Credit risk management at the branch of china bank in hochiminh city vietnam

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HCMC UNIVERSITY OF FOREIGN LANGUAGES AND INFORMATION TECHNOLOGY
DEPARTMENT OF INTERNATIONAL BUSINESS ADMINISTRATION

GRADUATION PAPER
l

CREDIT -RISK MANAGEMENT
AT THE BRANCH OF CHINA BANK
IN HOCHIMINH CITY~VIETNAM

\

Student's Name: Ly Le Lan
Class: KD0207

JULY 2005

I •..


Ho Chi Minh City
July 6,2006

ADVISOR'S COMMENTS
Student's Name: LY Li; LAN - KD0207
Paper Title: CREDIT-RISK MANAGEMENT AT THE BRANCH OF CHINA BANK
IN HOCHIMINH CITY - VIEJNAM
Practicality
Credit activities are in fact the major activities of any banks. However, these activities
also contain a lot of risks. The paper that focuses on the credit-risk management of

the branch of China bank in Vietnam meets the practical requirement of a research
paper for graduation fj'om university.
Content
Apart from the introduction and conclusion, the paper consists of 3 chapters that are
arranged in a logical way. The first chapter provides the general concept of credit
activities 'and the risk that is involved. The second chapter introduces the' branch of
China .bankin Ho Chi Minh city and its credit-risk management including assessing
risk, measuring risk and controlling risk. The last chapter offers two groups of
suggestions: one for credit-risk management and another for developing the bank: The
two are intel.twined and seem to be.feasib)e.
Presentation
The paper is ilh.istrated clearly. The techniques
references are acceptable.
General

of paging, making footnotes and

Assessment

In terms of applying financial knowledge harvested from university. into a specific
case, the paper is successful in making the analysis on the way a specific branch of .
bank manages its credit risk, and in making some feasible recommendations to control
the credit risk it is facing. The presentation of the paper is good and made in an
acceptable way.
Suggested Grade: Excel/eTl/

•....
Dr TRAN DUYEN ElJNH

.r

. COMMENTATOR'S ASSESSMENT

r

•


ACKNOWLEDGEMENT

After four years of studying, I would like to express my gratitude to all professors
ofHUFLIT who have taught and provided me valuable knowledge and

•

experience .

Also, I would like to send my special thanks and show my deep gratitude to my
advisor-Dr. Tran Duyen Dinh, who has devoted to give me advices, guidance and
encouragement so that I can complete this paper with the best utmost.

I also thank all of the staff of the Branch of China Bank who have created all good
conditions and supplied me necessary documents to finish my paper.
,

,

After all, from the bottom of my heart, I am really grateful to my parents, my
brothers and sisters, as well as all my friends who have helped and encouraged me

•

to continue studying this paper.

Thank you so much again!

Ly Le Lan

II


ABSTRACT
Nowadays, the economy is getting more and more competitive, especially when
Vietnam is preparing to become a member of WTO, a world-wide business
environment. In order to survive, companies need to improve its productivity as
well as its capacity. They need more capital to develop their companies. They can
raise their capital by issuing stocks, capitalizing, or some other forms. Among
them, banks seem to be an important and popular source of providing credit loans
for them. The credit activities are major activities that bring back much revenue
for banks. However, the higher the return is, the more risks banks have to face.
Banks should consider the relationships between credit risks and other banking
risks. The effective management of credit risk is a critical component of a
comprehensive approach to risk management and essential to the long-term
success of any banking organization.
As we know, exposure to credit risk continues to be the leading source of
problems in banks. So, banks should have a keen awareness of the need to
identifY, measure, monitor, and control credit risk as well as to determine that they
hold adequate capital against these risks and that they are adequately compensated
for risks incurred.

iii


CONTENTS
Page

•

•

A ckno wIedgem ent--------------------- -------------------------------------------

11

•

Abstract ----------------------------------------------- ----------------------------

111

•

Contents--------------------------------------------------------------------------

IV

•

List of figures-------------------------------------------------------------------

IX

INTFtOl)lJCllION----------------------------------------------------------------1
I. Objectives of the Topic-----------------------------------------------------

I

2. Scope of the Topic ----------------------------------------------------------

2

3. Research Method ------------------------------------------------------------

2

4. Contents-----------------------------------------------------------------------

2

CHAPllEFt

1

GENEFtAL

CONCEPll

OF CFtEI>Ill ACllIVIllY

ANI)

mSKS----------

3

AI Credit and Classification of Credit -------------------------------------------

3

1/ What is Credit? ---------------------------------------------------------------

3

2/ Classification of Credit ------------------------------------------------------

3

2.1- Purpose of the Loan ----------------------------~----------------------

3

2.2- Tenor/Maturity ---------------------------------------------------------

5

2.3- Customer's Creditworthiness ----------------------------------------

7

IV


2.4- Payment Method -------------------------------------------------------

8

BI Credit Risks Management and Major Types of Risks in Banking --------

10

1I Definition ---------------------------------------------------------------------

10

1.1- What is Credit Risk? --------------------------------------------------

10

1.2- What is Risk Management? ------------------------------------------

12

21 Maj or Types of Credit Risk -------------------------------------------------

12

31 Other Types of Major Risks in Lending ----------------------------------

12

3.1- Liquidity Risk ----------------------------------------------------------

13

3.2- Market Risk ------------------------------------------------------------

15

3.3- Interest Rate Risk ------------------------------------------------------

16

3.4- Earning Risk ------------------------------------------------------------

17

3.5- Solvency (or Default) Risk -------------------------------------------

18

41 Major Causes that make Banks Fail---------------------------------------

18

4.1- Subjective Causes -----------------------------------------------------

18

4.2- Objective Causes -------------------------------~----------------------

21

51 Damages Caused by Risks --------------------------------------------------

22

5.1- To the Banks ----------------------------------------------------------

22

5.2- To The Economy ------------------------------------------------------

23

Summary -~----------~----------------------------------~------------------------------

23

v


CHAPTER 2
CREDIT RISK MANAGEMENT AT THE BRANCH OF CIDNA BANK
IN HOCHIMINH

CITY ----------------------------------------------------------

AI An Overview of the Branch of China Bank in Hochiminh City ----------

24
24

1/ Establishment -----------------------------------------------------------------

24

21 Scope of Activities -----------------------------------------------------------

25

31 Products and Services --------------------------------------------------------

25

41 Organizational Chart of the Branch of China Bank

in Hochiminh City -----------------------------------------------------------

27

BI An Overview of the Credit Activities at the Branch of China
Bank in Hochiminh City---------------------------------------------------------

31

CI Risk Management at the Branch of China Bank in Hochiminh City ------

34

1/ Assessment of Credit Risk ---------------------------------------------------

34

1.1-"Credit Policy ------------------------------------------------------------

34

1.2- Credit Granting Criteria------------------------------------------------

36

1.3- Credit Administration and Monitoring Process --------------------

38

21 Measurement of Credit Risk -------------------------------------------------

39

2.1- General Credit Process-------------------------------------------------

40

2.1.1- Credit Granting Proposal Letter ------------------------------------

40

2.1.2-Credit Analysis --------------------------------------------------------

41

2.1.3- Credit Decision -------------------------------------------------------

46

2.1.4- Money Issuance-------------------------------------------------------

47

vi


31 Control of Credit Risks -------------------------------------------------------

Summary -------------------------------------------------------------------------------

47
49

CHAPTER 3
SOME RECOMMENDATIONS

FOR CONTROLLING

THE BRANCH OF CHINA BANK IN HOCHIMINH
AI Recommendations for Credit Risk Management

CREDIT RISKS AT

CITY -------------

50

---------------------------

52

1/ Diversification -----------------------------------------------------------------

52

21 Have a Clear "Definition" of Target Customers --------------------------

53

31 Set Provision Fund for Loan Losses ----------------------------------------

54

41 Set a Sensible and Structured Credit Policy -------------------------------

54

51 Establish a Group of Legal Officers ----------------------------------------

55

61 Self-Insurance -----------------------------------------------------------------

56

71 Credit Insurance ---------------------------------------------------------------

56

BI Recommendations for Developing the Bank----------------------------------

57

1/ Build Website for the Bank --------------------------------------------------

58

21 Issue a More Specific Brochure

or Booklet about the Credit Granting -------------------------------------

59

31 Organize Meetings to

Launch New Services or PR about the Bank -----~-----------------------

60

41 Invest in Banking Industry ---------------------------------------------------

61

51 Monetary Trade----------------------------------------------------------------

61

VII


6/ Establish a Group of Professional Internal Auditors ---------------------

62

7/ Training and Developing Employees--------------------------------------~

62

Summary -------------------------------------------------------------------------------

63

CO N CL USI 0 N ----------------------------------------------------------------------

64

~IC~~NC~------------------------------------------------------------------------ 65

viii


LIST OF FIGURESOrdinal Number
Figure I

Table I
Figure 2

Name
Organizational Chart of the Branch of China Bank
in HCMC
The Major Industries of the Bank's Customers
Percentage of the Borrowers' Industries

IX

Page
27
32
32


INTRODUCTION

11Objectives

of The Topic

The global business environment continues to grow in complexity. The typical
business process is no longer under a single point of management control. It needs
to be enlarged to survive and develop in such a competitive environment. As like
in Viet Nam, a developing country with a high growing speed, the business
environment is also on its developing pace, especially when we are becoming a
member of WTO, a world-wide business environment. Many businesses need to
enlarge their business through investment in order to prepare for a better

competency in such a competitive economic environment. How can they get more
capital? They can get it from many sources, such as, capitalizing, issuing stocks,
borrowing money from investors, venture capital companies, banks, etc. Among
them, bank seems to be the popular source for gaining more capitals. As a source
. of both supplying capital for business and mobilizing idle capital from public,
. banks have become financial intermediaries to inflate money into the economy.
For most banks, loans are the largest and most obvious source .of credit risks.
However, other sources of credit risks exist throughout the activities of a bank. In
order to mitigate credit risks and develop, banks have to have a proper credit risk
management system. The main problem arising. here is that how can the bank
manage its loans and mitigate risks efficiently in credit granting activities.
- 1-


. With

the above

Management

reasons,

I have

decided

to choose

at the Branch of China Bank -in Hochiminh

this topic

"Credit-Risk

City-Vietnam"

for my

graduation paper ..

21 Scope of the Topic

"
In banking activities, there are various types of businesses. My paper concentrates
on the credit activity and credit-risk management
Bank

in. Hochiminh

knowledge,

City. Although

having

there are some shortcomings.

process at the Branch of China
tried

my best,

due to limited

Hoping that I can get much advice from

Teachers in order to improve my knowledge and make the paper better.

3/ Research Method

..
Analytical and synthetic methods based on books, Internet, secondary data, etc.
4/ Contents

Theopaper consists of three major chapters that are listed below

Chapter 1: Credits and Classifications

Chapter 2: Credit-Risk

Management

of Credits

at the Branch of China Bank in Hochiminh

City

Chapter 3: Some Recommendations

for Controlling Credit Risks at the Branch

of China Bank in Hochiminh City

- 2-



CHAPTER 1

GENERAL CONCEPT OF CREDIT ACTIVITIES.
AND RISKS

a

. Credit activities are of major activities of any banks. The degrees of risks involved
depend on different types of credits.
AI Credits and Classification of Credit

1- What Is Credit?
Credit is an asset transaction (money or goods) between Lender (banks and
financial

institutions)

and

Borrower

(individuals,

businesses

and

other

organizations) in which Lender transfers the asset to the Borrower for using in a
particular period of time as agreed. The Borrower takes responsibility to pay the
Lender principals and interest unconditionally when the loan becomes due.

1

a

2- Classification of Credit
2.1- Purpose of the Loan
Nowadays, our life is getting more and more modern. The living standard is
therefore increasing, too. The more demand people want to get, the more money
they want to have. So as the business, they also need more capital to improve and
develop their products in order to survive and develop. But their incomes or

I

TS.Ho Dieu, Tin Dung Ngan Hang (NXB Thong Ke: nom 2001), page

- 3-

u

19.


capitals are limited. How can they get wpat they desire with limited income
sources? With the purpose to fill people's needs, as well as to inflate money into
the economy in order to develop the business, banks offer various types of credit
loans. Following are some major types ofloan .
./ Real Estate Loan is the type of loan relating to purchasing and building
real estate, such as houses, lands, real estates in industry, trade and service
areas.
Customers who want to purchase real estate, or want to build houses, but do
not have enough money, they can apply for this type of credit loan. This
loan costs much money, so it takes a long time for repayment. It therefore is
applied in the form of mid-term or long-term loan.
./ Industry and Trade Loan is a short-term loan for supplementing working
capital for businesses in industrial, commercial and service areas .
./ Agriculture Loan is the loan to payoff production costs in agriculture, such
as fertilizer, pesticide, cattle-feed, labor, fuel, etc.
./ Financial Institution Loan includes granting credits for banks, financial
companies, financial leasing companies, insurance companies, credit fund
and other financial institutions.2

2

T5. Ho Dieu. Tin Dung Ngan Hang (NXB Thong Ke: nom 2001), page 20.

- 4-


./ Personal Loan is the loan to meet needs of consumption, such as

purchasing expensive goods, and the loans which cover daily expenditures
by issuing credit cards .
./ Leasing includes two types. They are operation leasing and financial
leasing. The assets for leasing includ~ real-estate and personal property that
are mainly machines and equipment.

2.2- Tenor/Maturity:
•
o

Short-term Loan: This type of loan has the maturity within one year and
it is used to make up working capital deficiency of firms and other short
term expenditure needs of individuals.
With this type of Short-term loan, the bank can quickly receive back the
loan's principal and the interest. Moreover, because the time taken to
receive the principal and interest is short, the risk is not much, so the
interest rate can be lower than the interest rates of mid and long-term
loans.
Opening Lie accounts for already transacted companies is also one type
of short-term loan.

•

Mid-term Loan: This type of loan has the maturity from 12 months to 5
years.3

3

T5. Ho Dieu, Tin Dung Ngan Hang (NXB Thong Ke: nam 2001), page 21.

-5-


It is mainly used to invest in purchasing fixed assets, improving or
innovating

equipments,

technology,

extending

business

activities,

building new projects with small scale and quick equity recovery.
Besides investing for fixed assets, mid-term loan is also a source of
working capital for businesses, especially the newly-established ones.
•

Long-term Loan: This type of loan has the maturity over 5 years and
the maximum period can be up to 20 to 30 years, some particular cases
may be up to 40 years.4
It is used to meet long-term need~, such as building houses, equipment,
transportation means with large scale, building new factories.
With this type of loan, the time taken to receive all the money back is
very long. The bank faces more risks than the other two types. The
longer this type of loan takes, the more risky the bank faces. Because
the interest rate, which bases on LIBOR, SIBOR, or VNIBOR, etc., is

affected by the fluctuations of the market. The longer the time is, the
more influences the loan suffers. Besides, the value of money can be
affected by many other factors, such as, the inflation rate, the money
depreciation, etc.

4

TS. Ho Dieu, Tin Dung Ngan Hang (NXB Thong Ke: nom 2001), page 22.

- 6-


2.3- Customer's Creditworthiness:
•

Loan witltout Guarantee is the type of loan which has no collateral, no
mortgage or the third party's guarantee. It just relies on the borrower's
creditworthiness itself.
However, this type of loan is rarely used among public business sectors,
because it will be unsafe for the bank when issuing the loan in this form.
Frankly to say; Creditworthiness is not a good thing to make the loan
safe as there is no specific physical proof to back the bank up. Anyway,
having a guarantee is much safer than having no guarantee for the bank.
This type of loan is not, therefore, a good choice for ballks to accept
credit granting for businesses.

'-

•

Loan witlt. Guarantee is the type of loan which is based on the
. guarantee of collateral, mortgage or the third party's guarantee. This
guarantee is the legal basis for banks to have a second source of debt
collecting,

supplementing

for the first uncertain

source of debt

collection.5
The third party herein can be the Government organizations, such as the
Ministry of Finance, the Ministry of Planning and Investment (MPI) or
highly appreciated companies. This type of loan with the third party

5

TS. Ho Dieu, Tin Dung Ngan Hang (NXB Thong Ke: nom 2001 j, page 23.

- 7-


guarantee is used mainly by some Government-guaranteed bodies or
State-owned companies. When they run a project, they have no or not
enough asset-backed guarantees, they can ask for help from the
Government.

Then, the bank will ask for some necessary legal

documents from the Government and, finally, accept to grant that
company the agreed loan without having any collateral or mortgage.
However, the bank may face the sovereign risk. This is the risk arising
from a loan to Government or government-guaranteed bodies. The risk
from such lending is that it might prove impossible to secure redress
from legal action, i.e., the borrower might claim immunity from process
or might not abide by ajudgment.

2.4- Payment Method:
•

Loan with one period time-limit of repayment
This is the type of loan which the counterparty has to make the
repayment just one time as agreed.

•

6

Loan with installments with periods time-limit of repayment
This is the type of loan that the counterparty has to pay for parts of the
principal and interest by installments at a particular period of time until

6

TS. Ho Dieu. Tin Dung Ngan Hang (NXB Thong Ke: nom 2001), page 24.

- 8-

the loan has been paid <:iff.The time taken to pay interests and principal
installments cannot be coincident. This type of loan is usually applied
for real estate loan, industry and trade loan, personal loan, etc. Almost
every banks use this type of loan when they Issue credit loans to
counterparties.

Because it makes it possible and convenient

for

borrowers to repay the money when they just have to pay a part of the
loan within a particular period oftime.
•

Loan with installments without specific time-limit
The repayment of this type of loan depends on the counterparty's
financial ability. They will make the repayment whenever they have
money. This type of loan is applied by the overdraft technique, which
means the counterparty can withdraw money over its amount of money
deposited in their account to a certain limit. The longer the borrower
pays for the loan, the more interest he will have to pay.7

. 7

TS. Ho Dieu. Tin Dung Ngan Hang (NXB Thong Ke: nam 2001), page 24.

-9-

.

B/ Credit Risks Management and Major Types of Risks in Banking:
1- Definition:
Risk to a banker means the perceived uncertainty connected with some event. For
example, will the customer renew his or her loan? Will deposits grow next month?
Will the bank's stock price rise and its earnings increase? Are interest rates going
to rise or fall next week and will the bank lose income or value if they do?
Bankers may be most interested in achieving high stock values and high
profitability, but none can fail to pay attention to the risks they are accepting as
well. A more volatile economy and recent problems with energy, real estate, and
foreign loans have led bankers in recent years to focus increased attention and
concern on how banking risk can be measured and kept under control. 8

1.1- What is Credit Risk?
Credit risk is the risk that the counterparty will fail to perform fully its financial
obligations. It includes the risk of default on a loan or bond obligation, as well as
. the risk of a guarantor or derivative counterparty failing to meet its obligations.
This risk is present to some extent in all sectors. although it is most important in
banks because lending, where credit risk is crucial, remains their core activity and
loans make up the bulk of their assets.9

8

Peter S. Rose, Commercial

.9

www.bis.org

Bank Management

- 10-

(Irwin McGraw-Hili:

1999), page

170.


There is another definition about credit risk.
The probability that some of a bank's assets, especially its loans, will decline in
value and perhaps become worthless is known as credit risk. Because banks hold
little o"wners' capital relative to the aggregate value of their. assets, only a
relatively small percentage of total loans needs to tum bad in order to push any
bank to the brink of failure. The following are four of the most widely used
indicators of bank credit risk:

>-. The ratio of nonperforming

assets to total loans and leases.

>-

The ratio of net charge-offs of loans and leases.

>-

The ratio of the annual provision for loan losses to total loans and
leases or to total equity capital.

>-

The ratio of allowance for loan losses to total loans and leases or
to total equity capital.

10

Nonperforming assets are income-generating assets, including loans, that are past
due for 90 days or more. Charge-offs, on the other hand, are loans that have been
o

declared worthless by the bank and written off its books. If some of these loans
ultimately generate income for the bank, the amounts recovered are deducted from
gross chargecoffs to yield net charge-offs. As both of the above ratios rise, the
bank's exposure to credit risk grows, and bank failure may be just around the
. comer. The final two credit-risk indicator ratios reveal the extent to which a bank

.10

Peter S. Rose, Commercial

Bank Management

- 11 -

(Irwin McGraw-Hili: 1999), page

170.

is preparing for loan losses by building up its loan-loss reserves (the allowance for
loan losses) through annual charges against current income (the provision for loan
10sses).ll

1.2- What is Risk Management? .
Risk

management

is the process

of measuring

or assessing

risk

and then

developing strategies to manage the risk.12

2- Major Types of Credit Risk
In general, there are some major credit risks happening,in

the business

sectors.

They are:

•

Risk for non-repayment

•

Risk for paying a part of the loan

•

Risk for late repayment

•

RiJ'k for paying by installments

13

3- Other Types of Major Risks in Lending
Lending

involves a number of risks. When analyzing

one counterparty's

business

situation to decide whether to accept to grant the credit loans or

not, apart from credit risks, the bank has also to consider other five main

types of risk. They are as follows

II

Peter S. Rose, Commercial

Bank Management

(Irwin McGraw-Hili:

12

www.bambooweb.com/articies/r/m/Risk_management.html

1999), page

171.

Pham Yu Dinh, Tim Hieu Ve Tin Dung & Hoi Doai (NXB Tre TP.Ho Chi Minh:1998), page'
142.

13

- 12-


./

Liquidity risk

./

Market risk

./

Interest rate risk

./

Earnings risk

./

Solvency riskl4

3.1-Liquidity

Risk.

Bankers are also very concerned about the danger of not having sufficient cash and
borrowing capacity to meet deposit withdrawals, net loan demand, and other cash
needs. Faced with liquidity

risk, a bank may be forced to borrow emergency

. funds at excessive cost to cover its immediate cash needs, reducing its earnings.
Very few banks ever actually run out of cash because of the ease with which liquid
funds can be borrowed from other banks.
Somewhat more common is a shortage of liquidity due to unexpectedly

heavy deposit withdrawals, which forces a bank to borrow funds at an elevated
interest rate_ higher than the interest rates other banks are paying for similar
borrowings. A significant decline in a bank's liquidity position often forces it to
pay higher interest rates to attract negotiable money market CDs. One useful
measure of liquidity risk exposure is the ratio of:

14

Peter S. Rose. Commercial

Bank Management

- 13-

(Irwin McGraw-Hili:

1999). page

170.