consumer lending - the case of techcombank = cho vay tiêu dùng trường hợp của techcombank

LIST OF FIGURES AND TABLES Figures Figure 1.1: Credit process Figure 2.1: Techcombank‟s Current Approving Process Figure 2.2 : Techcombank Outstanding of Cunsumer and Commercial Loans

VIETNAM NATIONAL UNIVERSITY, HANOI

SCHOOL OF BUSINESS

HOÀNG MỸ

CONSUMER LENDING IMPROVEMENT –

THE CASE STUDY OF TECHCOMBANK

MASTER OF BUSINESS ADMINISTRATION THESIS

Hanoi, 2010

TABLE OF CONTENTS

ACKNOWLEDGEMENT

ABSTRACT

TÓM TẮT

TABLE OF CONTENTS

LIST OF FIGURES AND TABLES

EXECUTIVE SUMMARY

INTRODUCTION

1 Background to the issue ……… 9

2 Problem Statement and Research Objectives of the study 10 3 Scope and Limitation of the Research ……… 11

4 Research Methodology ……… 12

5 Research Structure ……… 12

Chapter 1: COMMERCIAL BANK’S CONSUMER LENDING - THEORETICAL FRAMEWORK FOR ANALYSIC 1.1 The Basis of Bank Lending ……… 14

1.2 The Basis of Consumer Lending ……… 17

1.2.1 The Concept of Consumer Lending ……… 17

1.2.2 The Nature of Consumer Lending ……… 18

1.2.3 The Types of Consumer Loans ……… 19

1.2.4 The Effects of Consumer Lending ……… 24

1.2.5 The Factors Impacts on Consumer Lending ……… 25

1.3 The Process of Consumer Lending……… 27

1.3.1 Receiving application and collecting information ……… 28

1.3.2 Evaluating applications ……… 29

1.3.3 Approving loans ……… 32

1.3.4 Managing and collecting loans ……… 33

1.4 Precautions to be taken in granting consumer loans … 34

1.5 Pricing and structuring of consumer loans 35

1.5.1 Loan pricing ……… 35

1.5.2 Loan structuring ……… 37

1.6 Consumer Lending Quality ……… 37

1.6.1 Consumer Lending Quality from Different Perspectives 37

1.6.2 Measuring the Quality Consumer Lending ……… 39

Chapter 2: CURRENT SITUATION OF CONSUMER LENDING AT TECHCOMBANK 2.1 Techcombank profile ……… 44

2.1.1 History and Development ……… 44

2.1.2 Vision and Mission ……… 46

2.1.3 Techcombank‟s Organization ……… 46

2.1.4 The Products ……… 47

2.1.5 Achievements ……… 47

2.2 Current Situation of Techcombank’s Consumer Lending 47 2.2.1 Consumer Lending Process ……… 47

2.2.2 Consumer Lending Quality ……… 52

2.2.3 Quality of consumer loans ……… 56

2.2.4 Quality of Service ……… 58

2.3 Assessment of the Techcombank’s Consumer Lending Quality ……… 62

2.4 Development Trend of Techcombank’s Consumer Lending ……… 66

Chapter 3: CONCLUSIONS AND RECOMMENDATIONS 3.1 Conclusions ……… 68

3.2 Recommendations ……… 69

3.2.1 Developing the Outstanding of Consumer Loans ……… 69

3.2.2 Increasing in Capital Mobilization ……… 70

3.2.3 Clarifying the Responsibility of Professional Divisions … 70 3.2.4 Applying and Revising the Credit Scoring System ……… 71

3.2.5 Applying Up-to-date Technology and Modern Equipments 72 3.2.6 Following Some Tactics in Evaluating Applications and

Mitigating Credit Risk ……… 73 3.2.7 Expanding the Key Performance Indicators (KPIs) ……… 74 3.2.8 Increasing the Quality of Information Provided by the Credit

APPENDIX 2- TECHCOMBANK ORGANIZATION CHART

APPENDIX 3: TECHCOMBANK‟S PRODUCTS

LIST OF FIGURES AND TABLES

Figures

Figure 1.1: Credit process

Figure 2.1: Techcombank‟s Current Approving Process

Figure 2.2 : Techcombank Outstanding of Cunsumer and Commercial Loans

Figure 2.6: Level of Techcombank meeting clients‟ expectation

Figure 2.7: the ratio of Non-performance loan/ outstanding of Techcombank

2007

Tables

Table23.1: Some Main Figures of Techcombank

Table 2.2 : Techcombank‟s outstanding of consumer and commercial loans Table 2.3: Techcombank‟s non-performing loan situation from 2005 to

2008

Table 2.4 : Portfolios and quality of consumer loan on products in 2008

EXECUTIVE SUMMARY

This research mentions to both theory and empirical study of consumer lending After revising the basis of bank lending, the basis of consumer lending including concepts, nature, types, effects of consumer lending and impact of technology on consumer lending, is focused The common process

of consumer lending is deeply researched in the writing containing four stages such as Receiving application and Collecting information, Evaluating application, Approval and (Managing and Collecting loans At each stage, the readers can approach concise matters of the procedure which is implemented by banks from the beginning to the end of consumer lending process Especially, the thesis also analyses and compares the two primary methods of evaluating loan application such as judgmental analysis and credit scoring system Next, the precautions to be taken in granting consumer loans, the pricing and structuring loans are also mentioned The quality of consumer lending is paid much consideration by the author Additionally, the writing discusses the quality of consumer lending and several quantitative and qualitative criteria to measure the consumer lending quality Moreover, based on the study of the process and quality of consumer lending, the thesis raises a case study of the Vietnam Technological and Commercial Joint Stock Bank (Techcombank) in order to better understand the circumstance Follow the overview of Techcombank, the writing mentions to the consumer lending process, quality as well as the assessment of its customer lending performance Lastly, some recommendations for a development of Techcombank’s consumer lending in terms of market, procedure and quality are proposed

INTRODUCTION

1 Background to the issue

Based on the aim of credit using, financial institutions divides their credit portfolio into two types of loans namely business loans and consumer loans Business credit is credits supplying for customers to support their business activities such as building workshops, purchasing machinery, materials or goods or other expenditure in trading and producing process The subject of main customers of commercial loans is enterprises Besides, financial institutions also provide loans to individuals or their families to help them cover living cost as medical fee, learning expenses, buying houses, cars or motorcycles, etc called consumer loans The second type of lending activity

is also the subject of the research

When income and living standard increase, it certainly leads people to the change in spending habits, thus they are oriented to spend more Again, consumer debt is an element encouraging the economy growth Since the 1920s, American manufacturers have relied ever-increasingly on consumer loans to absorb the tremendous productivity increases of mass production, in other words, consumer credit made mass consumption possible To financial institutions, consumer lending is of the most profitability with reasonable risks

Vietnam has witnessed a high growth rate of people, improved average earnings and considerable changes in spending behavior of individuals in recent time In particular, the young age people who have a stable occupation and income, demands in more consumptions Therefore, looking for the financial solutions such as bank‟s consumer loans is completely understandable Identifying that market trend, understanding the role and prosperity of this lending category, banks continuously increase the

proportion of consumer loans in their credit portfolio Nevertheless, for a firm development of consumer lending, it is vital for Vietnamese commercial banks to have overview and deep insight in consumer lending activity, in order to evaluate the quality of the bank‟s consumer lending situation and give out some prompt and reasonable solutions

In this context, the Vietnam Technological and Commercial Joint Stock Bank - Techcombank is selected as a case study for this research Techcombank is customer driven institution supplying a wide range of high quality services to customers In terms of individuals, Techcombank provides a variety of financial services including demand deposit accounts, savings, loans, payments, credit and debit cards, investment, guarantees, and safe custody facilities The key products to these customers are cards, personal loans, and home loan These assets obtain over 30% of Techcombank‟s loan portfolio However, along with the current rivals and new comers of advanced technology, professional management and sound strategy, this bank will be under the pressure of harder competition Given these facts, it is necessary for the bank to clearly define weaknesses and strengths of its consumer lending performance and address suitable solution for not only the improvement of consumer lending quality but also the expansion of this activity

2 Problem Statement and Research Objectives of the study

Obviously, the consumer lending is implemented by almost commercial banks However, there is a lack of efficiency in this activity, for instance, complicated procedure, time-consuming lending process, shortage and imperfection of information, lack of regulation, inexperienced staff, poor loan monitor, etc The consequences are high proportion of un-performing loans and risk problems of capital loss And Techcombank is a bank of high percentage of consumer loans in the credit portfolio and individual

customer‟s targeting, the research attempts to explore the process and the quality of consumer lending, thus, propose some recommendations through analyzing a case study of Techcombank The research objectives are:

To review the fundamental issues related to consumer lending in order to study the necessity and complexity of controlling quality of consumer lending;

To enumerate the precautions to be taken in evaluating consumer loan applications;

To analyze the current situation of Techcombank‟s consumer lending in order to identify the problems exisiting and new findings regarding to the consumer credit activities and quality controls; And finally, based on these new findings and the development trend of the Techcombank,

To propose some solutions and recommendations to improve the quality of consumer lending and to expand the bank‟s consumer lending market in the future

3 Scope and Limitation of the Research

The research focuses only on the literature of consumer lending and process

of consumer loan applications It does not cover the business lending or commercial lending of financial institution

Consumer lending is carried out by most financial institutions, however, the research is aimed at examining only the process and evaluating the quality of the consumer lending through a specific case of the Vietnam Technological and Commercial Joint Stock Bank; other financial institutions are excluded The quality of data is not updated enough (for analysis the Techcombank performance, the data is collected from up to the year of 2008)

Data used for assessing consumer lending quality is not sufficient because information is extracted from the bank‟s survey, not the author‟s survey Only secondary data is used for this writing

4 Research Methodology

Research Approach and Strategy: The paper uses the inductive approach,

in which data are collected, analyzed and interpreted to answer the research questions The researcher has chosen the research strategy of carrying out a case study, which involves an empirical investigation of a particular bank, Techcombank It allows the researcher to gain a rich understanding of the on-going consumer lending performance of a

Vietnam‟s commercial bank within its real context

Data collection methods: The study exploits the secondary data which are

acquired through official data records of the selected bank, bank‟s profile, bank‟s former research findings, bank‟s business reports, and individual customer satisfaction survey of Techcombank Magazines, newspapers and Internet are among other potential sources of secondary data

5 Research Structure

Given the research objectives, the study is organized as follows:

Introduction: This chapter includes the background of the study, problem statement, research objectives and methodology used to obtain data and information, scope and limitation of the research

Chapter 1 – Theoretical Framework: This chapter provides a theoretical framework for the study of bank lending in general and consumer lending in particular The chapter also emphasizes on how commercial banks process consumer loan application and how they measure the quality of their consumer lending activity

Chapter 2 – Case Study of Techcombank: This chapter identifies the current performance of consumer lending in Techcombank; and analyzes the procedures of processing consumer loan which are implemented by related departments Apart from an illustration of the Techcombank‟s current approving process, a comparison of the Techcombank‟s consumer lending quality with the benchmark (the Hong Kong and Shanghai Bank Coporation)

is implemented to investigate strong and weak points of the bank Especially, the quality of consumer loans of this bank is also assessed by the customer satisfaction survey conducted by the bank itself

Chapter 3 – Conclusions and Recommendations: This chapter provides conclusions and suggestions on the issue to the readers for their own assessment Conclusions on the issue are summarized; recommendations for improvements and expansion of consumer lending of Techcombank and other banks are listed The chapter also concludes the limitation of the paper and gives recommendations for further research

1.1 The Basis of Bank Lending

Financial intermediation is the focus of lending It is the process of how surplus funds are collected and then dispersed through the financial markets, from surplus units to deficit units For many decades, primarily banks carried out this function

The basic principles of good lending are safety of loan, suitability of loan purpose and profitability (Weerasooriya, 1998)

Safety of loan- This principle requires that a loan is granted to only that

borrower who is considered safe A safe borrower is one who is of good character, is financially sound and has the ability and willingness to repay the loan In addition, the lender should account for meeting an unexpected emergency Such an emergency could arise when assumptions about the borrower turn out to be wrong, or when circumstances change so dramatically that assumptions made when the loan is made do net remain relevant Lending institutions wherefore often require a back-up for the loan

in the form of collateral security The collateral serves as a safety valve or insurance against unforeseen developments

Suitability of loan purpose- a loan can be given for any valid purpose A

valid purpose is one that is legal and conforms to the lending policy of the

bank A bank cannot lend for an activity that is not legal Can you imagine a bank giving a loan for an illegal activity, such as the heroin trade? It cannot, because such trade is not legal Other purposes for which a financial institution cannot lend include gambling If a bank starts financing gamblers, then it world soon go into liquidation! Suitability of purpose is also important for the safety of the loan If a loan is granted for an illegal purpose, then the lender may not be able to recover the money because the case may not stand in any court of law A purpose may be perfectly legal and valid, yet a lender may still refuse to finance it This may occur where the loan purpose is outside the lending policy of that institution

Profitability- Financial institutions are in the business of lending to earn

profits Lenders will compare the cost and benefit of a loan before granting

it Interest on loans and advances is a major source of income for any bank Lending institutions must carefully weigh the risks and returns from a possible loan This raises the issue of appropriate pricing of loans, as well as that of minimizing loan costs

Indeed, loans should be given to borrowers of good character and good creditworthiness, for approved purposes, and result in profit for the bank Whether the purpose of a loan is for meeting personal needs, financing small business, financing a dairy activity or financing an export trade, the principles of lending still apply Again, whether the loan is for an amount of

a few thousand dollars or may million dollars, the principles of lending still apply To follow these principles, financial institutions undertake credit analysis of all loan proposals

On the contrary, lending is often regarded as an art and not a science because lending needs much practice, so experience counts A top banker in Australia once said that anyone can lend, but it is lending money and ensuring its repayment in time together with interest that distinguishes between a good

banker and a bad banker When making a loan, credit officer is dealing with people and it is almost impossible to predict how someone will behave in future It is crucial therefore that lenders exercise sound judgment while granting a loan However, the principles are not laws of physical science that must hold whatever be the case; rather, the principles serve as a framework within which to make a decision

Lending decisions are taken within a framework of external factors such as macroeconomic policies, monetary policies and other regulatory restrictions; internal factors such as lending institutions‟ strategic objectives, lending programs and staff availability; and borrower - specific factors such as character, capacity, capital, conditions, and collateral (Sathye, et al., 2003) Principally, there are broadly two types of borrower: personal borrowers and business borrowers Individuals and households are considered to be personal borrowers Business borrowers may take many forms, including a sole proprietorship, partnership, limited company and so on There are also special types of borrowers, such as schools, clubs, and literary societies Additionally, in a lending institution, credit culture is very important It means the institutional priorities, traditions and philosophies that surround credit or lending decisions Credit cultures vary among banks For instance, some banks have a higher tolerance or willingness for risk than others The level of risk-taking in the loan portfolio is determined in part by the bank‟s possibilities for loan diversification as well as by management‟s objectives

In shortly, the lending function is among the most important activities, if not the most important activity, of a financial institution It provides income and cash flow run-off that can be allocated to new asset creation and ultimately allocated as year-end profit Poor lending can lead to doubtful or bad debts and, therefore, adversely affect the results Some write-offs are unavoidable because the reason for the loss arose after the advance A large proportion is

avoidable, however, if care in the analysis and approval process is increased and if awareness of the real causes of loss is generated A large body of evidence suggests that up to 30 per cent of all loan write-offs are bad at the time of approval; the lender just failed to notice or failed to correctly analyze the customer It is important to understand that only a small proportion of loan failures result from fraudulent actions; there is more danger from errors

in the loan approval process than from a loss due to fraud

1.2 The Basis of Consumer Lending

1.2.1 The Concept of Consumer Lending

Consumer lending generally refers to the loans that individuals or households require to meet personal needs such as travel or the purchase of furniture, household appliances, motor vehicles or homes Weaver and Shanahan (1994) state that „consumer finance is a broad term covering lending to personal rather than business or corporate customers, for a wide variety of worthwhile purposes‟ They state that the most common forms of consumer lending are personal loans and credit cards According to Fischer and Massey (1994), „consumer credits are loans to individuals for private, non-business purposes used to finance the purchase of consumer durables and services, including motor vehicles, home improvements, daily life expenditures, travel expenditures and paying off other debts for private consumption, but excluding home investments, such as the purchase of a residential property or financing the repayment of a mortgage or a small part

of the capital borrowed‟

Consumer loans may be defined as types of loans made to finance consumption, rather than productive purposes

1.2.2 The Nature of Consumer Lending

Scale of individual business is usually small while the cost related to this matter is rather high, therefore, consumer credit interest usually higher than commercial credit

Consumer needs depend on the national economic situation As commodity prices increase, people will tighten their purse-strings Moreover, if the national economy faces more difficulties, the financial institutions also face higher risk in consumer credit In contrast, economic development improves life quality and pushes up consumer credit

Income and collateral also affect consumer spending behaviors High income people prefer to consumer loan and the banks give priority to those customers because of their higher probability of repayment of interest and principal

It is hard to evaluate ethics of clients as it is qualitative assessment, credit officers usually base on their feeling to judge customers Hence, the sensitivity and experience of credit staff are very important for quality of consumer loans

Although innovations in the financial services industry during the last couple

of decades have boosted the variety of credit available to consumers, bank loans (installment loans and credit cards) continue to be an important source

of credit

Across time, banks‟ supply of credit varies in accordance with changes in consumers‟ credit quality If bank credit standards remain constant over the business cycle, supply will decrease during recessions as consumers‟ balance sheets deteriorate However, supply may also decrease if banks experience a shortfall of funds

1.2.3 The Types of Consumer Loans

In the consequent fierce competition in the consumer loan market, banks have devised credit plans to accommodate the financial needs of the consumers There are several different types of consumer loan These loans can be classified by purpose, by the term of the loan, by the terms of repayment or by security If we consider purpose-related categories, consumer loans include loans for the purchase of residential homes, investment properties, holidays, higher studies, household furniture, cars, shares and many other such purposes If we categorize consumer loans by the term of the loan, consumer loans include short-term loans (loans generally for a period of up to one year), medium-term loans (loans for a period of one to five years) and long-term loans (loans for a period of more than five years) Yet another classification is by the mode of repayment: installment loans are short-term to medium-term loans that are repayable in monthly or quarterly installments, while non-installment loans are drawn by consumers to meets an emergency and generally are repaid in one lump sum The use of security is a further classification When a loan is given against a security of a property of the borrower, it is called a secured loan In a secured loan, the credit provider enjoys rights conferred by contract over the property, which are exercisable in the event of the customer‟s default under the credit contract (Duggan & Lanyon, 1999) When a loan is given without obtaining security, it is called a clean loan or unsecured credit

In this writing, consumer loans are divided into three major types including personal loans, home loans/real estate loans and credit card loans

Personal Loans

Households generally require personal loans for the purchase of items such

as furniture, home appliances, and motor vehicles These loans may also be

in monthly or quarterly installments that extend over two to five years and carry a fixed rate of interest In recent years, variable interest rate personal loans have become more common Some banks in the United States have set

up separate finance companies to handle these types of loan, because finance companies can give riskier loans than those of banks, which may be restricted by regulations Personal loans can be negotiated with banks directly; that is, the borrower visits the bank, submits a loan application and obtains a loan, which he/she then uses for buying the desired asset Alternatively, banks may indirectly give these loans A motor vehicle dealer, for example, may enter into an agreement with the bank whereby the bank may provide finance to the dealers‟ customers (called auto-finance) The dealer will obtain a loan application from the customer, negotiate terms of the loan with that customer and then present the application to the bank Personal loans could be installment loans or non- installment loans Installment loans, the interest the principal are repaid in equal monthly or other such installments, as agreed by the bank and the customer These loans could be secured or unsecured The security for an installment loan is generally the asset (a motor vehicle) purchased out of the loan Unsecured installment loans are given to borrowers with a high credit standing who have been customers of the bank for a long time

Personal loans can be overdrafts or non-installment loans Overdrafts are also known as revolving line of credit Overdraft literally means an overdrawing of the account The bank allows the customer to withdraw amounts larger than the credit balance in the account It will charge the customer interest on the over drawn amount In non-installment loans, the entire loan is repayable in one lump sum or could be in the form of a line-of-credit facility Such loans are usually of a relatively small amount and repayable in a lump sum in a period of around one month These types of

loan are often given to finance a holiday, to meet medical and hospital care expenses or to pay for home repairs

Home Loans or Real Estate Loans

Loans that are made for financing the purchase of a home or to fund improvements to a private residential block come under the general category

of home loans These loans are also called residential mortgage loans or real estate loans, and are often made for longer periods of time, ranging from ten

to thirty years (In Vietnam it ranges from ten to twenty years) They are secured by the mortgage of the property against which the loans are made Home loans are such a special class of consumer loans They require a reasonalble understanding of property laws, mortgage underwriting practices, mortgage insurance, financial analysis, property valuation principles, tax law, investment analysis and the home loan market Home loans can be broadly categorized into loans for owner-occupied properties and loans for financing and investing in income-producing properties The distinction is important because the repayment of these two types of home loan is expected to come from different sources Owner-occupied home loans are generally paid out of the household income of the owners, while investment home loans are generally repaid out of the rental income of the property Accordingly, the repayment capacity of an applicant is assessed differently in these two types of loan

Secured housing finance is the largest single type of personal loan This form

of advance has a number of distinct features, including longer maturity, repayments in equal month installments, low risk compared with that of other types of consumer loan (because the property is collateral), a well-established system of financing, and high income from fees Home lending is

a lucrative portfolio for banks

Interest rates on loans generally take two forms Fixed interest rates do not change over a set period, the interest rate remains fixed for one year, three years or five years Generally, fixed interest rates are higher than variable interest rates, because the lender is bearing the interest rate risk Where fixed interest rates are charged, repayments are set for the duration of the loan period, regardless of any movement in market interest rates Banks issue variable rate consumer loans, for which the interest rate varies as conditions change in the market In Vietnam, almost banks calculate loan‟s interest based on interest rate of saving accounts of the 12 month term plus a margin and the rate changes periodically

In accordance with the development of the financial market, the home loan products become more sophisticated with line of credit loans and home loans with redraw Line of credit loans are any loan with a fixed limit (the amount

of funds can be borrowed) the borrowers are able to withdraw funds up to the limit A fixed limit will not change unless the borrower and the lender agree to change it The borrowers are usually required to make payments to

at least cover the interest and fees on the loan In the United State of America, most home loans now come with the option of redraw, so called home loans with redraw This means that the borrower can access any additional funds paid into the home loan This type of loan is different from

a line of credit loan, as the limit is not fixed The limit on the loan decreases each month by the amount of the borrower‟s scheduled repayments One enormous advantage with redraw is that the borrower can place his savings

in his home loan, save on interest costs and be able to withdraw that money

if needed The disadvantages of redraw and line of credit loans are that the draw funds are very tempting (to spend) In effect, most home loans now operate like an overdraft account and it is easy to end up with no additional

payments made, or in the case of credit loans, find that your loan is not reducing at all

Credit Card (Loans)

Credit cards are fast becoming popular as a means of meeting personal financial needs Although several banks and nonbank credit card companies issue credit cards, two credit card companies stand out from the rest: MasterCard and Visa Most banks operate as franchises of these two companies The franchising arrangement is useful for a bank because the bank‟s card is accepted at most retail outlet all over the world

Credit cards are generally linked to bank accounts of the customers, who are required to pay only a fraction of their monthly bill to keep the card going The balance is treated as a loan on which an agreed interest rate is charged The customer can pay the entire amount due any time to save interest Credit card offers their holders access to either installment credit form or non-installment credit form The holder can use card to purchase goods and pay off the charges according to the bills period, in this case, they are not charged They also choose to pay by installment monthly until settlement; in this case, interest paying is requirement

Beside many advantages to customers (convenience, monthly summary, financial freedom, quick and easy procedure, low credit card fees, electronic bank devices), credit cards offer several advantages to the credit card issuer

 Higher risk-adjusted return than that from other types of loans- The

studies of credit card industry in the mid to late 1980s in the United States showed that the average rate of return on equity for credit card lending was 60-100 per cent, whereas the average rate of return on equity for banks was only 20 per cent (Evan & Schmalensee, 1999) Card issuers receive income from three sources: annual fees, interest

on unpaid balances after the lock-in period and the discount charged

to merchants

 Huge market- The market for credit cards is ever expanding and the

competition for a larger market share is fierce among credit card providers

 Profitability- Credit cards signify a profitable source of income for

banks

 Expanding services- Credit cards enable banks to expand their

operations nationwide without the need to open branches Further, once the customer details are available on the bank‟s database, these can be used to cross-sell other products such as mortgages or insurance

There is also a down side to issue of credit cards: the issuing bank has to bear the risk of loss or fraud arising out of the credit card transaction The United States has witnessed much larger losses on credit cards than on other types of loan Consumers often spend more than what they can reasonably service out of their income

1.2.4 The Effects of Consumer Lending

According to recent studies, consumer credit is often of the most profitable assets of financial institutions These loans are often priced at a high interest rate due to the assumption of its higher risk Banks satisfied a large market when most consumers purchase first, then sponsorship is arranged Thus, bank can achieve substantial earnings, especially increase of earning as well

as present consume expenditure Indeed, many well-known banks of the world such as Citicorp, HSBC, and ANZ have been directing its business toward consumer lending, especially in marketing of credit card, home loans) and electronic consumer services via its world-wide branches

Consumer lending benefits the stakeholders in the economy It is carried out

to sponsor for consumer itself, one of the upward tendencies in recent decades Thus, it can be compared with producing loans or other assets transaction of a bank In two consumer groups of a bank, personal consumers have more and more borrowing demand It is not only a method to meet urgent demands but also a mean to improve their living standard when they cannot afford to pay As a result, consumer credit benefits retailers‟ sale, manufacturers, and consumers and encourages the economic growth

Last but not least, consumer lending was also used as a monetary tool of the macro economy In the recession, government can reduce some credit conditions to encourage credit granting from financial institutions in order to push the whole economic activities

1.2.5 The Factors Impacts on Consumer Lending

External Factors

Government regulation and the actions of government may have an impact

on individual expenditure, thus, the consumer lending changes For example, the decrease in import-tax levied on cars may encourage people for purchasing cars As a result, the product of car loans will increase dramatically

Technology advances are another external influence In recent years, technology has affected many aspects of financial institution management The lending aspect is particularly suited to the use of technology Consumer lending has involved a growing use of technology Financial institutions are using technology to sell consumer lending products and services receive loan applications, process loan applications, advise approval/rejection, and follow

up and monitor loans A customer can obtain all the information needed to make a borrowing decision in the comfort of his/her home, either over the

telephone or online The main impact of technology, however, has been in the delivery of financial services to consumers Technology has opened up a range of alternative delivery channels, including telephone credit approvals, mobile banking, sophisticated kiosks and Internet banking It has helped the development of new products by allowing wider access to redraw facilities and equity access loans It is stated that technology has lowered the barriers

of entry to financial markets generally and with respect to credit products in particular Additionally, the impact of technology is being felt particularly in three areas: retail payments and financial service distribution channels; risk management and data assessment; and the conduct of markets and exchanges Present trends show that the use of technology in banking, particularly in consumer lending, will continue to grow

Changing customer preference is also an external pressure The modern consumer is more fickle than clients of the past and more likely to change service providers if unhappy Is the borrower producing a product that the market no longer wants? A good loan manager will identify this catastrophic event before the customers From an institutional viewpoint, loyalty is not a common word in the financial community of today Institutions striving for market share have created a competitive environment that detrimental to the maintenance of a long-term client base Lender must strive to ensure the customer is serviced within the lending guidelines, while fostering an ongoing relationship with current customers and approaching new ones Successful loan officers will have detailed knowledge of the external environment facing their customers and, in some cases, may be able to identify and suggest several recommendations

Internal factors

The strategy of each commercial bank also affects on the expansion of consumer lending For example, the Bank for Foreign Exchange of Vietnam

focuses on granting business or commercial loans while the Vietnam

Technology and Commercial Joint Stock Bank targets individual customers

Pricing is another factor impacting on the consumer loan outstanding

Competitive interest rate and reasonable fees and charges can be an

important decisive factor for bank to attract customers, especially the

individual borrowers

Procedures and process of loan application need to take consideration as well

because customers prefer to be served professionally

1.3 The Process of Consumer Lending

This process presents a step-by-step approach that is generally followed

while assessing a consumer loan, thus, it is helpful to grasping the essentials

of valuating consumer loans Many steps are common to all type of loan,

although some of the details may vary The four steps in basic credit process

consists of receiving application and collecting information, evaluating

application, approving loans, and managing and collecting loans

Figure 1-1 Credit process (Source: Oestenchide Nationalbank)

1.3.1 Receiving application and collecting information

At some point during the loan application process the loan applicant is requested to complete a loan application The information on this form is used to make inferences about the applicant‟s capacity and willingness to repay the debts The information also may be useful in determining the bank‟s risk exposure and potential credit prices or interest rate In this step, the prescribed application form from the prospective borrower Ensure the applicant has provided full details in all sections of the loan application, for instance, credit purpose, credit history, occupation, income, marital status, number children of family, and accommodation, etc The borrowers‟ monthly income need to be confirmed by their employers and investigated

by banks‟ credit officers The information of credit history of customers always collected through local Credit Information Centre – the professional organization in recording and providing such information

It is important to ensure the applicant has signed the application and accepted various disclaimers, such as authority to give information to the Credit Information Centre (in Vietnam) or to the Credit Advantage (formerly the Credit Reference Association of Australia), authority to obtain certain information and verify personal details, and authority to exchange information with other credit providers as required under the banking legislation

Applications can be received by telephone or mail or at the branch The development of a selling network of financial market and technology has created more convenience for customers to get consumer loans However, each method of information collecting shows its advantages and disadvantages Information collected directly by interviewing customers is more exactly and credit officers may have a better knowledge of borrowers,

even the information not mentioned in the application form Nevertheless, indirect channels such as bank‟s agents, dealers help expand customer network rapidly due to their broadly distribution However, the agents will provide loans according to bank's standards requirements Additionally, the electronic distribution has become more easily and safe for customers to access bank loans Just staying home, customers can apply loan online It helps save time and expenses; therefore, this indirect method is more popular

in the developed countries

In Australia, applicants must be residents and preferably are residents of the service area of the branch The lender should ensure the application is fully completed In particular, the full name and address of all the borrowers, information about employment of the borrowers (such as designation, contract term, salary, tax and other deductions) and living expenses should

be obtained The Privacy Act (Commonwealth Government legislation) applies to all consumer loans It requires that credit checks cannot be done without written permission from the prospective borrowers All parties to the loan contract, including guarantors, have to sign the authorization to carry out credit checks In case of applications over the telephone, verbal authority should be obtained and then written authority should be taken before loan approval and kept on record

Dependents noted on the application must include children from a previous relationship for whom the applicant pays child support If the applicant is not

an existing customer of the bank, then it may be appropriate to open a savings account first, after following the usual precautions It is important to obtain documentary evidence to support all the information given in the application

1.3.2 Evaluating applications

There are two primary methods of evaluating a loan application such as judgmental analysis and credit scoring system

Judgmental analysis is traditionally used by banks The lending officer of the bank subjectively interpreted the information provided by the applicant, keeping in view the bank‟s lending policy, and decided to accept to accept or reject a loan Banks thus relied on the judgment of their officers, who were usually given adequate training before they started as lending officers Judgmental lending was not only subjective but also time consuming The cost of credit assessment was considerably high, given that the number of applications one could assess in a day was limited Successful use of the judgment analysis method depends on the evaluator having complete and accurate information Institutions relying primarily on this method to evaluate loans spend considerable energy evaluating the accuracy of the disclosed information and search for non-disclosed information Considerable effort is spent validating the application‟s accuracy in order to ensure that the lending decision is valid

Credit scoring models are relatively new and have been used extensively only since World War II (Linda, 1992) In present, financial institutions mostly use the credit scoring models where certain points (scores) are allotted for each piece of information that the borrower provides The sum of all these points is compared with a cut-off score Credit scoring does not rely

on the accuracy of the information on the loan application; however, it is based on consistency The scoring method quantifies the response (or non- response) to each of the application‟s questions in order to differentiate at least two classes of applicants (usually “good” or “bad”) The benefits of credit scoring models allegedly include better decision making, compliance with fair lending requirements, designed consistency of decisions, the ability

to quantify various credit risk variables, thus allowing changes hurdle rates

to either increase or decrease approval rates It is claimed that their use reduces bad debt loses, that more consumers are granted credit, and that organizational consistency in decision making is achieved Further, the costs

of granting credit are reduced since less skilled personnel are required and fewer credit reports need be purchased The credit scoring system for assessing consumer loans serves as a guide, with approval decisions to be based on income capacity, length of time in residence, length of time in employment, association with the bank and previous credit history of borrowers

Fundamental Cs of lending

Banks often use the three fundamental Cs of lending: character, capacity and collateral (Bock, 1994) Some authors (Weaver & Kingsley, 2001, for example) add capital and conditions, and thus have the five Cs of lending However, this research will follow the three Cs of character, capacity and collateral, incorporating the other two Cs (capital and conditions) therein

Character- The character of the prospective borrower is the single most

important factor that influence a lender‟s decision whether to approve or reject a loan and it is the most difficult factor to assess Although assessment

of character is subjective issue, the following factors can assist: track record

of the individual (the longer the relationship, the better it is), the loan‟s purpose (lawful and consistent with the loan policy of the bank), the integrity

of the borrowers (ability and willingness to repay the loan), and the spending habits

Capacity to repay- If satisfied that the purpose of the loan is genuine and if

the character checks on the prospective borrower are all encouraging, then the lender will start taking a serious interest in the loan application The lender can judge the repayment capacity of the borrower in several ways: net

with the bank, stability of job (job stability and continuity are other indicators of capacity to repay), stability of residence (home ownership is oftern viewed as solid evidence of a stable financial situation), and borrower‟s margin (the borrower‟s capital in the total investment)

Collateral- Collateral is used as synonymous to security It is often said that

a prudent banker never gives a loan against security alone, which means that security should not be the prime consideration in giving alone Loan should

be given if the borrower has capacity to repay Collateral is something to fall back on if the circumstances of the borrower change and he/she finds it hard

to repay the loan out of normal sources of income

Taking securities and pricing loans

At this stage, securities that will be taken for personal loans consist of one or more of the following documents: a resisted bill of sale over a motor vehicles and a charge over bank deposits Once all the information has been submitted, the required documentation has been given and the application is

in order, credit officers determine the applicant‟s eligibility for the loan In terms of home loans, banks organize a valuation of the property, character check, and determine the amount of loan that the applicant can reasonably service from his/her income Additionally, banks also determine the repayment period, interest rate options, fees and charges and so on These work loads are implemented by the Sale department or Front office and Credit Appraisal department

1.3.3 Approving loans

Applications are approved as per sanctioning powers given to managers working at various levels of the bank If an application is rejected, it is necessary to record suitable reasons for rejection in the loan application control register and advises the applicant in a formatted rejection letters In

these letters, there is no need to give any specific reason, just advise that the application did not meet the guidelines of the bank If a loan is approved, the

at the time of disbursement, a senior officer should be present to verify all the documents, ensure the borrower and guarantor sign in this/her presence and verify that this has been done Besides, funds held in the account of the borrowers or guarantors may be frozen automatically at the time of approval This is known as the creation of a charge over deposits

1.3.4 Managing and collecting loans

Once the loan has been approved and the credit arrangement has been properly entered into the bank‟s operating systems, the attention of the lending officer typically turns to new business However, the officer is still responsible for monitoring or managing the existing loans in his portfolio The “sales transaction” is incomplete at this time Only when the principal and all interest and fees are paid or they are written off as uncollectible is the transaction complete

If the managing process of corporate loans involves reviewing periodic financial statements, industry conditions, business climate and performance

on the loan However, consumer loan accounts do not require much supervision, just a regular follow up to ensure the repayment of loan installments are made in time Reminder letters may be sent to the borrowers whose installments are in arrears The first reminder is generally sent within one week of the installment falling in arrears, and a second is sent a week later if the payment still has not been received Every effort should be made

to assist borrowers who are in arrears The credit/legal department of the controlling/head office generally takes legal action when the borrower fails

to pay despite follow up Where security is to be repossessed due to nonpayment of dues, banks generally appoint an asset managing company (AMC) Borrowers should be informed in advance about the action and

given sufficient time to bring the security (goods) to the bank themselves If this warning fails, then the asset managing company may be asked to possess the goods and bring them to the yard of the bank The loans department has

to report loan defaults to the central bank

1.4 Precautions to be taken in granting consumer loans

Consumer loans are far simpler to assess and monitor than, say, corporate loans or farm loans, but it is still important to take adequate care to avoid problems down the track A banker may face some of the following challenges:

- Individuals may withhold information that is crucial to decision-making There could be issues relating to health or continuity of employment

- The applicant may provide inconsistent information The inconsistencies may be intentional or due to lack of knowledge of bank procedures

- Verifying some of the information provided could be a problem On many occasions, employers may not be willing to disclose details about their employees to the banks The banker also needs to be more cautious

in disclosing information about a prospective or existing borrower

- The applicant may have a good character otherwise but not realise the importance of making repayments on the due date

- Individuals are susceptible to sickness, injury, loss of employment and other such issues that may affect their ability to repay Even family disputes can affect the repayment performance of a borrower

- Individuals tend to over-commit through nondisclosure of other debt

- The individuals must have a capacity to enter into a loan contract A loan contracst, like any other contract, requires that the person should not be a

minor (less than 18 years of age), someone of unsound mind or an insolvent

- The personal loan borrower should be encouraged to maintain a savings account with the bank

- Borrowers must sign loan documents in the presence of an authorised bank officer and preferably at the branch of the bank

- Loans should normally be not given to repay an existing loan from another source

- In the case of salaried borrowers, their salary should be credited by the employers directly to a savings account with the bank

- In the case of fixed interest loans, if payment is received in advance, an early repayment penalty applies The penalty applies the current fixed interest rate is lower than the contracted fixed inters rate The penalty is equal to this difference

1.5 Pricing and structuring of consumer loans

An important part of a lending banker‟s job is to price and structure the loan

1.5.1 Loan pricing

The pricing of a loan refers to the rate of interest, fees and other terms on which a bank gives a loan Several factors influence the pricing of loans, including the sources of funds used for lending, the cost of financing the sources, risk considerations in giving loans, the national economic growth rate, the rate of inflation and the interest rates that competitors are charging Most lenders are financial intermediaries that procure funds from savers and lend to deficit units When the intermediary borrows fund from the savers (deposits, for example), it has to pay interest This is a financial cost of procuring funds and is always factored into the pricing of all loans, including

consumer loans In addition, a financial institution incurs administrative costs that it includes when costing loan products Lastly, there is a risk premium and profit margin that need to be added The price of a loan product therefore typically includes the financial cost, the administration cost, the risk premium and the profit margin

Fixed and variable rate consumer loans

Where fixed interest rates are charged, repayments are set for the duration of the loan period, regardless of any movement in market interest rates Some borrowers find fixed interest rates easier for budgeting, because the loan repayments do not change for an agreed period A fixed rate loan involves an interest rate risk for the lender, so the lender may chare a slightly higher inters rate to cover the risk

Banks also issue variable rate consumer loans In this type of loan, the interest rate varies as conditions change in the market This means the repayments may vary during the term of the loan In a variable interest loan (known as adjustable rate loan in the United States), the borrower shares the risk of a fluctuating interest rate with the lender These loan generally have

no prepayment penalties The bank fixes the interest rate by adding a mark

up (risk premium) to the prime lending rate

Bank fees

A further pricing asset involves the levying of fees The average borrower may have little knowledge about the fees being levied by banks There is growing criticism of the exorbitant fees charged by banks The banking industry is in the public eye and has to be sensitive to the needs of the people These fees vary depending on the type of loan

1.5.2 Loan structuring

Besides pricing, a loan needs to be structured Structuring refers to the repayment patterns and other terms agreed between the bank and the borrower A bank loan officer usually works with the customer to select from different pricing and loan structuring plans The banker and the customer mutually agree on the pricing and structuring of the loan before the bank makes a formal offer of loan While proposing the various options, the bank accounts for the customer‟s other debt obligations and the loan amount that the customer can reasonably service

Two important elements of debt structuring are taking security for the loan and deciding the loan covenants The term security refers to both the asset against which a loan is given and also the documents (such as bonds, bills of exchanges, promissory notes and share certificates) that establish ownership and payment rights Documentation should be completed at the branch; an loans should not be disbursed until all documents are properly signed The duly signed security documents are then kept in the safe custody of the bank Another important aspect in loan structuring is the finalisation of the terms and conditions of loan The loan covenants (terms and conditions) are decided in consultation with the borrower A loan agreement form us usually from usually includes the following covenants: repayment amount each month/quarter, interest rates, security/insurance, default clause, schedule of fees, stamp duty, etc

1.6 Consumer Lending Quality

1.6.1 Consumer Lending Quality from Different Perspectives

From the perspective of lenders- Loans of high quality should follow the

principles of safety, suitability of loan purpose and profitability Generally, if financial institutions obey all of the credits rules and principles, their capital

source will be preserved and the loyalty of the bank will expand Credits quality must be competitive when there are a number of competitors‟ exploiting the same market To the bank itself, credits quality represents the best combination between areas, levels, limitations of credits and the financial strength of the bank Moreover, credits quality shows reasonable profit growth, rising credit outstanding, non-performance loan ratio in the allowed level, structure of long term and short term loans

Financial institutions grant billions of dollars of consumer loans each year, much of that amount is to people whom they have never seen before It is crucial to measure the quality of the loan or to manage its credit risk because the possible effects of loan loss include “immediate decline in asset value, reduction in income from those loans, any further loss of income because of reduced ability to make other loans, forced sales of assets, and possible loss

of public confidence that leads to still more decline in assets and income” (Hedges, 1985)

Poor quality loans result from a number of sources Whatever the cause, in addition to losses in interest of principal that may be incurred, poor quality loans all result in higher operating expenses for the bank than were originally allocated for the loan, thus reducing the profit For any loan that does not perform as agreed or that requires additional attention, the expected return on the loan is diminished

In fact, a strong credit culture helps a lending institution manage credit risk effectively and gives it a competitive advantage in the market place It is recognized that banks with higher excess loan returns (interest and fees generated through lending activities) tended to end up with both higher excess loss rates and unusually large amounts of simultaneous risk (as measured by loan-asset ratio, volatile funds ratio, and equity-asset ratio)

From the perspective of borrowers- Loans are considered as those of quality

when a credit account features reasonable amount, rate and term of loans with simple procedures Additionally, it must satisfy the customer‟s capital need, and encourage debtors to make a good use of their loan Aiming that, customers should maintain their long-term relationship with their banks via frequent transactions The relationship helps the banks better grasp activities and predicts capital demand of customer periodically Consequently, the banks will establish their plan to meet their clients‟ capital demands The longer and closer that relationship is, the more available opportunities to meet capital demands will be; the more benefit customer could gain

1.6.2 Measuring the Quality Consumer Lending

To make the consumer lending quality measurable, it is necessary to research some of the quantitative and qualitative criteria

Quantitative criteria

Quality of the lending decision is defined as the performance of the loan as evaluated by internal and external bank auditors and examiners, not on the perceptions of the customers Banks usually use five degrees of perceived risk of default on loans These are 1) current, 2) especially mentioned, 3) substandard, 4) doubtful, and 5) loss Current loans are the good performing loans Especially mentioned loans usually have some minor problem Loans classified as substandard have more critical problems, but the problems are viewed as correctable The last two categorizes represent the real problems with the loan portfolio Doubtful indicates as possibility of loan loss Lastly, loss is the worst case when loan loss turns to be an outcome In Vietnam, the loan categorization implies as follow:

 Group 1 (Current): loan not overdue is estimated good

 Group 2 (Especially mentioned): loan overdue up to 90 days is estimated fair

 Group 3 (Substandard): loan overdue above 90 days and up to 180 days is estimated bad

 Group 4 (Doubtful): loan overdue above 180 days up to 360 days is estimated very bad

 Group 5 (Loss): loan overdue above 360 days is estimated terrible There are several quantitative indexes for measuring loan quality as following:

Overdue loans ratio: The credit quality of financial institutions in Vietnam

can be calculated in some equations as follows:

Overdue loans of total outstanding

ratio

=

Total overdue loans

Total outstanding loans

The ratio presents the lending quality of the bank, if the ratio is up, the riskier the bank faces

In such circumstance, it is necessary for bank to reassess appraisal and management quality of loans Commercial banks of high overdue loans ratio leads to a bad image and poor profitability The credit rating of that bank goes down means less opportunity in business and co-operation in the market In addition, that bank is put under the tight supervision and control

of the central bank Thus, more preservation must be done and less capital available for granting loans This will affect directly to the expanding strategy of the bank In brief, this is a basic ratio, which is easily to calculate,

to measure the loan quality of financial institution

According to the State Bank of Vietnam, the banks with the non-performing loans ratio out of total outstanding loans is over 7% belong to low credit quality ones It is considered good credit quality when this ratio is lower than 5%

This criterion is also divided in two classes:

Overdue loans

Overdue loans from 6 months to 12 months

Total outstanding loans

Bad debt

Total overdue loans over 1 year

Total outstanding loans

To measure the consumer loan quality, it can be calculated as:

Overdue consumer loans

ratio of total consumer

outstanding loans

=

Total overdue consumer loans

Total consumer outstanding loans

It is obviously that, the higher the overdue loans ratio or bad debt ratio is, the poorer the credit quality is

Time of credit process: Nowadays, most of banks are trying to offer

customers a simple and safe procedure of processing application Some studies show that borrowers concern to the procedure more than the interest rates The scoring system has been used more popularly which helps shorten the procedure and satisfy customers better, thus, improve bank‟s image in the customer‟s opinion

Interest rates: Loan interest should be competitive in a fierce competitive