NATIONAL ECONOMICS UNIVERSITY

CENTER FOR ADVANCED EDUCATIONAL PROGRAM

Credit Risk Management of Commercial Banks

In Vietnam: Facts And Issues
BANKING MANAGEMENT 2
GROUP ASSIGNMENT
Instructor: Ph.D. Do Hoai Linh

Group 2 Banking 58
1 Nguyen Thanh Thu
2 Nguyen Thi Ngoc Anh
3 Nguyen Minh Le
4 Pham Tung Giang
5 Do Le Mai
6 Phan Ha Phuong
A. Introduction to credit risk management
1. Definition
Credit risk is most simply defined as the potential that a bank borrower or counterparty will
fail to meet its obligations in accordance with agreed terms.  Traditionally, it refers to the
risk that a lender may not receive the owed principal and interest, which results in an
interruption of cash flows and increased costs for collection. Although it is impossible to
know exactly who will default on obligations, properly assessing and managing credit risk
can lessen the severity of loss
.
2. Causes of credit risks
a. From the Bank.
- The credit policy is not suitable for the economy and the lending regulations have
loopholes for customers to take advantage of the Bank's capital appropriation.
- Bank staffs have not properly complied with the lending process .
- Due to the professional qualifications of credit officers, so the evaluation of projects and
loan applications is not good, and the situation of the project still lacks feasibility and still
lends.
- Bank staffs lack the sense of responsibility, violate business ethics such as colluding with
customers to create fake documents to borrow capital, invade loans when disbursing or
collecting debts, and sometimes be interested in relations.
- The bank focuses too much on profitability, placing more profitable loans than healthy
loans.
- Due to competitive pressure with other banks.
- Due to corruption and negative situation happening within the Bank
b. From customers.
- Borrowers use loan capital for wrong purposes and use in activities with high risks
leading to losses that cannot repay debts to the Bank.
- Due to weak business qualifications, the ability of the executive to manage business
production is limited.
- Enterprises borrow short-term to invest in fixed assets.
- Business and production enterprises lack flexibility, do not improve technological
processes, are not equipped with modern machinery, do not change models or research to
improve product quality ... leading to real products the lack of competition, stagnation in
the market makes enterprises unable to recover capital to pay debts to the Bank.
- Because the enterprise itself deliberately deceives and appropriates the Bank's capital,
using a collateral to borrow many places, not having legal capacity.
c. Other causes
- Due to the unusual changes of policies, due to natural disasters, floods due to unstable
economy, both banks and customers cannot cope.
- Due to the loose and incomprehensive legal environment, many loopholes lead to
uncontrollable frauds in the use of customers' capital.
- Due to domestic and foreign political and social fluctuations, it is difficult for enterprises
to lead risks to the Bank.
- Due to economic fluctuations such as economic recession, exchange rate fluctuations,
rising inflation affects businesses as well as banks.
- Inequality in the State's treatment for different commercial banks.
- State policies are not suitable to the national development situation.

3. Impact of credit risk

a. Reducing the profitability of the bank
When credit occurs, bad debts will be generated, stagnant capital will lead to a decrease in
bank turnover. On the other hand, when there are too many difficult or irrecoverable debts,
costs of management, supervision and debt collection will arise, which are higher than the
income from the overdue debt interest rate increase. , since these are just virtual earnings,
one of the bank's remedies, it is very difficult for banks to fully recover them. In addition,
the bank still has to pay interest on the mobilized money while a part of the bank's assets do
not earn interest nor convert it into money for others to borrow and collect interest. As a
result, the bank's profits will be reduced.
b. Reducing the bank's solvency
The bank usually makes a plan to balance out the cash flow (pay interest and principal on
deposits, loans, new investments, ...) and cash inflows (money received, principal and
interest on loans, ...) at the future time. When loan contracts are not paid in full and on
time, there will be an imbalance between the two cash flows. In fact, customers 'savings
must still be paid on time, while customers' loans are not repaid in time. If the bank does
not borrow or sell its assets, the bank's ability to pay will be weakened, facing major
problems in liquidity risk.
d. Reducing the reputation of the bank
Repeated insolvency, or information about banks' credit disclosure to the public, the bank's
reputation in the financial market will be reduced, this is a good opportunity for the
Competitors seize the market and customers.
d. Bankruptcy
If enterprises borrow from banks with difficulties in repaying, especially large loans, it may
lead to a crisis in the operation of the bank itself. When banks fail to prepare contingency
plans, are unable to meet the demand for capital withdrawal too large, will quickly lose
their solvency, leading to the bank's collapse.
B. Credit risk management system of commercial banks in Vietnam
1. Viewpoint of commercial banks in Vietnam about credit risk management
Credit risk management is considered as the vital issue to many commercial banks in
Vietnam due to these following reason

Firstly, credit risk management is one of the problems that all commercial banks
must face. Preventing the restriction of credit risk is a difficult and complicated issue
because the credit risk is indispensable, always associated with credit activities, and at the
same time is very diverse. The credit also is often difficult to control and leads to the loss
of capital and income of the bank.

Secondly, if the activity of preventing or restriction of credit risk  is well

implemented, it will bring benefits to banks such as reducing costs, improving income,
preserving capital for commercial banks; creating trust for depositors and investors;
creating a premise to expand the market and increasing the prestige, position, image and
market share for banks.

Thirdly, good prevention of credit risk will bring benefits to the whole economy. In
the current era, financial institutions are closely connected. If a commercial bank has
problems, it will immediately affect the chain to other banks. Therefore, credit risk
management brings safety and stability to the market.

Last but not least, because the bank's equity compared to the total asset value is very
small, just a small percentage of the problematic loan portfolio will push a bank to
bankruptcy. In particular, because the loans of businesses are often of great value, the
losses that occur if the loan cannot be recovered will cause serious damage to the bank.

2. Credit risk management process in Vietnam

Step 1: Develop a credit risk management strategy:

Credit risk management strategies are often based on the credit policies that banks have set
out and experience from management that banks have. This is the foundation step for
implementing the following steps.

Step 2: Identify credit risks:

Bank customers are diversified, each with different risks at different levels. So the bank
needs to identify customer information that the bank has collected. The source of
information received by the bank usually provided by the customer and other sources of
information found by the bank. The problem is that the bank must determine what types of
risks customers may have before granting credit, so that they can measure the level of each
type of risk. On the other hand, after granting credit, the bank must regularly supervise to
that credit, in order to determine what types of risks arise in the process of customers using
capital, which in turn tends to solve the risk is lowest. If losses occur, that interior is the
lowest.

Step 3: Measure credit risk:

This is often considered the most important step in the credit risk management process.
From preliminary reviews of the types of risks that customers may have, banks will
conduct assessments and measure risks based on different methods to determine customer’s
repayment capability. When identifying risks, banks need to measure in advance the
possibility of customers not being able to pay their debts when granting credit as well as
after credit extension. This step usually conducted by the appraisal department. Economists
and experts have come up with different models for risk analysis and measurement. These
models are very diverse, including models that reflect qualitative or quantitative aspects of
credit risk use. On the other hand, these models are not mutually exclusive, so many
models can be used to assess credit risk from many aspect.

Step 4: Report the credit risk:

The credit risk report is made throughout the process from considering the grant of credit to
collection capital. Based on the report, the bank managers will identify those customers or
groups of customers can create risks, levels of possible risks, from that point banks bring
out measures to limit the damage that risks may cause.

Step 5: Handling risks:

An indispensable problem banks often face is solving problems related to losses after the
bank has taken all measures to prevent risks, but the risks still occur – credit losses.
Currently, banks often apply measures to resolve or remedy credit losses such as:
additional capital supply, debt extension, sale collateral assets, sale debt, debt write-off,
conversion into equity. Steps of risk management process don’t separate each other but
constitute a closed cycle, without a step will result in unpredictable consequences.

3. Credit risk management at commercial banks in VietNam Basel II

a) Overview of Basel II

One of the important contents to determine the capital adequacy ratio

according to Basel II is that banks have to develop methods of risk determination
according to Basel II methods.

With credit risk, one of the three methods can be used as a standard method, in
which risky assets are subject to different risk factors specified by the rating
organization; basic internal methods - assets with risk of RWA are calculated based
on internal data on the probability of default, the total outstanding balance of the
customer at the time the customer cannot pay the debt, the term; and advanced
internal methods - assets with risk of RWA are calculated from general internal
data but more complex.
b) Basel II credit risk management at VCB
The identification of credit risks
According to the route of improving risk management capacity, preparing
conditions for the application of the advanced Basel II Treaty (IRB), Vietcombank
has gained important results with the completion of constructing Early warning
system of credit risks.

Early warning system (EWS) aims to automatically review all debts and detect
possible degradation in the next 6 months, thereby helping Vietcombank to take
measures Effective management of credit portfolio quality.

EWS system is a system based on the risk signs and loans of customers (declining
business situation, financial indicators, customers' payment cash flow with
abnormal signs, adverse effects of the market ...) and through modern calculation
techniques, statistical models from historical data to list customers are likely to be
difficult within the next 6 months. This list of customers will then be analyzed by
business units and reviewed by experts of the departments at the Head Office.

EWS system is self-researched and developed by Vietcombank informatics and

professional staff. The system has been implemented and put into practice with
some key features as follows:

- Automatically provide a list of potential risk customers to business units, risk,

inspection and internal control departments to review every quarters;

- The system pre-installs a number of appropriate measures, corresponding to the

level of customer risk so that the business departments can actively select and
deploy in time;

- The system is developed by the officials of Vietcombank, based on the transfer of

knowledge of international consultants. Therefore, helping Vietcombank save a lot
of time, cost and most importantly, master the system and technology.

EWS is an effective tool for early detection of potential risk customers, supporting
the Approval, Risk Management, Internal Audit and Management Department at
the Head Office to update and manage. Credit portfolio of remote branches, from
early. To maximize the effectiveness of the EWS system, Vietcombank has also
issued a policy framework for early warning which clearly defines functions, tasks
of each department, implementation process and operational mechanism, ensuring
delivery. Regularly changing and updating between professional departments about
risk signs, algorithms consistent with continuous and complicated changes from
reality.
Credit risk measurement

- In 2017, the bank also succeeded in the project of building credit risk ranking
models based on "probability of default" (PD).

- In 2018: Vietnam Joint Stock Commercial Bank for Foreign Trade (Vietcombank
- Code: VCB) said that it has completed the construction of quantitative "Loss of
default" (LGD) and "Outstanding debt at the time of default" ( EAD) for retail
customer lists.
This is one of three key quantitative risk models including (PD, LGD and EAD)
which is an important foundation for Vietcombank to adopt advanced internal
ranking methods, risk measurement methods. most advanced according to Basel II.

The model is built to the standards of international practice and is developed for
individual business production loan segments, personal real estate loans and
consumer loans, with coverage Most of Vietcombank's retail credit portfolio.
Credit risk control

Board of Management and Executive Board VCB has issued many processes and
regulations on credit granting for each customer, including: Regulations on lending
to customers; Regulations on credit approval competence. Strengthening internal
processes and regulations such as Credit Guarantee Policy; Credit process for
wholesale customers and SMEs. After the project is implemented, it will help
centralize information management, shorten the processing time of documents.

Indicators Unit 2015 2016 2017

Balance of provision for credit risk at the billion

beginning of the period VND 7084 8069 8124

billion
Provision for appropriation in the period VND 7053 6461 6187

billion
Redundancy numbers used for credit risk VND 6068 6406 6198

Balance of credit risk reserve at the end of the billion

period VND 8069 8124 8113

billion 62922
Total loans VND 2 739805 982735

Proportion of provision % 1.277 1.031 0.783

Discrimination/total outstanding loans % 0.964 0.866 0.63

The balance of the provision for credit losses at the beginning of the period of VCB
is relatively high and increases steadily over the years. However, at the end of the
period their balance tends to decrease.
In 2016, VCB's financial statements showed that the Bank increased the risk
provision expense by 5.5 percent compared to 2015, at VND6,068 billion. This
figure accounts for part of the net profit from the Bank's business activities.
However, in 2017, the cost decreases slightly.

Remarkably, VCB's total debt tends to increase over the years, from VND 630,000
billion to VND 980,000 billion. However, the provision for credit risk that the bank
has set aside was likely to decreases. This proves that the Bank is quite successful
in managing credit risk and collecting debt from customers that they lend to avoid
causing the consequences of this type of risk.

Moreover, VCB’s proportion of provision is generally within 2% and

Discrimination/total outstanding loans is under 1%.

In short, nevertheless, the way that the commercial bank has too large risk
provisions or high NPL ratio  is not necessarily a negative sign because it may also
contain a message about transparency in the bank's debt classification. In other
words, proactively setting up risk provisions can be considered "savings" of
commercial banks. It is possible to understand if banks save the amount of money
to prevent bad debt, when the money is recovered, all other reserves will be
recorded as profits. Therefore, this promises extraordinary profits for banks in the
future if they finally have control over bad debt recovery. It is a way to sacrifice
immediate benefits for more sustainable development in the future.

2015 2016 2017

Proportio
Indicators Value Proportion Value n Value Proportion

37063 44594 53244

Standard debt 7 95.73% 9 96.77% 2 97.97%

Debt-notes 9377 2.42% 7923 1.72% 4783 0.88%

Sub-standard debt 797 0.20% 1359 0.30% 684 0.12%

Doubtful debt 750 0.20% 1330 0.28% 3584 0.66%

Irrecoverable debt 5590 1.44% 4247 0.92% 1940 0.36%

Total outstanding loans 38715 46080 54343

(excluding loans for 1 100% 8 100% 4 100%
 loans and
entrustments)
Unit Billion.

The percentage of standard debts increased gradually over the years, and also
occupied a largest ratio over total debt (generally  over 90% of the total debt). It
further proved that the bank has done quite well in managing credit risk during the
period of 3 years.

In general, VCB’s doubtful debt and irrecoverable debt remained at low level
which were always under 2%. However, the amount of doubtful debt of VCB
slightly increased, on the other hands, irrecoverable debt tended to decline after 3
years. Althought it seemed to be a good sign for VCB, Department manage credit
risk of the bank should bring out the practical solution to reduce bad debt to the
lowest level.

3. The situation of credit risk management of commercialbanks in Vietnam

a) Vietnam’s current situation

Recently, the system of credit institutions in Vietnam has basically maintained, the
financial management capacity of commercial banks, especially risk management has
changed drastically and accumulated, step by step meeting the requirements of
international integration. The legal framework for security standards of credit institutions
has been improved, closer to international banking practices and standards, creating a
foundation for credit institutions to operate more safely and promote restructure according
to the set objectives and orientations. Vietnamese commercial banks gradually
implemented and applied Basel II capital security standards. However, risk management in
the financial market is still an issue that Vietnamese commercial banks should concern
about, because the banking system is suffering from high bad debts compared to
international standards...

According to the financial statements of 17 commercial banks including: Bac A, ACB,

Kien Long, Lien Viet Postbank, Vietcombank, TPBank, HDBank, MBBank, VietinBank,
BIDV, VietBank, Techcombank, Eximbank, VIB, SHB, Sacombank, VPBank, on
30/6/2018, the amount of customer loans of these 17 banks reached VND 4,262 trillion, an
increase of 9.1% compared to December 31, 2017. Along with the increase in the balance
of loans, bad debt of banks also increases to 71.7 trillion, up 10.4% compared to December
31, 2017. There are 14/17 banks growing in terms of bad debt balances and 12/17 banks
have higher NPL ratios than last year. In particular, the total debt of group 5, which is
likely to lose capital as of the end of June 2018, increased by 17.9% compared to
December 31, 2017, to nearly 38.2 trillion dong, accounting for 54% of total bad debt,
while this figure was only 50.2% at the end of 2017.

In absolute value, 11/15 banks have increased bad debts in the first 6 months of 2018.
However, thanks to credit growth, only 9/15 banks have bad debt / total outstanding loans
ratio. Of the 17 banks, 2 banks (VPBank and Sacombank) have a bad debt ratio of over 3%,
however, a good thing is that the bad debt ratio in these banks has tended to decrease
compared to the previous period (Table 1).

In recent years, although commercial banks have made great efforts in dealing with bad
debts but the NPL ratio is still high. SHB is one of the banks with a strong increase in bad
debt in the first 6 months of 2018 about 1 trillion VND ,more over VND 5.6 trillion
(equivalent to an increase of 21.7% compared to 31 / 12/2017). In which, the debt is likely
to lose capital at 3,273 billion dong, up by 14.2% and accounting for 58.2% of the total bad
debt. NPL ratio of the bank also increased sharply, from 2.33% at the beginning of the year
to 2.7% / total loans. This is also the bank with the third highest NPL ratio among 17
banks.

Similarly, Techcombank also belongs to a group of banks with a high growth rate of bad
debt, at the end of the second quarter of 2018, there were VND 3,396 billion of bad debts,
up 31.44% compared to December 31, 2017. In which, the debt is likely to lose capital at
VND 1,982 billion, up 27.6% compared to December 31, 2017 and accounting for 58.4%
of the total bad debt. NPL ratio of the bank is currently at 2.04% / total loan, increasing
 quite sharply compared to 1.62%. At smaller banks, the ratio of bad debts and customer
loans also increased slightly. Specifically, TPBank loans to customers as of June 30, 2018,
reached VND 73,770 billion compared with the figure of VND 63,422 billion on December
31, 2017, and the bad debt ratio from 1.10% at the end of 2017 to 1.17% at the end of June
2018

The current limitation of bank credit management is due to excessive credit expansion,
which means poorly selected customers, the weak ability in monitoring the use of loans.
Compliance with the credit process loosen. In addition, the weakness of bank staff is also
likely to lead to credit risk. Another cause of credit risk for commercial banks is the
situation that some companies and corporations make guarantees or authorize affiliated
branches to borrow capital from commercial banks to avoid checking and supervision of
banks. When the borrower loses the ability to pay, the guarantor and authorizing party will
not pay the debt repayment.

b) International environment influencing Vietnam

- With the issues raised in the integration phase, Inside Magazine (2017) stated that the
banking industry is at the peak of change and uncertainty. The competitive environment is
growing between banks, non-banks and financial technology companies (FinTech). At the
same time, low economic growth and low interest rates are putting pressure on the
traditional method of earning profit. The problem of bad debt that has not yet been resolved
is still existent is a great risk of Vietnamese commercial banks. Besides, the Industrial
Revolution 4.0 with the foundation of internet connection, big data and cloud computing is
also impacting and contributing to the rapid improvement of information technology
infrastructure of the banking industry

- Moreover, the types of risks due to the impact of the Industrial Revolution 4.0 greatly
affect the security of banking information

- With the appearance of the Industrial Revolution 4.0, banking information security can be
greatly affected as there will be more highly sophisticated types of frauds.

C. Evaluation of credit risk management of commercial banks in Vietnam

1.Success
- Debt quality, credit structure changes in a positive direction: Most commercial banks
have implemented bad debt management model, including specialized debt management
departments from the head office to the branch. Group 2 debts, bad debts are well
controlled, this shows that the measures of credit risk management of commercial banks
have had positive results compared to the previous period.
- Develop a comprehensive system of credit mechanisms and policies: Credit activities are
carried out uniformly throughout the system, ensuring the limits to accept risks through
credit standards. , as well as credit management measures, ensure that customers make
transactions at any branch will get the same benefit. But at the same time, individuals and
units are entitled to actively implement the decentralization and authorization of the Board
of Directors, General Director and competent authorities base on the basis of
environmental compatibility and operational quality, credit ratings of each unit and
management capacity, qualifications and experience of authorized person.
- Management of credit risk for enterprises has been gradually applied towards
international practices: According to the Government's policy on the application of Basel
International Treaty in Vietnamese commercial banking system (Decision No. 112/2006 /
QD-TTg On May 24, 2006, the Prime Minister promulgated the approval of the Vietnam
Bank development project till 2010 and the orientation to 2020), by the end of 2016,
Vietnam will apply fully the Basel I international standards and gradually the application of
Basel II and Basel III. By the end of 2018, Vietcombank and VIB are the first two banks
meet the Basel II standards.
- Develop and apply the internal credit rating system in risk measurement activities:
Currently, most commercial banks have completed the internal credit rating system. In
particular, the method of scoring in the internal credit rating system of BIDV, VCB,
Vietinbank is a very popular method in the world, used by international ranking
organizations such as S&P, Moody's .... The customer rating is done by scoring a set of
indicators related to the financial situation and production and business activities of
customers. The credit rating system of these banks has used financial targets and non-
financial targets, which are divided into levels. These indicators have a relationship with
each other, complement each other and are maximized to minimize subjective errors of
assessors ...
- Strengthened inspection and control activities: Commercial banks tend to change their
control model, from single to dual control model, with the supervision of shareholders,
investors,…. With the new model, commercial banks will have a more objective way of
assessing the risks that may occur, from then on, to promptly introduce measures to limit
the occurrence of bad debts. In addition, the dual control mechanism also requires the
commercial banks themselves to constantly improve the quality of internal inspection and
auditing, to ensure that the financial statements are clearly transparent and enhance risk
governance effectiveness and operational efficiency of the bank.

2. Drawbacks

- The Information technology system needs to develop further. Information technology is

the key to operating the credit risk management model. The centralized information system
will help banks better analyze customers, and provide corresponding risk management
measures.

The bank needs to build a modern information technology system, making it easier for
bank officials to search and find information related to customers. In addition, a modern
information technology system also helps improve the quality of customer analysis and
appraisal, minimizing risks due to lack of information; Building a centralized data
management system as a basis to assess and monitor continuously and timely investment
credit portfolio.

- Currently, banks tend to focus on individual customers so it partly reduce credit risks for
commercial banks. However, this has made it easier for crooks to forge information to take
consumer loans, while Vietnam's information coverage is still low, making it difficult for
banks to assess customers correctly and make a loan decision.

- Vietnam's credit growth is still quite high. Economic experts from the World Bank (WB)
said that despite the deceleration in the first quarter of 2018, Vietnam's credit growth is still
quite high. By the end of the first quarter of 2018, total credit in the banking sector was
estimated to increase by 3.6% compared to the beginning of the year, up 14% over the
same period last year. Notably, the credit / GDP content is relatively high - about 130% of
GDP by the end of 2017, while the credit growth rate is 1.4 times higher than the GDP
growth rate at current prices.

According to the World Bank, high credit levels compared to GDP in Vietnam show that
the financial sector still relies heavily on banks when the capital market is still relatively
underdeveloped. High credit growth may pose a risk to the stability of the banking sector,
especially with weaknesses remaining on the balance sheet and a thin capital ratio in some
banks. In particular, although real credit growth has been declining in China and has been
curbed in East Asian and Pacific countries, it continues to rise in Vietnam.

"Abundant liquidity may put pressure on Vietnam's financial market, especially in the
context of tighter global monetary policy and high domestic credit growth," said Sebastian
Eckardt, the WB's chief economist in Vietnam.

3. Solutions
- Banks need to build risk management system according to international standards,
specifically according to “Basel III” published by the Basel Committee.

- Complete the early warning system of credit risk, in which, early warning indicators of
risks need to cover the causes of major insolvency for corporate customers such as:
Business prospects, situation finance, solvency, collateral and credit records, changes in
management or strategy ... At the same time, increase the use of indicators can be
calculated automatically as the rate of use level, number of days of overdue, volatility of
cash flow ... to increase efficiency, ensure updated data in real time.

- Strengthen management and supervision before and after disbursement, improve the
qualifications of bank officials ... This will help the steps of the credit management process
be implemented more effectively and more closely.

- Improve the quality of credit appraisal, in addition to the traditional methods, credit
analysis and appraisal should be applied using cash flow simulation. This is a very suitable
method for assessing credit appraisals for transactions where customer trust is based
primarily on future cash flows that the sponsored assets bring.

- Commercial banks also need to determine the bank's risk management strategy. The
bank's credit risk needs to be considered on both sides - opportunities and challenges and
not only on its impact on quantitative aspects such as economic capital, income volatility.
Select modern risk management methods, using quantitative methods in risk assessment in
each specific period.

- Build new behaviors and thinking because from many banks' point of view, operational
risks and related losses are inevitable costs of doing business and what banks are less likely
to be able to control.

- Documentize rules and procedures for identifying, collecting and processing internal loss
data, including minimum thresholds.