Risk management in commercial banks of Vietnam

ĐẠI HỌC QUỐC GIA HÀ NỘI
TRƯỜNG ĐẠI HỌC KINH TẾ

NGUYỄN HỘI TIÊN



Risk management in commercial banks
of Vietnam




LUẬN VĂN THẠC SĨ QUẢN TRỊ KINH DOANH



NGƯỜI HƯỚNG DẪN KHOA HỌC: TS. Tạ Ngọc Cầu





Hà Nội – 2007

ĐẠI HỌC QUỐC GIA HÀ NỘI
TRƯỜNG ĐẠI HỌC KINH TẾ

NGUYỄN HỘI TIÊN

Risk management in commercial banks
of Vietnam

Chuyên ngành: Quản trị kinh doanh
Mã số: 60 34 05



LUẬN VĂN THẠC SĨ QUẢN TRỊ KINH DOANH



NGƯỜI HƯỚNG DẪN KHOA HỌC: TS. Tạ Ngọc Cầu




Hà Nội – 2007
TABLE OF CONTENTS
Abstract .i
Acknowledgements iii
Table of contents…………………………………………………………………….iv
INTRODUCTION 1
1. NECESSITY OF THE THESIS 1
2. OBJECTIVE OF THE RESEARCH 1
3. KEY RESEARCH AREA 2
4. METHODOLOGY 2
5. CONTRIBUTIONS OF THE THESIS 2
6. THESIS STRUCTURE 2
Chapter 1: Literature review 3

1.1. Commercial Bank and the main risks in the bank operations 3
1.1.1. Commercial Bank and the main risks 3
1.1.1.1. Concept 3
1.1.1.2. Functions 3
1.1.1.3. Main professional competences 4
iv
1.1.2. Main risks in operations 5
1.1.3. Risk measurable indexes 8
1.2. Risk management in operations of Commercial Banks 10
1.2.1. Concept and role of risk management 10
1.2.2. Tools of risk management 11
1.2.2.1. Group tools limited credit risk 11
1.2.2.2. Group tools sponsored risk 16
1.2.2.3. Group tools prevented other risks 17
1.2.3. Factors impact risk management 18
1.3. Experiences in risk management of Foreign Banks 19
1.3.1. Model assessed credit risk 19
1.3.2. Model determined interest rate risk 21
1.3.3. Model reassessed 22
Chapter 2: Methodology, research paradigms, analysis 23
2.1. Status quo risk management in Commercial banks of Vietnam 23
2.1.1. Background of Commercial banks in Vietnam at present 23
2.2. Status quo risk management of commercial banks 24
2.2.1. Status quo of credit risk 24

2.2.2. Status quo of foreign exchange risk 27
2.3. Risk management policy of commercial banks (period 2005-2010) 29
Chapter 3: Recommendation and conclusion 33
3.1. Improving risk management in Commercial banks of Vietnam 33
3.1.1. Group of risk management solutions 33

3.1.1.1. Customers selection by grade system and credit rank 33
3.1.1.2. Criteria assessed by kind of customers 33
3.1.1.3. Some of methods support to fulfill credit grade process 43
3.1.2. Improving the evaluation quality of debts 45
3.1.3. Solution for improving guarantee assets management
in credit operations 49
3.1.3.1. Improving assessed technique and propose methods for guarantee
assets management 49
3.1.3.2. Solutions for support to fulfill 53
3.1.3.3. Solutions for deduction particular standby 55
3.2. Group of foreign exchange risk management solutions 55
3.2.1. Opening the mobilizing foreign currency resources and intensify to seek
customers had import/export payment demands 55
3.2.2. Combination buy/sell foreign currency spot and forward 57
3.3. Group of interest rate risk management solutions 59
3.3.1. Prevention interest rate risk by Swap 61
3.3.2. Determine the suitable exchange ratio between fixed and
floated interest rate 62
3.4. Group of improving organization system management 62
3.4.1. Signification in arranging organization framework suitable for risk
management functions 62
3.4.2. Organizing system professional competences management 62
3.4.3. Strengthen internal control 65
3.5. Some of petitions for State-owned Commercial banks to support for Commercial
banks in risk management 67
3.5.1. Some of petitions for State-owned Bank in credit management 67
3.5.2. Some of petitions for State-owned Bank to support in strengthen foreign
exchange risk management of Commercial Banks 69
3.5.3. Petition for Government and relative industries 70
CONCLUSION 72

REFERENCES
APPENDIXES


1
INTRODUCTION
.1. NECESSITY OF THE THESIS
Risk management was interested in by the managers, especially, bank industry.
Risks always threaten existence of the commercial banks and that thing effected to
the economic. Risk is a significant barrier in trading of banks. Therefore,
researching the preventative solutions to ensure the security and limit risks in
business is very necessary. Risk management in commercial bank operations is a
new field. Besides, risk management standard of Vietnam banks is the beginning
period in comparison with the countries had the development financial market in
hundreds years. As well as, banks are poor in financial products and services, small
scale and business capital sources. Operation scope is also major in domestic
market; weakness in financial management ability and unclear, closed the financial
system. Through the working in bank, I have chance to face with the practices and
compare to theory and practice, I decide to choose the topic: “Risk management in
trading in commercial banks of Vietnam”
.2. OBJECTIVE OF THE RESEARCH
- Research the issues about risks which banks have to face with including
discovery, measure and the overcome methods.

- Research the risk expression in professional competences of commercial bank
such as: credit operations, capital management, and international bank
services in bank
- Research the risk impact level because of the payment over time situation of
customers, the change of interest rate, foreign exchange to the direct income
in bank. Simultaneously, finding the limited reasons in risk management

tools application of bank in particular and commercial bank on general.


2
Reply on the realistic experiences of banks in the world, propose solution
groups to improve the risk management process, included the deploy some of
new preventive professional competences in practice conditions of bank.
.3. KEY RESEARCH AREA
Research risk management in business of commercial bank is the great topic.
Thesis only concentrates on major risks and the relation among risks in capital
trading of commercial bank to give out the preventive solutions.
.4. METHODOLOGY
Thesis is used methodology of dialectic materialism, logic reason
combination materialistic history, methods in raising the issues, interpretation,
analysis and giving the conclusion.
Thesis is also used statistic, formula illustration, interpreting the issues means.
.5. CONTRIBUTIONS OF THE THESIS
- Systematize the views about risks, the relationship among risks affect to the
operations in commercial banks.
- Analysis to seek the reasons, appreciate the status quo to conduct the
preventing risk methods and apply for the commercial banks.
.6. THESIS STRUCTURE
Topic: “Risk management in commercial banks of Vietnam ”
INTRODUCTION


3
Chapter 1: LITERATURE REVIEW
Chapter 2: METHODOLOGY, RESEARCH PARADIGMS, ANALYSIS
Chapter 3: RECOMMENDATIONS AND CONCLUSION

CONCLUSION
References


4
CHAPTER 1
LITERATURE REVIEW
1.1 Commercial bank and the main risks in bank operations
1.1.1 Commercial Bank and the main risks
1.1.1.1 Concept
America: Commercial Bank is a business company specialized in
providing financial services and operating in financial service industry.
France: Commercial Bank is an enterprise frequently receives from the
people deposit form or the other forms which their money was not used to
theirselves in discount professional competences, credit or financial
services.
India: Commercial Bank is a place to receive the deposit to loan or
sponsor and invest.
Vietnam: Commercial Bank is an organization trading in currency major
in and frequently to receive deposit from the customers with the
responsibility to refund and use that money to loan, carry out discount
operation and make payment means.
1.1.1.2. Functions
- Assets rotation function: Banks conduct at the same time two
operations. The first one, Banks mobilize capital by issuing deposit
certificate. The second one, Banks invest by providing credit and
stock investment.

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Table 1.1 Balance sheet assets of Bank (simple)
Bank
Credit assets
Primary stocks
- Bonds
- Stocks
- Credits
Debit assets
Secondary stocks
- Deposit
certificates
- Saving deposit
- Payment deposit

- Intermediary payment function: On behalf of customers to carry out
payment for buying goods or services by issuing and balance
cheque, providing e-payment networks, connecting funds and
distribution paper-money, coin-money; guarantee and commitment
in refund for customers, managing and protecting their assets;
issuing or redeeming stocks,…
- Function makes “book value” in economy.
- Intermediary function in conduct the country economic policy
1.1.1.3. Main professional competences
- Debit operations (mobilizing capital): Commercial Bank conducted its
operations throughout not only using its capital but also mobilizing
capital from the customers.


6

- Credit operations (business loan) currently, this is still the basic
operation of Commercial Bank.
- Intermediary/broker operations (payment, dealer, consultative,
protection documentary, valuable assets,…)
Trading principles of Commercial Bank
Firstly, banks ensure the benefit for customers with the providing
financial services. Secondly, banks have to conduct the safe methods in
trading: maintaining the fixed capital, ability in resisting the market
change, selecting customers, limited credit, controlling in perform,
diversifying assets to disperse risks. Besides, banks utilize forward
deposit market, optional market,…
1.1.2 Main risks in operations
Concept of risks
Banking operation is one of the economics ones had a lot of risks the
most. It is very difficult to define risk accurately for the trading
environment as well as all development economic and society periods.
However, the banking risks conception like that: “Risk in bank is
unexpected events make causes losses and damages to assets, income of
bank in operations.”
- Credit risk: risks associated with bank operations due to irrecoverable
debt up to due date. Credit risk did not only limit in business loan but
also include creditable operations such as: guarantee, trade sponsor,
inter-bank loan operations.
- Unusable capital risk: rising from transforming utilization of forward
capital and bank capital. Generally, the utilization of forward capital has


7
the long time compared with bank capital sources. Thus, bank has two
difficulties: dissatisfy its short-time commitment, the shorter forward

capital sources still be used capital in fixed-time.
- Interest rate risk: bank risk in transforming assets including buying
primary stocks, loaning (using capital), issuing secondary stocks
(mobilizing capital). Forward time and conversion in Debit assets items
do not correspond with Credit assets items. This thing makes bank taken
interest rate risk. It means that if the sensitive interest rate of bank Debit
assets is more than the sensitive interest rate of bank Credit assets, net
income of interests will be decrease when interest rate increase.
Therefore, bank income will go down. But when interest rate decrease,
the situation is vice versa.
The interest rates of bank products usually divide two kinds: fixed and
changed interest rate in bank operations. Thus, following, analyzing and
managing interest rate risk also carry out two kinds: fixed interest rate
risk and changed interest rate risk.
+ Changed interest rate risk will be happened when interest rate of
items in Credit assets and in Debit assets do not changed at the same time
as well as changeable level of market interest rate.
+ Fixed interest rate risk: impact on Debit assets and Credit assets at
once. There are two cases: the first one, if fixed interest rate of the
amount of items Debit assets is higher than fixed interest rate of the
amount of items Credit assets, banks get a lot profits when market interest
rate go up and incur risks when market interest rate go down. The second
one, the situation will be vice versa if fixed interest rate of amount of
items Credit assets is higher than fixed interest rate of the amount of
items Debit assets.


8
- Foreign exchange risk: this risk is happened when bank provided credit
for customers or kept stocks by foreign currencies. The change of rate

decreased the income value when foreign currency converted domestic
currency involving original debts and interests by foreign currencies.
- International credit risk and foreign trade credit risk: besides the
general credit risks, banks also had other risks such as: currency,
country and legal risk.
- Insolvency risk: this is the risk of bank. The one or many of over risks
make consequence of this risk and banks go bankrupt.
Relationship among the risks
After researching risks, we are considerable that there is really the
relationship closely among them. This risk is a cause or consequence of
another one.
Indeed, credit risk-customers insolvency- makes banks can not pay for
the deposit of customers. This expresses risk in capital. If there are a lot
credit risks, banks will reduce loan limit as well as the approving of loan
also will be restricted. Thus, banks were stagnated capital.
And between interest rate and foreign exchange also have the nearly
relation because if interest rate changes, foreign exchange will change.
Normally, interest rate and foreign exchange risk affected mutually. This
is the one of many reasons makes losses for banks and borrowers.
All over risks are causes of insolvency and bankrupt in bank.




9

Figure 1.1: Relationship among risks
1.1.3 Risk measurable indexes
Credit risk
There are four indexes used the widest to measure bank credit risks,
include:
- The ratio between value of overdue debts and total of loan and lease
debts.
- The ratio between net forgive debts and total of loan and lease debts.
- The ratio between allocated in prevention credit losses and total of
loan and lease debts or total of owner capital.
- The ratio between prevention credit losses and total of loan and lease
debts or total of owner capital.
The overdue debts are debts did not pay from 90 days and more.
The loans forgiven debts are loans, which bank declared none value and
delete in records.
Risks in bank
Credit risk
Interest rate risk
Foreign exchange risk
Unusable capital risk
International credit
and foreign trade risk
Insolvency


10
When the first two indexes increase, bank credit risks also increase.
Banks nearly go bankrupt. The last two indexes express the preparation
of bank for the credit losses through deducting credit losses prevention
every year of present income.

Interest rate risk
The change of market interest rate also influence strongly on earnings and
expenditures of bank operations. The measurable interest rate risk
methods are utilized the most in banks:
- The ratio between sensitive interest rate assets and sensitive interest rate
capitals. When scale of sensitive interest rate assets is bigger than scale
of sensitive interest rate capitals in the fixed time, it is a disadvantage
status quo of bank. Banks will be suffered losses when interest rate
decreased. Otherwise, loss is happened certainly if interest rate increased
when scale of sensitive interest rate capitals is larger than scale of
sensitive interest rate assets.
- The ratio between uninsured deposits and total of deposits. Normally,
deposits exceed the set standard maximum insurance and very sensitive
about interest rate. They will be withdrawn when the interest rate of
competitors is higher.
Foreign exchange risk
Banks can utilize one of many modes of foreign currency state to
determine foreign exchange risk level. Managing foreign currency state
mode of each foreign currency, bank measured through index:
Net present foreign currency state: the difference between total of Credit
assets and total of Debit assets.


11
Net present foreign currency state of one foreign currency is calculated
like that:
Net present foreign currency state (i) = inside state (i) + outside state (i) =
[Credit assets of foreign currency (i) – Debit assets of foreign currency
(i)] + [buying sales (i) – selling sales (i)]
In there: (i) as sequence of foreign currency

If net present foreign currency state (i) is more than zero (0), this state is
positive. It its state (i) is less than zero, state is negative.
To avoid the foreign exchange risk of fixed foreign currency, it means
that state of this foreign currency equal zero, Bank could conduct by two
ways:
- The first one, making balance between “buying and selling sales” and
“Credit and Debit assets” of this foreign currency.
- The second one, making inside and outside state had opposite mark.
Logically, if banks want to avoid foreign exchange risk, their state of all
foreign currencies has to equal zero. When foreign currency state is
positive, bank will face with risk if price of this one rises up. Therefore, if
foreign currency differ from zero, banks usually get risks when exchange
rate changes.
1.2 Risk management in operations of Commercial banks
1.2.1 Concept and role of risk management
Risk management is the preventing solutions to limit risk. Besides, it also
deals with risks when banks have to face with them. Depend on the kind of
risks; banks will have appropriate managing solutions


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Roles of risk management in bank operations;
Risk management is the central position in financial management at
present. It is very important and necessary for bank operations. Because if
without it, there are a lot of risks happened make banks can not show all
theirselves functions. So, economy will be losses.
1.2.2 Tools of risk management
1.2.2.1 Group tools limited credit risk
Risk management of credit operations is the process which did not have
loan losses, increased maximum interests while reduced maximum losses

in limited capital scale.
The main objective of credit risk management is prevention. In there,
banks have to set up legal barrier closely and completely. And, they also
build and perform the perfect credit process.
To restrict credit risk minimum, credit organizations frequently apply the
following preventing tools:
a) Grade system and customer rank
This grade system and customer rank is the probability evaluation process
of customer which did not fulfill its financial obligation for the bank such
as: unpaid due date loan and interests or violated other credit conditions.
Grade system and customer rank support to banks decisions in supplying
credit, involve limit, term, interest rate, loan guarantee methods, ratify or
not.



13




Figure 1.2: Credit grade process

b) Guarantee loan
Guarantee loan is bank application in protecting bank from risk. It makes
conditions of economic base and legal to recover customer loans. Its
purpose is to enhance responsibility of loan payment commitment and
prevent risks such as: the expectation of loan payment plan could not
carry out or unexpected risks.
Banks usually manage guarantee assets following the nature of each kind

of assets.
- Movables: banks hold and preserve during borrowed time.
- Immovable: banks keep completely original documents, including
proprietary certificate, buy/sell invoices, insurance contracts, and
documents conformed by relative organizations.
c) Classification loans
Classification loan is an important method to manage loans which have
problem.
Selecting
information
Determine business
Grading
enterprise scale
Grading financial
indexes
Ratifying and
ranking customer
Collecting and
ranking enterprises


14
It will help banks to manage easily its credit portfolio. From there, banks
can determine managing solutions, prevent timely and suitable to
minimize risks. Loans are classified like that:
Rank
Criteria
Rank 1
(high
quality)

-High convertible loans, perfect financial conditions, stable
income in the past and can be predicted in the future, have
replace sources, strong management, advantage development
trend
-Loans with perfect document, completed about right of
guarantee assets, high payment ability, ensure enough savings
certificates, bond, cash value of insurance,…
Rank 2
(good
quality)
-Loans of Rank 1, however, some of character is not really
strong as: periodic income and not ready for replace sources
-Guarantee assets have not higher convertible capacity than
real estate, stocks of large enterprises
-Potential income at present and future is strong
Rank 3
(accepted
quality)
-Fairy convertible ability and suitable financial conditions
-Income can be unusual and payment ability enough, but non
ensure in all conditions
-Loans are guaranteed by account receivable and inventory
which it is difficult and not sure to transfer to cash
-Replaced sources are limited
Rank 4
(medium
level
quality,
need to
follow)

-Low convertible ability, unusual income or loss
-Unclear payment sources and mortgage assets are sole sources
for payment
-Information in credit document is not enough to give out any
conclusion about quality
-Do not obey payment schedule, payment sign is not on time
Rank 5
-Guarantee assets, payment ability and cash flow can not


15
(low
quality)
support for loan
-Unclear payment sources, if there is not usual and closely
check, loss of one part or whole loan can be happened
-Payment is not on time, if there is not usual and closely check,
loss of one part or whole loan can be happened
-Supplement guarantee assets and clearly losses
-Payment is not on time and can be applied recover debt
solutions
Rank 6
(bad
loans)
-Payment is not on time
-Payment sources are only guarantee assets (if have)
-Can be applied for adjusting debt time, stretching
debt,…especially coiling debt, handling risks
-Overdue debt under 360 days
-Have to apply solutions of recover debt

Rank 7
(in stock
loans)
-Bad debts, overdue debt over 360 days
-Insolvency
-Still have guarantee assets but not have partner to recover
-Not have guarantee assets and parent to recover
-Not have guarantee assets, debtors still exist but loss in the
long-term, insolvency
-Must use solutions to recover debts

d) Follow up and appreciate loans utilization
To limit loans utilization with wrong objective or invest in high risk
trading caused insolvency for bank, terms of bank contracts were drafted
detailed and closed. During loan contract time, creditors always check,
assess the operations of loan projects which obey loan contract terms or


16
not as well as their progress and outcome satisfactory the formed loan
plan. This is the reason why it is necessary for auditing and collecting
information to evaluate the progress and outcome of customer loan
projects.
e) Building the long-term relationship with customers
This is one of the important principles in credit risk management. Long-
term relationship with customers will help bank to minimize expenditures
significantly related collecting information about the credit potentiality
and risk of customers. And it is easier to classify customers based on
credit risk.
If customers have ever borrowed money of bank before, establishing the

procedures in evaluating operations after borrowing will be easily. Thus,
lenders minimize risks and controlling expenses for the long time.
With borrowers, based on the long-term relation, they can get special
interest, simple loan procedure; value of loan can be higher than general
customers. It is useful for lenders because they can minimize the
collecting information fees to assess credit risk of customers.
f) Retaining the loan and controlling loan utilization through bank
accounts
Besides, banks require customers to open their accounts at their banks
and retain the minimum loans (for example, 10% of loan value for
standby). By this way, bank can control loan utilization through bank
accounts.
For example: customers change supplier, it means that customers may
open new business trend; when appearing unusual withdraw money, it


17
may be customers met difficulty about finance or money is used for high
risk operations.
This controlling methods help bank to set up long-term relationship with
customers as well as minimize expenses in following up and assessing
loans.
g) Credit limit
Credit limit is performed by two forms. The first one, credit organization
can refuse to supply credit although customers have loan demands and
readily pay with high interest rate. The second one, credit organizations
only satisfy part of loans not the whole.
The first form is applied for prevent inverse choice because if customers
want to borrow with high interest, they usually use loans for the high risk
projects

The second form is credit limit aim to avoid ethical behavior risk because
of the large loans, it is easy for customer to use loans with wrong propose
which lenders can not control. With 1000 USD loan, it is easier for
customer to pay than 5000 USD loan and with 1000 USD loan, it is more
difficult for customer to attend risk operations than 5000 USD loan.
1.2.2.2 Group tools sponsored risk
a) Credit insurance
Credit insurance is the form transferred one part or whole credit risks of
credit organizations to insurance organizations or required customers buy
insurance theirselves in insurance organizations. Credit organizations
consider this form of credit guarantee my credits. This is the solution aim


18
to share credit risk. And it is usually carried out by loan operation
insurance, assets insurance, loan insurance.
b) Selling debts
Selling debts is the important method aim to reject the low interest rate
assets from the list. It makes place for high convertible assets when
market interest rate rise. Selling debts in order to replace by higher
convertible assets as well as reject credit risks and interest rate risks.
Therefore, banks can get profit immediately instead of waiting for due
date loans.

Commercial bank Monetary and capital market




Figure 1.3: Buy/Sell debts relation

c) Deducting for standby
This is the solution which banks deduct one part of income to make up
for damage from credit losses as well as other assets. Based on
classification loans of each group depended on a lot of different criteria
and consider risk level for each loan, banks deduct with correlative ratio
of each loan value.
Assets
Cash account
Total of credit balance in
book of bank decreased
when selling credit
contract. Then, investors
can approach income flow
from loan
Individual and organizations
buy loan or payment
program of debts (investors
based on capacity of bank in
assessing the quality of
credit to limit risks)
Earnings from
buy/sell debts
Sell loans or
payment
program of
loans


19

1.2.2.3 Group tools prevented other risks
a) Interest rate risk
Interest rate affected directly on value of Credit and Debit assets in
balance sheet. So, impact on increasing/decreasing income, expenditures
and profits of bank.
The first step of assessing interest rate risk has to determine which assets
or loans are sensitive about interest rate change. Then, banks analysis
what will be happened if interest rate changes.
To manage interest rate risk, banks usually use the below solutions:
- Set up the balance relatively of time-limit
- Reduce interest rate risk by Forward and Future contracts
+ Future contract
+ Swap contract
b) Foreign exchange risk
There are two methods.
- Method of inside state prevention
Banks lend foreign currency by its capital which banks mobilized at the
same time. It means that if foreign exchange state of Credit and Debit
assets balance, banks will have net profit positive.
- Methods of outside state prevention