Risk management at vietinbank hoan kiem branch

Cohort 2015 – 2017 Master’s Thesis “Risk management at Vietinbank Hoan Kiem branch, Current situation and proposed solutions” Author: Nguyen Thi Kim Oanh Advisor: Assoc.Prof., Dr Ly Phuong Duyen Hanoi, June 2017 CONTENT TABLE OF ABBREVIATIONS .3 LIST OF TABLE AND FIGURES CHAPTER : INTRODUCTION 1.1 Background to the study 1.2 Aims of the study 1.3 Scope of the study 1.4 Method of the study .6 1.5 Outline .6 CHAPTER : THEORETICAL BACKGROUND .7 2.1 Concept of Risks in Commercial Banking .7 2.2 Classification of Risks in Commercial Banking 2.3 Causes of risks 12 2.4 Risk management in commercial banks 13 2.5 Risk Management Techniques 21 CHAPTER 3: RISK MANAGEMENT AT VIETINBANK–HOAN KIEM BRANCH 24 3.1 General introduction about Vietinbank Hoan Kiem Branch 24 3.2 Actual status of credit operation at Vietinbank Hoan Kiem Branch in 2014-2016 26 3.3.1 Products/services of Vietinbank Hoan Kiem Branch 26 3.3.2 Business performance of Vietinbank Hoan Kiem Branch in 2014-2016 27 3.3 Actual status of credit risk management at Vietinbank Hoan Kiem Branch 30 3.3.1 Actual status of credit operation 30 3.3.2 Credit quality and risk 33 3.3.3 Actual situation of credit risk management at VietinBank Hoan Kiem Branch 38 3.3.4 Actual status of operational risk management at Vietinbank Hoan Kiem Branch 45 3.3.4.1 Actual status of operational risk VietinBank Hoan Kiem Branch 45 3.3.4.2 Operational risk management procedure at VietinBank Hoan Kiem Branch 49 CHAPTER : SOLUTIONS AND RECOMMENDATIONS 54 4.1 Orientation for risk management at Vietinbank Hoan Kiem Branch 54 4.2 Solutions .55 4.3 Recommendations for strengthening of risk management at Vietinbank HK Branch 64 CONCLUSIONS 66 REFERENCES…………………………… ……………………………………….67 Page TABLE OF ABBREVIATIONS No Abbreviations Definition SSC State Security Commission of Viet Nam IT Information Technology BIS Bank for international settlement AMA Advanced Measurement Method KRI Key risk indicators VaR Values at risk ATM Automatical Technology Machine NPL Non Perfomance Loan HO Head Office 10 VTB Vietinbank 11 E&Y Earn and Young 12 SMEs Small and medium enterprises 13 EAD Exposure at Default 14 LEQ Equivalent Loan Exposure 15 PD Probability of Default 16 LGD Loss Given Default 17 EL Expected Loss 18 CIC Credit information center 19 AMC Asset Management Company Page LIST OF TABLE AND FIGURES No of tables/firgures Name of tables/firgures Page Table 3.1 Branch’s business performance over the years 28 Table 3.2 Condition and classification of loan by time 31 Table 3.3 Outstanding loan classification by economic sectors 32 Table 3.4 Outstanding loan classification by economic sectors 33 Table 3.5 Credit risk factor 35 Table 3.6 Analysis of overdue debt structure 36 Table 3.7 Bad debt situation over the years at the branch 38 Figure 4.1 Basic Risk Management Framework 60 Page EXECUTIVE SUMMARY CHAPTER : INTRODUCTION 1.1 Background to the study Risk management is very important to an organization, especially a commercial bank, which trades financial services with variety of risks In the context of the economic crisis in Vietnam and in the world recently, the Vietinbank system has faced up with so many risks, greatly affecting to the business operations of commercial banks in general and Vietinbank Hoan Kiem Branch in particular Nowadays when the economy is under the unpredictable volatility, risk management is increasingly concerned There are numerous causes for risks in the bank operation; therefore, risk management issues is compared as the survival matter of the banks by the saying profits is proportional to risks” In other words, the better a bank’s performance is, the higher the possibility of risks Besides, too tight risk management may lead to inefficiencies Through studying the causes, major risks Vietinbank Hoan Kiem Branch’s operation, the author thereby attemped to find out the best risk management solutions to balance risk management and business performance for Vietinbank Hoan Kiem Branch The common types of risks for commercial banks are credit risks, market risks, liquidity risks, operational risks, goodwill risks, compliance risks and strategic risks, etc., all of which have a huge impact on the operation of the entire Vietinbank system in general and Vietinbank Hoan Kiem Branch in particular at different levels and frequences depending on specific types of risks However, the thesis was only limited within the major risk types which have the most and deepest influence on the operation of Vietinbank Hoan Kiem Branch, namely credit risks, operational risks and market risks The remaining types such as goodwill risks, liquidity risks and compliance risks with low frequency and mild level effects on Vietinbank Hoan Kiem Branch’s operation are out of the scope of the thesis Page 1.2 Aims of the study The author, as the banker of Head Office of Vietinbank, would like to take this opportunity to select the subject “Risk management at Vietinbank Hoan Kiem Branch, current situation and proposed solutions” as the Master thesis with the aim to sum up, for completion of risk prevention and limitation in Vietinbank Hoan Kiem Branch, it is necessary to get an insight into the causes and types of potential risks to Vietinbank Hoan Kiem branch’s operation, from which possible solutions are provided for the best risk governance and the sustainable development of the business activities Research questions: - What are the kinds of risk at commercial bank? - Which kinds of risk can usually affect to operations of Vietinbank Hoan Kiem Branch? - What are the current situation and problems of risk management at Vietinbank Hoan Kiem Branch? - What are the solutions to solve and prevent the risk management at Vietinbank Hoan Kiem Branch? 1.3 Scope of the study The report studies the causes, major risks Vietinbank Hoan Kiem Branch’s operation In the context of report, it will research the risk management credit risk and operational risk at Vietinbank Hoan Kiem Branch from 2014 to 2016 1.4 Methods of the study: Thesis used qualitative and quantitative research methods are clarified, comparative and statistical methods 1.5 Outline The thesis consists of chapters, with the following: Chapter 1: Introduction Chapter 2: Theoretical background Chapter 3: Risk management at Vietinbank Hoan Kiem Branch Chapter 4: Solutions and Recommendations Conclusions Page CHAPTER : THEORETICAL BACKGROUND 2.1 Concept of Risks in Commercial Banking There currently exists many concepts of risks For example, risks are “losses or missing of opportunities” occuring in the future and resulting from current actions” Risks are not good and happen in an unexpected way Risks are bad lucks and uncertainties occurring in the course of banking business, adversly influencing on a bank’s activities Risks relate to changes in actions, ways of thinking and acting, position, etc., whether can change the future Moreover, risks involve in the selection and uncertainty of such selection’s order Finally risks will result in losses According to the material supplied by the State Security Commission of Viet Nam (SSC) in a workshop on “Risk Management for commercial banks” held in Ho Chi Minh City on August 05th, 2006, the risks in banking are defined as “the possibility that an action or event may bring adverse outcomes directly affecting an institution’s income or capital or create obstacles to that institution’s business continuity and use of opportunities to make profits” From the conventional viewpoint, risks are defined as “events, when occur, may make losses of assets or create a debt” The moderner definition of risks implies a broader meaning and not just takes into account financial risks but also those related to operational and strategic objectives Risks are the possibility that uncertain events in the future will make an entity not achieve its strategic and operational objectives as well as opportunity costs for such losses of market opportunities Risks concern both losses of capital and assets and impairment of goodwill and brand of a bank Accepting risks is the focus of banking activities, requiring the banks to assess their business opportunities based on the risk-benefit relationships for seeking out opportunities to gain the benefits worthy of acceptable risks The Banks will work well if their risk level is reasonable, under control and within their main resource and credit capabilities 2.2 Classification of Risks in Commercial Banking Risks can be classified by different aspects In the scope of commercial banking, the fundamental risks taken into account include credit risks, liquidity risks, Page market risks, operational risks, strategic risks, compliance risks/policy risks and goodwill risks Credit risks are the possibility of losses inccured by a commercial bank resulting from customers’ failure or inability to perform their obligations under commitments Liquidity risks lead to damages and/or loss or solvency of a commercial bank when it has not enough funds available for reasonable costs and/or fails to sell its assets at reasonable costs and/or forces to raise funds at high costs and on time needed to meet its financial obligations Liquidity risks are consider the largest when a commercial bank cannot anticipate the needs for new loans or deposit withdrawals and access commitments, risk concentration or asset and liability structure Market risks are of asset loss types, occuring when the interest rate, exchange rate or market rate adversely volatile Market risks covers a very wide range, thereby divided into three specific subtype including exchange rate risks, interest rate risks and market price risks Operational risks are risks that may cause damages due to insufficient or defected internal processes, human and systems or external factors and events Strategic risks arise from the inability of a commercil banks to implement its business plan, strategies, decision-making, adequate resource allocation as well as adapt to changes in its business environment Compliance risks are the risks that may arise from the parties’ breaches of or non-compliance with laws, rules, regulations or practices, or when the rights and legal obligations of the parties have been established Compliance risks relates to not only legal compliance but also professional ethical standards, conventions and treaties issued by associations Goodwill risks are the risks that may arise from the public’s negative opinionsc about commercial banks (when negative news about them are made in public) leading to the loss of funding sources, loss of customers, reduced revenues Goodwill risks may involve actions that contribute to the lasting negative perceptions in the public about the general operations of commercial banks; thus, Page the ability to establish and maintain customer relationships will become difficult with reduction of the public confidence in commercial banks The above definition has shown that banks can classify risks in their operations into four main categories, including financial risks, operational risks, business/economic risks and incident risks In fact, such categories as liquidity risks, market risks, credit risks, foreign exchange risks, interest rate risks, operational risks and asset risks are often mentioned Each category has its own characteristics besides an intimate relationship with each other and a direct impact on banks’ operations • Credit risks As defined by the Basel Committee, credit risk is the possibility that a borrower or counterparty fails to perform its obligations under a contract Also according to this committee, credit risks are known as risks of loss for a bank or a default in contractual covenants” due to any material violation of the contract obligations on repayment of principals and/or interests.” In other words, “Credit risk in banking activities of credit institutions is the possibility to occur losses in banking activities of credit institutions due to customers fail or are inable to perform their obligations under commitments” Pursuant to Clause of Article Regulations on loan classification, establish and use of provisions against credit risks in banking activities of credit institutions in attachment to the Decision 493/2005/QD-NHNN dated April 22nd, 2005 made by the Governor of the State Bank of Vietnam, credit risks are defined as the possibility of losses in the banking activities of credit institutions Despite different ways of definitions, the aforesaid concepts of credit risks have the same nature that is credit risks are the possibility (probability) of triggering the economic losses suffered by banks due to the borrowers’ delay or failure in repayment of loans (including principals and/or interests) Credit risks may cause financial losses for banks, for instance, reduction of net incomes and capital market prices, in serious cases, lead to losses or, at a higher level, bankruptcy of banks In terms of objective and subjective features of causes, credit risks are classified into objective risks and subjective risks Page In terms of cause of risks, credit risks are divided into the following categories: transaction risks and portfolio risks • Operational risks Operational risks exist in most departments of banks which engage in the transactions of business, service rendering or risk-weighted activities Operational risks are losses due to human, working processes, insufficient or inactive internal systems or external events It can be understood that operational risks arise from human factors (negligence or frauds); weaknesses of IT systems; loopholes and lack of regulations of commercial banks This definition includes legal risks other than strategic and goodwill risks Operational risks involve employee frauds, thefts, system failures, power failure, flooding or other reasons for the errors in a bank which can not be included in other risks Operational risks also include compliance risks Compliance risks are potential exposures to earnings and capital arising from failure to comply with laws, rules, regulations, best practices, internal policies and procedures or other ethical standards Operational risks are not new to banks These losses resulted from operational risks have been reflected in the balance sheets of banks for many decades They occur every day in the banking industry However, most of the losses are immaterial and entirely predictable and preventable, for example, errors in book recording, credit card errors, or brokendown of some banking equipment, etc Besides, some events can cause huge losses such as illegal stock trading, corruption, book forgery or external factors namely natural disasters, fires, etc In the process of research and interviews with numerous bank executives around the world since 1998 sofar, BIS (Bank for international settlement) have given various definitions of operational risks After many revisions, operational risks are generally accepted to be the risks that can causes damages due to human, incomplete or poor operational processes and systems and objective external events Operational risks includes legal risks, except for strategic and goodwill risks Under Basel II, Operational risks are the exposures to losses directly or indirectly caused by unqualified or failed processes, human and internal systems Page 10 at headquarters to coordinate with the Office of the market risk management and in providing operational input information for risk management activities But in fact VietinBank not built mechanism effective coordination between functional units, so only when room market risk management and operational consulting written request for information input to operational risk management, the Board, departments, the new center provides results This process makes the provision of information does not guarantee the timely and effective Fifth, due to a small department officials and employees in the system are not fully aware of the importance of operational risk management; thereby leading to subjective reporting is not interested and superficial, even branch also dishonest reporting operational risk status of branch => this phenomenon will lead to state input information is incomplete, did not reflect the true state of operational risk throughout the system Sixth, because in Vietnam currently undeveloped diversified insurance products, in many cases, VietinBank want to buy insurance for their professional activities also difficult and can not deploy (in Vietnam only current activities of deposit insurance, no insurance activities of payment, insurance trade) Page 53 CHAPTER : SOLUTION AND RECOMMENDATIONS 4.1 Orientation for risk management at Vietinbank Hoan Kiem Branch In Vietnamese bank’s business sector, profit from credit operations accounts for a large proportion in the bank’s income However, this activity entails risks, especially in the countries with economic situation like Vietnam whose the information system lacks of transparency and adequacy, risk management capacity is limited, unprofessional Therefore, it is necessary to establish an effective and suitable model of risk management to limit risk in credit activities, upto international level Risks always exist in any bank; the basic difference between the banks is risk management capacity basing on an effective risk management model in compliance with the operating environment for mitigating risks to minimum According to Basel Committee, the weakness in the banking system of a country, whether developed or developing one, threats to the financial stability Therefore, it is necessary to improve the strength of financial system Recognizing the necessary of the credit risk management, VietinBank system has directed and applied risk management models from the central level as well as two transaction centers and its branches throughout the country as follow: - Organizational structure and human resource: - To classify customer contact function, assessment function, risk management and debt management functions in credit granting to businesses Accordingly, the entire credit limits determine basing on overall risk shall be implemented independently by risk management departments, ensuring objectiveness as well as limiting the dispersal of information when supply credit products On that basis, the customer relations department will be responsible for contacting, receiving the customer's request, providing information for the risk management department, and monitoring, inspecting the customer’s commitment implementation process Risk management department monitors customer relations department‘s making the decision of credit approval to detect signs of risk as well as monitor and check loans, collateral and the loan conditions Page 54 - To clearly define the functions, legal tasks of customer relations department, risk management and debt management The clear defining of responsibilities will ensure fairness in the evaluation of the quality of work, be a condition for processing the signals of risk Each department should develop its objectives in granting credit on acceptable bad debt ratio, quantity and customer groups to be set, and the level of credit growth It is necessary to develop a mechanism for effective information exchange, update constantly and promptly of critical information between the functional units in credit activities The important information in borrowing process should be periodically updated by customer department Simultaneously, the bank should develop an information system and comprehensive information analysis systems, provide accurate, reliable information sources for the related department, the report, analyze all sectors in the analytical data system connected between banks to share information The comprehensive cooperation between banks in establishing and sharing information databases on businesses is the shortest way to improve the information system and reduce the cost of information exploit - To enhance the practicality and the ability to accurately assess the credit rating system This is an effective scientific tool in risk management by assessment and appropriate decisions Customer credit ratings system is applied but it still needs to be amended, adjusted to satisfy the actual conditions 4.2 Solutions 4.2.1 Considering environmental factors in loans At present, environmental factor is important when considering lending a business Therefore, when considering each loan, the bank must pay attention to the link between the loan and the environment under different factors to avoid the regrettable risks in business, such as: Is the project cost inclusive of the interactions between environmental factor and the loan project? Is the income and profitability of the project ensured? What is the relationship between environment and collateral? From then, determining the environmental impact to the collateral value and necessary expense to protect environment, if any Page 55 Has the bank loan applicant protected the environment, especially when that person operates on many different fields, totally unrelated to the project, the bank must consider if that customer has implement environmental protection plans for all of it business factor This will impact considerably on the financial condition and ability to repay bank debt on time 4.2.2 Improving the internal control quality at the branch Currently, the internal controls and inspection in commercial banks in general and bank branch in particular still face many shortcomings compared with the international internal control standards In the documents relating to the inspection, audit, the tasks and powers of internal control and internal audit of the monitoring system have not been clarified; not clearly define the concepts related to the inspection, internal audit; the laws and legislation consider internal audit apparatus under General Director and executive board are the subject of internal control On the other hand, if only focus on the condition of the credit enterprise at a certain point of time, it cannot be assured whether the credit enterprise will have risks in the near future or not? Therefore, it is necessary to apply many testing methods to provide the best performance, as follows: - The internal control staff is responsible for cross-checking the professional application in accordance with the process - There are at least two people in each process who assign responsibility, check, control in details for each employee participating in the process - Allowing the inspectors to access to the documents, as well as people relating to the internal control activities - When developing operational strategies, it is necessary to analyze, calculate the macro-economic conditions, the development trend of the market in which, consider the international situation -Supplementing and using the high tech solutions such as ICTNews of APC solutions This solution along with accurately and quickly updated data at the center will significantly reduce risks in business at the branch - Internal controllers should work competently and regularly trained, in addition they have to learn constantly to improve their capabilities Especially for the title of Chief, Vice chief of internal audit department, the conditions for admission Page 56 should increase the number of years of experience (minimum years) working in the fields of finance, banking, thereby ensuring professionalism of internal audit activities -Adopting policies to encourage and reward the best performing staff, as well as penalty policies for fraud, breach of rules Besides, the control content at banks is cumbersome, there is no early warning program, the bank evaluation results is just the statistical data Therefore, the monitoring results have not proved effectively in preventing and detecting credit problems The internal control staff at the branch also has no formal relationship to exchange information with banking supervisory authorities of the country having branches in Vietnam as the Headquarters of the bank mother, while this is one of the Basel standards Therefore, there should be provisions on information exchange and cooperation with the supervisory authorities and main transaction center of holding bank; seeking the support of international organizations in exchanging information, receiving advice on control methods, technologies and training to improve the capacity of inspection and internal control staff In short, the checking, internal control system is one of the core structure of credit risk management; therefore, the branch should perform this activity well to improve the operations quality, increase the bank value and reduce risk to a minimum 4.2.3 Further improvement in human resources quality People are the central element, are fundamental to detect, assess and limit the risks but also are the cause of credit loss deriving from their moral attitude and capacities The human factor is always the most important factor determining the success or failure of any activity in all fields For credit activities, the human factor plays an even more important role, it decides to quality, credit safety, service quality and the image of banks, which affect to bank credit effectiveness Therefore, in the future, to improve the quality of risk management, the bank should pay much more attention to human resources staff, use of humans as a primary element in establishment and operation of risk management mechanisms, to specify: Page 57 It is necessary to develop risk management staff with experience, knowledge, ability in considering and evaluating the credit proposal Guiding, training, training on professional knowledge, qualification of appraising businesses and its projects, focusing on marketing, sales skills, negotiation and business culture There should be monthly, quarterly meetings, training programs, practical exchange between leaders and staff to achieve information and experience Currently, Vietinbank Hoan Kiem Branch is considered as one of the efficient risk management branch Therefore, in future, the branch should further promote the role of risk management department At present, this department includes employees one person must take over many different tasks without specialization in the assigned task Therefore, I recommends that the branch should recruit more personnel to to arrange the work in a scientific way and focus on the individual task of each staff, ensuring the application processing time, improving work efficiency; on the other hand, having clear criteria on qualifications and experience In the future, the risk management department should further promote its role in risk management, particularly in the appraisal report, it must analyze, evaluate deeper potential risks, offer detailed warnings to replace the current general reports To achieve this goal, the staff should be regularly trained, enhanced professional skills Besides, recruitment, use, compensation and promotion policy must conform to the requirements and job responsibilities, in accordance with objective reality in branches Appointing must be objective and as stipulated to choose the qualified people, experience, good moral attitude At the same time, there are clear policies and specific assignment related to lending, debt collection and debt settlement (credit manuals) for each employee in each department to understand its responsibilities and powers 4.2.4 Basel II application in setting risk management model in Vietinbank Hoan Kiem Branch Currently many banks around the world are implementing risk management according to risk management frameworks as suggested by Basel II Committee Figure 4.1: Basic Risk Management Framework Page 58 (Source: KPMG International 2008) Main components of risk management framework are a set of core standards providing guidance on the basis of control and environmental protection The frame is complemented with different tools with the major components: determining risk quality, establishing governance structures, allocation of reporting flows and selfassessment control, risk event management, the the main risk indicator and risk reduction programs If implementing properly all of the above principles in compliance with the actual condition of the bank, the bank's risk management work will follow standards and accomplish the bank goals However, depending on the capacity and level of use, the branch can develop into different patterns in terms of size and level of complexity as well as implementation time In my opinion, the branch should establish a risk specialized division, innovate reporting system and apply modern technology in the future Besides the existing human resources, the bank should make use of the resources from VTB system to manage risk, currently, VTB is cooperating with E & Y to set up risk management framework for with a implementation schedule until 2018; thereby, the branch can manage operation risk basing on self assessment Operation of the departments, business units is identified, assessed regularly; therefore, the decision to adjust and modify activities to reduce risk gradually and limited risk The risk is analyzed on two perspectives: frequency of appearance and impact level Since then, the bank shall determine method of organizing and planning the risk minimizing program such as internal controls, insurance Accordingly, the risk management tools and techniques are used as self-assessment control, event management, risk analysis and reporting Page 59 On the other hand, all levels and employees must be aware of the importance of risk Board of management must seek for risk management framework consultancy for its banks and the business environment In particular, two key issues need to be invested are: establishing, improving strategies for risk management and completing risk management structure, especially organizational structure Risk management strategies often include the following issues: identifying risks and causes of risk, describing the risk profile On risk management structure, banks should establish and complete the separating risk management committee, in which risk is a division Monitoring apparatus of bank risks should operate independently, not involved in the process of establishing risk, to manage and supervise risk Second, the bank should establish the awareness of risk management throughout the system; select the priority to establish checkpoints on risk All bank employees must be trained to understand and participate in self-determination of risk, evaluating all existing risks in all products, activities, processes and banking system The Risk checkpoints are selected basing on the following criteria's: profitable sector, banking basic business, which can cause heavy losses if the risk occurs For each process, analyzing the magnitude of the risk impact (in terms of the amount of loss, other losses to the bank ) and the ability for each occurrence of risk, thereby collecting loss database The impact degree and likelihood of each risk type is assigned under the influence extent On the other hand, with the hint of basel 2, the bank will use models based on internal data systems to determine the ability of credit losses Thereby determining variables such as PD - Probability of Default; LGD: Loss Given Default; EAD: Exposure at Default Through the above variables, the bank will determine the EL: Expected Loss For each identified term, the estimated loss can be calculated basing on the formula: EL = PD x LGD x EAD First, the PD - Probability of Default The basis of this probability is the customer data on past debts, including the paid amount, term debts and irrecoverable debts As required by Basel 2, to calculate the debt within one year of the customer, the bank must base on the customer Page 60 outstanding debt balance within at least previous years These data are classified into groups: - Financial data group relating to the customer financial ratio as well as the assessments of rating agencies - Non-financial qualitative data group relating to management qualification, ability to research and develop new products,the ability of data on industry growth - Cautionary data relating to the inability to pay debts to the bank such as deposit balance, overdraft limit From these data, the bank entered into a predetermined pattern, thereby calculate the probability of customer default It may be the linear model, probit model which are often established by professional consultancy organizations Second, EAD: Exposure at Default For term loans, EAD can be easily determined However, for the loan under the credit line, revolving credit, EAD determination is quite complex According to the Basel Committee, at the debt default time, customers tend to withdraw the loan to approximate the granted limit Therefore, Basel committee require to calculate EAD as follows: EAD = Average outstanding debt balance + LEQ x Average unused credit line In which LEQ - Equivalent Loan Exposure is the percentage of unused capital which is likely to be drawn by customers at the debt default time "LEQ x Average unused credit line" is the percentage of unused capital which is likely to be drawn by customers at the debt default time beyond the average outstanding debt balance The determination of LEQ - additional withdrawal capital ratio is important to the estimates accuracy of customer outstanding balance at the debt default time LEQ determining basis is the historical data, which leading to great difficulties in calculation For example, reputable customers with full repayment rarely fall into this situation, therefore, it is impossible to calculate exactly the LEQ of a good customer Third, LGD: estimated loss ratio – this is the proportion of capital losses on total outstanding debt balance at the debt default time LGD not only cover loan losses but also other losses incurring when customers are unable to repay the debt, Page 61 which is interest in due but not paid and the administrative costs that may arise such as: cost of handling collateral, the cost of legal services and some related costs The proportion of total estimated loss can be calculated according to the following formula: LGD = (EAD - recoverable Amount) / EAD In which, the recoverable amount includes the paid amounts from customers and the proceeds from disposal of collateral or pledge LGD can also be considered as 100% - of the recoverable amount According to research by the Basel Committee, the most important factors in deciding the bank capital recoverability when the customers are unable to repay is collateral and customer asset structure Customer asset structure is mentioned in different liability repayment prioritize order in the case of bankruptcy In fact, when a enterprise is bankrupt, capital recovery rate from the bank's loans are usually higher than the recovery rate from bond capital because banks have priority right to be paid earlier than bond investors Besides, when the economy is in recession period, the capital recovery rate also decreases Currently, there is three main methods to calculate LGD: ✓ First, Market LGD - loss ratio based on the market This method is used when the credits can be traded in the market The bank may determine the loan loss proportion basing on the loan price for a short time after it was categorized as bad debts This price is calculated on the basis of market estimates with the current method of all recoverable cash from the loan in the future ✓ Secondly, Workout LGD - loss ratio basing on the processing of outstanding credits The bank shall estimate the future cash flows, the expected cash flows recovering and discounting period The determination of the appropriate discount rate is the key issue and most intractable ✓ Third, Implied Market LGD – Determining loss ratio basing on the market risk bond price By identifying an estimated loan impairment, the bank will implement the following objectives: It can be seen that when the bank lends to good customers, the risk ration is reduced, and all credit risk causes reduce As a result, capital adequacy ratio increase, which leads to better bank image to the market and the supervisory authorities The benefits from applying Basel rules are pretty much, namely Page 62 First, it helps the bank strengthen human resources management capacity which is credit staff management According to the theory of management, human resources management involves four main issues: recruitment; retraining; compensation system; promotion issues In fact, many banks around the world have developed a marking system of credit staff‘s working result to determine the suitable salary and promotion level With credit officers, salaries and bonuses are usually based on the outstanding balance, the number of customers and credit quality If the credit officers have high outstanding debt but low credit quality, their salaries could be very low, and of course, can not be promoted Thus, the determinination of estimated losses for each loan portfolio of individual credit officers will clearly quantify their credit quality This forced credit officers must strive to avoid risks, otherwise, they shall receive low salary amount regardless to their experience Second, the determination of estimated losses, especially to identify PD probability of default of customers will help the bank improve the supervision quality and re-rating customers after lending Thus, the establishment of the credit loss estimation system basing on the database system of internal evaluation - IRB is the inevitable trend of commercial banks in Vietnam in the integration process However, the calculation of any indicator of PD, LGD and EAD are very complex, requiring banks to have a complete database, which is stored scientifically with the modern data processing software All of these issues require commercial banks must invest much financial resources, people, time with scientific schedule Third, guidance on establishing risk management data system and using modern technology in analyzing and handling risk management In the near future, banks should quickly establish manual processes to collect additional information of losses If possible, bank should optimize modern technology to analyze, evaluate and settle risk management On the other hand, banks should engage in other organizations, strengthen the negotiation with other bank, the State Bank to share loss information, quickly realizing the recommendations in the workshop of the State Bank in 1/2011 on credit risk and establish risk management data system The core information for risk management data system include: The total loss amount, insurance subsidies and other recovery, the corresponding risk type, business sector, losses sector, date and causes of events Page 63 Fourth, the bank should limit the cause of credit risk from the internal elements such as people, processes and systems The policies of the Basel aim to establish human resources with high quality, good moral attitude; the operational procedures are reviewed regularly Information technology and operations systems are maintained and updated regularly The basic functions of the application software for credit risk will include decentralized data import (loss data, risk indicators, and feedback to the risk assessment), evaluation on business scope Finally, the bank should minimize the external risk management causes by establishing the plan, offering the existing situation to settle promptly and overcome the consequences of the communication error, natural disasters, and fire Basic solutions for decision making are: recognizing existing risks, converting risk to third parties (Eg through insurance); reducing risk by extending the control system, introduction of information technology for automatic errors identification system These measures should be added continuously to minimize and control risk at lowest level 4.3 Recommendations for strengthening of risk management at Vietinbank Hoan Kiem Branch 4.3.1 Recommendations to the Vietinbank Vietnam First, Branch need reserve enough capital for his risk operation, need determine rate of minimum capital for his risk operation, need to determine minimum capital ratios to compensate the risk, this is minimum capital calculated according to risk ratio of bank Second, need assess correctly the risks that facing and need implement under principles: - Have a process for assessing full capital of branch according to right strategy in order to maintain that capital - Staffs in risk management department need check and re-assess process of assessment of internal capital as well as loan that customer department submits to reappraise accurately, quickly - Not let capital level of bank under minimum capital according to regulations Page 64 Third, it needs to publish information reasonably according to market principle, information of capital structure, capital adequacy, and other information relating to sensitivity of bank for risk Forth, closely coordinate with State Bank to organize the exploitation of credit information effectively from CIC center to avoid risk in best way 4.3.2 Recommendations to the State Bank Vietnam First, need to complete documents, regulations to create and use risk reserve fund Today, creating risk reserve fund in credit activities is implemented under Decision No 493/2005/QĐ-NHNN, according to this decision, debts in group 2, 3, 5, rate of reserving will be different but in fact, regulating rate like that is not reasonable, because credits belonging the same group will have different loss Second, strengthen and improve effectiveness of inspecting, controlling base on applicable regulations, suit with international practice and actual status of banks In fact, inspection only when risk occurred without remote monitoring to prevent risk and prevent timely Through some issues such as bank staffs of banks use gaps in bank to carry out illegal actions, regulations of bank such as selling foreign currency for foreign countries or use reputation of bank to carry out selling foreign currency illegally… The above issues show lax management of State bank to commercial banks State bank need to have management software on computer to regularly check and monitor individuals, organizations who violating loan regulations, force banks to implement loan regulations Third, promote credit information in order to improve risk management of credit in commercial banks Operation of credit information of banks in Vietnam is still not good, not ensure quick, timely, accurate information State Bank need methods to improve credit information quality by equipping new, modern equipment for CIC center to meet working demands, improve quality of staffs in CIC not only in qualification but also in training informatics and foreign language 4.3.3 Recommendations to the Government First, Government with regulatory functions of economy by tools such as fiscal policies, monetary policy and adjustment in law system to make operation of bank more effective Government need to regulate management policy for foreign exchange in order to attract foreign currency floating in the market, supplement in Page 65 national reservation, ensure payment capacity with foreign countries in import-export sector Beside that, need control rate of foreign exchange in free market and interbank market, control price in market, to avoid high inflation rate Second, create synchronizing legal framework, for operation of economic objects and interbank operation in particular, especially for law on collateral assets, determining value of collateral assets as well as selling assets when loans meet problems under legal procedures To facilitate for commercial banks to handle outstanding debts, need cooperate with departments, relating sectors For example, collateral assets are properties, AMC of commercial banks will need to sell to collect debt but not having full documents of ownership and land using, Land administration department need to review to legalize documents, facilitate for bank to collect debts Third, Tax system of State need to simplify but still having full tax obligations to enterprises which having profits, reducing tax evasion, tax avoidance Fourth, financial statements of enterprises must be checked in accuracy and by independent auditor companies to help banks to have truthful financial information to support appraisal customers CONCLUSIONS Based on summarizing research methods, the following targets, scope and object of the study, it has completed the following tasks: First, the study has summarized basic issues of risks and risk management in banking operations Second, the study has analyzed status of risk and risk management in Vietinbank Hoan Kiem Branch Third, the study has given some methods solution to complete credit management in the Vietinbank Hoan Kiem branch and give some recommendations for the State authorities as well as Vietinbank on risk management Page 66 REFERENCES In Vietnamese - Vietinbank Hoan Kiem Branch ( 2014, 2015, 2016) Annual report - Tô Ngọc Hưng (2009) Introductory course: Commercial bank, The statictical Publishing House - Phan Thi Thu Ha (2009) Commercial bank Managements, The statictical Publishing House - Nguyễn Văn Tiến (2010) Risk Management in commercial bank, The statictical Publishing House In English - Fredic S Mishkin (1992) The Economic of Money, Banking and Financial Markets, Harper collins Publisher - Anthony M Santomero (1997) Commercial bank risk management an analysis of the Process, The Wharton financial institutions center - Joel Bessis (2011) Risk management in banking, John Wiley & Son, LTD - Amalendu Gosh (2012) Managing risks in commercial and retail banking, Wiley Finance - Basel cummitte on Banking Supervision (2006) International Convergence of Capital Measurement and capital Standard, Bank for International Settlements Press & Communications Author’s signature Advisor’s signature Nguyen Thi Kim Oanh Assoc Prof., Dr Ly Phuong Duyen Page 67 ... risk management at VietinBank Hoan Kiem Branch 38 3.3.4 Actual status of operational risk management at Vietinbank Hoan Kiem Branch 45 3.3.4.1 Actual status of operational risk VietinBank Hoan. .. operational risks such as insurance / risk transfer Page 23 CHAPTER : RISK MANAGEMENT AT VIETINBANK – HOAN KIEM BRANCH 3.1 General introduction about Vietinbank Hoan Kiem Branch Vietinbank Hoan Kiem. .. operations of Vietinbank Hoan Kiem Branch? - What are the current situation and problems of risk management at Vietinbank Hoan Kiem Branch? - What are the solutions to solve and prevent the risk