INTRODUCTION
Problem discussion
The banking sector in Vietnam has grown increasingly complex over recent decades, largely due to financial market volatility Many commercial banks have become involved with significant non-performing loans (NPL), amounting to trillions of dong by the end of 2011, often without fully understanding the associated risks This issue is particularly pronounced among private joint-stock banks, where, despite a decrease in outstanding loans, the NPL ratio has surged As a result, credit risk has emerged as a significant concern for Vietnamese banks, threatening their asset stability if not properly addressed.
The case of Vietnam Prosperity Joint-Stock Commercial Bank's Phu Tho branch highlights significant credit risk challenges, particularly during my four-month internship Established five years ago, the branch faced a staggering non-performing loan (NPL) ratio that peaked at around 30% in 2008, a figure that nearly led to its default Although there has been a gradual improvement in this ratio over the past year, it remains significantly above the standard benchmark of 3% set by the VP Bank Head Office.
Thus, the central question here is how to untie the knot of credit risk with which
VP Bank Phu Tho has been confronted That problem has motivated me to pursue this study and this thesis is an endeavor to find the answer
Objectives and research questions
The thesis aims at finding out VP Bank - Phu Tho branch’s the most problematic issue - the credit weaknesses and bringing out some solutions to credit risk
The discussed problem formulation makes me to have the following research questions:
- What is credit risk in commercial banks and how to measure it?
- What are the causes and impacts of credit risk?
- How is credit risk measured in VP Bank - Phu Tho branch?
- What are consequences that the branch has to suffer from?
- What causes serious credit risk in this branch from both external and internal perspective?
- How to deal with the current credit risk situation there?
Scope and limitation
The research focuses on assessing the credit risk situation at VP Bank Phu Tho, while other risk factors at the branch remain unexplored Limited information disclosure in official reports restricts the analysis, resulting in a sample that solely includes data and reports from the Phu Tho branch for the year 2009.
Due to the rejection of participation from the branch in the sample, primary data collection for the survey was not feasible Consequently, the findings of this study are exclusively applicable to VP Bank Phu Tho and cannot be generalized to other branches or commercial banks in Vietnam.
Methodology
This research examines the facts, concepts, techniques, and approaches related to credit activities aimed at identifying problems and developing necessary solutions for VP Bank Phu Tho Additionally, it provides a quantitative analysis of the application process, utilizing a descriptive approach to present the findings.
To identify the credit weaknesses of VP Bank Phu Tho, I analyzed secondary data sources, including financial reports, the bank's introduction, branch information available online, and relevant newspaper articles to assess various indicators effectively.
Disposition
Chapter I INTRODUCTION: In this chapter, I present the background of the thesis followed by the problem statement The discussion also contains the motivation for my thesis Finally, the chapter expresses the research question, the purpose, methodology and limits the area of the study
Chapter II THEORETICAL FRAMEWORK: In this chapter, I provide theoretical foundation to my study by presenting relevant literature
Chapter III ASSESSMENT OF CREDIT RISK IN VP BANK – PHU THO
BRANCH: In this chapter, I analyze the credit performance and find out the real causes of credit risk in the branch studied
Chapter IV RECOMMEDATIONS AND CONCLUSIONS: In this chapter,
I propose some sound recommendations as well as draw some conclusions to the matter given above
THEORETICAL FRAMEWORK
Definition of credit risk in commercial banks
The Basel Accords identify key risks faced by banks, including credit risk, market risk, and operational risk, with credit risk being the most significant due to its potential for substantial losses This risk is inherent in all banking operations, ranging from traditional loans to intricate lending agreements Consequently, strategies to mitigate and manage credit risk are essential for the stability and success of commercial banks.
Credit risk, as defined by the Basel Committee, refers to the likelihood that a borrower or counter-party will default on their financial obligations, such as failing to repay a loan This risk signifies the potential loss in value of a bank's loan portfolio if borrowers are unable to fulfill their repayment commitments.
Credit risk manifests in various forms due to the diverse range of obligors, including individuals and sovereign governments, as well as the multitude of obligations, such as auto loans and derivatives transactions The historical origins of credit risk can be traced back to 1800 B.C., marking its long-standing presence in financial systems.
Credit risk indicators
At present, Vietnam commercial banks classify loans based on the framework set forth by SBV in Decision No 493/2005/QD-NHNN and 18/2007/QD-NHNN
These regulations classify bank loans and these categories are arranged in the table below:
1 Current Current loans or loans overdue < 10 days
Loans with newly revised repayment terms can be offered to customers for the first time, provided they are deemed capable of repaying both the principal and interest based on these updated conditions, particularly in the case of enterprises and organizations.
Loans having rescheduled terms of repayment for the first time except for loans with revised terms of repayment classified in Group 2
Loans having exempt or reduced interest because customers are unable to pay interest according to contracts
Loans having rescheduled terms of repayment for the first time and being overdue 360 days
Loans having rescheduled terms of repayment for the first time and being overdue ≥90 days according to the first rescheduled terms of repayment
Loans having rescheduled terms of repayment for the second time and being overdue according to the second rescheduled terms of repayment
Loans having rescheduled terms of repayment for the third time
Blocked loans or loans awaiting settlement
Delinquency refers to the percentage of loans that are overdue and have not had their repayment terms adjusted It is a key metric used to assess the quality of a bank's loan portfolio, with the delinquency ratio indicating the proportion of past-due loans relative to the total number of active loans being serviced.
A higher-than-expected default risk (DR) can lead to significant negative consequences for banks, including disruptions to their business plans and liquidity, escalated operational costs, and diminished overall performance and profitability.
Non-performing loans (NPLs) are defined as loans that are in default or nearing default, typically classified when borrowers are more than 90 days late on payments These loans do not generate income and are characterized by principal or interest being delinquent for 90 to 180 days, installment repayments of medium and long-term loans being overdue for over six months, or debtors facing legal action for non-payment.
Banking Academy Graduation Thesis underlying collateral has been disposed, although the repayment of principal or interest has not been overdue for more than 3 or 6 months.
NPLR indicates how banks supervise their credit risk because it defines the proportion of NPL amount in relation to TL amount:
A high Non-Performing Loan Ratio (NPLR) can indicate that a bank is facing challenges in maintaining credit quality, as elevated NPLR levels often lead to cash flow difficulties Sustainable financial institutions typically aim for an NPLR of 3% or lower; however, it is essential to adjust this ratio according to the actual quality of the loan portfolio to ensure effective risk management.
In banking, a loan loss ratio reflects the amount of unrecoverable debt in a specific period (usually a year) relative to the average outstanding loan portfolio:
Loan write-offs typically happen with older loans, making the loan loss ratio less reflective of the current quality of the loan portfolio compared to the loan loss reserve By analyzing the loan loss ratio over time, one can assess whether loan losses as a percentage of the average outstanding portfolio are rising or falling Additionally, comparing the loan loss ratio to the loan loss reserve helps evaluate if the reserve is adequate in relation to historical loan losses.
Banks normally set aside money to cover potential losses on loans, called loan loss provisions, in their profit and loss account A loan loss provision can be said as a
“shock absorber” to offset probable future losses
In accordance with Decision No 493/2005/QD-NHNN and Decision No 18/2007/QD-NHNN established by the State Bank of Vietnam (SBV), commercial banks in Vietnam are mandated to adhere to specific regulations regarding the establishment of general and specific provisions.
The specific allowance rates outlined below are applied to the outstanding principal, provided it is less than the permitted value of loan collateral The calculation of the provision amounts for various loan types is determined as follows:
Where: R: Specific amount of provision to set up
C: Allowed value of loan collateral r: Rate of provision
Hence, loan loss provision is counted as follow:
: Allowance for loan loss (loan loss reserve) for period t
: Allowance for loan loss (loan loss reserve) for period (t-1)
The high provision against loan loss means the loan loss ratio is currently high
Relating to this measure, loan loss provision ratio is regarded as an important indicator in assessing asset quality:
The Loan Loss Provision Ratio (LLPR) measures the revenue needed as a percentage of average performing assets to cover loan loss provisions This ratio indicates the provisioning requirements for the current loan portfolio, directly impacting the bank's expenses for the period A higher LLPR signifies greater provisioning needs, which can lead to lower profits for the bank.
Loan concentration risk is the heightened danger associated with having a significant number of loans concentrated within a single firm, industry, or economic sector This concentration can lead to substantial losses occurring simultaneously or in succession, leaving little room to absorb the financial impact Credit concentration may manifest in various forms, highlighting the importance of diversifying loan portfolios to mitigate risk.
- Conventional concentration: in a single borrower/group or in a particular sector like steel, petroleum, etc
- Common/ correlated concentration: for example, exchange rate devaluation and its effect on foreign exchange derivative counterparties
Minimizing concentration risk in a loan portfolio is achieved by ensuring that the loans are distributed across a diverse range of economic sectors In banking, the assessment of concentration levels is determined by specific criteria that evaluate the diversity of the loan portfolio.
- The institution’s capital base (paid-up capital + reserves & surplus, etc…)
- The institution’s total tangible assets
- The institution’s prevailing risk level
Impacts of credit risk
Credit risk poses a significant threat to the banking industry, impacting not only commercial banks and the broader banking system but also the entire economy.
Nonpayment of loans significantly diminishes a bank's value, as it leads to potential losses in principal, interest, and fees, while the bank continues to incur operational costs The high administrative expenses associated with overdue loans, coupled with increased lending costs, adversely affect profitability without a corresponding rise in loan volume Additionally, since banks primarily raise capital for funding, defaults can result in liquidity risk, potentially pushing the institution into a deficit Furthermore, defaults undermine the bank's capacity for future lending, diminish staff morale, and erode borrower confidence, which can tarnish the bank's reputation and create a negative public perception.
The operation of a commercial bank is intricately linked to the banking system and the broader economic and social landscape Poor performance, liquidity issues, or bankruptcy of a bank can trigger a domino effect, impacting other banks and various economic sectors Without prompt intervention from government agencies, panic among depositors wishing to withdraw their funds simultaneously can jeopardize the liquidity of the entire commercial banking system.
From a macroeconomic viewpoint, banks serve as vital conduits for circulating money within the economy Therefore, a bank's bankruptcy due to credit risk can lead to widespread economic turmoil, resulting in stagnated activities, imbalances between supply and demand, rising inflation, and increased unemployment.
In conclusion, credit risk poses significant threats to banks, impacting profitability through loan loss provisions and unrecoverable interest In severe cases, uncollectible debts can result in high loan loss ratios, leading to capital losses, increased liquidity risk, and damage to the bank's reputation If left unaddressed, these issues can culminate in bankruptcy, affecting not only the commercial banks but also the broader economy.
Causes of credit risk
Credit risk is driven by the unpredictable volatility of financial markets, influenced by factors such as foreign exchange fluctuations, derivative contracts, liquidity backup lines, inflation, and recession Consequently, commercial banks must assess their customers' vulnerability to liquidity issues, even while maintaining a passive stance to mitigate sudden economic shocks The Basel Committee emphasizes that market and liquidity-sensitive exposures are probabilistic and can be correlated with the borrower's creditworthiness.
Financial liberalization and global integration pose unavoidable risks that can lead to an increase in non-performing loans (NPL) across commercial banks This situation creates a highly competitive environment among businesses and banks alike Additionally, the risk of NPLs escalates when customers are attracted to larger banks, often due to the inadequate administrative systems of smaller and medium-sized commercial banks.
Numerous laws and regulations are established to facilitate the credit operations of commercial banks; however, ineffective implementation by government agencies can lead to a disconnect between credit activities and necessary support services Additionally, unexpected regulatory changes may hinder a borrower's ability to repay, prompting banks to seek assistance from government and other institutions.
A robust supervision process is essential for a reliable credit system, necessitating timely oversight and follow-up mechanisms Historical instances in the finance and banking sectors reveal that defaults often stem from outdated and ineffective inspection practices To mitigate these risks, it is crucial to continuously enhance the supervisory system in response to evolving market conditions.
The credit information center is currently facing significant challenges due to its ineffective operations and reliance on outdated, monotonous data This broken connection with commercial banks hampers the accurate assessment of customers' creditworthiness Consequently, the inadequacies of the information system pose substantial obstacles for the banking sector in managing credit supervision and expansion.
Political fluctuations, including changes in government policy and unstable political climates, particularly in conflict or post-conflict regions like Afghanistan and Iraq, can significantly impact borrowers' willingness and ability to repay loans, thereby influencing banking operations.
Natural disasters such as droughts, floods, earthquakes, and cyclones, along with localized epidemic diseases, can significantly decrease the likelihood of loan repayment in affected areas Without rescheduling the loans to provide borrowers with additional time, these events can lead to stagnation in banking operations.
At the obligors’ level, the causes of credit risk include the followings:
The risk of loss arises from intentional deceit by the borrower or counterparty, who may exploit asymmetric information This deceit can lead to the diversion of loan funds for unintended purposes or a reluctance to fulfill repayment obligations Consequently, as the likelihood of loan repayment decreases, the level of risk that banks face increases significantly.
Weak management capacity poses a significant risk for banks, leading to various negative outcomes This often results in a series of poor decisions, such as inadequate capital management, unrealistic business plans, and inefficient capital allocation In practice, the size of a business can expand excessively after receiving a loan, outpacing the limited management perspective, which ultimately contributes to operational failures.
Credit officers conduct financial analyses for customers using figures and data that are often impractical and inaccurate, raising concerns for banks about potential risks stemming from customers' true financial situations This uncertainty underscores the importance banks place on collateral as a crucial safeguard against potential losses.
Unexpected external factors such as non-payment by customers, accidents, shortages of inputs or power, price increases, economic recession, and changes in government policies regarding excise and import duties can significantly impact borrowers' business performance, ultimately hindering their ability to meet financial obligations.
2.4.2 Internal cause (by commercial bank itself)
Many commercial banks often fail to adhere to credit regulations, primarily due to flawed loan appraisal procedures that can finance poor projects, resulting in increased delinquencies and defaults Additionally, the issue of credit concentration arises when these banks excessively focus their lending on a limited number of borrowers or sectors, heightening financial risks.
Focusing too heavily on a single business line, obligor, or related customer group can jeopardize lenders, as the principle of diversification warns against putting "all eggs in one basket." In the competitive landscape of credit growth, many institutions may overlook essential credit procedures and lower their assessment standards, potentially leading to negative consequences such as increased credit exposure that must be managed later.
The inadequacies of credit information centers, coupled with the ineffective management and utilization of data by commercial banks, result in significant challenges in lending and investment decisions Inaccurate and outdated information, along with a lack of essential data sources, contributes to costly errors that can lead to credit losses and defaults Furthermore, when banks struggle to maintain effective communication with borrowers due to poor accounting and information management systems, the likelihood of defaults increases.
In the commercial banking system, human resources are crucial to all operations, necessitating a thorough evaluation of risks associated with personnel Banks must scrutinize the potential for losses stemming from both intentional and unintentional fraud by credit officers, who may lack essential knowledge, field mobility, economic forecasting skills, and the ability to assess borrowers accurately This inadequacy can lead to a higher likelihood of loan defaults Furthermore, when loan officers focus primarily on meeting lending targets rather than on recovery performance, it can result in an increase in bad loans.
ASSESSMENT OF CREDIT RISK IN VP BANK – PHU THO
Overview of credit activity of the branch studied
3.1.1 Brief introduction of VP Bank - Phu Tho
Established in July 2007, the Phu Tho branch of VP Bank is located at 2040 Hung Vuong Street in Viet Tri City, Phu Tho Province The following year, the Tien Cat transaction office was launched, expanding the VP Bank Phu Tho network to a total of two Points of Sale.
Over five years of growth, VP Bank Phu Tho has successfully cultivated relationships with nearly 300 credit customers and over 1,200 depositors, focusing on Small and Medium-sized Enterprises (SMEs), households, and the middle class in the region To meet the diverse needs of its target customers, the branch offers a range of financial products, including vehicle loans, working capital financing, construction loans, guarantees, and medium to long-term financing options Recognizing the potential of 60% of the local labor force, VP Bank Phu Tho has also diversified its services, providing deposit accounts, individual payment cards, VP Super, money transfers, Western Union services, and savings accounts.
Established during the global financial crisis, VP Bank Phu Tho faced significant challenges from the outset, struggling with inexperienced leadership and a severe bad debt situation in 2008 Despite the daunting consequences that seemed insurmountable, the branch successfully navigated these difficulties through bold and comprehensive changes.
In early 2011, VP Bank Phu Tho underwent a comprehensive renovation, revitalizing its Board of Directors and transforming its working style and attitude This overhaul injected new energy into the institution, enabling it to identify and rectify its shortcomings However, the persistent threat of credit risk continues to loom, necessitating that all staff remain vigilant and exert their utmost effort to maintain caution.
The current organizational structure of VP Bank Phu Tho is shown in the chart below:
Chart 3.1.Organizational Structure of VP Bank Phu Tho
VP Bank Phu Tho operates with a streamlined management system due to its limited network of only two POS, encompassing four key sectors: administration, transaction and accounting, customer lending and trade-financing services, and monitoring, supported by a total of 29 staff members In 2012, the branch aims to enhance its market presence by opening a new Bai Bang transaction office, which is anticipated to significantly improve both the quality and quantity of its services.
From initial research on business, its resource and environment, I set up the SWOT analysis of VP Bank Phu Tho for further understanding:
Table 3.1: SWOT analysis of the branch
Young, dynamic, enthusiastic and passionate staff officers
Modern, commodious office; up-to- date and easy-to-use facilities
Feeble staff: lacking essential skills and product understandings, being untrained, working uncreatively
Credit officers and tellers: passively seeking for new customers
Little network, office being out of local center (unfavorable place)
Developing the SSP - “Support for
Interest rate back to 14%/ year
Limited facilities of other commercial banks in the area
High level of competition due to crowded density of local commercial banks (14 Level 1-Branches and 1,148 POS)
Price sensitivity of customer (interest rate, fee, …)
Difference compared with other competitors
Restrictive credit policy of government to customers on real estate
3.1.2 Credit activity in recent years
Since its establishment, the primary challenge facing VP Bank Phu Tho has been managing credit activities and associated risks.
Banking Academy Graduation Thesis mentioned in the problem discussion, the branch ever exposed to 30% of NPLR in
2008, proving that there must be a lot of troubles in credit activity of VP Bank Phu Tho
The net revenue structure of VP Bank Phu Tho indicates a concerning trend, with credit net income comprising only a small portion of total revenue in the past two years Typically, a microfinance institution relies heavily on its loan portfolio as a primary income source; however, this is not the case here Instead, net income from deposits constituted approximately 69% and 61% of the branch's revenue, while credit net income saw only a modest increase from 21% to 26%, representing about one-fifth of total revenue These figures suggest that the branch's current credit activities are not operating efficiently and are failing to generate significant profits.
(Source: Statements of Financial Performance, Consumer Banking Department, VP Bank Phu Tho)
The table illustrates the branch's credit activities across different types of loans over three consecutive years: 2009, 2010, and 2011 Notably, there is a downward trend in both the volume of loans and total outstanding loans during this period Specifically, from 2009 to 2011, the total amount decreased by 28,155.29 million VND in 2009 and by 22,997.12 million VND in 2011.
In response to the rapid expansion of credit and the economic recession of 2008/2009, VP Bank Phu Tho shifted its focus towards riskier business ventures and customers, ultimately leading to unforeseen consequences By 2011, the board of directors prioritized the collection of bad debts and the restructuring of the customer portfolio to safeguard business operations, which explains the subsequent decline in loan volume and total outstanding loans.
In 2009, the branch prioritized medium and long-term loans, which constituted over 52% of the total volume, despite the low debt collection likelihood being only half that of short-term loans Although the gap between these two types of credit has been gradually closing over the years, significant positive changes were not observed by 2011.
Table 3.3: Total Outstanding Loan Classified By Types of Client and Credit
(Source:Statements of Financial Performance, Consumer Banking Department, VP Bank Phu Tho)
To see things in the true color, let’s look at some credit indicators in table 3.3
In 2010 and 2011, the total outstanding loans were analyzed by client types and loan terms, revealing a significant reduction of nearly 16 percent following a year of tightened credit activity This decline in outstanding loans also led to a decrease in both the number of customers and the variety of loan products available.
Chart 3.3: Total Outstanding Loan Classified By Client Types
Despite a significant 30% decrease in individual clients, the enterprise experienced only a 6.6% decline overall In 2011, loans to enterprises constituted 56% of total loans, highlighting a growing preference for lending to businesses, which offers higher profits but also increased risks.
Chart 3.4: Total Outstanding Loan Classified By Credit Types
Medium & Long Term Short Term
In 2011, short-term loans experienced a higher interest rate compared to medium and long-term loans However, there was a notable decline in total outstanding loans across all categories, with short-term loans under one year decreasing by 16.51% and loans exceeding one year falling even more dramatically by 20.9% from 2010 to 2011.
Recent credit figures indicate weaknesses in VP Bank Phu Tho's credit activity, including low net revenue, a decline in loan volume, and an imbalance between short-term and medium-to-long-term loans, alongside a limited capacity to recover medium and long-term debts To gain a comprehensive understanding of the risks faced by the branch, key credit risk indicators will be evaluated, and the underlying causes of these issues will be analyzed in subsequent sections.
Credit risk assessment
Delinquency is often referred to as a "hidden beast," indicating that even a small amount can rapidly escalate and threaten your loan portfolio, much like the footprint of a bear foreshadows greater danger At VP Bank Phu Tho, the branch experienced significant financial strain due to the increasing number of loans in arrears that became unmanageable.
(Source: Credit Activity Assessment Report, Consumer Banking Department, VP Bank Phu Tho)
Table 3.5: Calculating Portfolio Quality Ratios
(Source: Credit Activity Assessment Report, Consumer Banking Department, VP Bank Phu Tho)
In 2011, the total amount of past due loans was reported at 11,196.6 million VND, showing a significant decline of 7,555.9 million VND over the following year Despite this reduction, the pace of decrease in delinquent loans was slower than anticipated, resulting in an arrear ratio that, while lower by 4.4% compared to the previous year, remained alarmingly high at 12.1% Additionally, there was a notable drop in group 1 loans, with a total decrease of 13,596 million VND in outstanding loans.
21,152 million VND in 2011 – see table 3.4), to some extent, seemed to put much pressure on loans in arrears This, once more, disclosed a serious credit risk existing in
Chart 3.5: Delinquent Loans Classified by Client Types
(Source: Credit Activity Assessment Report)
In details, the ratio of delinquency problem also differs by type of clients in
In 2010 and 2011, individual loan arrears decreased by approximately 2 billion VND over the year, while corporate arrears saw a modest increase to 2,799 million VND This data indicates that the majority of delinquency issues were attributed to individual loans.
Recent changes in loan classification indicate a decline in the branch's credit quality, with non-performing loans (NPLs) remaining persistently high and showing no clear signs of improvement This situation highlights significant limitations and weaknesses in credit activities, necessitating thorough analysis and reflection to derive valuable lessons.
Table 3.6: Calculating Portfolio Quality Ratios (cont.)
(Source: Credit Activity Assessment Report, Consumer Banking Department, VP Bank Phu Tho)
The high non-performing loan (NPL) ratio of 30% in 2008 has created significant challenges for the branch, which has struggled to reduce this figure over the past two years Despite the branch's best efforts, the NPL percentage has remained alarmingly high, with total NPLs classified under groups 3, 4, and 5 still posing a serious concern in 2011.
In accordance with regulations 493/2005/QD-NHNN and 18/2007/QD-NHNN, the total loans amounted to 8,890.76 million VND, reflecting a decrease of 7,902 million VND or 5.2 percent Notably, loans classified as group 5 experienced a significant reduction, plummeting by 50 percent due to an aggressive loan settlement process However, it is concerning that the proportion of group 5 loans remained high, reaching 12.4% in 2010 and 7.5% in 2011, which accounted for more than a substantial share of the total loans.
Three-quarters of total unqualified debts indicate a significant risk for the branch, which could face a complete loss of approximately 7 billion VND in 2011 if debt recovery efforts are not prioritized Additionally, the noticeable decline in group 1 loans, coupled with a modest increase of only 346.09 million VND in group 2 loans, raises concerns about the potential for hard-core debts.
Table 3.7: Non-Performing Loans by Terms
(Source: Credit Activity Assessment Report, Consumer Banking Department, VP Bank Phu Tho)
According to data in table 3.7, there was a positive change in NPLs of the branch recent years The total bad debts dropped considerably by 47.05 percent, in
The Banking Academy Graduation Thesis reveals a significant reduction in both short-term and medium-to-long-term non-performing loans (NPLs), decreasing by up to 50% compared to the previous year However, short-term NPLs constitute a major portion, doubling the amount of long-term NPLs, despite nearly equal volumes of loans granted in both categories This disparity can be attributed to three key factors: first, credit officers often overlooked the purpose of lending, particularly with working capital financing, leading to increased recovery risks; second, there was a misguided perception among credit officers that short-term loans were inherently more liquid and less risky, resulting in neglect of proper credit management; and third, the focus on collecting medium-to-long-term debts, primarily issued in 2008 and 2009, has diminished their representation in the NPL statistics over the past two years.
Chart 3.6: Non-Performing Loans Classified by Terms
To summarize, after observing the overall non-performing loans of the whole branch, a few notes are revealed:
- First, NPLs of the branch stayed at a highly risky rate (14.8 % & 9.6%) when being much higher than the standard NPL ratio (3-5%)
- Second, the ratio of group 4 and 5 loans extended further in unqualified debt structure – a clear signal about the risk of capital loss in this branch
Short termMedium & Long term
The loan loss ratio (LLR) in banking serves as a crucial metric for assessing actual loan losses By comparing the LLR over time, financial institutions can determine trends in loan losses as a percentage of the average outstanding portfolio, identifying whether these losses are on the rise or decline The accompanying chart illustrates the changes in LLR over a two-year period.
Table 3.8: Calculating Portfolio Quality Ratios (cont.)
(Source: Credit Activity Assessment Report, Consumer Banking Department, VP Bank Phu Tho)
Loan losses exceeding 2 percent annually typically signal a delinquency issue At VP Bank Phu Tho, the loan loss ratio improved to 1.7% in 2011, partly due to higher loan loss reserves influenced by write-offs Despite this improvement, the loan loss ratio remains significantly elevated at 5.3% and 3.6%, far above acceptable standards These losses primarily stem from reckless credit expansion activities in 2008 and 2009.
In late 2008 and early 2009, the Phu Tho branch took a bold risk by issuing numerous medium and long-term loan contracts despite warnings about the impending "dark era" of the real estate market This decision led to a wave of client insolvencies as the real estate bubble burst, resulting in significant loan losses for the branch that persisted for years Notable cases include the Phu Huong Real Estate Joint Stock Company and Mr Le, highlighting the financial repercussions of ignoring market signals.
Van Thang, Nam Van Investment Joint Stock Company …
While a non-performing loan has the potential to recover and become performing, evidence indicates that the likelihood of recovery is significantly lower compared to the risk of loans deteriorating further into bad debts Therefore, it is essential to concentrate on establishing realistic provisions and reserves for potential losses within the branch's loan portfolio.
Table 3.9: Loan Loss Reserve and Loan Loss Provision
(Source: Balance Sheet & Income Statement 2010 & 2011)
The table illustrates the branch's reserve for future losses and actual loan loss expenses during the period The allowance for loan losses (ALL) decreased by over 1.5 billion VND in the past year, attributed to a decline in total loans and a 50% reduction in group 5 loans However, the decrease in ALL is concerning, as loan loss provisions (LLP) indicated increased expenditures for loan losses in 2011 Due to deteriorating credit quality, the branch raised its provisions for bad debts from 524.6 million VND at the end of 2010 to 701.3 million VND the following year This rise in loan loss provisions corresponds with a reduction in net charged-offs, indicating that the volume of write-off loans significantly exceeded recoveries.
The Phu Tho branch has faced challenges in effectively managing credit risk, despite a commendable reduction in impaired loans over the year The impact of loan loss provisions (LLP) on the loan portfolio's risk will be reflected in the profit and loss statement provided below.
The decline in Allowance for Loan Losses (ALL) indicates a corresponding decrease in Non-Performing Loans (NPL); however, this does not accurately represent the branch's actual expenses incurred to mitigate losses over time Over the past two years, the Loan Loss Provision (LLP) ratio has risen by 0.29%, highlighting a concerning trend for the branch's profitability.
Causes of credit risk
This category could include the followings:
In recent years, the volatile fluctuations of the global market have significantly affected the national business landscape Events such as the economic-financial recession of 2008-2009, an inflation rate exceeding 18 percent in 2011, and variations in the consumer price index (CPI) have resulted in substantial losses for both borrowers and the industry.
The global integration and financial liberalization, particularly Vietnam's accession to the WTO in 2007, have led to an increase in non-performing loans (NPL) due to heightened competition This competitive environment poses significant risks for corporate clients, forcing them to navigate potential losses and stringent market regulations Additionally, the rapid expansion of other commercial banks in the region, such as Vietinbank, Vietcombank, Military Bank, Agribank, Techcombank, and BIDV, has intensified the competitive pressure on VP Bank Phu Tho across all business sectors, especially in the ongoing battle over interest rates.
The unfavorable regulatory environment poses significant risks for banks, as the State Bank of Vietnam (SBV) and related authorities have implemented numerous regulations governing banking credit activities Despite these efforts, challenges arise in the enforcement of these regulations, particularly concerning debt collection While commercial banks are entitled to settle collaterals when customers default on debts, they are constrained by the necessity of involving the courts in proceedings against delinquent borrowers This regulatory framework complicates the timely management of debts and collateral for banks, hindering their operational efficiency.
The current credit information center in Vietnam faces significant risks due to its lack of a comprehensive mechanism for publishing detailed information on enterprises and credit institutions The State Bank of Vietnam's Credit Information Center (CIC) provides limited and outdated data, primarily focused on total outstanding loans, without offering critical non-financial information or insights into the management capabilities of businesses This deficiency fails to meet the essential information needs of stakeholders.
Banking Academy Graduation Thesis and individuals are offered The information about individuals or corporates who do not have credit relations with banks has not been absolutely updated
Phu Tho faces significant challenges each year due to natural disasters, including floods, tornadoes, and landslides, which adversely affect both individuals and businesses These events result in substantial damage to properties and livelihoods Additionally, recent outbreaks of poultry diseases have left farmers financially devastated, severely impacting their ability to repay loans for agricultural ventures.
- Capital used for improper purposes, no goodwill in making payment: in
VP Bank Phu Tho reports that most firms submit concrete and feasible business plans when applying for loans, with only a small percentage misusing funds or committing fraud However, the significant size and volume of loans mean that cases of irrecoverable debts can have severe repercussions, impacting both the branch and other businesses in the area.
An investment trading company limited with the amount of fraud up to 1,787,000,000 VND, Thai Hung trading and material joint-stock company with 600,000,000 VND
Poorly-managed business operations often stem from a lack of financial information, absence of a solid business plan, and weak connections among products Many enterprises in the locality prioritize property investment over improving their management practices or financial monitoring systems when seeking loans for expansion This misalignment between business size and capacity frequently leads to bankruptcy, resulting in significant loan losses for the branch.
Dishonest financial statements (FS) significantly undermine the integrity of the Profit and Loss statement (P&L) submitted by clients, as they often fail to adhere to Vietnam's accounting regulations Alarmingly, over 50% of the financial statements reviewed by the branch's credit officers lack annual audits, which diminishes the effectiveness of client evaluations.
In 2009, an incident at VP Bank Phu Tho highlighted the risks of credit staff focusing solely on accounting appearances rather than the underlying financial reality Despite reporting profits in their financial statements, the bank was actually facing losses for two consecutive years and was unable to meet its loan obligations Fortunately, the discovery of this misleading data prevented the branch from incurring a significant loss of nearly 2 billion VND in principal and interest.
Over the past year, many businesses faced challenges in repaying debts due to external factors, particularly issues with their partners For instance, companies like PETEC Construction Joint-Stock Company and Van Phu Agricultural Material Import-Export Company Limited experienced delays in receiving full or timely payments for supplies Consequently, these unforeseen circumstances have significantly contributed to the rise in overdue debts within the industry.
The primary risk to business operations stems from individual group failures, where poor business decisions or external factors can lead to significant profit losses If these issues are not addressed promptly, businesses may struggle to secure alternative funding or face severe penalties, such as a 150% fine.
In the event of job loss, job changes, or loss of working ability, individuals with consumption loans may experience a significant reduction or complete loss of their primary income source, such as salary or wages Consequently, financial institutions must consider rescheduling these loans or implementing alternative debt recovery measures to mitigate the risk of exposure.
Clients in Phu Tho often face unexpected life events, such as theft, fire, or illness, with natural disasters like floods and landslides significantly impacting many These incidents lead to substantial financial losses, affecting their repayment capabilities Consequently, the branch has repeatedly had to implement measures to address these challenges.
Banking Academy Graduation Thesis method of rescheduling or moving into another overdue debt group with these cases from individual customers
One significant risk faced by financial institutions is poor personal morality among borrowers, particularly in vehicle loans for businesses These loans, intended for purchasing vehicles like trucks, buses, or ships, are secured by the vehicles themselves However, borrowers may default on payments due to various factors, such as business failures or accidents, or they may engage in deceitful practices This behavior can lead to substantial losses for the institution, as it may result in a high level of loan loss provisions (LLP) and the inability to recover either the principal or interest, ultimately jeopardizing the control over the collateral.
3.3.2 Internal cause (by the branch)
A thorough assessment of credit risk causes from the branch perspective is essential to address existing credit issues Analysis indicates that the primary factors contributing to credit risk at the Phu Tho branch include various underlying reasons.
RECOMMEDATIONS AND CONCLUSIONS
Recommendations
At present, it is vital to build a synchronous legal system as the base for commercial banks and their clients:
To effectively manage overdue debts secured by collateral, the government should empower banks to take a proactive approach in handling these assets during debt collection Upon maturity, if customers do not fulfill their obligations, banks should be allowed to promptly sell the collateral through a court order, thereby minimizing costs and mitigating potential losses.
The government must enhance the functionality of the Credit Information Center (CIC) and establish additional information exploitation and provision centers This initiative aims to assist credit organizations and commercial banks in reducing risks effectively.
To enhance stability in the lending market, it is crucial for the government to intervene and regulate interest policies This action is essential in addressing the intense competition among commercial banks, which often leads to significant challenges for customers seeking loans.
4.1.2 To VP Bank - Phu Tho branch
Effective credit procedures, particularly in the loan appraisal phase, play a crucial role in minimizing errors, mitigating risks, and enhancing the overall quality of loans.
To ensure sound decision-making while safeguarding bank assets and enhancing customer convenience, the quality of the assessment process is crucial This involves evaluating the economic efficiency of loans, reviewing business plans for alignment with market growth trends, analyzing income and expense figures, and identifying repayment sources.
In detail, when implementing the loan appraisal, credit officers should pay attention to the following issues:
Updating the credit mechanism and legal documentation related to credit activities is crucial for ensuring compliance and efficiency in credit procedures It is essential to evaluate each project's objectives to determine alignment with governmental economic and social development goals Additionally, it is important to assess whether the project falls within government-approved categories, is subject to restrictions, or qualifies as part of a preferential client group.
- Evaluating multivariate information about customer and borrowings (see article 2 Improving the efficiency in collecting and using information)
- Focusing on assessing the feasibility of loan project Once project is feasible, its owner is more likely to earn interest, then fulfills the obligations to the branch
Establishing clear rules and regulations for each stage of work is essential for effective content management It is crucial to assign specific responsibilities to staff involved in the appraisal, monitoring, and approval processes The branch should implement a structured approach that defines both individual and collaborative duties throughout the workflow.
- Last but not least, inscribing in mind “never accept a loan based on collateral only” because the sale of collateral in only used as the last resort to repay loan
4.1.2.2 Improving the efficiency in collecting and using information
Adequate and accurate information about clients and market has played an important role in ensuring credit quality and controlling risks The following stages are needed to be done:
To enhance the accuracy of client assessments, credit officers must supplement the information obtained from clients with reliable secondary data sources This includes gathering insights from the client's partners, consulting other commercial banks with which the clients have relationships, and utilizing the Credit Information Center (CIC) of the State Bank of Vietnam (SBV) Addressing the challenges posed by non-audited or inaccurate financial statements is essential for improving the assessment process.
- Collecting information about market: it is a must that credit staff explores information about products that customers have been trading, for example: supply- demand prediction, product market price, collateral
- Analyzing and settling information: based on information gathered, credit officers focus on evaluating and determining credit rating for customers as a basis of a sound lending decision
To prevent errors stemming from subjective client information, credit officers should actively establish relationships with local authorities and departments across various industries This proactive approach enables accurate assessments of customers' legal capacity, business reputation, and social engagement, while also considering statistical data in financial statements and business plans.
4.1.2.3 Diversifying loans to disperse risk
Holding a diversified portfolio of loans effectively spreads risk, preventing significant losses from any single exposure However, achieving diversification necessitates that the branch gains expertise in multiple business sectors Therefore, a well-structured plan for credit diversification is essential for success.
- The branch should extend the amount of loan to medium – long terms; encourage clients of non-state owned enterprises As lending with longer term holds
To mitigate risks, the branch must prioritize thorough loan assessments, as research indicates that individuals in Phu Tho prefer short-term loans over medium and long-term options To alleviate their concerns and encourage the adoption of longer loan terms, the branch should adopt a tailored approach that addresses the unique needs of each borrower, providing essential advice and relevant information related to their specific business sectors.
To enhance client retention, traditional obligors who regularly transact with the branch should benefit from preferential interest rates, capital requirements, and rescheduling periods Additionally, the branch should prioritize activities aimed at VIP customers, such as celebrating important occasions like birthdays and business anniversaries, as well as International Women's Day These initiatives will strengthen customer confidence and satisfaction in the branch's products and services.
- Further promoting consumption loan to staff members had better be done because this kind of credit is less risky than the others
For customers in stable income sectors such as postal services, education, public security, electricity, and banking, it is essential for the branch to consider extending credit lines or repayment periods Simplifying the methods of interest calculation and debt collection for these loans can enhance customer experience Implementing a repayment schedule aligned with clients' income periods not only eases their repayment process but also allows the branch to effectively monitor fund utilization and repayment capacity, enabling early detection of potential risks.
VP Bank Phu Tho leverages its level 1 branch advantage to enhance syndicated loan offerings, effectively increasing profitability while ensuring collateral and diversifying risk This lending method meets customer capital needs and maintains healthy outstanding loans Additionally, co-sponsors in the syndicated loan process collaboratively evaluate projects and assess clients, thereby minimizing risks for the branch.
Banking Academy Graduation Thesis may encounter In case of risk occurrence, it would be distributed by many parties – risk dispersion
To optimize credit products, branches must accurately assess profit margins on outstanding loans for each product while analyzing competitive pressures and their standing against rivals This evaluation is crucial for deciding whether to focus on, sustain, or phase out specific lending products Additionally, ongoing market research is essential to identify opportunities for expanding into new client and product segments.
4.1.2.4 Clamping down on monitoring process
Conclusions
The conclusions section covers all the summary of the whole thesis
Chapter I – “Introduction” reveals the reason why I have chosen VP Bank Phu Tho and its credit problem as the subject for my thesis It states directly the credit risk and credit exposure that the branch has to encounter over the years The thesis is conducted with the aim of realizing the matter of credit risk, analyzing the causes and suggesting solutions for improvement Due to the limitation of gathering primary data, the analysis in this research would be covered by using secondary data and the result should not be applied for any other commercial banks in Vietnam
Chapter II – “Theoretical framework” or literature review provides readers with the definition of credit risk in commercial banks The information about some major credit risk indicators are insightfully discussed and clarified This chapter also points out the general causes and consequences of credit risk as a theoretical basis for credit problem of the branch studied
Chapter III assesses the credit risk of the case study At the first place, the chapter provides a brief overview on VP Bank Phu Tho during its establishment and development as well as particularly focuses on credit activities to find out its credit weaknesses From this general analysis, many matters arising from credit operations have been disclosed To closely approach, the credit risk indicators given in
The theoretical framework is thoroughly analyzed, revealing a severe credit risk within the branch, highlighted by alarmingly high non-performing loan (NPL) rates of 14.8% in 2010 and 9.6% in 2011, alongside significant arrears at 16.5% and 12.1%, and loan loss rates of 5.3% and 3.6% Additionally, issues with credit concentration and loan diversification have been identified The chapter interprets the consequences of these credit challenges, emphasizing their detrimental effects on bank assets and profits due to elevated loan loss reserves (LLR) and loan loss provisions (LLP), while also considering external contributing factors.
Banking Academy Graduation Thesis and causes from customers which are uncontrollable, the branch should be in charge of its credit exposure by loan process violation and capacity weakness
Chapter IV presents further support for mitigating and improving credit activity The chapter aims at giving solutions that directly fit with each cause by VP Bank Phu Tho in chapter III The branch should pay much attention to deal with credit risk and loss by controlling loan appraisal and monitoring process, especially the step of analyzing information from customers; diversifying loan properly; enhancing staff’s quality and expanding the branch network Such methods can be separated to implement for each period of time, from short to long-term, linking tightly to its specific credit orientation
This study offers valuable empirical evidence regarding the weak credit performance of VP Bank Phu Tho, highlighting longstanding and significant issues related to credit risk and losses from poor credit activities The thesis aims to assess the current level of risk, identify the underlying causes, and propose actionable recommendations for improvement.
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