Risk management at Vietinbank Hoan Kiem branch, Current situation and proposed solutions

However, debt of group 3 and group 5 still arose in 2015 and 2016, mainly due to loss of solvency of customers of fishery-agriculture-forestry sector, or force majeure such as dis[r]

Cohort 2015 – 2017

Master’s Thesis

“Risk management at Vietinbank Hoan Kiem branch, Current situation and proposed solutions”

Author: Nguyen Thi Kim Oanh

Advisor: Assoc.Prof., Dr Ly Phuong Duyen

Page

CONTENT

TABLE OF ABBREVIATIONS

LIST OF TABLE AND FIGURES

1 CHAPTER : INTRODUCTION

1.1 Background to the study

1.2 Aims of the study

1.3 Scope of the study

1.4 Method of the study

1.5 Outline .6

2 CHAPTER : THEORETICAL BACKGROUND

2.1 Concept of Risks in Commercial Banking

2.2 Classification of Risks in Commercial Banking

2.3 Causes of risks 12

2.4 Risk management in commercial banks 13

2.5 Risk Management Techniques 21

3 CHAPTER 3: RISK MANAGEMENT AT VIETINBANK–HOAN KIEM BRANCH 24 3.1 General introduction about Vietinbank Hoan Kiem Branch 24

3.2 Actual status of credit operation at Vietinbank Hoan Kiem Branch in 2014-2016 26

3.3.1 Products/services of Vietinbank Hoan Kiem Branch 26

3.3.2 Business performance of Vietinbank Hoan Kiem Branch in 2014-2016 27

3.3 Actual status of credit risk management at Vietinbank Hoan Kiem Branch 30

3.3.1 Actual status of credit operation 30

3.3.2 Credit quality and risk 33

3.3.3 Actual situation of credit risk management at VietinBank Hoan Kiem Branch 38

3.3.4 Actual status of operational risk management at Vietinbank Hoan Kiem Branch 45

3.3.4.1 Actual status of operational risk VietinBank Hoan Kiem Branch 45

3.3.4.2 Operational risk management procedure at VietinBank Hoan Kiem Branch 49

4 CHAPTER : SOLUTIONS AND RECOMMENDATIONS 54

4.1 Orientation for risk management at Vietinbank Hoan Kiem Branch 54

4.2 Solutions 55

4.3 Recommendations for strengthening of risk management at Vietinbank HK Branch 64

CONCLUSIONS 66

Page TABLE OF ABBREVIATIONS

No Abbreviations Definition

1 SSC State Security Commission of Viet Nam

2 IT Information Technology

3 BIS Bank for international settlement AMA Advanced Measurement Method KRI Key risk indicators

6 VaR Values at risk

7 ATM Automatical Technology Machine

8 NPL Non Perfomance Loan

9 HO Head Office

10 VTB Vietinbank

11 E&Y Earn and Young

12 SMEs Small and medium enterprises 13 EAD Exposure at Default

14 LEQ Equivalent Loan Exposure 15 PD Probability of Default 16 LGD Loss Given Default

17 EL Expected Loss

Page LIST OF TABLE AND FIGURES

No of tables/firgures

Name of tables/firgures Page

Table 3.1 Branch’s business performance over the years 28 Table 3.2 Condition and classification of loan by time 31 Table 3.3 Outstanding loan classification by economic sectors 32 Table 3.4 Outstanding loan classification by economic sectors 33

Table 3.5 Credit risk factor 35

Page EXECUTIVE SUMMARY

1. CHAPTER : INTRODUCTION 1.1. Background to the study

Risk management is very important to an organization, especially a commercial bank, which trades financial services with variety of risks In the context of the economic crisis in Vietnam and in the world recently, the Vietinbank system has faced up with so many risks, greatly affecting to the business operations of commercial banks in general and Vietinbank Hoan Kiem Branch in particular

Nowadays when the economy is under the unpredictable volatility, risk management is increasingly concerned There are numerous causes for risks in the bank operation; therefore, risk management issues is compared as the survival matter of the banks by the saying profits is proportional to risks” In other words, the better a bank’s performance is, the higher the possibility of risks Besides, too tight risk management may lead to inefficiencies Through studying the causes, major risks Vietinbank Hoan Kiem Branch’s operation, the author thereby attemped to find out the best risk management solutions to balance risk management and business performance for Vietinbank Hoan Kiem Branch

Page

1.2. Aims of the study

The author, as the banker of Head Office of Vietinbank, would like to take this opportunity to select the subject “Risk management at Vietinbank Hoan Kiem Branch, current situation and proposed solutions” as the Master thesis with the aim to sum up, for completion of risk prevention and limitation in Vietinbank Hoan Kiem Branch, it is necessary to get an insight into the causes and types of potential risks to Vietinbank Hoan Kiem branch’s operation, from which possible solutions are provided for the best risk governance and the sustainable development of the business activities

Research questions:

-What are the kinds of risk at commercial bank?

-Which kinds of risk can usually affect to operations of Vietinbank Hoan Kiem Branch?

-What are the current situation and problems of risk management at Vietinbank Hoan Kiem Branch?

-What are the solutions to solve and prevent the risk management at Vietinbank Hoan Kiem Branch?

1.3. Scope of the study

The report studies the causes, major risks Vietinbank Hoan Kiem Branch’s operation

In the context of report, it will research the risk management credit risk and operational risk at Vietinbank Hoan Kiem Branch from 2014 to 2016

1.4. Methods of the study:

Thesis used qualitative and quantitative research methods are clarified, comparative and statistical methods

1.5. Outline

The thesis consists of chapters, with the following: Chapter 1: Introduction

Chapter 2: Theoretical background

Chapter 3: Risk management at Vietinbank Hoan Kiem Branch Chapter 4: Solutions and Recommendations

Page

2 CHAPTER : THEORETICAL BACKGROUND 2.1 Concept of Risks in Commercial Banking

There currently exists many concepts of risks For example, risks are “losses or missing of opportunities” occuring in the future and resulting from current actions” Risks are not good and happen in an unexpected way Risks are bad lucks and uncertainties occurring in the course of banking business, adversly influencing on a bank’s activities Risks relate to changes in actions, ways of thinking and acting, position, etc., whether can change the future Moreover, risks involve in the selection and uncertainty of such selection’s order Finally risks will result in losses

According to the material supplied by the State Security Commission of Viet Nam (SSC) in a workshop on “Risk Management for commercial banks” held in Ho Chi Minh City on August 05th, 2006, the risks in banking are defined as “the possibility that an action or event may bring adverse outcomes directly affecting an institution’s income or capital or create obstacles to that institution’s business continuity and use of opportunities to make profits”

From the conventional viewpoint, risks are defined as “events, when occur, may make losses of assets or create a debt” The moderner definition of risks implies a broader meaning and not just takes into account financial risks but also those related to operational and strategic objectives Risks are the possibility that uncertain events in the future will make an entity not achieve its strategic and operational objectives as well as opportunity costs for such losses of market opportunities Risks concern both losses of capital and assets and impairment of goodwill and brand of a bank Accepting risks is the focus of banking activities, requiring the banks to assess their business opportunities based on the risk-benefit relationships for seeking out opportunities to gain the benefits worthy of acceptable risks The Banks will work well if their risk level is reasonable, under control and within their main resource and credit capabilities

2.2 Classification of Risks in Commercial Banking

Page

market risks, operational risks, strategic risks, compliance risks/policy risks and goodwill risks

Credit risks are the possibility of losses inccured by a commercial bank resulting from customers’ failure or inability to perform their obligations under commitments

Liquidity risks lead to damages and/or loss or solvency of a commercial bank when it has not enough funds available for reasonable costs and/or fails to sell its assets at reasonable costs and/or forces to raise funds at high costs and on time needed to meet its financial obligations Liquidity risks are consider the largest when a commercial bank cannot anticipate the needs for new loans or deposit withdrawals and access commitments, risk concentration or asset and liability structure

Market risks are of asset loss types, occuring when the interest rate, exchange rate or market rate adversely volatile Market risks covers a very wide range, thereby divided into three specific subtype including exchange rate risks, interest rate risks and market price risks

Operational risks are risks that may cause damages due to insufficient or defected internal processes, human and systems or external factors and events

Strategic risks arise from the inability of a commercil banks to implement its business plan, strategies, decision-making, adequate resource allocation as well as adapt to changes in its business environment

Compliance risks are the risks that may arise from the parties’ breaches of or non-compliance with laws, rules, regulations or practices, or when the rights and legal obligations of the parties have been established Compliance risks relates to not only legal compliance but also professional ethical standards, conventions and treaties issued by associations

Page

the ability to establish and maintain customer relationships will become difficult with reduction of the public confidence in commercial banks

The above definition has shown that banks can classify risks in their operations into four main categories, including financial risks, operational risks, business/economic risks and incident risks In fact, such categories as liquidity risks, market risks, credit risks, foreign exchange risks, interest rate risks, operational risks and asset risks are often mentioned Each category has its own characteristics besides an intimate relationship with each other and a direct impact on banks’ operations

• Credit risks

As defined by the Basel Committee, credit risk is the possibility that a borrower or counterparty fails to perform its obligations under a contract Also according to this committee, credit risks are known as risks of loss for a bank or a default in contractual covenants” due to any material violation of the contract obligations on repayment of principals and/or interests.”

In other words, “Credit risk in banking activities of credit institutions is the possibility to occur losses in banking activities of credit institutions due to customers fail or are inable to perform their obligations under commitments”

Pursuant to Clause of Article Regulations on loan classification, establish and use of provisions against credit risks in banking activities of credit institutions in attachment to the Decision 493/2005/QD-NHNN dated April 22nd, 2005 made by the Governor of the State Bank of Vietnam, credit risks are defined as the possibility of losses in the banking activities of credit institutions

Despite different ways of definitions, the aforesaid concepts of credit risks have the same nature that is credit risks are the possibility (probability) of triggering the economic losses suffered by banks due to the borrowers’ delay or failure in repayment of loans (including principals and/or interests) Credit risks may cause financial losses for banks, for instance, reduction of net incomes and capital market prices, in serious cases, lead to losses or, at a higher level, bankruptcy of banks

Page 10

In terms of cause of risks, credit risks are divided into the following categories: transaction risks and portfolio risks

• Operational risks

Operational risks exist in most departments of banks which engage in the transactions of business, service rendering or risk-weighted activities

Operational risks are losses due to human, working processes, insufficient or inactive internal systems or external events It can be understood that operational risks arise from human factors (negligence or frauds); weaknesses of IT systems; loopholes and lack of regulations of commercial banks This definition includes legal risks other than strategic and goodwill risks

Operational risks involve employee frauds, thefts, system failures, power failure, flooding or other reasons for the errors in a bank which can not be included in other risks Operational risks also include compliance risks Compliance risks are potential exposures to earnings and capital arising from failure to comply with laws, rules, regulations, best practices, internal policies and procedures or other ethical standards

Operational risks are not new to banks These losses resulted from operational risks have been reflected in the balance sheets of banks for many decades They occur every day in the banking industry However, most of the losses are immaterial and entirely predictable and preventable, for example, errors in book recording, credit card errors, or brokendown of some banking equipment, etc Besides, some events can cause huge losses such as illegal stock trading, corruption, book forgery or external factors namely natural disasters, fires, etc

In the process of research and interviews with numerous bank executives around the world since 1998 sofar, BIS (Bank for international settlement) have given various definitions of operational risks After many revisions, operational risks are generally accepted to be the risks that can causes damages due to human, incomplete or poor operational processes and systems and objective external events Operational risks includes legal risks, except for strategic and goodwill risks

Page 11

or external events Operational risks include legal risks, but exclude strategic and goodwill risks

From the definition of BIS, operational risks can be divided into subcategories below:

Human risks are risks related to banks’ employees For example, bank officers collude with customers to prepare forged documents for loans; raise collateral values for loans to receive remuneration, only submit interests to the banks after direct collection of both principals and interests from borrowers while retaining the principals for personal expenses In addition, human risks can be seen from the unexperienced and unqualifed employees leading false accounting and mistakes

Systematic risks are risks that may occur such as error data entry, poor control of changes, poor project management, programming, service and system secourtiy errors as well as inappropriateness of systems

External risks occur beyond the control of the banks and are usually caused by the events of other banks having influential impacts on the whole industry such as external frauds and thefts, fires, disasters, failed outsourcing arrangements, demonstrations, riots, etc

Legal risks are the risks arising from the ambiguity of the legal action or ambiguity in the application and interpretation of contracts, laws or regulations In some countries, legal risks stem from the ambiguity of the legal opinions

• Relationships of risk categories in operation of commercial banks

Page 12

2.3 Causes of risks • Causes of credit risk

Bank-related causes:

-The troubled loans and losses may occur due to procedural loopholes within the banks This is called the un-perfect lending activity with the following reasons: in-completed credit information, limited qualifications and professional ethics of the bank officers in general and credit ones in particular

-The banks have too focused on profits and put the desire for earnings in the higher position than healthy loans, unfairly competed with other banks and non-banking institutions to get the more proportion of loans whereas the control and supervision has not been carried out regularly (credit officers not grasp the credit situation of customers as well as credit environment of the economy) To this extent, there have close links with the operational risk of the banks

Customer-related causes:

-For corporate customers, the main cause stems from poor management level leading to the inefficient use of loans as expected or inaccurate business and production plans; weak and nontransparent corporate financial situation, and customers’ unwillingness to repay, ect

-For individual and household customers, the cause may be health conditions or diseases; temporary or permanent unemployment situation affecting their incomes; or borrowers’ incorrect budget planning, wrong use of loans, lack of experience in use of funds to organize production and manage business

Objective causes:

-Natural disasters, enemy sabotage, epidemics, fires, etc.; -Unstable economic environment;

- Unfavorable legal environment affecting business operations of borrowers and transferring credit risk of borrowers to commercial banks

• Causes of Operational Risk

Operational risk is caused by the following factors: procedures, human, systems, external events and other issues Such factors are expressed as follows

Internal issues

Page 13

-Risk due to professional regulations and procedures; -Risks from support systems, core banking

External issues External events which are factors beyond the control of the

banks also contribute to operational risk

-Risk due to deceptive acts, thefts and/or guilty of external entities (acts of sabotage, bombings, etc.)

-Risk from external events and/or natural disasters (earthquakes, hurricanes, etc.) making the banks’ operations disrupted/damaged

-Risk from changes in documents and regulations of the government, relevant departments affecting the banks’ operations

Losses due to external events may be reduced through insurance, contingency plans and recovery systems The continuous business planning is an important way to help banks prepare for the risk from external events and manage these risks

Other issues: volume and value of transactions, complexity of transactions,

changes that the banks are facing (new ownership, new management, new employees, new products, changes in policies, procedures, systems, etc.) The banks which are in the process of merging with other banking organizations have the particularly high level of operational risk

2.4 Risk management in commercial banks

2.4.1. Concept of risk management in commercial banks

Risk management is to identify the level of risk that a business wants and identify current risk level of businesses are suffering On the other hand, the use of derivatives or other financial instruments to minimize the occurrence of risks or adjust the risk level real risk that the rate they want

In other words, risk management is the process of approaching risk in a scientific, comprehensive and systematic in order to identify, control and mitigate the damage, loss, adverse effects of risks, concurrent trying to turn risks into opportunities successfully bring added value to the business

Page 14

institution and the requirement for financial institutions can achieve the objectives set and maintain the viability and financial transparency "

Main subjects are studied in this research is the risk management in banks - a problem never gets old but very important to the security and stability of the financial system - banks and large influence to the development of the economy Risk management includes the following steps: identification of risk, risk analysis, risk measurement, control, prevention and financing risks

Identify risks: Identify risks, this is a precondition for risk management Risk identification is the process of determining continuous and systematic business activities of the bank, including the monitoring and review, environmental research activities and all activities of the bank to agree Statistics are all kinds of risks, including projected new risks may appear in the future to take measures to control, suitable funding for each type of risk

Risk analysis: Risk analysis is finding the causes of risk From finding out the causes and the factors affecting the causes, risk analysis gives us measures of risk prevention more effective

Risk Measurement: This job requires the collection of data, matrix establish risk measurement and analysis To assess the significance of risks to the bank, it uses two criteria: frequency of occurrence of the risk and magnitude of risks (extent of damage caused by risky), this is criteria have a decisive role

Control, risk prevention is the focus of risk management, which is the use of methods, techniques, tools, strategies and action programs to prevent, prevent or minimize the damage Furniture, unwanted effects may occur to the bank These precautions may include: risk prevention, loss prevention, risk transfer, risk diversification, information management,

Sponsor Risk: Despite the implementation of precautionary measures, but the risk may still happen, then we need to monitor and pinpoint the loss of assets, human resources or on prices legal value Then, to set the appropriate funding measures Overall, these measures are divided into two groups: self-remediation and risk transfer

Page 15

Risk identification is the continuous and systematic process of determining risks and uncertainties of an organization The identification aims at developing information about sources of risks, risky elements and risk exposures

b) Identification of credit risk

Credit risk is a type of risk which is difficult to be identified in the course of operation of commercial banks Credit risk is shown in troubled loans and shown in different forms Stemming from the actual credit practices, the banks have drawn some basic signs to help credit officers recognize, judge and timely take measures to prevent the actual risks They are as follows:

Suspension rate: is the amount that customers fail to pay at due Suspension rate is also an important sign to identify credit risk because the interest payments are not linked to the principal repayment and very much smaller than the principals, paid at the end of every month The enterprises’ failures to make interest payments show their severely financial problems

Some other signs: Credit risk is often hidden in “troubled loans”, expressed by many signs; however, there is not a specific model to accurately and fully describe the signs of the occurrence of credit risk in the future Besides, through tests in the real credit operations, some signs below are generally effective warning for credit officers about the solvency of borrowers:

-Delay in submission of financial statements of borrowers -Changes in relationship between banks and borrowers -Abnormal increases in inventories as well as liabilities

-Reduced quality of enterprises’ products and services, loss of customer confidence, leading to sales with longer payment terms, sales to customers having weak financial capabilities and low liquidity

-Failures in repayment of loans orinterest on time

-Changes in organizational structure of business management -Natural disasters such as hurricanes, floods, fires, forest fires, etc c) Identification of operational risks

Page 16

its method of operational risk identification; yet, the operational risk identification in commercial banks is done through groups of signs below:

-Group of organizational structure, personnel and workplace safety related risk signs: Through analysis and evaluation, the banks will find out signs of risks such as risk from employees, risk from policies of staff recruitment, arrangement and appointment, risks from noncompliance with legal provisions for employees

-Group of internal policy and regulation related risk signs: Incomplete, loose

and general provisions leading gaps for bad guys to take advantage of and damages of the banks The texts and regulations are overlapped or impossible with unreasonable matters for people to implement The texts and rules are incompatible with the applicable provisions of the law

-Group of internal fraud related risk signs: With regard to this group, the banks shall identify risks such as officers intend or collude with customers to take illegal actions aiming at appropriating property, having bad influence on reputation of the bank

-Group of external fraud related risk signs: it is necessary to identify risk such as frauds made by of customers or third parties, such as providing false information, making false transaction records

-Group of working process related operational risk signs including errors or mistakes arising during the working process of all departments: is necessary to identify risks such as: Operational actions beyond their rights and authorities, failure to comply with regulations and procedures ; loose control, etc

-Group of information technology system related risk signs including: hardware, security systems, network equipment, transmission lines, operational software which affect business activities of the bank

-Group of property damage related risk signs including the likelihood of risks such as sabotage, terrorism, natural disasters, earthquakes, floods, fires, etc d) Risk measurement

• Measurement of credit risk

Page 17

• Qualitative models of credit risk - the model 6C

For each loan, the first question is whether the customers are willing to pay and afford to pay the debt in due or not This involves in studying in detail the "6 factors - 6C" of customers including:

-Character: Credit staff must ensure that the consumer borrows with clear purpose and seriously intention to pay in due

- Capacity: the borrower must have legal and civil capacity; the borrower must be legal representative of the enterprise

-Cash flow: determine the repayment source of the borrower -Collateral: is the second source of revenue to repay bank loans

-Conditions: the Bank stipulates the conditions according to the credit policy in each period

-Control: evaluating the impact of changes in laws and regulations of operation, the ability of borrowers to meet the Bank standards

The application of this model is relatively simple, but the limitations of this model is that it depends on the accuracy of information sources, predictability and the credit staff’s analysis and evaluation capacity

• The model quantifies the credit risk

Currently, most of the banks have accessed to the modern risk assessment methods These are the most common models

• Z scores Model:

This model depends on: (i) financial indicators of the borrower -X, (ii) the importance of these indicators in determining the probability of borrower default in the past

Z =1.2X1 + 1.4X2 + 3.3X3+ 0.6X4 + 1.0X5 In which:

X1: "Net working capital / total assets" ratio X2: "Accumulated profit / total assets" ratio

Page 18

The higher the value Z is, the lower probability of borrower default is Thus, when the Z value is low or is a negative number, it will be the basis for rating customers in the high risk of default group

If Z < 1.8, customer have high probability default If 1.8 < Z <3: not determined

If Z > customer have no probability default

This model of risk measurement techniques is relatively simple However, it only group customers to risk and no risk category In fact, the credit risk level of each different customer, from the low level such as the late interest payment or interest default to the level of losing both principal and interest

• Ratings model of Moody's and Standard & Poor's:

Credit risk in lending and investing is often expressed by rating bonds and loans In which, Moody's and Standard & Poor's is the leading companies Moody's and Standard & Poor's rates bonds and loans into groups and under quality decreasing class, in which, the banks should only lend to the first classes In summary, the bank’s assessment of the borrower risk’s probability to evaluate the loans or debts depends on the investment scope and the cost of collecting information The factors relating to the investment decision include:

-Group of borrower-related factor:

+ Credibility of borrowers: basing on the borrowing- prepaying history of

customers If during the borrowing process, customers always pay in full and on time, it will gain the Bank’s belief

+ The level of income volatility: For any capital structure, income has a huge influence on the borrower repayment capacity Therefore, the companies with stable earnings history will attract more investment

+ Collateral: is the main condition for any lending decisions to encourage the effective capital use and enhance the customer's responsibility to repay the bank

+ Interest rate: high interest rate is resulting from tight monetary policy which

Page 19

-Group of market-related factors:

+ Economic cycle: The economic cycle has a significant influence on the

production and operation of enterprises Therefore, the banks need to analyze the economic cycle to make decisions in the right time and invest in the low-risk sectors

+ Interest rate: a high interest rate is an expression of a tight monetary policy,

often associated with a high level of risks While investors are often attracted by largely profitable projectst while ignoring higher profits greater risk

- Risk assessment through simple ratios: This is a simple method to measure credit risk at the most basic level using the ratio below:

Bad debt ratio

Bad debt ratio =

Bad debts

*100% ( 3%) Total loans

Credit risk ratio:

Credit risk ratio =

Total loans

*100% Total assets

The ratio shows the proportion of credit items in the assets and risks • Measurement of operation risk

According to the Basel Committee, there are two methods to calculate capital requirements for operational risk, in the gradual increase order of complexity and risk sensitivity: (i) Standardization method; and (ii) Advanced Measurement Method (AMA)

Standardization Method

In the Standardization Method, banking operations are divided into segments of services: corporate finance, commerce & sales, retail banking, commercial banking, payment and agency services, property management and retail brokerage

Page 20

measured by multiplying the gross profit with a coefficient (coefficient β) applied to such service segment Coefficient β shows the industry-wide correlation between losses from the operational risk actually recognized and the industry’s scale of gross profit for each type of services The total capital requirements are calculated by adding up the capital requirements of service segments together The total capital requirements may be represented by the following formula:

KTSA = ∑(GI1-8 x β1-8) (i = 1-j) Whereby:

TSA

K : Capital requirements according to the Standardization Method; 1-8

GI : Average annual gross profit for three most recent years, determined by the Basic Indicator Method, for each of eight operation segments;

1-8

β : A fixed rate prescribed by the Basel Committee, reflecting the relationship between the required capital and the gross profit of each operation segment Details of β values are as follows:

coefficient β for each operation segment

Corporate finance (β1) 18%

Commerce and sales (β2) 18%

Retail banking (β3) 12%

Commercial banking (β4) 15%

Payment (β5) 18%

Agent services (β6) 15%

Property management (β7) 12%

Retail brokerage (β8) 12% Advanced Measurement Method (AMA)

Page 21

2.5 Risk Management Techniques 2.5.1 Credit Risk Management

Credit risk management must primarily ensure the general administration steps, including planning, organization, arrangement, management and inspection Methods of credit risk management is also recognized and implemented in collaboration in different aspects:

Credit risk management by influential factors

This is a method to identify and manage influential factors to credit risk, including the following groups:

- Bank-related factors: credit policies, risk management models, quality of human resources, credit appraisal, post-monitoring and inspection, credit growth rate, customers, loan terms, borrowers, loan valuation, collaterals, portfolio diversification, moral risk, and policies of human resource administration, etc - Market-related factors: economic cycles, inflation, interest rates, exchange rates, prices and markets, risk policies, etc

- Customer-related factors: feasibility and effectiveness of borrowing plans, collaterals, liquidity, profitability, leverage ratio, effective capital management, cash-flow, morality of business owners, management capabilities and qualification, industry prospects, competitiveness and diversification of business, etc

- Other factors: Accuracy and availability of information, legal framework, supervision role of the Central Bank of Vietnam, etc

Management by credit granting segments

Pre-disbursement: Management involves from policy making to evaluation and credit-granting decision This is a crucial stage in the entire process

During disbursement: Management includes preparation of records and inspection while disbursement

Post-disbursement: Causes for risks may have hidden in the two first segments (pre and during disbursement); however, credit risk is only really revealed and arises after disbursement

Management by time of credit risk occurrence - Before occurrence of risks:

Page 22

Determine risk level

Grasp and practice forecast steps Eliminate if risks are too large

Finance for acceptable risks by choosing among self-financing, insurance and risk diversification methods

- After occurrence of risks: manage damages, make plans of risk recovery

It can be concluded that the duties of the credit risk management are to forecast, detect potential risks, discover unfavorable events, prevent negative situations which have occurred and possibly spreaded in a wide scale, deal with risk consequences to limit damages to the assets and incomes of the banks This is a closely logical process which should be well conducted right from the forecasting and prevention stage until the handling of risk consequences by administrators 2.5.2 Operational risk management

It is the international standard-oriented operational risk management framework that serves as a firm base for the operational risk management of commercial banks in Vietnam This framework includes internal policies, organizational structure, procedures and software solutions for operational risk management in commercial banks In the current context when commercial banks operate in the market mechanism under the strict management of the Central Bank of Vietnam, it is necessary for them to consider carefully choosing an operational risk management framework which can meet the basic requirements in accordance with the international standards such as:

The banks’ strategies and methods of operational risk management must match together; methods of operational risk management practice and measurement must be determined; Standard tools for identification, measurement, inspection, monitoring and reporting in the whole system must be integrated in the operational risk management program

Page 23

Page 24

CHAPTER : RISK MANAGEMENT AT VIETINBANK – HOAN KIEM BRANCH

3.1. General introduction about Vietinbank Hoan Kiem Branch

Vietinbank Hoan Kiem Branch was established under the Decision 415/QD-VTB dated 01/10/1993 made by the General Director of Vietinbank

The institution has currently 298 employees, together with members of the Board of Directors having lots of experiences in banking industry Having bachelor’s degree or postgraduate degree matching their working capacity, and with average age of 35, Vietinbank Hoan Kiem Branch 's employees are very active and creative at work

Vietinbank Hoan Kiem Branch operates on medium scale including headquarter and 03 transaction offices of category Vietinbank Hoan Kiem Branch aims to the modernization-oriented development; the headquarter at Building No 25 Ly Thuong Kiet street, and 10 transaction offices

As a Branch of Vietinbank, Vietinbank Hoan Kiem Branch; however, remains the independent accounting unit According to Article 30 of the Articles of Association of Vietinbank, Vietinbank Hoan Kiem Branch acts in the capacity of authorized representative for Vietinbank, has business autonomy as assigned by Vietinbank, is bound to the obligations and rights for Vietinbank Vietinbank shall be ultimately responsible for the obligations arising out of the commitments of these units In addition, Vietinbank Hoan Kiem Branch is entitled to enter into economic contracts, to actively implement business operations, organization and personnel affairs in accordance with decentralized authorization of Vietinbank Organizational chart of Vietinbank Hoan Kiem Branch:

Page 25

Department of Business Planning: to deal with customers acting as enterprises (enterprises and organizations having revenues > VND 20 billion) providing products /services related to Corporate customer: raising capital, credit, trade financing, foreign currency trading, electronic banking, etc

Retail Customer Dept.: to deal with customers acting as super micro enterprises (having revenues < VND 20 billion) and customers acting as individuals or households providing products/services related to Corporate customer: raising capital, credit, trade financing, foreign currency trading, electronic banking services, etc

Transaction dept.: is a miniature Branch, including all operations such as raising capital, credit, trade financing, accounting, treasury, etc within the authorization Credit Support Dept (under Head office): to control credit approval records, enter the records into information technology systems, prepare credit contracts, secure, notarize, register of security transactions for security contracts, warehousing secured property records, control disbursement records

Treasury Currency Dept.: to carry out treasury security management, cash management as stipulated by the State Bank and Joint Stock Commercial Bank for Foreign Trade of Vietnam To advance and raise money for savings accounts and transaction points in and out the counters, make cash receipts and payments for enterprises having large amount of receipts and payments, carry out management of original documents for trade finance

Accounting Dept.: To carry out direct transactions with customers related to opening of accounts, making cash remittance home and abroad, accounting of credit, etc To fulfill works and duties related to financial management and internal expenditure at the Branch, provide banking services related to payment operations, carry out accounting of transactions, manage and take responsibilities for computer transaction system, manage cash accounts to every tellers, provide customer care services with regard to the use of bank products

Page 26

administration and operations of business office at the Branch, carry out protection and security at the Branch

Computing Team: to manage and maintain computing information systems at the Branch, carry out maintenance to ensure smooth operation of network and computer systems at the Branch

General Marketing Department: to give advice and submit to directors the expected business plans; gather, analyze and evaluate the business activities conditions; make annual reports on Branch’s activities; and manage and settle problematic debts (debt of group or higher and risk settlement)

3.2. Actual status of credit operation at Vietinbank Hoan Kiem Branch in 2014-2016

3.2.1. Products/services of Vietinbank Hoan Kiem Branch

The major activities of the Branch have been gradually improved and extended in order to provide following products and services:

Receiving deposits:

+ Receiving demand deposits and term deposit denominated in VND and foreign currencies

+ Receiving deposit accounts in various and attractive forms + Issuing notes and bonds

Loans and guarantees:

+ Short-term loans in VND and foreign currencies

+ Medium- and long-term loans in VND and foreign currencies + Import-export financing, negotiation of export documents

+ Co-financing and syndicate loan for significant projects, having long payback period

+ Consumer loans:

+ Bid security, contract performance guarantee, payment guarantee Trade finance:

Page 27

+ Import-export collection, sight bill collection and acceptance collection Payment service:

+ Domestic and international remittance + Encashment order, payment order, sec

+ Payment of salary for enterprises via liquidity and via ATM + Remittance payment, Western Union

Treasury Services:

+ Foreign currency transaction + Valuable instruments transaction Card and electronic banking services:

+ Issuing and paying international credit card + ATM card services

+ Internet Banking, Telephone Banking, Mobile Banking… Cross-selling service: to Vietinbank’s subsidiaries

+ Non-life insurance and life insurance services + Securities agent services

+ Financial lease agency services, gold trading services

3.2.2. Business performance of Vietinbank Hoan Kiem Branch in 2014-2016 Despite the significant violability of financial and monetary market condition in 2014, 2015 and 2016, the Branch has made many efforts and gained encouraging achievement, to be specific:

Table 3.1: Branch’s business performance over the years

Unit: billion VND

Items 2014 2015 2016

Comparison 2015/2014

Comparison 2016/2015 Value Ratio Value Ratio Raised capital 1298 1606 4066 308 23.73% 2460 153.18%

Total outstanding loan

887 900 1388 13 1.47% 488 54.22%

Page 28

Bad debt

Total income 155.961 222.589 308.437 66.628 42.72% 85.848 38.57% Total expense 120.044 175.230 223.287 55.186 45.97% 48.057 27.43% Realized profit 35.917 47.359 85.150 11.442 31.86% 37.791 79.80%

(Source: Report on business performance for 2015, 2016 VIETINBANK HOAN KIEM)

It can be seen from the Table 3.1 that, for the past year, business condition of Vietinbank Hoan Kiem Branch has been effectively improved, especially in 2016 Despite the significant violability of financial and monetary market condition in 2014, 2015 and 2016, the Branch has made many efforts and gained encouraging achievement

The current level of knowledge and professionalism at the Branch cannot meet customers’ essential needs in all aspects The Branch, therefore, always follows directives of VietinBank’s leaders, actively develops new products, and gives regular introduction about utilities of VietinBank products and services to customers, etc Additionally, actively improving service quality, reducing procedures, shortening transaction time, and improving working style of the staff dealing directly with customers are also effective ways applied by the Branch in order to make a good impression on customers The solidarity within the Branch is paid adequate attention together with high sense of responsibility so as for the Branch to overcome all difficulties and complete all tasks

Total capital Branch raised in 2015 reached VND 1606 billion, increasing by 23,73% compared with that in 2014; the figure in 2016 was VND 4066 billion, increasing by 153,18% compared with that in 2015 Total outstanding loan reached VND 900 billion in 2015, increasing 1,47% compared with that in 2014, and the figure in 2016 was VND 1388 billion, increasing 54,22% compared with that in 2015

Page 29

over the years The bank should further enhance this achievement in the coming period

Advantages and disadvantages of Branch’s business operations Advantages

NPL ratio of 0,27% in 2016 is a result of the Branch with respect to improving credit quality, finding effective measures to recover debts due and overdue, and healthy outstanding loans

In 2016, according to directives of Vietnam Joint Stock Commercial Bank for Industry and Trade, the Branch has set aside a risk reserve fund of 100% in accordance with assigned plan The analysis and evaluation of customers’s ability to pay debts are conducted regularly in order to take timely remedy The Branch also pays special attention to the recovery of NPL and credit risk liquidated obligations to minimize the NPL ratio to its lowest level as well as to create additional financial revenues from non-recurring earnings

Disadvantages

Prolonged labor shortage in many years leads to the fact that current employees at the Branch have to work under high pressure and stress

Although newly recruited young officers and employees are enthusiastic and dedicated to work, they have unadequate profesionalism, are inexperienced and unprofessional, and are still in apprenticeship at the Branch (around 6% of employees currently affects the business operation scale development)

It is the small scale of Branch's network compared to that of other competitors in the area that partially reduces the advantage of competition and approach to customers Actual status of credit risk management in 2014-2016 conducted by Vietinbank Hoan Kiem branch

Page 30

3.3. Actual status of risk management at Vietinbank Hoan Kiem Branch 3.3.1. Actual status of credit operation

a) Loan classification by time

Overall, Branch’s outstanding loan has increased over the years mainly including short-term loans; meanwhile Medium- and long-term outstanding loans accounted for a small ratio under volatility over time as follows:

Table 3.2: Condition and classification of loan by time

Unit: billion VND

Items 2014 2015 2016

Comparison 2015/2014

Comparison 2016/2015 Value Value Value Value Ratio Value Ratio Total outstanding

loan 887 900 1388 13 1.47% 488 54.22%

Short term

outstanding loan 597 623 924 26 4.36% 301 48.31% Medium- and

long-term

outstanding loans

290 277 464 -13 -4.48% 187 67.51% (Source: General Dept., VIETINBANK HOAN KIEM BRANCH)

Remark:

In 2014, short-term outstanding loans reached VND 597 billion, accounting for 67.31% of total outstanding loans In 2015 - VND 623 billion, accounting for 69.22% of total outstanding loans, increasing by VND 26 billion compared with the figure in 2014 In 2016 - VND 924 billion, accounting for 66.57% of total outstanding loans, increasing by VND 301 billion compared with the figure in 2015

Branch’s Medium- and long-term outstanding loans reached VND 290 billion in 2014, accounting for 32.69% of total outstanding loans; 2015 – VND 277 billion, making up 30.78% of total outstanding loans, droping by VND 13 billion compared with the figure in 2014; 2016 – VND 464 billion, accounting for 33.43% of total outstanding loans, increasing by VND 187 billion compared with the figure of previous year

Page 31

large enterprises aim to use the loan to reserve materials for production or to purchase agricultural products, etc., small and medium enterprises - to supplement to the capital; resident individuals - to purchase, build houses or buy cars in installment, etc Medium- and long-term loans are given to customers mainly to expand projects, invest in fixed assets and new projects, and repair residential houses, etc In 2016, there had been complicated socio-economic fluctuations, constant change in market interest rate; arising of large expenses by the Bank for project appraisal and large loans management, etc However, Branch’s medium- and long-term outstanding loans increased (+67, 51% compared with the figure of previous year), reaching 108.92% of 2016 plan It is partly because of Branch’s success in searching for projects, customers, and partly because of the disbursement of large projects in the previous year This shows that the Branch has been taking specific and effective measures to enhance the long-term credit efficiency, accordingly contributing to country’s industrialization and modernization

b) Loan classification by economic sectors

Along with the equalization process implemented strongly under State guidelines, Branch’s current loan structure has been given the proper redirection, in particular:

Table 3.3: Outstanding loan classification by economic sectors

Unit: Billion VND

Items 2014 2015 2016

Comparison 2015/2014

Comparison 2016/2015 Value Value Value Value Ratio Value Ratio Total

outstanding loans

887 900 1388 13 1.47% 488 54.22%

State-owned enterprises

61 60 100 -1 -1.64% 40 66.67%

Non-state

enterprises 826 840 1288 14 1.69% 448 53.33% (Source: Report on business performance for 2014, 2015, 2016 VIETINBANK HOAN KIEM BRANCH)

Remark:

Page 32

having been effectively using loans of the branch, at the same time, search for and actively give loans to new customers with feasible business projects Thus, Non-state enterprises’ loan-to-total outstanding loan ratio has been very high, increasing from 93.12% in 2014 to 93.33% in 2015 and reaching 92.8% in 2016

Besides, the use of loans at State-owned enterprises appears to be inefficient; these enterprises show many shortcomings and weaknesses in the business, together with weak consumption of inventories and regular application for debt extension As a result, the Branch finds hard to revolve business capital; credit quality diminishes, etc Additionally, since State-owned enterprises’ mechanisms and management regulations remain inadequate, and the amount of business loans sometimes up to 100% of the needs of the plan, the ratio of loans given to State-owned enterprises in total outstanding loans at the branch is very low: 6.88% in 2014, dropped slightly in 2015 reaching 6.67% and rising to 7.2% in 2016

c) Loan classification by economic sub-sector

The Branch is currently implementing credit investment structure transformation towards increasing investment in industry and construction sector, reducing investment in fishery-agriculture-forestry sector, and focusing on improving Trade and services sector, to be specific:

Table 3.4: Outstanding loan classification by economic sector

Unit: Billion VND

Items

2014 2015 2016 Comparison 2015/2014

Comparison 2016/2015 Value Value Value Value Ratio Value Ratio Total

outstanding loan

887 900 1388 13 1.47% 488 54.22%

fishery- agriculture-forestry

66.367 39.499 58.390 -27 -40.48% 19 47.83% Industry and

construction 510.903 533.051 821.638 22 4.34% 289 54.14% Trade and

Page 33

Remark:

Based on comprehensive cooperation agreements with companies specializing in production of building materials, cement, and stone and large construction enterprises, in 2016, VietinBank Hoan Kiem Branch focused on serving strategic customers in important economic sectors such as: production of building materials and construction

In 2014, fishery-agriculture-forestry sector’s outstanding loans reached VND 66.367 billion, accounting for 7.48% of total outstanding loans, in 2015 – VND 39.499 billion, accounting for 4.39% of total outstanding loans, decreasing by VND 27 billion compared with the figure of previous year; in 2016 – VND 58.390 billion, accounting for 4.21% of total outstanding loans and increasing by VND 19 billion compared with the figure in 2015

Industry and construction sector’s outstanding loans reached VND 510.903 billion in 2014, accounting for 57.6% of total outstanding loans; in 2015 – VND 533.051 billion, accounting for 59.23% of total outstanding loans and increasing by VND 22.148 billion compared with the figure of previous year; in 2016 – VND 821.638 billion, accounting for 59.2% of total outstanding loans and increasing by VND 289 billion compared with the figure of 2015

Trade and services sector’s outstanding loans reached VND 309.730 billion in 2014, accounting for 34.92% of total outstanding loans; in 2015 – VND 327.450 billion, accounting for 36.38% of total outstanding loans and increasing by VND 17.720 billion compared with the figure of 2014; in 2016 – VND 507.972 billion, accounting for 36.60% of total outstanding loans, increasing by VND 181 billion compared with the figure of 2015

In general, The Branch has currently implemented credit investment structure transformation in 2016 towards increasing investment in industry and construction sector, reducing investment in fishery-agriculture-forestry sector, and focusing on improving Trade and services sector: This is an appropriate transformation suitable for general development orientation of Ha Noi capital

3.3.2. Credit quality and risk

Page 34

in overdue debt rate because it can generate doubtful accounts, irrecoverable debts or bad debts To lower overdue debt rate, administrators often make risk assessment based on the following indicators:

a) Credit risk factor

This factor shows the proportion of credit items in assets, the high proportion of credit item will express high profit and high credit risk exposure

Table 3.5: Credit risk factor

Unit: Billion VND

Item 2014 2015 2016

Total assets 955,521 960,259 1460

Outstanding loans 887 900 1388

Credit risk factor 0,93 0,94 0,95

(Source: General Marketing Dept, VIETINBANK HOAN KIEM BRANCH) Remark:

The table shows that, credit item in total assets of the branch is pretty high leading to an increase in profit In principle, credit risk increases accordingly However, the branch had strengthened the appraisal and strict control of loan projects in 2015-2016, Branch’s credit operation remains effective, to be specific: group is almost equal to 0; bad debt accounts for a small proportion of the total outdtanding loans The table 3.5 shows the significant influence of outstanding loans on total assets; there will be fluctuation in total assets in case of difficulty arising in credit operation

b) Analysis of overdue debt structure

Pursuant to Decision No 493/2005/QD-NHNN and additional Decision No 18/2012/QD-NHNN dated 25/04/2012 made by the Governor of State Bank, overdue debts are classified into groups as follows:

Group (Standard debt):

Group (Special-mentioned debt) Group (Sub-standard debt) Group (Doubtful debt)

Page 35

In above groups, overdue debts are classified from group to group 5, in which bad debts are from group to group In other words, overdue debts comprise debts of group and bad debts

Table 3.6: Analysis of overdue debt structure

Unit: billion VND

Items 2014 2015 2016 Comparison 2015/2014

Comparison 2016/2015

Total

ourstanding loans

887 900 1388 13 1.47% 488 54.22%

- Group 874.662 893.159 1.384.263 18.497 2.11% 491.104 54.99% - Group 0.062 0.522 0.460 741.94% -0.522 -100% - Group 6.319 0.330 6.319 -5.989 -94.78% - Group 3.826 0 -3.826

- Group 8.450 3.407 3.407

(Source: Report on business performance for 2015, 2016 VIETINBANK HOAN KIEM BRANCH)

Remark:

The above table indicates that, despite the increase in outstanding loans, overdue debts in group - in 2016 have decreased significantly

Standard debt (group 1) of the bank over the years always made up very high proportion of total debts overdue, specifically: in 2014 reached 98.61%, in 2015 increased to 99.24% and in 2016 - 99.73%

Although debt of group had risen slightly from 0,062 in 2014 to 0.06% in 2015, in 2016, it accounted for 0% of the total overdue debts

Although debt of group had risen from 0% in 2014 to 0.7% in 2015, in 2016 it was well controlled reaching 0.02% in total overdue debts

Page 36

It can be said that, there has been no particular trend for overdue debts over the past years However, obviously, the Branch has made great efforts in controlling overdue debts Standard debt at bank is always maintained at a rate of over 98% that is considered a major success of the bank In 2016, the support in interest rate from the Government facilitated the business activities of enterprises Therefore, despite economic difficulties, in 2016, enterprises had carried out actively and effectively construction works, projects, hydropower plants, etc due to priorities with regard to capital and construction conditions Many enterprises specializing in construction, steel production, etc receiving loans from the branch can earn high profit and be able to repay debt on schedule The Bank was trying to limit the overdue debt within group and However, debt of group and group still arose in 2015 and 2016, mainly due to loss of solvency of customers of fishery-agriculture-forestry sector, or force majeure such as diseases (blue ear disease, foot and mouth disease, etc.), natural disasters, that the bank must accept as a risk-sharing with customers

Page 37

c) Bad debt situation over the years

Table 3.7: Bad debt situation over the years at the branch

Unit: billion VND

Loan classification 2014 2015 2016

Total outstanding loan 887 900 1388

Bad debt 12,276 6,319 3,737

In which:

- Debt of group - Debt of group - Debt of group

0 3,826 8,450

6,319 0

0,330 3,407 NPL-to-total outstanding loan ratio 1,38% 0,702% 0,27% (Source: General marketing Dept., VIETINBANK HOAN KIEM BRANCH)

In general, bad debt tended to sharply decline over the years Specifically, the NPL ratio was VND 6.319 billion in 2015, reducing by VND 5.957 billion compared with the figure in 2014 NPL in 2016 was VND 3.737 billion, declining by VND 2.582 billion compared with the previous year

According to current regulations of the State Bank, the maximum NPL-to-total outstanding loan ratio ranges from 3% to 5% The above tabel shows that, this ratio at the Branch is only about 0.27% to 1.38% which is much smaller than the allowable limit This indicates that, the Branch has stable, safe and effective credit operation; and bad debt problem is always in control and thorough settlement by the bank

However, it is deemed by the author that, notwithstanding the figures and results recorded in the table, in 2012 and the following years, the Branch should pay more attention to the quality and safety of credit According to Fitch – one of the three world prestige financial assessment organizations, method of classification of loans and provisions of Vietnam would be much less stringent if it was compared with IFRS And therefore, the NPL ratio measured in accordance with Vietnam accounting standards did not express the real issues

d) Risk reserve fund

Page 38

superior to handle credit risk totaling VND 2,228 million (including cases of reduction or waiver of interest, totaling VND 1,015 million)

In 2015, the Branch set aside a credit risk reserve fund of VND 6,700 million, of which specific provision is VND 1,860, outstanding debt of group is VND 11 million, group – VND 1,849 million The Branch submitted records of request for handling 2015 credit risk and received approval by superior to handle credit risk totaling VND 10 million, to collect risk-weighted off-balance sheet debt totaling VND 1,863 million, reaching 37.79% of the plan

In 2016, the Branch set aside a credit risk reserve fund of VND 10,381 million, of which specific provision is VND 23,429 million, outstanding debt of group is VND million, group – VND 17.429 million The Branch submitted records of request for handling 2016 credit risk and received approval by superior to handle credit risk totaling VND 36 million, to collect risk-weighted off-balance sheet debt totaling VND 37 million, declining VND 1,826 million compared with the figure of previous year, reaching 0.74 % of 2016 plan

The setting up credit risk reserve funds and risk treatment by the Branch over the years shows that the branch has made great effort in the process of overcoming risk The Branch has gradually implemented the restructuring of debts, cleaning up financial operations, handling of outstanding debts, etc To improve credit quality and minimize risk, the Branch also applied initiatives to credit activities in order to improve professionalism and bring efficiency at work Besides, the Branch has set up the appropriate provision to cover risk in banking activities in accordance with the Decision 493/2005/QD-NHNN, supplemented in the Decision No 18/2012/QD-NHNN made by the Governor of State Bank dated 25/04/2012 allowing the Bank to make risk provision at the rate specified based on the classification of overdue debt and recognition in expense, and to use the risk offset This approach helps to reduce the debt burden of the bank, relieve psychological pressure of credit officer as well as the leadership of the in case of encountering credit risk under time when the collateral to be enforced

3.3.3. Actual situation of risk management at VietinBank Hoan Kiem Branch a) Basic contents of credit risk management at the Branch

Page 39

Credit risk for customers are managed in comprehensive and continuous manner in all stages likely to generate credit risk, under specific regulations for each type of credit operations

- Credit grant limit to customers:

Complying with regulations on loan and guarantee limit for customers as prescribed by the State Bank and Vietnam Joint Stock Commercial Bank for Industry and Trade; carrying out internal credit ratings in order to quantify the risk level of each customer; determining credit limit so as to manage overall credit risk exposure There are 10 grades of internal credit ratings: AA+, AA, AA-, BB+, BB, BB-, CC+, CC, CC-, C Loan shall not be granted to customers having credit rating of ≤ CC Scoring structure, level, and technique applied in the credit ratings shall be continuously improved in conformity with reality

- Granting credit shall be limited with regard to customers posing risk, or failing to comply with provisions of law Specifically:

Signs from financial statements such as: submitting lately or failing to submit

statement on business performance, balance sheet; reporting with insufficient and unclear data on doubtful receivables-to-total increased receivables ratio; management cost occupies a large proportion of total costs; sales revenue decreases sharply, etc

Signs from business operations, relationships with partners: change in business

scope; decline in material supply; gradual reduction of market share of products/ services; inappropriate arrangement of plants and equipment compared to scale, business production process and distribution market, etc

Signs from transactions with banks: change in attitude with bank/bank staff; avoiding

contact with bank staff; finding it hard to pay due debts; frequently restructure of repayment period, etc

Signs related to corporate governance: the enterprise is going to transform

ownership form, make changes in personnel organization; internal lawsuits, etc

- Credit allocation policy:

By geographical location: credit grant scope shall be divided based on capacity and

Page 40

By loan terms and loan types: the conformity between the loan term structure and type of loan with capital structure

By type of products, type of customers, goods items and investment fields: diversifying loan products under principle of minimizing risk; diversifying type of customers to minimize potential risks; diversifying goods items and investment fields in accordance with economic development trend

- Jurisdiction:

Jurisdiction includes authority to approve credit limit, authority to make decisions on granting credit, and authority to enter into credit agreements They are classified by grades at the Branch (Branch’s Director, Base Credit Council, Head of Transaction Department, etc.)

* Policy on classification of loan, making of credit risk provisions:

Performing loan classification as prescribed by the State Bank, especially the NPL; regularly monitoring signs of doubtful accounts; more frequently assessing solvency to facilitate the quality and credit risk management at the Branch

Besides, the Branch shall measure and make specific provision for each loan; collaterals shall be taken to deduct when calculating the amount of provisions as prescribed in Clause 1, Article 10 added and adjusted

* Regulations on reporting, examining and monitoring risk:

Periodic reports on credit quality shall be made throughout the system to assess risk management and to propose measures for preventing risk and improving credit quality

b) Actual situation of credit risk management at the Branch

According to the 6C model, In general, staff taking charge of credit and risk management at the Branch is relatively dynamic and enthusiastic at work They were methodically trained in economic-financial-banking departments in various universities

Page 41

any violations of credit agreement terms; continuously improved professional qualifications, professional ethics of credit staff

Considering the current economic conditions in Vietnam, the branch has used quantitative models to evaluate loans during the process of appraisal, management, monitoring, inspection and supervision of loans

- Regarding loan appraisal: generally, the branch has set up strictly regulations on procedures for appraising loans including:

Appraising legality: checking legal status, legal capacity of the borrowers, loan application records, checking purposes of customers, etc

Verifying reputation of the borrowers, executive management capacity of the customers or business management board, moral quality, goodwill, reputation in transactions, management and administration capabilities, internal inspection and control system, etc

Verifying financial and operational capacity through indicators such as solvency, proportion of inventory turnover, profit margins

Verifying the effectiveness of the loan plan, specifically: ability to implement business plans, supply of raw materials, consumer markets, funding source for the plan, etc

Verifying source of repayment: which source of revenue projected by customers to make payment for principal and interest; is it stable or not?

Verifying loan collateral: whether the collateral is legally owned by the borrower or not; is it easy to transfer, or sell?

- Regarding credit check: the Branch has always followed most popular principles being applied in other banks to carefully check in detail all important aspects of each credit items, including:

Check the plan made by customers to ensure timely repayment Check the quality and condition of the collateral

Check the completeness and validity of the credit contract, ensuring the legitimacy to own property in case the borrower is unable to pay debt

Page 42

Regularly check great credit items since they have a huge influence on bank’s financial condition

Besides, Branch’s Risk Management Department operates quite actively and effectively in strict control of setting up loan records, making decision on lending, disbursement procedure, loan use condition and assessing customers’ solvency so as to propose timely solutions so that the Branch can minimize the risks in credit operations

In the past year, Branch’s Risk Management Department has implemented fairly fully and effectively the following specific contents:

+ To analyze Branch’s credit operations on a quarterly basis

+ Some principles under Basel II have been applied by the Branch to credit risk management in safe and effective manner

+ To manage black lists of customers on the systems and written records supplied by Vietnam Joint Stock Commercial Bank for Industry and Trade and Branches, to update specific information in the independent appraisal report on credit risk

+ To make independent appraisal on credit risk for customer credit limit, credit supply project/method: in 2016, the Branch made an independent appraisal on credit risk of 144 records, including 100% of records supplied by Customer Division

+ Review of credit ratings scoring: in 2016 the Branch scored credit rating/reviewed credit ratings scoring for 144 records of customers when performing independent appraisal on credit risk, in accordance with current regulations

+ Check the completion of credit records: in 2016 Branch’s Risk Management Department checked credit record completion for 149 written records and 100% of customers’ records declared on INCAS system - Customer Division

c) Result

Many bad debts and overdue debts are recovered and significantly reduced in 2015 and 2016, especially, there was no debt of group and group by 2016

Page 43

Regarding quality of independent appraisal on credit risk: there has relatively complete independent information; specify the level of risk and reason for assessing risk exposure on customer status, customer profiles, business condition, financial condition, projects/schemes for granting credit, collaterals, customer’s solvency; specify level of satisfying the current conditions on granting credit, submit independent proposal to the Branch’s leadership by the Risk Management Department mentioning whether or not to grant credit to customers; mitigate risk in deciding to grant credit to customers; make specific recommendation about the contents of the draft credit agreements and property mortgage contracts so as for customer divisions to adjust in accordance with current regulations, mitigate legal risks in making contracts

d) Disadvantages

- Regarding human resource: the Branch has currently many transaction offices

However, because of huge workload and limited human resource (an officer specializing in law was appointed to the branch from November 2016, but he is still in apprenticeship), (Risk Management Department has only four people), each employee or officer must concurrently take up many different jobs Job specialization accordingly cannot be ensured Division’s leaders sometimes have to directly make independent appraisal on credit risk, projects/schemes for granting credit sent by customer divisions

- Regarding implementing functions and tasks: due to huge workload and limited

human resource, the implementation of functions and tasks by Risk Management Department appears to be incomplete and unequal What is more, the major tasks have not been focused appropriately

- Relevant departments have not coordinated closely together; some data and figures on system of Risk Management Department cannot automatically extract without being operated by computerized information Team

Page 44

- The proposals on credit growth by consumer groups, by industry, by economic sectors are only implemented once a year, so the quality is not good

Some objective factors leading to credit risk epxosure in lending activity at the Branch

The fast and unpredictable volatility of domestic and global market is the major causes affecting the business activities of borrowers The global economic crisis followed by the decline of many economies has negatively impacted on our country’s economy In addition, frequent occurence of natural disasters, epidemics in the locality, sharp fluctuation in financial – monetary market, constant change in basic interest rate, and complicatedness of market prices, etc also have an adverse effect on business and production activities of all economic sectors in the province Accordingly, some borrowers of the branch faced many difficulties in recovery of capital to pay debts to banks on schedule as committed in Credit Agreement making their debts being converted into overdue debts

Besides, creating a fiercely competitive environment, the process of international economic integration also led to an increase in bad debts making most enterprises, and regular customers of the Banks have to cope with risk of loss and harsh rule of elimination of the market On the other hand, competition between domestic and international commercial banks also poses a risk of increasing in bad debts to domestic banks because customers with large financial potential have been attracted by foreign banks using new products and services with more utilities [6]

In recent years, the State has promulgated a lot of laws and legal documents guiding the implementation of laws related to credit activities However, there have been delay, inadequacy and problems in applying these laws to the Banks For instance, regarding asset levy for recovery of debt, notwithstanding the legal documents specifies "In case customer cannot pay debts, commercial banks may dispose of collaterals", in fact commercial banks are unable to this Acting as an economic organization, not state competent agency, the commercial bank cannot force customers to hand over collaterals to banks for disposal or to refer to court for handling

Page 45

4 to 2016 is completely equal to 0; however, debt of group and group was not settled in the total outstanding loan

The situation is mainly caused by the general objective condition of the economy, and partly caused by the subjective shortcomings of the Branch in credit risk management and partly caused by enterprises In order for my scientific research report to reflect the reality and gain higher efficiency, during the internship at the Branch, I decided to conduct survey to collect practical information via interviews with credit staff and send questionnaire to the staff working at the branch I would like to investigate the implementation of and compliance with credit risk management procedures, workflow of credit staff, management practices of credit leader and the internal inspection and control at the branch

Additionally, in order to understand the nature and cause of credit risk in the past years, I have gathered and conducted research on data sources in the records of overdue practical debts to have more accurate assessment

3.3.4. Actual status of operational risk management at Vietinbank Hoan Kiem Branch

3.3.4.1.Actual status of operational risk VietinBank Hoan Kiem Branch

Together with the growth rate of total assets, distribution network, the number of employees, and the rapid diversification of business operations over the years, Vietinbank has been facing increasingly potential risks in fields: credit risk and operational risk

For operational risk, most of risk notes belonging to above-mentioned groups have appeared in VietinBank Hoan Kiem Branch, namely:

Frauds and internal crime

In recent years, some operational risk incidents related to the ethical issues of staff occurred at Vietinbank The frauds often involve operational staff of credit transactions, payments, treasury, etc For example: creating false transactions and using fake documents to withdraw money at Bank One of the violating staff withdrawed VND 300 million, however, the case was promptly detected by Vietinbank, and the amount of money has been recovered

Page 46

Operational risks related to external factors mainly occur in the credit field, card and ATM transactions, and treasury operation

External credit fraud include following actions made by customers: making fake certificate of land use right or changing information in it to borrow money; using certificates of land use rights owned by many other people to creat loan application records; asking someone to borrow money from bank in the name certificate’s actual owner; using these people’s photo to make counterfeit certificate of ID card loss certified by public security; acting in representative capacity of officers and employees to have consumer loans from banks, but failing to delivery money to borrowers under the list signed by them after receiving the money

External fraud relating to treasury operations: customers have counterfeit money mixed with real money to send to a deposit account at bank or convert fake foreign currency into real domestic currency They even cut real bill into many pieces to make other bills so as to have more bills and exchange them for eligible currency External fraud relating to card and ATM operations is a popular phenomenon, for example: foreign customers use fake credit card to withdraw money at Vietnamese bank What is more, lost or stolen cards are also used to withdraw money Besides, thieves steal money from an ATM by destroying it

Error-related risks

Risks related to errors in the operation of staff appear to be the biggest risks bringing many damages among other risks incurred by VietinBank Hoan Kiem Branch Operational errors made by staff include:

- Errors in capital mobilization operations

Page 47

It can be seen that, capital mobilization poses many risks because of staff’s errors in operation Although these errors have reduced over the years, they still bring about high risk exposure They are mainly caused by unstrict observance of staff and negligence of cashiers at work

Errors in Remittance include:

Calculating and collecting charges which are not in accordanxce with bank’s regulations (6 cases in 2015 related to miscalculation, increasing by 150% compared to the figure in 2014); making errors in customers' profile, for example: the amount in figures and in words does not match (5 cases in 2014, 12 cases in 2015); making many remittance orders with the same content (3 cases in 2014, cases in 2015); improperly recording name of beneficiaries., etc

Errors in remittance are mainly due to subjective reasons of staff that can cause losses to the bank For example, in case making many remittance orders to a beneficiary, if bank’s controller cannot timely detect, bank’s capital will be appropriated

Errors in card and ATM transactions

Errors in card and ATM transactions happened at Vietinbank include following operational errors: failing to check daily ATM reports; importing insufficient kinds of money to the machine (2 cases in 2015, declining by 30% compared with the figure in 2014); particularly, making mistake in setting up currency structure parameter resulting in damages to the bank

Errors in treasury operations

Errors in treasury operations mainly include collection and payment transaction, remittance transaction, management and use of printed papers, and mistake in collecting and paying money It has been popular at some branches and transaction offices that, important printed papers were improperly made (48 case in 2015, decreasing compared to the figure in 2014); Besides, there have been risks related to the collection and payment of treasurers; failure to detect counterfeit money; mistake in classification of money; failure to package, seal and sort cash money in accordance with regulations; as well as under- or over-payment to customers, etc

Page 48

Common errors in the transfer of accounting documents include lack of signature and stamp of customers; lack of teller’s signature in the transaction documents (75 cases in 2016, dropping by 51% compared with the figure in 2015)

Another kind of risks related to the transfer of accounting documents is the delay in submitting transaction documents by transaction offices, savings desks to branches’ headquarters 52 cases in 2016, decreasing by 25% compared with the figure in 2015 This poses potential risks, making the accounting department find difficult to conduct post-inspection, and fail to detect operational errors

Errors in credit operations

Errors in credit operations are mainly related to compliance with executive regulations of branches’ Headquarters and with operational procedures such as: appraising records, making decision on loan, carrying out disbursement, collecting debt, testing use purpose of customers, receiving and valuating collaterals, classifying loan, etc

Errors in computing operation

Error during User and password management process poses highest potential risk include In fact, it is not popular at Vietinbank The case of using joint User and password between tellers, controllers and computing staff has reduced significantly, just 10 cases in 2015, declining by 52% compared with the figure in 2014 These errors has been completely overcome by Vietinbank in 2016

In addition, there have been other kinds of risks such as: failure to implement regular maintenance of computers at some branches To be specific, over 15 personal computers are under no timely maintenance, decreasing by 7% compared with the figure in 2014; 11 personal computers were installed programs which are not used by computing unit in 2015

Risks related to information technology systems (IT)

Page 49

3.3.4.2 Operational risk management procedure at VietinBank Hoan Kiem Branch

a) Risk management procedure

Identifying signs of operational risk: The base business units shall identify operational risk, specifically: self-assessment of risk exposure, risk source, risk objects, and risk level; making risk monitoring books The assessment of operational risk is based on criteria: risks related to personnel; to work handling process, to operational mechanisms and procedures of business divisions, to support systems; and to external factors

Identifying operational risk incidents: Under current regulations, the units shall be responsible for in identifying operational risk incidents In case of occurrence of any operational risk incident, the unit must take timely remedy and report to the head office (Market and operational risk management division)

Identifying doubtful and unusual transactions,: report on doubtful and unusual transactions is made based on the criteria set out by the Market and operational risk management division and operations division

Identifying risks for new products: In VietinBank, before being delivered to customers, new products undergo a review and evaluation regarding risk exposure conducted by sales division, operational risk management division and other relevant divisions Quantification of risks shall be accordingly implemented to determine the maximum loss that the bank may incur Product/services supply limit shall be disclosed and appropriate risk management measures shall be taken with regard to each risk

Based on identified types of operational risk, base busness units shall conduct qualitative and quantitative measurement After identifying and measuring risk, the units shall analyze the risks on the basis of the directives sent by VietinBank’s head office, accordingly make up plans for preventing and mitigating operational risk The contents of plans for mitigating operational risk include:

For acceptable risks: taking measures to minimize risks within the permissible limit

For unacceptable risks: taking following measures:

Page 50

Holding professional training courses – (quite frequently across in VietinBank every year)

Making plans for repairing defects, errors

Taking actions to prevent risks or stopping actions which may pose a risk Making risk mitigation plans for unforeseen events;

Buying insurance or taking other measures to mitigate risk

Monitoring operational risk

In accordance with internal regulations of VietinBank, heads of units shall directly supervise the operational risk management process in their unit with the following contents:

Monitoring the approach of operational risk management work

Monitoring and evaluating the implementation results of plans for preventing and reducing risks at the unit

Monitoring risk exposure at high level, proposing timely measures to avoid risks

Monitoring volatility level of risk exposure

Monitoring the preparation and submission of all kinds of reports on operational risk management in accordance with regulations

b) Result

Potential operational risks are hard to identify or anticipate, therefore operational risk management is one of the most difficult work of commercial banks, especially Vietnamese commercial banks

Vietinbank is one of the first commercial banks in Vietnam establishing Risk Management department, including operational risk management This shows that the Leadership of Vietinbank promptly realizes the importance of operational risk management, which contributes to the efficiency of risk management in Vietinbank Regarding operational risk management, Vietinbank has achieved some remarkable results, such as:

Firstly, it can be said that, Vietinbank has been using appropriate approach as well as

Page 51

Secondly, Vietinbank has initially established operational risk management

framework consistent with operational practices, such as issuing policy on operational risk management; specific rules and procedures for identifying, measuring, controlling, preventing and mitigating risk

Thirdly, operational risk management has made a breakthrough in awareness of

Vietinbank’s officers and employees on operational risk; thereby contributing to raising awareness and responsibility of staff at work, and minimizing risk

Fourthly, via operational risk management, Vietinbank’s documents, regulations, and

business processes have been reviewed, adjusted or changed in a consistent, timely, clear and detailed manner for each type of operations

Fifthly, Vietinbank has made a list of major risk exposures, thereby contributing to more accurately identify the risks arising in the course of business operations

Sixthly, errors of staff in business processes have been gradually limited Although Vietinbank has expanded operations scale on annual basis, risk incidents and errors have reduced with inconsiderable level of loss The losses are mainly related to moral quality of some officers - most difficult kind to predict and control

Seventhly, on the basis of reports on loss, Vietinbank have also built up data on losses

in for the past years This is useful document for holding internal training courses on risk management, facilating Vietinbank to use more advanted methods of capital measurement when these provisions and standards are officially applied in Vietnam c) Disadvantages

In addtion to encouraging achievements, operational risk management of Vietinbank poses some disadvantages, specifically:

Vietinbank’s management of operational risk aims to the requirement on compliance, other than to create value for the enterprise

Vietinbank fails to identify acceptable risk limit for each business segment for many different reasons Therefore, it is difficult to accurately assess the efficentcy of risk management

Page 52

officers take charge of multiple tasks will influence the specialization; accordingly, it is very difficult to bring high efficiency

The empowerment by Vietinbank to branches results in the difficulty in centralization at HO

The data and indicators for assessing and analyzing risks were gathered manually, with difficulty in synthesis process Current communication channels of the Headquarters are mainly fed by branches via official dispatches, of which procedures are quite complicated, resulting in failure to ensure timeliness, accuracy and objectivity

Tools for measuring operational risk are relatively simple, without advanced models of prediction and estimation Risk management tools have not been developed Vietinbank has currently utilized operational risk management tools: Self-assessing and controlling; reporting operational risk exposure; reporting operational risk matrix incidents, reviewing and approving new products; monitoring and improving recognition sent by audit and actuarial departments

Reasons

The above disadvantages of operational risk management at Vietinbank resulted from many different reasons, including:

Firstly, absence of regulations, directions and guidance on operational risk

management from State agencies

Secondly, limitation in business model: as specified in morden banking model,

business activities of the bank have been held by each segment, such as: wholesale, retail sale, currency transactions, etc Each segment shall be under management of a deputy general director However, the business model of Vietinbank was organized by the branch, a mixture, the whole business functions, so the business model of existing organizations, Vietinbank has not totally applicable models standard form of risk management

Third, due to technological constraints, existing in Vietnam in general and in particular Vietinbank software no operational risk management; No software programs to extract data, information risk management from the core banking system

Fourth, because of the cooperation between the Commission, the room at the

Page 53

at headquarters to coordinate with the Office of the market risk management and in providing operational input information for risk management activities But in fact VietinBank not built mechanism effective coordination between functional units, so only when room market risk management and operational consulting written request for information input to operational risk management, the Board, departments, the new center provides results This process makes the provision of information does not guarantee the timely and effective

Fifth, due to a small department officials and employees in the system are not

fully aware of the importance of operational risk management; thereby leading to subjective reporting is not interested and superficial, even branch also dishonest reporting operational risk status of branch => this phenomenon will lead to state input information is incomplete, did not reflect the true state of operational risk throughout the system

Sixth, because in Vietnam currently undeveloped diversified insurance

Page 54

CHAPTER : SOLUTION AND RECOMMENDATIONS

4.1. Orientation for risk management at Vietinbank Hoan Kiem Branch In Vietnamese bank’s business sector, profit from credit operations accounts for a large proportion in the bank’s income However, this activity entails risks, especially in the countries with economic situation like Vietnam whose the information system lacks of transparency and adequacy, risk management capacity is limited, unprofessional Therefore, it is necessary to establish an effective and suitable model of risk management to limit risk in credit activities, upto international level Risks always exist in any bank; the basic difference between the banks is risk management capacity basing on an effective risk management model in compliance with the operating environment for mitigating risks to minimum

According to Basel Committee, the weakness in the banking system of a country, whether developed or developing one, threats to the financial stability Therefore, it is necessary to improve the strength of financial system

Recognizing the necessary of the credit risk management, VietinBank system has directed and applied risk management models from the central level as well as two transaction centers and its branches throughout the country as follow:

- Organizational structure and human resource:

Page 55 - To clearly define the functions, legal tasks of customer relations department, risk management and debt management The clear defining of responsibilities will ensure fairness in the evaluation of the quality of work, be a condition for processing the signals of risk Each department should develop its objectives in granting credit on acceptable bad debt ratio, quantity and customer groups to be set, and the level of credit growth

It is necessary to develop a mechanism for effective information exchange, update constantly and promptly of critical information between the functional units in credit activities The important information in borrowing process should be periodically updated by customer department Simultaneously, the bank should develop an information system and comprehensive information analysis systems, provide accurate, reliable information sources for the related department, the report, analyze all sectors in the analytical data system connected between banks to share information The comprehensive cooperation between banks in establishing and sharing information databases on businesses is the shortest way to improve the information system and reduce the cost of information exploit

- To enhance the practicality and the ability to accurately assess the credit rating system This is an effective scientific tool in risk management by assessment and appropriate decisions Customer credit ratings system is applied but it still needs to be amended, adjusted to satisfy the actual conditions

4.2. Solutions

4.2.1. Considering environmental factors in loans

At present, environmental factor is important when considering lending a business Therefore, when considering each loan, the bank must pay attention to the link between the loan and the environment under different factors to avoid the regrettable risks in business, such as:

Is the project cost inclusive of the interactions between environmental factor and the loan project? Is the income and profitability of the project ensured?

Page 56

Has the bank loan applicant protected the environment, especially when that person operates on many different fields, totally unrelated to the project, the bank must consider if that customer has implement environmental protection plans for all of it business factor This will impact considerably on the financial condition and ability to repay bank debt on time

4.2.2. Improving the internal control quality at the branch

Currently, the internal controls and inspection in commercial banks in general and bank branch in particular still face many shortcomings compared with the international internal control standards In the documents relating to the inspection, audit, the tasks and powers of internal control and internal audit of the monitoring system have not been clarified; not clearly define the concepts related to the inspection, internal audit; the laws and legislation consider internal audit apparatus under General Director and executive board are the subject of internal control

On the other hand, if only focus on the condition of the credit enterprise at a certain point of time, it cannot be assured whether the credit enterprise will have risks in the near future or not? Therefore, it is necessary to apply many testing methods to provide the best performance, as follows:

- The internal control staff is responsible for cross-checking the professional application in accordance with the process

- There are at least two people in each process who assign responsibility, check, control in details for each employee participating in the process

- Allowing the inspectors to access to the documents, as well as people relating to the internal control activities

- When developing operational strategies, it is necessary to analyze, calculate the macro-economic conditions, the development trend of the market in which, consider the international situation

-Supplementing and using the high tech solutions such as ICTNews of APC solutions This solution along with accurately and quickly updated data at the center will significantly reduce risks in business at the branch

Page 57

should increase the number of years of experience (minimum years) working in the fields of finance, banking, thereby ensuring professionalism of internal audit activities

-Adopting policies to encourage and reward the best performing staff, as well as penalty policies for fraud, breach of rules

Besides, the control content at banks is cumbersome, there is no early warning program, the bank evaluation results is just the statistical data Therefore, the monitoring results have not proved effectively in preventing and detecting credit problems

The internal control staff at the branch also has no formal relationship to exchange information with banking supervisory authorities of the country having branches in Vietnam as the Headquarters of the bank mother, while this is one of the Basel standards Therefore, there should be provisions on information exchange and cooperation with the supervisory authorities and main transaction center of holding bank; seeking the support of international organizations in exchanging information, receiving advice on control methods, technologies and training to improve the capacity of inspection and internal control staff

In short, the checking, internal control system is one of the core structure of credit risk management; therefore, the branch should perform this activity well to improve the operations quality, increase the bank value and reduce risk to a minimum

4.2.3. Further improvement in human resources quality

Page 58

It is necessary to develop risk management staff with experience, knowledge, ability in considering and evaluating the credit proposal

Guiding, training, training on professional knowledge, qualification of appraising businesses and its projects, focusing on marketing, sales skills, negotiation and business culture There should be monthly, quarterly meetings, training programs, practical exchange between leaders and staff to achieve information and experience

Currently, Vietinbank Hoan Kiem Branch is considered as one of the efficient risk management branch Therefore, in future, the branch should further promote the role of risk management department At present, this department includes employees one person must take over many different tasks without specialization in the assigned task Therefore, I recommends that the branch should recruit more personnel to to arrange the work in a scientific way and focus on the individual task of each staff, ensuring the application processing time, improving work efficiency; on the other hand, having clear criteria on qualifications and experience

In the future, the risk management department should further promote its role in risk management, particularly in the appraisal report, it must analyze, evaluate deeper potential risks, offer detailed warnings to replace the current general reports To achieve this goal, the staff should be regularly trained, enhanced professional skills Besides, recruitment, use, compensation and promotion policy must conform to the requirements and job responsibilities, in accordance with objective reality in branches Appointing must be objective and as stipulated to choose the qualified people, experience, good moral attitude At the same time, there are clear policies and specific assignment related to lending, debt collection and debt settlement (credit manuals) for each employee in each department to understand its responsibilities and powers

4.2.4. Basel II application in setting risk management model in Vietinbank Hoan Kiem Branch

Currently many banks around the world are implementing risk management according to risk management frameworks as suggested by Basel II Committee

Page 59

(Source: KPMG International 2008)

Main components of risk management framework are a set of core standards providing guidance on the basis of control and environmental protection The frame is complemented with different tools with the major components: determining risk quality, establishing governance structures, allocation of reporting flows and self-assessment control, risk event management, the the main risk indicator and risk reduction programs

If implementing properly all of the above principles in compliance with the actual condition of the bank, the bank's risk management work will follow standards and accomplish the bank goals However, depending on the capacity and level of use, the branch can develop into different patterns in terms of size and level of complexity as well as implementation time

In my opinion, the branch should establish a risk specialized division, innovate reporting system and apply modern technology in the future Besides the existing human resources, the bank should make use of the resources from VTB system to manage risk, currently, VTB is cooperating with E & Y to set up risk management framework for with a implementation schedule until 2018; thereby, the branch can manage operation risk basing on self assessment Operation of the departments, business units is identified, assessed regularly; therefore, the decision to adjust and modify activities to reduce risk gradually and limited risk

Page 60

On the other hand, all levels and employees must be aware of the importance of risk Board of management must seek for risk management framework consultancy for its banks and the business environment In particular, two key issues need to be invested are: establishing, improving strategies for risk management and completing risk management structure, especially organizational structure Risk management strategies often include the following issues: identifying risks and causes of risk, describing the risk profile

On risk management structure, banks should establish and complete the separating risk management committee, in which risk is a division Monitoring apparatus of bank risks should operate independently, not involved in the process of establishing risk, to manage and supervise risk Second, the bank should establish the awareness of risk management throughout the system; select the priority to establish checkpoints on risk All bank employees must be trained to understand and participate in self-determination of risk, evaluating all existing risks in all products, activities, processes and banking system The Risk checkpoints are selected basing on the following criteria's: profitable sector, banking basic business, which can cause heavy losses if the risk occurs

For each process, analyzing the magnitude of the risk impact (in terms of the amount of loss, other losses to the bank ) and the ability for each occurrence of risk, thereby collecting loss database The impact degree and likelihood of each risk type is assigned under the influence extent

On the other hand, with the hint of basel 2, the bank will use models based on internal data systems to determine the ability of credit losses Thereby determining variables such as PD - Probability of Default; LGD: Loss Given Default; EAD: Exposure at Default Through the above variables, the bank will determine the EL: Expected Loss For each identified term, the estimated loss can be calculated basing on the formula: EL = PD x LGD x EAD

First, the PD - Probability of Default

Page 61

outstanding debt balance within at least previous years These data are classified into groups:

- Financial data group relating to the customer financial ratio as well as the assessments of rating agencies

- Non-financial qualitative data group relating to management qualification, ability to research and develop new products,the ability of data on industry growth

- Cautionary data relating to the inability to pay debts to the bank such as deposit balance, overdraft limit

From these data, the bank entered into a predetermined pattern, thereby calculate the probability of customer default It may be the linear model, probit model which are often established by professional consultancy organizations

Second, EAD: Exposure at Default For term loans, EAD can be easily determined However, for the loan under the credit line, revolving credit, EAD determination is quite complex According to the Basel Committee, at the debt default time, customers tend to withdraw the loan to approximate the granted limit Therefore, Basel committee require to calculate EAD as follows:

EAD = Average outstanding debt balance + LEQ x Average unused credit line In which

LEQ - Equivalent Loan Exposure is the percentage of unused capital which is likely to be drawn by customers at the debt default time

"LEQ x Average unused credit line" is the percentage of unused capital which is likely to be drawn by customers at the debt default time beyond the average outstanding debt balance

Page 62

which is interest in due but not paid and the administrative costs that may arise such as: cost of handling collateral, the cost of legal services and some related costs

The proportion of total estimated loss can be calculated according to the following formula: LGD = (EAD - recoverable Amount) / EAD

In which, the recoverable amount includes the paid amounts from customers and the proceeds from disposal of collateral or pledge LGD can also be considered as 100% - of the recoverable amount According to research by the Basel Committee, the most important factors in deciding the bank capital recoverability when the customers are unable to repay is collateral and customer asset structure

Customer asset structure is mentioned in different liability repayment prioritize order in the case of bankruptcy In fact, when a enterprise is bankrupt, capital recovery rate from the bank's loans are usually higher than the recovery rate from bond capital because banks have priority right to be paid earlier than bond investors Besides, when the economy is in recession period, the capital recovery rate also decreases Currently, there is three main methods to calculate LGD:

✓ First, Market LGD - loss ratio based on the market This method is used when the credits can be traded in the market The bank may determine the loan loss proportion basing on the loan price for a short time after it was categorized as bad debts This price is calculated on the basis of market estimates with the current method of all recoverable cash from the loan in the future

✓ Secondly, Workout LGD - loss ratio basing on the processing of outstanding credits The bank shall estimate the future cash flows, the expected cash flows recovering and discounting period The determination of the appropriate discount rate is the key issue and most intractable

✓ Third, Implied Market LGD – Determining loss ratio basing on the market risk bond price By identifying an estimated loan impairment, the bank will implement the following objectives:

Page 63

First, it helps the bank strengthen human resources management capacity which is credit staff management According to the theory of management, human resources management involves four main issues: recruitment; retraining; compensation system; promotion issues In fact, many banks around the world have developed a marking system of credit staff‘s working result to determine the suitable salary and promotion level With credit officers, salaries and bonuses are usually based on the outstanding balance, the number of customers and credit quality If the credit officers have high outstanding debt but low credit quality, their salaries could be very low, and of course, can not be promoted Thus, the determinination of estimated losses for each loan portfolio of individual credit officers will clearly quantify their credit quality This forced credit officers must strive to avoid risks, otherwise, they shall receive low salary amount regardless to their experience

Second, the determination of estimated losses, especially to identify PD - probability of default of customers will help the bank improve the supervision quality and re-rating customers after lending Thus, the establishment of the credit loss estimation system basing on the database system of internal evaluation - IRB is the inevitable trend of commercial banks in Vietnam in the integration process However, the calculation of any indicator of PD, LGD and EAD are very complex, requiring banks to have a complete database, which is stored scientifically with the modern data processing software All of these issues require commercial banks must invest much financial resources, people, time with scientific schedule

Page 64

Fourth, the bank should limit the cause of credit risk from the internal elements such as people, processes and systems The policies of the Basel aim to establish human resources with high quality, good moral attitude; the operational procedures are reviewed regularly Information technology and operations systems are maintained and updated regularly The basic functions of the application software for credit risk will include decentralized data import (loss data, risk indicators, and feedback to the risk assessment), evaluation on business scope

Finally, the bank should minimize the external risk management causes by establishing the plan, offering the existing situation to settle promptly and overcome the consequences of the communication error, natural disasters, and fire Basic solutions for decision making are: recognizing existing risks, converting risk to third parties (Eg through insurance); reducing risk by extending the control system, introduction of information technology for automatic errors identification system These measures should be added continuously to minimize and control risk at lowest level

4.3. Recommendations for strengthening of risk management at Vietinbank Hoan Kiem Branch

4.3.1. Recommendations to the Vietinbank Vietnam

First, Branch need reserve enough capital for his risk operation, need determine rate of minimum capital for his risk operation, need to determine minimum capital ratios to compensate the risk, this is minimum capital calculated according to risk ratio of bank

Second, need assess correctly the risks that facing and need implement under principles:

- Have a process for assessing full capital of branch according to right strategy in order to maintain that capital

- Staffs in risk management department need check and re-assess process of assessment of internal capital as well as loan that customer department submits to re-appraise accurately, quickly

Page 65

Third, it needs to publish information reasonably according to market principle, information of capital structure, capital adequacy, and other information relating to sensitivity of bank for risk

Forth, closely coordinate with State Bank to organize the exploitation of credit information effectively from CIC center to avoid risk in best way

4.3.2. Recommendations to the State Bank Vietnam

First, need to complete documents, regulations to create and use risk reserve fund Today, creating risk reserve fund in credit activities is implemented under Decision No 493/2005/QĐ-NHNN, according to this decision, debts in group 2, 3, 5, rate of reserving will be different but in fact, regulating rate like that is not reasonable, because credits belonging the same group will have different loss

Second, strengthen and improve effectiveness of inspecting, controlling base on applicable regulations, suit with international practice and actual status of banks In fact, inspection only when risk occurred without remote monitoring to prevent risk and prevent timely Through some issues such as bank staffs of banks use gaps in bank to carry out illegal actions, regulations of bank such as selling foreign currency for foreign countries or use reputation of bank to carry out selling foreign currency illegally… The above issues show lax management of State bank to commercial banks State bank need to have management software on computer to regularly check and monitor individuals, organizations who violating loan regulations, force banks to implement loan regulations

Third, promote credit information in order to improve risk management of credit in commercial banks Operation of credit information of banks in Vietnam is still not good, not ensure quick, timely, accurate information State Bank need methods to improve credit information quality by equipping new, modern equipment for CIC center to meet working demands, improve quality of staffs in CIC not only in qualification but also in training informatics and foreign language

4.3.3. Recommendations to the Government

Page 66

national reservation, ensure payment capacity with foreign countries in import-export sector Beside that, need control rate of foreign exchange in free market and interbank market, control price in market, to avoid high inflation rate

Second, create synchronizing legal framework, for operation of economic objects and interbank operation in particular, especially for law on collateral assets, determining value of collateral assets as well as selling assets when loans meet problems under legal procedures

To facilitate for commercial banks to handle outstanding debts, need cooperate with departments, relating sectors For example, collateral assets are properties, AMC of commercial banks will need to sell to collect debt but not having full documents of ownership and land using, Land administration department need to review to legalize documents, facilitate for bank to collect debts

Third, Tax system of State need to simplify but still having full tax obligations to enterprises which having profits, reducing tax evasion, tax avoidance

Fourth, financial statements of enterprises must be checked in accuracy and by independent auditor companies to help banks to have truthful financial information to support appraisal customers

CONCLUSIONS

Based on summarizing research methods, the following targets, scope and object of the study, it has completed the following tasks:

First, the study has summarized basic issues of risks and risk management in banking operations

Second, the study has analyzed status of risk and risk management in Vietinbank Hoan Kiem Branch

Page 67

REFERENCES

In Vietnamese

- Vietinbank Hoan Kiem Branch ( 2014, 2015, 2016) Annual report

- Tô Ngọc Hưng (2009) Introductory course: Commercial bank, The statictical Publishing House

- Phan Thi Thu Ha (2009) Commercial bank Managements, The statictical Publishing House

- Nguyễn Văn Tiến (2010) Risk Management in commercial bank, The statictical Publishing House

In English

- Fredic S Mishkin (1992) The Economic of Money, Banking and Financial

Markets, Harper collins Publisher

- Anthony M Santomero (1997) Commercial bank risk management an analysis of

the Process, The Wharton financial institutions center

- Joel Bessis (2011) Risk management in banking, John Wiley & Son, LTD

- Amalendu Gosh (2012) Managing risks in commercial and retail banking, Wiley Finance - Basel cummitte on Banking Supervision (2006) International Convergence of

Capital Measurement and capital Standard, Bank for International Settlements

Press & Communications

Author’s signature Advisor’s signature