Capital adequacy measurement, a case study of an binh commercial joint stock bank

M I NI STRY OF EDUCATI ON AND TRAI NI NG UNI VERSI TY OF ECONOM I CS HOCHI M I NH CI TY FALCUTY OF BANKI NG M BA PROGRAM Capital Adequacy Measurement A CASE STUDY OF AN BINH COMMERCIAL JOINT STOCK BANK Thesis made by NGUYEN THANH PHONG Thesis Tutor: Assoc Prof., Ph.D Tran Hoang Ngan Vice Rector of HCM C University of Economics 06/2010 Ho Chi M inh City Acknowledgements To achieve this thesis, I would like to convey my sincere thanks and appreciation to the Economics University of Ho Chi Minh City , MBA program officers who have facilitated and helped me with all their kindness and assistance My special thanks to Ms Pham Thanh Thuy, Director of Treasury Division of A n Binh Commercial Joint Stock Bank, Mr Vo Van Nhuan, Vice Head of Financial Accounting Department, of ABBank, M r Nguyen Cong Anh and Ms Tuy Loan, Expert of Financial Accounting Department of An Binh Commercial Joint Stock Bank who created favorable conditions, gave me relevant data and helped me to carry out significant analysis and CAR measurement jobs during the time I had been doing this research dissertation From DHL- VNPT Express Ltd., I appreciate Mr Do Huu Anh, Deputy General Director, M s Dao Thi Ngoc Anh who have supplied me valuable data, information and edited this research All of us have had good cooperation during the time of this thesis being done Apart from the above mentioned, Mr Nguyen Huu Nhan, M r Ngo Tran Kien Quocmembers of MBA Banking class, Dr Truong Tan Thanh- lecturer of Investment analysis and portfolio management and my wife having encouraged and helped me with all their hearts made me more confident and delighted to carry out this research dissertation I would like to say that a lot of thanks are owed, in particular, to the assistance and guidance from Assoc Prof., Ph.D Tran Hoang Ngan, Vice Rector of Ho Chi Minh City Economics University Ph.D Tran Hoang Ngan, the tutor has encouraged and given me a lot of advice on doing this thesis Without Ph.D Tran Hoang Ngan‘ s advice, a lot of difficulties would surely arise during my performance on this task Once again, all assistance helping me with this thesis is highly appreciated i Abstract In current age, globalization of financial institutions is a characteristic point and unavoidable trend that make each country have to establish a banking management system to protect against financial risks, to reinforce transparency in the banking payment system and to tighten regulation on capital adequacy In order to conduct the opening door policy and integrate intothe world economy, implement commitments of the WTO, Vietnam has many efforts to apply international standards in capital banking management In 2005, SBV issued the Decision 457/2005 promulgating the regulation on safety assurance ratio in activities of credit institutions and they continued to grant the Decree number 141/2006 date the January 1st, 2006 required Vietnamese commercial banks to have a chartered capital of 3,000 billion VND at the end of 2010 which were seen the interest of SBV in capital fund of commercial banks The research problem of the thesis is to examine the adequacy of bank capital in Vietnamese banking system through a case study of An Binh Bank In term of structure, the research study has six chapters Chapter One and Two review research background, scope of work, methodology, significance of the study, risk in banking operation and banking capital adequacy Chapter Three introduces research methodology is carried out in the thesis Chapter Four and Five present an overview of CAR measurement in Vietnamese banking system and survey results obtained from a real model Chapter Six provides some conclusions and recommendations from the research With the finding as presented above, the dissertation provides many implications to be able to improve in banking capital adequacy management in Vietnamese commercial banks ii Glossary of terms and abbreviations SBV State bank of Vietnam SOCBs State owned commercial banks JSCBs Joint stock commercial banks SPBs Social policy bank JVBs Joint-venture banks FBBrs Foreign bank branches FFOBs Fully foreign owned banks VAR Value at risk ORM Operational Risk Management ALM Asset Liability Management ALCO Asset Liability Committee ABB An Binh Commercial Joint Stock Bank FRB the Federal Reserve Board FRS the Federal Reserve System FDI C Federal Deposit Insurance Corporation OCC The Office of the Controller of the Currency RWAs Risk- weighted assets US the United States OECD The Organization for Economic Co-operation and Development BI S Bank for International Settlements CAR Capital adequacy ratio GDP Gross domestic product I BRD International Bank for Reconstruction and Development EBRD European Bank for Reconstruction and Development ADB Asian Development Bank AfDB Africa Development Bank iii EI B European Investment Bank I ADB Inter- American Development Bank ACB Asia Commercial joint stock Bank STB Saigon Thuong Tin Commercial Join Stock Bank VCB Vietnam Foreign Trade Commercial Join Stock Bank Vietinbank Vietnam Joint Stock Commercial Bank for Industry and Trade EAB Eastern Asia Commercial Joint Stock Bank TCB Technological and Commercial Joint Stock Bank EI B Export Import Commercial Bank OCB Orient Commercial Joint Stock Bank NAB Nam A Commercial Joint Stock Bank SCB Saigon Commercial Joint Stock Bank HDB Hochiminh City Housing Development Joint Stock Bank VBSP Vietnam Bank for Social Policies VDB Vietnam Development Bank BI DV Bank for Investment and Development of Vietnam M HB Mekong Housing Bank VBARD Vietnam Bank of Agriculture and Rural Development DAB Dong A Bank MB Military Bank VI B Vietnam International Bank ROA Return on Assets ROE Return on Equity EPS Earning per Share PCC Primary capital components TA Total assets AfL& LL Allowance for loan and lease losses ATRR Allocated transfer risk reserves SCC Secondary capital components iv Table of Contents Acknowledgements i Abstract ii Glossary of terms and abbreviations iii Table of Contents v List of Tables ix List of Figures .x Chapter One: Introduction 1.1 INTRODUCTION 1.2 RESEARCH BACK GROUND 1.3 RESEARCH PROBLEMS 1.3.1 RESEARCH OBJECTIVES 1.3.2 RESEARCH QUESTIONS .4 1.4 SCOPE OF WORK AND LIM ITATION 1.5 METHODOLOGY 1.6 SIGNIFICANCE OF THE STUDY 1.7 STRUCTURE OF THE STUDY Chapter Two: Literature survey 2.1 INTRODUCTION 2.2 RISK IN BANKING OPERATION 2.2.1 BANKING RISK OVERVIEW 2.2.1.1 Credit risk .7 2.2.1.2 Market concentrate risk v 2.2.1.3 Interest rate risk 2.2.1.4 Funding risk 2.2.1.5 Foreign currency risk 2.2.1.6 Economic risk .9 2.2.2 2.3 BANKING RISK MANA GEMENT ORGANIZATION ADEQUACY OF BA NK CAPITAL 10 2.3.1 REGULATIONS OF ADEQUATE CAPITAL 11 2.3.1.1 Uniform capital requirements 12 2.3.1.2 Risk- adjusted capital requirements 14 2.3.2 REGULATORS’ VIEW POINTS 16 2.3.3 BANKERS’ VIEW POINTS 17 2.4 CONCLUSIONS 17 Chapter Three: 18 Research methodology 18 3.1 DEFINE RESEARCH PROBLEM AND ESTABLISH RESEARCH OBJECTIV ES 18 3.2 DETERM INE A ND COLLECT DATA 18 3.3 EV ALUATE AND A NALYZE DATA 19 3.4 RECOM M ENDATIONS A ND CONCLUSIONS 20 Chapter Four: 21 An overview of CAR measurement in Vietnamese banking system 21 4.1 V IETNAM ESE BANKING STRUCTURE 21 4.2 REAL ACTIV ITIES OF V IETNAM ESE COM MERCIAL BANKS 23 4.2.1 ACHIEVEMENTS 23 4.2.1.1 Number of commercial banks increased annually 23 vi 4.2.1.2 Mobilizing and supplying a large amount of funds 24 4.2.1.3 Increasing chartered capital 26 4.2.2 SHORTCOM INGS 27 4.2.2.1 Bank- based financial system 27 4.2.2.2 Bad debts of state owned commercial banks 28 4.2.2.3 Small equity capital 28 4.2.2.4 Traditional and mono banking services .29 4.3 CAR REGULA TIONS IN V IETNAMESE BANKING SYSTEM 32 Chapter Five: 35 Capital adequacy ratio measurement analysis in ABBank 35 5.1 ABBA NK OV ERV IEW 35 5.1.1 CORPORATE INFORMATION 35 5.1.2 MILESTONE AND VISION 35 5.1.3 BANK’ S ORGANIZATION, PRODUCTS AND SERVICES 36 5.2 ROLE OF ALCO 37 5.2.1 TARGETS OF ALCO 38 5.2.2 TASKS OF ALCO 38 5.2.3 CONTENTS OF THE REPORT SUBMITTED TO ALCO 39 5.3 CAPITAL M ANAGEMENT IN ABBANK 39 5.3.1 REGULATIONS IN SAFETY 40 5.3.2 SUPERVISION 42 5.3.3 DEBIT CLASSIFICATION AND RISK PREVENTION 42 5.3.4 FOREIGN EXCHANGE STATUS 43 5.3.5 DEPOSIT INSURANCE 44 5.4 ABBANK ’S CAPITAL A DEQUACY 44 5.5 CAR CA LCULATED ACCORDING TO SBV IN COMPA RISON WITH PRIM ARY CAPITAL TO ASSET RATIO (FRB) 49 vii Chapter Six: Recommendations 52 6.1 QUALITY OF ASSET 52 6.2 INCREASING THE CURRENT CAR 52 6.3 APPLYING STANDA RDS OF BASEL II IN V IETNAM ESE COM ERCIAL JOINT STOCK BA NKS 52 Conclusions 54 Bibliography 56 List of appendices 58 viii List of Tables Table Page 4.1 Number of commercial bank 2004- 2008 23 4.2 Chartered capital of Vietnamese commercial banks 27 4.3 CAR of Vietnamese commercial banks from 2003 to 2008 33 5.1 Specific provision for debts 43 5.2 Total assets and capital in ABBank from 2006 to 2009 45 5.3 Capital adequacy ratio in ABBank 2006- 2009 48 5.4 Calculating CAR in accordance with different ways 50 ix Chapter Six: Recommendati ons and Conclusions Basel II in risk management to measure the operational risk and the market risk in banking operation, and credit rating institution should be established independently to rank credit rating of credit institutions which help the bank to calculate adequate capital to absorb losses in banking activities Finally, this thesis can not cover and solve all problems concerning capital adequacy in banking operation All recommendations and suggestions are put forth on purpose to contribute to improvement banking management in Vietnamese commercial joint stock banks 55 Bi bliography Bibliography Benton E.Gup and James W Kolari (2005), “Commercial bank the management risk”, John Willey and sons, Inc, third dition Budge, T.( June 1998), “ M anaging Bank Risk” , the Austral ian Banker , pp 79- 84 David H Pyle (July 1997), Banki ng risk management: Theory, pp2 Elmer Funke Kupper (Nov, 1999), ” Risk management in banking”, New Economics Papers, pp22 Frank K Reilly and Keith C Brown (2006), Investment analysis and portfolio management, Thomson South- Western, sixth edition, pp 202 Jean Charles Rochet and Xavier Freixas (2008), Microeconomics of Banking, second edition, the MIT Press Karlyn Mitchell (1984), “Capital adequacy at commercial banks”, economic review, the Economic Research Department at the Federal Reserve Bank of Kansas City, pp 17- 30 John W Bitner with Robert A Goddard (1992), successful bank asset/ l iabil ity management, pp9, John Willey and sons, Inc Le Minh Lam (Mar- June 1999), “ Reforming Vietnam’ s Banking System: learning from Singapore’ s Model” , Visiting Researchers series No (2000) , 2000 Institute of Southeast Asian Studies ISSN 0219-3582 10 Panos Angelopoulos and Panos Mourdoukoutas (2001), Banking risk management i n a globali zing economy, Quorum Books 11 Reto R Gallati (2003), “Risk management and capital adequacy”, McGraw Hill, pp 12 William J M cDonough (January 20, 1999), “ McDonough: The Changing Role of Bank Capital” 56 Bi bliography 13 Chu Thị Hương Giang (2009), Ứng dụng hiệp ước Basel II vào hệ thống quản trị rủi ro ngân hàng thương mại Việt Nam, Trường Đại học kinh tế TP.HCM, 2009, 144 trang, mã số 332.1068.CH500-GI6 14 Nguyễn Thị Thùy Linh (2006), Ứng dụng hiệp ước an toàn vốn Basel quản trị rủi ro hệ thống ngân hàng thương mại Việt Nam, Trường Đại học kinh tế TP.HCM, 2006, 94 trang, mã số 332.12.NG527-L312 Website http://en.wikipedia.org/wiki/Risk http://www.wisegeek.com/what-is-a-business-risk.htm http://en.wikipedia.org/wiki/Liquidity_risk http://www.investorwords.com/1808/exchange_rate_risk.html http://www.investorwords.com/401/bank.html http://www.advfn.com/money-words_term_401_bank.html http://www.slideshare.net/RChengeta/importance-of-banks-in-an-economy http://www.slideshare.net/RChengeta/importance-of-banks-in-an-economy http://www.faa.gov/library/manuals/aviation/risk_management/ss_handbook/media/ chap15_1200.pdf http://en.wikipedia.org/wiki/Basel_Committee_on_Banking_Supervision http://en.wikipedia.org/wiki/Basel_I http://en.wikipedia.org/wiki/Basel_II_Accord http://www.fdic.gov/regulations/laws/rules/6000-2000.html#fdic6000appendixb 57 List of appendices List of appendices Appendx 1: Tier capital according to SBV ’ s regulation 59 Appendx 2: Risk weight ratio of on balance sheet assets 60 Appendx 3: Risk converted ratio off balance assets 62 Appendix 4: ABBank's CAR calculation in 2008 according to SBV's 63 regulation Appendix 5: Seminar “ ABBA NK - Top Business V NR500: Financial 67 Solutions for gold class” Appendix 6: Profit and loss report 68 Appendix 7: The awards achieved 69 58 List of appendices Appendix 1: Tier capital according to SBV ’ s regulation a/ 50% of the increased value of fixed asset which are revalued according to the provisions of law b/ 40% of the increased value of investment securities (including investment shares, contributed capital) which are revalued according to the provisions of law c/ Convertible bonds and preferred stocks issued by credit institution are issued by credit institution and meeting the following conditions (i) Having an original maturity, the residual maturity of at least years before conversion into ordinary shares; (ii) Not being secured with assets of credit institutions concerned; (iii) Credit institutions are not allowed to redeem them at owners’ request or on secondary market or may redeem them only when it is so approved in writing by State Bank; (iv) Credit institutions may stop paying interests thereon and carrying forward cumulative interests to the subsequent year if the payment of interest thereon results in business losses in the year; (v) In case of liquidation of credit institutions, owners of convertible bonds may receive payments only after credit institutions may make payments to all other owners of secured or unsecured debts; (vi) Interest rate may be increased only after years as from the date of insurance and only once throughout the period before conversion into ordinary shares; d/ Other debt instruments meet the following terms (i) Being debts whose creditors are second to other creditors; in all circumstances, these creditors may receive payments only after credit institutions may make payments to all other owners of secured or unsecured debts; (ii) Having an original maturity of at least over 10 years; (iii) Not being secured with assets of credit institutions concerned; (iv) Credit institutions may stop paying interests thereon and carrying forward cumulative interests to the subsequent year if the payment of interest thereon results 59 List of appendices in business losses in the year; (v) Creditors may be paid their immature debts by credit institutions after it is so approved in writing by State Bank; (vi) Interest rate may be increased only after years as from the date of insurance and only once throughout the term of debts General reserve, at most equal 1.25% of total risk credit assets Total  Limit when determining tier capital Total value of amounts stated at items c and d shall be at most equal to 50% of the value of tier capital During the last years before their maturity, to convert into ordinary shares the values of other debt instruments, and convertible bonds which are accounted as tier capital must have their original value deducted by 20% each year Total value of tier capital shall be at most equal to 100% of the value of tier capital (Source: Decree 457/2005/QD-NHNN.) Appendix 2: Risk weight ratio of on balance sheet assets ON BAL ANCE SHEET ASSETS (Risk-adjusted assets = Book value x risk weight) Components The group of assets which have risk weight of 0% - Cash - Gold - Vietnam dong deposits maintained by State owned credit institutions at the Social Policy Bank under the Government’s Decree No 78/2002/ NĐ-CP dated 4, Oct, 2002 on credits for the poor and other policy beneficiaries - Loans being financed capital, trust investments under trust contracts under which credit institutions enjoy only trust commission and bear no risks - Vietnam dong receivables from the Vietnamese Government or State Bank of Vietnam 60 List of appendices - Discounts and rediscounts of valuable papers issued by credit institutions themselves - Vietnam dong receivables secured with valuable papers issued by credit institutions themselves; receivables dully secured with cash items, savings books, escrow deposits or valuable papers issued by the Vietnamese Government or State Bank of Vietnam - Receivables from central governments or central banks of OECD member states - Receivables secured with securities of central government of OECD member states or guaranteed by central governments of OECD member states The group of assets which have risk weight of 20% - Receivables from other credit institutions at home and abroad in each currency - Receivables from provincial/municipal People's committees, foreign-currency receivables from the Vietnamese Government or Sate Bank of Vietnam - Receivables secured with valuable papers issued by other credit institutions established in Vietnam - Receivables from State Owned financial institutions; receivables secured with valuable papers issued by State Owned financial institutions - Precious metals (excluding gold), gems - Cash item in the process of collection - Receivables from IBRD, IA DB, ADB, AfDB, EIB and EBRD and receivables guaranteed by these banks or secured with securities issued by these banks - Receivables from banks established in OECD member states receivables guaranteed by these banks - Receivables from securities companies established in OECD member states and comply with agreements on risk- basis capital management and supervision and receivables guaranteed by these companies - Receivables from banks established outside OECD member states with a residual maturity of under year and receivables with a residual maturity of under year and secured by these banks The group of assets which have risk weight of 50% 61 List of appendices - Investment in projects under contracts, stipulated in the Government's Decree No.79/2002/ND-CP of October 25,2002 on organization and operation of financial companies - Receivables secured by real estate of borrowers The group of assets which have risk weight of 100% - Charter capital allocations to subsidiary companies other than credit institutions, having the legal person status and practicing independent cost-accounting - Receivables from banks established in states other than OECD member states, with a residual maturity of under year or more claims guaranteed by these banks, with the remaining term of year and more - Receivables from central governments of states other than OECD member states, except for cases where loans as well as loan sources are in the national currencies of such states - Real estate, machinery, equipment and other fixed assets - Other receivables The group of assets which have risk weight of 150% - Loan for securities investment - Loans to security companies for securities trading - Loans to enterprises which are governed by credit institution themselves (Source: Decree 457/2005/QD-NHN N, Decisi on No 03/2007/QD-NHNN.) Appendix 3: Risk converted ratio off balance assets Components Conversion factor Commitments to guarantee, finance clients Irrevocable commitments in replacement of the form of direct provision of credits but carrying a risk level like direct provision of credits: loan 100% guarantees, payment guarantees, standby L/C Irrevocable commitments toward the credit institutions' obligation to 50% 62 List of appendices make payment on others' behalf: contract performance guarantees, bidding guarantees Other commitments with an original term of year or more 50% Trade-related commitments: irrevocable letters of credit, goods delivery guarantee Revocable L/C, Other unconditional revocable commitments 20% 0% (Source: Decree 457/2005/QD-NHN N, Decisi on No 03/2007/QD-NHNN.) Appendix 4: ABBank's CAR calculation in 2008 according to SBV's regulation @ million VND Tier Components a- Chartered capital b- The chartered capital addition reserve fund c- The financial reserve fund d- The operation development investment fund e- Undivided profit Total Book values 2,705,882 1,164,163 23,087 12,046 617 3,905,795 Tier 2: Components a- The increased value of fixed asset which are revalued according to the provisions of law b- The increased value of investment securities (including investment shares, contributed capital) which are revalued according to the provisions of law c- Convertible bonds and preferred stocks issued by credit institution are issued by credit institution have residual maturity within years d- Convertible bonds have residual maturity Risk RiskBook weight adjusted assets values category 50% 40% 100% 40% 0 63 List of appendices within 36 months ñ- Other debts have residual maturity within years e- General reserve 24,359 Total 100% 100% 24,359 24,359 On balance sheet assets 64 List of appendices accounting b- Receivables from banks established which are not OECD member states, have a residual maturity of under year or more claims guaranteed by these banks, with the remaining term of year and more c- Receivables from central governments of states which are not OECD member states, except for cases where loans as well as loan sources are in the national currencies of such states d- Real estates and other fixed assets ñ- Other receivables 5- The group of assets which have risk weight of 150% and 250% a- Loan for securities investment b- Loans to security companies for securities trading c- Loans to enterprises which are governed by credit institution themselves d- The contributed capital portion, jointventure capital amount, shares purchased of investment funds, and/or other enterprises which exceeds 15% of owned capital of credit institution Total 100% 677,357 2,325,106 100% 100% 677,357 100% 2,325,106 1,155,691 188,380 2,116,917 250% 470,950 195,000 250% 487,500 150% 772,311 14,077,951 150% 1,158,467 8,718,522 Off balance sheet assets Components a- Capital loan guarantees nominated by government b- Import payment guarantees c- Standby letters of credit issued as capital loan guarantees d- Contract performance guarantees nominated by government đ- Bidding participation RiskRisk Conversion weight adjusted Book factors assets category values 95,850 126,430 173,352 97,849 100% 100% 0% 100% 126,430 100% 100% 50% 50% 0% 100% 48,924 66 List of appendices guarantees e- Irrevocable commitments toward the credit institutions' obligation to make payment on others' behalf with an original term of year or more g- Irrevocable letters of credit issued to import merchandise h- Acceptances to pay short term commercial bills of exchange secured with goods I- Goods delivery guarantees k- Other trade related guarantees l- Revocable letters of credit m- Other unconditional revocable commitments, with an original term of months Total CAR = 2,342,315 390,358 3,226,154 50% 100% 1,171,158 20% 100% 20% 20% 20% 0% 100% 100% 100% 100% 0 78,072 0% 100% 1,424,584 38.7% Appendix 5: Seminar “ ABBANK - Top Business V NR500: Financial Solutions for gold class” Appendix 6: Profit and loss report 67 List of appendices 68 List of appendices Appendix 7: The awards achieved National reputable brand 2008 Reputable brand of vietnam 2008 Golden globe- The best banker 2007 Golden cup for the best retail service in V ietnam in 2007 69 ... 10.5% 13.7% VietCombank Asia commercial bank Dong A Bank Agribank Vietinbank Sacombank BIDV Eximbank Techcombank Orient commercial bank Other banks Figure 4.5: Top 10 banks ar e tr aded the best Concerning... Through a real case of ABBank applying the Basel I in capital adequacy management, Vietnamese regulators and banking managers learns useful lessons in banking capital management and strongly implements... banking system had a total of 95 types of bank including stated owned commercial banks, social policy bank, 40 joint stock commercial banks, joint venture banks, 39 branches of foreign bank and