LV Thạc sỹ_Internal credit rating system for corporation at BIDV

1 AKNOWLEGDEMENT By completing the thesis, I would like to send a sincere thanks to my lecturer, Ms…, Faculty of Banking and Finance, National Economics University for guiding and enabling me to complete this report I also send a sincere thanks to Mr … Risk management department at BIDV Thanh Xuan, for his ultmost supports to me during my internship I thank for the warm welcome spirit of everybody at the Risk management department has given to me and help me to complete this report ABREVIATION BIDV: Bank of Investment and Development of Vietnam SBV: State Bank of Vietnam CIC: Credit Information Center TABLE OF CONTENTS AKNOWLEGDEMENT ABREVIATION TABLE OF CONTENTS LIST OF TABLES/DIAGRAMS/CHART .5 CHAPTER 1: INTRODUCTION 1.1 Rationale 1.2 Objectives of the research .8 1.3 Research questions 1.4 Structure CHAPTER 2: THEORETICAL FRAMEWORKS OF INTERNAL CREDIT RATING SYSTEM FOR CORPORATION AT COMMERCIAL BANKS 10 2.1 Credit of commercial bank 10 2.1.1 Concept 10 2.1.2 Types 11 2.1.3 Credit procedure for corporation 12 2.2 Internal credit rating for coporation 16 2.2.1 Concept 16 2.2.2 Importance of internal credit rating system 19 2.2.3 Internal credit rating system for coporation methodologies 21 2.2.4 Criteria for internal credit rating system 23 2.2.5 Internal and external factors affecting credit rating system 24 CHAPTER 3: OVERVIEW OF BANK OF INVESTMENT AND DEVELOPMENT OF VIETNAM .26 3.1 History 26 3.2 Organisational structure 28 3.3 Key performance indicators 31 3.3.1 Overal assessment 35 CHAPTER 4: ANALYSIS INTERNAL CREDIT RATING SYSTEM FOR CORPORATION AT BIDV 37 4.1 Description of internal credit rating for coporate 37 4.2 Example 43 4.3 Effectiveness of Internal Credit Rating system for corporation at BIDV 44 4.4 Strength and weakness of Internal Credit Rating System for corporation at BIDV 44 4.4.1 Strength 44 4.4.2 Weakness 46 4.4.3 The cause of the limitations 47 CHAPTER 5: RECOMMENDATIONS 50 5.1 Recommendation to BIDV 50 5.1.1 Insert finance indicators which are cashflow indicators 50 5.1.2 Proposals on the management 52 5.2 Recommendation to SBV and other related agencies 53 5.2.1 Construct independent credit ratings organizations 53 5.2.2 Creating the environment for credit rating business .53 5.2.3 Improving the quality of credit information in CIC 54 CONCLUSION 56 REFERENCE 57 APPENDIX 58 LIST OF TABLES/DIAGRAMS/CHART Table 2.1 Financial criteria Page 23 Table 3.1 Historical highlight Page 27 Table 3.2 Board of Directors Page 29 Figure 3.1 Loan growth Page 31 Figure 3.2 Deposit growth Page 32 Figure 3.3 Income composition Page 33 Figure 3.4 Net interest income growth Page 34 Figure 3.5 Fees and commission growth Page 35 Figure 3.6 total asset Page 35 Table 4.1 Size criteria Page 38 Table 4.1 Financial indicators Page 39 Table 4.3 Non-financial indicators Page 40 Table 4.4 Weight of non-financial indicators Page 41 Table 4.5 Weight of financial and nonfinancial indicators Page 42 Table 4.6 Ranking scale Page 42 Figure 4.1 Total loan and propotion of bad debts Page 44 CHAPTER 1: INTRODUCTION 1.1 Rationale The increased number of bankruptcy cases worldwide, both corporate and personal, is the main reason for the renewed interest in credit risk management A bad loan situation often arises from a combination of factors, amongst which the major one is the absence of an adequate system to classify loans properly and to identify problem loans promptly so as to minimise the potential defaults and consequent losses More defaults mean more missed loan payments and a reduction in profitability for banks Poor management of credit risk is considered to be the major cause of banks’ bad performance and often the reason for their bankruptcy The basic condition to minimize the default risk of a financial institute is to predict the prospective borrower’s reliability and quality as accurately as possible Analysis of financial statements of the prospective borrower is considered as the essential component of evaluation process of a firm’s creditworthiness and loan repayment performance in the future Along with the financial statements analysis however, the financial institutes use other means to predict the prospective borrowers’ loan repayment performance These include a set of qualitative sources and methods such as investigation and interviews Thus, the determination of total creditworthiness of the firm is basically based on these two components, namely, financial (objective) and qualitative (subjective) criteria The accurateness and reliability of the financial statements has been one of the major issues that have been discussed worldwide especially after the cases of Enron, WorldCom etc As widely admitted, the financial statements all over the world are subject to the “window-dressing” problem to some extent Although advanced regulations and processes have been developed and strictly applied in especially developed countries, this window-dressing problem has been of importance until today The reliability of the financial statement problem has been a major issue in Vietnam as well In order to be more competitive especially in the credit activities, commercial banks in Vietnam now have their own innovations; one of the evolutions of domestic banks is building a system of credit risk management effectively, in accordance with international standards and practices Credit activities are high risk activities in the operation of commercial banks Therefore, creating complete management tool for credit risk is always the most important problems to the commercial banks Customer credit rating is one of the tools of credit risk management in a scientific and effective which commercial banks are now applying Although bearing different names, depending on each bank, the bank may called it "The system of internal credit ratings, credit scoring system " but the nature are to assess the credibility ability to repay in the future of customer relationship based on a ranking system To gradually improve the management of credit risk, on 31/12/2003 BIDV issued Decision No 5645/QD-TD2 named "financial profile client list" to perform rank of trusted business customers, as the basis for credit decisions, perform customer policy and finally the Decision 8598/QD-BNC on 20/10/2006 has shown the importance and practical significance in credit activities 1.2 Objectives of the research The aim of the thesis is to study following issues: - Presenting general knowledge of credit at commercial banks General introduction on internal credit system for corporation, principles and criteria used to internal credit system for corporation, the need for credit rating business loans for commercial banks - Showing reality of internal rating systems for customers of BIDV specifically the internal credit rating system for corporation, comments the ranking system of from which making the limitations, restrictions of the ranking system 1.3 Research questions Thesis research focused on the system of rating credit ability of customer, especialy the credit rating system for business customers The Research questions: - How Internal Credit Rating system at BIDV works? - Fact findings and recommendations to internal credit rating system at BIDV 1.4 Structure The thesis follows this structure: Chapter 1: Introduction Chapter 2: Theoretical frameworks Chapter 3: Overview of BIDV Chapter 4: Analysis internal credit rating system for corporation at BIDV Chapter 5: recommendations 10 CHAPTER 2: THEORETICAL FRAMEWORKS OF INTERNAL CREDIT RATING SYSTEM FOR CORPORATION AT COMMERCIAL BANKS 2.1 Credit of commercial bank 2.1.1 Concept Credit is a property transaction in the form of goods or currency between borrowers and lenders, including lenders transfer the property to the borrower use a certain period under the agreement, the borrower is responsible for paying when due, including principal and interest Bank credit is the credit relations between banks, individuals and institutions to make the form stand out raising bank capital and lending to those mentioned above In this relationship, the bank plays an intermediary has recently borrowed loan The nature of credit:  The lender transfers the property to the borrower use a certain time  The credit limit is determined by agreement between the borrower and lender  The owner shall receive a credit on the income in the form of income The function of credit Function of redistribution of resources Credit is the capital transfer from the subject to other subjects; through this transfer function redistribution of credit resources is shown in the following aspects:  The lender has a number of resources are temporarily not in use, through which credit of resources are redistributed to the borrower  Conversely borrowers also receive a redistribution of resources through credit rules businesses financial statements sent to the bank is not required to be audited if audited information will be more reliable Main sources of information to customers’ internal credit rating limited in both quantity and quality affect the results ranked; ranking results will not accurately reflect the level of business confidence In Vietnam's market there is currently have some organizations with independent credit ratings, provides credit ratings result for the market Ranking results of other organizations as a source of information for the commercial banks when making ratings, and can be used as a basis to compare results with the bank rate Subjective reasons a Awareness about effectiveness of credit ratings This is the first building BIDV, promulgation and application of systems within the customer credit rating system of bank Ranking system adopted on 12.31.2003, to date the business environment has changed a lot, thinking Risk Management has other previous methods so customer credit ratings of BIDV is incomplete and is limited, need to continue to improve and supplement in the future On the other hand when issuing credit rating system for corporation, the board of BIDV not underestimate the benefits of the system credit rating system in credit activities, especially in preventing and managing credit risk because So the main contents of this decision is to classify customers so that customers implement policies and measures for use with each client and customer groups as appropriate interest rate policy and policies to ensure money loan services policy to improve efficiency and ensure safe operation of BIDV b Qualified officers The customers ratings perform by credit officers, in addition to financial criteria there are other non-financial targets are the targets depends greatly on the ability to assess, collect information of the ranking Capacity, qualifications and experience of the staffs will determine the quality of ratings CHAPTER 5: RECOMMENDATIONS 5.1 Recommendation to BIDV 5.1.1 Insert finance indicators which are cashflow indicators Cash flow analysis focuses on understanding and forecasting how cash is generated and spent by a business It incorporates identifying a company’s cash flows, determining trends and sustainability, distinguishing operating from investing and financing flows, and understanding potential sources of distortion and future volatility All this must be considered in the context of a company’s individual characteristics, such as, where it is in its life cycle The ability to generate cash is determined by a firm’s business prospects— competitiveness, market dynamics, economic environment, etc., while its need for cash is a consequence of the balance-sheet structure, management’s financial strategy, and strategic needs An enterprise’s capacity to pay debts or any other obligation, which is the core underlying concept of internal credit rating system for corporation, is determined by the ability to generate cash—not earnings, which is an accounting concept Although there is generally a strong correlation between operating cash flow and profitability in the long run, many transactions and accounting entries may affect profitability and not the other during a specific period Aggressive accounting policies, for example, regarding revenue and expense recognition, asset write-downs, or adjustments to depreciation schedules, can have a material impact on earnings and none whatsoever on actual cash generation For more argument from credit rating Company, Fitch emphasizes those cash flow measures of earnings, coverage and leverage Cash flow from operations provides an issuer with more secure credit protection than dependence on external sources of capital In dealing with quantitative measures, Fitch regards the analysis of trends in a number of ratios as more relevant than any individual ratio, which represents only one performance measure at a single point in time Fitch’s approach attributes more weight to cash flow measures than equity-based ratios The latter rely on book valuations, which not always reflect current market values or the ability of the asset base to generate cash flows Measures such as debt-to-equity and debt-to-capital are less relevant to a credit analysis because they are based on formalized accounting standards, which are subject to interpretation In addition, these measures not reflect an issuer’s debt-servicing ability as transparen tly as those based on cash flow generation Because the equity account is presented at book value, it does not provide the most accurate assessment of an issuer’s asset base to generate future cash flows Thus, asset values may be over- or understated, while the issuer’s liabilities remain close to the cash obligation payable at maturity However, use of equity-based ratios is prevalent in many parts of the world, and these ratios have relevance in helping investors in those markets understand an issuer’s financial profile Based on these arguments, I suggest that in financial indicators should insert some cash flow ratios For example: Debt payback ratios  Funds from operations (FFO)/total debt: the most frequently used credit measure in industrial ratings; this coverage ratio compares a company's operating cash flow to its total debt, which, for purposes of this ratio, is defined as the sum of shortterm borrowings, the current portion of long-term debt and long-term debt This ratio provides an indication of a company's ability to cover total debt with its yearly cash flow from operations The higher the percentage ratio the better the company's ability to carry its total debt  Debt/EBITDA: used as a proxy of debt repayment capacity for high-yield issuers; Debt/EBITDA is a common metric used by credit rating agencies to assess the probability of defaulting on issued debt A high debt/EBITDA ratio suggests that a firm may not be able to service their debt in an appropriate manner Conversely, a low ratio can suggest that the firm may want take on more debt if needed  Total debt/discretionary cash flow: provides an indication of how many years would be required to repay outstanding debt using current cash flows, but is subject to changes in dividend policy; it also known as Debt Payback Period The lower the ratio, the stronger the issuer’s capacity to pay  Free operating cash flow (FOCF)/total debt: indicates a company’s capacity to pay debt with internal operating cash flow; it is more critical when analyzing weaker companies, because speculative-grade issuers typically face near-term vulnerabilities that are better measured by free cash flow ratios 5.1.2 Proposals on the management a Raising awareness about credit rating system As indicated in the cause of these limitations, one of the reasons making the ranking system of BIDV is limited in the management of credit risk due to high awareness of BIDV not about ranking system credit rating internal customers In any operation, to achieve good results, the first who must be made aware of the problem BIDV should be more aware of the meaning and role, the effect of credit rating systems customers To this BIDV to strengthen training, training, update knowledge of staff involved in the classification b Strengthening education and training of staffs Quality performance ranking officials will determine the quality of ranking results, so to rank the results actually reflect the situation of enterprises, BIDV to strengthen education and training of personnel: Education on ethics, intellectual strong mind, not be tempted by the matter, consciousness always comply with the law in the banking and credit activities To provide knowledge and professional knowledge related to bank credit as accounting, corporate finance, business analysis, project evaluation The training can be done by invite experts, lecturers, or self-training c Periodically or extraordinarily inspect the implementation of internal credit rating The effect of testing is to prevent errors, whether accidental or deliberate which may occur, in order to detect errors for better editing Without checking the performance can easily be ranked according to subjective ranking individuals not properly reflect the actual situation of the customer In recent years shows BIDV focused check credit file without checking the customer ranking while the ranking resulting decision to grant credit and credit mechanism applicable to the customer It's a need to overcome the shortcomings 5.2 Recommendation to SBV and other related agencies 5.2.1 Construct independent credit ratings organizations From the experience of countries with market economies that have built an independent credit ratings organization, not by government-owned shareholder of the credit rating organization The formation of an organization like this has huge role in the transparency of economic information Southeast Asia also known as the area involved quite early in this field Since 1982, the Philippines have established centers of their credit rating It was followed in 1991 as Malaysia, Thailand in 1993 and Indonesia in 1995 Learning experience of countries with market economy, Vietnam needs to build an independent organization internal credit rating, reputed to perform credit rating firms Credit rating organisation must be an independent organization operating under business model that no organization or individual may dominate; this will make the results more objective, which will be trusted by users 5.2.2 Creating the environment for credit rating business Today the problem understanding and evaluation of customer needs has become an indispensable market economy, as more and more opportunities for business cooperation opened On the other hand economic integration requires a high transparency of business information such as financial and operating capacity, technology applied So the future need the government promulgates legal documents and creates mechanisms for credibility environmental business developing 5.2.3 Improving the quality of credit information in CIC State Bank of Vietnam has the advantage compare to the commercial banks that it can provide material, financial records, legal, customer loans, debt situation and the level of trust in relation to credit conditions to assess the credibility customers more accurately CIC currently perform its function of providing credit information to credit institutions, enterprises, with fee, however, the CIC information provided is incomplete and the level determined is not high To improve the quality of information provided to CIC institutions requires CIC in the future should be much improved in the direction of: - Provide information quickly; - Sources of information updated, corrected; Develop data systems to provide business information quickly, fully and accurately To assess customer confidence required information, the more reliable information, the level the more accurate assessment So to judge credibility requires businesses have a responsibility to provide complete and accurate documentation and information on financial status and non-financial in its scope as required by the rating agencies price In addition to creating conditions for staff in the process of assessment tests, evaluating the information correctly In Vietnam most businesses tend to hide the truth about them and promote their good points, strengths, concealing the true financial information and its limitations This is a major difficulty in assessing credibility in Vietnam of the credit ratings company In market economies, information plays a vital role in business operations Information quickly and accurately provides the basis for managers to make decisions promptly and effectively, bringing business activities of enterprises get more results In Vietnam, the system provides information to businesses is still very weak and limited It is difficult to obtain information about a certain business aspects of the financial condition, results of operations; the level of trust with credit institutions except business which is listed in the Securities Trading Center, the financial records of the unit was announced for one of the external public For transparency of economic information, creating sources of public information provided to subjects in need requires the state to build an information system to provide fast, accurate full CONCLUSION With the aim of study internal credit rating methods, the judgment of the thesis is still limited, making customer credit rating results should reflect more substantive operational status, financial ability, the level of risk lending, thereby further enhancing the credit management, customer implementation of policies of BIDV, subjects "Internal credit rating system for business entity at BIDV: fact findings and recommendations" has solved the following problems: - The system of credit, the reasons for the credit rating, which for that customer credit rating system is needed in the credit management - To systematize the theoretical basis of internal credit rating corpotaion at bank, principles and criteria used to rank, internal and external factor affecting Internal credit rating system - Analysis and assessment of the situation in the Internal Credit Rating system for corporation in BIDV Recommend to the SBV and BIDV in order to improve the internal ranking system Recommend to state general, macro support for effective implementation of internal credit rating effective Internal credit rating system for corporation is assessing the risk of the borrower, the repayment capacity of the debtor's future Such system should fully cover all the content on the financial and business situation and business sectors that are trading, rating systems have been summarized in the world standard but at the same time still must be consistent with economic conditions, business environment of Vietnam In the framework of the project, the thesis is limited by not fully investigated the ranked program done automatically when people enter rating data into the program In order to better off credit ratings method, the implementation process need to continue research and complete unfinished matters REFERENCE www.cafef.vn www.bidv.com.vn Sổ tay tín dụng Ngân hàng Đầu tư Phát triển Việt Nam Sổ tay tín dụng Ngân hàng ngoại thương Việt Nam (Tháng 01 năm 2004) Báo cáo thường niên, Báo cáo tài năm 2008, 2009, 2010 cuả ngân hàng đầu tư phát triển Việt Nam APPENDIX Apendix A: Financial statement and financial indicator of BIDV from 2008 to 3Q2011 Apendix B: Apendix C: example of Internal Cerdit Rating System at BIDV ... of BIDV Chapter 4: Analysis internal credit rating system for corporation at BIDV Chapter 5: recommendations 10 CHAPTER 2: THEORETICAL FRAMEWORKS OF INTERNAL CREDIT RATING SYSTEM FOR CORPORATION. .. 37 CHAPTER 4: ANALYSIS INTERNAL CREDIT RATING SYSTEM FOR CORPORATION AT BIDV 4.1 Description of internal credit rating for coporate The system of internal credit rating business is done in accordance... credit rating for coporate 37 4.2 Example 43 4.3 Effectiveness of Internal Credit Rating system for corporation at BIDV 44 4.4 Strength and weakness of Internal Credit Rating