CREDIT RISK MANAGEMENT AT MILITARY BANK – THANG LONG BRANCH

Supervisor: Assoc.Prof.Ph.D Dang Ngoc Duc

Do Thu Ha - Advanced Finance 54B

TABLE OF CONTENTS

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Supervisor: Assoc.Prof.Ph.D Dang Ngoc Duc

Do Thu Ha - Advanced Finance 54B

ACKNOWLEDGEMENTS
First and foremost, I want to use this opportunity to thank my parents who
always trust on me whenever I make them disappointed. Thanks to their unconditional
love and support that I can complete my four years in the university.
Thank you lord, for bringing all good friends and family who are always with me
through my up and down, especially Khanh, who helps me understand how theories
are applied in the real world and the business activities as well. Thank you my friends,
Hang, My and Diep, who are always there to suppport and encourage me no matter
what happens.
A heartfelt thanks to my supervisor Assoc.Prof. - Ph.D Dang Ngoc Duc for his
enthusiastic guidance and useful advices during the time I conducted this thesis.
I would also like to send my great thanks to my colleagues at Military BankThang Long Branch for giving me the chances to do my internship and support me
throughout the internship period. Without their advice and guidance, I would not be
able to complete this thesis.

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Supervisor: Assoc.Prof.Ph.D Dang Ngoc Duc

Do Thu Ha - Advanced Finance 54B

ABBREVIATION
CIC

Credit Information Center

CR

Credit Risk

CRM

Credit Risk Management

MB

Military Bank

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Supervisor: Assoc.Prof.Ph.D Dang Ngoc Duc

Do Thu Ha - Advanced Finance 54B

LIST OF TABLES

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Supervisor: Assoc.Prof.Ph.D Dang Ngoc Duc

Do Thu Ha - Advanced Finance 54B

LIST OF FIGURES

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Supervisor: Assoc.Prof.Ph.D Dang Ngoc Duc

Do Thu Ha - Advanced Finance 54B

STATUTORY DECLARATION

I herewith formally declare that I myself have written the submitted Barchelor’s
Thesis independently. I did not use any outside support except for the quoted literature
and other sources mentioned at the end of this paper.

Hanoi, 31/05/ 2016

Do Thu Ha

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Supervisor: Assoc.Prof.Ph.D Dang Ngoc Duc

Do Thu Ha - Advanced Finance 54B

ABSTRACT
Credit activity is one of the basic activities and primarily generating profits for
commercial banks in Vietnam nowadays. On the other hand, credit risk (CR) always
brings unpredictable consequences for the economy as well as the commercial banks
(CBs). The statistics show that the risk of lending activities account for 70% of total
risk of commercial banks. Although there has been restructuring in profits for
commercial banks, the revenues from credit tends to decrease and revenues from
service tends to increase, but in Vietnam, operating income for loans still account for
60% - 70% of the total income of the commercial banks. Loans are primarily lucrative
source but it also contains many risks, determining the existence and development of
the commercial banks.
Nowadays, financial and monetary markets suffering from complicated
developments and it directly affects the lending activities of commercial banks, the
risk of lending activities is incresing and becoming hard to control than before. In
particular, during the financial liberalization and international integration, risks in
lending activities increased due to the unpredictable fluctuations of the world’s
economy. Risks in lending activities not only affect the commercial banks but also the
economy. Therefore, controlling the risks in lending activities becomes more and more
important in each credit operations.
Small and medium enterprises in Vietnam develop very dynamic and powerful in
both quantity and quality in recent years. It contributes significantly for the national
economic. This kind of enterprises is particularly concerned and given good conditions
by the government. With the specific characteristics of the scale there which consistent
with management capabilities and operational orientation of MB, SMEs are focused on
investing credit and becoming mainstream customers.
From the awareness of the effects of credit risk and the reality in credit risk
activities for SMEs in Military Bank – Thang Long Branch , the author has chosen the

topic: " CREDIT RISK MANAGEMENT AT MILITARY BANK – THANG LONG
BRANCH ".The goal of thesis is to concretize general theory of credit risk, solutions
to limit credit risk, using theory into practical in order to assess the limitations of credit
risk activities and make recommendations to limit credit risk in Military Bank – Thang
Long Branch.

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Supervisor: Assoc.Prof.Ph.D Dang Ngoc Duc

Do Thu Ha - Advanced Finance 54B

Acknowledging the important role of MB- Thang Long branch in the operation
of the bank, I have spent my internship time at the branch to research and investigate
deeply characteristics CRM of the branch. To be detailed, the general result of my
investigation includes:
+ Basic issues of credit risk and credit risk management.
+ Analysis of credit risk management of SMEs at the branch.
+ Strength and weakness of CRM in the branch; reason for current situation and
direction of development in the future.
Data within the report is collected from a wide variety of official sources, such as
bank websites and other data provided by the branch. During the paper,the author
decides to apply some theories and real-life findings to analyze, compare and
generalize the data.

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Supervisor: Assoc.Prof.Ph.D Dang Ngoc Duc

Do Thu Ha - Advanced Finance 54B

CHAPTER I : BASIC ISSUES OF CREDIT RISK AND
CREDIT RISK MANAGEMENT
1.1. Overview of credit risk.
1.1.1. Definition of credit risk
Bank credit is the credit relationship between banks, credit institutions and
economic organizations, individuals on the principle of repayment. The principal
repayments of credit means that the implementation of the value of goods on the
market, and the interest repayments of credit is the realization of surplus value in the
market. Therefore, credit risk can be viewed as business risk, but in view of banks
According to Thomas P.Fitch, credit risk is the type of risk occurs when the
borrower fails to repay the debt under a contractual agreement. Apart from interest rate
risk, credit risk is one of the primary risks in credit (Dictionary of Banking Terms,
Barron’s Edutional, Inc., 1997).
Credit risk, according to the most basic concept, is the risk of loss of principal or
loss of a financial reward stemming from a borrower's failure to repay a loan or
otherwise meet a contractual obligation.
1.1.2. Causes of credit risk
1.1.2.1. Commercial banks
Arranging unethical and unprofessional staff which lead to the failure in
evaluating financial situation, collateral and business plans of customers. Lack of
ethics, leading to process credit left to pursue personal interests; appraisal sketchy,
records matter, lacking control checks, assessment of collateral values are not right
with the actual value. On the other hand, the distinguish between rights and
responsibilities in the credit granting decision is unclear, the manager is not bound
tightly to their responsibilities as a result the doubtful loans continued to rise.
Credit approval process and lending process are lack of discipline; not focus on
annalysing customers, abusing mortage assets. For SMEs and personal loans, the

bank's lending decisions primarily based on experience but the analysis was limited
and inaccurate, lending decisions lack of scientific basis and it does not reflect the
situation as well as the possibility of using the capital.
Lack of supervision and management after loan. Banks often focused on the
verification and loose the control of capital after lending. Inspecting debt is an
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Supervisor: Assoc.Prof.Ph.D Dang Ngoc Duc

Do Thu Ha - Advanced Finance 54B

important responsibility of loan officers banks, partly due to troubling aversion to
customers, not provide timely and adequate information that banks require.
Lack of customers’ information or reliable credit information to analyze before
granting credit. Partly because of limited collecting channels to analyze information
efficiently. The cooperation between banks is too loose, the role of the CIC is not
really effective. In financial management, repayment capacity of a customer is a
specific figure, with its maximum limit. Without exchanging information, as a
consequence, a client can lend at many banks which exceeds this maximum limit.
1.1.2.2. Customers
Using the funds for improper purposes, not willing to pay the debt, creating
bogus records, unclear purchase contracts to banks.
Due to the size of firms and small capital so they will be unlikely to produce
highly competitive products. As the business expanded, the investment focus
mostly on physical assets but rarely changing the management.
Lack of compliance with accounting standards as banks will be difficult to
estimate the financial situation of enterprises. The appraisal reports are impractical,
therefore banks have always considered part of collateral severe as the last solution to
prevent credit risks.

1.1.2.3. Others factors
 Unstable economic environment
With fast and unpredictable changes in the world market: Economy of Vietnam
mostly relies on imported raw materials such as steel, petroleum, fertilizers,etc as well
as the major exported items such as textiles, agricultural,etc.
Liberalization of trade and international integration increases the competitive
pressure on firms and banks. Due to limited capital, technology, management skills,
many companies and banks are not strong enough to create competitive products, then
they lose customers which lead to losses and bankruptcy.
Economic development lack of direction, assigning, specialization labor and macroregulation of the state ... led to the spontaneous development of the industry, companies and
banks caught up in the economic syndrome. Therefore, when market becoming satiation or
being back to the balance of supply and demand , the excess occurred, causing difficulties
and losses for these investments, lending of banks and enterprises.
 Political risk
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Supervisor: Assoc.Prof.Ph.D Dang Ngoc Duc

Do Thu Ha - Advanced Finance 54B

Political risks such as a military coup, new elected government discontinuing
certain policies and programmes, wars, terroism, international isolation , etc, can
severly impact the quality of a credit asset and may lead to losses.
 Disaster risk
Disaster risks such as natural disaster, fire, epidemic diseases,etc.These are risks
that both customers and banks had anticipated for their credits, customers suffer
difficulties which affect the ability to repay loans for banks. For customers with strong
financial status, it also takes time to stabilize the business processes to be capable of
repaying debt, and with potential customers, the credit can highly transform to bad

debts. Although this type of risk can be limited by insurance, however, when this type
of risk occurs, clients and banks would take much time to take money from insurance
companies to fulfill the obligations to repay loans for banks.
1.1.3 Consequence of credit risk
1.1.3.1 Impact on bank
 Lowering the prestige of commercial banks
With the trend of intense competitive nowadays, almost all commercial banks in
Vietnam try to open branches throughout the territory of Vietnam, and bringing the
best service for their customers. Banking activities are always placed the prestige on
top, they always try to minimize all bad news in mass media affecting the bank's
operations. If a commercial bank has high ratio of bad debt, or it was placed under
special control by State bank, then the reputation of the bank will be reduced
dramatically. At that time there will be no individuals or organizations using the bank's
services because they do not know the capital they put in the bank safe and profitable
or not.
 Reducing the solvency of commercial banks
To have sufficient funds to provide credit for customers, the banks must raise
funds from organizations and residents, in other words the banks borrow money from
institutions and residents to sponsor credit. If the credit risk due to irrecoverable debts,
the bank will limit the ources to pay deposit for creditors which are residents and other
economic organizations.

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Supervisor: Assoc.Prof.Ph.D Dang Ngoc Duc

Do Thu Ha - Advanced Finance 54B

 Bankruptcy.

As mentioned above, credit risk affects the credibility, liquidity and profitability
of the bank. If this proportion continues to extend and corrosion on the bank's own
capital, bankruptcy is inevitable.
1.1.3.2 Impact on economy
Most banks now are using short-term funds to finance long-term debt, which
means that the time banks collect debts from customers can not as fast as the time
customers withdraw money. Thus, banks are faced with liquidity risk .Once credit risk
occurs , it will lead to the prestig and solvency of the banks, people and organizations
will rush to withdraw money and terminate the relationship. It will cause a chain effect
to the economy as follows:
Firstly, when the liquidity of banks reduces, banks will not be able to continue
funding for legal person and natural entity. Thus, the funding recipients were greatly
affected.
Secondly, chain reaction to other commercial banks.When faith of public for
banks drops, customers will lose confidence in banks, thereby causing a chain
reaction withdrawal at other banks.
Finally, it is the chain reaction to other economic sectors. Banking collapse
leading to economic recession, reduced purchasing power, rising unemployment and
social instability.
1.2 Overview of credit risk management
1.2.1. Definition of CRM
Credit risk management is the practice of mitigating those losses by
understanding the adequacy of both a bank’s capital and loan loss reserves at any
given time – a process that has long been a challenge for financial institutions.The goal
of credit risk management is to maximise a bank's risk-adjusted rate of return by
maintaining credit risk exposure within acceptable parameters
1.2.2. Process of CRM
1.2.2.1 Credit Risk Recognition
Credit risk recognition includes the steps of:
• Monitoring

• Reviewing
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Supervisor: Assoc.Prof.Ph.D Dang Ngoc Duc

Do Thu Ha - Advanced Finance 54B

• Researching environmental activities and the lending process to classified credit
risk forms
• Forecasting underlying causes
To identify risks, the administrators must make a list of all the types of risk have
been and will be able to appear in the future by these methods:
• Establishing research questionnaires
• Conducting investigations
• Analysising credit records
• Investigating the records that had problems.
The analytical wil lresult for the signs, manifestations, causes
from which to find effective measures to prevent risks.
1.2.2.2 Credit Risk Measurement
To measure the risks, it is necessary to collect data and analyze the level of risk
based on the criteria set out. Entities need to assess the level of risk includes clients,
loans and investment portfolio.
• Estimating borrowers risks:
Basel II allows banks choose between "Benchmarking" and "method based on
internal assessment" also known as "internal classification" . There are two basic tools
which are credit rating for enterprises and credit scoring for individual customers.
These tools have made the task of credit grading, the main difference is that
credit scoring only applies in banks system to estimate credit risk for loans of small
enterprises and individuals. Credit scoring is mainly based on non-financial

information, the information required in the loan application along with other
information about customers collected by banks will be imported to computers,
through the system of credit information for analysis. These results will give a number
- credit score - only the level of credit risk of the borrower. This high technical
efficiency help risk management for small businesses and individuals effectively.
Because these clients do not often have financial report or, lack of 0

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Supervisor: Assoc.Prof.Ph.D Dang Ngoc Duc

Do Thu Ha - Advanced Finance 54B

Credit rating applies for large enterprises, with financial reports, statistical data of
accumulated period are very helpful for classification. Applied more widely, not only in
the banking activities, securities trading business, but also in trade, investment ...
Each banks may have different ways in implementation but always have common
purpose which is to determine the ability, the attention of the customers in repaying
loans, credit contractual interest signed application. Thereby determining the risk
premium and limit maximun credit safety for customers as well as a provision for
risks. There are 2 types of analysis:
• Non-financial analysis:
Quality models based on factors 6C:
 Character
Character is the resposibility to start & finish the debt successfully
It is about customers’ personal, professional capacity to execute the debts
successfully. roficient ability to execute the obligations effectively. Character will be
assessed uniquely in contrast to various individuals, including loan specialists. Some
individuals will think a firm handshake is an indication of solid character. Others will

need to see a decent acknowledge record and a stable job history. The financial record
is a record demonstrating your past obtaining execution. Loan specialists will take a
gander at past execution deliberately and assess the borrower on his or her potential for
future insolvency. Contingent upon your strategy for success and the advance you ask
for, the moneylender may take a gander at the record of loan repayment of the
business, the individual borrower, and any co-signors, underwriters, or financial
specialists.
It is imperative that you recognize what is on your credit record preceding
applying for an advance. A terrible imprint on your credit record does not as a matter
of course keep you from getting an advance. In any case, it is essential that you have
found a way to address any negative blemishes on your credit record and that you can
disclose to your loan specialist why you got those imprints in any case.
 Capacity
Capacity is the ability of enterprises can pay the loan or not. Capacity depends on
laws of each country. The borrower must have civil legal and civil act capacity.
o The legal documents proving the legal capacity of business loans
o Describe the operation of the business to the current time including the
ownership structure, owners, nature of activities, products, key customers, suppliers of
the enterprise.
Credit officers must make sure that customers are fully capable and qualified
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Supervisor: Assoc.Prof.Ph.D Dang Ngoc Duc

Do Thu Ha - Advanced Finance 54B

loans legal in signing loan agreements.
 Cashflows
Cash flow tells you how much of the cash you make persists after expenses and

reimbursement of debt. A Cash Flow Projection demonstrates your salary and also the
costs looking forward into what's to come. Credit officer will take a gander at Cash
Flow as a measure of your ability to reimburse an advance. While you can take a
gander at income for a period as short as a month, a quarter, or a year, most credit
officers need to see money streams anticipated three to five years into what's to come.
Income is infrequently measured by devaluation, profit before interest and
deterioration.
Credit officers use income to figure out if a business can meet month to month
advance installments. Income articulation is utilized to infer a proportion regularly
called a base obligation administration scope (DSC) proportion prerequisite. The credit
officiers will need to see that you have more trade turning out every month from wage
than you have going out from costs and advance reimbursement. Loan specialists use
diverse methods for figuring DSC proportions, however a decent general guideline is
to shoot for a DSC proportion of 1.2 to 1.25. That implies that for each $1,000 of
obligation reimbursement you need to make every month, you ought to have $1,200 to
$1,250 of money after costs. You will make a cushion that ensures you (and your loan
specialist) from the surprising like increasing expenses or falling costs by having more
cash than you have to pay costs.
 Collateral
Collateral is the security for loans. Credit officers will need to consider all potential
outcomes, and must arrangement for the most dire outcome imaginable. In the event that the
borrower can't reimburse the advance, how does the loan specialist get back their cash?
Security is the domain, hardware, houses, autos, and other profitable things that a bank can
hold as insurance for an advance if the advance is not reimbursed.
The estimation of the property being held as security is an essential component:
Lenders will probably require their own particular evaluation of the property or
different resources. Frequently, resources are not esteemed by worth, but rather at
what a loan specialist can get for the thing on the off chance that they need to
dispossess or sell. That frequently implies the most minimal product cost for yields
and domesticated animals and a serious rebate on gear. Keep in mind loan specialists

are not in the matter of working the ranch business and/or purchasing and offering
ranch items, so the bank may not get the best cost on live creatures, crops in the field,
perishable, or repossessed products.
Likewise, most banks have arrangements with respect to advance to esteem

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Supervisor: Assoc.Prof.Ph.D Dang Ngoc Duc

Do Thu Ha - Advanced Finance 54B

proportions. For instance, banks may just advance 80% of the estimation of a package
of property, or 25% to half of the estimation of a specific bit of hardware. Different
banks require 150% insurance in light of the expenses and misfortunes brought about
in a liquidation of the security. The sort of guarantee is vital, as well: Lenders may ask
that you secure the advance with your home, on the hypothesis that you will be less
inclined to default if your house is at danger.
 Conditions
Conditions refers to the lender’s consideration of the broader conditions within
which your proposal must be evaluated. The lender first looks at the intended purpose
of the loan: Will the money be used for working capital, inventory, or additional
equipment, and does that make good business sense within your overall enterprise?
Will the investment make sense within local economic conditions and the overall
business climate, both within your industry and in other industries that could affect
your business?
 Control
It evaluates the impact of changes in laws, regulations operate to the ability to
meet customer needs of customers.
• Laws, regulations, current rules relating to credit are being considered.

• Enough paper records serve for control.
• Profile loan documents and disbursement must be completed and signed by the
parties.
• Coverage of the loan for the rules and regulations of the Bank.
• Comments by economic experts, environmental technicians of the sector, the
product, the other factors can affect the loan.
Bank focuses on issues such as changing laws and regulations related activities
are adversely affecting customers or not, credit needs of customers who meet the
criteria of budget line or not.
In addition, there are other assessment models such as 5P ( based on the
following factors: Purpose, Payment, Protection, Pilicy, Pricing) and CAMPARI
(based on the following factors: Character, Ability, Magin, Purspose, Amount,
Repayment, Insurance).
• Financial analysis:
For loans of enterprises, besides non-financial factors, banks also use financial
indicators to evaluate the repayment capacity of enterprises. This is curent financial
analysis, overview capital management capabilities and business activities through the
numbers in the financial reports of companies. Some indicators of financial analysis
which are often applied:
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Supervisor: Assoc.Prof.Ph.D Dang Ngoc Duc

Do Thu Ha - Advanced Finance 54B

+ Liquidity indicators
+ Operating indicators:
+ Debt balance
+ Profit targets

Depending on the type of credit that banks are interested in different indices:
Current index and debt index for short-term loans; profitability ratios and dividend
payable for long-term loans.
Z – credit scoring model
The Z-score is the output of a credit-strength test that gauges a publicly traded
manufacturing company's likelihood of bankruptcy. The Z-score, is based on five
financial ratios that can be calculated from data found on a company's annual report.
The Altman Z-scoreis calculated as follows:
Z = 1.2X1 + 0.6X4 1.4X2 + + + 1.0X5 3.3X3
X1: Current assets – Current liabilities / total assets
X2: Retained Earnings / Total Assets
X3: Earnings before interest and taxes / Total Assets
X4: Market value of equity / Total Liabilities
X5: Sales / Total Assets
The lower/higher the score, the lower/higher the likelihood of bankruptcy.
A score below 1.8 means the company is probably headed for bankruptcy, while
companies with scores above 3.0 are not likely to go bankrupt. Any company with Z
score <1.81 must be classified as at risk of high credit risk.
 Loan risk evaluation
Basel II can also calculate the expected loss according to the probability of
default, loss given default exposure and exposure at default as the formula:
EL = EAD x PD x LGD
If a loan is considered as a test, if any risk statistics complete, we can determine
fairly accurately the probability of risk of each bank's assets in each period , each type
of credit, every investment sector
 Portfolio risk evaluation : Value at Risk (VAR)
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Supervisor: Assoc.Prof.Ph.D Dang Ngoc Duc

Do Thu Ha - Advanced Finance 54B

Value at risk (VaR) is a statistical technique used to measure and quantify the
level of financial risk within a firm or investment portfolio over a specific time frame.
Value at risk is used by risk managers in order to measure and control the level of risk
which the firm undertakes. The risk manager's job is to ensure that risks are not taken
beyond the level at which the firm can absorb the losses of a probable worst outcome.
1.2.2.3 Credit Risk Controlling
Risk control is the use of measures, techniques, tools, strategies and operational
programs for preventing, avoiding and minimizing risks. Based on the level of risk
which was calculated, the safety of the financial system, and the ability to take risks,
then there are several preventive measures to reduce the extent of damage, such as :
Passively accept the risk: with small loans, sometimes the costs of preventing
are higher than accepting losses. Or if the probability of risk is too high, banks will
avoid risk by limiting or refusing to grant credit.
For the remaining loans, whereas the risk prevention tool is particularly effective
for preventing, avoiding or minimizing the likelihood of risks and losses. The
measures include: preventing risks, sale debt, spread risk and derivative instruments.
Sponsor Risk: including insurance, asset disposal to ensure the recovery of debts
and lawsuits, a provision for risks to process these items can not be recovered
To ensure that these methods are carried out smoothly and efficiently, the banks
need to conduct simultaneously these steps:
Based on the current situation as well as the bank's forecast of economic
development situation, from which issued the policy, specific documents, as well as
strategic planning is apparent.
Identify the resources required to implement the goals, including human
resources, material and technical base as well as minimum initial capital
Develop plans to allocate labor resources, distribution of financial resources,
design and construction of apparatus functions for operating, set the development of

banks ... Thereby, leadership labor force and step by step
set out targetss in short term and in long term
Having credit granting process, testing internal controls, including the
observance of the principles and procedures for granting credit (including the contents
of separation between responsibility and delegated powers), warning systems effective

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Supervisor: Assoc.Prof.Ph.D Dang Ngoc Duc

Do Thu Ha - Advanced Finance 54B

internal report, risk prevention plan, etc.
1.2.2.4 Credit Risk Solving
 Diversify portfolio
This is the best and most proactive method in dispersion of credit risk. Banks
should divide their money into various types of credit investments, different industries
as well as customers in diffirent areas. This has expanded the scope of credit activities
of banks, strengthen their reputation and achieving the purpose of risk diversification.
To do this task ,the bank should indicate some appropriate business strategies based on
a thorough study of the following issues:
Investing in different economic sectors to avoid competition from other credit
institutions in spending snatching market share in narrow range of developing career as
well as to avoid the risk faced by the government policies with the aim of limiting
activities of a certain number of lines in the plan to restructure certain economic sectors.
Invesying in manufacturing business objects, different types of goods to avoid
centralized lending produce some types of products, especially the non-essential
product categories that the government does not encourage to appear in the market.
Avoid excessive lending for a customer, always ensure a certain proportion of

lending activity in the capital costs of the customer to avoid the customer’s
dependence and unpredictable risk. The State Bank has also issued regulations on
lending products due to the Decision No 1627/2001 / QD-NHNN of which stated "
The total outstanding loans to a single client may not exceed fifteen (15) per cent 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. If the capital
requirements of a client exceed fifteen (15) per cent of the equity of the credit
institution or if a client wishes to raise capital from a number of sources, credit
institutions may enter into a syndicated loan in accordance with regulations of the
State Bank."
Loans with different types of time limits to guarantee a balance between the
short-term , medium term, long term loans and to ensure steady growth as well as to
avoid credit risks due to changes in interest rates .
Create an appropriate ratio between loans in VND and foreign currency to
ensure the needs for loans of customers avoiding credit risks due to changes in
exchange rates.

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Supervisor: Assoc.Prof.Ph.D Dang Ngoc Duc

Do Thu Ha - Advanced Finance 54B

Diversify portfolio has the advantage of enabling banks to spread risk in active
ways, however, the diversification of the credit portfolio will also have disadvantages
such as: dificult in management, increase the cost of inspection and surveillance,etc
and decrease profitable opportunity.
 Co-financing loans
In fact, there are enterprises with massive demand for loans that banks can not

serve, it usually needs to invest in major projects and difficult to determine the level of
risk that may occur . In this case, banks will link together to evaluate projects, lending
and risk sharing ensure the rights and obligations of each party.
This form of credit is not really popular with commercial banks in Vietnam.
Partly because of the complexity of this form, others due to problems in the banking
compromise between the rights and responsibilities of the link. This is also drawback
of this measure.
Currently, the State Bank of Vietnam has issued regulations on the issue of
co-financing loan is the premise legally basis for promoting such activities. To
implement effective this form of credit, banks must have a sense of cooperation and
banks need to have a chair for compromise between them, this role can be assigned
to the State Bank.
 Credit Insurance
In social life, "insurance" is a common definition used to refer to one of the most
effective methods to disperse risks. Credit insurance is also an important method to
share risk in credit activities of banks. For example Vietcombank and VietcombankCardif Life Insurance (VCLI) has cooperated continuously and distributed the product
"Security Credit" for borrowers since 2009. After more than 6 years of implementing
the credit security products, VCLI paid insurance benefits for compensatio up to
billions in many cases which borrowers unfortunately died or were injured
permanently. Some cases have received benefits from the first year of the contract.
VCLI has also created impression to customers with quick processing and timely
payment of insurance benefits. Moreover, in order to encourage borrowers to
participate this integration, Vietcombank has adopted preferential policies such as
shopping voucher worth up to 2 million, the system used in supermarkets and other
shopping systems. Credit insurance can be implemented in various forms such as
insurance for lending, property insurance, mortgage insurance.
Customers buy credit insurance. When customers fall into unemployment,
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Supervisor: Assoc.Prof.Ph.D Dang Ngoc Duc

Do Thu Ha - Advanced Finance 54B

bankruptcy and unable to pay loan, the insurance company will pay. This is a
method of credit risk management should be concerned, especially in conditions of
banks operating in Vietnam. So far, only a handful of banks in Vietnam to use
credit insurance to manage risk prevention for themselves and especially for
individual customers.
Banks buy insurance directly from insurance professional organization and will
be compensated for losses.
Insurance of loan collateral
Advantage of using credit insurance is that when credit risk happen, it can be the
best way to overcome the consequences of such risks.
Thus, every business activities contain potential risks, if we do not take risks, we can
not create new investment opportunities. Business activities of commercial banks as well
as other enterprises activities are inevitably risks. Thus risk management is an
indispensable requirement set out in the existence and development of the bank. So to
manage risk effectively banks should use the flexibility of risk management methods to
achieve the goals of the bank as well as limited to the lowest level possible risks out.
1.3 Credit Risk Management – According to Basel.
1.3.1 Basel I Banking regulations
• Credit granting criteria and credit monitoring process (Standard 7): The main
part of controlling system is to assess policies, practices and procedures related to
credit granting, implementation of investment and management of current portfolio.
Credit and investment functions of banks are objective based on healthy principles. It
is necessary for banks to maintain prudential lending policies, purposes and
procedures in compliance with reasonable lending documents. The bank should have a
process to monitor the existing credit relations of customers. Database is an important
factor for the information management system because credit portfolio is determined.

Consequently, it is important that banks grant credit to such parties on an arm’s-length
basis and that the amount of credit granted is monitored. Such controls are most easily
applianced by requiring that the terms and conditions of such credits not be more
favourable than credit granted to non-related borrowers under similar circumstances
and by imposing strict limits on such credits. Another method of control is the public
disclosure of the terms of credits granted to related parties. The bank’s credit-granting
criteria should not be altered to accommodate related companies and individuals.
• Asset quality assessment and provisions for debt loss (Standard 8):Bank
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Supervisor: Assoc.Prof.Ph.D Dang Ngoc Duc

Do Thu Ha - Advanced Finance 54B

inspectors should be all aware that the bank establishes and maintains policies, habits
and procedures appropriate with asset quality assessment and provisions.The bank
should develop a process to identify problematic debts and filter past-dues.In
implementation of guarantees or receipt of mortgages, the bank must assess reputation
of the guarantor and evaluate the mortgaged asset.In the events of problematic debts,
the bank promotes its lending activities on the basis of credit granting and overall
financial strengths. For the various components of credit administration to function
appropriately, senior management must understand and demonstrate that it recognises
the importance of this element of monitoring and controlling credit risk.
• Risk centralization and huge risks (Standard 9):The bank need to develop a
credit monitoring system, which allows determination of notable points in the
investment portfolio and set up prudential ratios to restrain a trend that the bank
centralizes on particular customers or a group of customers. Specific individuals
should be responsible for monitoring credit quality, including ensuring that relevant
information is passed to those responsible for assigning internal risk ratings to the

credit. In addition, individuals should be made responsible for monitoring on an
ongoing basis any underlying collateral and guarantees. Such monitoring will assist
the bank in making necessary changes to contractual arrangements as well as
maintaining adequate reserves for credit losses. In assigning these responsibilities,
bank management should recognise the potential for conflicts of interest, especially for
personnel who are judged and rewarded on such indicators as loan volume, portfolio
quality or short-term profitability.
• Relationship lending (Standard 10):To prevent the abuse that may arise from
relationship lending, credit relations should be based on the principle of “under
control”, so that credit expansion can be assessed effectively for risk control and
mitigation. Relationship lending often results in special risks to the bank, so it should
be approved by Board of Directors. Internal risk ratings are an important tool in
monitoring and controlling credit risk. In order to facilitate early identification, the
bank’s internal risk rating system should be responsive to indicators of potential or
actual deterioration in credit risk. Credits with deteriorating ratings should be subject
to additional oversight and monitoring, for example, through more frequent visits from
credit officers and inclusion on a watchlist that is regularly reviewed by senior
management. The internal risk ratings can be used by line management in different
departments to track the current characteristics of the credit portfolio and help
determine necessary changes to the credit strategy of the bank. Consequently, it is
important that the board of directors and senior management also receive periodic
reports on the condition of the credit portfolios based on such ratings.
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Supervisor: Assoc.Prof.Ph.D Dang Ngoc Duc

Do Thu Ha - Advanced Finance 54B

1.3.2 Methods of credit risk approach according to Basel II

There are two methods for calculation of bank credit risks:
The first method: measures credit risks by the standardized approach based on
external credit assessments.
The second method: the banks use their own internal ratings-based system (IRB).
 The Standardized Approach (SA):The standardized approach means that
banks classify credit risks based on observable features of risks (such as risks from a
company loan or from a loan secured by collateral being a house). The standardized
approach classifies fixed ratings for each type of risks supervised and bases on
external assessments to enhance the sensitivity of risks. The standardized approach
provides inspectors and supervisors with guidelines to decide whether external
assessments are appropriate to apply in banks or not. An important change of this
approach is that loans are classified as past-dues if their credit rating is 150%, except
when provision has been booked for such loans.
When banks expand their credit derivatives such as mortgage, guarantee, Basel II
considers such tools as factors to mitigate credit risks. The standardized approach widens
the scope of eligible collaterals beyond the nation’s issues and simultaneously introduces
several methods to assess the level of capital decrease upon market risks of collaterals.
The standardized approach also consists of specific handling with retail risks.
Ratings of risks in loans mortgaged with houses will be reduced together with other
risks of loans to non-rated firms. Besides, some loans to small and medium-sized
enterprises may be processed as retail risks in case of meeting certain criteria.
To help banks and supervisors in case there are not many options, Basel
Committee developed “the simple standardized approach” consisting of the simplest
options to calculate risk-weighted assets. Banks applying the simple standardized
approach should comply with requirements of market inspection, monitoring and
discipline equivalent to the new Basel agreement.
 The Internal Ratings-Based Approach (IRB):Banks must have independent
credit risk supervision units specializing in designing and implementing their own
internal rating systems. Such units are independent in terms of functions from
management units who are responsible for creating potential risks. Aspects of

supervision include:
- Check and follow up the internal ratings;

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Supervisor: Assoc.Prof.Ph.D Dang Ngoc Duc

Do Thu Ha - Advanced Finance 54B

- Prepare and analyze summary reports from the rating system of the bank,
including historical data on cases of failures in repayment classified at the time of
occurrence and one year prior to this occurrence, analyze measures to mitigate risks,
monitor trends in major rating criteria;
- Implement processes to inspect whether rating definitions are uniformly used
by Departments, Boards and regions or not;
- Assess on and record all changes in the rating process and reasons thereof
- Consider rating criteria to assess if they are still of any effects for risk
anticipation. Changes in the rating process, criteria or parameters must be made into
written records and archived for supervisors’ consideration.
- The credit risk supervision unit should be proactively involved in the
development, selection, implementation and determination of valid values of rating
models, undertake the supervision and monitoring of all models used in the rating
process and bear the highest responsibility for frequent assessments and changes of
rating models.
1.3.3. Criteria for development of a modern risk management model as per Basel
Committee
Basel Committee says: Weaknesses in the banking system of a country, whether
developed or developing, threaten the stability of both its finance and internal affairs.
Therefore, Basel Committee pays much attention to strengthening the power of the

financial system. Basel Committee has issued principles on management of defaults
which are by nature principles on credit risk management, ensuring the efficiency and
safety in credit granting. Such principles focus on the following contents:
• Develop a fitting credit environment: Accordingly, Basel Committee requires
Board of Directors to routinely affirm credit hazard strategies, survey credit dangers
and develop an exhaustive system in the bank's operations (terrible obligation rate,
hazard acknowledgment level, and so forth). Upon such premise, Board of
Management embraces to actualize such bearings and create approaches and strategies
to distinguish, measure, screen and control awful obligations in all operations at the
level of every credit and the entire financing portfolio. Banks need to decide and
oversee credit dangers in each item and action. Particularly, new items must be
endorsed by Board of Directors or Committees under control of Board of Directors.
• Healthily allow credits: Banks need to plainly characterize criteria for sound
credit conceding (target markets, qualified clients, terms and states of credit giving,
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Supervisor: Assoc.Prof.Ph.D Dang Ngoc Duc

Do Thu Ha - Advanced Finance 54B

and so forth). Banks ought to develop credit lines for every sort and gathering of
borrowers to recognize distinctive sorts of credit dangers, which can be thought about
and caught up upon inside appraisals of clients in different perspectives and segments.
Banks ought to issue clear procedures of acknowledge giving, credit changes for
investment of showcasing division, credit investigation division and credit
endorsement division, and also unmistakable obligations of members. At the same
time, banks ought to build up a group of experienced and educated danger
administration staff to convey prudential choices on evaluation, endorsement and
administration of credit dangers. Credit conceding ought to be led upon reasonable

exchanges among gatherings. Particularly, there ought to be prudential and sensible
evaluations on relationship clients.
• Maintain a reasonable credit postliminary, observing and administration
process: Banks ought to be outfitted with cutting-edge administration framework
towards the venture portfolio with potential dangers, including upgrading credit
records, gathering current money related data, archive drafts, for example, credit
contracts, and so forth upon the banks' degree and level of multifaceted nature. In the
meantime, the framework ought to have the capacity to handle and control clients'
money related circumstance, duty consistence, and so on to auspicious distinguish
risky obligations. Banks ought to have a framework to opportune adapt to awful and
dangerous obligations. Credit hazard arrangements ought to elucidate strategies for
overseeing risky credits. Obligations towards such attributes might be relegated to the
promoting division or obligation recuperation division or the blend of such divisions,
contingent upon the degree and nature of every credit. Also, Basel Committee urges
banks to create and develop an inside rating framework for danger administration,
empowering to recognize levels of credit dangers for possibly hazard weighted
resources of the bank.Inconclusion, to develop the credit risk management model,
Basel principles include the following significant contents:
Analyzing the credit granting system by division of marketing, credit analysis
and credit approval.
Improving the quality of risk management staff.
Developing efficient information management and updating system to maintain
a proper credit monitoring and measuring process, coming close with the requirements
of credit assessment and risk management.
1.3.4. Vietnam’s existing regulations on debt classification, provisioning and use of

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