credit risk management in agribank thai nguyen province

With respect to undue debt, both groups of respondents evaluated “undue debt” with mean of 3.2 corresponding to level Risky.. With respect to the Credit activities aspects of Agribank Th

Thai Nguyen University

Socialist Republic of Vietnam

Southern Luzon State University Republic of Philippines

CREDIT RISK MANAGEMENT IN AGRIBANK – THAI NGUYEN PROVINCE

A Dissertation Presented to the Faculty of Graduate School of Southern Luzon State University, Philippines and Thai Nguyen University, S.R Vietnam

APPROVAL SHEET

DEDICATION

This piece of work is dedicated

To my wife and my children, All the staffs of the Agribank in Thai Nguyen Province

ACKNOWLEDGMENT

The researcher wishes to extend him most since gratitude to the following people who made this piece of work a reality

Dr Cecilia N Gascon, President of Southern Luzon State University, Republic

of the Philippines, who made possible the linkage with Thai Nguyen University and the offering of Doctor of Business Administration, through the ITC-TUAF;

Dr Dang Kim Vui, the President of Thai Nguyen University, who made the

linkage with Southern Luzon State University, Republic of the Philippines and the

offering of Doctor of Business Administration, through the ITC-TUAF;

Dr Walberto A Macaraan, for his support and supervision throughout my graduate study program His kindness and daily instructions in the last three years are greatly appreciated and this dissertation is as much his work as mine;

Prof Nordelina Ilano, Director, Office for International Affairs of URS for her support to the DBA1 students;

Dr Tran Thanh Van, the Dean of the Graduate School of Thai Nguyen University, for his assistance and encouragement to pursue this study;

Dr Dang Xuan Binh, the Director of International Training Center, for his assistance and encouragement to pursue this study;

Dr Nguyen Thanh Hai, the Vice Director of International Training Center, for his assistance and encouragement to pursue this study as DBA Class Manager;

To all the SLSU and TNU Professors, for their support and guidance extended throughout the graduate studies in Thai Nguyen University, Vietnam;

To his ever dearest friends for their kindness and remarkable support;

To his family, for their support, encouragement for being the sources of greatest inspiration, which made his career a success

ABSTRACT

This study was conducted on the basis of practical reasoning combined with analysis of the status and operation characteristics of the Bank for Agriculture and Rural Development, Vietnam to build a strategy for credit risk management effectiveness, which proposed solutions and recommendations for improvement, improve credit risk management of the Bank for Agriculture and rural Development

of Vietnam, contributing to the economic restructuring of agriculture and rural towards industrialization and modernization, promoting our country's economic integration and development

The result will the present situation of credit risk in terms of bad debts, undue debts, overdue debts, debts requiring attention, under qualified debts, doubtful debts and frozen debts as perceived by managers and staff of the Agribank, and from that, the researcher recommended the appropriate solutions to limit credit risk in effective ways in bank

The findings of the study shows that with respect to “segment structure which contain the big risks”, respondents evaluated it with mean of 3.5 corresponding to level More Risky The evaluated the item “Credits for industries” with highest mean

of 3.6 corresponding to level More Risky and ranking first of all They evaluated the item “Credits for service sector” with lowest mean of 3.2 corresponding to level Risky and ranking last of all For overall assessment of both managers and staffs, they evaluated all items of ‘types of customers, which contain the big risks” with mean of 3.4 corresponding to level More Risky They evaluated the item “individuals” with mean of 3.6 corresponding to level More Risky and ranking first of all They evaluated the item “Big companies and organizations “ with lowest mean

corresponding to level Risky and ranking last of all For overall assessment of two groups of respondents, they evaluated all items of “not have guarantee properties” with mean of 3.1 corresponding to level Risky They evaluated the item “Not have guarantee properties” highest mean of 3.6 corresponding to level More Risky and ranking first of all While, the item “Have guarantee properties’’ was evaluated with lower mean corresponding to level Less Risky With respect to “the account outstanding acc to time”, two groups of respondents evaluated short term credit with highest mean of 3.5 corresponding to level More Risky and ranking first While, the item “medium and long term credit” received lower mean of 3.2 corresponding to level Risky and ranking last With respect to overdue debts, both groups of managers and staffs evaluated all items of “overdue debt” with mean of 3.3 corresponding to level Risky They gave highest mean of 4.3 for the item “Both principal and interest can be recovered partially” corresponding to level Most Risky and ranking first While, the item “Both principal and interest can be recovered fully” was evaluated with lowest mean of 2.4 corresponding to level Less Risky and ranking last of all With respect to undue debt, both groups of respondents evaluated “undue debt” with mean of 3.2 corresponding to level Risky They evaluated the item “Customers are traditional borrowers” with highest mean of 3.5 corresponding to level More Risky and ranking first of all They evaluated the item “It is easy to collect principle and interest” with lowest mean of 3.1 corresponding to level Risky and ranking last of all With respect to “debt requiring attention”, two groups of respondents evaluated “debt requiring attention” with mean of 3.6 corresponding to level More Risky They assessed the item “The interest rate is suitable for customers” with highest mean of 3.6 corresponding to level More Risky and ranking first While, the item “The mechanism for this debt is so clear” received lower mean of 3.5 corresponding to rank

last With respect to qualified debt two groups of respondents evaluated “qualified debt” with mean of 2.9 corresponding to level Risky They evaluated the item “Able

to pay the interest and principle at maturity” with highest mean of 3.6 corresponding

to level More Risky and ranking first of all The item “The interest is made free for customers” was evaluated with lowest mean of 1.7 corresponding to level Least Risky and ranking last of all With respect to doubtful debt, all respondents evaluated the item “The bank controls closely this type of debt” with highest mean of 4.3 corresponding to level Most Risky and ranking first of all While, they evaluated the item “Creditors do not carefully appraise the borrowers” with lowest mean of 3.5 corresponding to level More Risky and ranking last of all With respect to frozen debt, two groups of respondents evaluated frozen debt with mean of 3.3 corresponding to level Risky They evaluated the item “There are a lot of customers classified in frozen debt group” with highest mean of 3.6 corresponding to level More Risky and ranking first of all; and evaluated the item “The rate of frozen debt is too high” with lowest mean of 3.2 corresponding to level Risky and ranking last of all With respect to “bad debt”, both groups of respondents evaluated the item “It is difficult to collect both interest and capital” with highest mean of 3.7 corresponding to level More Risky and ranking first of all While, the item “The mortgage is hard to sell” was evaluated with lowest mean of 3.5 corresponding to level More Risky and ranking last Considering all items of “bad debt”, they evaluated them with mean of 3.6 corresponding to level More Risky With respect to items of subjective criteria, all respondents evaluated all items of subjective criteria with mean of 3.6 corresponding to level Frequent They evaluated the item “Credit process follows the common regulations of State bank” with highest mean of 4.3 corresponding to level Always and ranking first While, the item “The information quality in banking network and outside is good” was evaluated

with lowest mean of 2.8 corresponding to level Often and ranking last With respect to objective criteria, both groups of respondents evaluated all items of objective criteria with mean of 3.7 corresponding to level Frequent They evaluated the item “The political and legal environment is stable” with highest mean of 4.5 corresponding to level Always and ranking first of all While, the item “The economic environment facilitates for both bank and customer” was evaluated with lowest mean of 3.1 corresponding to level Often and ranking last of all With respect to the Credit activities aspects of Agribank Thai Nguyen in term of four aspects, both groups of respondents evaluated the Credit activities aspects of Agribank Thai Nguyen term of four aspects with mean of 3.3 corresponding to level Risky They evaluated the item

“Segment structure contain the big risks” with highest mean of 3.5 corresponding to level More Risky and ranking first of all They gave lowest mean for “Based on the guarantee level, types of guarantee contain the big risks” with mean of 3.1 corresponding to level Risky With respect to all items of Current status of debts, both groups of respondents, they evaluated all items with mean of 3.4 corresponding to level More Risky They evaluated the item ‘doubtful debt” with mean of 4.0 corresponding to level Risky and ranking first of all They evaluated the item “under qualified debt” with lowest mean of 2.9 corresponding to level Risky and ranking last

of all With respect to two aspects affecting the risk management of credit, respondents evaluated them with mean of 3.7 corresponding to level More Risky Two items were evaluated with a same mean of 3.7

It is recommended that the research and define the appropriate types of credit for individuals The bank should require guarantee properties for credits The bank should pay more attention more on long – term and medium credits Review procedure and conditions of them to manage and control in order to minimize risks of

credit Review to define appropriate solutions to collect interest and capital Review and find suitable solutions to recovery both principle and interest fully Research to find suitable solutions to collect principle and interest Review to produce clear mechanism for “debt requiring attention” Review to decrease cost to improve the competitive ability of services Creditors should carefully appraise the borrowers Review to define exactly ability of borrowers before credits Review to establish a good information network Carefully manage segment structure; define exactly targeted customers The bank should pay attention on both subjective criteria and objective criteria affecting on risk management of credit

TABLE OF CONTENTS

APPROVAL SHEET ii

DEDICATION iii

ACKNOWLEDGMENT iv

ABSTRACT v

TABLE OF CONTENTS x

LIST OF TABLES xii

LIST OF FIGURES xiv

CHAPTER 1 INTRODUCTION………1

Background of the Study 2

Statement of the Problem 3

Hypothesis of the Study 5

Significance of the Study 5

Scope and Delimitation 6

Definition of Terms 6

2 REVIEW OF LITERATURE AND RELATED STUDY ……… …8

Review of Related Literature 8

Review of Related Studies 31

Conceptual Framework 55

3 METHODOLOGY……… ………56

Research Design 56

Population and Sampling 56

Sampling Design and Techniques 57

Research Instruments 58

Data Gathering Procedures 59

Statistical Treatment 60

4 PRESENTATION ANALYSIS AND INTERPRETATION OF DATA… 61

5 SUMMARY OF FINDINGS, CONCLUSIONS AND RECOMMENDATIONS.91 Findings 91

Conclusions 96

Recommendations 97

BIBLIOGRAPHY 99

APPENDICES A 101

APPENDICES B 102

QUESTIONNAIRE 103

CURRICULUM VITAE 109

LIST OF TABLES

1 Frequency and Percentage of respondent’s profile 61

2 Mean Distribution of Respondents on Credit risk management of

Agribank Thai Nguyen in terms of segment structure 62

3 Mean Distribution of Respondents on Credit risk management of

Agribank Thai Nguyen in types of customers 64

4 Mean Distribution of Respondents on Credit risk management of

Agribank Thai Nguyen in types of guarantee 65

5 Mean Distribution of Respondents on Credit risk management of

Agribank Thai Nguyen in terms of account outstanding 66

6 Mean Distribution of Respondents on Credit risk management of

7 Mean Distribution of Respondents on Credit risk management of

8 Mean Distribution of Respondents on Credit risk management of

Agribank Thai Nguyen in Debt requiring attention 71

9 Mean Distribution of Respondents on Credit risk management of

Agribank Thai Nguyen in Under qualified debt 72

10 Mean Distribution of Respondents on Credit risk management of

11 Mean Distribution of Respondents on Credit risk management of

12 Mean Distribution of Respondents on Credit risk management of

13 Mean Distribution of Respondents on Credit risk management of

Agribank Thai Nguyen in Subjective criteria 78

14 Mean Distribution of Respondents on Credit risk management of

Agribank Thai Nguyen in Objective criteria 79

15 Summary table on the Assessment of the Two groups of Respondents

the Credit activities aspects of Agribank Thai Nguyen term of four

16 Summary table on the Assessment of the Two groups of Respondents 82

the Current status of debts of Agribank Thai Nguyen term of Current

status of debts

17 Summary table on the Assessment of the Two groups of Respondents

the factors affecting the limitation of Credit Risks of Agribank Thai

18 T-test Results for the Differences on the Assessment of Two Groups

of Respondents on the Agribank Thai Nguyen 87

19 T-test Results for the Differences on the Assessment of Two Groups

of Respondents on the Current status of debts Agribank Thai Nguyen 88

20 T-test Results for the Differences on the Assessment of Two Groups

of Respondents on the factors affecting the limitation of Credit Risks

LIST OF FIGURES

The banks system as the lifeblood play very important role of the economy Vietnam's banking system in recent years has gained encouraging achievements such

as contributing to stability and control inflation, the effective implementation of national monetary policies However, in the economy market, business risk is unavoidable, especially in the field of risk banking business activities because it has the potential to cause a chain reaction, spreading and increasingly complex expression The collapse of the focal bank to influence the whole of life - economic - political - and social resilience can spread within a country even just settle the whole region and global

Before the integration trend, the financial institutions, banks will always have

to deal with competition as well as many different types of risk In Vietnam, the starting point of the banks is quite low compared with the average in the region should focus on developing the right and interest earnings are considered a priority This leads to the risk management of banks virtually Vietnam are still being left open and the construction has not been a satisfactory and professional That is why, the ratio of bad debt problems arising from loss of control is becoming unsolved problem

in most of Vietnam's current banking and in the Bank for Agriculture and rural Development in Vietnam - a financial institution operating mainly in the agricultural sector and rural areas Profit brought mainly from bank credit activity (accounting for 90% of total banking income)

Therefore, the credit risk management is crucial for the survival and development of the bank comes up agricultural and rural development in Vietnam

Background of the Study

Agribank Thai Nguyen province was formed in October 1998 on the basis of getting the entire facility, workers from several departments of the provincial state banks and state bank branches in the province districts Thai Nguyen, with workforce

of 760 people, 2.3 billion funding, and debt balances 3.5 billion mainly being overdue

Commercial banks is the industry that is high risk, which is the type of credit business with the highest risk, especially in the context of the global financial crisis now and will adversely Bank's activities in general and in particular credit activities

In fact, on average between 2005 and 2009, the percentage of REO commercial banks Vietnam has steadily increased from 12% to 30%, but from early 2010 until now, this index has fallen down dramatically, REO 2010 decreased 40% compared with 2009,

2011 decreased 30% compared to 2010 (Source: annual reports of the Bank and the author's calculations) Net interest margins are also in a similar situation Profitability decreased, while the CAR is very low, meaning that the commercial banks in recent years has paid a high price does not perform well due to the credit risk management which is most evident ratio of bad debts rise

Recently, the credit risk management in commercial banks but has were given more attention, but generally are not effective, not to be carried out in a basically

Bank of Agriculture and Rural Development of Vietnam (Agribank) is one of the first commercial bank in Vietnam, was a prestigious and affirmed its brand domestically and internationally Not outside the general trend of development of Vietnam's banking system since our country transition to a market economy, Agribank continuous expansion of asset size, capital size, in which the credit scale

constantly expanding and this is also the main source of profit for the operation Agribank

Currently, the credit rate on the total assets of the Agribank about 80%, while the credit risk management is still inadequate, the percentage of total outstanding loans high: from 0.98% in 2005 to 2.24% in 2009, 3.3% in 2010, 6.8% in 2011 and is expected to increase further in 1012, ROE from 2006 to now tended to decrease significantly (down 43% ) With Agribank Thai Nguyen, the percentage of total debts balance in 2006: 1.26%, 2007: 2.58%, 2008: 2.34%, 2009: 1.42%, 2010: 0.98%, 2011: 0.58% Despite the bad debt ratio of Agribank Thai Nguyen is also lower than the average bad debt ratio of Agribank Vietnam but also the amount of bad debt increases in the current economic conditions If bank does not implement well to control risk, the efficiency of credit activity will be decrease The growth of bank is slow

With this situation, while credit remains the main activities of the commercial banks, the activities of credit risk management is vital to the commercial banks as well as Agribank Vietnam and Thai Nguyen Agribank in particular, and also means that the stability of the economy

From the above reasons, researcher has chosen the topic: “Credit Risk Management in Agribank Thai Nguyen Province" to conduct the study of his

dissertation

Statement of the Problem

On the basis of practical reasoning combined with analysis of the status and operation characteristics of the Bank for Agriculture and Rural Development, Vietnam to propose recomendation for credit risk management, improve credit risk management of the Bank for Agriculture and rural Development of Vietnam,

contributing to the economic restructuring of agriculture and rural towards industrialization and modernization, promoting our country's economic integration and development

Specifically it seeks to answer the following questions:

1 What is the profile of the respondents in terms of:

3 What is the assessment of the managers and staffs of Agribank Thai Nguyen

on the credit risk management in terms of:

a) Overdue Debt

b) Undue Debt

c) Debt requiring attention

d) Under qualified Debt

e) Doubtful Debt

f) Frozen Debt

g) Bad Debt

4 What is the assessment of managers and staff on the factors affecting credit risk management of Agribank Thai Nguyen in terms of:

Hypotheses of the Study

1 There is no significant difference in the assessment of two groups of respondents on credit risk management implemented by the bank

2 There is no significant difference in assessment of two groups of respondents

on the factors affecting the limitation of Credit Risks

Significance of the Study

To the Manager This will provide them with valued information concerning the

credit risk management of the branch In this regard they will be able to adapt their development programs to help the bank reduce credit risk management

To the Researcher The researchers as an employee of bank and as a candidate for

Doctor of Business Administration Degree, this study will enhance his knowledge that he can use and apply to the bank in the future

To Future Researchers This can serve as reference materials for future researches

similar to this

Scope and Delimitation

This study chooses subjects as the credit risk management at the Bank for Agriculture and Rural Development in Thai Nguyen province

The researcher studied the present situation of credit risk in terms of bad debts, undue debts, overdue debts, debts requiring attention, under qualified debts, doubtful debts and frozen debts as perceived by managers and staff of the Agribank, and from that, the researcher recommended the appropriate solutions to limit credit risk in effective ways in bank

Definition of Terms

To clearly understand the different terms used in this study, the following were technically and operationally defined:

Bad Debt: Bad debt is an amount owed to a business or individual, for which there is

zero probability of collection

Credit risk: Credit risk is the risk of loss due to a debtor's non-payment of a loan or

other line of credit (either the principal or interest (coupon) or both) The default events include a delay in repayments, restructuring of borrower repayments, and bankruptcy

Debts requiring Attention: Debts have been rescheduled the maturity for the first

time (to the customers as enterprises, organizations, credit institution must have customer assessment record on ability to pay the principal and interest in full and in time as rescheduled at the first time)

Doubtful debt: Doubtful debts are those debts which a business or individual is

unlikely to be able to collect

Frozen debt: Frozen debts are uncollectible debts, credit institution will not

restructure the payment maturity, not move the overdue debt, not calculate the

interest from the moment of deciding to freeze the debt; here normally are

loans under the State policy, loans under the Government’s assignment and

being allowed by the State for temporarily “freeze” for later settlement

Overdue debt: Overdue debt is the debt that being unpaid when due

Undue debt: Debts are not due that are assessed by credit institution to be

able to pay the principal and interest of debts in full and in a timely manner

Under Qualified debts: debts which are assessed by credit institution to be

unable to pay the principal and interest at maturity These debts are assessed

by credit institution to have potential for partial loss of the principal and

interest

Segment structure: Banking segment structure enables banks to target different

categories of consumers who perceive the full value of certain products and

services differently from one another

Types of customers: Type of Customer is defined as the psychological type of your

customer, also known as personality type There is a tremendous personal

benefit to knowing your type

Types of guarantee: A guarantee from a lending institution ensuring that the

liabilities of a debtor will be met In other words, if the debtor fails to settle a

debt, the bank will cover it

Account Outstanding: is account which still in existence; not settled or resolved

CHAPTER II REVIEW OF LITERATURE AND RELATED STUDY

This chapter will present concepts and theories from related literature and

studies that have significant effect on the study

Review of Related Literature

Credit activities of commercial banks

Commercial bank is a financial organization supplying a diversified financial

service - especially credits, saving, payment services- and other financial functions

compare to any organization within the economy (Tran Van Viet (2004) Business in

Commercial Banks, Hanoi: Banking Publishing House)

The basic activities of Commercial Bank

The main activities of Commercial Bank is to transform money from saving to

investment: The individuals and organizations who are temporarily spending deficit,

which means the spending for consumption and investment go beyond income and

that's why they need to add more fund On the contrary, individuals and organizations

who are spending surplus, which means their income is higher than the spending they

spend on goods and services and they have money to be saved

Bank becomes the largest payment intermediaries present in most countries

nowadays With the development of the economy, where banks from supplying

deposit, has increased the services on many operating valuated segments such as fund

mobilization, credits, payment intermediates and others activates (Tran Van Viet

(2004) Business in Commercial Banks, Hanoi: Banking Publishing House)

The details as follow:

 Fund Mobilization

It contains mobilizing funds: deposit payments, term and demand deposits, issuance of bonds and notes, loans of credit institutions, capital funds, investment funds, etc.

 Loaning: Loaning activities include:

Loaning for consumption: for individuals and households

Loaning for business: short-term loan, medium and long-term loan for

customers to buy material, equipments, build manufactures

 Payment:

On behalf of customers, banks perform payments for buying goods and services All of the services of midterm payments include check, payment orders, recovering money, etc Previously, banks performed internally in the narrow range, within districts, but now they have performed interbank payment and on the global

 Other transactions:

Guarantee: Banks commit to perform financial obligations for their customers

when customers do not perform the obligations as committed Banks often guarantee

customers to buy goods, equipments, bidding, and implementation of contracts

Assignation, consultant: working in financial field, banks might be assonated

as investing assignation, loaning assignation Banks can receive assignation such as assignation for investing, borrowing, etc., and can perform such services as investment consultancy, financial management, buying and merging for customers, etc

Treasury management: banks open accounts and keep moneys from most of

customers and individuals Therefore banks always have close relationship with their customers

Property protection: banks store gold, valuable documents and other

properties for customers in safe

Leasing and buying: when the customers have demand to borrow capital to

buy unaffordable assets, the Bank can buy the asset and lease them to the customers There are two main forms of leasing which are operation leasing and financial leasing

Stock investment brokers: this is a best service that banks can meet customers'

demands At the moment this service are set up to be a security company to improve professional activities of stock investment brokers

Insurance service: Bank is joint-venture with Insurance Corporations or

Insurance Institutes, banks provide saving service stick with insurance such as welfare, saving, and pension saving

Providing service agents: a bank can provide service agents to other banks as

payment, issue certificates of deposit, as representative in supplying, etc

In general, every basic activity of Commercial Banks, the credit operation is the most important activity, because this activity accounts for 60-70% of portfolio assets and bring primary income for commercial Banks

Credit payment of Commercial bank

Credit derives from Latin means "trust", or in other way it means using trust to make the loan relationships amount of value material or money in the period of time

Credit relationship was understood by temporary transmitting relationship of a mount of value material (formed by money or commodity) from the owners to users after a period of time and recovers a higher value of material than the initial one Credit manifests externally as unilateral movement of the two values together in the opposite direction a particular time

In summary: Credits is considered as the relationships among entities within the economy, in which an entity transfers the rights to use an amount of value (in form of goods or money) to another entity under particular conditions and time that were agreed by them basing on the regulation of returning

When the banks act as the credit intermediate, they are understood as:

+ Banks play as a capital mobilization: Commercial Banks can attract temporary spare capitals such as deposit, and payments, etc, from economic organizations and individuals of the economy at different interest rates

+ Banks play as a loaner: From the mobilized capitals, the Banks shall provide loans to economic organizations and individuals that need capital to recover their business and for domestic uses in the economy

Therefore, bank credit is considered as the debt-credit relationship between the customer-bank, especially in the field of money, in which one party is the economic organizations, individuals and citizens of the economy for a particular time, basing on the rule of returning both the principal and interest timely

Basically, there are some credit activities of Commercial Banks for the customers as follow:

In order to borrow capital, customers have to ensure principles as follows:

Using loan capital for right purposes as agreed in the Credit Contract

Repaying principal and loan capital as timely as agreed in the Credit Contract

Credit shall be considered and lent by the Bank only when the customers

meet following conditions:

Having civil legal capability, legal acting competence and bearing responsibilities as regulated by the Law

Having legal purpose of using loan capital

Having enough financial resource for repaying debt within the time as committed

Having feasible and efficient project or business

Following regulations on loan security as regulated by the law

In general, to minimize credit risks, Banks must never stop diversifying forms

of credit and make them suitable to customer’s demands

Based on different criteria, bank credit may be divided as follows:

 Based on time, banking credit is divided into 3 types

Short-term credit means credit having up to 12-month lending time This kind

of credit is regularly applied for different forms of customer under the form of limited loan or due loan Customer will have one part of property as guarantee for entire the loan

Medium-term credit is credit which has lending time in the range of 12

months to 60 months This is often the form that a bank gives credit to project of purchasing equipment and devices, project of constructing workshop, warehouse, etc Regularly, asset formed by loan capital shall be used as mortgage for the bank

Long-term credit is credit which has lending time up to 60 months or more

This credit form is often given by the Bank to project of purchasing synchronous devices equipment line, project of infrastructure construction, etc Mortgage for this kind of credit is mainly formed from loan

 Based on guaranteeing method, bank credit is subdivided into two types

Asset ensuring for credit enables the bank to have the second earning source

by selling such asset when withdrawing debt from business is nothing or not enough

Secured credit is credit in which debt service obligations of customer are

ensured with pledge, mortgage, and asset formed from loan of customer or secured by asset of a third party This form of credit ensures the bank to be safer, the low risk of losing capital as the bank can selling the mortgage to withdraw capital in force majeure that customer is unable to repay the loan at maturity

Unsecured credit is credit in which debt service obligations of customer is not

ensured by mortgage, asset formed from loan of customer or secured by asset of a third party This form of credit is risky to the bank and is applied for prestigious customers who are trusted by the bank and are traditional or strategic customers of the bank

 Based on risk level, bank credit is divided into group of debts

Qualified debt group (group 1) includes: Undue debt which are considered

able to be withdrawn both principal and interest timely

Debt requiring attention group (group 2) includes: debts which are able to be

withdrawn both principal and interest but appearing signals of declining capacity of repaying by customer

Substandard debt group (group 3) include: debts which are considered by

credit organizations as able to lose principal and interest partly

Doubtful debt (group) include: debts which are in the high risk of lost

Highly losing capable debt (group 5) include: debts which are unable to be

withdrawn and capital is lost

In general, bank credit plays a very important role in economy It enhances accumulation, concentration of capital and reallocates social investment effectively to different area of the economy Credit of one healthy banking system reflects capacity

of absorbing capital of national economy; low risk rate of economy is the condition

that calls for foreign capital for development of the country However, as the bank lend customers in different aspect of business such as construction, industrial production, commerce, consumption, tourism services, etc, capital ownership is temporarily separated from the right of using capital after lending, activeness of the bank, thus, is lowered down and easy become passive against borrower and in the risk

of losing partly or entire capital (Kim Thi Ngoc Diep (2008) Banking Credit, Hanoi:

Financial Publishing House)

Credit risks of Commercial Banks

Definition of credit risks

 Basically, Bank’s credit has the following characters:

+ Credit banking is the loan relationship basing on the rule of returning both seed money and interest between the entity of the Commercial Bank (credit issuer) and individuals and organizations (borrower) of the economy

+ There should have a basis to belief that the borrower shall return the asset in time when the Loaner transfers it to the borrower

+ The returned value should be higher than the lending value, it means the interest should also be paid apart from the principal

 Rules of Bank’s credit:

- Firstly, loan for particular purpose

The purpose for loan should always be stated clearly in Credit contracts between the Bank and the borrowers to ensure that the Bank shall not support illegal activities and that the borrowers use the loan for the right purposes

- Secondly, loan with guarantee

This rule is a guarantee for the loaner, to minimize the capital lost when there

is problem with the loan

- Thirdly, principal and interest should be returned in time

Bank’s credits originate mostly from the deposits of customers and from loans

of the Bank; therefore, the Bank is also responsible for returning both the principal and the interest as committed Hence, when the Bank issues credits, it always asks the receivers to follow commitments as stated in the Credit Contract

As the Bank’s credit is based on the trust in each other in lending and borrowing between the Bank and economic organizations, there are many potential risks in this activity The risk is the possibility of unexpected events happen that cause lost and damage to the assets

The risks always come along with the credit of the Banks In its efforts to gain the interest, Banks cannot avoid risks but only can find ways to make this activity become safer and to minimize the lost by establishing a suitable strategy

According to the opinion of the Basel committee of the Bank for International Settlement: “Credit risk is the possibility that borrowers or partners cannot carry out their responsibilities as committed”

Pursuant to the Decision No 493/QD- NHNN dated 22nd April, 2005 of the Governor of the State Bank of Vietnam on classifying debts and establishing risk contingency fund, “Credit risk of credit agencies in Banking is the possibility of lost happening in banking as the customers do not or cannot carry out their responsibility

as committed”

In general, there are different ways to define credit risk and, in the author’s opinion, credit risk is simply understood as the risk of unrecoverable due debts

Credit risk is reflexed in both the aspects of:

- Quantitative: Credit risk is reflexed by the number and rate of overdue debt, bad debt, etc, of the Commercial Banks

- Qualitative: Credit risk has a contrary relationship with the credit quality It means that the higher the credit quality is, the lower the credit risk is, and vice versa

Credit risk is associated with the credit activity: credit is an important activity

of the Commercial Banks as the value of productive assets allocated to the loans is highest Therefore, on issuing credit, Commercial Banks should analyze the factors of the borrowers to have the safest level including the introduction of methods to minimize credit risk Credit risk affects the activities of the Banks a lot, it can lower the prestige of the Bank, decrease the paying capacity of the Banks, reduce the interest, or even cause looses or bankruptcy Hence, the realization of credit risk manifestation, prevention, limitation, and control of the risk are the priority of the managers in Baking

Limitation of credit risks

 Bad debts:

A bad debt is an amount owed to a business or individual, for which there is zero probability of collection This is not to be confused with doubtful debt which is and amount for which payment is unlikely

A bad debt when it occurs is not a surprising event when is occurs as the debt will have become doubtful almost the instant that payment was refused by the customer and the remedial action required to attempt recovery (Court proceedings, binding arbitration, dispute resolution, etc) take a considerable amount of time to complete

In commercial banking system, banks and creditors can forecast the credit risk based on:

- The Customers ask the Bank to extend their payment terms

- Late in paying salary for workers

- Ununity inside the organization, there is contradiction and fight for power

- Reduction in output and income from customers

- Commercial debts increase extraordinarily

- Late or delaying in submitting financial statement; data in the financial statement are not reasonable and accurate

- Increase in selling but decrease in interest or even having loss

- Customers change the business lines into other lines that are not its sociality

or into high risk business lines

- Unfavorable factor input: increase in input materials’ price, could not import specialized materials, etc

- Use short term loan to support fixed assets, etc

 Overdue debts

The nature of overdue debt in credit activity is that the borrowers could not carry out their paying responsibility to the loaner at the payment time Overdue debt is the most specific manifestation of credit risk Overdue debt is inevitable, but if the overdue debt is higher than the permitted rate, the Commercial Banks shall loose their paying capacity

Basing on the nature and other criteria, overdue debts can be classified as:

- Basing on the recovering capacity

+ Overdue debt whose both principal and interest can be recovered + Overdue debt whose a part of principal or interest can be recovered + Irrecoverable overdue debt

- Basing on the terms of the loans

+ Overdue debt of short term loans

+ Overdue debt of medium term loans

+ Overdue debt of long term loans

- Basing on the overdue time

+ 10 days overdue debts

+ 10 to 90 days overdue debts

+ 91 to 180 days overdue debts

+ 181 to 360 days overdue debts

+ More than 360 days overdue debts

- Basing on the reason of the debts

+ Overdue debts due to the borrowers’ fault

+ Overdue debts due to the loaner’s fault

- Basing on the guarantee of the loan

+ Secured overdue debts

+ Partial guarantee overdue debts

+ Unsecured debts

Classifying and evaluating overdue debts play an important part in establishing methods to recover principal and interest as well as to minimize to the lowest level of the risk in credit activity of Commercial Banks

Credit risks of the Commercial Banks can be affected by both subjective and objective factors In order to get a good credit quality, the activity to minimize the risks should be effective and the credit relationship between the bank and the customers should be established basing on the trust and respect for each other

The action of understanding the nature of credit risks, analyzing, evaluating and identifying correctly the limitations leading to the low credit quality for having methods to overcome it shall help the banks find out suitable mode of operation to survive and develop in the current potential and challenging market economy

Some assessment criteria of credit risk limitation

a/ Overdue debt criteria

Overdue debt balance

Overdue debt ratio = - x 100%

Total credit debt balance

Overdue debt is a debt of which partial or full principal and/or interest has been overdue The overdue debts can be arisen due to such subjective reasons: Weak management ability of the customer, outdated production technology, customers can not adapt to the market and also because of objective reasons such as: the changing of State policy, business risks like disasters, war…The ability to recover overdue debts is also different: debts due to delayed goods payment, temporary difficulties and some customers are in state of production stagnation, heavy losses resulting in the inability

to pay debt

Based on the criteria of delinquency rate may assess the restriction ability in credit risks of any Bank High rate of overdue debt presents that the policies, tools being applied by the Bank to prevent risks are not effective The Bank needs to review the qualities of loans, introduce necessary solutions to quickly recover the overdue debts If this rate is low proving that the Bank’s measures to limit credit risks are effective, however has to tighten regulations, criteria on loaning accordingly to enterprise type and business industry

Commercial Banks currently transfer overdue debts, classify debts, and loss provisioning to deal with risks under the Decision 493/2005/QD-NHNN dated April 22/2005 and Decision 18/2007/QD-NHNN dated April 25/2007 (amending Decision 493) of the State Bank However, to assess accurately the credit risks of credit institutions in general and Banks in particular, it should be based on the ratio of bad

debt Bad debt is identified on the basis of assessing the ability to pay debts, including undue debts

b/ Bad debt criteria

Bad debt balance

Bad debt ratio = - x 100%

Total credit debt balance

As bad debt impacts major to profit of the bank, it should base on the bank bad debt criteria to assess whether the credit risk restriction level being applied by the Bank can provide the security for credit operation or not The higher ratio of bad debt shows that methods to limit risks of the Bank are inefficient; the Management board

of the Bank needs urgent guidance to lower bad debt ratio

Under the Decision 493/2005/QD-NHNN dated April 22/2005 and Decision 18/2007/QD-NHNN dated April 25/2007 (amending Decision 493) of the State Bank

on debts classification, loss provisioning in Banking operation of credit institutions, bad debt ratio over total debt balance is the ratio to assess the credit risk level of credit institution

Debts of Commercial Banks are grouped in 5 categories in which bad debts are classified from category 3 to category 5

 Undue debt (category 1) including:

Debts are not due that are assessed by credit institution to be able to pay the principal and interest of debts in full and in a timely manner

Debts are overdue less than 10 days and assessed by credit institution to be able to pay in full the overdue principal and interest and pay in full the principal and interest in time of the rest

In case the customers have paid the principal and interest in rescheduled maturity at least a year for medium and long term debts, three months for short term debts and it has been assessed by credit institution to be able to pay the principal and interest in full and in time according to rescheduled maturity, credit institution can classify that debt into category 1

 Debts require attention (category 2) including:

Debts are overdue from 10 to 90 days

Debts have been rescheduled the maturity for the first time (to the customers as enterprises, organizations, credit institution must have customer assessment record on ability to pay the principal and interest in full and in time as rescheduled at the first time)

Debts from category 3 to category 4 are bad debts, including:

 Under qualified debts (category 3) including:

Debts are over due from 90 to 180 days

Debts have been restructured the maturity for the first time, apart from the debts rescheduled for the first time that were classified into category 2

Debts of which the interest is made free or decreased as the customers are unable to pay the interest in full according to credit contract

Debts in the category 3 are debts which are assessed by credit institution to be unable to pay the principal and interest at maturity These debts are assessed by credit institution to have potential for partial loss of the principal and interest

 Doubtful debts (category 4) including:

Debts are overdue from 181 to 360 days

Debts that have been restructured the maturity for the first time of overdue less than 90 days according to the rescheduled maturity

Debts are restructured the maturity for the second time

Debts at category 4 are debts which are assessed by credit institution of high potential for loss

 Debts are uncollectible (category 5) including:

Debts are overdue more than 360 days

Debts that have been restructured the maturity for the first time of overdue more than 90 days according to the rescheduled maturity

Debts are restructured the maturity for the third time or more, including undue and overdue debts

Debts are subject for the arrangement from the Government

Debts in the category 5 are debts to which have been assessed by the credit institution to be unable to pay the principal In addition, in case one customer has more than one debt with credit institution in which there is any debt being moved to higher risk debt category, credit institution ought to classify the rest debts of that customer into higher risk debt category in accordance with risk level In case, debts (include undue debts and debts are restructured but still in payment period by the restructured maturity) to which credit institution has enough basis to assess that payable ability of the customer has decreased, the credit institution initiatively decides

to classify these debts into higher risk categories in accordance with risk level

c/ Criteria of frozen debt, forgiven debt (risk settlement debt)

Frozen debt, forgiven debt

Ratio of frozen debt = - x 100%

Total credit debt balance

Frozen debts are uncollectible debts, credit institution will not restructure the payment maturity, not move the overdue debt, not calculate the interest from the moment of deciding to ffreeze the debt; here normally are loans under the State

policy, loans under the Government’s assignment and being allowed by the State for temporarily “freeze” for later settlement

Forgiven loans are loans having no source to recover the debt (including ensured property), after a certain period of time when the loan has been dandled the risk to which the bank is unable to recover the debt in spite of having used different measures, it is allowed to be forgiven

Ratio of bad debt, frozen debt, forgiven debt arising makes the bank establish risk reserves for such loans and account them into business operation cost so the bank’s profits have been declined; even if the ratio of frozen debt and forgiven debt is big, the bank will be at loss or bankrupt Therefore, base on this criterion the bank can assess measures to limit credit risk being applied by the bank to be suitable or not, really reduce the risk of Bank’s capital loss or not

d/ Criteria of property ensured credit debt

Property ensured credit debt balance

Property ensured credit debt balance ratio = - x 100%

Total credit debt balance

Banks to consider the loans for customers not only focus on ensured property but mainly base on financial capability, business operation, measures and investment project of the customers However, in case risk occurs, unprofitable business operation, inefficient investment project, inability to pay debts, if the customers have ensured property for loan, Banks can sell the property to recover debts Therefore, this is one of important criteria reflecting risk restriction level of Commercial Banks If the ratio of property ensured credit debt balance is higher, the safety level of the capital is higher; on the contrary, the ratio is lower showing that the risk of inability to recover capital of the Commercial Banks is at high level Or in other words, the property ensuring for the loan is higher, the occurrence of credit risk is lower It is the dialectical relationship in credit relation

e/ Credit risk reserve

“Risk reserve” is the amount of money to be set for loss provisioning that can occur as the customers of credit institution do not follow the commitment The loss reserve is calculated on the basis of the principal of debt and is treated as operating expenses of credit institutions Risk reserve includes: Specific reserve and General reserve

Specific reserve is amount of money established on the basis of classifying debts to reserve for possible losses

General reserve is amount of money established to reserve for unidentified losses in the process of classifying and setting specific reserve and in cases of financial difficulty of credit institutions when the quality of credit debts decreased

So, the nature of risk reserve aims to limit loss occurring to the Bank when it cannot recover the loan capital However, if the risk reserve is big proving that the method to limit credit risks of Bank operates inefficiently which leads credit activity

to meet many risks as the debt is classified into higher debt category, the ratio of establishing risk reserve is higher The Decision 493/2005/QD-NHNN dated April 22/2005 and Decision 18/2007/QD-NHNN dated April 25/2007 (amending Decision 493) of the State Bank regulates the ratio for risk reserve for specific debt category of Commercial Bank:

Particularly to the debts which are subject for arrangement from the Government can be established risk reserve in accordance with concrete financial ability of credit institution

Besides, there are some other criteria such as the density of bad debt in the total of overdue debts, ratio of suspension interest, credit loss… also commonly used

to reflect the level of credit risk

The capacity of credit staff

In all areas, human is the decisive factor In banking sector, people with qualification, capacity, thinking ability and professional ethics is always the major factor for the limitation of credit risk Credit staffs have to handle daily with changing operations, so they need to be selected carefully, arranged logically, to be trained methodically and to meet some following standards:

Must have the economic, scientific, technical and social knowledge and have thorough grasp of banking specialties

Must be ethical, conscientious and highly professional liability

Must have the professional spirit and experience

In lending operation, credit staff sometimes easily arise subjective thinking while checking the legal dossier of customers, analyzing financial capability, business

operation, business area of customers, appraising cursorily, having problem with profile, lack of inspection and control or not understand appropriately about law, market economy…so they identify incorrectly the efficiency of the project and payment ability of customers leading to highly potential risk in lending operation of the Bank Moreover, the information that the Bank received or provided by the customers sometimes is not proportionate also leading to inaccurate conclusion of

credit staff (Tim Powel (2005) Credit activities of Commercial Banks, Ranger:

Roudledge Fringe Book)

Information quality

The loans to each type of customers often have difficulties in collecting sufficient information about the competitiveness of customers, financial capacity, management, business ability, reputation of customers… it leads to wrong assessment about customers or being defrauded and abused by customers Therefore, having a lot

of accurate, timely information is an important factor to win the competition When deciding to grant credit, the bank has to gather information from many different sources Quantity and quality of the information collected relating to the accuracy of the analysis, the identification of market situation, customers… to make right decisions The more accurate, sufficient, timely information is the higher ability to prevent risks in credit activity

Internal inspection, control

The internal inspection, control in credit activity is extremely important It is also a tool, an “ear and eye” for the leaders to know about business situation of the machinery; to detect errors, unsuitability, potential signs of risk in credit operation in order to produce solution methods, risk limitation to improve operation quality and lending quality In credit term, inspection and control activity includes: