Trang 1 HANOI UNIVERSITYFACULTY OF MANAGEMENT AND TOURISMTOPIC TREASURY MANAGEMENT 2021ANALYSIS OF CREDIT, LIQUIDITY, INTEREST RATE RISK, SCENARIOS ANALYSIS ON THE IMPACT OF INCOME AND C
lOMoARcPSD|38544120 HANOI UNIVERSITY FACULTY OF MANAGEMENT AND TOURISM TOPIC TREASURY MANAGEMENT 2021 ANALYSIS OF CREDIT, LIQUIDITY, INTEREST RATE RISK, SCENARIOS ANALYSIS ON THE IMPACT OF INCOME AND CAPITAL, AND HEDGING PROPOSAL FOR VIETTINBANK 2018-2020 Member 1 Nguyen Thi Hoai Huong Tut 4 1604040050 3TC18 : 2 Vuong Thi Nam Kieu Tut 4 1804040056 2TC18 3 Ngo Phuong Linh Tut 4 1804040063 2TC18 4 Nguyen Thi Duc Tut 4 1804040039 2TC18 Course: TRM Spring 2021 Due date: 14 May 2021 Downloaded by Uy vu Nguyen (tailieuso.11@gmail.com) lOMoARcPSD|38544120 HA NOI 2021 Peer contribution Downloaded by Uy vu Nguyen (tailieuso.11@gmail.com) lOMoARcPSD|38544120 Abstract Vietnam’s banking industry was expected to weaken in 2020 as a result of decrease in credit growth, rising loss provision and along with worsening of asset quality, and inadequacy of capital in this a weak economic environment However, in the beginning of 2021, credit growth and asset quality improved That should a good signal of recovery in bank profits The aim of this research on ViettinBank (2018-2020) is to analyze risk exposure including credit, liquidity and interest rate risk and set up different scenarios to detect the bank have problem The final result indicates that ViettinBank did not meet capital requirement, however liquidity is not shown problematic Downloaded by Uy vu Nguyen (tailieuso.11@gmail.com) lOMoARcPSD|38544120 Table of content Abstract .3 I Introduction .5 1.1 Financial crisis and covid-19 pandemic 5 1.2 Background of ViettinBank 5 II Analysis of liquidity risk, credit risk, interest rate risk .7 2.1 Liquidity risk .7 2.2 Credit risk 9 2.3 Interest rate risk .13 2.4 The impact of inflation in bank’s performance 16 III Scenarios analysis on the impact of income and capital and hedging proposal 16 3.1 Recession scenarios 16 3.2 Credit risk hedge 19 3.3 Interest rate risk hedge 20 Reference 22 Downloaded by Uy vu Nguyen (tailieuso.11@gmail.com) lOMoARcPSD|38544120 I Introduction I.1 Financial crisis and covid-19 pandemic After a decade of the Great financial crisis 2007-2008, covid-19 pandemic clearly gives fear to bank industry In the historical records, a sudden stop lending by bank might feed a warning signal of recession in the economy Furthermore, as a domino effect, recession also damages to bank via credit losses, declines in the value of investment, reduction in a bank revenue Even worse, the situation can spiral downward as damage to banks cuts into credit availability, force bank to cut back further However, Viet Nam has performed well in comparison to the rest of the world by considering following key macroeconomic factors: GDP has continued to growth over the 6 months of 2020, albeit at a slower pace than in the past Inflation has been contained despite the easing of monetary condition by the SVB, which lead to the expansion of credit by commercial banks to business Country has been able to cope with the pandemic by maintaining a trade surplus I.2 Background of ViettinBank The background of Viettinbank is summarize as a following table Type Joint-stock company Traded as HOSE: CTG Industry Financial services Founded 1988 Headquarters Hanoi Area serves Vietnam Key people Lê Đức Thọ (Chairman); Trần Minh Bình (Diretor) Owner State Bank of Vietnam Website www.viettinbank.vn In the following parts, we will discuss and assessing risks related in the bank and propose hedging plans which the bank can employ to reduce the uncertainty situation Downloaded by Uy vu Nguyen (tailieuso.11@gmail.com) lOMoARcPSD|38544120 II Analysis of liquidity risk, credit risk, interest rate risk II.1 Liquidity risk When discuss about liquidity problem, in general, it is important to look back for the lessons from Global financial crisis in 2007-2008 It is a shadow pictures to the economy of numerous nations, including Viet Nam However, Vietnamese banking system has not seriously suffered from the impact of this catastrophe since it only at the beginning of integration The difficulties its banking system has been faced to the extent of: Limitation of carrying out international transactions that impacts negatively on Viet Nam’s short-term loans The consequence is that many bank’s profits have reduced, NPLs increased including ViettinBank, hence, the impact for banking system can remain in several year Due to that fact, liquidity risk should be detected, analyzed and managed carefully in bank and in any financial institutions That is the very first step in order to prepare for the future unexpected events because, practically speaking, the economic cycle is, in fact, fluctuated and most of the time future prediction is beyond the human ability Follow that, in this part we are going to examine the liquidity situation of ViettinBank over three year from 2018 to 2020: discussion of fundamental liquidity; statement of structural liquidity maturity gaps II.1.1 Liquidity risk background Liquidity problem occurs when banks do not have enough cash to meet depositor withdrawal request When a bank is in cash-strapped situation, it is may forced to borrow or quicky liquidate some of its assets at less than market value in order to meet unexpected withdrawal demands Moreover, it can happen because banks finance long Funding liquidity and funding liquidity risk Those two terms sound similar however they are different concepts Funding liquidity is defined as the ability to settle obligation with immediacy If the bank in the trouble of illiquid, it simply means that bank is unable to settle obligation in time and bank default can be the possible consequence then both shareholders and depositors will incur losses On the other hand, funding liquidity risk derives by the chance that over the specific horizon the bank will become unable to settle obligation immediacy Therefore, we can see funding liquidity risk has two components: future cash flow in- and outflow; and future price of obtaining liquidity from different sources In another words, to distinguish those two terms, we can consider the number of possible results and also time horizon Funding liquidity is a binary concept since only 2 possible outcomes: able to settle or not able to settle obligations Funding liquidity risk has infinite outcomes because it is in the relation with the changes in future cash flow and future price (future price is a very random factors) in addition, the combination of different scenarios creates uncounted results To detect liquidity risk, it is worth to trace back statement of structural liquidity and maturity gaps of the bank II.1.2 Analyze statement of structural liquidity and maturity gap of ViettinBank Statement of structural liquidity is reported as per their maturity profile (bucket) and play a vital role for ALCO to draw ideas of mismatches depending on cash inflow and outflow of each bucket It can serve as early warning signal of impending liquidity problem Downloaded by Uy vu Nguyen (tailieuso.11@gmail.com) lOMoARcPSD|38544120 The tables below illustrate Viettin bank statement of structural liquidity in short form and also compare the maturity gaps over 3 years *The detailed tables are provided in indexes section 2018 (Million VND) Overdue Due Over 3 months from 1m to from 3m to from 1y to 14,171,811 3 months 1month 3m 12m 5y above 5ys Total 5,799,721 Total 199,026,76 205,405,641 310,087,496 198,698,165 247,105,721 1,180,295,315 assets 0 227,652,703 412,188,529 134,176,537 28,842,235 1,096,558,639 Total 293,698,63 liabilities 5 Gap 14,171,811 5,799,721 -94,671,875 -22,247,062 -102,101,033 64,521,628 218,263,486 83,736,676 2019 (Million VND) Overdue Due Over 3 from 1m to from 3m to from 1y to months 3 months 1month 3m 12m 5y above 5ys Total Total 11,403,411 5,677,439 193,677,695 219,886,697 340,424,709 204,983,813 285,724,696 1,261,778,460 assets Total 319,486,667 261,284,108 440,464,470 107,212,074 34,423,650 1,162,870,969 liabilities - Gap 11,403,411 5,677,439 -125,808,972 -41,397,411 100,039,761 97,771,739 251,301,046 98,907,491 2020(Million VND) Overdue Due Over 3 from 1m to from 3m to from 1y to months 3 months 1month 3m 12m 5y above 5ys Total Total 9,592,414 2,799,154 229,460,871 229,005,709 392,517,058 213,416,411 277,776,322 1,354,567,939 assets 321,826,292 210,210,526 477,512,740 210,821,995 34,883,605 1,255,255,158 Total liabilities Gap 9,592,414 2,799,154 -92,365,421 18,795,183 -84,995,682 2,594,416 242,892,717 99,312,781 Maturit Over 3 3 months 1month from 1m from 3m to from 1y to above 5ys Total y Gap months to 3m 12m 5y 83,736,676 5,799,72 -94,671,875 - - 218,263,48 98,907,491 2018 14,171,811 1 - 22,247,06 102,101,03 64,521,62 6 99,312,781 125,808,97 2 3 8 2019 11,403,411 5,677,43 2 - 251,301,04 2020 9,592,414 9 - 100,039,76 97,771,73 6 2,799,15 -92,365,421 41,397,411 1 9 242,892,71 4 18,795,18 7 3 -84,995,682 2,594,416 Downloaded by Uy vu Nguyen (tailieuso.11@gmail.com) lOMoARcPSD|38544120 Maturity gap 2018-2020, unit: Thousand VND 300,000 250,000 200,000 150,000 100,000 50,000 0 -50,000 -100,000 -150,000 2018 2019 2020 Graph: Maturity gap, 2018-202, ViettinBank According the graph, in general, positive gaps are seen at the buckets of above 5 years; over 3 months and three months maturity in all periods and also gap positive in the year of 2018 and 2019 for bucket from 1 year to 5 years maturity However, negative maturity gaps are clearly draw from 1 month maturity up to 1 year It can be seen that in the 2 tails of the graph, maturity gaps are positive and in the middle period they are mainly negative A positive maturity gap shows that value of rate sensitive assets is more than the value of rate sensitive liability and vice versa Moreover, the gaps in 1 month maturity, from 3 months up to 1 year statically significant The larger the negative gap, the higher degree of potential risk or more volatile And also, the upfront discussion of funding liquidity risk depicted that this problem has the component of future value of the instruments It makes sense that longer repricing periods have higher sensitivity to the change in interest rates and repricing means that its most likely to happen the interest rate in the long future is very different from the past II.2 Credit risk Obviously, the best indicator of credit risk is overdue debt Overdue debt is unavoidable in the context of a credit relationship Overdue debt rates are always of interest to administrators because they can result in doubtful accounts, irrecoverable debts, or bad debts II.2.1 Credit risk factors This factor represents the proportion of credit items in assets; a high proportion of credit items indicates a high profit and a high credit risk exposure Downloaded by Uy vu Nguyen (tailieuso.11@gmail.com) lOMoARcPSD|38544120 Unit: million VND Item 2018 2019 2020 1,240,711,475 1,341,436,468 Total assets 1,164,289,661 935,270,945 1,015,333,270 Outstanding loans 864925948 0.75 0.76 Credit risk factor 0.74 Table 1.1: Credit risk factor The table shows that the credit item in the bank's total assets is quite high, resulting in an increase in profit In principle, credit risk increases accordingly However, the bank had strengthened the appraisal and strict control of loan projects, and the bank's credit operation remains effective, to the extent that special-mentioned debt in 2020 is half that of 2019; bad debt accounts for a small proportion of total outstanding loans.The table depicts the significant impact of outstanding loans on total assets; total assets will fluctuate in the event of a credit operation difficulty II.2.2 Analysis of overdue debt structure Based on Decision No 493/2005/QD-NHNN and additional Decision No 18/2012/QD- NHNN dated 25/04/2012 made by the Governor of State Bank overdue debts are classified into 5 groups as follows: Group 1 (Standard debt) Group 2 (Special-mentioned debt) Group 3 (Sub-standard debt) Group 4 (Doubtful debt) Group 5 (Bed debt - possibility of principal loss) Overdue debts are categorized from group 2 to group 5, while bad debts are classified from group 3 to group 5 To put it another way, overdue debts include both group 2 and bad debts Downloaded by Uy vu Nguyen (tailieuso.11@gmail.com) lOMoARcPSD|38544120 Unit: million VND 2018 2019 2020 Comparison Comparison 2019 vs 2018 2020 vs 2019 Total 864925948 935270945 1015333270 70344997 8.13% 80062325 8.56% outstanding loans Group 1 846022474 918780095 1003015015 72757621 8.60% 84234920 9.17% 483313 9.30% -2878285 -50.70% Group 2 5194126 5677439 2799154 -76606 -3.58% -205374 -9.96% -469988 -23.30% 64888 4.20% Group 3 2139221 2062615 1857241 -2349343 -24.59% -1153824 -16.02% Group 4 2016689 1546701 1611589 Group 5 9553438 7204095 6050271 Table 1.2: Analysis of overdue debt structure Despite an increase in outstanding loans, overdue debts in groups 2 - 5 in 2020 decreased substantially, as seen in the table above Over the years, the bank's standard debt (group 1) has always made up a large percentage of overall overdue debts, reaching 97.81% in 2018, 98.24% in 2019, and 98.79% in 2020 Although debt of group 2 had risen slightly from 5194126 million in 2018 to 5677439 million in 2019, in 2020, it plummeted to 2799154 million From 2018 to 2020, the debts of groups 3, 4, and 5 were effectively managed, which decreased steadily Over the last three years, there has been no discernible trend in the number of outstanding debts However, it is clear that the bank has made significant efforts to manage overdue debts The bank's standard debt is still held at a rate of over 98%, which is regarded as a major success In 2020, the Covid-19 pandemic has a great impact on enterprises in Vietnam, including domestic private enterprises and foreign direct investment (FDI) enterprises The support in interest rate from the Government facilitated the business activities of enterprises Therefore, despite economic difficulties, in 2020, enterprises had carried out actively and effectively construction work, projects, etc Many enterprises specializing in garment, information and communication, electrical equipment manufacturing, real estate, agriculture, fisheries, etc receiving loans from the bank can earn high profit and be able to repay debt on schedule Downloaded by Uy vu Nguyen (tailieuso.11@gmail.com) lOMoARcPSD|38544120 II.2.3 Bad debt situation over the years Unit: million VND Loan classification 2018 2019 2020 Total outstanding loan 864925948 935270945 1015333270 Bad debt 13709348 10813411 9519101 In which: - Substandard debt 2139221 2062615 1857241 - Doubtful debt 2016689 1546701 1611589 - Bad debt - possibility of 9553438 7204095 6050271 principal loss NPL-to-total outstanding loan ratio 1.59% 1.16% 0.94% Table 1.3: Bad debt situation over the years at the bank In general, bad debt has been decreasing over time In 2019, the NPL ratio was 10813411 VND million, down VND 2895937 million from the previous year In 2020, NPL was VND 9519101 million, a decrease of VND 1294310 million from the previous year The overall NPL-to-total outstanding loan ratio, according to current State Bank regulations, is between 3 and 5 percent This ratio at the bank is just around 0.94 percent to 1.59 percent, which is much lower than the permissible limit, as seen in the table above This implies that the bank's credit operations are stable, safe, and effective The bad debt situation is always under control, with the bank completing a comprehensive settlement I.1.1 Risk reserve fund Unit:million VND 2018 2019 2020 13059964 12945694 Remaining balance 8302823 8644513 6326933 -8758783 -6711225 Provision For Credit Losses (PCL) 5011682 12945694 12561402 Use of risk provisions -254541 Balance at the end of the year 13059964 Table 1.4: Reserve fund at the bank As can be seen from the table, the bank's establishment of credit risk reserve funds and risk treatment over the years demonstrates that the bank has put forth significant effort in the Downloaded by Uy vu Nguyen (tailieuso.11@gmail.com) lOMoARcPSD|38544120 process of overcoming risk Viettin bank has been steadily restructuring loans, cleaning up financial activities, managing outstanding debts, etc It also applied measures to credit activities in order to enhance professionalism and bring productivity to work in order to improve credit quality and minimize risk Furthermore, the bank has established an adequate provision to cover risk in banking activities by making risk provision at the prescribed rate based on the classification of overdue debt and cost identification, and using the risk offset This strategy aids in reducing the bank's debt burden, relieving psychological strain on credit officers and the bank's leadership in the case of a credit risk during the period when the collateral is to be enforced I.2 Interest rate risk Interest rate risk (IRR) is an integral part of banking business, which can be a source of profitability and shareholder economic value (Basel committee on banking supervision) IRR usually occurs when there is a large fluctuation in the input interest rate and the output interest rate Excessive IRR, which is an important element creating the failure of the bank, threatens the bank’s earnings and capital base Changes in interest rates may have an impact on a bank's net interest income, level of interest-sensitive income, and operating expenses Moreover, due to the fact that present value of future cash flows changes when interest rates have a new tendency of increasing or decreasing, which effect on underlying asset, liability and off- balance sheet instruments (Basel committee on banking supervision) Consequently, interest rate risk management, predicting interest rate trend changes is a crucial issue that every bank would have its efficient strategies to minimize the risks and maximize the institutional value/profit In Vietnam, interest rate decisions are regulated by the State Bank of Vietnam (SBV) This picture shows the annual interest rates of Vietnam from 2017 to January 2021 It can easily be seen that the interest rates have a gradual decreasing trend from 6.5% down to 4% Graph : Interest rate in Viet Nam The central bank must have the adjustments in the interest rates due to the strong relation between IRR and environmental risks such as monetary, fiscal and economic policies of the Government The purpose is to manage the national financial market (Hien, 2013) I.2.1 Sources of interest rate risk There are many different sources that causes interest rate risk in commercial bank such as Gap risk, Basis risk (also known as Spread risk), Net Interest position risk, Embedded Option Downloaded by Uy vu Nguyen (tailieuso.11@gmail.com) lOMoARcPSD|38544120 Risk, Yield Curve risk, Price risk, Reinvestment risk.Specially, According to research gate,the three most important sources of risk are Basis risk, Gap risk and Yield curve risk The first main source of interest risk is Basis risk which is connected with the imperfect correlation in the adaptation of interest rate to assets and liabilities with otherwise similar maturities and revaluation In the case of a change in an interest rate, these differences in adaptation of interest rate can cause an adverse impact on the value of the bank Secondly, Gap risk works on the principle that groups of assets and liabilities will be sensitive to interest rate changes over their maturity Finally, Yield curve risk is also one of the main sources causing interest rate risk Specifically, Yield curve risk arises when changes in the value, slope and shape of the yield curve have an adverse impact on financial flow and value of the bank I.2.2 Measure of Interest rate risk Tools I.2.3 Gap analysis Gap analysis is a method of asset-liability management It represents the imbalance between the rate sensitive asset (RSA) and rate sensitive liability (RSL), which directly affect net interest income (NII) of the bank To hedge the gap, banks have to maintain the RSA equal to RSL Here is the summary of the consequences of the gap GAP Change in IR Change in NII Negativ RSA < RSL Increase Decrease e Negativ RSA < RSL Decrease Increase e Positive RSA > RSL Increase Increase Positive RSA > RSL Decrease Decrease Zero RSA = RSL Increase No impact Zero RSA = RSL Decrease No impact Interest-sensitive Assets (ISAs) are assets that have maturities of less than one year and loans with interest rates depending on market interest On the TSN side, interest-sensitive Liabilities (ISLs) are capital mobilization with a maturity of less than 1 year and other deposits associated with fluctuating interest rates in the market The difference between these 2 assets: GAP = ISAs - ISLs If interest-sensitive Liabilities is greater than interest-sensitive Assets, the difference is negative (GAP 0), if the interest rate in the market increases, the interest rate earned from investing in TSC will increase faster than the cost of mobilizing capital that means the bank's income will increase Conversely, if the interest rate in the market falls, the bank's income falls Components 2018 2019 2020 ISA 1,123,695,270 1,202,502,511 1,290,914,474 ISL 488,022,574 474,870,439 393,442,988 Interest Sensitivity Rate (ISA/ISL) 2.3025477 2.5322749 3.2810712 Interest Sensitivity Gap 635,672,696 727,632,072 897,471,486 Net Interest Margin Net Interest Income 2.07% 2.86% 2.85% 22,518,086 33,199,037 33,199,037 Downloaded by Uy vu Nguyen (tailieuso.11@gmail.com) lOMoARcPSD|38544120 Table 1: Interest sensitive Assets & Interest sensitive Liabilities from 2018 to 2020 (Million VND) According to the above table, Vietinbank’s gap experienced a positive gap during the period 2018 to 2020 Interest - sensitive Assets are larger than interest sensitive Liabilities, thus this bank has a positive gap and is asset sensitive Both Relative IS GAP and ISR ratio illustrates an Asset -sensitive financial bank (Relative IS GAP >0 and ISR greater than one) With positive interest-sensitive GAP, the risk will occur in the case of decreasing interest Interest income will rise faster than interest expenses which leads to the increasing of NIM The net interest margin of VietinBank in 2018, 2019 and 2020 is 2.07%, 2.86% and 2.85% respectively as given in the table which grew steadily indicating the management and staff have been able to keep well the growth of revenues ahead of rising costs During the period from 2018-2019, Vietinbank experienced an increasing NIM that rose from 22,518,086 million VND in 2018 to 33,199,037 million VND in 2019 Nevertheless, The NIM is nearly constant in 2020 (33,199,037 Million VND), almost the same as that of 2019 due to the impact of COVID- 19 I.2.4 Duration Gap (DGAP) Another method to hedge with interest risk is the Duration gap (DGAP) model which focuses on managing net interest income, recognizing the timing of all cash flows for every security on a bank's balance sheet It is known as the mismatch of asset and liabilities timing This indicates the time value of money Unlike GAP analysis focusing on rate sensitivity or the frequency of repricing, duration gap analysis focuses on price sensitivity DGAP along with interest rate change directly conducts the gain or loss of a bank's net worth (Hien, 2013) Because of complicatedly processing more numbers and specific patterns in unwell-defined assets, DGAP measurement is ignored in this research However, we cannot deny that this method provides a better vision for total portfolio rather than individual account measurement Here is the table shows the relationship of net worth, duration gap and interest rate Duration Gap Change in interest rate Change in net worth Positive Increase Decrease Positive Decrease Increase Negative Increase Increase Negative Decrease Decrease Zero Increase No impact Zero Decrease No impact I.2.5 Vietinbank Interest risk management Currently, Vietinbank has applied relatively fully the interest rate risk management tools according to international practices and continues to research and develop strategies and measures to manage interest rate risk according to a roadmap in line with the requirements, demand of the State Bank such as: building debt management software, adjusting loan repricing terms to suit capital Downloaded by Uy vu Nguyen (tailieuso.11@gmail.com) lOMoARcPSD|38544120 Since 2018, VietinBank has established a system of regulations, and banking interest rate risk management processes in accordance with international practices and Basel II regulations, implemented interest rate risk management in accordance with the principles of "3 rounds of control" Vietinbank has also completed the construction and officially implemented the Debt and Asset Management (ALM) software system In addition, Vietinbank also adjusts the revaluation term of the loan corresponding to the term of capital valuation, controlling the repricing term difference within the permitted range It can be said that the interest rate risk management and management of Vietinbank is quite good In 2020, the impact of disease COVID-19 has a direct impact on the economy and profitability of banks However, Vietinbank has maintained total capital income compared to 2019, with NIM of 33,119 037 million VND II.3 The impact of inflation in bank’s performance Inflation is important for banks because they deal in financial instruments,that is, instruments dominated in fixed VND amounts When a bank makes a loan, for example,it accepts a nominal financial instrument as debtor obligation to the bank When a bank borrows, it issues nominal financial instruments to creditors as evidence of its obligation Year 2018 2019 2020 Inflation rate 2.80% 3.54% 3.77% Loan Volume 1,025,237,943,000 941,574,705,000 869,161,114,000 (VND) 7.73% 7.71% 7.94% Lending Rate Table 2: The relationship between inflation, lending rate and lending volume According to the above table, there was the positive relationship between inflation rate and the base lending rate charged by the bank, as inflation levels rose, so did the bank’s base lending rate both from the key informant figures, showing that inflation has a significant effect on Vietinbank lending rate Moreover, it can be seen that inflation has a moderate effect on Vietinbank new lending volumes; however, an increase in base lending rate contributed most towards the reduction in the lending volumes The given table also revealed that a rise in inflation led to a high rate of loan defaulting activities in the bank Overall,it is indicated that a rise in the inflation figures contributes to an increase in the base lending rate Secondly, rise in inflation also affects the loan default rate, since the banks are forced to increase their interest charges, seriously affecting customer ability to service their loans, on the other hand rise in inflation may lead to an influx of less creditworthy borrowers who may easily default on their repayment obligations The banks should have policy on minimum base lending rate to be charged on loans and in order to maintain this, the bank would need to diversify to other sources of incomes streams such as aggressively undertaking non interest related activities e.g.collection of commission and fees, to cushion it during high inflation period when the uptake of loans dwindle since the organization has no control of macroeconomic factors affecting the inflation of the country Secondly the bank can encourage borrowers to take fixed interest loan repayment offers, rather than the flexible repayment models to reduce the rate at which loans are defaulted as a result of fluctuation of the repayments amounts III Scenarios analysis on the impact of income and capital and hedging proposal III.1 Recession scenarios After a decade of the Great financial crisis 2007-2008, covid-19 pandemic clearly gives fear to bank industry In the historical records, a sudden stop lending by bank might feed a warning signal of Downloaded by Uy vu Nguyen (tailieuso.11@gmail.com) lOMoARcPSD|38544120 recession in the economy Furthermore, as a domino effect, recession also damages to bank via credit losses, declines in the value of investment, reduction in a bank revenue Even worse, the situation can spiral downward as damage to banks cuts into credit availability, force bank to cut back further In this section, we are going to discuss about new capital and liquidity standards reduce recession related risk And scenarios of recession on the impact of profit and also capital in Viettin Bank I.1.1 New capital and liquidity standards According to BIS (Bank for International Settlements), banks are now required to have much more capital than before crisis Before crisis, Basel III stipulated a minimum of Tier 1 capital to RWA of 4% In the post-crisis under the latest version of the Basel standards, this ratio increases to 7% of which 4.5% absolute minimum plus 2.5% capital conservation buffer The benchmarks of Basel III capital of BIS are illustrated bellow BASEL III Ratios Capital ratios, percent Common equity All Tier 1 Capital Total Capital 8% Minimum 4.5% 6% 10.5% Conservation buffer 2.5% Minimum plus 7% 8.5% conservation buffer Countercyclical buffer 0-2.5% *Common equity or other fully loss-absorbing capital Source: BIS Table: BIS Basel III ratios The adoption of Basel standards in Viet Nam In the period 1999-2006, Basel I was implemented (SVB never informed officially the adoption explicitly, but incorporated some benchmark ratios into Vietnam banking regulation) From 2006- 2013, Basel I was applied fully to regulate banks in Vietnam However, the great financial crisis 2007- 2008 affected badly on banking system and that resulted in the changes of policies related to bank’s capital Since 2014 the economy and bank system of Vietnam are more integrated, Basel II was introduced and SVB, step by step, cleared a road map for Basel implementation The following table will summarize the shifts of Basel standards in Viet Nam Basel components Implementation Law regulated and date Informal adoption Basel I Decision 297 (25 August Informal adoption Simple rules on 1999) Basel II prudential ratios: Tier 1 at 8% Decision 457 (19 April Basel III CAR (Tier1 and Tier 2) 2005) at 8% Basel I as supervision Prime Minister’s Formal adoption standard Implement Basel II Decision 112 (24 May guidelines 2006) Decision 112/2006-PM: CAR separate and Circular 13/2010 (20 May 2010) consolidated at 9% Total liquidity reserves at 15% Requirement on stress- testing and scenario analysis CAR at 9% Circular 36/2014 (20 Informal adoption Downloaded by Uy vu Nguyen (tailieuso.11@gmail.com) lOMoARcPSD|38544120 Liquidity ratio (proxy) November 2014) LCR 30days: 50% for VND; 10% for other currencies NSFR:10% Source: SVB Table: Basel implementation in Viet Nam ViettinBank’s CAR and liquidity ratios From the period of 2018 to 2019, the bank’s CAR is greater than 9%, which means the bank has completely achieved SVB Basel II bench mark, however due to unexpected situation in the economy 2020, CAR only at 8.6% which is not satisfied Basel II requirement Capital Adequacy Ratio 2018 2019 2020 NPL/Gross loan 1.60% 1.20% 0.94 CAR >9% >9% 8.60% Source: consolidated annual report 2020 Table: CAR, consolidated report The issuance of VietinBank's capital raising bonds was an annual activity being carried out since 2015 until now in order to meet the SBV's regulations on operating limits and prudential ratios, as well as to improve CAR ratio as they claimed in annual report I.1.2 Optimistic case As the new standards was introduced and carried on, the bank will be safer The bank might will not need to cut back on lending since the high level of capital and liquidity will reassure their funders and customers and allow a gentle slowdown in credit provision Moreover, recession will not translate as quickly to problems in the bank because of bank’s greater safety margin This optimistic view is seasonable since new standards on requirement of the amount of capital was applied to prepare for the future recession Or in another way, policy makers intended the new rules to enhance financial stability, assure the financial system to continue to provide needed credit and other services to the economy I.1.3 Pessimistic case However, it is possible that when recession goes deeply, the banks will face the situation that customers will systematically default on loans Viettin bank, as their annual report, reached the requirement of regulatory minimum capital, however, the recession-related risks have become higher, not lower, increased requirement And, in this context, it more likely to happen the “domino” effect in this chaotic situation of financial distress leads to more costs incur and less profits since the economy stops its working mechanism In the liquidity side, many empirical researches proved the strong relationship between liquidity ratio and probability of bankruptcy in banking system Logically, in a liquidity crisis, liquidity problems at individual institutions leads an acute increase in demand and decrease in supply of liquidity, referred to a simultaneous lack of liquidity across many institutions a finally an entire financial system The following chart illustrates liquidity situation of ViettinBank over 3 years Downloaded by Uy vu Nguyen (tailieuso.11@gmail.com) lOMoARcPSD|38544120 Chart: Liquidity ratios According to the chart, the liquidity ratios are relatively consistent over the period, it proves that the bank is stable in term of liquidity To sum up, lately ViettinBank did not meet requirement of CAR due to many reasons, however liquidity is not really problematic in this bank In the following parts we will discuss more details on major risk exposures and how the bank hedge against risks I.2 Credit risk hedge III.2.1.Optimistic case In the optimistic case, the bank's NPL ratio will continue to decline from 0.94% in 2020 and always remain below 3% Because bad debt decreased, the rate of provision for bad debt at VietinBank continued to increase That means the bank has enough backup and is ready to handle it if needed III.2.2.Pessimistic case In case of pessimism, if the NPL ratio is too large (greater than 3%), the Bank may be put under special control by the State Bank and then the Bank's reputation will be reduced Those who have deposits at the Bank will massively withdraw their money and terminate the relationship This is serious intangible damage that cannot be valued When bad debts arise, the Bank also has to spend a lot of expenses on debt handling such as staff costs, travel expenses, meeting costs to handle debt,etc In addition, the bank also loses opportunity costs for new loans, slow credit turnover and so on All of which lead to reduced cost efficiency and reduced profitability of the Bank III.3.3.Hedging proposal Downloaded by Uy vu Nguyen (tailieuso.11@gmail.com) lOMoARcPSD|38544120 Provision is recognized as an expense in the consolidated income statement and is used to deal with bad debts According to Circular 02, the Bank establishes a Risks Settlement Committee to deal with bad debts if they are classified in group 5, or if the borrower is an organization that is dissolved, goes bankrupt, or is a dead or missing personnel Besides, credit derivatives in general are used to hedge credit risks They can be thought of as a series of methods for "grooming" a bank's loan portfolio Credit derivatives allow for more effective risk-return combinations without jeopardizing consumer relationships Credit derivatives are also versatile contracts that can be used to protect against other mutually agreed-upon incidents like the reference party's rating being downgraded or a credit spread moving adversely The most popular credit derivatives are credit swaps which are divided in two categories: pure-credit or default swap and total-return swap In a pure-credit or default swap, a bank pays a small fee to the swap counterparty on a regular basis If the bank's borrower defaults, which is the credit risk the bank is trying to avoid, the counterparty compensates the bank for its loss according to the contract's terms If the credit accident does not occur, the option expires, and the bank is responsible for the payment as a cost of credit insurance The total- return swap is a bit more complex, and it entails some market risk due to interest rate fluctuations The bank's cash inflow is normally indexed to its cost of funds Without a credit case, the bank joins a standard interest swap in which it pays fixed and earns floating The bank hedges its cost of funds if the index rate rises The bank's fixed payment is decreased by the depreciation of the loan's value whether the borrower's credit risk is negatively and positively correlated with increasing interest rates III.4 Interest rate risk hedge Interestrateistheprimarywellspringofbanks.Interestratehikesconnectdirectlytotheprofitability ofthebankingsector.Therelationshipispositive.Therefore,bankshavetopreparethestrategiesfor thevulnerabilityofinterestratefluctuations.Whatbankneedsistheincreaseinchaninginterestrate Because bank can profit off the spread between the two-side loaning activities of depositors and lendingcustomers.Thejumpininterestratedirectlyrunsintotheproceedsofearningsandcashyields However,thechangeininterestratecannotbeadjustedbyitsownbank.Itisaffectedmostlyby macroeconomicfactors.Themajoroneisbytheincreaseofoilpriceforoildrillers.[CITATION Mar19\l1066].Besides,whentheinterestrateincreases,morepeopleseekforloans,banksmake moreprofitfromthedifferenceoflendinglongrunandinvestingshortterm,whichreflectsthegrowth in economy IncaseofVietinbank,wesetupthescenariosincreaseordecreaseinterestratebyintherangefrom 1-2% toseeitseffectsonprofitsofthebank Scenarios of interest rate and their impact on profit The change in NII for any given bucket of ∆NIIi is measure as Downloaded by Uy vu Nguyen (tailieuso.11@gmail.com) lOMoARcPSD|38544120 ∆NIIi = $Gapi*∆r where: Gapi is the dollar size of the Gap between RSA and RSL for each bucket ∆r is the change in level of interest rate Maturity Over 3 3 months 1month from 1m to from 3m to from 1y to above 5ys Gap months 3m 12m 5y 2020 9,592,414 2,799,154 -92,365,421 18,795,183 -84,995,682 2,594,416 242,892,717 ∆NIIi from 1y to above 5ys 5y (2,428,927.2) ∆r Over 3 from 1m to from 3m to (25,944.2) (4,857,854.3) 3m 12m (51,888.3) 242,892,717.0 months 3 months 1month 2,594,416.0 2,428,927.2 25,944.2 4,857,854.3 -1% (95,924.1) (27,991.5) 923,654.2 (187,951.8) 849,956.8 51,888.3 -2% (191,848.3) (55,983.1) 1,847,308.4 (375,903.7) 1,699,913.6 0 9,592,414.0 2,799,154.0 (92,365,421.0) 18,795,183.0 (84,995,682.0) 1% 95,924.1 27,991.5 (923,654.2) 187,951.8 (849,956.8) 2% 191,848.3 55,983.1 (1,847,308.4) 375,903.7 (1,699,913.6) Table:scenariosofinterestrateimpactsonNII,basecase2020 Overall,mostlythedollargapsofthebankarepositive,exceptforthematuritiesof1monthandfrom 3monthsto1year,sointhatcasethebankwillbebetteroffifinterestincreasesandviceversa.Inthe long-run,Vietinbankexpectsanincreaseininterestratechangewhichresultsingrowthinthebank profits.However, in the reality, interest rate is still remain lower compare to the past time as the folowing chart It is clearly that ViettinBank’s profit is decreaseed Downloaded by Uy vu Nguyen (tailieuso.11@gmail.com)