LV Thạc sỹ_Improving the credit rating system at ACB bank

1 Acknowledgement I would like to send a sincere thanks to my lecturer, Prof…, National Economics University for guiding and enabling me to complete my theisis I give a sincere thanks to Ms…, Deputy Manager of the Center, for her wholehearted supports to me during my internship I thank for the warm welcome spirit everybody at the Center have given to me and help me to complete my thesis Contents Acknowledgement ABSTRACT .6 CHAPTER I – INTRODUCTION 1.1 Rationale 1.2 Research Objectives 1.3 Research Methodology 1.4 Premises and Limitations of research CHAPTER – THEORETICAL BACKGROUND .10 2.1 Introduction to Credit risk .10 2.1.1 Definition of credit risk 10 2.1.2 Causes of credit risks 10 2.1.2.1 Instability economic environment .10 2.1.2.2 Ineffective macroeconomic management 11 2.1.2.3 Immature credit information management system at the nation scale .11 2.1.2.4 Limited legal framework 12 2.1.2.5 Credit risk from the side of the borrower 12 2.1.2.6 Credit risk from the commercial bank .13 2.2 Purposes of Credit Rating System 13 2.3 Principles of Credit Rating System .14 2.4 International experiences of CRS 15 2.4.1 Fitch Ratings Corporate Rating Methodology 15 2.4.2 Moody’s Rating Methodology 18 2.4.3 Standard & Poor’s corporate rating system .21 CHAPTER – CREDIT RATING SYSTEM AT ACB 24 3.1 Introduction to ACB .24 3.1.1 Foundation and development of Asia Commercial Bank 24 3.1.2 Organizational Structure 25 3.2 Business result analysis of ACB from 2008 to 2011 26 3.3 Credit Rating System at ACB 32 3.3.1 Introduction of Credit Rating at ACB 32 3.3.2 Credit Rating Process 33 3.3.3 Collecting Information .34 3.3.4 Evaluating Collateral 36 3.3.5 Defining business area .36 3.3.6 Evaluating Company Size 37 3.3.7 Scoring Financial Criteria 38 3.3.8 Scoring Nonfinancial criteria 41 3.3.9 Calculating total score .44 3.4 Strengths and Weaknesses of the ACB Credit Rating System 46 3.4.1 Strengths and achievements .46 3.4.2 Weaknesses 48 3.4.3 Reasons 50 3.4.3.1 Lack of information 50 3.4.3.2 Lack of comparison with external credit rating agencies 51 3.4.3.3 Weak control of the credit rating process at branch levels .51 Chapter – Recommendations & Solutions 52 4.1 Rating methodology recommendations 52 4.1.1 Adjusting quantitative analysis to include industry specialize 52 4.1.2 Modifying weighting nonfinancial criteria method 54 4.1.3 Increasing role of cash flow analysis in quantitative analysis 55 4.1.4 Using Stress Testing 56 4.2 Managerial recommendations 57 4.2.1 Increasing the awareness of Credit rating system to all employees 57 4.2.2 Refining the internal information system at ACB .58 CONCLUSIONS 59 REFERENCES .60 APPENDICES 61 Appendix 61 Appendix 62 Appendix 63 Appendix 64 List of Tables and Figures Table 1: Classification of Total Outstanding Loans Table 2: Classification of Company Size Table 3: Company size scores Table 4: Credit Scores for Credit Assessment Table 5: Credit Scores for Loan Categorizing Figure 1: Organizational Structure of the Asia Commercial Bank Figure 2: Total Outstanding Loans from 2006 – 2011 Figure 3: Net Interest Margin from 2006 – 2011 Figure 4: Asset and Deposit’s growth from 2007 – 2011 Figure 5: Composition of Outstanding Loans Portfolio Figure 6: Credit Process Figure 7: Credit Rating Process Diagram 1: Nonfinancial Analysis Diagram 2: Credit Assessment for company without financial statement Diagram 3: Credit Assessment for company with financial statement Diagram 4: Loan Categorizing for company without financial statement Diagram 5: Loan Categorizing for company with finanacial statement Abbreviation No ACB CRC CIC Description Asian Commercial Bank Credit Rating Center The Credit Information Center ABSTRACT The Vietnamese banking industry has come a long way since the country began its economic and financial reform program a decade ago The number of financial institutions has risen quickly, following of many efforts from the Vietnamese government to build and develop an advanced and efficient market Banking firms, especially commercial banks, are always considered to be a back bone of the whole financial system, which call for the greatest attention and supervisions As the nature of banking business, credit risk is one of the major risks banks faced with There have been so many investments and human sources which commercial banks have devoted for their interenal credit rating systems so that they can depend on this background and facilitate all other financial services The main focus of this thesis is the internal credit process which is performed at the Asian Commercial Joint-Stock Bank First, an owverview of credit scoring techniques and of corporate rating methodologies was given, by studying the interpretations and creiteria of some most famous credit rating system in the world After having an understanding on how these systems work, the theisis analyzed the internal credit rating system performed at the Asian Commercial Bank Next, an assessment of strengths and weaknesses of the rating method was given The last part of the thsis focused on the recommendations to improve the credit rating systems of the banks CHAPTER I – INTRODUCTION *** 1.1 Rationale Credit is a fundamental activity of commercial bank Credit consists of interaction and influence of participants in what relates to monetary and financial relationships It is needless to declare the importance of credit risk management for a commercial bank The matter, yet, is about “How can realize the risks” To answer this question, all banks use their internal credit rating as primitive tool given following manner They carefully evaluate all customers, appoint each a score; and for any decision making, the ratings of the customers will act a key factor For recent years in Vietnam, the economy and financial market have experienced a rapid emergence; many investments and credit needs also follow the trend, and have increased considerably This turns the role of commercial banks as credit conciliators more critical than ever Manufacturers and non-finance business, for the lack of expertise and knowledge or the unwillingness to reveal factual information, can hardly provide their credit status All must depend on banks internal evaluators to truly access these customers; and for their specific orientations, each bank normally builds its particular standard and criteria For ACB, the task is in hand of its “Credit Rating Center for Business Customer-North Division”; and it’s so-call Credit Scoring compendium full of quantitative and qualitative guidelines to rate business customers All benchmarks set by this center are applied for every branch and subsidiary of ACB Having much personal interest in banking industry and credit rating, I have chosen it as my graduate thesis Writing about it, I would serve for the purpose of introducing, understanding the system’s advantages and disadvantages, and therefore realizing what can be improving in the Credit Scoring system at ACB Such paper will provide deeper insight and individual opinions about credit rating as the center of attention in all commercial banks I present here my paper “Improving the Credit Rating System at Asia Commercial Joint-Stock Bank” 1.2 Research Objectives This study aims:  To understand how ACB measures the creditworthiness of its business customers  To analyze the strengths and weaknesses of the Credit Rating System  To provide recommendations to improve the Credit Rating System 1.3 Research Methodology The research will utilize both quantitative and qualitative data collection tools Data Collection Data collection will consist of observations and interview with staffs of the Credit Rating Center, as well as documents available Secondary data consists of papers and researches of organizations, scholars’ researches and studies on the credit rating in banking topic Qualitative Evaluation A qualitative evaluation shall be utilized for this research including careful analysis of obtained data to prepare different evaluation methods (i.e SWOT analysis) to analyze how to best capture the creditworthiness using the system Quantitative Evaluation The research will study the performance of the ACB bank in general and of the Credit Rating Center in particular during the period from 2006 to 2011 Quantitative tools used are ratios analysis and trend analysis 1.4 Premises and Limitations of research The premises of research are:     The overview of Asia Commercial Bank The factors including in the Credit Rating System The quality and performance of the Credit Rating Center Recommendations Limitations are:  This research will not consider statistical and mathematical modeling of the Credit Rating System  This research will not study the usefulness or utility a particular computersupported cooperative work technology products used in the Credit Rating Center 10 CHAPTER – THEORETICAL BACKGROUND *** 2.1 Introduction to Credit risk 2.1.1 Definition of credit risk Like other companies operate in the market, banks have to face with many underlying risks In banking industry, typical risks are Credit risk, Liquidity risk, Foreign exchange risk, Interest rate risk, Market risk, Operational risk, Regulatory risk Credit risk, also known as default risk, is the biggest risk facing a commercial bank By definition, credit risk is the risk of loss of principle or loss of financial rewards resulted from borrower’ failure to repay the loan or to meet contractual obligations Credit risk in Vietnam is defined in Decision 493/2005/QD-NHNN dated 22 April 2005 by the State Bank of Vietnam: “Credit risk in banking activities of the credit institutions mean the possibility of losses to be incurred in banking activities of credit institutions due to their clients’ failure or incapability to fulfill obligations as committed” Estimation from State Bank of Vietnam indicates that the percentage of bad debt to total outstanding loan in the banking system in 2011 is roughly 3.3%, higher than the percentage of 2.14% of 2010 55  Large, Medium and Small enterprises: Loan payment ability/ business plan Weight 30% Management experiences and company Credit history Industry risk Business risk 10% 15% 15% environment 30% Revaluation of the feasibility of the business plan and analyses of management teams of the companies are equally important 4.1.3 Increasing role of cash flow analysis in quantitative analysis This recommendation is learned from Fitch’s methodology on cash flow measures Fitch uses numbers of measures for the purpose of assessing debt-servicing abilities These include fund flow from operations (FFO), cash flow from operations (CFO) and free cash flow (FCF) Funds flow from operations Post-Interest and Tax, Pre-Working Capital FFO is the fundamental measure of the firm’s cash flow after meeting expenses, including taxes and interest FFO is measured after cash payments for taxes, interest and preferred dividends but before inflows or related to working capital Fitch’s computation also subtracts or adds back an amount to exclude noncore or nonoperational cash in- or outflow FFO offers one measure of an issuer’s operational cash-generating ability before reinvestment and before the volatility of working capital When used in interest coverage ratios, interest paid is added back to the numerator Cash Flow from Operations Post-Interest, Tax and Working Capital 56 CFO represents the cash flow available from core operations after all payments identified by the issuer for ongoing operational requirements, interest, preference dividends and tax CFO is also measured before reinvestment in the business through capital expenditure, before receipts from asset disposals, before any acquisitions or business divestment and before the servicing of equity with dividends or the buyback or issuance of equity Free Cash Flow Post-Interest, Tax, Working Capital, Capital Expenditures and Dividends FCF is the third and final key cash flow measure in the chain It measures an issuer’s cash from operations, after capital expenditure, nonrecurring or nonoperational expenditure and dividends It also measures the cash flow generated before account is taken of business acquisitions, business divestments and any decision to issue or buy back equity, or make a special dividend, by the issuer 4.1.4 Using Stress Testing Stress testing is a part in all three top-world rating models of Fitch’s, Standard and Poor’s and Moody’s Stress testing is used to determine the stability of a given system or entity It involves in hypothetical testing of strains beyond normal operational capacity, often a breaking point, in order to observe the results It ensures the observers of the survivability of the subject under plausible hazardous events There are three types of scenario can be used to conduct stress testing: Extreme event: hypothesize the consequences given a catastrophic event, often the recurrence of a historical event Risk factor shock: shock any factor in the chosen risk model by a user-specified amount The factor exposures remain unchanged, while the covariance matrix is used to adjust the factor returns based on their correlation with the shocked factor 57 External factor shock: instead of a risk factor, shock any index, macro-economic series (e.g., oil prices, property prices), or custom series (e.g., exchange rates) Using regression analysis, new factor returns are estimated as a result of the shock 4.2 Managerial recommendations 4.2.1 Increasing the awareness of Credit rating system to all employees As stated in the causes of weakness, one reason, which reduces the quality of the CRS in analyzing and managing credit risks at ACB, is the attitude to underestimate the important of credit rating process at the branch levels To overcome this weakness, ACB should support its employees with trainings, workshops, conferences on regular basis, to: (3) Nature strong corporate ethics and working morals not be tempted by bribery, always complying with the laws and ACB’s policies (4) Educate professional knowledge on credit rating and the credit rating system of ACB Not only the credit Rating Staffs at branch levels, and at the ACB Credit rating center, who are directly in charge the credit rating process, should be trained, but also credit clerks, who receive the loan request from customers, should have deep consciousness about the important of the credit rating 4.2.2 Refining the internal information system at ACB Like other credit institutions, lack of high quality information is a common weakness that ACB has to face when operates in Vietnam ACB has to improving the quality of its internal information system to support its Credit rating system ACB has one advantage that its branches are located in all developing areas in Vietnam Thus, to build an effective Information system, ACB should develop a centralized information center, where branches must summit on regular basis 58 information of their customers The hub of information will support board of managers to have an overall view of the current credit quality of ACB’s customers and control the performance of credit rating process at branch levels 59 CONCLUSIONS It is undoubtedly to believe that the most important ingredient build up the financial market in Vietnam is the banking system In recent years, following the strategic policies of Vietnamese governments, many laws and regulations incentive have gone into effective to support the growth of banking industry One of the most crucial factors for a bank to have a healthy and strong growth rests in its ability to justify the credit worthiness of customers To so, all banks use their own credit analysis system and make credit decision based firmly on it The Research “Understanding and Improving Credit Rating System at Asia Commercial Joint-Stock Commercial Bank” has conducted following outcomes: - Systematizing credit risks, causes of credit risk in banking industry - Analyzing performance and functioning of Credit Rating System at ACB - Providing recommendations to improving the Credit Rating Process at ACB In the context of the thesis, due to the limit of budget and time, the research can neither tap to the statistical analyzing of credit rating process nor provide the mathematical modeling for the Credit Rating System This area will be an opportunity for higher research 60 REFERENCES Joe Bessis (2002) Risk Management in Banking West Sussex: John Wiley & Sons Ltd, Edward I Altman and Herbert A Rijken (2003) How rating agencies achieve rating stability New York: NYU Salomon Center, Leonard N Stern School of Business Asia Commercial Joint-Stock Bank Annual Reports of Asia Commercial Bank: 2006 – 2011 Moody’s Investors service (2012) Incorporation of Joint-Default Analysis into Moody’s Bank Ratings Global Methodology Fitch Ratings (2006) Corporate Rating Methodology Retrieved June 2006 from www.Fitchratings.com Standard & Poor’s (2011) Guide to Credit Rating Essentials.Retrived March 2011 from www.Standardandpoors.com Investopedia dictionary, www.investopedia.com/dictionary/#axzz1urDDkJvb 61 APPENDICES Appendix Industry Classification No 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 Classification Agriculture, Forestry and Aquatic Wood processing and other products from forestry Aquatic and Fisheries processing Mining Foods, Beverage and Agricultural foods Textile and shoes production Fertilize, basic chemistry, synthetic rubbers production Medicines and other pharmaceutical production Steel industry Electronic, optical devices and telecommunication devices production Construction material (except steel) production Electrical, energy and telecommunication services Construction Real estate and infrastructure Consumer production Agriculture and industrial trade Transportation Hotel, Food & Entertainment Services Healthcare, Education Services Advertising, consultant and inspection, printing services House tools, office equipment, education and healthcare equipment production Mechanical and machinery equipment Dye – dyeing production Warehouse and supporting services Metallic tools and welding equipment Airline services 62 Appendix Collateral Asset Category No Type of Collateral Pledged Asset Asset Category Gold, Silver and Precious Metals: have legal documents of ownership - Gold plate: SJC, PNJ, Bong Lua - Precious stone: Diamond, Ruby, Saphire… Car, plan, ship: - Legal documents of ownership (with registered vehicles) or documents of origin ( with unregistered vehicles) - Brand new or quality minimum 80% Machinery, Equipment and Assemble Line: - Completed product - Legal document of ownerships or document of import Goods and Raw Materials: - Have high liquid market - Can be stored - Legally accept - May require insurance on the asset Valuable papers: - Bond, stocks… - Legal document of ownerships - Specified value, term, quantity Valuable papers: - Bond, stocks… - Legal document of ownerships - Specified value, term, quantity Legal right over generated asset - Copyright, Industrial ownership, right to claim loan, right from contributed capital, right to nature resource exploration, other right from contracts or other legal sources - Require legal documents of ownership Collateral Land use right - Have legal documents - Locate inside cities of Vietnam - Face with high way - Land of industrial, processing zone Houses and buildings attached with land Have legal ownership documents Third-party Guarantee Equity Asset Same asset type as Pledged and Collateral Requirements for borrower: Have financial ability to repay loan Have financial plan, or production, manufacture plan for repayment Contributed capital in the project minimum of 15% of total capital Requirements for asset: Generated asset from the loan must have legal right, uses and specifiable value, in some cases may require insurance 63 Appendix Financial Criteria Score 64 No Criterion Weight 100 80 60 40 20 Liquidity Ratios Current Ratio 12 > 1.4 1.1 – 1.4 0.8 –1.1 0.5 – 0.8 < 0.5 Quick Ratio > 0.8 0.6 – 0.8 0.4 – 0.6 0.2 – 0.4 < 0.2 Operating Cash flow Ratio > 0.3 0.24 – 0.3 0.18 – 0.24 0.12 – 0.18 < 0.12 Operating Efficiency Ratios Working capital turnover ratio > 4.5 3.67 – 4.5 2.83 – 3.67 – 2.83 8 6.33 – 4.67 – 6.33 – 4.67 12 9.67 – 12 7.33 – 9.67 – 7.33 7 5.33 – 3.67 – 5.33 – 3.67 90% Long term debt to total asset ratio < 20% 20% – 33.33% 33.33% – 46.67% 46.67% – 60% > 60% 10 Profit Ratio Net Profit Margin > 15% 10.67% – 15% 6.33% – 10.67% 2% – 6.33% < 2% 11 Operating margin > 10% 7.67% – 10% 5.33% – 7.67% 3% – 5.33% < 3% 12 ROA >18% 15.33% – 18% 12.67% – 15.33% 10% – 12.67% < 10% 13 ROE >8.1% 5.9 – 8.1 % 3.7% –5.9% 1.5% – 3.7% 2.5 2.17– 2.5 1.83 – 2.17 1.5 – 1.83 < 1.5 Appendix Nonfinancial Criteria No Criteria Sub-criteria CUSTOMER WITHOUT FINANCIAL STATEMENT 65 Business activities risks The efficiency of carrying out project and managing business plan The efficiency of implementing strategy and main business activities of the customer Are the costs and expenses closely monitored? Quality of the carried out project Level of guarantee The speed of project’s process 2a Business plan 2b Business performance Business environment risk Risk from unpredictable event Financial risk The speed of business plan’s process Experiences and abilities of management team Is the business plan effective at the moment regarding changes in input market? Is the business plan effective at the moment regarding changes in output market? Does the customer have abilities, including financial ability to carry out project/ business plan? Does NPV of the project/ business plan change, regarding changes in the market? Does IRR of the project/ business plan change, regarding changes in the market? Does the payback period of the project/ business plan change, regarding changes in the market? The relationship with suppliers The relationship with main customers and buying network Adaptation and swiftness of management team with changes in the market Competitive edge of the customer Marketing plan of the customer Competitive abilities of the product/ service Survivability of the product/ service Price trend of input materials in recent 12 months Price trend of output products in recent 12 months Political and policy effects Foreign exchange rate effects Interest rate effect Unpredictable events that could affect the project/ business plan Owner equity/ total capital Total money inflow to account/ loan outstanding at ACB Sources of repayment 66 LARGE, MEDIUM AND SMALL CUSTOMERS Loan payment ability/ business plan Ability to pay medium and long term loans Ability to pay medium and long term loans used to operate business activities Analysis of cash flow statements Source of repayment in next quarter Management experiences and ability Legal history of the heads of enterprise and chief accountant Professional experience of the heads of enterprise Academic degree of the heads of enterprise Management experiences of the heads of enterprise Relationship of the management team with authorities Adaptation and swiftness of the management team with changes in the market Accounting culture Organizational structure Power and responsibility structure Internal policy Human resource management Business goal and strategy in to years Credit history with ACB Numbers of debt restructuring at ACB Rate of restructuring debt/ total debt at ACB Impaired loan at ACB Impaired loan/ total loan at ACB Credit history of off-balance sheet activities Repayment will of the customer Information supply of the customer by demand of ACB Average deposit at ACB/ Average loan at ACB in recent 12 months Balances of revenue gain and expenses of ACB to customer Revenue gain/ total loan at ACB Frequency of customer to use other products of ACB Credit history with ACB Loan status at other bank in recent 12 months Credit relationship objective of ACB 67 Industry risk Business risk The future of the industry Ability to enter the industry Stability of input market Political and policy effects Business interruption by unpredicted events The reliance on limited suppliers The reliance on limited wholesalers The stability of output market Survivability of the product/services Average growth rate of revenue in last years Average ROE in last years Growth rate in the recent quarter Expected ROE of the year Years in the business Geographical area of the business Political and policy effects Brand images of the company in the market Level of guarantees Human resource management Ability to meet capital source for business activities Promissory of the company Ownership with business location Quality of machineries and equipment Competitive edge Marketing plan Market position Wholesaler network Time remaining of investment license Health and safety quality Environment pollution management Investment in R&D 68 The speed of the project’s process VERY SMALL CUSTOMER Management experiences Credit history with the customer Industry risk Business risk Ages of business owner Legal history of business owner Academic degree of business owner Management experiences of business owner Relationship of business owner with suppliers Level of commitment with the company of the owner Financial strength of business owner Internal policies Accounting culture Human resource management Ownership of business location Business goal and strategy in to years Overall impression of credit staff with the customer Similar to nonfinancial – large, medium and small customer Future of the industry Ability to enter the industry Stability of the market Political and policy effects Business interruption by unpredictable events The reliance on limited suppliers The reliance on limited wholesalers The stability of output market Survivability of the product/services Average growth rate of revenue in last years Average ROE in last years Growth rate in the recent quarter Expected ROE of the year Years in the business Geographical area of the business 69 Financial risk Political and policy effects Brand images of the company in the market Level of guarantees Human resource management Ability to meet capital source for business activities Promissory of the company Ownership with business location Quality of machineries and equipment Competitive edge Marketing plan Market position Wholesaler network Time remaining of investment license Health and safety quality Environment pollution management Investment in R&D The speed of the project’s process The reliance on limited suppliers The reliance on limited wholesalers The stability of output market Survivability of the product/services Average growth rate of revenue in last years Average ROE in last years Growth rate in the recent quarter Repayment ability in medium and long term Repayment ability in short term Source of repayment ... credit risk, the credit rating system must comprehend all of these differences and produce a result that are comparable to credit ratings of other business entities The Credit Rating System at. .. which enables the credit rating process to apply in nation scale manner At branches levels, Credit Rating staffs can have access to the credit rating database of ACB and summit their rating activities... by credit rating system to be more creditworthy than subjects with lower credit rating 2.4 International experiences of CRS 2.4.1 Fitch Ratings Corporate Rating Methodology Fitch’s corporate ratings