LV Thạc sỹ_Quality improvement in business credit risk management at Vietinbank

ACKNOWLEDGEMENTS I really appreciate studying process in Nation Economic University as well as internship period in VietinBank – Hanoi branch Studying at National Economic University, especially in Advanced Program, has provided me amount of good basic and specialized knowledge Besides, internship period in Hanoi branch has given to me opportunity to study overall the actual operations of bank I am heartily thankful to my supervisor, Ph.D…, who encourages, guides and supports me from the initial to the final level, as well as helps me to develop an understanding of the subject Also I would like to sincerely thank to whole staffs in Hanoi branch who provides me real knowledge and data to complete this thesis To complete this thesis, I have spent a lot of time and effort to collect information and to accumulate practical knowledge However, because of lacking experience and limited understanding, this report should have many mistakes I really expect suggestions and comments from the supervisor to make this report better Table of Contents Table of Contents ABBREVIATION LIST OF TABLES LIST OF FIGURES INTRODUCTION 1.Rationale 2.Research objective 3.Research methodology .8 Object and Scope of research 4.Research question .9 5.Research structure CHAPTER I: OVERVIEW OF BUSINESS LENDING ACTIVITY AND CREDIT RISK MANAGEMENT IN COMMERCIAL BANK 10 1.1Business lending activity in commercial banks 10 1.1.1Definition of business lending 10 1.1.2Characteristics of business loans .11 1.1.3Role of business loans 12 1.1.4Classification of business loans .13 1.2Credit risk management in commercial bank 14 1.2.1Credit risk 14 1.2.1.1The defintion .14 1.2.1.2Reasons for potential credit risk 14 1.2.1.3Measurement of credit risk 16 1.2.2Credit risk management 19 1.2.2.1The definition 19 1.2.2.2The process of credit risk management 20 1.2.2.3Features of credit risk management in commercial banks .23 1.2.2.4Factors affecting credit risk management in commercial banks .24 CHAPTER II: THE CURRENT SITUATION OF CREDIT RISK MANAGEMENT OF BUSINESS LOANS AT VIETINBANK – HANOI BRANCH 25 2.1Overview of VietinBank – Hanoi branch 25 2.1.1Overview of VietinBank 25 2.1.2Formation and development process of VietinBank – Hanoi branch 27 2.1.3Organization structure of Hanoi branch 27 2.1.4Situation of business operation at VietinBank – Hanoi branch in recent years .29 2.1.4.1Capital mobilization 29 2.1.4.2Credit activity 31 2.1.4.3Performance results 32 2.2Current situation of credit risk management of business loans at VietinBank – Hanoi branch 33 2.2.1The process of business credit risk analysis and assessment 33 2.2.2Analysis of bad debt and provision situation 36 2.3Evaluation of credit risk management of business loans at VietinBank – Hanoi branch 40 2.3.1Achievement 40 2.3.2Limitation 41 2.3.3Reasons 43 CHAPTER III: SOLUTIONS AND RECOMMENDATIONS TO IMPROVE THE QUALITY OF CREDIT RISK MANAGEMENT FOR BUSINESS LOANS AT VIETINBANK – HANOI BRANCH 46 3.1Orientation to complete credit risk management activity for business loans 46 3.2Solutions to improve the quality of credit risk management for business loans 47 3.2.1Improve the process of assessment based on qualitative and quantitative methods 47 3.2.2Improve technical capacity and ethics quality of credit officiers 53 3.2.3Improve the ability of collecting and analyzing data 53 3.2.4Transfering risk through other tools 54 3.2.5Improve the quality of assessment and collateral management 55 3.2.6Self-insure thourgh credit insurance and provision 56 3.2.7Improve the efficiency of internal supervision .56 3.3Recommendations 57 3.3.1Recommendations to the Government 57 3.3.2Recommendation to VietinBank .58 CONCLUSION 60 REFERENCE .62 INTERNSHIP ASSESSMENT .63 ABBREVIATION VietinBank Vietnam Joint Stock Commercial Bank for Industry and Trade BOD Board of directors VND Viet Nam Dong SBV State Bank of Vietnam IFRS International Financial Reporting Standard CIC Credit Information Centre LIST OF TABLES Table 1: Result of mobilizing funds in Hanoi Branch – VietinBank in recent years Table 2: Credit activities at VietinBank – Hanoi Branch in recent years Table 3: Profit proportion of Hanoi Branch – VietinBank compared to all VietinBank system Table 4: Credit quality of Hanoi Branch in recent years Table 5: Provision level for credit risk in Hanoi Branch in recent years Table 6: Provision change of credit risks of Hanoi branch in recent years LIST OF FIGURES Figure 1: Hanoi Branch operating structure Figure 2: The process of credit risk management Figure 3: The process of business credit risk analysis and assessment Figure 4: Overdue debts by customer types INTRODUCTION Rationale VietinBank is a pioneer in applying information technology and e-commerce and the first commercial bank in Vietnam getting ISO 9001:2000 certificate in credit activities and payment, which ensure its position as one of “big 4” among Vietnam banks By year-end 2010, total asset of Vietinbank reached 367,712 million VND, shareholders’ equity increased by 46%, profit before tax is 4,598 billion VND Until now, VietinBank has developed an operations network comprising of 01 Transaction Centers, 149 branches, 527 transaction offices, 166 savings offices, 02 Representative offices, 04 Subsidiaries, 03 administrative units and 1042 Automatic Telling Machines (ATMs); has established correspondent relationship with 850 banks, financial institutions of 90 countries and territories all over the world From the starting point of a State-owned bank, VietinBank did make many significant changes to get into success The process of transformation has been surely requiring many innovative ideas, especially in operating structure and risk management, which inspired me to have an internship period in this bank Through this, it can be realized that credit activities for enterprises is still growing up year by year and bad debt ratio is low However, there are many exiting factors of potential credit risks, especially in this sensitive time period when many firms are encountering with the consequence of world financial depression Therefore, I hope my thesis “Solutions for quality improvement in business credit risk management at Vietinbank – Hanoi branch” can benefit for the sustainable development of the bank Research objective The objectives of the research are: - Detailed analysis of the efficiency of operation at Vietinbank – Hanoi branch - The current situation of credit risk management at Vietinbank – Hanoi branch - Solutions for improvement in managing credit risk of business loans Research methodology The thesis used the method of dialectical materialism science combining with logical thinking and the method of analyzing economic activities, as well as the method of statistic to analyze and solve problems Object and Scope of research - Object: the quality of credit risk management in commercial bank - Scope: credit risk management activities at VietinBank – Hanoi branch Research question The thesis will answer three questions: - What is the quality of credit risk management? - What are the problems of the quality of credit risk management at VietinBank – Hanoi branch? - What are solutions to improve credit risk management at VietinBank – Hanoi branch? Research structure The thesis includes three chapters: Chapter I: Overview of business lending activities and credit risk management in commercial bank Chapter II: The current situation of credit risk management of business loans at VietinBank – Hanoi branch Chapter III: Solutions and recommendations to improve the quality of credit risk management for business loans at VietinBank – Hanoi branch CHAPTER I: OVERVIEW OF BUSINESS LENDING ACTIVITY AND CREDIT RISK MANAGEMENT IN COMMERCIAL BANK 1.1 Business lending activity in commercial banks 1.1.1 Definition of business lending Business lending is one of credit activities of banks There are many different way to define the phrase “business loans” but it is possible to understand it in a general given concept A business loan is a loan granted by a financial institution to a nonindividual entity usually to be repaid by a certain date with a certain amount of interest Business loans can be given to sole proprietors, corporations, limited liability companies, partnerships and nonprofits 10 would occur, for example, in an economic crisis with extremely high default rates Therefore, the VaR analysis should be complemented by stress tests which calculate the value fluctuations based on the assumption of extreme market movements The value-at-risk analysis offers the advantage that it allows the comparison of different risks not only across different portfolios, but also across different types of risks such as credit, market, and operational risks However, this must not distract from the fact that the VaR is based on assumptions and estimates and can thus lead to misinterpretations of the risk In addition, there are limits to the comparability and aggregation of different types of risks due to the different distribution of the risk types Another restriction to the calculation of the VaR in credit risk is posed by the historical data which are often not available to a sufficient extent (e.g on probabilities of default, exposure at default, and correlations) Scenario techniques Under a scenario analysis, the available historical market data and/or internal bank data are used to create scenarios concerning the possible development of default rates Like in VaR analysis, scenarios for the normal case, in which loss developments are assumed that have already occurred in a certain historical period under review; and worst case scenarios assuming the incurrence of extreme losses are assumed These scenarios are used to determine the extent of the fluctuations in the portfolio’s value for the occurrence of the event Value fluctuations may, for example, refer to the extent of losses from lending or changes in the value of the collateral The highest possible risk is calculated on the basis of the scenario analysis The scenario analysis is limited in its explanatory power as it takes into account only a few changes in parameters Its results will be of lower quality than those of the VaR concept, as the scenarios applied are limited to a small number of historical 49 events and the diversity of the parameters contained in the VaR concept cannot be achieved Banks that base their risk controlling on the results from scenario analysis usually have to accept less precise results than they would get using the VaR approach Therefore, it seems advantageous to shift to a value-at-risk process, but it is essential to determine what additional cost would be incurred in implementing the concept, and what additional benefit would be derived from more effective management that would result from the implementation Internal Ratings Based method EL = EAD x PD x LDG EL: expected loss EAD: exposure at default LGD: Loss given default PD: Probability of default The method is based on previous loan information of customer, including repaid loans, current loans and overdue/bad debts Portfolio models Portfolito models are used to determine the risk of a credit portfolio The following aspects have to be taken into account: - The individual credit risks in terms of their probability of occurrence and the - associated loss The correlation of these individual riska at a portfolio level These input parameters are used to estimate the loss distribution for the total portfolio in order to derive expected and unexpected losses Due to unsufficient data, one of the biggest weaknesses of the credit portfolio models currently available in the 50 market is the problem of determining the correlations in an accurate fashion The major difference between the models is the way in which the correlation values are derived and applied Simplifications are used that assume, for example, the non-existence of correlations between borrowers from different industries or the stability of input factors over time Other major differences can be found in the selection of the required input parameters and the modeling approaches In the following, I would like to give an overview of two model types that differ in terms of modeling approaches and the integration of correlation effects: default mode models and mark-to-market models Default mode models Default mode models distinguish only two states: default and non-default of the borrower These two states are assessed in terms of their probability of occurrence to determine the loss given default The input parameters for this model class are derived from internal data or complemented by assumptions for unavailable data External data that, for example, reflect the business cycle, are usually not taken into account Important input parameters for default mode models are the loan amount; the default rate of the loan and its fluctuation; the recovery rate, i.e the proceeds that can be achieved when selling the collateral used for cover; and the correlations (assumed to be constant) between the default risks Possible fluctuations in the recovery rate and changes in the borrower’s credit standing are usually not simulated The statistical analysis yields the loss distribution of the portfolio The advantages of default mode models are their ease of use and the relatively low data requirements On the other hand, the limited precision due to the small volume of processed data proves to be a disadvantage Mark-to-market models 51 Mark-to-market models evaluate credit portfolios in terms of their market value and the risk the bank incurs if the market value changes The evaluation includes the same parameters that are used in default mode models, but it also takes into account the changes in the borrower’s credit standing and often also in the recovery rate over time, as well as the correlations of the credit risks The changes in rating and value of collateral are modeled on the basis of various procedures, by using internal historical data, or procedures based on option pricing theory Including the changes in the borrower’s credit standing means that it is possible, in addition to the two states of default or non-default, to calculate rating migration probabilities The possible market values of the individual loans are calculated by discounting the future cash flows The impact of the rating on the loan value is taken into account by using different discount rates that are derived from the credit spreads of different bonds traded in the bond market The potential changes in the value of the loans calculated in this manner are combined with the probability of occurrence of the rating changes, and this is used to calculate the volatility of the loan value The volatilities of the individual loan values are combined taking into account the correlations between the borrowers and consolidated to yield the portfolio risk The advantage of the mark-to-market model is that due to the various parameters and the fact that they can easily be modeled, the actual portfolio risk can be shown far more accurately than is possible using default mode models In practice, however, it is not always easy to apply mark-to-market models as all the data required are not available, and calculating the values takes a lot of time depending the portfolio’s complexity 52 3.2.2 Improve technical capacity and ethics quality of credit officiers In any steps of credit risk management, no matter how modern the techonology is, human resource is still the key factor Therefore, it should be identified that each officiers is dispensable for the whole success Besides organizing tehinical training courses, sharing from international and domestic experts, sending officers to abroad training, the Branch should focus on training soft skills for all staffs At this time, the communication skill is very important With such advantage, the bank can get an easier access to more information of the business, then improve risk management ability Moreover, each staff represent the whole image of the bank to customer, help the bank get the reputation and strong market position However, the quality of human resources can be evaluated through career ethics and passion In the subjective reasons of credit risk, the unresponsibility of credit assessment is considered as the main reason Therefore, BOD of the Branch should pay more attention on the staff, especially credit officier and risk management department Beside competitive salary, the Branch needs to create a healthy, united working environment with the spirit “All for goal” Therefore, the whole effot from BOD and all the staffs are very necessary 3.2.3 Improve the ability of collecting and analyzing data Information is the first and most important factor in the whole process of credit risk management Missing or incorrected information will misjudge the potential risk of the business, causing the risk of adverse selection, then moral hazard is a prerequisite for the occur of credit losses Therefore, the solution for the Branch is the need to improve data collection and information processing Beside information from loan application, reference information from partners of customers, suppliers of customers, credit officiers need to look for information from realiable source such as 53 CIC or other institutions The optimal solution is directly involved in project evaluation by observing the working environment, interview managers and the related others The long term solution is the Branch need to build an information system for the purpose of credit risk management – a management tool controllingrisk through data collection and analysis, analysis methods, reporting and historical data There are usually main parts in such system: - The first part includes data-providing system such as Core banking, CRM, Treasury, Trade Finance, ERP, and so on - The second part analyzing and give solutions (Risk Management System RMS), includes system of data collection of the first part (ETL), data warehouse (DW) for preventing risks, Data Analysis, Alert system and Report Too, which are flexible, timely, and accurate in accordance with the international standard of the branch’s risk management Not only does it help the Branch control credit risk, this information system also help manageing market risk and operation risk through quantitative models compared to the Branch’s standard 3.2.4 Transfering risk through other tools The most basic solution to disperse credit risk for the branch is to diversify the loan portfolio At the moment, the Branch focuses much on state-owned enterprises operating in food and commercial industry In the future, the Branch need to raise the loan portfolio for non-state-owned firms and allocate capital for more industries such as information telecom, goods manufacturing and service to reduce systematice risk Another solution is that transferring risk by the co-financing loan or loan guaranteed by a third party For long term, high volume loans, the Branch should mobilize capital from other Branch or other institutions or require the guarantee from a 54 third party who has enough financial ability and reputation Despite low income from interest or unattractive due to many obligations, this will help the Branch minimize the risk The loans from weak performance business can transfer all the risk to “selling loans” At the moment, the activities of buying and selling loans happens legally at DATC of Financial Ministry The transfer of debt to another organization willing to accept the risk is double-edged knife The branch can avoid risks or losing sales if misjudging the possibility of firm’s repayment ability In the future, when Vietnam derivative market grew, the Branch can also use future, option, swap to manage loan portfolio The derivatives can be considered as the activities of selling and buying debts at this time, but more complex and require more technical analysis If the Branch can get the advantage of such tool, it can reduce much risk and get more profit from price difference 3.2.5 Improve the quality of assessment and collateral management The collateral can be considered as the second repayment sources of the business if the risk happens However, that effort of increasing the price is not an optimal solution because the Branch will get more lost from assessment expense, management expense Therefore, first of all, the Branch should have a correct collateral pricing After that, the Branch needs to reinforce management activites and periodical re-evaluation In the current situation of inflation, the margin 20% to re-evaluation is very risky, especially for financial assets such as valuable notes That is, the Branch should not give a mechanical reponse but be active quarterly re-pricing and implement unusual evaluation if necessary in order to ensure the liquidity of the assets Each time of assessment should be implemented independently by credit officers, risk management department’s officers, and BOD of the Branch In the near future, the Branch should reduce the non-collateral loans, then 55 improve the management of cash flow of the business in the account in order to decrease the expense and increase the flexibility 3.2.6 Self-insure thourgh credit insurance and provision Accepting to lend for a business means accepting all the risks Therefore, loan insurance is very necessary, which many banks in Vietnam pay no attention The Branch needs to send a request of buying insurance to business or buy itself the insurance for high risk loans However, this solution can make the expense increase much due to insurance expense The Branch can self-insure through provision Besides, the Branch can compare the result of debt classification with IFRS for the aim of choosing the optimal risk preventing strategy 3.2.7 Improve the efficiency of internal supervision Credit risk management will be better if the internal supervision should be usual and objective Internal Supervision department needs to operate independently with the BOD to ensure the independence of controlling and manageing activites It also should be oriented to complete tasks based on international standards For high credit or decreasing value of collateral loans, the supervision should be implemented more frequently Besides, it is necessary to collect and classify data, check performance status of the business periodically and in each industry in order to give a correct assessment about financial situation of the Branch Such activities also need the management and supervision from BOD and all the staffs The Branch can get advisory from external audiors to improve the quality of internal auditing In addition, the Branch can apply many softwares to managing transaction automatically 56 3.3 Recommendations 3.3.1 Recommendations to the Government In the globalization situation, Vietnam banking system is encountering to very difficult circumstance: the weak ability of management, unrealiability of objectiveness, honesty, high capital demand, the weak ability of meeting business demand In the high competitive domestiv market, Vietnam commercial banks are also put into pressure from international banks with higher reputation and service quality Therefore, many banks, especially medium and small banks in regardless of weak ability skipped many important steps in the process of credit assessment, causing the probability of losing safety of the whole system In order to foster development of VietinBank – Hanoi branch, in particular, and all other institutions, in general, the government and SBV needs specific and strategic action Firstly, monetary policy needs to get more careful reseach, so the money flowing in the economy serves for the recovery process in a minimized inflation rate The most effective way to develop business credit is the need to attract deposit from citizens However, the policy of interest rate and exchange rate should be adjusted to attract deposit from citizens, instead of gold or real estate investment or nonmanufacturing industry SBV should have the policy of supporting credit for importing and exporting firms, and medium and small enterprises through preferential interest Secondly, SBV should supervise more tightenedly business credit activites in commercial bank for sustainability of economy development The supervision includes process checking, policy and regulation compliance checking It is time for SBV to create a safe standard about business credit management The commercial bank, if can not satisfy such standard, SBV should put them in merge and aquistition to prevent risk for the whole system 57 Thirdly, SBV should improve performance of CIC which still reflects very basically and cursorily about the ability of the business’s repayment Also, SBV needs to encourage new born firms of independent and professional credit rating in order to provide more realiable information sources for the whole banking system 3.3.2 Recommendation to VietinBank To improve operational efficiency in credit risk management, VietinBank should: Firstly, the bank should create short, medium and long term target right, timely and possibly Allocating too much heavy tasks on the Branch can increase the pressure, which makes more errors in the process of loan evaluation Therefore, based on internal ability and current market situation, the bank needs to identify a specific and reasonable target for the Branch, focusing on improve the quality rather than the quantity, especially in the current fluctuating market Secondly, the bank needs to complete the policy of credit risk management and make the policy in a do-it-right way in staff’s mind set The regulations of pointing and rating business credit, regulation of loans insurance, regulation of lending and credit limit setup as well as regulation of debt classification and provision level should be complied, but the bank also can add more policy to make a suitable legal system The process of credit risk management needs more research and improvement along with technology apply in order to increase synchronization, unity and accuracy reaching to international standards such as ISO, Basel, and IRFS Thirdly, through internal supervision department, the BOD should give a tightened supervision to the process of applying policy and regulation, detect timely the signal of breaking laws from the staffs For the individuals who has excellent achievement, the bank can give reward or recognition to bring incentive for that individual and the others Getting more advise from international and domestic experts 58 as well as international auditing companies can help the bank ensure the quality of credit risk management and business credit risk management for high growth rate and stable and sustainable development 59 CONCLUSION Business loans are the most profitable source of commcial banks in Vietnam Therefore, how to improve credit risk management in order to minimize cost and maximize profit got much concern from the banks The study of solutions to improve business credit risk management is necessary and meaningful, not only with VietinBank – Hanoi Branch, but also with the other bank and the government in the effort of creasting more stable macroeconomies In the course of the study, I have used a combination of theory and practice with the aim of giving reasonable solutions and recommendations in order to improve business credit risk management quality at VietinBank – Hanoi branch The contents of the thesis have completed the goals set out: Firstly, the thesis gave an overview of business credit risk management activity, including analysis based on credit activity of commercial bank, theory of credit risk and business credit risk management, subjective and objective factors impacting on the effectiveness of such management activity Secondly, the thesis gave general introduction of VietinBank – Hanoi branch, reflected the current situation of business credit risk management including the process, analysis of bad debt and provision level The thesis also evaluated the achievements and the limitations with reasons in business credit risk management Thirdly, the thesis has proposed some solutions and recommendations to improve business credit risk management, which is relevant with the orientation of VietinBank – Hanoi branch During researching, due to time limitation as well as knowledge limitation, it is inevitable to prevent the thesis from mistakes I am looking forward to comments and suggestion from teachers and VietinBank – Hanoi branch to make it more complete I 60 also want to send a sincere appreciation to my instructors and VietinBank – Hanoi branch to help me this thesis 61 REFERENCE Vietnamese Consolidated Financial Statement 2011 of VietinBank Financial Statement 2009, 2010, 2011 of VietinBank – Hanoi Branch Report of debt classification and provision level of 2009, 2010, 2011 of VietinBank – Hanoi Branch VietinBank credit note Law of credit institutions 2010, Decision 493/2005, 18/2007 of SBV, Decree 11/2011 and 178/1999 of the Government Phan Thi Thu Ha (2007), Ngân hàng thương mại, Nhà xuất đại học Kinh Tế Quốc Dân, Hà Nội English Peter S.Rose & Sylvia C.Hudgins (2008), Bank Management & Financial Services, The McGraw-Hill, New York Peter S Rose, Commercial Bank Management, The McGraw-Hill, New York Frederic S Mishkin, The Economics Of Money, Banking And Financial Markets (7th Edition) 10 Thompson, Strickland & Gamble (2010), Crafting and Executing Strategy, The McGraw-Hill, New York Website www.en.wikipedia.org www.sbv.gov.vn www.ifrs.com 62 INTERNSHIP ASSESSMENT 63 ... system of business credit risk management which should automatically update the data, the analysis, including marking before lending, supervising the lending cash flow, saving the information for reference... the quality of credit risk management? - What are the problems of the quality of credit risk management at VietinBank – Hanoi branch? - What are solutions to improve credit risk management at VietinBank. .. situation of credit risk management of business loans at VietinBank – Hanoi branch Chapter III: Solutions and recommendations to improve the quality of credit risk management for business loans at