Credit risks at central people’s credit fund hatay branch and some solutions to minimize that

Academy of finance

Graduation Thesis

TABLE OF CONTENTS
Secondary source of information is collected from available
information in reference books, company’s annually reports, SBV
regulations, and official documents of CCF, Internet and newspapers,
thesis, and specially the results of financial performance at CCF Hatay
branch.....................................................................................................34
11.The People's Credit Funds of Vietnam: A prudentially regulated credit
cooperative movement : Seibel, Hans Dieter; Tam, Nguyen Thac Volume
21, Number 2, June 2010 , pp. 137-153(17).................................................66

INTRODUCTION
1. Rationale of the study
Concerns about unsafe credit activities and vulnerable credit risk
management system have been climbing these years, from the United States‟
troubled mortgage lending (2008) to the European debt crisis (2010). It urges the
significance of a sound credit risk management in lending organizations. Credit
risk is a popular type of risk that credit institutions must deal with. In banking
business, credit risk happens when “payments can either be delayed or not made
at all, which can cause cash flow problems and affect a bank’s liquidity. Hence,
credit risk management in a bank basically involves its practices to “manage”, or
in other words, to minimize the risk exposure and occurrence. For a bank,
lending activities form a critical part of its products and services. In fact, more
than 70% of a bank’s balance sheet generally relates to this aspect of risk
management. Therefore, credit risk management is crucial to any bank’s success.
In a small country like Vietnam, the financial sector is still in the development
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phase and many credit institutions have not been able to establish a firm risk
management framework, particularly credit risk management, in order to prevent
unfavorable events. This is dangerous when Vietnamese banks’ customer
services are still in their infancy and banks’ revenue depends heavily on lending
activities and credit growth is central to any bank’s profit. In addition, the control
work from the central bank, though playing a growing role, has not been
protective enough. Access to credit information and history is very limited. Thus,
small banks and credit funds are facing the big question of establishing a strong
credit risk management framework in order to maximize their profits and to gain
competitive advantage over their rivalries. Central people credit fund (CCF) - a
joint stock credit institution which is supervised by SBV is not an exception..
CFF provides financial services to LCFs and the general public, including SMEs,
farmers and CCF staff. Thus, its operation has all specific characteristics of an
commercial bank, especially in potential credit risk. This is where the research
problem for this thesis arises. Instead of analyzing other credit institutions that
have quite more comprehensive risk management framework, the researcher is
far more worried about the practices in central people’s credit fund Hatay branch
which are still weak and less competitive in banking market . What could they
have done in order to prevent or at least lessen the bad impact of credit risks
happening?
In brief, all of the facts mentioned above have encouraged me to direct my study

on: “Credit risks at Central people’s credit fund Hatay branch and some
solutions to minimize that”
2. Aims of the study
The biggest objective of this research is studying the current situation of credit
activities, analyzing credit risks at CCF Hatay branch during the 2008-2010
period and then giving some suggestions to minimize these risks.
This thesis also explains to the readers the significance of credit risk
management in banking in general and CCF Hatay branch in particular

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3. Methods of the study
Research methodology is a philosophical framework for any research .It
contains the data used and the research data collection techniques. For this thesis,
both primary and secondary data are used. Secondary data are collected from the
literature (books, journals, previous research papers, electronic sites, etc.), the
SBV regulation database, the CCF, PCFs annual reports and published internal
policies. Primary data are gathered by the researcher through both qualitative and
quantitative methods. An in-depth interview was conducted with three credit
staffs in the branch to gain insight into the office’s daily credit operations. A
questionnaire was also designed and handed to 30 peoples to find out more about

the staffs’ characteristics and practices.
4. Scope of the study
Because of the limitation of the writer’s knowledge, experience and time, this
study only focuses on the management of credit risks in short, medium and long
term loans at CCF Hatay branch from 2008 to 2010
5. Organization of the study
Besides an Introduction giving a brief description of the research including the
reason for choosing topic, scope, aims and methods of the study and a
Conclusion which summarizes the main points of the study and gives suggestion
for further study, this thesis was divided into three main chapters:
Chapter 1 : Literature review providing a theoretical background of credit risks in
financial institutions’ activities
Chapter 2 : Method methodology showing the method used to evaluate the
practice of managing credit risk at CCF Hatay branch
Chapter 3 : Implication/ Recommendations suggesting some solutions to
minimize credit risks at the CCF Hatay branch.

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CHAPTER 1 : LITERATURE REVIEW
THEORETICAL BACKGROUND OF CREDIT RISKS IN CERDIT

INSTITUTIONS’ ACTIVITIES

1.1 THE CREDIT ACTIVITIES OF CREDIT INSTITUTIONS
1.1.1 The concept of credit
We are living in a world of credit. Everyday, in every way, we become more
and more involved in various aspects of this credit world. As consumers,
business people, and bankers, we are experiencing continued growth in using
credit. Therefore, all of us need to understand what credit is, and how it is used.
Some concepts such as a credit transaction, credit activity and credit line are
often mentioned in everyday life, however, many people may not understand the
exact meaning of these. IN fact, it is hardly to give a clear definition of credit
because of its large scale.
Traditionally, credit may be defined as “ a transaction between two parties in
which one ( the creditor or lender) supplies money, goods, services or securities
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in return for a promise of future payment by the other ( the debtor or borrower)”.
Such transactions normally include the payment of interest to the lender.
In the case of a credit institution, credit means lending or advances made by it.
The bank itself is the lender, and the borrower from an credit institution is the
interest or commission charge that they have to pay through the life of the

lending.
In terms of language, a credit has the similar meaning as a loan to some
extent. For example, a short-term and long-term credit is often understood as a
short-term and long-term loan respectively.
1.1.2 Types of credit
In order to manage and control a large scale of credit, credit is often classified
into different groups according to various criteria.
1.1.2.1 Time of credit
a. Short-term credit: is a type of credit which is advanced for a year or less with
an agreement that they will be repaired in one payment at the end of the period.
b. Medium and long-term credits: are those with maturities longer than one year.
Evidence of the transaction is the promissory note, either secured or unsecured.
Usually, such credits are repaid at specified intervals mutually agreed on by the
lender and borrower.
1.1.2.2 Subjects involving in credit activities
a. Private credit: is credit used by individuals and businesses in order to carry
on exchanges in the private sector of the economy.
Private credit includes:
-

Consumer credit: is the use of credit as a medium of exchange for
the purchase of finished goods and services by the ultimate user

-

Business credit: describes the credit relationship involved in
purchasing goods, raw materials, and inventory for resale, or obtaining
funds to start, maintain, and operate business activities, using credit as a
medium of exchange

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b. Public credit: is credit extended or used directly by a government agency to
finance the goods, services, and welfare programs it offers to citizens.
Governments borrow money primarily through the sale of bonds and other
securities if tax revenues are not sufficient to cover current spending needs.
1.1.3.3 Security
a. Unsecured credit: is a credit that bases solely on the creditworthiness of the
borrower, and on which no collateral is pledged. The evidence of this type of
credit is usually the borrower’s signed promissory note.
b. Secured credit: is a credit that relies not only on the borrower’s promise to pay
but also on a pledge of some specified property. The bank can exercise its lien on
the collateral in the event the borrower defaults.
1.1.3.4 Borrowing purposes
a. Real estate credit: which is secured by real property- land, buildings, and other
structures. It includes short-term loans for construction and land development
and longer-term loans to finance the purchase of houses, apartments, or foreign
properties.
b. Financial institution credit: contains credit to banks, insurance companies and
other financial institutions.
c. Agriculture credit: which is extended to farm and ranch operations to assist in

planning and harvesting crops and to support the feeding and care of livestock.
d. Commercial and industrial credits: which are granted to business to cover such
expenses as purchasing inventories, paying taxes, and meeting payrolls.
e. Credits to individuals: include credit to finance the purchase of automobiles,
appliances, and other retail goods to repair or modernize homes, cover the cost of
medical care and other personal expenses, either extended directly to individuals
or indirectly through retailed dealers.
1.2 CREDIT RISKS IN CREDIT INSTITUTIONS’ ACTIVITIES
1.2.1 What is risk?
1.2.1.1 Definition

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The economists define risk in many different ways, but all agreed that risk is
uncertainty or unreliability about the result in the future.
IN the financial world, credit institutions have to face a various range of risks.
Indeed, it is believed that the main business of each banking institution is to
manage these risks.
Some of the major risks that bankers are concerned with are credit risk,
operational risk, liquidity risk and legal risk, which are discussed below.
1.2.1.2 Types of risks of credit institutions

a. Credit risk
“Credit risk is most simply defined as the potential that a bank borrower or
counterparty will fail to meet its obligations in accordance with specified terms
in a credit agreement” (Wikipedia)
b. Operational risk
Operational risk is the risk of loss resulting from non-financial problems, such
as technology ( e.g., technological failure and deteriorating systems), employees
( e.g., human error), customer relationships (e.g., contractual disputes), capital
assets ( e.g., destruction by fire and other catastrophes) and external events(e.g.,
external fraud). In other words, operational risk is associated with a bank’s
overall organization and can arise whenever existing technology malfunctions or
back-office support systems break down.
c. Liquidity risk
“Liquidity risk is the risk that a sudden in liability withdrawals may leave a
financial institution in a position of having to liquidate assets in a very short
period of time and at low prices.” (Wikipedia)
Faced with liquidity risk, a bank may be forced to borrow emergency funds at
excessive cost to cover its immediate cash needs, thus reducing its earnings.
d. Legal risk
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“Legal risk is the risk from uncertainty due to legal actions or uncertainty in
applicability or interpretation of contracts, laws or regulations” (Wikipedia)
Legal risk may also occur when there are contradictions in the legal system.
Sometimes, commercial banks are confused by various regulations and they face
difficulties in following one rule which may go against another.
Despite innovation in the financial service sector, credit risk is still the major
single cause of bank failures due to the fact that nearly 90% of a bank’s revenue
generally brought by credit activities. Thus, the effective management of this risk
is central to a commercial bank’s performance. That is the reason why the thesis
will mainly focus on credit risk and its management approach.
1.2.2 Viewpoints on credit risk
Financial institutions’ credit capital often involves in all economic periods,
therefore, danger that are exposed to the economy as a whole are believed to be
the dangers to credit institutions as well. Although each bank has different
considerations for credit risk management, it is hardly denied that credit risk is an
inherent part of banking activities.
In addition to the above mentioned definition, credit risk also refers to the risk of
financial losses due to unexpected changes in the credit standard of debtors and
counterparty in a financial agreement. It occurs as an obstacle that prevents
businesses from increasing profits.
Heffernan ( 2005) has shown that “ credit risk comprises the possibility which as
asset or a loan is irrecoverable in the case of default, or the risk of delay in
repayment of the loan:. It is often the case in the business of lending that a
borrower knows more about its solvency than the lender, therefore, the financial
institution is being at an informational disadvantage. The lender may seek out its
solution by setting a credit line, rather than permitting the borrowers to access
their own loan size without any restriction. However, the quantitative exposure
limits company’s competitiveness in the market. For example, reducing a credit
line might make the volume of clients decrease and thereby gains lower profit.
Contrary to it, extended credit may lead to higher risk.

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Some bankers argued that credit risk is mainly associated with the risk in
assessment process. For example, if a customer is unwilling to provide the bank
with adequate and accurate information on his/her business activities, it will run
the risk of making wrong decision on offering a credit. Thus, the most important
step for bank is to focus on evaluating the borrower’s business condition.
1.2.3 Types of credit risk
Credit risk often occurs in the daily activities of a credit institution in various
types
• Overdue-debt risk:
Overdue-debt are soundness examples of credit activities which show a sign of
threats to either banks or customers.
A bank takes overdue-debt risk when its borrowers can not pay back their debts
at maturity date.
• Default risk:
Default risk occurs when a borrower fail to pay the interest and principle a
loan on time. It is also understood as the uncertainty surrounding a firm’s ability
to service its debts and its obligations. If a borrower has a questionable reputation
or is having financial difficulties, the lender faces the risk that the borrower will
default. Moreover, the default of borrower will downgrade the current value of

the assets. Prior to default, however, there is actually no way to discriminate
clearly between firms that will default and those that will not. At best, a credit
institution can only bank probabilistic assessments of the likelihood of default.
The loss suffered by a credit institution in the event of a customer; default is
usually significant and is determined largely by the details of the particular
contract or obligation.
• Excessive capital risk:
Excessive capital risk arises when a bank is able to mobilize a large amount of
capital from the public but there is not enough demand for loans from its
customers. In this case, there will probably be a growing imbalance between the
amount of capital and capital utilization. As a result, earnings from the loans’
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interest can not compensate for bank’s operational costs and payments for
interest of customers’ deposits
• Capital shortage risk:
Contrary to the excessive capital risk, capital shortage risk occurs when a bank
is undercapitalized, which may lead to the loss of making payment ability. On the
one hand, the bank can not offer a wide range of credits. On the other hand, it has
to ask for capital from external sources with such a higher interest rate than that
of its own loans.

1.2.4. Causes of credit risks
Commercial banks are still aware of their shortcomings and mismatches in the
credit activities which lead to the above mentioned risks
1.2.4.1 Objective causes
Credit activities probably have direct and massive impacts on the economy,
and in return, they are influenced by the objective factors from the society. Thus,
every commercial bank should realize the potential of credit risks
Firstly, risks in a commercial bank’s activities may result from several factors
associated with the economic environment such as economic cycle, inflation,
foreign exchange rate, interest rate, monetary policy and unemployment rate.
When the economy witnesses an enormous growth, industries in general and
enterprises will positively thrive as well as generate high earnings. Therefore, the
debt collections of commercial banks are probably easier, and customers’ bad
debts are mitigated, apart from the case of maturity risk. In contrast, in the period
of economic recession, high inflation and unemployment rate accompanied by
strict monetary policy will pose considerable threats to the production and profits
of individuals and business as a whole. In this situation, credit risks in
commercial banks’ activity are unavoidable.
Secondly, political issues and the legal system are also likely to affect greatly
business activities in general and credit activities in particular of a bank. A
country with stable politic environment is surely an ideal place for both domestic
and foreign investors. Besides, without having to worry about political conflicts,
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crisis and terrorism, people will more concentrate on how to increase the
productivity as well as raising turnover. As a result, they can pay back all their
debts to banks at maturity date, which reduces credit risks for banks. On the other
hand, cumbersome and nontransparent legal framework might give a limit to
serious frauds in using customers’ capital.
Thirdly, commercial banks have to take social factors into consideration as
well, including population, consuming behavior, literacy rate, etc. The reason is
that providing unsuitable credit products for the local customers can also put
banks at risk.
1.2.4.2 Subjective causes
a. From borrowing customers
The level of credit risk may vary depending on different types of borrowers. In
the case of individual customers, there are a wide range of reasons why they are
unable to service their debts. For example, the borrower loses his/her job and
then has no financial resource to pay off a debt, or the debtor has to face
unpredictable problems such as an accident, service illness and other health
problems. A customer’s delinquency can also result from his/her failure in
managing personal finance or using the lending fund properly.
In the case of corporate customers, causes for a bank’s credit risk are more
complicated. In running their business, these enterprise clients usually have to
encounter serious financial difficulties which take root from the nature of supply
and demand. For instance, when the price of raw material goes up, a
manufacturer will have to run the risk of either higher operation cost or lower
profit rate. Besides, if the supply of material in the market is inadequate, the
company will hardly meet the demand for products of consumers as well as
satisfy the ordered amount according to its business contracts. This will
consequently effect the company’s reputation and competitiveness. In addition,

an enterprise may have to deal with other non-financial problems, such as weak
management skill of its directors, depression of the economy as a whole, and
decreased purchasing power. Generally speaking, all of the mentioned examples
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which often lead to a big decline in business’ profits and pose obstacles for them
to fix their debts can be considered the direct causes for credit risk of a
commercial bank.
b. From lending risks.
Credit risks can be resulted from the activities of a commercial bank itself. Lack
of responsibility and qualification is the common cause of credit risks. If the
banking officers are poor qualified, they cannot recognize the warnings signs of
delinquency as well as conduct transactions in the most beneficial way to their
bank. Besides, some are careless in making hastily loan decisions without proper
assessment or through non-observance of credit guidelines, which often leads to
serious dangers. For example, it is believed that many bad debts have been
caused by lending to customers who use the advance for speculative purposes, or
ones in weak financial position without proven reliability.
Lack of information is another cause. The result of incomplete knowledge of
customer’s activities is that the true nature and purpose of borrowing is not
known. This, of course, should never arise. It is necessary to make inquiries at

the beginning to obtain as much as information as possible regarding the
borrower’s background and find out the borrower’s financial standing.
In addition, staffs’ immorality and disobedience to banking principles often lead
to negative consequences to commercial bank.
1.2.5 Criteria for evaluating credit risks
1.2.5.1 Banking criteria
The ultimate goal of credit risks management is to minimize potential credit
risks at an acceptable level to the bank. In order to assess risks properly,
commercial banks must have to the ability to measure risks. there are often
helpful ratios used to measure credit risks.
a. Overdue debt ratio
Overdue debt ratio =

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Total overdue debt
Total oustanding debts

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Overdue debts are debts of which part or the whole principle and interest are
overdue. Indeed, the higher this overdue debt ratio is the greater credit risks a
bank has to face. In this case, the bank may suffer from increasing cost of

supervising and controlling debt collection, and more importantly, the loss of
other loans to customers who have better payment ability.
b. Bad debt ratio

Bad debts ratio =

Outstanding bad debts
Total oustanding debts

The higher the bad debt ratio is, the risks the bank’s credit is.
c. Default debt ratio
Default debt ratio =

Outstanding default debts
Total outstanding debts

Outstanding default debts include loans which have the probability of default.
Thus, banks will run the serious risk of credit activities if this default debt ratio is
high.
d. Risk provisions ratio
A risk provision is the additional amount ò money reserved for the purpose ò
dealing with loses caused in credit activity.
Risk provision ratio =

The amount of money reserved for losses
Total oustanding debts

If a bank spends too much on this reserved fund for risk, its operational cost will
probably increase, thus reducing its profit. The high rate of risk provisions ratio
may indicate the bank’s poor quality in credit activity.

1.2.5.2 Borrower criteria
Commercial bank often use quantitative models to assess credit risks,
particularly the probability of default of the borrower. One of the most

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commonly used is the liner discriminant model which is known as a part of Z –
credit scoring models. The model will help risk managers either calculate a “
score” representing the borrower’s probability of default or sort those into
different default risk classes..
a. Linear discriminant model – “ Z – credit scoring model”
In order to employ this scoring model, the banker must identify objective
economic and financial measures of risk for any particular class of borrowers.
For customer debt, the objective characteristics may include income, assets, age,
and occupation. For commercial debt, cash flow information and financial ratios,
such as the debt to total assets ratio which measures the percentage of the firm’s
assets that are financed with debt and total asset turnover ratio which measures
how efficiently a firm utilizes its assets, are usually key factors.
The discriminant model divides borrowers into high or low default risks classes
depending on their observed characteristics ( Xj).
The following example considers the discriminant model developed by E. I.

Altman for publicly traded manufacturing firms in the Unites States. The
indicator variable Z measures the default risk classification of a commercial
borrower as a whole. This is contingent on the values of various financial ratios
of the borrower ( Xj) and the importance of these ratios in deciding the default
probability of the borrower. These values in turn are estimated by the past
observed experience or defaulting versus non-defaulting borrowers which are
derived from a discriminant analysis model. The formula of Altman’s
discriminant model ( credit-classification model) is:
Z = 1.2X1 + 1.4X2 + 3.3 X3 + 0.6X4 + 1.0X5
Where: X1 = working capital ratio ( working capital/total assets)
X2 = retained earnings to total assets ratio
X3 = earnings before interest and taxes to total assets ratio
X 4 = market to book value ratio ( market value of equity/book value of
long-term debt)
X5 = total asset turnover ratio ( sales/total assets).

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According to this model, the higher the value of Z, the lower the default risk
classification of the borrower. Therefore, low or negative values of Z may be
evidence of relatively high default risk class of borrowers. Besides, discriminant

analysis model produce a switching point, Z =1.81, which is the average
difference between the Z scores of a defaulting firm and a non-defaulting one..
This discriminant model is straightforward and its calculation is made simply.
However, there are several shortcomings remaining. The first weakness is that
the model only reflects two extreme cases of a borrower: default and no default,
but there are a variety of risks in the real world. The second problem is that
constant variables estimated in the model are no always the same due to changing
real financial conditions of borrower as well as the economy. In addition, the
model has ignored important, hard-to-quantify factors, such as reputation of the
borrower and long-term relationships between banks and their debtors, which
may play a crucial role in the default or no default decision.
b. The policy on customer rating of CCF
Besides linear discriminant model, there are also various methods for
commercial banks to estimate or “ score” their customers’ creditworthiness. A
specific example of those methods is the CCF's policy on customer rating.
From December 1st 2006, all of the branches and transaction departments of
CCF, including Hatay branch, have followed this customer rating policy in order
to implement diversified customer policies adapted to a variety range of clients
of CCF. The policy based on 60 criteria including financial and non-financial
ones.
Financial criteria contain:
- Profitability ratios which comprise of gross Profit Margin, Operating Profit
Margin, Net Profit Margin, Return on Assets and Return on Equity measure
how a firm’s returns compare to its sales, asset investments, and equity.
- Liquidity ratios which consist of Current ratio and Quick Ratio measure the
ability of the borrower to meet its short-term obligations.
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- Asset activity ratios which include Inventory Turnover ratio and Total Asset
Turnover measure how efficiently a company uses its assets.
- Debt ratios include debt to total Assets ratio, Debt to Equity ratio and EBIT /
Interest expense ratio.
- Besides, there are also several non- financial criteria including:
- Management expertise, professional knowledge and experience of the board of
directors who involve directly in day-to-day activity of a company.
- Human resources of the firm; its vision and business strategies in the five-year
period; its average growth rate during the past 3 years.
- Customer’s reputation and his credit relationship with the bank over the last 12
months.
- External factory, such as industrial potential, a new enterprise’s ability to enter
the market, the stability of input materials ( in both quantity and price),
government’s subsidies.
After considering all of these criteria, the branch will be able to “ score” its
customers in accordance with their credits. According to CCF’s internal rating
system, customers’ credits van be divided into ten following rating groups:
No.

Rating

1

groups
AAA

Meaning
Best group of customers with the best credit quality. Their

AA
A

ability to pay off their debts is extremely reliable.
Customers rated AA are also very reliable
Customers rated A are more susceptible to negative impacts

2
3

of external factors and economic conditions than the AAA
and AA ones, but their ability to pay off debts is still highly
4

BBB

evaluated.
BBB-rated-customers have adequate conditions to pay back
all debts. However, economic and external changes have

5

BB

more influence on the customer’s ability to fix their debts.
Caution is necessary for this group of customers. Although
they are not likely to run the risk of default like those from B

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to D group, they are facing potential risks which affect their
6

B

ability to liquidate their debts.
These customers are more vulnerable to changes in
economic and financial conditions, but they are currently

7

CCC

showing the ability to meet their obligations
CCC-rated-customers are currently being put at risk of a

default. Their ability to pay off debts depends on favorable

8
9

CC

economic conditions.
Customers rated CC are highly vulnerable to a payment

C

default.
C-rated-customers have close to or already declared
bankruptcy, but their payment on the financial obligations is

10

D

currently continued.
This is the worst group in which customers actually face a
default.

Being on the status of customers from the above rating system, CCF has
implemented five main groups of customer policy.
A wide range of policies is developed which is suitable for each group of
customers. The ultimate goal of adopting these policies is to minimize credit
risks in the most effective way.
1.2.6 The impact of credit risks on banking activities

It is widely known that profit and risk are parallel factors in any business
activities, particularly in trading currencies. Business entities which can earn a
huge profit, such as commercial bank and credit institutions, in turn have to take
considerable credit risks.
• Credit risks decrease banks’ profit
The main source of Vietnam bank’s earnings is from credit activities.
Therefore, when any type of credit risks occurs ( ex. A borrower’s default), it
will directly affect banks’ benefits. For example, banks may have difficulties in
collecting debts from overdue credits but at the same time they still have to pay
interest foe mobilized capital from customers’ deposits or savings. It is also
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understood that greater risks in credit activities will lead to banks’ lower
competence in making payment. On the other hand, if a bank is able to manage
and control credit risks, it will have an adequate source of money to meet its
operational cost as well as additional expense and even to expand its business
scale.
• Credit risks damage banks’ prestige
A bank with high level of credit risks is said to have ineffective operation and
limits capability for providing banking products and services. Once a bank has
bad reputation as unsuccessful credit risk manager, it probably losses people’s

confidence and becomes an unreliable business partner for both domestic and
international banks. Consequently, it will be hard for that bank not only to attract
capital from the public but also to maintain its competitiveness in the market.
• Credit risks may be the main cause of a bank’s insolvency
When the level of credit risks dramatically increase beyond the bank’ s
expectation, a threat of bankruptcy is unavoidable.
1.3 SOME EXAMPLES OF GOVERNMENT REGULATIONS IN
CONTROLLING RISKS OF CREDIT INSTITUTIONS
Regulatory policies play a fairly important role in reducing risks and
enhancing risk management operation. Vietnam is not a member of the Basel
Committee on Bank Supervision and therefore, has not adopted Basel Accords
yet. However, the State Bank of Vietnam is trying to issue policies that require
the banks to direct their operations more and more closely to international
standards. Indeed, Vietnamese bank are doing their best in that direction.
For the scope of this thesis, there is not enough time to mention all policies but
only to analyze the most basic ones.
1.3.1. Provision on lending by credit institutions
On 31.12.2001, the Vietnamese central bank issued the Decision No.
1627/2001/QD-NHNN on the provision lending by credit institutions to clients
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Recently, Circular No. 13/2010/TT-NHNN dated 20.05.2010

revised the

regulations on lending activities:
• Loan interest rate:
This interest is agreed between the credit maker and its customer in
accordance with regulations of the SBV. Importantly, the interest rate for
overdue debts must be fixed by the credit institution and stated in the credit
contract and must not exceed 150% of the interest rate applicable during the loan
term.
• Credit limits:
Fundamentally, the credit institution decides the limits on its own, based on the
borrowing requirements of clients and their ability to repay and on its available
capital sources.
“The total outstanding loans to a single client may not exceed 15% of the equity
of the credit institution, except in cases of loans funded by capital sources
entrusted by the Government, by organizations or by individuals.
“The total outstanding debts of a credit institution for a group of related clients
must not exceed 50% of its own capital, in which the total outstanding debts for a
single client must not exceed 15% of its on capital”
To prevent inadequate lending practices, a credit institution is required not to
provide loans to:
(a) its affiliated companies being securities trading businesses;
(b) members of the board of management or inspection committee, the general
director or deputy general director of the credit institution;
(c) staff of the credit institution who carry out loan evaluation and approval;
(d) parents, spouses or children of the members of the board of management or
inspection committee, the general director or deputy general director.
(Vietnam Embassy in the USA 2002, Thu vien phap luat 2010)

Decision 1627 and Circular 13 specify very clearly the lending limits and
other important provisions on an adequate loan process. They will act as useful
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guidelines for the credit providers in order to improve the soundness of the
lending decisions.
1.3.2. Regulations on Classification of Debts and Loss provision
The rules concerning debt classification and loan loss reserve are covered by
the Decision No. 493/2005/QD-NHNN dated 22.04.2005 and Decision No.
18/2007/QD-NHNN issued on 25.04.2007. The systematic categorization of
debts or loans makes it easier for banks to calculate non-performing loans and
loss provision.
• Local people credit funds shall be obliged to carry out debts classification to
applicable groups as follows:
Group 1 includes: good debts which are paid within maturity
Group 2 includes: noticing debts including those are overdue for nearly 90 days.
Group 3 includes: debts overdue from 90 to 180 days
Group 4 includes: suspicious debts which are overdue from 181 to 360 days
Group 5 : defaults debts which are overdue for more than 360 days
• Loss provision is utilized when the borrowers are unable to repay the debt.
Two types of loss provision specified in the decision are general and specific

provisions:
General provisions are the guard against losses inherent in a credit
institution’s loan portfolio. General provisions are equal to 0.75% of the total
debt classified from category 1 to category 4.
Specific Provision : The minimum specific provision made for each customer
in a debt category is calculated as follows:
R = Σ Ri
Ri = max {0, (Ai - Ci)} x r
In which:
R: Total specific provision made for each customer;
Ri: Specific provision made for this outstanding principal;
Ai: this outstanding principal;

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Ci: Discounted value of collateral for Ai;
r: Ratio for specific provisioning of the debt category.
Under this formula, the credit provider needs to consider both the loan and the
collateral amount. It is essential that collateral is accurately valued
Ratio for specific provisioning of each debt category is as follows:
a) Category 1: 0%;

b) Category 2: 5%;
c) Category 3: 20%;
d) Category 4: 50%;
Generally, decision 493 has set up higher standard for credit risk management
with respect to loan loss provision. Despite the complex changes that they have
to adopt, proper practices in accordance with this decision will ultimately
enhance the credit institutions’ operation efficiency.
In the next chapter, credit risks which Vietnam credit institution in general and
Central people's credit fund Hatay branch in particular often face will be
discussed in more detail

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CHAPTER 2: RESEARCH METHODOLOGY
2.1. RESEARCH QUESTIONS
In order to further understand how the objectives of this study will be
achieved, three following research questions are introduced:
1. Which types of credit risks could pose potential dangers to CCF Hatay branch?
2. How effective are credit risk management practices in the CCF Hatay branch?
What is their strength and weaknesses?
3. What could CCF Hatay have done in order to prevent or at least lessen the bad

impact of credit risks happening?
2.2. SUBJECTS OF THE STUDY
2.1.1 History and development of CCF Hatay branch
2.1.1.1 An overview of Central people's credit fund
Vietnam is a special case among studies of the restructuring and reform of
financial institutions. The primary act of reform consisted in closing the old
system of rural credit cooperatives and replacing it with a new system under a
new name: People’s Credit Funds (PCFs). SBV has been in charge of designing
new system. The PCF-system comprises three managing levels: the Local credit
funds (LCF), the Central People’s credit fund (CCF) and Vietnam Association of
People’s Credit Funds (VAPCF) ( See Figure 1)
Central people’s credit fund (CCF) is a cooperative credit institution
established according to the Document No 6901/KTTH dated on February 9,
1994 by Government’s Prime minister and the Decision No 162/QD – NH5 dated

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on June 8, 1995 by Governor of the state bank. Its headquarter is located in
Hanoi.
It is considered as the apex cooperative financial institution of the PCF
network .There was no equivalent in the old credit cooperative system. The CCF

is a joint stock credit institution under the law of cooperatives, the law of credit
institutions; it is supervised by SBV.
The CCF’s initial equity is over VND 110 billions , it is estimated that up to
2011 the equity would be increased to VND 3000 billions that expected to be
transformed into a commercial bank.
CCF provides financial services to LCFs and the general public, including
SMEs, farmers and CCF staff. The CCF’s operating network covers 53
provinces, cities with 24 branches that directly take care, intermediate fund for
nearly 1000 LCFs through the country to strengthen the linking network.
The key target is mutual help within the network, help LCFs in communes
developing firmly. In addition it provides technical assistance to LCFs and has
been acting as focal point for the network in its relations with SBV, domestic and
international organizations. Its annual report comes out in two languages,
Vietnamese and English, and reports on CCF, the PCFs and VAPCF. It is audited
by Deloitte.
Since 2004 CCF is an active member of the Asian Confederation of Credit
Unions (ACCU), which is part of the World Council of Credit Unions
(WOCCU).
Figure 1: Apex structure of the People’s Credit Fund network

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State Bank of Vietnam
Supervision
Investment

Vietnam Association
of PCFs
Central
People’s
Credit Fund

Supervision
Membershi
p
Membership

Refinance

Local Credit Funds

2.1.1.2 The development of CCF - Hatay branch
In 1994, Hatay province started the pilot establishing 12 People’s credit
funds under the steering Committee and CCF
Central people’s credit fund Hatay branch (CCF Hatay Branch) is established
according to Decision No 2072/QD – NH5 dated on March 20, 2001 by
Governor of the State bank.
The main function of CCF- Ha Tay branch is intermediating fund within the
network; providing services, taking care, consulting member’s LCFs in 3
provinces: Hanoi (old Hatay area), Hoa Binh and Son La province, doing
monetary business, credit and banking services, implementing some tasks of

linking PCF’s network regulated by the Governor of State bank.
In the recent year, Ha Tay branch had to face many difficulties. For
example, the branch was located in the same place with more than 5 commercial
banks; thus, it has suffered from fierce competition in attracting potential
customers. In addition, its staffs at first lacked professional skills and experience.
Being aware of these challenges, the directors as well as all staffs of Hatay
branch had to try their best to overcome weakness, take full advantage of
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strengths and enhance positive image for the branch. Thanks to conducting
innovation of many aspects of operation and applying policies suited for social
and economic conditions, CCF Hatay branch is gradually growing andachieving
many accomplishments. By 30/06/2010, Hatay branch has 3 transaction offices, 1
saving fund and manages 92 LCF members comprising of 81 LCFs members in
Hanoi, 4 ones in Hoa Binh and 7ones in Son La province.
Services offered
CCF gradually expanded products, services and continuously innovated and
improved serving quality for not only PCF network but also non-members to
confirm its position in banking system in particular and society-economy in
general.
◙ Capital mobilization:

- Receiving capital from its members (LCF )
- Receiving demand deposit, term-deposit, deposit for settlement and other
deposits of the institutions and individuals,
- Issuing deposit certifications, bonds and other valuable papers in
accordance with the SBV regulations.
- Borrowing capital in the domestic money market and domestic and foreign
financial credit institutions and other institutions and individuals according to the
law.
- Receiving sponsored capital, entrusted investment capital from
government, Internal, International organizations, individuals from inside and
outside country
- Borrowing fund from SBV and Implementing other forms of mobilizing
allowed by SBV.
◙ Credit activities
- Lending short-term, medium term and long term fund PCF members, the
institutions, individuals outside the network according to the capacity of fund of
each period in the principle of giving priority with the members.
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