Improving credit risk control through reforming business customer assessment methodology the case of vrb’s hanoi office

Cohort 2015– 2017 Master‟s Thesis Improving Credit Risk Control through reforming Business Customer Assessment methodology – the case of VRB’s Hanoi office Author: Le Hong Quan Supervisor: Nguyen Phu Hung Hanoi, June 2017 TABLE OF CONTENTS TABLE OF CONTENTS i LIST OF TABLE iv LIST OF FIGURES v LIST OF ABBREVIATIONS vi ACKNOWLEDGEMENT .vii ABSTRACT viii CHAPTER PROBLEM STATEMENT 1.1 Introduction of the VRB 1.2 Challenges facing VRB .3 1.3 Research objectives 1.4 Research questions 1.5 Scope of research .4 1.6 Methodology and Data 1.6.1 Methodology of the research .5 1.6.2 Variables and Indicators 1.6.3 Description of Data, Population, and Sample .5 1.6.4 Tools of survey and analysis 1.7 Conclusions and Roadmap of Dissertation 1.8 Plan of implementation CHAPTER LITERATURE REVIEWS 2.1 2.2 Operations of commercial bank .7 2.1.1 Function of commercial Banks .7 2.1.2 Credit activities of commercial banks 2.1.3 Risks of banks .8 Credit risks of commercial banks 2.2.1 The origins of risk 2.2.2 Credit risk i 2.3 2.4 2.2.3 Key elements of credit risk 10 2.2.4 The causes and effects of credit risk 11 2.2.5 Factors driving credit exposure 12 Credit Risk Management 15 2.3.1 Risk management process 15 2.3.2 Collateralized 17 2.3.3 Tools 20 2.3.4 Measuring Credit Risk 20 2.3.5 Measures to Control risk .22 Conclusion .23 CHAPTER SURVEY RESULTS OF THE CURRENT STATUS OF RISK SITUATION AND CONTROL OF VRB HANOI 24 3.1 3.2 Survey results of current VRB‟s risk situation and control 24 3.1.1 Bad debts status 24 3.1.2 Awareness of risk 25 3.1.3 Opinions in credit recovery and credit risk management 27 3.1.4 Opinions on the measures to reduce credit risk 31 Findings 36 3.2.1 Worsening credit risk 36 3.2.2 Credit risk management system need enhancing 36 3.2.3 The seriousness of credit staffs are inadequate 37 3.2.4 Quality of credit staffs is inadequate 37 3.2.5 Worsening economic situation is one of major causes of worsening customers credit .37 3.2.6 The internal system may be over rigid to react to business change 38 3.2.7 Problems of current credit risk management 38 3.2.8 Objective of credit risk management reform of VRB HANOI 38 3.2.9 Attributes of a viable credit risk management model in case of VRB HANOI 38 3.3 Financial pictures of competing banks 39 CHAPTER CREDIT RISK MANAGEMENT REFORM PROPOSAL 41 4.1 Summary of credit risk management issues of VRB-Hanoi 41 4.2 Summary of credit risk management requirements 41 4.3 Principal bases guiding developing measures to enhance credit risk management at VRB Hanoi 41 4.4 Credit risk management policy reform recommendation 42 4.4.1 Tighten credit policy 42 ii 4.4.1 Adjust lending policy appropriate to current economic situation .42 4.4.2 Enforce the compliance to credit assessment procedures and regulation 45 4.4.3 Require adequate collateral in all cases 46 4.4.4 Re-price loans for each customer group to reflect accurately new situations of risk 47 4.4.5 Diversify loan 47 4.4.6 Increase the degree of monitoring and inspection of active loans 47 4.4.1 Enhanced the role of inspection and internal control 47 4.5 Improving Credit Risk Control through reforming Business Customer Assessment methodology 48 4.5.1 Improve the quality of assessment 48 4.5.2 Improve internal audit operations .49 4.5.3 Improve credit risk forecasting 51 4.5.4 Improve transparency to promote accountability 52 4.5.5 Application of information technologies to improve management data system 52 4.6 Other recommendations 53 4.6.1 Innovation in organizational structure and improvement in human resource quality .53 4.6.2 Establishment department of research, analysis and macro-economic forecasting 55 CHAPTER CONCLUSIONS 56 5.1 Conclusion .56 5.2 Limits of thesis 56 LIST OF REFERENCES 57 APPENDICES 58 1.1 Survey questionnaire .58 iii LIST OF TABLE Table 1-1: Variables and Indicators Table 2-1: The causes and effects of credit risk 11 Table 3-1: The magnitudes of credit risk 24 Table 3-2: What is the most critical risk category? 25 Table 3-3: Four most critical factors that exist in the creation, registration, and enforcement of security and collateral 26 Table 3-4: Adequacy of current internal credit risk management system, procedures, and regulations 27 Table 3-5: The major factors affecting the quality of loan request assessment 28 Table 3-6: Compliance of credit officers with standardized procedures for handling credit assessment and credit recovery 29 Table 3-7: Four most important causes of credit risk 30 Table 3-8: Need of having a consolidated customer risk database 31 Table 3-9: The need of keeping documented records 33 Table 3-10: Ability for organization to adapt to changes in business environment 34 Table 3-11: Implementation of technology 35 iv LIST OF FIGURES Figure 1-1: Organizational Structure of the VRB Figure 2-1: Four levels of credit risk based on the risk level 11 Figure 2-2: Factors driving credit risk 15 Figure 2-3: Risk management process 16 Figure 2-4: steps of Risk management process 17 v LIST OF ABBREVIATIONS VRB Vietnam Russian Bank CRM Credit Risk Management vi ACKNOWLEDGEMENT First of all, I would like to express my sincere gratitude to my supervisor, Dr Hung Nguyen for his instruction and help for me to complete this dissertation Thanks for his support and his patience with my slow progress Moreover, I would like to give special words to all lecturers of the program who always supported, inspired and guided me to carry on such a challenging project And moreover, I want to say thank you to my entire family member, classmates in FAB7 who give me the best time during I attended the course vii ABSTRACT During the past two years, Vietnam‟s economy has suffered a severe recession due to a financial crisis The bankruptcy of various enterprises has had a negative impact on the performance of the banking sector Thus, during this time, the primary objective of commercial banks become risk management, especially activities regarding credit risk management The types of risks associated with banking activities are diverse, complex and usually hidden They can present from the cards, deposits and trade finance b usiness to investment and foreign exchange business and often at many different levels So far, the most serious and far-reaching impact that risks can have is on credit This is because credit is considered the basic operation and usually produces the bank‟s largest amount of profit as well the largest amount of potential loss Not only that this phenomenon has been predicted in theories, it has been considered true in the practices of the banking sector This thesis focuses on measures to ensure the safety of banking activities in the midst of increasing complexity and breadth of risks in credit, such as the traditional policy of management focusing onincreasing revenue and decreasing cost, credit risk management.The new way to assess customers is critical to the successful business of VRB because it help to reduce potential losses viii CHAP TER PROBLEM STATEMENT 1.1 Introduction of the VRB The Vietnam-Russia Joint Venture Bank (VRB) was established in 2006.The establishment of VRB is the result of the economic co-operation of the Vietnamese and Russian Governments and the two Central Banks VRB is a joint venture between the two leading banks in Vietnam and Russia, Bank for Investment and Development of Vietnam (BIDV), accounts for 50% and Bank for Foreign Trade of Russia (VTB) with 50% of chartered capital VRB opens new opportunities for co-operation of the two economies and the financial systems The opening ceremony was attended by the President of Vietnam Nguyen Minh Triet and of Russian President Vladimir V Putin VRB‟svision is to be the leading bank to finance for bilateral trade and investment activities between Vietnam and Russia VRB will develop to become a multi- functional business bank with modern banking model under the principles of sustainable, effective, secure, and integrative development, meeting all safety indexes of normal operations of international banking practices VRB has a commitment to customers, striving to bring conveniences to customers in approaching funds, products and services; the goal of VRB is to increase values and bring success to customers Main business activities of VRB include a Investment:  VRB provides consultancy and information about investment possibilities  VRB arranges investment capital, directly give loans or co-finance projects the sensitivity of the project to consider lending decisions; advising clients how to borrow capital to promote the most effective; and re-evaluated after lending to evaluate the effectiveness of investment projects The literature review shows that to increase the quality of assessment, VRB should work to improve the (i) credit officer‟s knowledge of business sectors in which the customers are operating and investing in,(ii) Experience of credit officers, and their (iii) honesty of credit officers (Table 3-5) Learnt from empirical lessons abroad, the thesis recommends VRB credit managers that the assessment should assess credit transactions as below to improve the quality(Oesterreichische Nationalbank , 2004):  the appropriateness and theapplication of the administrative, accounting, and control procedures thatare required to capture and assess  the credit institution‟s business and operational risks;  the risks that may arise from new types of business;  parallel risksof large exposures and any changes in them as well as of monitoring those with regard to conforming to the bank‟s creditpolicy For the enclosure showing primary company data, for example, it is essential to check whether it matches the details in the credit agreement and whether it iscurrent in terms of the borrower, its credit standing, loans and collateral (customerdata, credit rating information, credit agreements, valuation of collateral,estimates, encumbrances, balance sheets, etc.) 4.5.2 Improve internal audit operations The Survey found that VRB lack adequate audit actions to control risks (see section 3.2.6, 3.2.7) This measure is to dress this problem With regard to internal review procedures, the VRB should review the setting up administrative, accounting, and control procedures that are required to capture and assess the risks in terms of the bank‟s business and operations which may result from new types of transactions as well as parallel risks In addition, VRB should further stipulate the implementation of internal review procedures in credit approval process to prevent internal staffs colluding with customers for their owned benefits, or to prevent unwanted mistakes of credit control staffs 49 With regard to granting a loan it will be necessary for the Internal Audit to check whether the loan applications were duly signed, if the borrower‟s property and risk situation were recorded, if the debt service capacity was calculated and the current exposure situation was determined, if the account manager provided his opinion (including an assessment of the borrower‟s credit standing), and if the required documents covering credit rating, loan request, and agreed collateral are included Internal auditing is thus characterized by a process-independent review (see 2.3.1, 2.3.3, 2.3.4) Therefore,it is necessary for the VRB to make sure that internal auditing is independent andobjective concerning the processes to be reviewed, while the internal reviewsystem carries out process-based monitoring by the persons involved in therespective processes The internal auditing should reviewing credit transactions In the course of reviewing credit transactions, the new credit assessment procedures should require that staff to both substantive and formal credit reviews: - Under a formal credit review, it is checked whether the credit transaction and the documents are in order and complete, with a special focus on the compliance with legal and internal regulations, guidelines, and documentation - Under the substantive credit review, the substance of the transaction (e.g credit rating, risk assessment, and value of the collateral) has to be reviewed For example, it is necessary to review/check the legitimacy of their creation and their enforceability of collateral Lesson learnt from other banks shows that internal auditing unit has to review account management and credit monitoring(Oesterreichische Nationalbank , 2004, p 100) Specifically, auditing staffs should both reviewing and monitoring items below:  account management in general;  troubled loans;  specific loan loss provisions and write-offs of claims  overdrafts and;  reminder procedures 50 4.5.3 Improve credit risk forecasting Lessons learnt from Literature Review shows that to play against the risk, forecasting future situation is very important That helps the Bank to prepare for possible scenarios (see more at 2.3) The expectation of future economic situation would largely affect our credit decisions Thus, forecasting is critically needed The current forecast techniques can be improved to return better predictions Effective exploitation of information in credit activities may include:  Collect information about customers This affects directly to lending decisions Currently, the exploitation of customer information through customer reports such as financial information is often based on financial statements Reports prepared by the client usually does not pass the audit, no authorities determine the authenticity of the report Because the information provided by the customers may not higher accuracy, especially in cases of willful false customers to avoid having to information risk, banks need to be combined with a number of the functional departments to collate information provided by the customers and apply directly interviewing business owners, borrowers, or even partners of clients, and use radical sources from the Credit Information Centre (CIC) of the State Bank, information center of the bank to capture the authenticity of the information  Collect information about market Besides the exploitation of information about customers, loan officers have to extract information about the nature of the product market, the service which customers operate such as predict demand and supply, product price and collaterals The collected information process is regularly performed, timely and accurately to ensure the management of credit risk Credit officers are often interested in gathering information before lending, there is no interest or concern improperly after lending, and therefore credit risk is very high  Classifying and evaluating customers, loans As mentioned above, the risk could be occurs when credit officers assess the financial capacity of client subjectively or intentionally making subjective judgments To limit credit risk, banks must classify each client; evaluate each loan and the recoverability of the loan On 51 the basis, the specific credit policies to each type of customers, appropriate measures to ensure payback, safe in credit activities are released Therefore, software for classifying grading business and personal loans will be applied to help the bank in making lending decisions and interest rates, implementing effective credit policy As oriented, the bank implements scoring system and ranking customers in 10 classes, namely: Group AAA, AA, A: best-case, with honor and good groups This is the group with the lowest credit risk, priority to extend loans, preferential interest rates and services Group BBB, BB, B: type of average groups The group of medium and high risk should be cautious in extending credit Group CCC, CC, C, D: type of below average, weak and very weak This is the credit risk group from high to very high, to restrict lending, debt collection and apply necessary measures to limit credit risk The current software has not really achieved the desired effect as well as the expression of grading process information is still limited, lead to unconvincing results of classification This credit scoring system needs to be improved to expand scale, increase the target informat ion to achieve higher efficiency 4.5.4 Improve transparency to promote accountability This measure is to dress the problem 3.2.7 Transparency would result in better cross-check verification, reduce the risk of customer credit staff collusion However, the survey shows that only 5/15 answered that the bank should disclose bad debt information to the public to make use of transparency in promoting accountability of credit officers 4.5.5 Application of information technologies to improve management data system This measure is to reflect general opinion of credit staffs as reviewed in the Survey ( read 3.1.4.5) Besides human resources, the management of credit risk system requires an effective tool to support first and foremost an advanced information infrastructure technology enough to 52 provide timely and accurate data upon request as well as supportive software for the calculation and analysis of bank credit to help determine exactly when the loan, information to track loans The implementation of technology in VRB HANOI is assessed as of low levels Because the crucial role of information technology system in credit risk management, the branch should upgrade the software and use as the primary tool to manage customers, statistics, storing information that to complete the rate of customers Staffs should be trained to use available software and tools to assist them in assessment jobs 4.6 Other recommendations Risk management is a continuous process of commercial banks, therefore in order to operate sustainably; there would be non-stop to propose solution for further improving the effectiveness of risk management, particularly in the credit operation A proactive system solution is necessary in commercial bank to prevent and mitigate risks from internal subjective reasons as well as to limit the influence of the customers This initiative is reflected from human resource organizational structure, the loan policy, the lending process, implementation process and including technical measures to prevent influences from customers as well as ensure the safety of capital for banks when customers are at risk The deeper analysis of application and effectiveness of the applied measures are as follow: 4.6.1 Innovation in organizational structure and improvement in human resource quality This measure is to dress the problems found in the Survey (see 3.1.3.1 and 3.1.3.4) regarding the quality of credit staff Human factor in credit activity plays an important role; it decided to credit quality, service quality and image of the bank, which decides the efficie ncy of bank credit In the fact, the working intensity of credit officers in recent years is quite stressful, even overtime work is also quite common And this led to the restriction of activities in contact with customers, check and control the loans Therefore, to enhance both the quantity and quality will help the bank to ensure the pace of credit growth while ensuring credit quality  Re-organize the department of credit risk management 53 To organize professionally structure of credit risk management department, there is required to recruit risk management staffs in VRB HANOI or establish a division at first level branch of banks to advice in the administration and direction, direct treatments of debt problems Functions and responsibilities of each functional department and each staff are defined clearly to avoid overlapping, cumbersome and inefficient as well as to enhance accountability and personal role in credit activities Development and maintenance in structure of credit approval authority as well as qualified and experienced individuals are granted approval authority Moreover, the aims are to ensure independence, self-control and coordination in lending process such as lending division, appraisement division, assessing assets, approving lending and inspection  Improve the ethical quality, awareness, capacity and sense of responsibility of staffs Standardized credit officers: the recruitment needs to be a close process with some basic standards such as formally trained in universities, foreign la nguage skills, computer skills, good ethics, social understanding and communication ability Numbers of experienced credit officers in VRB HANOI today are lacking, whereas the new established banks attract personnel with better remuneration policy Hence the formulation of policies to attract staffs must be concentrated on by the bank Enhance the responsibility of credit officers, mounted responsible for the rights of workers There remuneration, rewards and punishment are clear, reasonable to avoid the r isk of professional ethics To communicate frequently for people to understand and implement as prescribed professional regulations  Enhance the expertise and professional level of staffs In banking operations, bank officials who are both directly supply products and services to customers as well as relate to customers Thence the relationship between bank staffs and customers decide on the quality of products and services offered Training staffs from basic to advance for each specific business, each customer with specific features since the credit risk management division at the infant stage Hold seminars to exchange lessons learned in different situations, cases involving credit, banking sector By credit operations involving multiple sectors, products, while credit officers are trained mainly from the economic field, experience in other areas is limited This is required them 54 constantly improving professional qualifications; regularly learn trades, other areas to cater for credit operations Credit officer must be able to advise clients in business operations, business performance of clients associated with the performance of the bank Besides that, employees actively study, seize and comply with the laws and regulations of the state, government, relevant ministries such as state business law, corporate law or land law  Separate marketing department from the credit department Currently at the VRB HANOI, the marketing and assessment activities are undertaken by same officer, referred to as credit officers Because there is no separation between the business development and appraisement with the pressure of business targets, the credit officers tend to ignore the presence of defective customers, embellish them approved to provide credit to achieve business targets In addition, there are other occurred negative in providing credit process to customers In hence, the branch needs to separate marketing and assessment mission to avoid potential germ in credit operations of the bank 4.6.2 Establishment department of research, analysis and macro-economic forecasting As stated in the previous content, a portion of risk in credit activities stemming from the lack of information or received inaccurate information from customers, processing market information was sketchy In addition, the system provides credit information of VRB HANOI and state bank are not high effective because the information provided is merely the numbers which lack of professional judgment, reliable forecasts To avoid the risk from this cause, a department of research, analysis and macro-economic forecasting should be established in VRB HANOI This component will be based on all the channels of communication, research resources and other forecasts to orient credit operations, strategic management of credit risk, customer strategy and credit investment strategies In other hands, this department will conduct the analysis, scale evaluation, structure and efficient credit of economic sectors, rural and urban areas in order to on this basis, the bank does solutions to extend secure – effectively – sustainable credit 55 CHAP TER CONCLUSIONS 5.1 Conclusion How would the proposed reform solution be appropriate to sustain VRB HANOI? The first measure would reduce the proportion of bad debts The second measure would improve recovery The third measure would reduce the magnitude of exposure to risk The last measure help to proactively respond to deal with occurrences 5.2 Limits of thesis Considering the time data constraint, the study is limited to apply in the VRB Hanoi Branch only Therefore the finding analysis, conclusion, as well as recommendation cannot present for the whole VRB system It also could not be applied to the banking industry like noncommercial banks as it could produce different results at other banks Since this study only assesses the credit risk management practice in the context of commercial banks in Vietnam and in Hanoi, it may not be suitable to apply its proposal to banks in other parts of Vietnam 56 LIST OF REFERENCES Bessis, J (2003) Risk management in banking (2nd edn) Chichester: Wiley Diamond, & Dybvig (1986) Banking Theory, Deposit Insurance, and Bank Regulation The Journal of Business, 59(1), 55-68 Gestel, T V., & Baesens, B (2008) Credit Risk Management Basic Concepts: financial risk components, rating analysis, models, economic and regulatory capital Hanoi: Oxford University Press Gregory, J (2012 b) Counterparty credit risk and credit value adjustment: a continuing challenge for global financial markets John Wiley & Sons Ltd Heffernan, S (2005) Modern Banking Hoboken, New Jersey: John Wiley & Sons, Ltd Oesterreichische Nationalbank (2004) Guidelines on Credit Risk Management Credit Approval Process and Credit Risk Management Oesterreichische Nationalbank Rochet, F & (2008) Microeconomics of Banking Cambridge, Massachusetts: MIT Press 57 APPENDICES 1.1 Survey questionnaire Risk management Questionnaire Do you have any customers' bad debt? * Yes No In your opinion, which is one of the following risk is the most critical to the bank? Market risk Liquidity risk Operation risk Interest risk Credit risk Foreign exchange risk For the borrowing customers under your management, how many percepts of customers involved bad debt? 0% 0+% up to 2.5% 58 2.5+% up to 5% 5+% up to 7.5% over 10% For the customer loan total amount under your supervision, how many percent are the bad debt share (%)? 0% 0+% up to 2.5% 2.5+% up to 5% 5+% up to 7.5% 7.5+% up to 10% Over 10% What proportion of corporate lending is secured? under 100% 100% Sellect four most critical factors that exist in the creation, registration, and enforcement of security and collateral * Customer's character Customer's ability Customer's Capacity Customer's capital Collateral to the loan contract 59 The purpose of the loan Amount of the Loan Obligation Repayment of customer What are the major factors affecting the quality of loan request assessment? Expertise Experience Knowledge of business sectors in which the customers are operating and investing in Credit of the customers The honesty of credit officers The support from supervisors to credit officers Training Process for staff in the credit department Credit recovery and credit risk management How you think about the adequacy of current internal credit risk management system, procedures, and regulations? * Not adequate Adequate exessive How you comply with standardized procedures for handling credit assessment and credit recovery? * Totally comply Comply with some exceptions 60 Comply with large flexibility Do not comply Sellect four most important causes of credit risk? Legal and political environment Economic Environment Borrowers Financial situation and business of customers Lack of supervision and management after loan Weakness of credit officers The role of Credit Information Center (CIC) Do you think your office has adequate system in place to identify and monitor credit risk on an ongoing basis? Yes No Do you think your office has adequate capital reserve for bad debts? * Not adequate excessive Select a value from a range of 1,Not adequate, to 3,exessive, Does the bank disclose bad debt to the public? Yes 61 No Having an customer risk database * Very Low Very Select a value from a range of 1,Very Low, to high 5,Very high, Adequate credit officer training * Very low Very Select a value from a range of 1,Very low, to high 5,Very high, Documented records * Very low Very Select a value from a range of 1,Very low, to high 5,Very high, Ability for organization to adapt to changes in business environment Very low Very Select a value from a range of 1,Very low, to 5,Very high, Implementation of technology 62 high Very low Very Select a value from a range of 1,Very low, to 5,Very high, 63 high ... Percentage Credit officer’s Expertise 13% Credit officer’s Experience 40% Credit officer’s knowledge of business sectors in which the 12 80% Credit of the customers 20% The honesty of credit officers... credit The support from department supervisors to credit 11% officers 7% The honesty of credit officers 4% Credit of the customers 11% Credit officer’s Experience Credit officer’s Experience 22% Credit. .. appropriate credit risk control This is the reason that this thesis will study the? ? ?Improving Credit Risk Control through reforming Business Customer Assessment methodology? ?? 1.3 Research objectives The