Measure the interest rate risk a case study of vietcombank

i MINISTRY OF EDUCATION AND TRAINING UNIVERSITY OF ECONOMICS HO CHI MINH CITY PHAM THI XUAN LIEN MEASURE THE INTEREST RATE RISK: A CASE STUDY OF VIETCOMBANK ECONOMICS MASTER THESIS HOCHIMINH CITY, 2010 MINISTRY OF EDUCATION AND TRAINING UNIVERSITY OF ECONOMICS HO CHI MINH CITY PHAM THI XUAN LIEN MEASURE THE INTEREST RATE RISK: A CASE STUDY OF VIETCOMBANK Major: Financial and Banking Major Code: 60.31.12 ECONOMICS MASTER THESIS Supervisor: Dr Le Thai Thuong Quan HOCHIMINH CITY, 2010 ACKNOWLEDGEMENT I would like to express my honest gratitude to my devoted research Supervisor, Dr Le Thai Thuong Quan, for his assistance and valuable guidance during the course of fulfillment this thesis I would like to thank my colleagues from Vietcombank, who have helped me in collecting data for this thesis: Ms Nguyen Thi Minh Trang from An Giang Branch, Ms Le Mai Trinh from Dong Thap Branch Especially, I would like to express my sincere thanks to Ms Ho Thi Bich Lien – chief accountant of An giang Branch for her recommendation to Ms Phung Nguyen Hai Yen, Deputy Director of Finance and Accounting Department in Vietcombank head office I would like to avail this opportunity to express my appreciation to Professor Nguyen Dong Phong, UEH Board of Director for conceiving the Banking Master Program in English I also would like to express my sincere gratitude to all mu teachers at Post-graduate Faculty- University of Economics Hochiminh City for their teaching and guidance during my Master in Banking course Finally, I would like to extend my deepest gratitude to my beloved family, special thanks to my husband, Pham Trung Khanh, my son, Tony for their endless love and great support during study period ABSTRACT With the volatility in the interest rate recent years, the interest rate more becomes a vital problem of Vietnamese bankers Fluctuations in the interest rate since 2008 that effected sharply to the bank‟s interest income and value, making interest rate risk management decisive to its success It is necessary to call for high degree in the asset and liability management with the duty of managing the bank‟s interest rate risk exposure through the use of various hedging strategies and instruments as well as balance sheet adjustment This qualitative research measures the interest rate risk in Vietcombank - the leader in interest rate maker in domestic banks by using the gap model (dollar gap) also referred to as the funding gap or the maturity gap The research shall investigate the movement of the Vietnam interest rate in financial market since 2008 Then it will analyze the gap (dollar gap) in Vietcombank financial statement to measure the interest rate risk that affected to the income of the bank Finally, there shall be some suggested solutions in improve the gap as well as the net interest income Keywords: Gap, Gap analysis, interest rate, interest rate risk, interest rate risk measurement, asset and liability management, Vietcombank, financial statement, SBV, VNIBOR CONTENTS Acknowledgement Abstract Contents List of Tables List of Figures Abbreviations Chapter 1: INTRODUCTION 1.1 Background, context and rationale for the research 1.2 Why is the problem worth addressing? 1.3 Objectives/goals of the research 1.4 Methodology 1.5 Data analysis and finding 1.6 Study structure Chapter 2: THEORY OF INTEREST RATE RISK AND INTEREST RATE RISK MEASUREMENT 2.1 Background 2.2 Risks assumed by banks 2.2.1 Credit risk 2.2.2 Interest rate risk 2.2.3 Operational risk 2.2.4 Liquidity risk 2.2.5 Price risk 2.2.6 Compliance risk 2.2.7 Foreign Exchange risk 2.2.8 Strategic risk 10 2.2.9 Reputation risk 10 2.3 Interest rate risk 10 2.4 The model of measuring the interest rate risk 12 2.4.1 Definition 14 2.4.2 Calculation 14 2.4.3 Limitation of gap model 17 2.5 Interest rate risk management 18 2.5.1 On balance sheet adjustment 18 2.5.2 Off balance sheet adjustment 19 2.5.2.1 Using interest rate futures to hedge a dollar gap position 19 2.5.2.2 Using forward contract 20 2.5.2.3 Using option contract 21 2.5.2.4 Using interest rate swap 22 2.6 Manage interest rate risk with dollar gap 24 2.6.1 Aggressive management 25 2.6.2 Defensive management 25 2.7 Conclusion Chapter 3: 25 INTEREST RATE MOVEMENT IN VIETNAM AND VITECOMBANK INTEREST RATE POLICY 3.1 The movement interest rate in Vietnam 27 3.1.1 Interest rate before the Renovation Policy 27 3.1.2 Interest rate after the Renovation Policy 28 3.1.3 Interest rate volatility period 29 3.2 Interest rate policy in Vietcombank 31 3.2.1 Background 31 3.2.2 Interest rate policy 32 3.2.3 The fluctuation in 2008 34 3.2.4 The fluctuation in 2009 36 3.2.5 The movement in first six month of 2010 37 3.3 Conclusion Chapter 4: 38 MEASURE THE INTEREST RATE RISK IN THE COMMERCIAL JOINT STOCK BANK FOR FOREIGN TRADE OF VIETNAM (VIETCOMBANK) 4.1 Introduction 39 4.2 Research design 40 4.2.1 Data collection and analysis 41 4.2.2 Personal interview 42 4.3 Interest rate risk exposure 42 4.4 Balance sheet structure 45 4.5 Gap Analysis 47 4.6 Conclusion 54 Chapter 5: Suggest and conclusion 5.1 Conclusion 56 5.2 Conclusion related to search questions 57 5.3 Suggest for hedgeing the gap 59 5.3.1 Balance sheet adjustment 59 5.3.2 Off – balance sheet 5.4 Limitation of the research and suggest for further research References Appendix 60 63 ABBREVIATIONS ALM Asset and Liability Management ALCO Asset and Liability Committee VCB The Bank for Foreign Trade of Vietnam SBV The State Bank of Vietnam SOCBS State Owned Commercial Bank RSA Rate Sensitivity Asset RSC Rate Sensitivity Viability FS Financial Statement SMEs Small and Medium Enterprises NRS Non Rate Sensitivity VND Vietnam Dong VAS Vietnamese Accounting Standard BOM Board of Management 10 LIST OF TABLES Table 2.1 Exposure to interest rate Table 2.2 Classification of Assets and Liabilities by interest rate sensitivity Table 2.3 The relation in Gap, Interest rate changes and net interest income Table 2.4 Distinction incremental gap and cumulative gap Table 4.1 VCB balance sheet in 2009 Table 4.2 VCB Classification of Assets and Liabilities by interest rate sensitivity Table 4.3 VCB Gap, Relative gap, interest sensitivity ratio Table 4.4 Maturity buckt of loans and deposits from customer at 31.12.2009 Table 4.5 VCB Reprcing mismatch in 2008, 2009 and first six months in 2010 Table 4.6 The compnent of net interest income in each maturity bucket Table 4.7 The effect f changing interest rate to NII liabilities is always over than meant that VCB controlled the interest rate volatility to achieve the positive net interest income The sensitive asset and liability are divided into incremental (1-30 days, 30-90 days, 91-360 days, 360+ days, over years) that 1-30 days „maturity bucket‟ always appears negative All interviewee agree that this phenomenon occurs due to the customers were attracted by competitive interest rate and other promotion in short time (within month) and while the borrowers tend to engage loan in longer term In dead, this incremental shall be rolled over in several terms so that bank can utilize to lend longer term What is the extent of interest rate risk in Vietcombank? Whether or not such risk affect to its profit? The bank interest income mainly generate from lending and interest expenses stem from fund mobilization, any changes in interest rate should effect to the net interest income desperately It was elucidated that VCB has an asset sensitive balance sheet and maintain a consistent growth for many years The interest income was contributed by long term while interest expenses natured from shorter term Among of incremental, the highest interest income mainly are short term loans within year and 360+ days and interest expenses are bear by short term deposit (within month) All interviewee agree that the current interest rate risk measurement help them have suitable judgment in driving their interest rate policy not only in each branch of the whole system but also the ALCO decision The researcher also explored that the interest income as well as expenses changes pro rata during surging or declining interest rate scenario The inerest expense burden in short term has been improved year by year while the longer term interest income has also reach to an ideal ratio that 30-90 days and 90-360 days term Moreover, the interest income in longer term (360+ days and over years) has been reduced thanks to eliminate longer term credit policy All interviewee agree that they keep track of the Gaps every transaction day and they can manage the Gap in short term as well as long term related to lending and borrowing policy in short term and long term Since each branch must follow the target from the Head Quarter so they can assure about the Gap in their balance sheet structure 5.3 Suggestion for hedging the gap With the great achievement in the past, VCB are proud as the leader banker in Vietnam However, in the violent competition banking market, there is not sure for the man resting on his laurels, some suggestion to hedge the gap that closely to improve the net interest income are needed in this circumstance 5.3.1 Balance sheet adjustment: Due to its asset sensitive balance sheet, the VCB will have a prosperous net interest income position during upward sloping phases of the interest rate cycles Bank can vary the interest sensitivity of assets by making deposit to SBV, other financial institutions or loan maturity In fact, VCB have managed the balance sheet well, but the negative gap in 1-30 days horizon can get trouble in raising deposit interest rate competition Another thing to maintain the positive gap, the Bank must pay more attention to credit quality to reduce the allowance for loans and advances customers associated with bad debt For many years, VCB‟s credit activities mainly focus on SOEs with long term finance at corporate interest rate Nowadays, it‟s time to expand the credit activities to SMEs with variable interest rate to diversify the credit products In the liability side, banks can also diversify the maturity of the deposit offered to customers or may borrow in the interbank market The fund mobilization plays a significant role in the growth target of VCB, so it is necessary to attract more attention from customers as well as improve the relation with existing ones In recent, head office allocate all main targets to every branch with the aim to enhance the status of consolidated balance sheet The ALCO has managed the interest rate risk with the aggressive strategy to ensure the consistent growth in net interest income 5.3.2 Off-balance sheet At present, risk on derivative products are mainly conduct in foreign change transaction, specifically the forward contracts They are managed by Vietcombank on the basis of compliance with regulations, imposed by the SBV on foreign exchange management (Ordinance on Foreign Exchange in 2006) and other applicable regulations of the SBV relating to foreign exchange position and transactions of credit institutions that are allowed to engage in foreign exchange transactions as specified in Decision 1081/2002/QD-NHNN of October 2002 However, banks have not conducted interest rate hedging yet in specific condition in Vietnam Although VCB should take some risks in an acceptable management practice but never bet the bank on any interest rate forecasts Most of derivative instruments are executed internal between branches and head office complied with regulations In accordance with the Bank‟s regulations and policies, branches are only allowed to deal with customers on the basis to ensure the overall safety position of the Bank and in compliance with regulations relating to forward contracts Branches are not allowed to maintain their own position in order to avoid interest rate risk and settlement risk All transactions, including forward foreign exchange transactions, are managed and monitored centrally via internal accounts of Vietcombank In accordance with this Decision, position at branches including position of the forward contracts at the end of each day will be automatically squared to the Head Office The BoM has applied the aggressive management to ensure the net interest income In conclusion, the using derivatives instruments are not aware by the nature of a SOCB as well as the undeveloped market in Vietnam 5.4 Limitation of the research and suggest for further research It would be interesting to conduct the measurement of interest rate risk with others models applied to joint-stock commercial banks in Vietnam (such as Duration, ratio analysis, risk return exposure,…) With the limitation of knowledge and time, the researcher have just survey a simplest and most common model in measuring the interest rate risk In the fierce competition in interest rate market, the interest rate risk measurement and management should be treated as prior in the process of developing and penetrating the international context This thesis is designed as case study, so future research is needed to expand and make the findings more representative References  rd Benton E.Gup and James W Kolari Edition – Commercial Banking The Management of Risk  Bessis, J.,2002 Risk management in banking (2e)  Eugene F.Brigham and Michael C Ehrhardt 10 Edition – Financial th Management Theory and Practice  st Frank Skinner – published 2005 – Pricing and Hedging interest and credit risk sensitive instrument  Gareth Alan Williamson, 2008 – Interest rate risk management: a case study of GBS Mutual Bank Master in Commerce (Financial Markets) of RHODES University  Mahshid, D and Naji, M.R.,2003 Managing interest rate risk – a case study of four Swedish savings banks Master thesis Hostterminen: School of Economics and Commercial Law, Goteborg University  Mishkin, Frederic S, Eakins, Stanley G (2003) - Financial market and th institutions edition Boston: Addison Wesley  rd Maurice D.Levi Edition – International Finance The Markets and Financial Management of Multinational Business th  Neil J.Salkind – Edition – Exploring Research  Ross Westerfield Jaffe Edition – Corporate Finance  Robert K.Yin – Case Study research Design and Methods Edition th rd  Santomero, Anthony M, Babel, David F (1997) – Financial Markets, Instruments and Institutions  Saunders, Anthony (2000) Financial institutions management – A modern perspective  Van Son, Lai, Hassan, Kabor M (1997), An empirical investigation of asset-liability management of small US commercial banks  Website www.sbv.gov.vn  Website www.vietcombank.com.vn  Website http://asianbondsonline.adb.org  Vietcombank Annual Report 2007, 2008, 2009  Ms Phung Nguyen Hai Yen – Deputy Director of Financing and Accounting Department in VCB head office, personal communication 15 Nov 2010 APPENDIX A BALANCE SHEET STRUCTURE & GAP CACULATION APPENDIX B AN INTERVIEW WITH MS PHUNG NGUYEN HAI YEN- A SENIOR OFFICER IN VIETCOMBANK ALCO Conducted by personal phone call in the middle of November 2010 Researcher: I was attracted by a consistent growth and remarkable net interest income of VCB recent years I would like to know what key that VCB have achieved Ms Hai Yen: For more than 50 years of establishment and development, VCB has been proud as a specialized bank in servicing as well as a friendship accompany With the whole country net work (over 300 branches, local subsidiaries) employed about 10,000 skillful staff, VCB try to pursuit the consistent growth harmonized with community activities We have conducted a closed process in managing interest rate to maintain the positive growth net interest income Researcher: How does the bank calculate the interest rate risk, which models are used to measure the interest rate risk? Ms Hai Yen: Among the existing interest rate measurement such as Maturity structure analysis, Balance sheet projection, Gap analysis, Net interest income projection, Risk-return exposure, Duration analysis, Ratio analysis we choose the most common and basic method to measure the interest rate risk that is Gap Analysis This measurement has been adopted in whole system of the VCB and in charged by ALCO Researcher: What is the ALCO personnel and how long ALCO execute meeting as well as leave the decision? Ms Hai Yen: Usually, ALCO hold the meeting every month with participant of Board of Director, Head of Treasury Department, Head of Accounting Department and some other involved officer Moreover, ALCO can call for extraordinary meeting in urgent interest rate chaos Researcher: In your opinion, what are the advantages and disadvantages of this model used? How long does your bank apply this method? Ms Hai Yen: Of course, this is the most common and basic model to measure the interest rate risk It‟s easy to conduct daily not only in the H.O Treasury Department as well as each branch in while system They can have a thorough grasp of an interest rate problem day by day, week by week and month by month This method is suitable for us at least in current and near future Researcher: What is the shape of the GAPs? How the GAPs effect to the bank income and how can your bank manage the GAPs? Ms Hai Yen: Our bank has maintained the positive Gap for many years and we shall that in the future Although some time horizons have been negative such as 1-30 days or 31-90 days but we always maintain positive position to ensure the asset sensitive balance sheet About the GAP management or interest rate risk management, we drive it actively to preserve the net interest income in which on balance and off balance sheet adjustment have been implemented We allocate some main target to each branch about the loan turnover related to interest rate ceiling, deposit turnover concerning interest rate floor and leave them their plan That concluded the interview Kindly give me a favor for more information about the thesis INTERVIEW QUESTION WITH SOME BRANCHES OF VIETCOMBANK The interviews were conducted in Treasury and Accounting Department of some branches: An Giang, Dong Thap, Chau Doc I About the branches and the deposit and lending interest policy What is the deposit and lending volumes in your branch? Do you have flexible decision in deposit and lending interest rate? How long you change your interest rate policy? II About the Gap How long you analyze the Gap in your branch? Do you equip enough to that? What the shape of your Gap? Are they positive or negative and why? III About the net interest income How long you keep track of the interest income and interest expenses? Do you actively manage your net interest income or follow the target from Head Quarter? What is componet of net interest income in your branch? IV Managing the GAPs How can your branch manage the GAPs? Does your branch have an active hedging policy? What instruments that your branch use to improve the GAPs? Thank you for your answer Kindly give me a favor for more information about the thesis ... Credit risk is the primary cause of bank failures, and it is the most visible risk facing the bank managers 2.2.2 Interest rate risk Interest rate risk is the risk to earnings and capital that market... Face value of the future contract : MC Maturity of the anticipated cash asset M F: Maturity of the futures contract b: the ratio of the variability of the cash market to the variability of the. .. Bankers are in the war of fund mobilization by offer a negotiable interest rate and lending it with higher rate The interest rate risk management in Vietnam bankers are became vital banking activities