credit losses These provisions are divided into two categories: specific provisions, which address identified risks, and general provisions, which account for potential future losses.

The amount of specific provision is calculated under the following formula:

Source: Decision 493 and amended Decision 18 by SBV

R: Amount of specific provision to be made

A: Outstanding principals of the debt

C: Deduction value of collateral asset r: specific provision rate

Under both quantitative and qualitative methods, the rate of specific provision for debts of 5 groups is as follows:

Table 1.3: Rate of specific provisions for debts Source: Decision 493 and amended Decision 18 by SBV

For frozen debts which await the settlement by the Government, the specific provisions shall be made depending on the financial capacity of the bank

General provision refers to the funds set aside to cover potential non-estimated losses during the classification of loans and the establishment of specific provisions, particularly in situations where commercial banks encounter financial difficulties.

Setting up an internal credit rating system

An internal credit rating system enables commercial banks to evaluate their customers based on qualitative criteria, categorizing them into distinct groups This classification facilitates the implementation of tailored measures for specific customer segments, enhancing the bank's ability to manage risk and improve service delivery.

Securitizing operation and credit derivative operation

Securitization refers to the process of converting contractual debts into tradable securities in the secondary market, transforming illiquid assets into liquid ones While it is often viewed as a method for diversifying risks, this benefit is somewhat limited for commercial banks.

When bad debts arise, commercial banks must immediately have appropriate responses to reduce loss at minimum

Step 1: Assess the customer’s ability to repay the loans

When a customer fails to repay a debt at maturity, the credit officer must promptly reach out to the customer to understand the reasons for non-repayment This assessment involves evaluating both the customer's ability and willingness to pay The primary goal of this process is to determine whether the bank should consider restructuring the loan If restructuring is not viable, the loan should be reclassified into an appropriate category.

In this step credit officer analyzes all information related to customer with the purpose of checking all decisions made in step 1

Step 3: Decide measures to process bad debts

THE REAL SITUATION AND THE PROCESS OF HANDLING BAD

Overview of Vietnam’s banking system

The banking system serves as the cornerstone of the economy, functioning as a vital financial intermediary To ensure the seamless operation of economic activities, it is essential that all banking operations are conducted smoothly, efficiently, and securely.

As of the end of 2011, the Vietnamese banking system comprised five state-owned commercial banks, including Vietcombank, Vietinbank, and BIDV, which were equitized while the state maintained a 70% controlling stake Additionally, the system featured one policy bank, 37 commercial banks, five joint venture banks, five wholly foreign-owned banks, and 54 branches of foreign banks.

Student Vu Thi Hong The_ATCBK12 Page 31 also non-bank financial institutions, including 18 finance companies, 13 financial leasing companies and credit system of the People's Fund

It is widely known that banking activity always comes hand in hand with various underlying risks Following is some of main risks

Credit risk remains a significant concern for banks, as lending constitutes a large portion of their assets, yet the quality of credit is inadequate, highlighted by a high rate of bad debt Recent global economic challenges, including the financial crisis, stock market downturns, a volatile real estate market, and fluctuating gold prices, have notably impacted credit quality.

- Liquidity risk: this risk often arises when commercial banks use short-term funds which account for 70% – 80% of total mobilizing funds to finance long- term business plans

The persistent high inflation in recent years has resulted in unstable interest rates within both the money market and financial market, significantly increasing the risk of interest rate fluctuations.

- Exchange rate: under the pressure of inflation and fluctuation of gold price and

As the USD rises alongside higher VND interest rates and lower USD rates, commercial banks are increasingly involved in foreign exchange trading This shift significantly impacts foreign currency liquidity and exposes banks to exchange rate risks, particularly the VND/USD exchange rate Key factors influencing this exchange rate include the current account deficit, trade deficit, high inflation, and unstable capital flows.

- Operational risk: this risk is more and more sophisticated and complicated in the context of information technology development

The questions raised in Vietnam’s commercial banking system

Vietnam’s commercial banking system has some following outstanding issues:

Vietnam's economy is heavily reliant on its banking sector, with credit institutions' assets accounting for a significantly higher percentage of GDP compared to other similarly developed countries in the region This dependency means that any underperformance by banks can negatively impact the overall economy, while macroeconomic instability can easily jeopardize the banking system As of the end of 2011, the total assets of credit institutions represented 200% of GDP, and outstanding credit to the economy reached 100% of GDP.

The banking system's total assets have experienced rapid growth over the years, but there is significant variation in growth rates among different banks, which may not accurately reflect reality Commercial banks typically hold the largest share of assets, followed by state commercial banks (SCBs) Foreign investors, including venture banks and foreign bank branches, account for 11% of total assets, while non-bank financial institutions and other organizations hold the smallest share This indicates that while total assets have surged, the figures may be inflated, leading to an exaggerated representation of asset scales on balance sheets.

Figure 2.1: proportion of credit institutions’ assets

The structure of assets and funds in Vietnam's commercial banks is deteriorating, as evidenced by the decreasing percentage of mobilized funds—a critical activity—in total liabilities over the years Many banks are increasingly dependent on the interbank market and external borrowing sources, including international lenders and the central bank Additionally, the rising financial leverage ratio highlights a decline in equity relative to total assets, raising concerns about whether these banks are straying from their core commercial functions.

- Credit growth which is often very high in the past few years has declined sharply in 2010 and 2011 and was negative during the first 5 months of

In 2012, the financial landscape was marked by a significant increase in non-performing loans, raising concerns about the growing scale of bad debts This issue was exacerbated by the high proportion of debts categorized within the Doubtful and Loss groups, highlighting the urgent need for effective debt management strategies.

The current credit structure is problematic, characterized by a significant reliance on long-term loans despite the majority of mobilized funds being short-term This maturity mismatch leads to liquidity issues, compounded by an excessively high proportion of lending directed towards state enterprises and the real estate market.

The rapid decline in asset quality, coupled with low levels of loan loss provisions, poses a significant risk to banking operations Current data indicates that provisions for credit risk fall short of the total bad debts recorded, which could jeopardize the stability of financial institutions if adverse events arise.

The income of banks is often not transparently reported, leading to concerns that their profits may significantly decline in the near future The income structure within the credit system reveals that a substantial portion of banks' profits is derived from their lending activities.

In the current environment of increasing bad debts and declining credit growth, banks are at significant risk of financial loss Additionally, if banks fully provision for classified loans and adhere to international accounting standards, their reported business performance may decline even further.

Current analyses indicate that many banks are operating under increased risk and insecurity, raising concerns about their stability in the face of a deteriorating macroeconomic environment The rapid rise in bad debts among banks is alarming, highlighting the urgent need for effective and timely interventions to safeguard the banking system.

The increase of bad debts in commercial banks in recent years

“Bad debts” currently seem to be the most concerned issue in the economy when the quantities of bad debts in commercial banks continuously increase

Figure 2.2: The rate of bad debt (2008 – 2012), unit: %

The figure shows an increase of bad debt rate in banking system in general and in commercial banks in particular during 2008-2012 In commercial banks including state

In 2012, bad debt levels in commercial banks surged to over 4%, significantly higher than those in foreign banks, highlighting the challenges faced by domestic financial institutions While the State Bank of Vietnam (SBV) Governor reported bad debts at approximately 10% by the end of 2012, other sources, including the Inspection and Supervision Authority and the Financial Supervisory Commission, provided varying figures of 8.6% and 11.8%, respectively This discrepancy underscores the uncertainty surrounding the actual extent of bad debts, which are widely regarded as a pressing issue for the banking sector.

Following are some figures of bad debts in some major banks currently:

Figure 2.3: the rate of bad debts in some commercial banks in 2012

Source: SBV, and Financial Statement 2012

Figure 2.4: The number of bad debts in some commercial banks in 2012

Source: SBV and Financial Statement 2012

According to the data, SHB has the highest bad debt rate at 8.53%, exceeding the overall system average by 1.53% Baovietbank and Agribank follow, each with nearly 6% Notably, the four largest commercial banks—Agribank, BIDV, Vietcombank, and Vietinbank—account for a significant portion of the total bad debts, totaling 47,256 billion VND, which represents approximately 25.5% of the system's bad debts Agribank, in particular, holds the largest share with bad debts amounting to 27,803 billion VND, significantly surpassing those of other credit institutions.

Bad debts pose a significant challenge to banking operations and the economy, with approximately 185,000 billion VND tied up in collateral, representing a wasteful use of resources, particularly in tough economic times This issue leads commercial banks to restrict their lending activities despite having sufficient funds, as they must exercise caution to avoid accruing additional bad loans Consequently, a paradox arises where enterprises require more capital for their operations, yet banks continue to limit their lending capabilities.

2.3 The causes of the increase of bad debt rate

With the aim to handle bad debts thoroughly, it is very important to identify the causes of bad debts from both inside and outside banks

Firstly, it is due to the negative influence of the global financial crisis

The global financial crisis that began in 2008 severely disrupted economic activities worldwide, leading many industrialized nations into their worst downturn in nearly 70 years Vietnam experienced significant repercussions, with its economic growth, trade, employment, and investment severely impacted Vietnamese exporters faced numerous challenges as traditional markets like the US and EU grappled with their own crises Small and medium enterprises struggled with contract rejections, delayed sales, and rising inventory levels As manufacturing and trading stagnated, many customers found themselves unable to repay loans, resulting in increased bankruptcies.

Secondly, the inefficient business operation of enterprises borrowing money from banks brings about the failure to perform their obligations in accordance with their commitments

Approximately 70% of bad debts originate from state-owned enterprises, which benefit from easier access to credit and represent a significant portion of the economy's total loans These companies face high loan costs while experiencing a sharp decline in revenue compared to the previous year, resulting in financial instability In many cases, the total interest payable is several times greater than employee salaries, with profit margins falling short of interest rates Additionally, companies like Vinashine, Vinalines, and the Electricity Group struggle with low operational efficiency, poor financial health, and limited capacity to adapt to business challenges.

Student Vu Thi Hong highlights the challenges faced by businesses due to environmental constraints, coupled with economic difficulties such as low purchasing power and high inventory levels These factors lead to a decline in revenue, leaving companies unable to meet their obligations for both principal and interest payments.

The second largest number of bad debts is from real estate, security, transportation

Following is the proportion of bad debts based on industry groups

Figure 2.5: The proportion of bad debts based on industry groups

The data reveals that 88.21% of bad debts originate from seven key industries, with transportation, real estate, and construction leading at 23.28%, 14.61%, and 10.77% respectively Over the past few years, companies within these sectors have faced significant challenges due to the economic crisis, exemplified by the struggles of the Southern Container Joint Stock Company.

110 billion VNDs chartered capital suffered from a loss of – 23.45 billion VNDs in first 6 months of 2012 and its accumulated loss at present is about 105.4 billion VNDs

Another example is the loss of VND 16.3 billion of the Song Da Infrastructure

Vietnam experienced some of the highest credit growth in the world, averaging 33% per year over the eight years leading up to 2011, with a peak of 32.43% in 2010 before dropping to 14.31% in 2011 This rapid credit growth was driven by banks' focus on business efficiency, often at the expense of sound risk management practices As banks competed to mobilize funds, they pushed interest rates higher and adopted a "the more, the better" approach to lending, resulting in many enterprises taking on loans they ultimately could not repay.

The limited capacity for effective risk management poses a significant challenge for banks, as many institutions lend to high-risk sectors such as real estate and securities without thorough evaluations Additionally, a substantial portion of business clients—90% of whom are small and medium enterprises—lack accurate financial statements, with most of these documents remaining unaudited, further complicating the banks' ability to assess risk.

The existing legal framework for managing bad debts in banks has notable limitations While it includes essential regulations on loan classification, loan loss provisions, collateral processing, and debt trading activities, these laws often fail to demonstrate their effectiveness in practice.

The cross-ownership status within the banking system creates a complex web where large companies, particularly state-owned economic groups, act as strategic investors in commercial banks This interlinking often results in commercial banks holding shares in one another, leading to unregulated lending practices and a lack of proper assessment and control, ultimately contributing to the issue of rising bad debts.

2.4 The government and banks’ efforts in handling bad debts in recent years

2.4.1 Loan classification and loan loss provision

On 22/4/2005, the SBV’s Governor promulgated the Decision 493/2005/QD-NHNN of loan classification and loan loss provision as a measure to prevent credit risk in banking operation

Loan classification enables commercial banks to accurately assess the status of their loans, facilitating the development of effective credit risk management policies This process is essential for establishing adequate loan loss provisions, allowing banks to operate efficiently while mitigating credit risk in their lending activities.

Currently, all banks are implementing Decision 493 to reclassify loans and establish provisions based on qualitative and quantitative factors This initiative has significantly contributed to a rapid decline in the bad debt ratio, dropping from 8.6% at the end of 2012 to 6% in early 2013.

In the end of 2012 In the early of 2013 Total outstanding credit 2,774,721.22 3,028,363.20

Number of bad debts (billion dongs) 238,626.02 184,941.79

Table 2.1: the decrease of bad debts Source: Vietcombank Security

The rate of bad debts decreased by 2.6%, amounting to 53,684.23 billion VND, largely due to the proactive measures taken by commercial banks in reclassifying and restructuring loans, as well as addressing bad debts in accordance with official document 3739/NHNN.

Restructuring loans can assist banks in lowering their current bad debt levels; however, without indications of economic recovery, some of these loans may still be reclassified as bad debts in the near future.

2.4.2 Establishing Vietnam Asset Management Company (VAMC)

The government and banks’ efforts in handling bad debts in recent years

2.4.1 Loan classification and loan loss provision

On 22/4/2005, the SBV’s Governor promulgated the Decision 493/2005/QD-NHNN of loan classification and loan loss provision as a measure to prevent credit risk in banking operation

Loan classification enables commercial banks to assess the actual status of their loans, facilitating the development of effective credit risk management policies This process is essential for establishing adequate loan loss provisions, allowing banks to operate efficiently while mitigating credit risk in their lending activities.

Currently, all banks are implementing Decision 493 to reclassify loans and establish provisions based on both qualitative and quantitative factors This initiative has significantly contributed to the rapid decline in the bad debt rate, which fell from 8.6% at the end of 2012 to 6% in early 2023.

In the end of 2012 In the early of 2013 Total outstanding credit 2,774,721.22 3,028,363.20

Number of bad debts (billion dongs) 238,626.02 184,941.79

Table 2.1: the decrease of bad debts Source: Vietcombank Security

The bad debt rate decreased by 2.6%, amounting to 53,684.23 billion VND, largely due to the proactive measures taken by commercial banks in reclassifying and restructuring loans, as well as addressing bad debts in accordance with official document 3739/NHNN.

While restructuring loans can assist banks in lowering their current bad debt levels, a portion of these loans may still be reclassified as bad debts in the near future if the economy shows no signs of recovery.

2.4.2 Establishing Vietnam Asset Management Company (VAMC)

In 2001, the government permitted the establishment of asset management companies (AMCs), leading to the creation of 27 AMCs linked to commercial banks However, these AMCs primarily serve their parent banks due to limited capital, resulting in less effective management of bad debts than anticipated To address this issue, the Vietnam Asset Management Company project was completed and is set to be implemented in May 2013.

Banks transfer their bad debts to the Vietnam Asset Management Company (VAMC), which issues low-interest special bonds in return This process transforms bad debts on banks' balance sheets into good assets, making them liquid and tradable in the market Additionally, these bonds can be discounted by the State Bank of Vietnam (SBV) at a specific rate, although the discount cannot exceed 50% of the bonds' nominal value This feature is regarded as the primary advantage of VAMC bonds.

Banks are actively collecting debts for several reasons Firstly, it's crucial to understand that the State Bank of Vietnam (SBV) does not purchase VAMC bonds; instead, it provides loans to commercial banks using these bonds as collateral Consequently, banks need to recover debts to ensure they have sufficient funds for repayment.

Student Vu Thi Hong from The_ATCBK12 Page 42 states that banks are entitled to 85% of the funds from processing bad debts, while the Vietnam Asset Management Company (VAMC) retains the remaining portion Despite the transfer of bad debts to VAMC, the obligation to recover these debts and manage collateral remains with the banks.

VAMC serves as a crucial intermediary for the State Bank of Vietnam (SBV), facilitating loans to commercial banks to address liquidity challenges, improve balance sheets, and provide time for banks to explore alternative funding sources to recover from previous losses.

2.4.3 Strengthening commercial banks’ credit policies

Establishing the internal credit rate system for their customers

Many commercial banks today have implemented their own credit rating systems for customers, enhancing loan classification and loss provision methods The Internal Credit Rating System evaluates customers based on a combination of financial and non-financial factors An example of such a system is utilized by Vietcombank.

The information inputs applied to specific normal customers are classified into these following groups:

 Financial indicators (accounting for 30% - 35% of the total scores of customers depending on audited or unaudited financial statement)

 Non-financial indicators (accounting for 60% of the total scores of customers)

 The ability to pay debt of customers (5%)

 Management ability and internal environment (15%)

After considering all factors, there is a Credit Rating System as follows:

Table 2.2: The Credit Rating System of Vietcombank

Source: Vietcombank’s Loan Portfolio Review Report

Then, based on types of customers (individuals, normal corporate, or newly established corporate), the bank will have appropriate method of loan classification and provision calculating

The Internal Credit Rating System (ICRS) plays a crucial role in helping commercial banks manage credit risk effectively By utilizing ICRS, banks can decline applications from customers with low credit scores, allowing them to focus more on servicing standard clients Furthermore, ICRS aids in making informed decisions regarding the extension of new credit to reliable customers and enables early intervention for clients who are categorized in lower ranks, thus promoting better risk management.

In response to rising bad debts, commercial banks have revised their lending policies to adapt to the current economic landscape They are now limiting loans to high-risk sectors such as real estate and securities, while encouraging lending to more stable areas A recent poll revealed that 86.7% of credit institutions will not increase real estate lending, and 95.89% are disinterested in expanding loans for securities in 2013 Instead, banks are focusing on providing credit to priority clients, particularly those involved in exports and small to medium-sized enterprises.

Tightening the conditions of lending and collaterals

In lending, banks mandate that credit officers adhere to strict regulations, assess potential risks, and thoroughly understand their customers, following the "Know Your Customer" principle It is essential for credit officers to monitor all customer activities before, during, and after the loan disbursement process.

Banks conduct thorough evaluations of both financial and non-financial indicators for each loan, emphasizing the importance of reliable audits for financial metrics Key sources of repayment include cash flow and collateral, leading many banks to tighten collateral requirements to minimize bad debts For instance, HDBank limits loans secured by rural land, high-risk securities, unlisted securities, or other illiquid assets, while commercial banks prioritize collateral that is free from disputes.

Assessment

In the process of handling bad debts, efforts of the government, commercial banks and involved parties reach some following achievement

The approach to managing bad debts has been clearly outlined, detailing the methods and procedures involved, as well as the responsibilities of all parties engaged in the debt resolution process.

The growth rate of non-performing loans (NPLs) and the NPL ratio has decreased, primarily due to Decision 780 by the State Bank of Vietnam (SBV), which focuses on classifying restructured and rescheduled loans Additionally, commercial banks have actively reduced NPLs by utilizing provisions and successfully recovering a portion of bad loans.

The significance of publicity and transparency regarding bad debts has increased notably Previously, banks were reluctant to disclose their bad debt figures due to concerns about their reputation However, these numbers have now become a regular part of banks' communications.

The legal framework for restructuring has been progressively enhanced, with the recent issuance of Circular 02/2013/TT - SBV by the State Bank of Vietnam (SBV), which outlines asset classification and the methods and levels for making provisions to address credit risk.

Finally, many banks have built their own plans to tackle with bad debts

The handling of bad debts is a slow process, exemplified by the proposal to establish the Asset Management Company (VAMC) over a year ago, which remains incomplete to this day.

The inconsistency in non-performing loan (NPL) figures reported by the State Bank of Vietnam (SBV), commercial banks, and other institutions poses a significant challenge in effectively addressing bad debts This disparity in data hinders the swift and comprehensive resolution of these financial issues.

Current strategies for addressing bad debts primarily focus on short-term fixes, leaving underlying issues unresolved Long-term solutions, including support measures for businesses and interest rate reduction policies, have not been effectively integrated into the overall approach.

The coordination among the involved ministries and parties remains insufficient, hindering progress in essential areas For instance, commercial banks are seeking more favorable conditions for processing collaterals, yet the Ministry of Justice has not relaxed the legal requirements governing this matter.

Chapter 2 mainly focuses on studying following issues:

This chapter provides an overview of Vietnam's banking system, highlighting the primary risks that commercial banks encounter in their operations and addressing current challenges within the banking sector.

Secondly, based on collected information, chapter 2 clarifies the real situation of the upward trend of bad debts in Vietnam recently, and then represents practical causes of bad debts

Finally, the chapter also analyzes the efforts of the government and commercial banks in addressing bad debts accompanied with critical assessment.

SOLUTIONS TO HANDLE BAD DEBTS

Solutions from the government and the SBV

Restructuring the banking system to eliminate weak banks, upgrade large scale banks with the aim to operate safely and effectively This process includes 2 aspects:

Restructuring organizations necessitates that banks distinctly separate their lending activities, aligning with government policies aimed at supporting key priorities, from the commercial aspects of their operations To thrive, commercial banks must adhere to market principles while effectively executing their business functions.

Restructuring the financial sector necessitates that banks increase their chartered capital through various methods, including mergers and acquisitions, issuing additional shares, or closing down underperforming banks Additionally, addressing overdue debts is crucial for stabilizing the financial landscape, which in turn enhances banks' competitive capacity and ability to manage risks effectively.

Improving the legal system in banking operation

To effectively address bad debts, it is essential to enhance laws and regulations on loan classification Clear and precise identification of corporate debts is crucial for banks to manage these issues comprehensively Current legislation should include explicit terms and consistent criteria for classifying bad debts across all credit institutions, integrating both quantitative and qualitative methods Additionally, there must be a standardized approach for quantitative criteria and specific regulations governing the classification process It is also vital to enforce a rule requiring all banks to adhere strictly to these classification regulations, prohibiting practices such as debt swapping and restructuring that obscure the true state of bad debts.

The government must enhance laws regarding collateral processing to effectively manage bad debts To address challenges in collateral handling, relevant ministries should swiftly issue circulars targeting key issues such as the seizure and storage of collaterals, procedures for processing assets when the mortgagor or third-party investor's status changes, and the transfer of ownership or usage rights to buyers Furthermore, establishing a legal framework for resolving collateral disputes is essential to protect the interests of banks and other stakeholders.

Abolishing the cross-ownership status among commercial banks

Cross-ownership complicates the identification of debtors and creditors within the banking system, obscuring the true ownership of assets If the existing cross-ownership issues are not addressed, resolving the problem of bad debts will remain challenging The resolution of these cross-ownership situations is a significant concern, prompting various economic specialists to propose potential solutions.

Dr Tran Du Lich, a member of the National Monetary Policy Advisory Council, emphasized the necessity for the State Bank of Vietnam to establish a legal framework to regulate cash flow, noting that issues faced by commercial banks stem from this area.

The Fulbright Economics Teaching Program advises that the State Bank should revise ownership limits and credit disbursement regulations concerning major shareholders It is essential to close legal loopholes that enable individuals and organizations to exert control over banks through intermediaries Furthermore, existing shareholders, both state and private, should be prohibited from exceeding the established limits on bank share ownership.

"Vietnam government should have clear governance on the cross-ownership status; and banks must also disclose information transparently” said Tomoyuki Kimura, ADB director in Vietnam

Establishing the Vietnam Asset Management Company (VAMC) promptly and finalizing the legal framework for its debt trading operations are critical priorities VAMC plays a crucial role in addressing bad debts, yet its effectiveness has been hampered by a limited legal structure, resulting in previous inefficiencies in debt resolution.

Currently, the significant volume of bad loans indicates that VMAC's involvement in purchasing these debts is insufficient Furthermore, bad debts can also be viewed as a critical issue impacting financial stability.

The trading of bad debts has proven to be a profitable commodity for investors in the global market To enhance the management of bad debts in Vietnam, the government must not only refine the legal framework governing debt trading but also establish a dedicated market for such transactions Implementing these strategies will facilitate more effective debt management and bolster investor confidence.

(i) Adding a regulation to allow VMAC to arrange loans on trust for debtors in order to facilitate the recovery of those enterprises

Credit institutions must clearly define their responsibilities in ensuring that debt information is public and transparent Banks are obligated to sell their bad debts, viewing the sale to the Vietnam Asset Management Company (VAMC) as a duty rather than a choice This accountability in disclosing bad debts is essential for facilitating debt trading activities among other companies Additionally, implementing policies that encourage investor participation in the debt trading market, such as tax incentives, is crucial for fostering a vibrant trading environment.

To stimulate the effective operation of Vietnam's debt trading market, it is crucial to implement measures that control enterprises with overdue bank debts, simplify collateral processing and asset liquidation procedures, and establish mechanisms for swiftly addressing bankruptcy cases These actions will reassure investors, encouraging their participation in trading and loan processing, ultimately fostering a more dynamic financial environment.

Solutions from commercial banks and enterprises

To enhance their risk management capacity, commercial banks must focus on developing robust metrics for quantifying risks This foundational step is crucial for making informed lending decisions and ensuring accurate loan classification, ultimately leading to improved long-term risk management strategies.

To enhance the professional ethics of credit officers, banks must prioritize raising awareness about ethical standards and professional conduct Given the current decline in professional etiquette among many credit officers, it is crucial to not only increase awareness but also implement strict penalties for those who violate ethical guidelines By doing so, banks can foster a greater sense of responsibility and uphold the integrity of their credit officers.

Thirdly, there should be solutions for each group of bad debts Specifically:

To address the issue of bad debt stemming from unsold inventory, an effective solution is to assist companies in liquidating their stock through tax reductions or exemptions This approach enables businesses to lower prices and boost consumer demand, ultimately resolving inventory challenges and allowing enterprises to restore their production cycles.

In cases of absolute loan loss, such as corporate bankruptcy where collateral loses its value, it is essential to clearly outline the responsibilities of banks Banks are required to absorb losses, establish provisions, and may need to utilize a portion of their profits to cover outstanding debts.

Loans secured by collateral face significant challenges in recovery, as the value of these assets often declines sharply—vessels can lose around 50% and shares can decrease by 60% to 70% from their original loan value The lengthy process of selling collateral frequently results in banks recovering only a fraction of the owed amount Additionally, while some equipment holds substantial value, it is not easily liquidated, and specialized assets like ships and machinery are typically intertwined with other assets, complicating their use in production Disputes over collateral linked to multiple loans further hinder the sale process Therefore, integrating bad debt securitization and trading emerges as a more effective solution for managing these challenges.

(i) The debt securitizing may quickly and thoroughly have solved bad debt problem, enabling business borrowers to unfreeze funds and have opportunities to recover production

Banks can sell securitized debts to investors who have a strong understanding of debtor operations and the financial capacity to generate greater value than the banks themselves For instance, a consumer goods company could strategically acquire these debts to enhance its value creation potential.

Student Vu Thi Hong The_ATCBK12 Page 53 packaging manufacturing company, or a company manufacturing papers acquired a company specializing in manufacturing wood-pulp

Securitizing loans and selling these securities effectively unfreezes funds for businesses while simultaneously allowing banks to write off bad debts from their financial statements and recover funds However, if banks focus solely on securitizing bad debts, they risk facing challenges if enterprises fail to resume production Conversely, bypassing the securitization process and directly selling bad debts can lead to prolonged delays in managing these debts.

The integration of these two processes offers significant advantages for all parties involved Enterprises can rejuvenate their production, eliminate bad debts, and stabilize their financial structure Banks benefit from a swift resolution to the bad debt issue Additionally, buyers of securitized debts find a valuable opportunity to acquire other companies at a low cost, enhancing their operational capabilities.

To ensure the effectiveness of solutions for bad debt securities, state agencies must intervene by establishing an organized market for these assets It is crucial to publicize information regarding bad debt securities to attract potential buyers Additionally, lawmakers should implement mandatory regulations for the disclosure of bad debts and their securities, accompanied by strict penalties to foster the growth of the bad debt securities market.

State-owned enterprises (SOEs) must undergo restructuring due to their significant outstanding loans in banks This restructuring process should prioritize financial adjustments, as outlined in the government-approved project, enabling SOEs to enhance their operational capacity.

The chapter proposes solutions to handle bad debts which come from not only the government and the SBV but also commercial banks themselves and enterprises

To effectively address bad debts, the government and the State Bank of Vietnam (SBV) must tackle macroeconomic issues by restructuring the banking system, enhancing the legal framework, eliminating cross-ownership, and establishing the Vietnam Asset Management Company (VAMC).

Commercial banks enhance their ability to address challenges by improving credit activities and refining the management of bad debts Additionally, restructuring enterprises and providing them with support are essential strategies for effective problem resolution.

To address the pressing issue of bad debts, the government should swiftly establish the Vietnam Asset Management Company (VAMC) with an effective operational framework, enhance the legal structure for collateral processing, and take immediate measures to revitalize the real estate market.

To effectively eliminate bad debts and foster long-term economic recovery, it is crucial for the government to implement reasonable and effective macroeconomic policies Supporting domestic businesses, particularly small and medium enterprises, will play a vital role in revitalizing the economy.

To the State Bank of Vietnam

To enhance the performance of commercial banks in managing bad debts, the thesis advises the State Bank of Vietnam (SBV) to provide clear guidance to banks on monetary policy implementation It also recommends that relevant departments continue to review and update regulations concerning loan classification, loan loss provisions, and collateral processing, aiming to minimize bad debts within the banking sector.

Tiêu đề	Handling Bad Debts In Vietnamese Commercial Banks: The Real Situation And Solutions
Tác giả	Vu Thi Hong
Người hướng dẫn	MA. Ngo Tung Anh
Trường học	Banking Academy
Chuyên ngành	Foreign Language
Thể loại	graduation thesis
Năm xuất bản	2013
Thành phố	Hanoi

Định dạng
Số trang	60
Dung lượng	0,9 MB