Perfecting internal control system over credit operations in commercial banks in hai phong,graduation thesis

Rationale of the study

In a commodity-based economy, the emergence and growth of banks are essential to meet the capital and payment needs of businesses and individuals Commercial banks serve as financial intermediaries, mobilizing capital to stimulate economic activity while providing banking services to generate profits Among their various operations, credit activities are crucial due to their significant impact on capital turnover and profitability.

This operation carries several risks, notably credit risk, which occurs when borrowers fail to repay the bank as agreed Such defaults can result in liquidity risk due to unrecovered loans To mitigate and prevent credit risk, it is essential to implement not only technical measures but also a robust internal control system.

As Hai Phong experiences rapid economic growth, the demand for savings and financial services has led to a significant increase in the number of commercial bank branches To remain competitive, these banks are modernizing their services; however, many face challenges due to their small size, limited governance capacity, and varying professional qualifications This situation exposes them to risks, particularly in an unstable business environment with an inadequate legal framework that allows for potential fraud The overdue loan rate among commercial banks in Hai Phong is concerning, highlighting the need for improved credit risk management and the establishment of effective internal control systems.

In the era of economic globalization, Vietnam's accession to the WTO underscores that financial liberalization is essential for countries aiming to integrate their economies into the global market.

This study evaluates the strengths and weaknesses of the internal control system governing credit operations in commercial banks across Vietnam, with a specific focus on those in Hai Phong Additionally, it proposes targeted solutions to enhance the internal control systems for credit operations within the province's commercial banks.

The study uses questionnaires to examine the status of internal control over credit operations in typical commercial banks in Hai Phong

We discuss with a number of managers, internal auditors and loan officers at a number of state-owned and joint-stock commercial banks in Hai Phong

We synthesize the reports and data related to outstanding loans, overdue loans and the causes to the overdue loans of the State Bank of Hai Phong

The study pays attention to the internal control problems over credit operations in commercial banks in Hai Phong

This study aims to assess the effectiveness of internal control systems in identifying and mitigating credit risks By analyzing the strengths and weaknesses of these systems, the research offers actionable solutions to enhance their performance, ultimately ensuring optimal control over credit operations in commercial banks.

The study is important as follows:

The research serves as a valuable resource for the State and the State Bank of Hai Phong, aiding in the refinement of laws governing credit operations and enhancing policies and measures for the inspection and monitoring of commercial banks.

The study highlights key challenges faced by authorities and emphasizes the importance of providing substantial support to commercial banks This support will empower these banks to expand their operations, ultimately fostering economic and social development in Hai Phong and across the nation.

1 What are strengths and weaknesses of internal control system over credit operations in commercial banks in Hai Phong?

2 What are the causes of those weaknesses?

3 What are measures to overcome those weaknesses?

Chapter 1: Theoretical background This chapter summarizes the banking internal control system and discusses the credit operations, credit risk and internal control over credit operations

Chapter 2 delves into the establishment and evolution of Vietnam's banking system, with a focus on commercial banks in Hai Phong The study conducts a survey to identify and analyze the factors contributing to credit risk within these banks, while also examining the strengths and weaknesses of their internal control systems related to credit operations in the province.

Chapter 3: Solutions This chapter provides some solutions to perfect the internal control system over credit operations in commercial banks in Hai Phong

CHAPTER 1: THEORETICAL BACKGROUND 1.1 Internal control in commercial banks

“Bank” shall mean a credit institution permitted to conduct all banking activities and other related business operations

“Banking activities” shall mean monetary business activities and banking services, with regular operations as accepting deposits, and using them to provide credit and payment services

In the course of their operations, banks are invariably faced with different types of risks that may have a potentially negative effect on their business

Banks face several operational risks, including liquidity risk, credit risk, and market risks such as interest rate risk, foreign exchange risk, and fluctuations in the market prices of securities, financial derivatives, and commodities Additionally, they are exposed to operational risk, legal risk, and reputational risk.

Liquidity risk is the risk of negative effects on the financial result and capital of the bank caused by the bank’s inability to meet all its due obligations

Credit risk is the risk of negative effects on the financial result and capital of the bank caused by borrower’s default on its obligations to the bank

Market risk includes interest rate and foreign exchange risk

Interest rate risk is the risk of negative effects on the financial result and capital of the bank caused by changes in interest rates

Foreign exchange risk is the risk of negative effects on the financial result and capital of the bank caused by changes in exchange rates

A special type of market risk is the risk of change in the market price of securities, financial derivatives or commodities traded or tradable in the market

Operational risk refers to the potential negative impact on a bank's financial performance and capital due to employee errors, insufficient internal procedures, poor information management, and unforeseen external events.

Legal risk refers to the potential for financial loss resulting from penalties or sanctions arising from court disputes related to the violation of contractual and legal obligations, as well as penalties imposed by regulatory authorities.

Reputational risk is the risk of loss caused by a negative impact on the market positioning of the bank

Internal control is an ongoing process involving the board of directors, senior management, and all personnel within a bank, rather than a one-time procedure It is essential for the board and senior management to foster a culture that supports effective internal controls and to continuously monitor their effectiveness Active participation from every individual in the organization is crucial The primary objectives of the internal control process can be categorized into key areas that ensure operational efficiency and compliance.

1 efficiency and effectiveness of activities (performance objectives);

2 reliability, completeness and timeliness of financial and management information (information objectives); and

3 compliance with applicable laws and regulations (compliance objectives)

Performance objectives for internal control focus on enhancing the bank's effectiveness and efficiency in utilizing its assets while safeguarding against potential losses The internal control process aims to ensure that all personnel align their efforts with the bank's goals, promoting efficiency and integrity while avoiding unnecessary costs and prioritizing the bank's interests over those of employees, vendors, or customers.

Information objectives focus on creating timely, reliable, and relevant reports essential for decision-making within banking organizations They emphasize the necessity for trustworthy annual accounts, financial statements, and disclosures for shareholders, supervisors, and external parties Management, the board of directors, shareholders, and supervisors require high-quality information that they can depend on for informed decision-making In the context of financial statements, "reliable" signifies the fair presentation of statements grounded in comprehensive and well-defined accounting principles and rules.

Methodology of the study

The study uses questionnaires to examine the status of internal control over credit operations in typical commercial banks in Hai Phong

We discuss with a number of managers, internal auditors and loan officers at a number of state-owned and joint-stock commercial banks in Hai Phong

We synthesize the reports and data related to outstanding loans, overdue loans and the causes to the overdue loans of the State Bank of Hai Phong

The study pays attention to the internal control problems over credit operations in commercial banks in Hai Phong

This study aims to assess the effectiveness of the internal control system in identifying and mitigating credit risks within commercial banks By analyzing its strengths and weaknesses, the research offers targeted solutions to enhance the system, ultimately improving the management of credit operations.

The study serves as a valuable resource for the State and the State Bank of Hai Phong, aiding in the enhancement of laws governing credit operations and informing policies and measures for the inspection and monitoring of commercial banks.

The study highlights the challenges faced by authorities and emphasizes the importance of providing substantial support to commercial banks This assistance aims to enhance their confidence in expanding business operations, ultimately fostering economic and social development in Hai Phong and across the nation.

Chapter 2: The Real Situation examines the establishment and evolution of Vietnam's banking system, focusing on commercial banks in Hai Phong The study conducts a survey to identify and analyze the factors contributing to credit risk within these banks, while also assessing the strengths and weaknesses of internal controls governing credit operations in the region.

CHAPTER 1: THEORETICAL BACKGROUND 1.1 Internal control in commercial banks

Banks face several operational risks, including liquidity risk, credit risk, and various market risks such as interest rate risk, foreign exchange risk, and risks associated with fluctuations in the market prices of securities, financial derivatives, and commodities Additionally, they are exposed to operational risk, legal risk, and reputational risk, all of which can significantly impact their stability and performance.

Operational risk refers to the potential negative impact on a bank's financial performance and capital due to employee errors, insufficient internal procedures, poor information management, and unforeseen external events.

Legal risk refers to the potential financial loss arising from penalties or sanctions resulting from court disputes related to breaches of contractual and legal obligations, as well as penalties imposed by regulatory bodies.

Internal control is an ongoing process involving the board of directors, senior management, and all employees within a bank, rather than a one-time procedure The board and senior management play a crucial role in fostering a culture that supports effective internal controls and continuously monitoring their effectiveness It is essential for every individual in the organization to engage in this process The primary objectives of internal control can be categorized into several key areas.

Performance objectives for internal control focus on enhancing a bank's effectiveness and efficiency in utilizing its assets while safeguarding against losses The internal control process aims to ensure that all personnel within the organization work towards achieving the bank's goals with integrity and efficiency, avoiding unnecessary costs and prioritizing the bank's interests over those of employees, vendors, or customers.

Information objectives focus on creating timely, reliable, and relevant reports essential for decision-making within banking organizations They emphasize the importance of accurate annual accounts, financial statements, and disclosures to shareholders, supervisors, and external parties The information provided to management, the board of directors, shareholders, and supervisors must possess high quality and integrity, enabling informed decision-making In the context of financial statements, reliability means that these documents are fairly presented and adhere to comprehensive and well-defined accounting principles and standards.

Compliance objectives are crucial for ensuring that banking operations adhere to relevant laws, regulations, and internal policies Meeting these objectives is essential for safeguarding the bank's reputation and franchise value.

The control environment encompasses the standards, processes, and structures that underpin internal control within an organization Established by the board of directors and senior management, it sets the tone for the importance of internal control and expected conduct This environment includes the organization's integrity and ethical values, governance oversight capabilities of the board, organizational structure, and the assignment of authority Additionally, it involves the strategies for attracting and retaining competent personnel, as well as the performance measures and incentives that promote accountability Ultimately, the control environment significantly influences the overall internal control system.

Every organization encounters diverse risks from both external and internal sources, defined as the likelihood of events that could negatively impact goal attainment Risk assessment is a dynamic and ongoing process that identifies and evaluates these risks in relation to the organization's objectives and established risk tolerances This foundational assessment guides the development of effective risk management strategies.

Effective risk assessment begins with the establishment of clear objectives across various levels of the organization, as defined by management These objectives encompass operations, reporting, and compliance, enabling the identification and analysis of associated risks Additionally, management must evaluate the appropriateness of these objectives for the entity while also considering potential changes in the external environment and within its business model that could compromise the effectiveness of internal controls.

Control activities are essential actions defined by policies and procedures that ensure management's directives are effectively implemented to mitigate risks and achieve objectives These activities occur at all organizational levels and throughout various stages of business processes and technology environments They can be either preventive or detective, involving a mix of manual and automated tasks such as authorizations, approvals, verifications, reconciliations, and performance reviews Typically, segregation of duties is integrated into the design of these control activities; however, when this is not feasible, management is responsible for selecting and developing alternative control measures.

Significance of the study

This study aims to assess the effectiveness of internal control systems in identifying and mitigating credit risks within commercial banks By analyzing the strengths and weaknesses of these systems, the research offers actionable solutions to enhance their performance, ultimately ensuring better management of credit operations.

The research serves as a valuable resource for the State and the State Bank of Hai Phong, aiding in the enhancement of laws governing credit operations and informing policies and measures for the inspection and monitoring of commercial banks.

The study highlights key challenges faced by authorities and emphasizes the importance of providing substantial support to commercial banks This support will empower banks to confidently expand their operations, ultimately fostering economic and social development in Hai Phong and contributing positively to the nation's growth.

Research questions

Organization of the study

Chapter 2 delves into the establishment and evolution of Vietnam's banking system, focusing specifically on the commercial banks in Hai Phong The study conducts a survey to pinpoint and analyze the factors contributing to credit risk within these banks, while also evaluating the strengths and weaknesses of their internal control mechanisms over credit operations in the province.

THEORETICAL BACKGROUND

Internal control in commercial banks

Banks face various operational risks, including liquidity risk, credit risk, and market risks such as interest rate risk, foreign exchange risk, and fluctuations in the market prices of securities, financial derivatives, and commodities Additionally, they are exposed to operational risk, legal risk, and reputational risk.

Operational risk refers to the potential negative impact on a bank's financial results and capital stemming from employee errors, insufficient internal procedures, poor information management, and unforeseen external events.

Legal risk refers to the potential for financial loss resulting from penalties or sanctions arising from court disputes related to breaches of contractual and legal obligations, as well as those imposed by regulatory bodies.

Internal control is a continuous process involving the board of directors, senior management, and all personnel within a bank, rather than a one-time procedure It requires the board and management to foster a culture that supports effective internal controls and to regularly assess their efficacy Active participation from every individual in the organization is essential The primary objectives of the internal control process include ensuring compliance, safeguarding assets, and enhancing operational efficiency.

Performance objectives for internal control focus on enhancing the bank's effectiveness and efficiency in utilizing its assets and resources while safeguarding against losses The internal control process aims to ensure that all personnel are aligned with the bank's goals, promoting efficiency and integrity without incurring unnecessary costs or prioritizing external interests over the bank's objectives.

Information objectives focus on creating timely, reliable, and relevant reports essential for decision-making within banking organizations They emphasize the necessity for trustworthy annual accounts, financial statements, and disclosures for shareholders, supervisors, and external parties The quality and integrity of the information provided to management, the board of directors, and stakeholders must be high enough to support informed decision-making In this context, "reliable" financial statements are those that are presented fairly and adhere to comprehensive and well-defined accounting principles and rules.

Compliance objectives are essential for ensuring that banking operations adhere to relevant laws, regulations, and internal policies Meeting these objectives is crucial for safeguarding the bank's reputation and franchise.

The control environment encompasses the standards, processes, and structures that form the foundation for internal control within an organization Established by the board of directors and senior management, it sets the tone for the significance of internal control and outlines expected conduct standards Management further emphasizes these expectations throughout the organization Key components of the control environment include the organization's integrity and ethical values, the framework for governance oversight, the organizational structure with defined authority and responsibility, and effective strategies for attracting, developing, and retaining skilled personnel Additionally, it incorporates performance measures, incentives, and rewards that promote accountability This comprehensive control environment significantly influences the overall internal control system.

Every organization encounters various external and internal risks that can hinder its objectives Risk is defined as the likelihood of an event negatively impacting goal attainment The process of risk assessment is dynamic and iterative, focusing on identifying and evaluating risks in relation to established risk tolerances This assessment is crucial for effective risk management strategies, ensuring that organizations can navigate potential challenges while striving to achieve their objectives.

Establishing clear objectives across various levels of the organization is essential for effective risk assessment Management must define objectives related to operations, reporting, and compliance, ensuring they are specific enough to facilitate risk identification and analysis Additionally, management evaluates the appropriateness of these objectives for the entity while also considering potential changes in the external environment and internal business model that could compromise the effectiveness of internal controls.

Control activities are essential actions defined by policies and procedures that ensure management's directives effectively mitigate risks and achieve objectives These activities occur at all organizational levels and throughout various stages of business processes and technology environments They can be either preventive or detective, including a range of manual and automated tasks such as authorizations, approvals, verifications, reconciliations, and performance reviews Segregation of duties is typically integrated into the design of control activities, and when it is not feasible, management implements alternative control measures.

Effective internal control requires access to relevant and high-quality information, which is essential for achieving organizational objectives Management must gather and utilize this information from both internal and external sources to enhance the effectiveness of other internal control components.

Effective communication is a continuous process of sharing and obtaining essential information within an organization Internal communication facilitates the flow of information among personnel, ensuring that clear messages from senior management regarding control responsibilities are understood Conversely, external communication serves a dual purpose: it allows for the inbound exchange of relevant information from outside sources and provides necessary responses to external parties based on their requirements and expectations.

Ongoing and separate evaluations are essential for determining the presence and effectiveness of the five components of internal control, including the controls related to each principle Ongoing evaluations are integrated into business processes, offering timely insights, while separate evaluations occur periodically, with their scope and frequency influenced by risk assessments and management considerations Findings from these evaluations are measured against criteria set by regulators and standard-setting bodies, with any deficiencies reported to management and the board of directors as necessary.

Internal control over credit operations

Credit is the trust that enables one party to provide resources to another without immediate reimbursement, creating a debt that is repaid or returned later This can involve financial resources, like loans, or goods and services, such as consumer credit Essentially, credit represents any form of deferred payment, extended by a creditor (lender) to a debtor (borrower).

Credit operations are major activities in banking business and risks mainly focus in this area, followed by business transactions and other operations

Financially, this operation constitutes major and important parts of assets in commercial banks The weaknesses of this operation will threaten the financial situation of commercial banks

Lending is a crucial business activity for banks, significantly contributing to their total income Commercial banks leverage mobilized funds to profit from the difference between lending and borrowing costs, making it essential to optimize fund utilization Additionally, lending activities serve as a foundation for various banking services, including international payments, financing foreign trade, credit card transactions, and deposit services.

Commercial banks significantly contribute to economic and social development by facilitating credit operations that inject substantial funds into the economy This funding supports various initiatives, including business growth, infrastructure development, investment expansion, job creation, and fulfilling consumer and housing needs.

1.2.2 Credit risk and its related matters

Despite many reforms in the field of financial services, credit risk remains the cause of bank failures

Effective credit risk management is crucial for banks, as it can lead to significant consequences if not properly handled A thorough evaluation of a bank's capacity to identify, operate, monitor, inspect, consolidate, and collect debts is essential This process involves assessing and implementing policies that ensure comprehensive financial information from customers is available for credit extension and conducting regular risk assessments.

1.2.2.2 The causes of credit risk

 Objective causes risk categories market risk

Risk taking as core business of banking

- Changing business environment affects the financial ability and the repayment ability of customers In addition, customers have weak financial health and slowly adapt to the environment

- Customers do not have a good business plan, specific, clear and logical, unable to fully predict the impact of factors such as market, cost, competition, resources

- Inadequate legal and macro environment

- Lack of economic and social information in the nation and in the world

- Other causes related to the change of business conditions, management machine, the family’s situation, income, natural disasters

- Due to the operating policies, banks target to increase outstanding balance without fully lending control

- Due to poor ability and qualification of credit officers

- Loan officers do not have full understanding and comprehensive assessment of customers

- Incomplete information about the loans leads to improper lending, unclear analysis of environmental business, income and collateral

- The banks do not fully understand the customers’ demands, the loan structure is not suitable with their cash flow

- Incomplete credit process and legal loopholes make it disadvantageous for banks

- Credit officers commit fraud and collude with customers

- Weak loan management, irregular inspection and monitoring make it difficult to detect problems

1.2.3 Internal control system over credit operations

The SBV should take the following measures:

1.2.3.1 Establish model of organization and control

The board of directors is responsible for approving and reviewing the bank's overall business strategies and significant policies, understanding major risks, and setting acceptable risk levels They ensure that senior management effectively identifies, measures, monitors, and controls these risks while also approving the organizational structure Ultimately, the board must ensure that a robust internal control system is established and maintained to safeguard the bank's operations.

Senior management is tasked with executing board-approved strategies and policies, establishing processes to identify, measure, monitor, and control banking risks, and maintaining a clear organizational structure that defines responsibilities, authority, and reporting lines They must ensure that delegated tasks are performed effectively, establish robust internal control policies, and oversee the adequacy and effectiveness of the internal control system.

The board of directors and senior management play a crucial role in fostering high ethical standards and integrity within the organization, creating a culture that highlights the significance of internal controls It is essential for all personnel in a banking organization to comprehend their responsibilities in the internal controls process and actively participate in it.

1.2.3.2 Establishment of the tight credit process

Every professional activity, including credit, follows a specific process tailored to its unique characteristics Commercial banks develop their credit processes based on business traits, state regulations, and internal policies to ensure seamless and professional operations Implementing a well-structured credit process yields significant advantages.

- Base on credit process, banks will operate proper credit activities, in which tasks and functions of the departments in credit activities are clearly defined

- Base on credit process, banks will establish administrative procedures in accordance with regulations to ensure safety in operations

The credit process is outlined in a comprehensive handbook to ensure consistency in credit operations This clarity helps performers understand their roles, positions, and responsibilities, fostering a positive work attitude.

- Credit process is the basis to control granting process and regulate credit policies of banks, help administrators detect these stages and regulations which need adjustment and control credit risk

1.2.3.3 Designation of effective internal control system and credit risk management

 The process of dealing with credit operation and disbursement

Controlling loan request procedures is to ensure that any request applications are given competence to be closely monitored to record the assignment of credit officer in authorizing the loan

Controlling the implementation of lending standards is to ensure that the lending complies with the standards and conditions of granting credit

Controlling the information analysis is to ensure that information is truthfully and accurately presented as well as carefully and objectively analyzed as a basis for loan approval decisions

Effective collateral assessment is essential for ensuring that the collateral documents are valid and meet the bank's established baseline criteria This process confirms that the collateral is suitable for mortgage, pledge, or guarantee purposes.

Effective credit approval management is essential for maintaining competence within the established limits set by the bank's highest executive level Additionally, ensuring the proper execution of legal procedures for collateral and credit contracts is crucial to mitigate any potential weaknesses related to credit risk for banks.

Controlling approved credit limit is to ensure that disbursement is valid in the limit and in accordance with the disbursement conditions when authorizing the loan

 Controlling the monitoring credit process

Controlling the monitoring of compliance with commitment to pay capital and interest is to ensure that the monitoring of the customer’s repayment is performed on a regular and complete basis

To ensure effective verification and monitoring procedures post-loan, it is crucial to control the verification process, regularly update the customer’s business and financial status, and accurately recognize the findings in the verification reports.

Effective management of overdue principal and interest reports is crucial for enabling authorities and senior executives to take appropriate actions This process is a key component of the information and communication aspects of an internal control system To ensure timely and accurate reporting, banks must implement efficient accounting systems and robust control mechanisms that effectively handle computer-based information.

Controlling the data of credit report is to ensure the time accuracy and timely provide for managers to supply for the monitoring of credit portfolio

Controlling bad debt recovery process and evaluating the recoverability of bad debt is to decide the appropriate provision

 Controlling the periodical assessment and authorization on following aspects

The standard to make provisions for nonperforming loans ensures that the provisions are authentic and reasonable

The safety of collateral ensures that the current loan amount on collateral is always reasonable and safe

The performance of regular monitoring even for standard loans

 Controlling and managing credit risk

Effective management of the credit limit system is crucial to ensure that each customer's credit limit is determined through a rational assessment of their capital needs and repayment capacity.

Accurate and objective classification of customers is essential for effective lending decisions, as it helps prevent mistakes in the evaluation process Implementing clear classification criteria ensures that customers are categorized correctly, enhancing the reliability of lending assessments.

Controlling the development of quantitative methods in assessing risk and way to monitor risk in bank

Controlling the compliance of decentralization principles in the credit process

THE REAL SITUATION

The formation and development of banking system in Vietnam and

commercial banking system in Hai Phong

2.1.1 The foundation and development of Vietnam’s banking system

2.1.1.1 The period of building mono-banking system in Vietnam

In February 1951, based on the new economic and financial policy from the 2nd Congress of the Vietnam Workers' Party, President Ho Chi Minh established the Vietnam National Bank through Decision 15/SL, marking it as the first people's democratic state bank in Southeast Asia Its primary missions included issuing banknotes, managing the treasury, implementing credit policies to support production, and coordinating monetary management to combat adversaries On January 21, 1960, the bank was renamed the State Bank of Vietnam in line with the 1946 Constitution Following the liberation of the South in 1975, the integration of the Republic of Vietnam National Bank and private banks initiated a nationwide banking system under a centrally planned economy During this period, the State Bank of Vietnam experienced significant growth, expanding its branches and enhancing professional qualifications, serving as a crucial payment and credit center that contributed to key economic objectives like sustainable agricultural development and military enhancement However, the new banking system also revealed weaknesses and backwardness during this time.

Many economic concepts, including competition, inflation, trade credit, and loan rates, have become outdated or neglected Discrimination and subsidization in credit operations have led to a focus on lending principles that provide economic benefits, while reimbursement processes have been largely ignored Additionally, credit allocation plans and cash collection have been viewed as essential objectives, compelling bank branches to meet these criteria at all costs.

Nominal interest rate was maintained under the subjective direction rather than based on the state of the economy and the inflation index Thus, the real interest rate is

Excessive lending has resulted in capital losses, driving up customer demand for credit that necessitates additional money issuance Furthermore, preferential interest rate subsidies for specific customer groups have diminished business motivation.

In the context of serious economic imbalances, great funding pressures for economy, prolonged and unpreventable hyperinflation, monetary, credit and payment operations were left confused

The government is committed to transforming banking activities into a system of economic accounting and socialist business This initiative aims to establish a professional banking framework, ensuring that credit and banking services operate under the principles of economic accountability, as outlined in the Political Report of the VI Party Congress.

In 1987, the Chairman of the Council of Ministers authorized the State Bank to pilot banking reforms in select provinces, aiming to enhance its business banking framework This initiative culminated in Decree 53/HDBT, signed on March 26, 1988, which transitioned Vietnam from a mono-banking system to a two-tier, market-driven banking structure, effectively delineating state management from commercial banking functions Subsequently, specialized banks were established, including the Vietnam Bank for Industry and Trade, Rural Development Bank, Vietnam Bank for Foreign Trade, and the Bank for Investment and Development of Vietnam South By the end of 1989, the financial landscape had expanded significantly, featuring nearly 7,000 rural credit cooperatives, 500 urban credit funds, and 17 foreign-owned banks, reflecting a diverse array of capital-raising and lending institutions across various economic sectors.

The State Bank issued a series of untimely and uncontrolled regulations, failing to keep pace with the rapid development of banking institutions Operating in a challenging economic environment, many banks, driven by the pursuit of illicit profits, faced significant credit risks This issue began with the Thanh Huong perfume factory and extended to various credit institutions across Ho Chi Minh City, Hanoi, Can Tho, and throughout the country.

In May 1990, the State Council approved two key ordinances: the Ordinance on the State Bank and the Ordinance on Banks, Credit Cooperatives, and Financial Companies This established a diverse banking system in Vietnam, which includes State-Owned Commercial Banks (SOCBs), joint-stock commercial banks, credit cooperatives, and other financial institutions, with the State Bank functioning as the central bank By December 1995, Vietnam's banking system had expanded to encompass various ownership types.

- 28 branch offices of foreign banks

In addition to a social policy bank, the financial landscape includes several finance-leasing companies and people's credit funds The five state-owned commercial banks (SOCBs) dominate the market, accounting for three-fourths of total deposits and loans, while the remainder is held by joint-stock commercial banks, foreign bank branches, and other credit institutions.

In response to evolving banking activities and the need for modernization, the Government and State Bank of Vietnam issued a series of instructions based on two key ordinances This two-tier banking system was established to enhance economic renewal, yet it faced challenges due to the emergence of diverse standards and operations To align Vietnam's banking system with international practices, the President announced two new bank laws on December 26, 1997, which were approved by the 10th National Assembly These laws took effect on October 1, 1998, aimed at effectively implementing national monetary policy, strengthening State Bank management, and fostering economic stability and development within a market-driven framework.

2.1.2 The foundation and development of commercial banks in Hai Phong

Hai Phong is a coastal city in Northern Vietnam, situated 120 km east of the capital, Hanoi Covering a natural area of 152,318.49 hectares, it represents 0.45% of the total land area of the country, according to 2001 statistics.

After switching to a two-tier banking system, Hai Phong only has a provincial branch of Agribank and BIDV and 8 other district branches District of those banks By

1993, the provincial branch of Vietinbank was established

In late 1996, the banking system in Hai Phong was rearranged as follows: there were three provincial banks: Agribank, BIDV and Vietinbanl Agribank Hai Phong had

4 district branches And 2 Commercial Joint Stock Banks were Viet Hoa and Mai Phuong

In 1999, the Hai Phong branch of Vietcombank was established

Until now, the banking system in Hai Phong has made great progress with a broad network and the positive business growth

2.1.3 Characteristics of credit operations in commercial banks in Hai Phong

Hai Phong's robust economic growth has led to the establishment of numerous industrial parks, attracting significant domestic and foreign investment This surge in production and business activities has heightened the demand for credit to support infrastructure and project investments, as well as the operational needs of large enterprises Consequently, the credit market has expanded, accompanied by the rapid development of credit institutions in the region, resulting in a notably high outstanding credit growth rate among these institutions.

Table 2.1: Summary of outstanding balance growth in credit institutions in Hai Phong

12 Housing developing bank Hai Phong 40.264 100,00 88.196 119,04 154.423 75,09

15 Phuong Dong joint stock bank 58.499 100,00 131.021 123,97

18 Viet Thai joint venture bank

22 Housing developing bank HCM city 2.830 100,00

By the end of 2013, the total outstanding lending balance in Hai Phong's banking sector reached 15.57 trillion VND, marking an increase of 3.4 trillion VND from 2012, with a credit growth rate of 27.95% Most credit institutions experienced significant growth, contributing to the province's economic development The expansion of industrial zones led to the establishment of more businesses, driving up capital demand Additionally, household businesses sought to secure extra working capital for land purchases, home investments, and consumer needs.

Historically, four state-owned commercial banks dominated lending and capital raising in Vietnam, with Agribank leading due to its extensive branch network across provinces, districts, and industrial areas, followed by Vietcombank and BIDV However, since 2006, joint stock commercial banks have recognized Hai Phong as a promising market, significantly increasing their branch presence and actively engaging in credit operations, particularly targeting small and medium-sized businesses and residential customers Notable players like Sacombank and ACB have established strong reputations, effectively addressing the credit needs of urban residents Nevertheless, rural areas remain underserved due to a lack of banking infrastructure, while joint-stock banks are also focusing on providing substantial loans to large enterprises, with outstanding balances reaching hundreds of billions.

Bad debt situation of the credit institution in Hai Phong:

Bảng 2.2: Summary of bad debts in credit institutions in Hai Phong

12 Housing developing bank Hai Phong 40.264 1 88.196 399 154.423 253

15 Phuong Dong joint stock bank 58.499 131.021 1.683

18 Viet Thai joint venture bank

22 Housing developing bank HCM city 2.830

Between 2011 and 2013, total bad debts in the area were reported at 89.024 million, 293.812 million, and 167.234 million, representing 0.96%, 2.41%, and 1.07% of total loans, respectively Overall, these figures indicate that bad debts remained within the safe credit limit set by international regulations, which is under 5% This positive outcome is attributed to the concerted efforts of credit institutions in client selection, investment project evaluation, lending practices, and debt management However, some banks, including the branch of BIDV, Finance Leasing Company II, and Agribank, showed concerning trends in credit activities due to rising bad debts or excessively high bad debt balances.

Vietinbank,etc Banks with high bad debts need to review and re-evaluate their credit operations, identify the causes to have effective prevention measures

2.2 Identifying and analyzing the causes to credit risk in commercial banks in

The study identifies various causes of credit risk in commercial banks, focusing on the specific context of Hai Phong These causes are categorized into two groups based on objective and subjective perspectives, highlighting both external and internal factors that contribute to credit risk.

(1) The volatility of the business environment and other factors beyond the control of banks and customers

These objective reasons are unpredictable because business activities of borrowers are affected by many factors such as income, family, health, the safety of borrowers’ assets

Strengths and weaknesses of internal control system over credit operations in

in commercial banks in Hai Phong

Senior leaders of Vietnam's commercial banks recognize the critical role of credit operations in ensuring the banks' survival and the necessity of managing credit risk effectively While most commercial banks in Hai Phong are headquartered in major cities like Hanoi and Ho Chi Minh City, they tend to adopt the management styles from these central offices However, the branches operate more compactly and often adapt to local customs, highlighting the need for a balanced approach to credit management.

Commercial banks in Hai Phong establish specific credit development goals, with branches assigned mobilization targets and outstanding balance limits set by the head office These banks not only prioritize credit growth but also implement safety regulations Notably, State-Owned Commercial Banks (SOCBs) have begun to shift away from the traditional lending mechanisms that favored state enterprises, now offering loans to all qualifying borrowers while providing preferential conditions This shift includes reduced oversight and monitoring, which exposes banks to potential losses if borrowers default on their debts.

Commercial banks are perfecting their organization structure to strengthen management capacity, because it is a precondition in integration process and the competitiveness of commercial banks

Commercial banks recognize the crucial role of internal audit systems in overseeing and regulating banking operations, particularly in credit management Each bank's head office adheres to an audit and internal control framework established by the State Bank Some institutions have implemented remote control internal audits to enhance oversight Any discrepancies identified during the day are promptly addressed by the audit and control department, which coordinates with branches for immediate solutions In Hai Phong, every branch is equipped with internal auditors responsible for conducting monthly evaluations of branch operations, with a specific focus on credit activities, and submitting detailed audit reports to the head office each month.

(3) Method of separation of powers and responsibilities

Vietnam's commercial banks establish a structured credit approval system that spans from the head office to individual branches, assigning authority based on operational scale and management style Loans that exceed the designated authority must be escalated for approval to a higher level within the organization.

To apply for a bank position, candidates must meet specific educational qualifications, typically requiring a degree from an economic university or college Following recruitment, new employees undergo practical training facilitated by experienced staff or through short courses organized by the bank.

As commercial banks expand their branch networks, the demand for skilled human resources rises significantly To attract qualified and experienced professionals, these banks implement various incentive policies, including competitive salaries, performance-based bonuses, and comprehensive welfare programs.

Many commercial bank managers have failed to consistently adhere to banking regulations, often prioritizing personal or collective interests over safety principles This disregard for safety, particularly in credit operations, can arise from the pressures of power and relationships.

Commercial banks are inadequate in the management structure and organization The overlapping and the irrationality of the organizational structure result in inefficient management and exchange of information between banks

Credit operations are the primary revenue drivers for banks, particularly commercial banks, which often prioritize credit growth over safety strategies related to customer and credit risk This focus on high outstanding balance targets for credit officers can lead to a neglect of long-term risk assessments and credit quality analysis, resulting in incomplete adherence to business processes Additionally, the competitive landscape prompts banks to engage in questionable practices, such as acquiring bad debts and issuing loans solely to boost turnover.

Bank managers prioritize the analysis, evaluation, and management of various risks, including credit risk, interest rate risk, liquidity risk, operational risk, and legal risk To effectively address these challenges, every bank establishes a dedicated risk management department, typically situated at the head office Additionally, banks implement internal credit rating systems to enhance their risk management strategies.

Commercial banks also regularly coordinate with relevant agencies to organize training courses to improve the assessment, measurement and risk analysis capacity for credit officers

However, in the field of risk assessment, particularly credit risk, banks in Hai

Phong reveal the following weaknesses:

Commercial banks often lack a comprehensive analysis of various credit risk types and have not established sufficient monitoring processes to mitigate these risks Additionally, they do not have contingency plans in place to address unforeseen changes stemming from shifts in the business environment, organizational structure, or technology advancements.

Many commercial banks continue to rely on emotional and subjective evaluation systems for loan approvals, primarily focusing on collateral and the presentation skills of credit officers This approach often neglects thorough inspection and re-authorization of borrower information, leading to potential risks in the lending process.

Commercial banks in Hai Phong operate independently while adhering to the overarching framework and regulations set by their head office The head office has a dedicated department for credit operations, which establishes comprehensive credit policies and procedures As a result, branches are not required to redesign these processes but must simply comply with the existing procedures and regulations.

- Credit authorization and approval are regulated tightly in some commercial banks

To maintain operational integrity, it is essential to separate the functions of credit operations from accounting duties, as well as to distinguish credit activities from those related to asset protection and financial transactions This independence helps ensure transparency and accountability within financial processes.

- Regulations on maintaining and recording credit and collateral profiles

- Every bank analyzes credit operations to assess the effectiveness and risk of loan portfolio

Despite such achievements, control activities in credit operations reveal the following weaknesses:

- The credit processes often focus on the form and the requirements of the legal procedures for loans rather than on control purpose

Many commercial banks face challenges in credit allocation due to unreasonable limits set for their branches, resulting in a lack of independence Additionally, the weak remote monitoring systems within the executive department contribute to poor decision-making across various branches.

- The assignment for credit officers is not suitable with authorization capacity or the work overload leads to poor quality of authorization

- For outstanding debts, many commercial banks do not have positive measures, monitor the implementation of debt recovery

In today's banking landscape, information systems play a crucial role in shaping management and business strategies The effectiveness of these information strategies significantly impacts overall management and business results For banks, investing in information systems and embracing continuous innovation is essential due to the rapid advancements in technology This investment not only fosters trust in banking institutions but also enables them to satisfy the growing and varied demands of their customers.

SOLUTIONS

As for authorities

3.2.1 Integrity among notary public's offices

Hai Phong currently has two notary public offices, but their notarization procedures and forms are inconsistent To enhance the mortgage notarization process and prevent opportunities for customer fraud, it is essential to review and standardize these procedures and forms, ensuring a smoother and more reliable experience for clients.

3.2.2 As for the authorities issuing property certificates

To prevent customers from using the same asset as collateral for loans at multiple commercial banks, it is essential to review the issuance of property certificates Additionally, unifying the formats of property certificates will help eliminate confusion in the lending process.

3.2.3 People's Committee should assist commercial banks when businesses go bankruptcy and use their property to recover debts

The management of collateral involves multiple state administrative agencies, which are tasked with assisting credit institutions in debt recovery However, the implementation of these responsibilities is often inadequate, leaving banks without proper rights to the mortgaged assets The inefficiency of local enforcement mechanisms further complicates the process, hindering banks' ability to manage risky loans effectively.

As for commercial banks

3.3.1 The solutions to complete control environment

(1) Enhancing the capacity of the management machine and organizational structure of commercial banks

The Board of Directors needs to appoint individuals with highly specialized capabilities, extensive experience in the banking sector and good moral qualities to undertake the banking management

Clearly defining the responsibilities and powers of every managing level, avoiding personal imposition and arbitrary

It is essential to educate senior managers on banking business principles, emphasizing the importance of legal compliance and the development of a risk management system tailored to the unique operational characteristics of each bank.

(3) Changing opinion on credit growth

Effective credit extension must be paired with robust credit management Solely prioritizing credit expansion without enhancing credit risk management can result in a rise in overdue loans and increased bank losses On the other hand, concentrating solely on credit risk management without considering credit growth proves to be ineffective Balancing both elements is crucial for sustainable financial health.

Credit growth should match with the qualifications and ability to manage credit risk

Credit expansion should focus on pioneering projects and industries

(4) Improving the training quality for bank staff

To enhance the capabilities of bank staff, it is essential to implement comprehensive training programs that range from basic to advanced levels Providing a complete set of resources will ensure employees acquire the necessary knowledge for their roles Organizing seminars for sharing insights on credit management is also vital Furthermore, establishing a team of seasoned credit experts to develop and update practical curricula, along with improving teaching facilities and methodologies, will significantly benefit staff training initiatives.

(5) Commercial banks should have clear criteria to recruit and train credit officers to ensure their capacities to carry out operations

When recruiting staff, it's essential to establish clear standards that outline career progression and training plans This includes comprehensive training at the bank and opportunities to participate in business classes, ensuring employees are well-prepared for their roles.

(6) Commercial banks should research and design credit handbooks to guide the performance of the operations

The board and executive committee must recognize the critical role of the internal audit department in banking operations By investing appropriately and regularly assessing the quality and effectiveness of auditing activities, they can significantly prevent fraud and reduce business risks.

3.3.2 The solutions to improve the effectiveness of the internal control system in the prevention, control and management of credit risk

(1) Establishing departments to research, analysis and forecast changes of macroeconomic in short-term and long-term

Commercial banks should establish private research departments that utilize various information channels, research sources, and forecasts to inform their credit operations, manage credit risk, and develop effective credit and capital investment strategies.

(2) Setting up credit risk assessment department in commercial banks

Commercial banks should establish risk management department This body will operate independently from the credit department of branches Functions of this department include:

To effectively conduct quantitative credit risk analysis, the credit risk assessment department must collaborate with the macroeconomic research and analysis team to evaluate external environmental risks It is essential for the department to employ experienced experts who possess in-depth knowledge of credit and lending products, strong analytical skills, and sound judgment Additionally, these professionals should stay informed about the latest developments in industry trends, economic conditions, societal changes, and legal regulations.

Before approving loans, it is crucial to analyze and evaluate credit risks related to various lending types, borrowers, macroeconomic factors, and operational risks of businesses The risk assessment department staff should collaborate with credit officers for significant loans to ensure an accurate evaluation of credit risk.

Following disbursement, the credit risk management department actively oversees the disbursement process and debt collection, providing regular reports on customer operations This department conducts practical examinations to ensure the effectiveness of credit officers' monitoring activities Additionally, they engage directly with customers to address late payments or any unusual indicators.

Performing periodic assessment of the credit risk in the loan portfolio of banks to have timely adjustments and solutions, minimize risks as well as supervision methods for each customer

(3) Developing and perfecting the credit rating system

Many commercial banks are now implementing credit rating systems to guide their lending decisions In the future, larger banks may develop tailored rating systems that align with their specific credit operations These systems will evaluate loans using both quantitative and qualitative factors, providing a foundation for informed lending choices To maintain the accuracy of credit assessments and ratings, it is essential that qualified credit officers conduct thorough examinations and evaluations.

(4) The solutions to limit credit risk due to lack of information during authorization and making lending decisions

Along with the development of technology and information systems, looking for information is not difficult, but it is important to identify the appropriate information channel

- Loan officers can collect information from websites of the State Bank’s credit information center, general department of taxation

- Verifying the information about the economic contracts and debt situation of customers through communication with their partners

- Marketing departments organize the study and assessment of market and business sectors

As for authorization activities: managers assign credit officers with profile authorization corresponding with their capacity in terms of qualifications, experience and their knowledge about the sector

(5) Controlling the valuation of collateral, verifying the actual status of collateral and reducing the risk of collateral devaluation

To enhance real estate market oversight, banks must establish a comprehensive market price table for each area To facilitate effective monitoring, authorized personnel should consistently display identification cards and carry referrals from banks Additionally, property owners are required to document their identity numbers and provide signatures to verify the time of authorization.

Authorization officers must photograph and document the operational status of movable assets such as machinery, transport vehicles, and ships, while also gathering relevant evidence If banks find discrepancies between the actual condition of mortgage assets and their original descriptions, the responsibility will fall on the authorization officers.

Authorization officers should fully verify the legal nature of the borrowers and collateral In special cases, they should consult lawyers or legal experts

Making loans should be based on high security properties rather than properties with high liquidity risk

(6) Measures to restrict fraud and dishonesty of loan officers

Many commercial banks are implementing a division of responsibilities among property authorization officers, finance authorization officers, and disbursement officers This separation of roles is designed to reduce errors, fraud, and dishonesty within the banking process.

To ensure effective oversight, it is essential to establish a robust system for independent examinations of the credit department These assessments are conducted regularly by the credit risk assessment team, internal auditors, and the head of the credit department, ensuring continuous monitoring and evaluation of credit practices.

Clearly defining responsibilities of property authorization officers, credit officers, legal staff through professional error summary Defining material compensation if there is any damage to banks by intentional commitment

(7) The solutions to limit credit risk due to loose lending control

Controlling credit profiles, documents proving the borrowing purposes through the following steps:

Once completing credit contracts and mortgage contract, their correctness need to be checked in comparison with related documents

Legal staff is responsible for the correctness of the certificate of land use rights, house ownership, project ownership and other papers on the property use and ownership rights

Before conducting the disbursement procedures, inspectors or loan approval level check the necessary contents

(8) Controlling ex-post monitoring of loans

Commercial banks must recognize the significance of ex-post monitoring by establishing stringent regulations for loan supervision post-disbursement This monitoring should occur on a monthly, quarterly, or semi-annual basis, tailored to the specific nature of each loan profile Comprehensive records are essential to accurately reflect the customer's current situation, ensuring a thorough and diligent approach rather than a superficial one.

Tiêu đề	Perfecting Internal Control System Over Credit Operations In Commercial Banks In Hai Phong
Tác giả	Pham Thi Tuyet Trinh
Người hướng dẫn	MA Ngo Tung Anh
Trường học	Banking Academy
Chuyên ngành	Banking
Thể loại	graduation thesis
Năm xuất bản	2014
Thành phố	Hanoi

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Số trang	57
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