Khóa luận tốt nghiệp Tài chính ngân hàng: Capital adequacy ratio (CAR) according to basel at joint stock commercial Bank for foreign trade of Vietnam (Vietcombank)

After the piloting process at commercial banks, in November 2018, Vietcombank was the first bank that the SBV officially recognized to successfully implement Basel II in accordance with

RATIONALE

Since the 1980s, the relaxation of financial regulations, advancements in banking technology, and increased global financial integration have heightened the complexity and risk in the banking sector This has led to a surge in financial risks, compelling both domestic and international entities to confront various challenges As a result, commercial banks worldwide, including those in Vietnam, have prioritized risk management in their operations The State Bank of Vietnam has incorporated Basel risk management standards into its roadmap, particularly emphasizing the importance of maintaining a minimum capital adequacy ratio (CAR) This ratio, which indicates the relationship between a bank's equity and its risk-adjusted assets, is essential for assessing the safety and stability of banking operations, as established by the Basel Committee's experts.

According to the strategy for the development of the Vietnamese banking sector, by

By 2020, commercial banks are expected to meet equity capital requirements in accordance with Basel II standards, with full implementation of the standard method by 2025 To ensure a standardized approach across the banking sector, the State Bank of Vietnam (SBV) issued Circular 41/2016/TT-NHNN, which outlines capital adequacy ratios for banks and foreign bank branches Additionally, in 2014, ten commercial banks were selected to pilot the regulations related to Basel II.

Vietcombank, a prominent player in the Finance and Banking sector, has successfully implemented Basel II standards, as recognized by the State Bank of Vietnam (SBV) on November 28, 2018, a year ahead of schedule This achievement is significant not only for Vietcombank but also for the broader Vietnamese banking system, marking a crucial milestone in the Accord's implementation roadmap As one of the top two banks meeting Circular 41's Capital Adequacy Ratio (CAR) requirements, a thorough analysis of Vietcombank's preparation process, organizational structure, and compliance methods is essential This article provides an overview of the current status of CAR calculation at Vietcombank, identifies existing challenges, and offers recommendations for improvement.

LITERATURE REVIEW

Following the 2008 global financial crisis, banking emerged as a sector facing numerous risks, particularly amid increasing market integration and international service expansion, leading to significant losses for commercial banks (Le Cong, 2017) To navigate the unpredictable financial landscape, banks must establish effective risk management systems The Basel II Accord has become a global benchmark for risk management practices, enabling banks to adhere to international standards and enhance the stability of the banking sector, thereby facilitating successful integration However, the implementation of Basel II varies across Asia and the ASEAN region.

II in Vietnamese commercial banks has faced many limitations

According to Hoang Van Cuong and partners (2018), international economic integration compels Vietnamese commercial banks to expand their capital scale to enhance competitiveness in the global financial market As global integration becomes a vital trend for economies worldwide, Vietnam actively engages in this process, particularly within the banking and financial services sectors While this integration offers significant development benefits for Vietnamese banks, it also presents challenges, notably increased market competition A key factor contributing to the inferior competitiveness of Vietnam's banking industry compared to its international counterparts is its relatively low capital size, which is crucial for a bank's operational capability.

Friedman and Schwartz (1963) identified the banking crisis as the primary cause of the financial crisis, prompting supervisory agencies to implement the Capital Adequacy Ratio (CAR) in line with Basel standards to safeguard depositors and maintain the stability of the banking system (Casu et al., 2015) The capital level has become a critical monitoring standard, essential for evaluating the system's stability and transparency, and serves as a buffer for banks against financial shocks, ultimately protecting both depositors and the banks themselves (Jeff, 1990; Hoggarth et al., 2002).

The capital adequacy ratio, as defined by Vo Hong Duc (2014), serves as a crucial safety indicator for banks, established by international regulations such as the Basel standards This ratio enables banks and investors to assess the risk levels associated with each financial institution, signaling potential risks to depositors and enhancing the overall stability and effectiveness of the commercial banking system By evaluating the capital adequacy ratio, investors can gauge a bank's capability to repay term debts and withstand financial shocks, ultimately safeguarding both the institution and its customers.

Bank capital is contributed by shareholders - investors in common and preferred stocks that a bank has issued (Rose and Hudgins, 2013) According to Casu et al

In 2015, bank capital is defined as the net asset value, which is the difference between total assets and total debt The Basel Treaty introduced two categories of capital: tier 1 and tier 2 According to this treaty, the availability of capital is linked to the assets and loans of a financial institution, influenced by the size and quality of its properties (Casu et al., 2015) Banks assess their risk levels through risk-weighted assets (RWA) (BIS, 1999) The capital level is determined using the capital adequacy ratio (CAR), a percentage set by regulatory authorities that reflects the bank's capital in relation to its risk exposure.

Economic integration is closely linked to global business activities, with Vietnamese commercial banks actively participating in this trend The State Bank of Vietnam (SBV) has incorporated Basel's risk management standards into its roadmap, particularly through the "Restructuring the System of Credit Institutions for 2011-2015" initiative A key focus is on ensuring the minimum capital adequacy ratio (CAR), which is now being implemented by these banks Following regulatory changes, the SBV officially released Circular 41/2016/TT-NHNN on December 30, 2016, addressing the capital adequacy ratio for banks and foreign bank branches Tran Thuy Ngoc, Deputy Director of Deloitte Vietnam, noted that this Circular reflects a commitment to enhancing the Vietnamese banking industry's operations in a safe and effective manner, aligning with the Basel Committee's capital standards (Basel II and its updates) adopted globally.

However, until now, the results have not been really positive and there is no uniformity in implementation status between banks (Nguyen Thi Hoai Phuong & Le Van Chi, 2017)

In November 2018, Vietcombank became the first bank officially recognized by the State Bank of Vietnam (SBV) for successfully implementing Basel II in line with Circular 41 on capital adequacy ratios This achievement marks a significant milestone in a landscape where many banks continue to face challenges in compliance This paper analyzes the current situation in Vietnam regarding the implementation of capital adequacy ratios as stipulated in Circular 41, highlighting existing issues and proposing viable solutions.

RESEARCH OBJECTIVES

The research concentrates on clarifying certain issues of the Basel II implementation process related to the Capital Adequacy Ratio according to Circular 41 at Vietcombank, including:

- Clarify current status of capital adequacy ratio at Joint Stock Commercial Bank for Foreign Trade of Vietnam (Vietcombank) before, as-in and after Circular 41 implementation;

- Analyze the real process of preparing for CAR calculation at Vietcombank, compared to Circular 41;

- Indicate difficulties for the Bank while implementing capital regulations;

- Propose solutions for the facilitation of Basel II implementing for Vietcombank and preparation for meeting the Basel II standards using the advanced methodology.

RESEARCH SUBJECT

This thesis concentrates on the analysis of the CAR calculation process of Vietcombank in comparison to Circular 41/2016/TT-NHNN.

RESEARCH SCOPE

The scope of this thesis has been limited in terms of:

The CAR analysis was performed at Vietcombank, one of the ten commercial banks chosen to pilot the Basel II regulation Notably, Vietcombank was the first bank to be acknowledged by the State Bank of Vietnam (SBV) for its successful adherence to Basel II standards, serving as an exemplary case for this thesis analysis.

- Time frame: Research content was collected in the duration of over ten years from

2005 to 2018, the period before and as-in Circular 41 implementation of xiv

Vietcombank, this provides a thorough overview on the implementation process and status of the Bank.

DATA AND METHODOLOGY

Data methodology

The author employed a qualitative research method to effectively explore the implementation status of CAR according to Circular 41 at Vietcombank Given the novelty of the topic and the ongoing debates surrounding it, this approach facilitated a comprehensive summary, comparison, and evaluation of the findings Data was sourced from reliable secondary sources and subsequently analyzed, with expert consultations ensuring the validation of the information Detailed methodologies for data collection and analysis are outlined in the subsequent sections, and the research background was carefully chosen to align with the topic.

Research instruments

The study employs qualitative analysis to summarize insights from various researchers, drawing on reliable sources to ensure the validity and reliability of the information presented Additionally, the findings reflect the author's perspectives gained from a four-month internship at Vietcombank, enhancing the uniqueness of the thesis.

Data setting

Following the successful implementation of Basel II in Vietnam, research data indicated that only three commercial banks met the Capital Adequacy Requirement outlined in Circular 41 During this period, information sources remained internal and were not publicly disclosed.

Data collection

The researcher employed a qualitative approach for the thesis, utilizing both secondary data collection and primary data gathered through direct observations at the Vietcombank head office and its branches.

Secondary data, collected and organized chronologically from credible sources, offers an updated and objective overview of the Basel II implementation at Vietcombank The sources utilized for this analysis are reliable and comprehensive, ensuring a thorough understanding of the subject.

- The enacted Circular on the Capital Adequacy Requirement, according to Basel II of the SBV;

- Internal documents of the Bank;

- Professional publications of previous researchers: gathered from the Banking Academy’s library along with reliable online website;

- Annual Financial Reports of Vietcombank Board of Directors, Board of Managers: collected from the official website of the Bank;

- Public Reports: collected from websites of official institutions, namely the SBV, National Economic University, Banking Academy, etc.;

- Journal Articles: collected from online newspaper and websites, including website of SBV, National Economic University, Banking Academy, etc.;

- Other Articles: summarized from online newspaper and websites such as VnExpress, VnEconomy, Dantri, etc

In addition to the processed data, the study incorporated self-collected information through the researcher’s direct observations at Vietcombank’s Head Office and branches During an internship lasting over four months on a Basel II-related project, the researcher gained valuable insights and perspectives from project managers and execution teams This gathered information primarily concerns the implementation progress of a Basel II model and highlights existing data challenges encountered throughout the project.

Data analysis

Data analysis is conducted in consistent subsequence

To ensure a reliable data source, the author has consulted a variety of information channels, including previous theses from seniors, master's, and Ph.D candidates at esteemed institutions Additionally, data was sourced from official statistics and reputable journals, including those from the State Bank of Vietnam (SBV) and the Basel Committee on Banking Supervision (BCBS), as well as articles from respected local online newspapers like VnExpress, CafeF, and Vietnam Financial Times Information regarding Vietcombank's operational performance and Capital Adequacy Ratio (CAR) implementation has been meticulously gathered and verified through its annual reports and internal documents Consequently, the thesis is supported by diverse and credible sources, making its content trustworthy and reflective of the current status of Vietcombank.

The author systematically organizes and compares information, presenting data chronologically from a broad overview of performance to specific details related to each topic The analysis focuses on contrasting Vietcombank with the overall banking system to highlight discrepancies between anticipated outcomes and actual results In concluding the research, the author references prior studies and consults with Vietcombank officials to substantiate the findings presented in the thesis.

The thesis is primarily based on secondary information, with sources detailed above, complemented by primary data collected during a four-month internship at Vietcombank The researcher obtained permission to access internal data and validated the information through consultations with senior staff regarding its public relevance and appropriateness Ultimately, the author summarized the data, incorporating both expert insights and personal perspectives.

RESEARCH CONTRIBUTION

- Generalize the theoretical basis and development process of Basel II;

- Provide an overview on the process of preparation and construction meeting Basel

II requirements in accordance with Circular 41 on policies, organizational structures, and method of calculating CAR at Vietcombank;

- Indicate difficulties that the Bank encountered in the process of CAR implementation according to Circular 41;

- Provide solutions to fully implement regulations under Circular 41 on CAR capital adequacy ratio.

RESEARCH STRUCTURE

The thesis was constructed based on the following structure:

Chapter 1: Overview of CAR according to Basel Accord

This chapter offers a comprehensive overview of the constructive theories associated with the analysis of Vietcombank's capital adequacy ratio (CAR) It discusses the regulatory framework governing CAR and provides essential insights into its calculation methods used in practice.

Chapter 2: CAR according to Basel at Vietcombank

This section analyzes Vietcombank's compliance with CAR requirements as outlined in Circular 41, highlighting the bank's capital adequacy in comparison to its peers before, during, and after the validation of the circular The preparation process for meeting CAR standards is succinctly illustrated, and the chapter concludes by identifying challenges faced by Vietcombank in adapting to the CAR requirements and fulfilling the mandates of Circular 41.

Chapter 3: Recommendations for improvement of CAR

In this chapter, the researcher indicates certain solutions for above issues and make suggestions to enhancing the quality of Basel II compliance at Vietcombank

This chapter bring the comprehensive conclusion of all the main points of the thesis.

LIMITATIONS OF RESEARCH

The author acknowledges that limitations in research duration and language differences may lead to insufficient clarity in the findings Consequently, feedback from instructors and readers is valued for enhancing the quality of the work.

OVERVIEW OF CAR ACCORDING TO BASEL ACCORD

BACKGROUND OF BASEL

In the early 1980s, the Latin American debt crisis heightened the Basel Committee's concerns regarding the declining capital ratios of major international banks amid increasing global risks To prevent a potential collapse of banks that could negatively impact global finance, the Committee, with support from G10 Governors, established the Basel Capital Accord (Basel I) in July 1988 This framework aimed to standardize capital adequacy requirements for internationally-active banks and improve risk management practices There was a strong consensus among Committee members on the necessity of a multinational agreement to bolster the stability of the international banking system and address competitive imbalances caused by varying national capital requirements.

Despite its original intention for internationally active banks in G10 countries, Basel

The I Accord has been recognized as a global standard, with over 140 countries adopting it, thereby enhancing relationships between supervisors in both home and host nations (BIS, 2018) Yeh and colleagues (2005) highlight that Basel I introduced two fundamental concepts.

The Accord focused on defining the types of capital that banks could hold, categorizing it into tier 1 and tier 2 based on their ability to absorb losses.

Under Basel I regulations, Tier 1 capital, which consists of common stock and retained earnings, is prioritized for its capacity to absorb unexpected losses without significantly disrupting trading activities In contrast, Tier 2 capital serves a dual purpose: it not only possesses loss-absorbing characteristics but also acts as a safeguard for depositors in the event of a bank failure, as it is the final layer of debt addressed during a bank's insolvency.

Basel I introduced the crucial concept of linking bank-held capital to the risks associated with the assets on a bank's balance sheet It established minimum capital requirements as a percentage of risk-adjusted assets by assigning risk weights to different asset types; riskier assets like corporate loans received higher weights, while safer assets such as government exposures received lower weights Banks then calculated their total risk-weighted assets by summing these adjusted figures To ensure financial stability, Basel I mandated that banks maintain a minimum total regulatory capital of at least 8 percent of their total risk-weighted assets, with core capital (Tier 1) comprising at least 4 percent of this total.

In 1996, significant amendments to the banking framework were introduced, addressing credit risk and expanding to include market risk in 1997 This change implemented an additional capital charge to cover risks associated with foreign exchange, traded debt securities, equities, commodities, and options Notably, for the first time, banks were permitted to utilize internal value-at-risk models to measure their market risk capital requirements, contingent upon meeting stringent quantitative and qualitative standards.

Basel I played a crucial role in stabilizing the declining solvency ratios of banks and fostering fair competition regarding capital requirements Nevertheless, the Accord preserved the fundamental approach to measuring credit risk capital.

Despite the evolving definitions of assets and capital due to financial innovation, the advancement of financial market architecture and instruments has prompted international banks and financial institutions to adopt increasingly complex risk management and calculation methods, widening the gap between regulatory frameworks like Basel.

I simple risk pattern and the real practice of some banks c Drawbacks of Basel I

Exposing to the continuous progress of the global financial system, the Basel I suffered from several problems that become increasingly apparent over time:

The lack of adequate differentiation in risk assessment for individual loans leads to a uniform capital charge across all corporate exposures, regardless of the borrower's credit rating This approach fails to consider essential factors such as the counterparty's financial strength, legal validation, and business longevity, as well as loan characteristics like pledged collateral, covenants, and maturity Consequently, banks with identical capital adequacy ratios (CAR) may be exposed to vastly different levels of risk, undermining the effectiveness of risk management practices.

The decline of the Accord can be attributed to the lack of recognition of diversification benefits While standard portfolio theory acknowledges that diversification can mitigate risk, Basel I failed to differentiate capital treatment between well-diversified credit portfolios, which are less risky, and concentrated portfolios, which carry higher risk.

Improper management of sovereign exposures ranks third among the challenges faced, as existing regulations fail to account for realistic economic effects This mechanical implementation has led to adverse stimuli and misjudgment of risks In their 2005 paper, "Credit Risk Measurement under Basel I: An Overview and Implementation Issues for Developing Countries," Stephanou and Mendoza illustrate this issue, highlighting that banks find it appealing to extend credit to OECD governments due to the absence of regulatory constraints.

Despite the inclusion of diverse credit-rated countries such as Turkey, Mexico, and South Korea, a capital charge was incurred The recognition of claims to the central national government as zero risk weight led many banks, particularly in developing nations, to disregard fundamental diversification principles Consequently, they allocated a significant portion of credit to their sovereigns, either directly or through state-owned enterprises, which ultimately resulted in a decline in financial intermediation.

Over time, limited incentives for enhancing overall risk measurement and management have emerged, but progress in banks' risk governance has been hindered by insufficient focus on various risk categories, such as operational and interest rate risks, as well as financial infrastructure issues like the accounting legal framework This has led to an over-reliance on a high capital adequacy ratio, which, as experience shows, is inadequate without complementary measures Additionally, the practical irrelevance of Basel I has been highlighted by Chu Thi Huong Giang.

In 2009, it was shown that the Basel Accord was not applicable to scenarios involving banking mergers, banking groups, parent banks, and bank branches The researcher noted a trend where banks were increasingly merging to improve their competitive edge in finance, technology, and global expansion As certain regulations under Basel I remained outdated and unsuitable for modern banking operations, there arose a pressing need for new, comprehensive regulations in risk governance and bank supervision.

The development of various financial products, such as 364-day revolvers and 'balance sheet' securitizations, primarily aimed at navigating regulatory capital arbitrage, highlighted the shortcomings of Basel I and the limited relevance of regulatory capital ratios as indicators of actual capital adequacy Additionally, the advancement in risk measurement and management enabled banks to create sophisticated internal economic capital models that operate alongside traditional capital measures, diminishing the importance of regulatory capital assessments.

CAR ACCORDING TO BASEL

Basel I provides a framework for measuring credit risk with minimum capital adequacy standard of 8% It was not only popular and compulsory to be applied in G10 member countries but also voluntarily joined by other countries in the world

According to Nguyen Van Hieu (2010), Basel I mandates that banks maintain a minimum capital ratio of 8% based on their risk-weighted assets (RWA) An ideal capital adequacy ratio (CAR) is considered to be above 10%, while a CAR above 8% indicates sufficient capital Conversely, a CAR below 8% signifies inadequate capital, with a CAR under 6% reflecting a serious capital deficiency and a CAR below 2% indicating a critical lack of capital.

Another achievement of Basel 1 is the international definition of bank capital Accordingly, banks' capital is divided into 3 categories:

Tier 1 capital refers to the core capital that a financial institution has available, which includes permanent equity such as charter capital or common share capital, announced reserve capital from retained earnings, minority interests in subsidiaries reflected in consolidated financial statements, and business advantages like goodwill.

Tier 2 capital serves as a supplementary financial resource characterized by lower reliability, which includes surplus capital arising from asset revaluation, general loss provisions, and additional capital sourced from hybrid debt instruments such as convertible bonds, preferred shares, and secondary debt instruments It also encompasses financial investments in subsidiaries and other financial institutions.

- Tier 3 capital: are short-term loans

The effectiveness of utilizing capital sources to manage risk decreases from tier 1 to tier 3 capital, with tier 3 being the least reliable for risk response Consequently, the Basel I Accord establishes the standard for these capital tiers.

Tier 1 capital ≥ Tier 2 capital + Tier 3 capital

Because tier 3 capital is the least trustworthy capital so when determining capital adequacy ratio (CAR), it normally considers only tier 1 and tier 2 capital

Basel I categorizes asset risk into four levels: 0%, 20%, 50%, and 100%, corresponding to government, bank, and business loans This framework simplifies risk assessment, as the risk ratio remains unaffected by loan size or borrower creditworthiness However, Basel I primarily emphasizes a single risk management approach—minimum capital requirements—while neglecting other crucial measures, particularly operational risks.

In the fourth quarter of 2003, the Basel II treaty was finalized, succeeding the original Basel I framework, and became effective in January 2007, with a transition period concluding in 2010 Basel II not only retained the objectives of Basel I but also emphasized the importance of stringent risk management practices, particularly in the areas of monitoring, controlling, and disclosing internal information and figures.

1.2.2 CAR according to Basel II

Pillar I mentions the maintenance of amount of legal capital calculated for three risk factors faced by the bank: market risk, credit risk and operational risk As the same in Basel I, the capital adequacy ratio (CAR) still remains ≥ 8%, which is calculated by dividing the overall capital by the risk-weighted assets as the equation follwing:

Equation 1-1 Capital adequacy requirement under Basel II

Bank ′ s capital ratio = Total Capital

Credit RWA + Market RWA + Operational RWA≥ 8.00%

Total Capital is determined same in Basel I, which is divided into 3 types including capital tier 1, tier 2 and tier 3:

Tier 1 capital represents a bank's core equity and includes common stock, retained earnings, capital surplus, accumulated other comprehensive income, noncumulative perpetual preferred stock, and general provisions for reserves This capital is essential for financial stability and is publicly announced as part of the bank's chartered capital and reserve fund Additionally, it encompasses trust facilities that can be converted and are intended to cover potential credit losses.

Tier 2 capital serves as the secondary component of bank capital, complementing tier 1 capital to fulfill required reserves Recognized as supplementary capital, tier 2 includes elements like revaluation reserves, undisclosed reserves, hybrid instruments, and subordinated term debt While essential for a bank's financial stability, tier 2 capital is regarded as less secure compared to tier 1 capital in the calculation of reserve requirements.

Total tier 2 capital must not exceed 100% of tier 1 capital, with subordinated debt capped at 50% of tier 1 capital General reserves are limited to a maximum of 1.25% of risk-weighted assets (RWA), while revaluation reserves are discounted by 55% Additionally, subordinated debt must have a remaining maturity of at least five years, and banks' capital calculations should exclude intangible assets such as goodwill.

- Capital tier 3 for other short-term loans

Risk-weighted assets (RWA) are a critical component of capital adequacy assessments under Basel II, which expands on Basel I by incorporating operational risk alongside credit and market risks The RWA calculation in Basel II is more intricate and dependable, allowing for a more accurate evaluation of capital requirements Additionally, Basel II enhances the assessment process by integrating credit ratings into the RWA evaluation, ensuring a tailored capital requirement for each specific risk type.

For credit risk assessment, there are different methods for evaluation:

The Standardized Approach enhances the Basel I framework by increasing the risk sensitivity of regulatory capital requirements It adjusts the value of a bank's on- and off-balance sheet assets using risk weights based on the riskiness of the underlying assets Unlike Basel I, which treated all corporate loans uniformly, Basel II incorporates credit ratings from eligible agencies like Fitch and Standard & Poor's, allowing for a more nuanced categorization of risk within and across asset classes This results in higher-rated loans having lower capital requirements compared to lower-rated ones Additionally, Basel II categorizes debts into five risk weight groups: 0%, 20%, 50%, 100%, and 150%.

Internal-ratings based (IRB) approaches

Basel II allows banks to utilize their internal credit rating assessments, categorized into foundation and advanced levels, to evaluate customer debt, default probabilities, effective maturity, and credit loss proportions, which are essential for calculating credit risk-related assets To implement this internal method, banks must obtain approval from their banking supervisory agency This approach enables a more precise determination of the minimum required capital for credit risk, differentiating capital requirements based on the specific loans provided to various customers.

- EAD (Exposure at Default): refer to the maximum amount of loss in the event of a default

The K ratio represents the essential capital needed to mitigate unforeseen credit risks, calculated using three key components: PD (probability of default), which indicates the likelihood of a borrower failing to meet their obligations; LGD (loss given default), which reflects the expected loss percentage the bank will incur if a default occurs; and M (effective maturity), which signifies the remaining duration of the obligation.

- RWA – Risk-Weighted Assets: specifically determined for each type of loan, RWA is different for small and medium enterprises with loans for large businesses b Operational Risk

OVERVIEW ON CIRCULAR 41 OF SBV

To enhance the competitiveness of the Vietnamese banking industry, it is essential for the commercial banking system to broaden its capital sources This expansion will ensure compliance with Basel II international standards for capital safety, while also reinforcing the overall stability of Vietnam's banking system.

The State Bank of Vietnam (SBV) has developed a roadmap for implementing Basel II across all credit institutions, structured in two phases The first phase, spanning from 2011 to 2015, aimed to eliminate ineffective banking units and organizations through various measures, including mergers, consolidations, and the resolution of non-performing debts This initiative significantly enhanced the overall financial health of the economic system and improved the operational capacity of banks (Ha Minh, 2017).

To expedite the adoption of Basel II, the Vietnamese Government and the State Bank introduced numerous supporting decrees, circulars, and action programs from 2016 to 2020 These initiatives aim to improve the quality of risk management in the banking sector, aligning it with international standards and practices.

To standardize the process, in December 2016, Circular 41 is officially issued by the SBV, taking Vietnamese banking system a significant step closer to the international

25 standards Ten “pilot banks” 1 are appointed to implement the capital adequacy ratio calculation regulated in Circular 41 before 2019 while the deadline for other remaining banks is 2020

In an interview with correspondent Nguyen Nam Phuong, Tran Thuy Ngoc highlighted key differences between the new Circular 41 and the previous Circular 36/2014/TT-NHNN regarding the capital adequacy ratio (CAR) calculations Unlike Circular 36, which did not consider collateral value in determining required capital, Circular 41 introduces four measures that allow banks to mitigate credit risk by reducing the value of receivables These measures include the recognition of eligible assets such as cash, gold, and valuable papers, enhancing the framework for calculating capital adequacy.

Offsetting the balance sheet, utilizing third-party guarantees, and employing credit derivative products can significantly lower required capital This approach offers a more accurate assessment of risk-weighted assets, as claims backed by valid collateral are inherently less risky, leading to a reduction in the necessary capital requirements.

In addition to assessing the capital needed for credit risk, banks must now also calculate the required capital for market risk and operational risk, which were not previously regulated As a result, the overall capital requirements for banks are set to increase.

According to Circular 36, the credit risk coefficient ranges from 0-150%, whereas Circular 41 expands this range to 0-250%, introducing a more nuanced approach that reflects the varying risk levels associated with each loan and borrower This change means that banks will see an increase in risk-weighted assets for credit risk, necessitating a more complex and precise determination of risk factors for individual loans.

Circular 41 covers most elements in the two out of three pillars of Basel II, namely Capital Adequacy Ratio (CAR) and Disclosure of Information The major part of the

1 including BIDV, VietinBank, Vietcombank, Techcombank, ACB, VPBank, MB, Maritime Bank, Sacombank and VIB

Circular 26 provides banks with comprehensive guidelines for calculating the Capital Adequacy Ratio (CAR), incorporating credit, operational, and market risks The CAR is determined by using equity capital as the numerator and combining risk-weighted assets (RWA), capital requirements for operational risk, and capital requirements for market risk as the denominator Additionally, Circular 41 promotes the development of low-risk business strategies and encourages banks to prioritize loans that qualify for credit risk mitigation techniques.

Circular 41 effectively aligns with Basel II standards as outlined in the Basel Committee's report on capital measurement and standards, published by the Bank for International Settlements (BIS) Both frameworks require a minimum Capital Adequacy Ratio (CAR) of 8%, with risk-weighted assets calculated by multiplying capital requirements for market and operational risks by 12.5 and adding these to credit risk assets While Circular 41 shares many similarities with BIS guidelines, it also presents notable differences, such as a 75% risk weight for retail portfolios, albeit with varying criteria for what constitutes retail exposures Additionally, while risk weights for sovereign and central bank exposures are similar based on credit ratings, Circular 41 applies a 0% risk weight for claims on Vietnam's sovereign and central bank, contrasting with foreign entities For residential real estate, Circular 41 adopts the Basel Committee's approach of assigning risk weights based on loan-to-value and debt servicing coverage ratios for home mortgage loans, reflecting the borrower's ability to repay.

The Basel Committee proposed that risk weight differentiations for exposures should be based on the loan-to-value (LTV) ratio and the reliance on cash flows generated solely by the property Circular 41 applies this treatment to real estate-secured exposures formed before the properties exist Both Circular 41 and the Basel Accord accept four credit mitigation techniques: collateral, on-balance sheet netting, guarantees, and credit derivatives, with similar requirements for calculating collateral haircuts, maturity mismatches, and currency mismatches While the Basel Accord offers more detailed classifications and complex calculations, Circular 41 represents the State Bank of Vietnam's effort to align its banking supervision frameworks with Basel II standards through standardized approaches.

CAR ACCORDING TO BASEL AT VIETCOMBANK

OVERVIEW ABOUT VIETCOMBANK

Vietcombank, officially known as the Joint Stock Commercial Bank for Foreign Trade of Vietnam, was established on April 1, 1963 It originated from the Foreign Exchange Bureau, which operated under the State Bank of Vietnam, marking its significance in the country's banking history.

On June 2, 2008, the Joint Stock Commercial Bank for Foreign Trade of Vietnam commenced operations as the first state-owned commercial bank selected by the Government for pilot privatization, following a successful Initial Public Offering (IPO).

On June 30 th of 2009, Vietcombank shares were officially listed on Ho Chi Minh City Stock Exchange (HOSE) with the stock code of Vietcombank

Head office: 198 Tran Quang Khai Street, Hoan Kiem District, Hanoi

For over 50 years, Vietcombank has played a crucial role in enhancing the stability and growth of the national economy As a leading foreign trade bank, it has significantly contributed to efficient domestic economic development while also impacting the regional and global financial landscape.

Vietcombank, initially established as a specialized bank for foreign trade, has evolved into a multifunctional financial institution offering a comprehensive array of services These include leading financial solutions in international trade, traditional banking services such as capital trading, mobilization, credit, and project financing, as well as modern offerings like forex trading, derivatives, card services, and e-banking Furthermore, Vietcombank leverages advanced technology to enhance its automatic banking system and develop innovative e-banking services.

The high-tech foundation of 29 includes key products such as Digital Lab, Internet Banking, VCB Money, SMS Banking, and Phone Banking These innovations have drawn a significant customer base due to their convenience, speed, safety, and efficiency, fostering a widespread habit of non-cash payments.

Vietcombank, one of Vietnam's largest commercial banks, has been a key player in the market for over 50 years, employing more than 15,000 staff and operating over 500 branches, transaction offices, and representative offices both domestically and internationally Its extensive network includes the Head Office in Hanoi, 101 branches, and over 395 transaction offices across Vietnam, along with three subsidiaries and representative offices in Singapore and Ho Chi Minh City Additionally, Vietcombank boasts an advanced autobank system with over 2,300 ATMs and more than 43,000 merchants nationwide, supported by a global network of over 1,726 correspondent banks in 158 countries As of the fourth quarter of 2017, Vietcombank's charter capital reached VND 35,977 billion, with total assets amounting to VND 1,035,293 billion, reflecting its significant financial strength and stability.

Vietcombank has demonstrated remarkable growth and commitment, earning numerous accolades, including being named the Best Bank in Vietnam by esteemed global organizations In July 2013, The Banker recognized Vietcombank as the top bank in the country, ranking it 445th among the world's leading 1,000 banks Furthermore, in 2016, Vietcombank was distinguished as the only Vietnamese bank featured in Nikkei's "Top 300 Most Dynamic Companies in Asia," highlighting its significant scale and robust growth among 300 companies from 11 countries.

CAPITAL ADEQUACY RATIO (CAR) AT VIETCOMBANK

In April 2005, Decision 297/1999/QĐ-NHNN established a minimum capital adequacy requirement of 8% However, this decision simplified the identification of owner's equity and risk-weighted assets, leading to inconsistencies with the capital requirements set by Basel I The following table presents data on equity capital and the Capital Adequacy Ratio (CAR) of three major commercial banks during this period.

Table 2-1 Equity and CAR ratio of State-owned commercial banks on 31 st December 2005

Despite having a substantial equity amount, Vietcombank's capital adequacy ratio (CAR) fell below the standard 8%, similar to other state-owned commercial banks like BIDV, Vietinbank, and Agribank This issue is largely attributed to a high rate of bad debt and cross-ownership within the banking system, which has complicated relationships between banks and businesses, undermining regulations designed for safe operations Additionally, while mobilizing interest rates have risen, the pace of capital mobilization remains sluggish, adversely affecting liquidity and increasing capital costs, which further depresses the CAR Nevertheless, Vietcombank's CAR of 4.1% is still favorable compared to the average for state-owned commercial banks.

In summary, despite Vietcombank enjoying a relatively high Capital Adequacy Ratio (CAR) compared to the rest of the banking sector, it still fell short of the 8% minimum requirement set by Decision 297 and the Basel I standards.

During this period, the Capital Adequacy Ratio (CAR) calculation adhered to Decision 457/2005/QĐ-NHNN, maintaining a minimum of 8% This decision addressed the shortcomings of the earlier Decision 297, which led to confusion regarding owner equity in relation to Basel I Issued in April 2005, Decision 457 aligns closely with the capital standards established in Basel I.

Figure 2-2.The fluctuation of CAR ratio of three big commercial banks

During the period of 2006-2007, the equity capital of commercial banks experienced significant growth, driven by favorable business conditions and a booming securities market Notably, Vietcombank emerged as a leader in this sector, consistently maintaining the highest Capital Adequacy Ratio (CAR) compared to its competitors.

The fluctuation of CAR ratio of three large commercial banks (%)

During the research period, Vietcombank consistently maintained a Capital Adequacy Ratio (CAR) above the State Bank of Vietnam's required minimum of 8% as per Decision 457 and Basel I standards, while both Agribank and BIDV reported CARs that fell below the acceptable threshold.

In 2008, Vietcombank successfully raised its charter capital to VND 12,100 billion by transitioning to a Joint Stock Commercial Bank, executing an IPO, and offering shares at preferential prices to employees This strategic move significantly boosted Vietcombank's owner equity, ensuring that its Capital Adequacy Ratio (CAR) consistently met the required standard of 8%, in accordance with current regulations and the Basel I Accord.

At the conclusion of this stage, the effects of the demand stimulus policy and the State Bank's monetary easing measures implemented during 2008 became evident.

In 2009, a significant rise in credit deals resulted in an increase in total risk assets, causing commercial banks to experience a decline in their capital adequacy ratios Notably, Vietcombank's capital adequacy ratio fell below the safe minimum level of 8%, dropping to 7.64%.

CAR at Vietcombank, in the period of 2005 - 2009 unstably changed Especially after the crisis of the year 2008, due to difficulties of the whole financial system, the CAR of Vietcombank decreased

In conclusion, Vietcombank's Capital Adequacy Ratio (CAR) initially met the regulatory requirement of 8% but later fell below this threshold, failing to comply with the standards While there were periods when the CAR was equal to or exceeded 8%, the true effectiveness of the CAR in mitigating the bank's risks was not accurately assessed in accordance with Basel I guidelines.

2.2.3 The duration from 2010 up to now

During this time, the minimum capital requirement was established due to concerns that certain banks might not maintain sufficient capital to ensure their operational safety.

Table 2-2 CAR at Vietcombank from 2011 to 2018

Source: Author self’s collection a The duration from 2010 to 2014

From 2010 to 2014, during the implementation of Circular 13/2010/TT-NHNN, the minimum capital requirement was set at 9% Vietcombank consistently demonstrated impressive Capital Adequacy Ratio (CAR) figures that met this requirement, thanks to improvements in credit quality and positive debt recovery The bank effectively controlled credit quality, which allowed for a reduction in credit risk-weighted assets, thereby enhancing its CAR to comply with State Bank regulations These factors contributed to maintaining an adequate CAR in alignment with the prevailing Circular.

According to Hoang Huy Ha and colleagues (2012), compared to Basel II, Circular

Circular 13/2010/TT-NHNN imposes stricter regulations on risk weights compared to Basel II, which categorizes risk assets into five groups with a maximum risk weight of 150% While Circular 13 addresses adjusted assets related to credit risk, it lacks provisions for minimum capital requirements concerning market and operational risks Additionally, as noted by Do Thien Anh Tuan (2013), although Circular 13 outlines regulations for capital tiers 1 and 2, it does not specify the ratios applicable to each type.

35 capital compared to asset (for example Basel II assigns capital tier 1 ratios minimum of 4%) Consequently, Circular 13 generally still employed the approach of Basel I

In summary, while Vietcombank demonstrated favorable cumulative abnormal returns (CARs) from 2014 to 2018, its capacity to adequately address potential losses from various risk factors remains inadequately assessed.

Undergoing some changes in regulatory policies, in the next duration beginning from

From 2015 to 2018, Vietcombank adhered to Circular 36/2014/TTNHNN, which established safety ratios for credit institutions While this Circular addressed certain weaknesses found in Circular 13, it largely maintained the foundational regulations, including a Capital Adequacy Ratio (CAR) set at 9% Notably, it did not amend owner equity capital or risk-weighted assets, as the total risk-weighted assets primarily focused on credit risk, omitting market and operational risks Additionally, the calculation of owner’s equity included general provisions for capital tier 2, and there were revisions in the categorization of risk-weighted assets and their corresponding risk weights.

REQUIREMENT FOR VIETCOMBANK TO IMPLEMENT CAR REGULATION

In order to implement Circular 41, Vietcombank must satisfy those conditions:

2.3.1 Organizational structure and internal audit regarding capital adequacy ratio management

Vietcombank must establish an organizational structure and a system for decentralization and authority delegation, assigning specific functions and responsibilities to individuals and divisions This is essential for managing the capital adequacy ratio in accordance with regulatory requirements outlined in the Circular, while also aligning with the bank's operational risks, trading cycles, and risk management strategies.

- Vietcombank must perform internal audits on the CAR in accordance with regulations of the State Bank on the internal control systems of the Bank

2.3.2 Database and information technology system

- Vietcombank must maintain an adequate data and information technology system as appropriate to calculate the capital adequacy ratio as prescribed by the Circular

- Vietcombank must collect and manage data to ensure conformity to the minimum requirements as mentioned hereunder:

+ Have their organization structure, functions and duties of individuals and divisions, working processes and tools for data management to fulfill data quality and sufficiency requirements;

To ensure compliance with capital adequacy ratio requirements, it is essential to implement robust processes for collecting and comparing both internal and external data This includes effective storage, easy access, regular supplementation, secure provision, reliable backup, and systematic deletion of data.

+ Meet requirements set out in the internal rules of Vietcombank, and regulations of the State Bank on the reporting and statistical regime

- The information technology system of Vietcombank must ensure conformance to the following minimum requirements:

+ Promote connection and centralized management in the entire system, ensure information security, safety and effectiveness upon calculation of the capital adequacy ratio as prescribed by the Circular;

To ensure precise and timely calculations of equity and total assets, it is essential to prepare tools that enhance connections with other systems These tools will facilitate the assessment of credit risks, regulatory capital for specific risks, and the overall capital adequacy ratio.

+ Have the processes of reviewing, examining, providing for and responding to any failures or breakdowns, and periodic and regular maintenance processes;

+ Meet requirements set out in the internal rules of Vietcombank, and regulations of the State Bank on the reporting and statistical regime

- On biannual basis in a given financial year, Vietcombank shall disclose information on the status of capital adequacy ratio implementation;

- Vietcombank must develop information disclosure procedures ensuring:

+ Suitable form of disclosure and location of disclosure of information about the capital adequacy ratio is specifically stipulated to guarantee transparency, public access and convenience for approaching;

+ Disclosed information (especially quantitative information) must correspond to figures shown in the financial statement released at the same date;

+ There are processes and methods for collecting information (qualitative and quantitative contents) about the capital adequacy ratio;

+ There are policies and procedures for examining accuracy, adequacy and update of disclosed information;

+ Responsibilities, authority and cooperation in concerned departments and individuals must be fully prescribed;

+ Information disclosure procedures must be made known to individuals and departments concerned, and must be reviews and revised on annual basis.

PREPARATION FOR CAR ACCORDING TO CIRCULAR 41

In order to implement the CAR calculation program according to Circular 41, Vietcombank has performed following tasks:

- Develop and implement the CAR relating program: Vietcombank set specific timelines for the implementation process:

+ 2015 - the research phase: Vietcombank conducted research on policy, implemented the calculation of quantitative impact (QIS) according to Circular 41;

+ 2016 - the development phase: Vietcombank developed programs to calculate CAR ratio and tested programs;

+ In 2017, the completion phase: Vietcombank updated the internal regulations on CAR according to Circular 41 and adjusted according to the audit recommendations

- Make CAR calculation program known in the whole bank;

Specifically, the process is carried out under the following categories on next page:

- Requirement of data analysis according to the business segments:

+ Data is collected from different sources, namely financial reports, Core Banking, operational reports, etc Information includes: customer information, credit, collateral, capital, finance, market risk, partner risk, etc

+ Data is analyzed in the method of business and risk categories (credit risk, market, and operation)

- Request of the organization and the data structure:

+ Data must be handled centrally and automatically;

+ Store information in detail to the account;

+ The user is authorized to access data in the datamart at times in the past

- Requirement of inserting additional data/ calculating lack information:

+ Information to be amended/supplemented: credit risk data (financial status, customer debt balance, etc.), operational risks (interest income, interest expenses, etc.), market risks and partner risks

Additional data is sourced from various programs and systems, including Core Banking, credit ratings classification software, and Treasury programs, which manage credit limits and collateral declarations.

- Update and refinement of data: conducted on the whole system from head office to branches

2.4.3 Internal regulation of CAR calculation at Vietcombank

Vietcombank has set the following regulations to manage CAR calculation program

- Calculation of CAR is in accordance with Circular 41;

- The responsibility of calculating and managing CAR belongs to different levels, departments of head office, branches and subsidiaries;

- CAR data processing is done monthly;

- Regulations on data management have been issued, which relates to data categorization, establishment, usage and management of datamart, data management policy and monitoring data quality;

- Data Management Committee has been established and includes Treasury department, Financial department, Risk department, Retail, Wholesale department

The Internal Audit Department is tasked with auditing the CAR Calculation Program in accordance with Circular 41, aiming to assess Vietcombank's compliance with legal regulations regarding the capital adequacy ratio This comprehensive evaluation encompasses the full operation of the CAR program.

The calculation involves 42 components, encompassing equity, credit, market, and operational risks The process initiates with information gathering, followed by a thorough review of processes and data, ensuring compliance with Circular 41, and concluding with discussions among stakeholders.

2.4.5 General Assessment of the implementation process at Vietcombank

The CAR calculation program has enhanced Vietcombank's governance capabilities and ensured compliance with the capital adequacy ratio regulations outlined in Circular 41 by the State Bank of Vietnam (SBV), as well as the bank's internal policies, thereby aligning with Basel II standards.

Vietcombank's regulatory framework and documentation concerning capital adequacy ratios align with Circular 41 The software used for calculating the Capital Adequacy Ratio (CAR) is regularly reviewed and updated to meet the requirements set by the State Bank and internal regulations Additionally, the data for owner-capital calculations and the capital required for various risk types is reliable and appropriately aligned.

Vietcombank's internal regulations outline the early warning threshold for the Capital Adequacy Ratio (CAR), detailing the management framework, reporting requirements, and action plans Additionally, it defines the rights and obligations of the Board of Directors, CEO, Capital Management Council, and associated departments, subsidiaries, and branches in overseeing the capital adequacy ratio.

To comply with Circular 41, Vietcombank has implemented a comprehensive process for managing the capital adequacy ratio This process outlines the sequence of tasks, the processing times for various functional departments—from operations to technology—and provides detailed steps for processing within the technology system, ensuring accuracy and timeliness in calculations.

The calculation of capital adequacy ratio is carried out through a separate software program and updated regularly based on the proposal of the focal department This

The calculation formula adheres to both the State Bank of Vietnam's regulations and the internal policies of the bank For a comprehensive overview of the internal regulations regarding the calculation of the Capital Adequacy Ratio (CAR) as per Circular 41, please refer to section 2.5.

The CAR calculation program efficiently gathers and processes data from multiple application sources, including Core Banking, Cards, Credit Ratings, and Treasury It is structured in compliance with Circular 41 and adheres to internal regulations for accurate CAR calculation data processing.

In general, basically Vietcombank has built a specific implementation roadmap, applying the provisions of Circular 41 to the letter.

CAR CALCULATION AT VIETCOMBANK

The capital adequacy ratio is a key indicator of Vietcombank's financial health, assessing its capital strength relative to the risks it faces in its operations In accordance with Circular 41 and the guidelines established in Pillar 1 of Basel II, banks are required to maintain a minimum capital adequacy ratio of 8%.

Vietcombank calculates the capital adequacy ratio (CAR) using two types: the separate capital adequacy ratio and the aggregated capital adequacy ratio While the formula for calculating CAR is fundamentally similar for both categories, the key distinction lies in the type of capital considered The general formula for CAR remains consistent across these two classifications.

- RWA = Total risk weighted assets according to credit risk;

- K OR = Regulatory capital for operational risk;

- KMR = Regulatory capital for market risk

Vietcombank's internal regulations define the structure of equity capital as the sum of tier 1 and tier 2 capital, excluding any deductions when calculating owner equity The maximum allowable value for tier 2 capital is equivalent to that of tier 1 capital Owner equity data is automatically gathered through the CAR program and subsequently evaluated and reviewed in conjunction with Vietcombank's internal management reports.

According to Circular 41, Vietcombank determines equity capital for both separate and consolidated types when calculating the capital adequacy ratio Overall, the components and calculation methods for owner’s equity at Vietcombank align with the guidelines set forth in Circular 41.

Tier 1 capital is defined by Vietcombank based on the concept and structure of capital in Basel II and Circular 41 of the SBV It is bank’s core equity capital and comprised of a bank’s chartered capital (financed and contributed capital); additional charter capital reserve fund; fund for investment in service development; financial reserve fund; undistributed profits; share premium

Amounts deducted from tier 1 capital includes goodwill; accumulated deficit; treasury stock

Tier 2 capital is the secondary component of bank capital, in addition to tier 1 capital, making up bank's required reserves The capital includes other funds set up by profits after corporate income tax (not including commendation fund, welfare fund and fund for steering committee rewards); 50% of the increase due to re-assessment of fixed assets as regulated by laws;45% of the increase due to re-assessment of contributions for long-term investment as regulated by laws; 80% of general provisions under the State Bank's regulations on classification of owned assets; equity instruments with characteristics of liability issued by a bank; subordinated debts issued/accepted under loan agreements by a bank

Deductions from tier 2 capital involve the positive variance between the general provision value for owned asset classifications and 1.25% of total assets based on credit risks Additionally, it includes the positive difference between the value of subordinated debts issued or accepted under loan agreements by a bank and 50% of tier capital.

Purchases and investments in subordinated debts issued by credit institutions and financial and banking businesses (FBBs) are eligible to be counted towards their tier 2 capital, excluding any subordinated debts of clients used as collateral, discounted, or re-discounted.

Except for deductible items of tier 1 and tier 2 capital, owner’s equity capital also excludes the following items:

- Credit extensions used for capital contribution or purchase of shares from other credit institutions;

- Investments in and purchases of shares of other credit institutions;

Investments and acquisitions in companies operating within sectors such as insurance, securities, remittance, foreign exchange, gold, factoring, credit cards, buyer credit, and those offering intermediary payment and credit information services are crucial for business growth and financial diversification.

Investments in shares of an enterprise or an investment fund are permissible only after deducting specified amounts, provided that these investments do not exceed 10% of the bank's charter capital and additional charter capital reserve fund.

Total investments and share purchases in enterprises and investment funds, after deducting specified amounts, must not exceed 40% of the bank's charter capital and additional charter capital reserve fund.

Separate equity refers to the total of tier 1 and tier 2 capital, adjusted by subtracting the deductions related to capital contributions and share purchases from both tiers.

The structure and methodology of aggregated equity closely resemble that of separate capital; however, due to the nature of corporate groupings, calculating tier 1 capital includes not only the components of separate capital but also additional items for investments in fundamental construction and fixed asset purchases Similarly, consolidated tier 2 capital incorporates minority interests and equity instruments with liability characteristics issued by Vietcombank and its subsidiaries, rather than solely by Vietcombank itself The deduction items for both types of capital remain consistent with those in separate equity.

2.5.2 Components of asset in calculating CAR

Assets taking risks into account include 3 components:

- Total assets calculated by credit risk;

- Operational risk according to the capital requirement for operational risk;

- Market risk according to the capital requirement for Market risk

Risk-bearing assets are determined for separate and consolidated Vietcombank when calculating the capital adequacy ratio a Risk-weighted asset (RWA)

According to Circular 41 regulations, total assets assessed for credit risk consist of two components: credit risk-weighted assets (RWACR) and counterparty credit risk-weighted assets (RWACCR).

Equation 2-2 Risk-weighted asset calculation

RWA = RWA CR + RWA CCR Where:

- RWACR:Credit risk-weighted asset;

- RWACCR:Counterparty credit risk-weighted asset

Credit risk-weighted asset (RWA CR )

Credit default risk, as defined in Article 6, clause 27, point a, refers to the potential risk arising from a customer's inability to meet debt obligations under a contract with a bank or foreign bank branch Vietcombank has identified various types of credit risks requiring capital reserves in its internal "Regulation on Capital Adequacy Ratio According to Basel II." These credit risks encompass a range of entities, including government bodies, central banks, national and local public organizations, financial institutions, non-performing loans, securities trading, mortgage lending, real estate collateral, retail, wholesale, and more.

Credit risk-weighted asset (RWA CR ) is calculated on the balance sheet according to the below formula:

Equation 2-3 Credit risk-weighted asset

RWA CR = ∑ E j x CRW j + ∑ Max{0, (E i ∗ − SP i )} x CRW i

- 𝐸 𝑗 : Value of the 𝑗 𝑡ℎ asset (other than claims);

- 𝐶𝑅𝑊 𝑗 : Credit risk weight for the 𝑗 𝑡ℎ asset;

- 𝐸 𝑖 ∗ : Value of the outstanding amount of the 𝑖 𝑡ℎ claim;

- 𝑆𝑃 𝑖 : Specific provision for the 𝑖 𝑡ℎ claim;

- 𝐶𝑅𝑊 𝑖 : Credit risk weight of the 𝑖 𝑡ℎ claim

CAPITAL ADEQUACY RATIO ACCORDING TO CIRCULAR 41

On November 28, 2018, the State Bank of Vietnam (SBV) recognized Vietcombank as compliant with the Basel II standards outlined in Circular 41, a year ahead of schedule, marking a significant milestone in the bank's Basel II implementation and the broader Vietnamese banking system Throughout 2018, Vietcombank continued to use the Capital Adequacy Ratio (CAR) calculation based on Circular 36, resulting in figures in the Annual Report that were not aligned with the updated regulations Nevertheless, in an internal strategy report for 2019, Vietcombank's management projected the CAR in accordance with Circular 41.

Table 2-4 CAR at Vietcombank on December 31st 2018

Circular 41/2016/TT-NHNN (estimated figure)

At the end of 2018, CAR at Vietcombank, under the current regulations of Circular

In 2018, the capital adequacy ratio rose to 12.14%, reflecting a 0.51% increase from 2017, indicating positive progress in maintaining financial stability The Board of Management reported that the owner's equity reached VND 62,179 billion, marking an 18.3% growth compared to the previous year.

In 2017, Vietcombank's undistributed profit surged to VND 16,139 billion, a significant increase from VND 8,715 billion in the previous year, while assets expanded by 3.74% to VND 1,074,027 billion Through rigorous credit quality management and effective recovery of bad debts, Vietcombank achieved a historic milestone in 2018 by reducing its bad debt ratio to 0.97%, the first time it fell below 1% since equitization These efforts have bolstered the bank's total equity and enhanced its capital adequacy ratio in accordance with Circular 36.

Vietcombank's capital adequacy ratio (CAR) appears strong at 12.14% compared to the overall banking system; however, when adjusted according to the updated Circular 41, it falls sharply to 8.30%, indicating a significant decline of approximately 4% This discrepancy highlights Vietcombank's actual position regarding its preventive measures for safeguarding capital against potential risks Three primary factors contribute to this situation.

Circular 41 introduces four credit risk mitigation measures that banks can utilize to lower the value of receivables and reduce required capital, including qualified collaterals like cash and gold, balance sheet offsetting, third-party guarantees, and credit derivative products This approach offers a more accurate representation of risk-weighted assets, as receivables backed by valid collateral are deemed less risky and can contribute to capital reduction However, these risk mitigation measures are not valued as highly as other collateral types, such as real estate or machinery, which are not considered for capital deduction.

To accurately assess this component, Vietcombank evaluates the type of recognized risk mitigation, considering strict criteria such as the remaining duration of the risk mitigation measures, liquidity conditions, release objects, and the credit rating of the issuer associated with the secured assets.

In accordance with Circular 41, Vietcombank now calculates the required capital for market risk and operational risk, in addition to credit risk, leading to an overall increase in required capital for banks Consequently, the Capital Adequacy Ratio (CAR) for 2018 was notably decreased, aligning closely with the State Bank of Vietnam's mandated threshold of 8%.

Thirdly, in terms of credit risk, if according to Circular 36, the risk coefficient is 0 - 150% (according to Circular 06, the highest risk factor is 200% for real estate loans

59 applied from January 1 st , 2017), the risk coefficient according to Circular 41 is from

The risk weight of loans ranges from 0% to 250%, categorized to accurately reflect the risk associated with each loan and partner This change results in an increase in risk-weighted assets (RWA) for credit risk at banks, necessitating a more complex assessment of risk factors for each loan Consequently, this demands greater precision and can lead to reduced capital safety rates.

RESULTS OF CAR IMPLEMENTATION ACCORDING TO CIRCULAR 41

2.7.1 Achievements of Vietcombank on CAR implementation

Since its initiation until 2018, the Basel II program has seen extensive implementation, involving over 160 personnel from both headquarters and branches The execution of 82 initiatives as per the established roadmap has enabled Vietcombank to fulfill Basel II requirements using the standard method In addition to meeting the necessary figures outlined in Circular 41, Vietcombank has achieved significant results.

To enhance organizational efficiency and risk management, it is essential to adopt a model that aligns with international standards This approach should adhere to the principle of three lines of protection as outlined in the State Bank's regulations under Circular 13/2018/TT-NHNN.

The regulatory framework has been thoroughly reviewed and updated to align with Basel II management requirements and the directives of the State Bank, ensuring compliance and relevance in current policies.

- Risk measurement tools relevant to international practice: Develop thorough systems of risk quantification models covering almost banks’ entire portfolio

- Data quality: Issue and implement data management policies to improve the quality and completeness of data for CAR calculation and information management

- Vietcombank’s Basel II program has helped the Bank continue to improve the management culture and risk control in the whole system Vietcombank has taken

To achieve a harmonious balance between business development and risk management, companies should implement 60 strategic steps aimed at diversifying their portfolios This includes a strong emphasis on retail growth and the expansion of non-credit activities, ensuring sustainable progress while effectively controlling potential risks.

Vietcombank has demonstrated its capability to operate safely, adhering to advanced practices from developed nations to mitigate credit, market, and operational risks It leads the market in operational scale, growth quality, and market capitalization, having been the first commercial bank to effectively address bad debts at VAMC in 2016, three years ahead of the national timeline This achievement helped lower its bad debt ratio to 0.97% and maintain a capital adequacy ratio of 8.3%, surpassing Circular 41 requirements The bank's profitability ratios have consistently improved, bolstered by significant support from foreign investors like Japan's Mizuho Bank, which enhanced management practices In early 2019, Vietcombank successfully raised charter capital through a private placement of 111.1 million shares, increasing its capital to VND 37.1 trillion (approximately US $1.6 billion), solidifying its position as a top bank in Vietnam with a robust capital base that meets Basel II standards.

Eventually, on November 28 th , 2018, SBV decided to recognize Vietcombank as one of the first two banks meeting the Basel II standards in accordance with the Circular

41, a year earlier than stipulated, marking a turning point in Vietcombank's Basel II implementation roadmap as well as Vietnam commercial banking system in general

Vietcombank has made significant progress in meeting the essential requirements for the application of Basel II under the advanced method, confirming its readiness to adopt the Internal-Ratings Based (IRB) approach The bank has successfully developed a model to quantify the probability of default on credit risks, covering most of its credit portfolio, with test results indicating that the majority of models meet international standards Additionally, Vietcombank has proactively implemented components of the Internal Capital Adequacy Assessment Process (ICAAP) and established a risk appetite framework to enhance the quality and performance of its credit portfolio, focusing on maintaining reasonable credit growth and targeting low-risk sectors to optimize capital utilization.

Vietcombank demonstrates its strong commitment to becoming one of the top 100 banks in Asia and one of the 300 largest financial banking groups globally, all while adhering to international management standards.

2.7.2 Difficulties in the duration of CAR implementation

After recalculating the Capital Adequacy Ratio (CAR) in accordance with Circular 41, it is evident that Vietcombank's CAR has significantly decreased compared to previous regulations The Board of Directors' report on Vietcombank's business performance for 2018 and outlook for 2019 indicates that the CAR under Circular 41 stands at only 8.3% While this figure meets the minimum requirement of 8%, it remains relatively low and unsustainable The decline is attributed to insufficient capital growth from retained earnings and the delay in issuing private shares to foreign investors until the end of 2018.

Vietcombank's capital adequacy ratio (CAR) has not reached the maximum approved level, primarily due to the inclusion of market and operational risk components in the risk-weighted assets This situation has kept the CAR at a relatively low level, contrasting sharply with the impressive figures calculated under Circular 36, and highlighting the bank's actual safety capital status against various potential risks.

Upgrading equity capital levels to meet the standards set by Circular 41 and Basel II poses significant challenges for Vietnam's commercial banking system The pressure to increase equity capital is intense, potentially raising capital costs and constraining credit growth This limitation may hinder banks' ability to maintain an adequate Capital Adequacy Ratio (CAR), ultimately impacting credit growth and overall industry profits in the near future Consequently, finding a balance between sustaining an adequate CAR and expanding profit margins remains a complex issue for banks.

State-owned commercial banks, particularly Vietcombank, face significant pressure to increase their capital, more so than their joint-stock counterparts This pressure arises from their dual responsibility to maintain profitability while also supporting national monetary policy and contributing to economic development and social security Typically, these banks have a lower Capital Adequacy Ratio (CAR) compared to joint-stock commercial banks due to their need for higher credit growth According to VCBS calculations from 2018, a 1% increase in CAR necessitates an 8-10% rise in the bank's charter capital Consequently, the banking sector is navigating a challenging landscape in its efforts to enhance financial capacity through capital raising solutions.

Banks, whether in the preparation phase for Capital Adequacy Ratio (CAR) compliance or already executing it, are experiencing significant pressure on their capital adequacy Nguyen Dinh Tung, CEO of Oricombank, emphasizes that Basel II should not be viewed merely as a business strategy, but rather as an elevated standard that banks must adhere to in order to ensure their own protection.

In the context of increasing globalization and foreign investment, banks must enhance their credibility and competitiveness by adhering to higher standards and requirements To mitigate potential risks, it is crucial for banks to adjust their growth indices in line with Basel II regulations if their capital raising strategies become unfeasible during operations, ensuring the institution's safety and stability.

To enhance the value of Capital Adequacy Ratio (CAR), Vietnamese banks like Vietcombank can either increase owner equity or reduce risk-weighted assets However, the latter is challenging due to the reliance on credit as the primary income source for commercial banks in Vietnam Consequently, Vietcombank must carefully evaluate the advantages and disadvantages of various capital expansion strategies during its operational activities.

One potential strategy for increasing capital in State-Owned Commercial Banks (SOCBs) involves issuing additional shares to current investors, attracting new investors, and selecting foreign strategic partners However, this approach is challenging to implement in the short term and relies heavily on two key factors: investor interest and market conditions, both of which are currently unfavorable for SOCBs Investors perceive SOCBs as risky due to their limited financial capacity, while the stock market suffers from poor quality and transparency Moreover, attracting foreign capital has become more difficult due to the instability caused by the US-China trade war Even if suitable investors are found, SOCBs face significant barriers related to policy and regulatory issues The Politburo's decision to maintain a controlling stake of at least 65% in SOCBs further complicates the potential for non-state investor participation in Vietnam's banking sector.

RECOMMENDATIONS FOR IMPROVEMENT OF CAR

RECOMMENDATIONS FOR THE STATE BANK OF VIETNAM

The government should instruct the State Bank of Vietnam (SBV) to finalize projects aimed at enhancing Vietcombank's overall financial capacity, establishing clear plans and a roadmap for increasing the bank's capital.

The National Assembly's decision to refrain from using the state budget to boost the charter capital of Joint Stock State-Owned Commercial Banks (JSSOCBs) does not eliminate the possibility of state support for these banks The government can explore alternative methods such as capital guarantee tools, refinancing special bonds from the Vietnam Asset Management Company (VAMC), and establishing an equitization fund to aid commercial banks, particularly Vietcombank This bank faces unique challenges in raising owner equity capital, as it must balance profit generation with fulfilling state socio-economic objectives, including implementing government preferential credit policies This dual focus may hinder its profitability and competitive edge in the banking sector.

The Government has directed the State Bank of Vietnam (SBV) to collaborate with relevant agencies to facilitate Vietcombank's public share issuance strategy State shareholders lacking sufficient capacity may opt out of purchasing shares, allowing Vietcombank to actively pursue domestic investors and small shareholders while offering preferential shares to employees This approach is viable only if current shareholders possess financial strength and prefer to maintain their ownership stake, alongside a stable and developed stock market environment.

Promoting a vibrant financial market with active participation from both domestic and international investors is essential for enabling banks to issue bonds, thereby creating a valuable source of Tier 2 capital Additionally, implementing a comprehensive strategy for both the stock and bond markets is crucial to satisfy the long-term capital needs of businesses This approach will alleviate the pressure on the long-term credit growth of commercial banks, facilitating the restructuring of risk-weighted assets, particularly for Joint Stock State-Owned Commercial Banks (JSSOCBs).

The State Bank of Vietnam (SBV) should consider implementing a mechanism to attract competent foreign investors, particularly in Joint Stock Commercial Banks (JSSOCBs) with significant potential for capital mobilization This could involve increasing the foreign ownership limit from 30% to 35%, enabling Vietcombank to draw more investment from both domestic and international sources, thereby enhancing its financial capacity and leveraging advanced technology and management practices Additionally, the SBV must continue to refine its guiding documents to ensure transparency and feasibility in the capital selling process Alongside preferential policies for foreign investors, it is crucial to improve Vietnam's credit rating system, both for the banking sector and individual banks, to build credibility and reliability that will attract potential foreign investments.

RECOMMENDATIONS FOR VIETCOMBANK

As a joint-stock commercial bank, Vietcombank operates under the oversight of the State, playing a crucial role in helping the Government achieve its economic development and social security goals Given that Vietcombank's operations primarily rely on credit, the author suggests implementing specific strategic solutions to enhance its business performance.

3.2.1 The solutions relating to capital mobilization

Firstly, in order to enhance the scale of owners’ equity, Vietcombank itself needs to develop a specific plan to mobilize capital in short, medium and long term

According to the bank's regulations, if the Capital Adequacy Ratio (CAR) falls below 9% or is between 9% and 11%, the bank is required to retain all profits after tax and is prohibited from paying dividends or repurchasing shares This policy is justified as it holds shareholders accountable for maintaining the capital safety of the bank; when capital is insufficient, shareholders cannot receive profits.

To enhance capital, companies can seek equity from current shareholders and both domestic and foreign private investors This strategy should be executed early during favorable macroeconomic and stock market conditions; otherwise, banks may be forced to accept lower stock prices.

To enhance its capital, a bank can not only raise funds through external means like issuing shares and bonds but also focus on internal processes By improving the quality of its financial services, the bank can gradually increase service income while simultaneously reducing operating costs, ultimately lowering capital mobilization expenses.

Mergers and acquisitions (M&A) present a crucial opportunity for commercial banks in Vietnam, particularly for Vietcombank While M&A activities may not address all underlying issues within the banking system, they play a significant role in fulfilling minimum capital adequacy requirements Consequently, Vietcombank should proactively seek potential domestic and foreign partners for M&A to enhance its capital base and mitigate potential losses.

Thirdly, Vietcombank may also contemplate the strategies for CAR enlargement by reducing the denominator value in the CAR calculation formula This means that:

Vietcombank can enhance the effectiveness of its credit portfolios by restructuring them to align asset volume, conversion risks, and capital levels with corresponding profit outcomes A thorough review of each credit portfolio is essential to assess the relationship between invested sources and their returns, particularly focusing on assets with high conversion ratios, such as real estate loans and high-risk business loans characterized by significant financial leverage and lack of transparency As noted by Le Thanh Ngoc and partners (2015), there is a direct correlation between the growth of equity capital and the increase in return on assets (ROA).

To effectively manage systematic risks that are challenging to control, it is essential to establish policies that facilitate the development of suitable hedging tools Additionally, collaboration with organizations recognized for their strong risk control capabilities is crucial This approach allows Vietcombank to transfer risk to these organizations in situations where it cannot effectively manage those risks itself.

Vietcombank should enhance its risk management capabilities to reduce risk provision expenses, which represent a substantial cost in its operations The bank aims to decrease management costs by 3-4% compared to initial estimates.

3.2.2 The solutions relating to banking management

Vietcombank should establish an internal credit rating system to address the shortage of professional credit rating organizations in Vietnam By proactively developing a credit ranking system tailored to different customer groups, Vietcombank can enhance its risk assessment and decision-making processes.

- The Bank should improve the quality of assessing and measuring potential risks when granting credit to business customers, which focuses more on the following factors:

Financial default is influenced by several key factors, including profitability, liquidity, operational efficiency, financial leverage, asset structure, capital resources, solvency, and growth ratios Additionally, non-financial factors play a crucial role, such as the qualifications and quality of management personnel, which encompass their experience and expertise, as well as the internal environment of the organization.

The article discusses various factors influencing business performance, including personnel management, operational regulations, and business plans It emphasizes the importance of input supply and output market dynamics, as well as the company's relationship with credit institutions, which is shaped by past repayment behavior and cooperation in information sharing Additionally, it highlights the ability to access corporate capital, the impact of industry cycles and government support, and the sensitivity of revenue, income, and cash flow to market fluctuations, such as changes in input and output prices and exchange rates Lastly, it addresses the significance of credit information from the Credit Information Center (CIC).

The Bank creates specialized departments to oversee results and evaluate credit ratings Annually, the internal credit rating system is reviewed and updated based on data and information gathered from customers throughout the year.

Vietcombank should focus on enhancing its information technology system, emphasizing two key areas essential for establishing a robust foundation for Basel application.

To successfully implement Basel II, Vietcombank must enhance its IT infrastructure, which is crucial for ensuring information transparency and effective management By developing a modern IT framework, the bank can accelerate the Basel II implementation process while maintaining safe and efficient information handling.

Vietcombank must establish a real-time database system to facilitate the collection and analysis of essential information at any moment This development requires a unified reporting regime, an automated reporting analysis system, and enhanced capabilities for data retrieval and information sharing Additionally, to effectively manage credit risks, Vietcombank needs an analytical and technical information system that can accurately measure risks associated with both internal and external balance sheet activities.

71 measurement process depends great deal on the quality of the management information system

CONCLUSION

Enhancing owner’s equity is crucial for Vietcombank to boost its capacity and competitiveness in the global financial market During the initial years of the second phase (2016-2020), Vietnamese commercial banks, including Vietcombank, faced significant challenges in increasing equity capital to meet the Basel II capital adequacy ratio while addressing existing limitations To raise the capital adequacy ratio (CAR), Vietcombank's most feasible option is to increase owner equity, as reducing risk-weighted assets is currently unviable Additionally, implementing effective banking management strategies can further improve the bank's situation Ultimately, developing a suitable roadmap for these initiatives is essential for fostering a new impetus and advancing the application of Basel II within Vietcombank, both now and in the near future.

CONCLUSION 73 REFERENCES

Since 2014, the State Bank has been implementing Basel II within the Vietnamese commercial banking system to establish a robust banking industry This initiative aims to restructure the banking sector, reduce the number of weak banks, and enhance operational management and risk control, particularly regarding the capital adequacy ratio (CAR) As a result, Vietnamese banks are better positioned to access the international capital market at lower costs, increasing their credibility with global financial institutions, investors, and international organizations.

Utilizing scientific research methods grounded in the constructive approach and examining the current Capital Adequacy Ratio (CAR) implementation as per Circular 41 of the State Bank, aligned with the Basel II standard method, this thesis has reached several significant conclusions.

Firstly, in the period before the issuance of Circular 41/2016/TT-NHNN, in general, the capital adequacy ratio at Vietcombank met the current regulations under Circular

In 2016, the State Bank introduced Circular No 41/2016/TT-NHNN, set to take effect on January 1, 2020, which revised the Capital Adequacy Ratio (CAR) from 9% to 8% This adjustment aligns with Basel II principles, addressing not only credit risks but also market and operational risks, which were previously overlooked As a result, if Vietnamese commercial banks adhere to the new CAR calculation requirements, their ratios may decrease significantly, emphasizing the urgent need for banks to bolster their own equity capital to comply with legal standards.

74 the State Bank of Vietnam, as well as serve the goals, strategies and needs to expand business activities, and the credit growth of each bank

Vietcombank was chosen as one of ten banks to pilot Basel II under Circular 41, leading to the development of internal regulations, including the "Internal Regulations on Managing Minimum Capital Adequacy Ratio According to Basel II." The implementation process received approval from the State Bank of Vietnam (SBV) and successfully met Basel II standards on November 28, 2018, a year ahead of the January 1, 2020 deadline This achievement marked a significant milestone in the Basel II implementation roadmap for both Vietcombank and the broader Vietnamese commercial banking system.

In 2018, Vietcombank's CAR ratio met the minimum requirement set by Circular 41, exceeding 8%, but remained low and unstable The bank's growth in owner equity primarily stemmed from tier 1 capital increases through share issuance Economic experts attribute this situation to a combination of internal and external factors, as detailed in Chapter 4 To address these challenges, two main groups of solutions are proposed: one aimed at macroeconomic measures by the State Bank of Vietnam (SBV) and the other focused on the bank's internal strategies.

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The article discusses the advancements made by Vietnamese banks in aligning with Basel II standards, emphasizing the importance of these regulations for enhancing financial stability and risk management in the banking sector It highlights the ongoing efforts and gradual improvements within the industry, showcasing the commitment to adopting international best practices in finance The article underscores the significance of these developments for the overall economic growth and resilience of Vietnam's financial system.

In his 2014 publication, Hoang Huy Ha examines the implementation of safety standards in business and risk management within Vietnam's banking system, highlighting the current situation and proposing effective solutions The study, published by the State Bank of Vietnam, emphasizes the need for adherence to international practices to enhance the banking sector's stability and resilience The findings underscore the importance of integrating global safety standards to mitigate risks and improve overall operational efficiency in Vietnamese banks.

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II race? Retrieved May 22, 2019, from VnEconomy: http://vneconomy.vn/vib-va- vietcombank-dan-dau-cuoc-dua-basel-ii-nhu-the-nao-2018120321293131.htm

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In his 2017 work, Le Cong discusses the implementation of Basel II in the risk management frameworks of Vietnamese commercial banks The findings were presented at a national workshop hosted by the National Economics University, focusing on the opportunities, challenges, and strategic roadmap for applying Basel II in Vietnam's banking sector The insights aim to enhance the effectiveness of risk management practices within these financial institutions.

In their 2015 study published in the Journal of Development and Integration, Le Thanh Ngoc, Dang Tri Dzung, and Le Minh Nguyen Phuong explore the relationship between equity and risk in commercial banks in Vietnam The research provides valuable insights into how these financial institutions manage their capital in relation to risk exposure, highlighting significant evidence from the Vietnamese banking sector This analysis contributes to a deeper understanding of banking stability and risk management practices in emerging markets.

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Ngo Van Chien (2017, June 17th) Impacts and Roadmap of the Application of Basel

The implementation of Basel II standards in Vietnam has significant implications for the country's financial sector This framework aims to enhance risk management and improve the stability of banks, aligning them with international practices As Vietnam continues to integrate into the global economy, adopting these standards is crucial for fostering investor confidence and ensuring sustainable economic growth The ongoing process of implementing Basel II reflects Vietnam's commitment to strengthening its financial system and adhering to global regulatory standards.

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SUMMARY OF THE CALCULATION OF OUTSTANDING AMOUNT OF CLAIM (E I ∗ ) AND CREDIT RISK WEIGHT OF CLAIM(CRW I ) ACCORDING

TO VIETCOMBANK INTERNAL REGULATION ON CAR MANAGEMENT

1 VALUE OF THE OUTSTANDING AMOUNT OF CLAIM (E I ∗ )

According to Section 2, Article 8, Clause 3, the outstanding claim amount (𝐸 𝑖 ∗) at Vietcombank, which includes any unpaid principal, interest, or applicable fees, will be calculated based on specific criteria outlined in the clause.

Equation 1 Value of the outstanding amount of claim

- 𝐸 𝑖 : Value of the outstanding amount defined according to the method of determining the historical cost of the 𝑖 𝑡ℎ claim;

- 𝐸 𝑜𝑛𝑖 : Value of the outstanding amount of the on-balance sheet portion of the 𝑖 𝑡ℎ claim;

- 𝐸 𝑜𝑓𝑓𝑖 : Value of the outstanding amount of the off-balance sheet portion of the 𝑖 𝑡ℎ claim;

- 𝐶𝐶𝐹 𝑖 : Credit conversion factor 2 of the off-balance sheet portion of the 𝑖 𝑡ℎ claim