Luận văn thạc sỹ Improve credit risk management VJSC bank for industry and trade

Luận văn thạc sỹ tiếng Anh Cải thiện quản lý rủi ro tín dụng Ngân hàng VJSC cho ngành công nghiệp và thương mại. Chapter 1: The fundamentals of credit risk management in commercial banks Chapter2: The situation of credit risk management in Vietinbank and Vietinbank branch Nam Thang Long. Chapter 3: The solution to improve the credit risk management in Vietinbank. Conclusion part. TABLE OF CONTENTS INTRODUCTION 1. The necessary of the topic: improve the credit risk management 2. The purpose of the internship thesis 3. The scope and scale of the internship thesis 4. Research method 5. The structure of the internship thesis CHAPTER 1: THE FUNDAMENTALS OF CREDIT RISK MANAGEMENT IN COMMERCIAL BANKS 1 1.1. The credit risk 1 1.1.1. Basic concepts of credit risk 1 1.1.2. Features of credit risk 2 1.1.3. The main signal to identify credit risk 3 1.1.4. The cause of credit risk 6 1.1.4.1. Objective causes 6 1.1.4.2. Causes by the customers 7 1.1.4.3. Causes by the banks 7 1.2. The credit risk management 9 1.2.1. Basic Concepts of credit risk management 9 1.2.2. The necessary of credit risk management 11 1.3 The methods to manage credit risk 12 1.3.1. Setting limitation of the loan amount 12 1.3.2. Classification of loans 13 1.3.3. Provision and allowance for credit losses 14 1.4. Model used to evaluate credit risk 15 1.4.1. Qualitative model: 6C 15 1.4.2. Quantitative model: credit scoring 16 CHAPTER 2: THE SITUATION OF CREDIT RISK MANAGEMENT IN VIETINBANK AND VIETINBANK BRANCH NAM THANG LONG 22 2.1. Basic policies of credit risk management in Vietinbank 22 2.1.1. The lending policy of Vietinbank 22 2.1.2. The policy of credit risk management in Vietinbank 24 2.1.3. Policies on loan classifications and risk provision 27 2.1.4. Organization structure of and operating structure of credit risk management . 29 2.1.5. The supervision and inspection of credit risk management in Vietinbank 35 2.2. The summary of different types of credit risk and the causes of these types in Vietinbank 36 2.2.1. The summary of different types of credit risk 36 2.2.2. The causes of the types 37 2.3. Information of Vietinbank Nam Thang Long branch as an example of good branch in credit risk management 39 2.3.1. The foundation and development of Vietinbank Nam Thang Long branch 39 2.3.2. The organization structure of Vietinbank Nam Thang Long branch 45 2.3.3. Overview of the credit activities in Vietinbank Nam Thang Long branch in five years from 2005 to 2009 46 CHAPTER 3: THE SOLUTION TO IMPROVE THE CREDIT RISK MANAGEMENT IN VIETINBANK 49 3.1. The general viewpoint of Vietinbank about credit risk management 49 3.2. The solution to improve the credit risk management in Vietinbank and Vietinbank branch Nam Thang Long 50 3.2.1. The solutions to manage risk in credit activities 51 3.2.1.1. Identify and manage the existing credit risk in different credit activities 51 3.2.1.2. Improve the process to deal with bad debt. 52 3.2.1.3. Collect offbalance sheet debts and frozen loans 53 3.2.2. The solutions to improve the ability and ethics of credit employee 54 3.2.2.1. Improve the abiltity of employee 54 3.2.2.2. Improve the ethics of employees 55 3.3. Some recommendations 55 3.3.1. Recommendations to the headoffice of Vietinbank 55 3.3.2. Recommendations to the State Bank of Vietnam 56 3.3.3. Recommendations to the Government 57 CONCLUSION 58

Bank For Industry And Trade

INTRODUCTION

1 The necessary of the topic: improve the credit risk management

In the period of economic renovation, our economy has made many positivechanges GDP growth is maintained at a high rate, people's lives are improved.Along with the changes of the country, banking sector has also reformedperceptively with significant improvement in the organization and operation.Banking sector and particularly commercial banks play an important role in theachievement of economies day by day

In the process of reform and restructuring, along with some traditionalservices, commercial banks have been gradually changing their activities forexample the banks have moved to a variety of products and services, developed newproduct applications in the business However, the credit activity of the banks is stillconsidered as the key in business operation and takes a high proportion of theprofits of every commercial bank Credit operation has contributed a positive rolefor the development of the banking sector and all the economy, is a tool forfinancing the economy It also is contributing to industrialization and modernization

of the country However, it also reveals the limitations and risks that banks mustface today

The high- level competition of commercial banks in the market economymakes risks especially credit risk tends to increase more rapidly and more difficultly

in controlling Therefore, the issue of improving credit risk management isincreasingly needed The author clearly realizes that fact in the period of internship

in Vietinbank system in general and Vietinbank- branch Nam Thang Long inparticular

Vietinbank as well as banking sector in Vietnam in this period.

2 The purpose of the internship thesis

- Express some basic points of credit risk in commercial banks in the marketeconomy

- Evaluate the fact of credit risk in Vietinbank and Vietinbank- branch NamThang Long Then, the author assesses the limitation and the causes of credit risk

- Propose some solutions and make some recommendations to reduce creditrisk management

3 The scope and scale of the internship thesis

Thesis focuses on studying and evaluating the current situation of credit riskmanagement in Vietinbank Moreover, the author uses data from Vietinbank- branchNam Thang Long as an example to help the internship thesis be morecomprehensive and practical

Research focuses on the period from 2000 to 2010 However, because of thefinancial year 2010 has not ended yet, only the data up to the end of 2009 is used

4 Research method

- Combining many research methods such as: synthesis, analysis, statistics…

- Exchanging ideas, asking for the advice from those who have experience incredit risk management in Vietinbank- branch Nam Thang Long (the internshipplace)

- Introduction part.

- Chapter 1: The fundamentals of credit risk management in commercial banks

- Chapter2: The situation of credit risk management in Vietinbank and Vietinbank- branch Nam Thang Long

- Chapter 3: The solution to improve the credit risk management in Vietinbank

- Conclusion part

-Subject: Solution to improve credit risk management in Vietnam Joint Stock Commercial

Bank For Industry And Trade 1

INTRODUCTION 1

1 The necessary of the topic: improve the credit risk management 1

2 The purpose of the internship thesis 2

3 The scope and scale of the internship thesis 2

4 Research method 2

5 The structure of the internship thesis 4

TABLE OF CONTENTS 4

ABBREVIATION 7

CHAPTER 1: THE FUNDAMENTALS OF CREDIT RISK MANAGEMENT IN COMMERCIAL BANKS 1

1.1 The credit risk 1

1.1.1 Basic concepts of credit risk 1

1.1.2 Features of credit risk 2

1.1.3 The main signal to identify credit risk 3

1.1.4 The cause of credit risk 6

1.1.4.1 Objective causes 6

1.1.4.2 Causes by the customers 7

1.1.4.3 Causes by the banks 7

1.2 The credit risk management 9

1.2.1 Basic Concepts of credit risk management 9

1.2.2 The necessary of credit risk management 11

1.3 The methods to manage credit risk 12

1.3.1 Setting limitation of the loan amount 12

1.3.2 Classification of loans 13

2.1 Basic policies of credit risk management in Vietinbank 22

2.1.1 The lending policy of Vietinbank 22

2.1.2 The policy of credit risk management in Vietinbank 24

2.1.3 Policies on loan classifications and risk provision 27

2.1.5 The supervision and inspection of credit risk management in Vietinbank 35

2.2 The summary of different types of credit risk and the causes of these types in Vietinbank 36

2.2.1 The summary of different types of credit risk 36

2.2.2 The causes of the types 37

2.3 Information of Vietinbank- Nam Thang Long branch as an example of good branch in credit risk management 39

2.3.1 The foundation and development of Vietinbank- Nam Thang Long branch 39

2.3.2 The organization structure of Vietinbank- Nam Thang Long branch 45

2.3.3 Overview of the credit activities in Vietinbank- Nam Thang Long branch in five years from 2005 to 2009 46

CHAPTER 3: THE SOLUTION TO IMPROVE THE CREDIT RISK MANAGEMENT IN VIETINBANK 49

3.1 The general viewpoint of Vietinbank about credit risk management 49

3.2 The solution to improve the credit risk management in Vietinbank and Vietinbank- branch Nam Thang Long 50

3.2.1 The solutions to manage risk in credit activities 51

3.2.1.1 Identify and manage the existing credit risk in different credit activities 51

3.2.1.2 Improve the process to deal with bad debt 52

3.2.1.3 Collect off-balance sheet debts and frozen loans 53

3.2.2 The solutions to improve the ability and ethics of credit employee 54

3.2.2.1 Improve the abiltity of employee 54

3.2.2.2 Improve the ethics of employees 55

3.3 Some recommendations 55

3.3.1 Recommendations to the head-office of Vietinbank 55

3.3.2 Recommendations to the State Bank of Vietnam 56

3.3.3 Recommendations to the Government 57

CONCLUSION 58

Firstly, I would like to express my profound thanks to Dr Dang Ngoc Duc,

my supervisor who has given valuable guidance, advices, and comments throughoutthe whole period of this minor thesis Needless to say, without his support, the thesiswould not be either inspired or finished

Secondly, I want to thank Ms Pham Thi Thanh Mai- Head of Risk

Management Department at Vietinbank- branch Nam Thang Long for the valuable information and advices she provided

I would like to give a special thank to the professors at Advanced Program, National Economics University as well for their guidance and assistance during my study

Finally, I would like to take this opportunity to extend my great gratitude to

my beloved parents, family members and close friends for their support and

encouragement not only during the period of this minor thesis but also for my wholelife

GDP Gross Domestic Product

SBV State bank of Vietnam

Vietinbank Vietnam Joint Stock Commercial Bank For Industry And Trade

Subject: Solution to improve credit risk management in Vietnam Joint Stock Commercial

Bank For Industry And Trade 1

INTRODUCTION 1

1 The necessary of the topic: improve the credit risk management 1

2 The purpose of the internship thesis 2

3 The scope and scale of the internship thesis 2

4 Research method 2

5 The structure of the internship thesis 4

TABLE OF CONTENTS 4

ABBREVIATION 7

CHAPTER 1: THE FUNDAMENTALS OF CREDIT RISK MANAGEMENT IN COMMERCIAL BANKS 1

1.1 The credit risk 1

1.1.1 Basic concepts of credit risk 1

1.1.2 Features of credit risk 2

1.1.3 The main signal to identify credit risk 3

1.1.4 The cause of credit risk 6

1.1.4.1 Objective causes 6

1.1.4.2 Causes by the customers 7

1.1.4.3 Causes by the banks 7

1.2 The credit risk management 9

1.2.1 Basic Concepts of credit risk management 9

1.2.2 The necessary of credit risk management 11

1.3 The methods to manage credit risk 12

1.3.1 Setting limitation of the loan amount 12

1.3.2 Classification of loans 13

1.3.3 Provision and allowance for credit losses 14

1.4 Model used to evaluate credit risk 15

1.4.1 Qualitative model: 6C 15

1.4.2 Quantitative model: credit scoring 16

CHAPTER 2: THE SITUATION OF CREDIT RISK 21

MANAGEMENT IN VIETINBANK AND VIETINBANK- BRANCH NAM THANG LONG 21

2.1 Basic policies of credit risk management in Vietinbank 22

2.1.1 The lending policy of Vietinbank 22

2.1.2 The policy of credit risk management in Vietinbank 24

2.1.3 Policies on loan classifications and risk provision 27

2.1.5 The supervision and inspection of credit risk management in Vietinbank 35

2.2 The summary of different types of credit risk and the causes of these types in Vietinbank 36

2.2.1 The summary of different types of credit risk 36

2.2.2 The causes of the types 37

2.3.1 The foundation and development of Vietinbank- Nam Thang Long branch 39

2.3.2 The organization structure of Vietinbank- Nam Thang Long branch 45

2.3.3 Overview of the credit activities in Vietinbank- Nam Thang Long branch in five years from 2005 to 2009 46

CHAPTER 3: THE SOLUTION TO IMPROVE THE CREDIT RISK MANAGEMENT IN VIETINBANK 49

3.1 The general viewpoint of Vietinbank about credit risk management 49

3.2 The solution to improve the credit risk management in Vietinbank and Vietinbank- branch Nam Thang Long 50

3.2.1 The solutions to manage risk in credit activities 51

3.2.1.1 Identify and manage the existing credit risk in different credit activities 51

3.2.1.2 Improve the process to deal with bad debt 52

3.2.1.3 Collect off-balance sheet debts and frozen loans 53

3.2.2 The solutions to improve the ability and ethics of credit employee 54

3.2.2.1 Improve the abiltity of employee 54

3.2.2.2 Improve the ethics of employees 55

3.3 Some recommendations 55

3.3.1 Recommendations to the head-office of Vietinbank 55

3.3.2 Recommendations to the State Bank of Vietnam 56

3.3.3 Recommendations to the Government 57

CONCLUSION 58

CHAPTER 1: THE FUNDAMENTALS OF CREDIT RISK

MANAGEMENT IN COMMERCIAL BANKS 1.1 The credit risk

1.1.1 Basic concepts of credit risk

In the market economy context, the operations of commercial banks are verysensitive to any socio-economic fluctuations, which can cause disturbance to thebusiness of banking For banks, although credit supply is the basic economicfunction which often provides the main income to the bank, it still has to follow therule above and always contains risks

There are many concepts of credit risk that can be quoted as follows:

Saunders and H Lange, two highly regarded consultants in banking andfinance defines that: "Credit risk is the potential loss when a bank grants credit to acustomer, that is, there is the possibility that the income stream expected from theloan cannot be fulfilled on both the amount and duration."

Timmothy W Koch, Professor of Finance at the University of South Carolinadefines that: "Credit risk is the potential change of net income and market value ofcapital coming from the situation in which debt is not paid or paid late."

Credit risk as defined by the Basle Committee of Bank for InternationalSettlements: "Credit risk is the possibility that the borrower or counterparty does notperform their obligations under the terms agreements."

Under the Decision 493/2005/QĐ- NHNN by the bank governor, credit risk

is defined as follows: "credit risk in the banking activities of credit institutions is thepossibility of losses in the banking activities of credit institutions as the customersfail to perform or are unable to perform its obligations under the commitment "

There can be many different ways to define credit risk, but all concepts ofcredit risk are converging with one another in nature, which is: Credit risk is thepossibility (probability) of economic losses occurring to banks as borrowers do notpay debts on time or fully repay the debt (principal and interest) Credit risk maycause financial losses for commercial banks, reducing net income and market value

of capital, in severe cases it can lead to losses and at higher levels can lead tobankruptcy

Credit risk is associated with credit operation - an important activity ofbanks, in which the scale of profitable assets which are allocated to loans is thelargest Therefore when granting credit, banks often try to analyze the elements ofthe borrower to ensure the highest level of safety

To improve the credit quality, banks need to make operational measuresbefore, during and after lending The task of preventing, restricting and handlingrisks also includes all measures from executive management, control, professionalprocesses, handling bad debts to provisioning and handling risks Limiting creditrisks is the overall of all measures to minimize the damage to banks in creditoperations These measures will be presented more clearly in the following sections

1.1.2 Features of credit risk

Credit is the most important activity with the largest scale of commercialbanks based on the opposite choices between two entities, which are the borrowersand the banks The borrowers are willing to take risks for the use of capital for theirbusiness opportunities On the other hand the banks want the maximum safety fortheir capital This is the expression of asymmetric information between the twoentities, thus it contains a very high risk to the banks As bank credit is a specificfunding activity with high risk, the banks always try to analyze the elements of theborrowers so that the safety level is the highest In general, the banks only make

not happen However, no business banking genius can accurately predict whetherthe problems will occur or not Customer’s ability to repay their loan may be altered

by many factors Moreover, many bank officers do not have the ability to performproper credit analysis Therefore, in view of the entire bank management, credit risk

is inevitable, objective, preventable and limited but cannot be excluded

1.1.3 The main signal to identify credit risk

In credit operation, loans always carry potential risks, but they do not justhappen suddenly without any warning Therefore, for most cases, loans that aregradually turning bad all show various warning signs of imminent troubles If loanofficers want to detect problem loans, they must continuously scrutinize the loansthrough the use of capital to determine the factors signaling potential risks Beloware some signs of possible risks to the loan

First: Customers do not pay principal and interest on time

This is the most visible sign to banks, as it reflects a very high possibility ofrisk The return of principal and interest is the basic criterion for assessing creditquality, if customers fail to pay principal and interest on time as committed in thecredit contract then credit risks are bound to happen

Second: Customers delay in submitting financial reports

Financial report is one of the most important documents that help creditofficers to evaluate and decide whether they need the assistance from the authoritiescompetent for the loan The financial reports (balance sheet, cash flow statement,income statement) help banks assess the customers’ financial capacity and demandfor capital On that basis, the bank will take appropriate measures and policies tocustomers

Delaying in submitting financial reports can be caused by many issues, so banksalso need to consider them The customers may have problems, or their financial

condition is in trouble Thus, they deliberately try to delay in submitting reports tohave time for amending and adjusting the data, thus reflecting incorrect businessresults Therefore, information about customers is inaccurate and the banks maymake lending decisions containing high potential risks.

Third: The enterprise’s quality of products and services declines

For enterprises, quality of products and services plays an important role totheir success; it is a criterion to evaluate the results of the business operations In theprocess of tracking enterprises, if bank officers find that the ability to sell theirproducts meets difficulty, inventories rise, sales decrease, debts increase, then itreflects the declining of the enterprises’ competitiveness, problems in theenterprises’ repayment capacity, meaning credit risks are possible

Fourth: Unclear borrowing purposes

Each customer when asking for loans has to clearly define their purpose forthe loans, which is one of the bases for banks to consider granting credit Forcustomer raising unclear purposes for their loans, the possibility of them using theloans inappropriate with the purpose when they proposed for the loans couldhappen Therefore, the repayment capacity is not high and credit risks can occur

Fifth: In credit relationships with more than one bank

In their business operations, customers usually have transactions with onlyone bank However, when customers expand relationships with many banks, thecustomers need to be considered, as maybe the customers meet difficulty in payingthe loans on time, so they have to borrow from many banks for funding; or maybethey get in relationship with another bank just to avoid the control of capitalpayment from the lending bank, therefore avoiding repaying the debts when theyare due

Sixth: Unusual change in the organizational structure or under investigation

by the authorities

The executive management of the customers plays an important role in theirbusiness operations Whenever there is an unusual change in the organizationalstructure; it is usually because the customers are facing such problems as losses orlawsuits If the new executive board does not have the good will to repay the debts

of the old board and considers it is the old board’s own problem to solve then creditrisks can easily occur

In case the customers of the banks are being investigated by law enforcementagencies, then the risks can easily occur as business operations are stalled,enterprises’ asset are susceptible to be blockaded by law enforcement agencies

Seventh: The customers’ partners are facing risk, bankruptcy, prosecution

In the market economy, trade relationships always happen, therefore whenpartners of the customers are facing risks; the repayment capability of enterprises isvery low, leading to credit risks for the banks

Eighth: Natural disasters, socio-political fluctuations

Natural disasters, socio-political fluctuations always affect the business

operations of enterprises, especially for enterprises that activities depend on nature,

so when those fluctuations occur, enterprises may encounter difficulties inproduction, affecting the repayment capability to banks, thus credit risks can occureasily

Ninth: Abnormal transaction relationship between customers and banks

Regular borrowing level increases, requests for loans exceed projectedproduction while demand has not changed, or demand for a loan no matter theinterest rate is high or low

Tenth: Other signs of risk

Customers expand their business too quickly while their investment capital isnot sufficient, so they borrow funds for their business, creating imbalance betweentheir assets and equity, thus risks can occur.

Customers always make decisions immediately and hastily in their businessoperations

The disappearance or decreasing in price of mortgage, pledge or guaranteewhen credit risks occur also makes the full recovery of debts difficult

Customers purchasing prior to arranging financial capacity is a sign of riskfor banks, especially in investing in fixed assets Because when customers have notbeen able to prepare the financial resources but still decide to purchase, so if afterthe purchasing they cannot arrange the financial resources, they will have to useother sources to pay for such purchases, thus reducing their repayment capability ofthe debts

Family business management: All important positions in the enterprise areoccupied by relatives in the family; all decisions about the business are personalregardless of the collective opinion Spending, purchasing decisions are all made byone person, thus it is very likely to lead to corruption and profiteering, businessoperations of the enterprise are neglected; enterprise can easily suffer losses,affecting its repayment capability to the bank

1.1.4 The cause of credit risk

1.1.4.1 Objective causes

Objective causes are causes such as natural disasters, war, or changes inmacroeconomic policies (import export policies, tariffs ) affecting the borrowers,making them reduce or lose their repayment capability to the banks They arebeyond the control of the customers and the banks

When these changes happen regularly and continuously affect the customers

as well as the banks, they can both facilitate or restrain the borrowers Manyborrowers with their skills are able to predict, adapt or overcome difficulties Thereare cases when the borrowers suffer some losses but still maintain the ability torepay the bank on time However, most customers suffer losses from objectivecauses have their repayment capability reduce, or are even unable to pay debts

1.1.4.2 Causes by the customers

Limitation of the borrowers’ knowledge in the prediction of business issues,weaknesses in management, bank staff’s intention of fraud are the causes ofcredit risk Many borrowers are willing to take risk with expectations of highprofits, so to achieve their goals they are willing to try all the tricks to cope withbanks such as providing false information, bribing bank officials Many borrowers

do not calculate carefully, prefer to expand investment scale, unable to calculate theuncertainties that can occur, unable to adapt and overcome the difficulties in theirbusiness The rest are borrowers that make profit but still do not repay on time, theydelay payments, hoping that the creditors will erase their loans or simply that theycan take up the loan as long as possible

1.1.4.3 Causes by the banks

In addition to the subjective causes by the customers, subjective causes bythe banks analyzed by the Basel Committee (2000) show that credit risk usuallyoccurs in two main areas, which are the concentration level and issues in the creditgranting process

Concentrations level can be regarded as the most important cause of thecredit risk issue Credit concentration risk exists when the level of credit risk in acontent of the credit portfolio becomes relatively large compared to the capital orassets of the bank Credit concentration risk does not only depend on the value ofthe committed credit, but also on the high loss rate of capital when the risk occurs

Credit concentration risk can be divided into two categories: normal creditconcentration risk and credit risk due to the risk factors which are common orassociated with each other Normal credit concentration risk usually happens whencredit is concentrated too much on one customer, customer group, or sector /industry such as the real estate sector Meanwhile, credit concentration risk due tothe association of risk factors links to many specific factors and can only bediscovered through analysis Example for this type of risk was the financial crisis inAsia in 1997 In this crisis, the relation between market risk and credit risk, as well

as between credit risk and liquidity risk, has created profit losses or capital lossesacross Asia

Concentration risk often occurs due to the strategic planning process,especially in developing countries, where banks identify and select a number ofindustry / sector or priority customer groups and from there optimistically grantcredit to those customers And credit risk often occurs to large banks because thelarge capital value enables these banks to grant credit with very high value for aclient without violating the provisions of law

Problems in the credit granting process is also a cause of credit risk, which isprimarily related to the evaluation and credit monitoring process Many banks find

it very hard to implement a thoroughly credit assessment process because of theincreasing competitive pressure in the banking sector Due to this pressure, manybanks tend to rely on some simple criteria for granting credit Besides, the absence

of system for testing and evaluating new credit techniques has caused many risks

Other causes related to the credit process, including:

- Lack of re-evaluation of credit quality Therefore, banks cannot getinformation promptly and accurately about their credit status, or to put it in anotherway, banks do not evaluate correctly the level of risk over time

- Not tracking and supervising regularly the customers or collaterals Thismakes the banks have no basis to take early measures to prevent risks.

- Not applying interest rates based on risks This problem mainly affects theoffset ability of banks in case there is risk (through the risk provisioning operation)

- Not taking into account the business cycle of the economy, the life cycle ofcommercial products, especially for banks with a high level of concentration in realestate This is the weakness in the credit portfolio management

- No draft plans in the worst case, making banks lack of careful preparation

In many cases, a clear action mechanism used to disseminate and train the bank’sstaff regularly can help the bank respond quickly, in time and therefore mayovercome adverse shocks

1.2 The credit risk management

1.2.1 Basic Concepts of credit risk management

According to the modern opinion which is applied universally at banks,credit risk management is the process of formulating and implementing strategies,policies and credit business management in order to maximize profits within theacceptable risk level Controlling credit risk at an acceptable level is thatcommercial banks strengthen the measures to prevent, limit and lower delinquencydebts, bad debts in the credit business, thus increasing sales, lowering costs to offsetrisks and achieving efficiency in the credit business "Efficiency in the credit riskmanagement is an important component of the overall risk approach and isconsidered a crucial role in the success of banks in the long term" (Basel Committee

on Banking Supervision, 2000)

In summary, the concept of credit risk management can be addressed atdifferent angles, but the essence is the same and we can interpret the concept ofcredit risk management as the process of bank developing the planning, organizing,

implementing and supervising all the credit operations to maximize the profits ofbanks with an acceptable risk level.

The process of credit risk management can be classified into four steps

as follows:

- Detecting credit risk is the realization of the risks existing in creditoperations The development of technology, market and the globalization tendencyincrease the number of risks and also the possibility of risks happening Therefore

an effective system of risk management is a system able to identify all the risks thatexist in credit Banks need to handle the risk situation of the credit portfolio, andthey need to clearly define what credit risk is

- Learning, measuring and analyzing is the next step after the risks are discovered

In fact these steps are quite close together and are often done collectively in theoperating process The purpose of this step is to let the entire risk managementapparatus understand accurately and consistently that the risks are identified,analyze clearly the cause and the most important reason is to quantify the level ofrisk that can happen to the bank

- Monitoring: Once identified, analyzed and established the measurementindicators, the risks need be monitored regularly The purpose of this step is to letthe risk management apparatus know how the risk status of bank changes over time

- Managing, reporting, and controlling risk: This is the step that shows themost clearly the strategy as well as the bank's opinion about the credit risk Firstbank needs to build a system of management tools to limit risks such as risk limits,authorization levels, credit granting standards, credit rating Then a policy aboutresource preparation to compensate for the expected risks

Credit risk control is the independent monitoring of credit risk and managing

it, the credit risk control process must ensure an independent assessment to complywith the credit goals and directions of the bank’s leadership

1.2.2 The necessary of credit risk management

Credit risk management is always a necessary task that cannot be missed forcommercial banks According to the study of the Kaminsky, in the period from 1970

to 1995, there was on average one banking crisis each year in the world, and in theperiod 1980 to 1995 this ratio was 1.44

Some major causes of the increasing risks in bank’s business operations:

First: the process of liberalization and loosening regulation of banking

activities in the whole world In recent decades, the trend of globalization,economic liberalization, promoting competition has become more common.Increase in competition means that risk and bankruptcy will also increase In thebanking sector, competition reduces the difference in margin interest rates Thiseffect makes the banks increasingly tend to expand their business scale to offset thedrop in profits, however expanding the credit scale also means that credit risk mightincrease Besides, the elimination rule competition will increase the level ofbankruptcy of the banks’ customers, leading to the banks’ damage

Second, with the business operations of banks tend to be more and more

complex and multi-functional, the growing technology along with the integrationtrend and fierce competition, all have increased the level of risks and hazards In thefield of credit, credit products are developing strongly, far exceeding the traditionalcredit products Credit products based on the development of technologies such ascredit cards, personal loans always contain new risks But under competitivepressure, the expansion and diversification of products as well as the scope of creditoperations become more urgent, vital to banks With the variety and complexity of

the credit products as well as the credit risks, it is required that credit riskmanagement must be focused on and upgraded.

Third, for developing countries, especially countries in a transition state like

Vietnam, the economic environment is not stable, the legal system is developing,the transparency level of information is low, therefore the banking operations iseven riskier than normal, therefore doing a good job of credit risk management atthe very beginning is a very important task

In fact, the credit risk management operation is expressed specificallythrough the credit risk management policy and the organizational model used toimplement that policy

1.3 The methods to manage credit risk

1.3.1 Setting limitation of the loan amount

Credit limit has many different methods and approaches Within the scope ofthis graduation thesis, the author would like to mention three basic limits, whichare: credit limit for large customers, credit limit for related customer groups, Creditlimit according to sectors or geographic areas

Credit limit for large customers: The law system in all countries has made

regulations about this limit to prevent commercial banks from focusing too much onone customer or a group of customers This limit is set on the basis of the bank'scapital; usually the loan balance on a customer does not exceed 10-25% of acommercial bank’s capital In fact, in countries with a developed market economy,banks often set the limit lower than the amount prescribed by law

In this process of setting limits, banks have to calculate the total amount ofall outstanding loans in the forms of risk-containing credits, such as paymentguarantees, L/C, financial leasing…

Credit limit for related customer groups: Currently the related customer

group criterion is still being debated by banks and they have not fully agreed on thebuilding criteria However, the current maximum limit for customer groups isparticularly important in the lending of banks; this type of customer has becomepopular for some banks tending to use lending method based on credit rather thantraditional and commercial procedures and conditions A bank with good credit riskmanagement is a bank that usually constructs limits for its related customer groupsbased on its customer management system As usual, the lending limit for therelated customer groups does not exceed 50% of the bank’s equity and 60% if theguarantee balance is taken into account, or at a tight control deciding andconsidering by the board of directors

Credit limit by industry or sector: This policy controls the maximum

outstanding loans to an industry or sector, or even to a geographic area (region,country) It also prevents credit losses from a series of customers meetingdifficulties of the same reason However, establishing a system of statistical reportinformation according the standard of industry or sector; or the borrowersthemselves have diversified businesses will make it hard for banks to classify based

on the criteria above

1.3.2 Classification of loans

Banks may have different classifications of loans, but usually there are fivegroups used to classify, which are: standard loan or conventional loan; watchfulloan; loan below standard; troublesome loan; loan causing capital loss/damage, thelast three are considered bad debts (non-performing loans)

Refers to the criteria for loan classification by Price Waterhouse Coopers inannex 03 to assess the credit quality of commercial banks, it can be seen that aconsensus is needed for the definitions of certain loans:

- Overdue loans are loans that some or all of the loan principal and/or interesthave expired.

- Bad debt (NPL) is a loan which belongs to group 3, 4, 5 defined in Article 6

of the document 493/2005/ QĐ-NHNN, dated 22/04/2005 by the bank governor

- Debt in which the repayment term is restructured is a debt that financialinstitutions approve the adjustment or extension of the loan repayment term as theyevaluate the customers’ capacity to repay the debt as scheduled in the contractreduced However, after that banks have sufficient basis to evaluate customerswhether they have the ability to repay the full principal and interest with the therestructured repayment term

1.3.3 Provision and allowance for credit losses

Provisioning to offset risk is to help banks actively cope with losses if there

is any Price Waterhouse Coopers suggests the rate of the provision for credit risksfor all loan groups as follows: group 1 (standard loan)- deduct 1%, group 2- 2%,group 3- 25%, group 4 (troublesome loan)- 50%, group 5 (capital loss loan)-100%

There are two ways to use reserve fund to offset credit risk The first one is

to keep the bad debts remain on the balance sheet and only use the reserve funduntil there is no longer any available treatment or it is unable to recover the debts.The second way is to take out all the bad debts off the balance sheet on the basis ofusing the reserve fund to "clear internal debts"

Another rule needs to be followed is that bank must recourse debt to the end

to offset the loss caused by the debt that bank has to handle with reserve fund.Information about the handling of debts under the “clearing internal debts” criterionmust be secured

1.4 Model used to evaluate credit risk

1.4.1 Qualitative model: 6C

When considering a loan application, credit officers and assessment officersmust answer three questions:

Question 1: Is the borrower creditworthy? How to know that?

Question 2: Can the credit contract be structured to secure the loans as well

as enable the customers to use the loans effectively?

Question 3: Does the bank have the right to the customer’s property andincome in case the loan faces problems and whether the bank can quickly recoverthe capital with low costs or not?

To answer the three questions above, many commercial banks in Vietnam aswell as in the world often study six aspects (6C) of the loan application

Character: Credit officers must gather evidences that customers have clearobjectives when applying for loans and serious repayment plans Responsibility,honesty and serious borrowing purpose are the standards creating the “character” ofcustomers If the credit officers feel that the customers are not honest, the loan willnot be carried out as if it is approved it will probably become a bad debt

Capacity: Credit officers have to make sure that customers have the legalstatus of the loan contract Loan officers must be sure that the representativecommissioned by the company to carry out the agreements and sign credit contractmust have the board of directors’ approval of the company's loan application inaccordance with the provisions of law

Cash flow: This is an important content for a loan application and often focus

on the question: Does the borrower have the ability to generate a sufficient cashflow to repay the debt or not? Borrowers generally have three sources that can be

used to pay debt: Cash flow from sales or earnings, cash flow from selling assets,mobilized funds from issuing debts or stocks Any source of the three sources abovecan be used to meet the cash demand to pay the bank’s debts However, banksalways concern and give the most prominence to the cash flow generated from salesand consider it a major source for debt repayment.

Collateral: In the assessment of collateral for loans, credit officers must askthe question: Does the borrower own any assets with net value matching the loan?Credit officers must be very sensitive to characteristics such as usage time, currentstatus and level of specialization reflected in the customer’s asset Here, technologyplays an important role If the customer’s assets are too outdated, the value of theirmortgage will be reduced as the banks may have difficulty in finding people to buyback the properties if the loan is not repaid

Conditions: Credit officers must identify the trend of recent developments ofcustomers as well as the industry in which the customers are active, and realize theimpact of the changes in the economy to the loan A loan seems to be very good onpaper but its value may decline due to the customer's sales or income decreaseduring the economic downturn or the interest rates rise due to pressure of inflation

To be able to analyze this content, banks are required to store data and informationfrom newspapers, magazines, research reports about the industries in which bankserve primarily

Control: the final factor in assessing the reliability of a customer is thecontrol; it focuses on such questions as: Does the change when there are new policyrules affect the borrowers adversely and do the customers meet the standards ofcredit quality set by the bank management agencies?

1.4.2 Quantitative model: credit scoring

Today, many banks have advanced in the scoring of borrowers on the basis of

because of the limited framework of the thesis, the author will only mention thenon-financial indicators and financial indicators of the corporate customer groupsand individual customer groups:

(+) General principles of summing credit scores for enterprises:

- In the non-financial indicators, depends on the importance of each indicatorthe bank will assign a certain weight for each, and the total weight is 100%

- The financial indicators with 11 indicators of four groups are calculated byweighting, same as the non-financial indicators and the general indicators

- After calculating and summing the scores of the non-financial indicators(A) and financial indicators (B), banks continue to apply weights (%) to these twoindicator groups, for example, commercial bank stipulates that weight A = 45%, B =55% if the financial indicators have been audited

(+) Scale of professional credit rating organizations and commercial bankscan have different symbols by number or by text, but they are the same at the level

of credit rating assessment For example, ratings of Moodys, the highest creditrating are Aaa, Aa1, Aa2, Aa3, the poorest quality is the lowest credit rating Caa; ofStandard & Poors, the highest credit rating are AAA, AA , AA, AA-, the lowestcredit rating is CCC; some banks may classify using points of 1,2,3 7 (1 being thebest score, worst score is 7)

(+) Commercial banks typically offer standard framework for rating eachgroup of corporate customers, in more details the banks can provide criteria forrating with very specific rules in the credit manual

Regulations of credit standards for what level of rating enterprises will begranted credit, what level the bank should consider withdrawing in case credit isalready granted; what level credit cannot be granted are also regulated specifically

in the credit manual

Thus, we can see that when considering the model of credit risk assessmentfor corporate customers by the scoring method, it almost inherits all the classicalanalysis methods, the non-financial indicators such as business environmentanalysis, business capability, collateral as well as the financial indicators whichare all used in the rating model Even the scoring method is up to 50% based on theanalysis and evaluation of analysts, so the level of credit risk assessment is alsorelative, therefore it needs to be be reviewed, updated, assessed regularly

Criteria for scoring consumer credit for individual customers

Table 1.1Scoring criteria for individual customers

1 The borrower's occupation

Professionals or is in charge of business

3 Classification of credit quality

4 Work experience

Less than 1 year 2

5 Time living in current location

More than 1 year

Less than 1 year

21

6 Having telephone

Yes

No

20

7 Living with anyone else

8 Bank accounts

Both saving account and checking account

Only saving account

Only checking account

None

4320

Source: Peter S Rose (2001), Commercial Bank Management, Financial Publisher (p 735).

In practical, service products for personal consumer loans are increasing, so

to handle the growing number of customers with the available system of personalinformation, banks use the scoring system to assess the risk of customers to grantcredit according to a specific level of lending This scoring system are automated

by many banks and are preferred by many customers, because it shortens theprocessing time for a loan, and within minutes banks can notify the results of theloan application

Consumer credit scoring models often use 7-12 items, and each item isscored from 1 to 10 Table 1.1 above is the scores for category of items that U.S.banks usually use to assess the risk before granting consumer credit

The rationale of this system is for banks to realize the financial factors,economic factors and purposes of customers to separate good loan accounts withbad loan accounts through the observations of income and review from a majority

of customers who were previously in debt, creating the difference between goodcredits and not very good credits which can still be applied in the future with smallerror rates This assumption may be wrong if there are sudden fluctuations in theeconomy and other factors Therefore, the banks also need to update the scoringsystem regularly

Maximum score the customers can receive from the 8 above factors is 43points, and the lowest score is 9 points Suppose the bank finds that the loanpreviously approved has a score of no more than 28 points, then 40% of such debthas become bad quality, and 28 points above are credits with medium to highquality Commercial banks base on statistical analysis to set score level: Below 28points, the banks refuse to grant, 29-30 banks can grant credit of 10 million, 31-33points 15 million…and at the peak level of 41-43 points banks can grant credit of

50 million

Summary of Chapter 1:

Through the basics of credit risk presented throughout the chapter, we realizethe nature of credit risk, causes, credit risk classification; the core content of thecredit risk management policy; views and perceptions about credit riskmanagement, development stages and especially the content and requirementneeded for the credit risk management operation have enormous impact on bankingoperations, not only it causes the variation in profits, but also directly affects thepossibility of the bank's bankruptcy Therefore, chapter 1 tries to mention a briefsummary of some credit risk analysis models

Risk management in general and credit risk management in particular are

have the basis to build an effective system of credit risk management that meets therequirements and is suitable with the actual capacity of the bank, chapter 1 alsopresents the content of the method to evaluate the effectiveness and efficiency ofcredit risk management activities as the basis to analyze and assess the actual creditrisk management activities of Vietinbank in Chapter 2.

CHAPTER 2: THE SITUATION OF CREDIT RISK

MANAGEMENT IN VIETINBANK AND VIETINBANK- BRANCH

NAM THANG LONG

2.1 Basic policies of credit risk management in Vietinbank

2.1.1 The lending policy of Vietinbank

17 years of establishing and operating as can be seen in the generalevaluation above shows that the credit operation of Vietinbank is always the themost exciting and the largest operation with many changes Through consideration

of the credit operation Vietinbank, we can see an overview of Vietinbank’s strategicdirection of lending through 3 important periods

Period from establishment on 7/1988 to March 12/1990:

The main lending orientation of Vietinbank in this period can be generalized

as a business bank specialized in lending to the industrial transportation andcommerce sectors; Vietinbank’s partners were primarily state-owned enterprises andco-operatives, doing business from district management level to province, centralmanagement level

Was newly established and brought into operation, therefore the startups ofVietinbank’s strategic planning of lending in this period was evaluated to be stillfuzzy, Vietinbank was mainly handed over outstanding loans from the SBV andcontinued lending to customers from the subsidy period

Credit risks in this period that can be seen: risk from loan portfolio whichwas highly focused on industry and commerce sector, risk from lending according

to plans, subsidy characteristic through the loan rate was still high, risk frompartners who were trade companies at all levels and co-operatives with lowefficient business operations, these losses were even accrued to the end of 2004,which was 1368 billion (loans according to plans and debts due to changes inmechanisms; Source: reports on the quality of credit investment and creditmanagement system of Vietinbank - Price Waterhouse)

This is the period that Vietinbank had a significant step forward in thedirection of lending, with the strength of branches and occupying places in largeurban areas of provinces throughout the country, and there were also the rapid shift

in economic structure and non-state enterprises which were also born in this periodand already thriving Therefore, in this period the lending directions of Vietinbankhad two highlights which were:

- Switching to lending to a wider variety of industries: Industrial production;trading; telecommunications, construction, transportation

- Switching to lending to a wider variety of ownerships: In addition to twotypes of state-owned enterprises and co-operatives, there were also limited liabilityCompany, joint stock Company, individual enterprises, households and individuals,and initial contact with foreign invested enterprises

Period from 2000 to present

The author takes the mark from 2000 to date to review and evaluate, eventhough about the bad debt settlement plan, in the process of restructuring Vietinbankwas approved by the government to consider it as the outstanding loans which weredue 31.12.2000, because in 2000 following the turmoil in credits, in November

2000 regulations about the classification of assets with credit risk provision andreserve official came into effect according to Decision 488/2000/QD- NHNN; also

at the time between the end of 1999 and turning into 2000, Decree on creditinstitutions’ loan guarantee (December 1999), Decree on deposit insurance,regulations on filtering the financial system to restructure banks meeting difficultieswhich were directed aggressively by the Government and the State Bank

After the big losses from the case Minh Phung - Epco, in this period the twostrategic missions directed for credit operations by Vietinbank are not only focusing

on handling and overcoming the consequences of the bad debts from the case Minh Phung II at Transaction center II as well as other branches, but also only

Epco-lending to reliable and effective targets; and the navigation in credit strategy to largegroups of customers which are the State Corporations (Vietinbank’s board ofdirectors has already signed a few fundamental contracts with those corporations).2.1.2 The policy of credit risk management in Vietinbank

Vietinbank has made remarkable progress in the making of credit riskmanagement policy Page 41 of the manual credit issued under Decision 163/QD-HDQT-NHCT on 29/9/2004 by Vietinbank’s board of directors has defined twoimportant points:

First, about the risk management principles:

- General principles of credit risk management are risks must be diversified,must not focus too much credit on a customer, a group of customers or a group ofrelated industries or sectors

- The granting credit process must be approved through various levels, alsoknown as "multiple-eyed credit”, the lowest is third level "6 eyes"; credit officers,business manager, director or authorized person, large applications needing re-assessment, or opposite opinions needing the assist of the credit council

- Inspecting and monitoring the loans regularly, must have independent creditinspecting and monitoring unit

Second, building limits of the credit risk control

Vietinbank has also outlined in the manual about the limits to restrict creditrisk, such as the granting proportion of secured and unsecured credit; betweendomestic currency and foreign currencies, between the short term and medium tolong term, between granting credit to the economy and granting credit to other