The application of altmans z model to measure default risk of the vietnamese commercial banks borrowers

MINISTRY OF EDUCATION AND TRAINING UNIVERSITY OF ECONOMICS- HOCHIMINH CITY Trần Thị Kim Dung THE APPLICATION OF ALTMAN’S Z’ MODEL TO MEASURE DEFAULT RISK OF THE VIETNAMESE COMMERCIAL BANKS’ BORROWERS MASTER’S THESIS In Finance- Banking Ology Code: 60.31.12 Academic supervisor Pr.Dr Trần Ngọc Thơ Ho Chi Minh City- 2010  ACKNOWLEDGEMENT I would like to express my sincere gratitude and deep appreciation to my research Supervisor, Pro Dr Tran Ngoc Tho for his precious guidance, share of experience, ceaseless encouragement and highly valuable suggestions throughout the course of my thesis I would like to thank many of my friends from The state bank of VietnamDong nai branch, Vietcombank and Techcombank, who have helped me during the collection of data as well as support me during doing the research I also would like to take this opportunity to express my appreciation to Professor Nguyen Dong Phong, UEH Board of Directors for creating MBA program in English and Dr Vo Xuan Vinh, Dr Tran Dinh Kien for his support during the course Specially, my thanks go to Mr Quyet, Mr Trung for their valuable and enthusiastic support for this research study and for their comments of English from early draft of my thesis Last but not least, the deepest and most sincere gratitude goes to my beloved parents, my brothers for their boundless support and encouragement throughout my period of study I, therefore, dedicate this work as a gift to them all i ABSTRACT The bankruptcy of a series of large and long- standing banks in the United States has created an alarming signal to the Vietnamese commercial banks, especially in the context of existing too many banks combining with over- expanded credit growth in recent years The objective of the thesis is to introduce an intenal model for banks which will improve their current predictive power of financial risk factors The thesis aims at validating the efficiency of Altman z’ score model for credit risk evaluation through emphirical data Besides that, a simple and reliable defaulted prediction model for manufacturing and privately held firms is also developed on the basis of gathering variables from many models developed in developing countries Financial profiles of 48 defaulted and healthy companies are examined and a model is built using the Discriminant analysis technique The model can be used as a part of intenal credit rating in commercial banks It is also used to assist investors, creditors, auditors to predict business failure Key word: Altman’s model, default risk, bankruptcy risk ii TABLE OF CONTENTS Acknowledgement………………………………………………………………… i Abstract…………………………………………………………………………… ii Table of contents……………………………………………………………………iii List of figures……………………………………………………………………… v CHAPTER ONE: INTRODUCTIONi 1.1 Introduction 1.2 Research background .4 1.3 Research problem 1.3.1 Research questions .11 1.3.2 Research objectives 11 1.4 Research method 12 1.5 Data analysis and findings 12 1.6 Significance and scope of the study 13 1.7 Structure of the study 13 CHAPTER TWO: LITERATURES REVIEW 15 2.1 Overview of the Vietnamese banking system .15 2.2 Credit risk 16 2.2.1 Causes 16 2.2.1.1 Macro factors 16 2.2.1.2 Customers 17 2.2.1.3 Banks .18 2.2.2 Credit risk management 18 2.3 Overview of Altman’s model 20 2.3.1 The Z’ model 24 2.3.2 Previous studies 27 CHAPTER 3: METHODOLOGY & DATA ANALYSIS 35 3.1 Research design .35 iii 3.2 Item generation .36 3.3 Pilot test 37 3.4 Main study 37 3.4.1 Bank selection .37 3.4.2 Sampling 43 3.5 Description of sample 43 3.6 Results of discriminant analysis 47 3.7 New points and limitation .54 3.7.1 New points 54 3.7.2 Limitations .55 CHAPTER 4: CONCLUSIONS AND IMPLICATIONS 57 4.1 Conclusions related to the research question .57 4.2 Implications of the study .58 4.2.1 Theoretical implications 58 4.2.2 Implications for banks and practitioners 58 4.3 Limitations and recommendations for further research 59 iv LIST OF FIGURES Figure 1.1- Export- Import during the period of 1986- 2008 Figure 1.2- GDP growth- Inflation during the period of 1986- 2008 .5 Figure 1.3- Exchange rate USD/VND in the year of 2008 .6 Figure 1.4- Research problem .11 Figure 3.1- Research process 36 Figure 3.2- The number of banks’ branches in Dong nai province 38 Figure 3.3- VCB DN’s outstanding structure in 2009 40 Figure 3.4- Loan portfolio………………………… 42 LIST OF TABLES Table 2.1- Vietnamese banking system 15 Table 2.2- The summary of Altman’s models 24 Table 3.1- The business result of VCB DN from 2002- 2009 40 Table 3.2- Bad debt (group 3- 5) of VCB DN from 2005 – 2009 41 Table 3.3- The summary of classification points of z’ score model .45 Table 3.4- Categorization of companies based on industry 46 Table 3.5- Categorization of companies based on total assets .46 Table 3.6- Group statistics………………… 47 Table 3.7- Pooled within- groups matrices 48 Table 3.8- Eigenvalues 48 Table 3.9- Wilks’ Lamba 48 Table 3.10- Canonical Discriminant Function Coefficients 48 Table 3.11- Classification Results 49 Table 3.12- Tests of equality of group means 50 Table 3.13- Tests of equality of group means- a 51 Table 3.14- Pooled within- groups matrices 51 Table 3.15 – Eigenvalues 51 Table 3.16 – Wilks’ Lamba 52 v Table 3.17- Standardized Canonical Discriminant Function Coefficients 52 Table 3.18- Canonical discriminant function coefficients …………… .52 Table 3.19 - Classification Results .53 vi CHAPTER ONE: INTRODUCTION 1.1 Introduction Since the year of 1986, Vietnam has transformed from the centrally planned economy to the market oriented economy with many important reform policies One of them is for creating an attractive investment environment to draw foreign investment capital Together with the dramatic growth of the Vietnamese economy, the banking industry has also developed strongly in volume and diversified forms of ownership, this has contributed to increasing GDP and promoting the nation’s growth of international trade However, in the years of 2008 and 2009, the banks have faced a lot of difficulties on the way to development due to increasingly bad debt ratios in the context of economic recession and financial crises in the global market Bank failures can be contagious and stem from depositor panics or contractual links between banks In Viet Nam, with bank account holders accounting for only 10% of the population, there has always been a promising market with large potential profits for the banking sector This characteristic creates attractiveness resulting in many banks being founded for only short periods of time Competition became fierce among banks Due to a much deeper level of integration into the world’s economy, Vietnam has a diversified investment channels including the stock market, gold, and the real estate market In the past, banks lent capital to businesses to support for their main operations Nowadays, investors can accept riskier investments to gain higher profits as the market grows There is an increasing risk of borrowers receiving multiple loans, specially as many big corporations expand their business into new sectors such as financial investment and real estate Over- dispersed investments without overall strategic planning in macro perspective which is suitable for the development conditions in Vietnam is extremely risky Lessons in bankruptcy in the United States (too big to fail) has cautioned Vietnamese banks In Vietnam, more than 70% of commercial banks’ revenues are from credit activities So the State bank of Vietnam as well as banking managers always concentrate on credit risk management issues for the purpose of ensuring the safety and soundness of the banking system This thesis studies one of the tools that is used to predict the default/bankrupt risk of companies: Altman’s models Altman’s models have been used widely in developed countries as an efficient tool to predict the bankruptcy risk of companies The author has not found any research in Vietnam specific to only to this model However, in many theses relating to credit risk management in Vietnam, Altman score models are always cited as a popular method in developed countries Nowadays there is numerous research in the world focusing on quantitative method formed models based on financial ratios as well as market- value formulas The Altman model may be relatively simple and although this model is worldfamous in the world, it is not certain to be applicable in Vietnam In principal, any model is builted based on certain assumptions and they can not cover all conditions in reality That is the reason why model analysis is always considered a part of the decision process In the research aspect, no single model helps users deliver their final decisions and Altman models are not exceptional in this respect Users can’t rely solely on this model to make a final judgement about bankrupt or nonbankrupt, default or non-default However, this thesis hopes to open up paths for further empirical study and to stress the importance and necessity of quantitative research before studying more complicated methods in credit risk management aspect Therefore, this thesis examines whether Altman’s models can be suitable to use as a credit risk management measurement for commercial banks in Vietnam Altman has written score models for predicting bankruptcy risk including: the z score model for manufacturing and listed firms, the z’ score model for manufacturing and privately held firms, and the z’’ for non- manufacturers There is much empirical evidence in the application of Altman’s z model- used to measure the bankruptcy risk of listed manufacturing firms in many countries Almost all results favor Altman’s score as a good predictor for bankruptcy risk Therefore, this thesis focuses on testing another Altman model- the z’ score for privately held firms in the manufacturing sector At the current time in Vietnam the research into methods for measuring default risk quantitatively are essential not only for bank directors but also for investors, shareholders, and state agencies This is the rationale behind the research: “The application of Altman’s z’ score model to measure default risk of the Vietnamese commercial banks’ borrowers” The objectives of the thesis are (1) to apply Altman’s z’ model in measuring default risk of the sample companies including customers borrowing money from banks, (2) to contribute to the implications of Altman’s z’ model on the safety and soundness of credit operations in Vietnamese commercial banks In term of structure, the thesis consists of four chapters The thesis begins by defining the research problem and questions, and providing a justification for the study Chapter one also reviews the research background, significance and scope of the study Overview of the Vietnamese banking system and credit risk are presented in chapter two, previous researches and application of Altman’s model in the world are also involved in this chapter Describing the methods used in the study is presented in chapter three The main objective of the study is to test whether Altman’s z’ model is suitable to apply in Vietnam Surveying a sample of 48 companies is made to test Altman’s z’ model in predicting default risk to banks’ customers ... research: ? ?The application of Altman’s z? ?? score model to measure default risk of the Vietnamese commercial banks? ?? borrowers? ?? The objectives of the thesis are (1) to apply Altman’s z? ?? model in measuring... measuring default risk of the sample companies including customers borrowing money from banks, (2) to contribute to the implications of Altman’s z? ?? model on the safety and soundness of credit... credit risk management However, the current credit risk measurement tools has not been developed in Vietnam Banks often evaluate credit risk of their customers due to their subjective judgement, their