Credit risk management a case study of BIDV

MI ISTRY OF EDUCATIO A D TRAI I G
U IVERSITY OF ECO OMICS HOCHIMI H CITY
----------------------

MAI XUÂ VIỆT

CREDIT RISK MA AGEME T:
A CASE STUDY OF BIDV

MASTER THESIS

HoChiMinh City - 2011


MI ISTRY OF EDUCATIO A D TRAI I G
U IVERSITY OF ECO OMICS HOCHIMI H CITY
----------------------

MAI XUÂ VIỆT

CREDIT RISK MA AGEME T:
A CASE STUDY OF BIDV

MAJOR: BA KI G
MAJOR CODE: 60.31.12
MASTER THESIS
I STRUCTOR: DOCTOR HỒ VIẾT TIẾ

HoChiMinh City - 2011

i

ACK OWLEDGEME T
I would like to express my deepest gratitude to my research Instructor, Dr. Ho
Viet Tien for his precious guidance, intensive support, ceaseless encouragement and
highly valuable suggestions during the course of my research.
I would like to extend my sincere thanks to Dr. Truong Tan Thanh for his
instruction and advice during the course of my thesis.
I would like to express my sincere gratitude to all of my teachers at Faculty of
banking and finance and Postgraduate Faculty, University of Economics Ho Chi
Minh City for their teaching and guidance during my MBA course.
I would like to express my sincere thanks to all of my classmates, my friends
for their support and encouragement.
I would also like to avail this opportunity to express my appreciation to Dr
Nguyen Minh Kieu for his proposal of organizing the MBA program in English.
Finally, I would like to thank my boss and all of my colleagues for their help
in knowledge, experience of banking practice and data collection during the course
of my research.


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ABSTRACT
Along with the development of the economy, the Vietnam banking system has
developed rapidly. It brings about comfort to businesses with a lot of modern
banking services, financing the economy, giving citizens and businesses a channel
for investment. Banking business brings about huge profit. However, the banking
business has a lot of potential risk, especially credit risk. Credit risk may bring
severe consequences to a bank and to the whole banking system, it increases
expense of banks, causing loss to banks, or even worse, it may bring about a

collapse in the banking system. Many collapses in human history prove the bad
consequences of poor credit risk management practices.
Vietnamese bankers now are paying much attention to risk management in
general and credit risk management in particular. This is a part of their business
strategy. Banks are trying to improve their credit risk management capacity and
practice.
A case study of BIDV is performed to explore and evaluate the performance
of credit risk management in banking sector and find out some solutions for credit
risk management practice.
The result of this study will help the Vietnam banking system in the
performance of its credit risk management policy and practice.


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TABLE OF CO TE TS
Acknowledgment...................................................................................................... i
Abstract ................................................................................................................... ii
Table of contents ....................................................................................................iii
List of tables ......................................................................................................... viii
List of abbreviations ............................................................................................... ix
Chapter 1: Introduction ........................................................................................ 1
1.1. Introduction ...................................................................................................... 1
1.2. Research background ........................................................................................ 1
1.3. Statement of the problem .................................................................................. 3
1.4. Research objectives and questions..................................................................... 4
1.4.1. Research objectives. ................................................................................. 4
1.4.2. Research questions ................................................................................... 4
1.5. Scope and limitation ......................................................................................... 4
1.6. Research methods ............................................................................................. 5

1.7. Structure of the study ........................................................................................ 6
Chapter 2: Theoretical framework ....................................................................... 8
2.1. Introduction ...................................................................................................... 8


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2.2. Risk and risk management in banks .................................................................. 8
2.3. Credit risk and credit risk management banks ................................................. 10
2.3.1. Credit risk.............................................................................................. 10
2.3.2. Credit risk management ......................................................................... 12
2.4. Standards of credit risk management of BCBS................................................ 17
2.4.1. Establishing an appropriate credit risk environment................................ 17
2.4.2. Operating under a sound credit granting process..................................... 18
2.4.3. Maintaining an appropriate credit administration, measurement and
monitoring process ........................................................................................... 19
2.4.4. Ensuring adequate controls over credit risk ............................................ 19
2.5. Regulations of the State Bank of Vietnam on credit risk management ............ 20
2.5.1. Regulations on classifications of debts and loss provisioning in banking
operation of credit institutions ........................................................................ 20
2.5.2. Credit rating for customers ................................................................... 23
2.6. Some knowledge on credit risk management .................................................. 24
2.7. Conclusions .................................................................................................. 25
Chapter 3: Research Methods............................................................................ 26
3.1. Introduction .................................................................................................... 26
3.2. Business research .......................................................................................... 26


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3.3. Research Design ............................................................................................. 27
3.4. Data collection ............................................................................................... 29
3.4.1. Document Collection .............................................................................. 29
3.4.2. Depth Interviews .................................................................................... 30
3.5. Reliability ...................................................................................................... 32
3.6. Conclusions .................................................................................................. 33
Chapter 4: Introduction to BIDV ....................................................................... 34
4.1. An overview of BIDV..................................................................................... 34
4.2. Business performance of BIDV in the period 2006-2010 ............................... 37
4.2.1. Business environment in the period 2006-2010 ...................................... 37
4.2.2. Total assets ........................................................................................... 37
4.2.3. Capital .................................................................................................. 39
4.2.4. Profitability ........................................................................................... 40
4.3. Credit activities in the period 2006-2010........................................................ 41
4.3.1. Credit growth ........................................................................................ 41
4.3.2. Credit structure ..................................................................................... 42
4.3.3. Credit quality ........................................................................................ 44
4.4. Strategic objectives in the time to come ........................................................ 47


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Chapter 5: Data analysis and findings ............................................................... 48
5.1. Introduction .................................................................................................. 48
5.2. Regulations on credit risk management of the bank ....................................... 48
5.2.1. Documents related to credit risk ............................................................ 48
5.2.2. Credit risk management policy ............................................................. 50
5.2.3. Regulations on lending ......................................................................... 51
5.2.4. Credit policies ....................................................................................... 54
5.2.5. Policies on security transactions ............................................................ 55

5.2.6. Credit risk management information system ......................................... 56
5.2.7. Credit extension limits and credit restrictions ........................................ 57
5.3. The credit risk management system and organization ..................................... 58
5.4. Measurement of and controls over credit risk ................................................ 59
5.5. Classification of Debts, Loss Provisioning and using provisions to compensate
for credit risk ...................................................................................................... 60
5.5.1. Classification of debts and loan loss provisioning ................................. 60
5.5.2. Using provisions to compensate for credit risk ...................................... 62
5.6. The compliance with standards of Basel Committee on Banking Supervision
and regulations of the State Bank of Vietnam ...................................................... 63
5.7. The effectiveness of credit risk management policy of BIDV ........................ 64


vii

5.8. Conclusions .................................................................................................. 65
Chapter 6: Conclusions and Recommendations ............................................... 66
6.1. Introduction ................................................................................................. 66
6.2. Conclusions related to research questions ..................................................... 66
6.3. Recommendations ......................................................................................... 67
6.3.1. Regulations on credit risk management ................................................. 67
6.3.2. Credit staff ............................................................................................ 67
6.3.3. Credit policies ....................................................................................... 67
6.3.4. Technology ........................................................................................... 68
6.4. Limitations of the research ............................................................................ 68
References ........................................................................................................... 69


viii

LIST OF TABLES
Table 4.1: Total assets of BIDV in the period 2006-2010
Table 4.2: Total assets of BIDV in comparison with some big commercial banks in
Vietnam in 2010
Table 4.3: Loans and advances to customers (net of allowance for impairment
losses)
Table 4.4: Owner’s equity over 2006-2010 period
Table 4.5: Owner’s equity in 2010 compared to some Vietnamese commercial
banks
Table 4.6: CAR at the end of 2010 compared to some big Vietnamese commercial
banks
Table 4.7: BIDV’s profitability over the 2006-2010 period
Table 4.8: BIDV’s profitability in 2010 compared to some other commercial banks
Table 4.9: Credit growth of BIDV over the period 2006-2010
Table 4.10: Credit structure by types
Table 4.11: Loan classification
Table 4.12: The percentage of loan classes
Table 4.13: NPLs of BIDV in 2010 in comparison with some other big commercial
banks
Table 5.1: Internal credit rating system of BIDV
Table 5.2: Internal credit rating and debt classifications of BIDV


ix

LIST OF ABREVIATIO S
Agribank

Bank for Agriculture and Rural Development of
Vietnam

BCBS

Basel Committee on Banking Supervision

BIDV

Bank for Investment and Development of Vietnam

CAR

Capital Adequacy Ratio

CEO

Chief Executive Officer

CPI

Consumer Price Index

Eximbank

Vietnam Export Import Commercial Joint Stock
Bank

NPL

Nonperforming Loan

ODA

Official Development Assistance

ROA

Return on Assets

ROE

Return on Equity

Sacombank

Saigon Thuong tin Commercial Joint Stock Bank

VCB

Joint Stock Commercial Bank for Foreign Trade of
Vietnam

Vietinbank

Vietnam Joint Stock Commercial Bank for Industry
and Trade


1

CHAPTER 1

I TRODUCTIO
1.1. Introduction
This chapter provides a general introduction to the current study, by drawing a
picture of the following chapters and the study as a whole, beginning with a general
introduction in section 1.1, section 1.2 examines the research background, section
1.3 makes a statement of the problem, and section 1.4 specifies research objectives
and defines the research questions.
In addition, section 1.5 discusses scope and some limitations of the study;
section 1.6 briefly discusses the general aspects of research methods such as
research types and research design; Section 1.7 introduces the structure of the study.
1.2. Research background
Credit is always a source of benefit to banks, profit from credit always
accounts for a big amount in total earnings. However, credit is also a source of risk.
Adequately managing credit risk in banks is critical for the survival and growth of
banks. The issue of credit risk is of great concern because of the high levels of
perceived risks resulting from some of the characteristics of clients and business
conditions that they find themselves in.
Banks are in the business of safeguarding money and other valuables for their
clients. They also provide loans, credit and payment services such as checking
accounts, money orders and cashier’s checks. Banks also offer investment and
insurance products and a wide range of other financial services.
Credit brings main income to banks, but this activity involves huge risks to
both the lender and the borrower. The risk of borrowers not fulfilling their


2

obligations as per contract on due date or anytime thereafter can terribly jeopardize
the smooth functioning of a bank’s business. On the other hand, a bank with high
credit risk has high bankruptcy risk that puts the depositors in jeopardy.

Among the risk that faces banks, credit risk is one of great concern to most
bank authorities and banking regulators. This is because credit risk is the risk that
can easily and most likely prompt bank failure.
Credit risk management is a structured approach to managing uncertainties
through risk assessment, developing strategies to manage it, and mitigation of risk
using managerial resources. The strategies include transferring to another party,
avoiding the risk, reducing the negative effects of the risk, and accepting some or all
of the consequences of a particular risk (Takang Felix Achou & Ntui Claudine
Tenguh, 2008).
Traditional risk managements focus on risks stemming from physical or legal
causes. Financial risk management on the other hand focuses on risks that can be
managed using traded financial instruments.
The objective of risk management is to reduce the effects of different kinds of
risks to the level accepted by the society. It may refer to many types of threats
caused by environment, technology, humans, organizations and politics. On the
other hand, it involves all means available for humans, or in particular, for a risk
management entity.
This thesis makes a brief look on Credit risk management practice of Bank for
Investment and Development of Vietnam (BIDV) and further probes into risk
exposure, assessment, management and control of the bank. An attempt will be
made to discover the use of some risk management, evaluation, assessment tools
and techniques of the bank at the moment. The way the bank manages credit risk
will be explored.


3

1.3. Statement of the problem
The major risk in banking business is credit risk. This is the risk banks have to
measure, manage and accept. Banking business is so sensitive because most of

banks’ liabilities are deposits from depositors. Banks use these deposits to lend their
borrowers. Lending is a revenue generating activity for banks. This process exposes
banks to high default risk that may lead to financial danger including bankruptcy.
However, banks must make loans to their clients to make money, to grow and
develop.
Risk management in general and credit risk management in particular always
draw great attention of bankers. In order to survive, banks have to manage risks
well. Bankers now pay more attention to credit risk management. Every bank now
has its credit risk management department with main task of issuing credit policies
and credit procedures so as to simultaneously serve customers well to earn profit
and to mitigate risks.
Credit risk management is always an activity of great concerns of Board of
Management, Board of Directors and every credit officer of BIDV. BIDV has
established a credit risk management Department in order to monitor credit activity,
to manage and mitigate credit risk. Besides, BIDV has issued a system of policies,
procedures and regulations for lending activity. As a result, credit risk is mitigated
significantly, loans are well controlled and non-performing loans are in acceptable
limitation.
The purpose of this study is to explore the way BIDV manages credit risk and
to make an assessment of credit risk management practice of BIDV, its policy and
procedures compared to standards of Basel Committee on Baking Supervision and
regulations of the State Bank of Vietnam in order to help improve its credit risk
management practice. Besides, the result of the study may have an implication on
other banks and the banking system as a whole.


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1.4. Research objectives and questions
1.4.1. Research objectives

The research objective is the researcher’s version of the business problem.
These objectives explain the purpose of the research in measurable terms and define
standards of what the research should accomplish (Zikmund 1997).
In order to solve the research problem, the research objectives of this study are
to explore and evaluate the credit risk management practice of BIDV in order to
strengthen the effectiveness of its credit risk management system.
1.4.2. Research questions
A research question is the researcher’s translation of the business problem into
a specific need for enquiry (Zikmund 1997). In order to get the above-mentioned
research objectives, this study should answer the following questions:
- How does BIDV manage credit risk?
- How effective is credit risk management policy of the bank?
1.5. Scope and limitation
Banking business is affected by many factors; banking profitability is affected
by many banking risks that need to be managed and controlled. Risk management in
banks involves many kinds of risks arising from daily banking activities including
market risk, interest rate risk, foreign exchange rate risk, liquidity risk and credit
risk. This study focuses on credit risk only and it takes the case of BIDV, which
does not represent the whole banking industry in Vietnam. Its findings therefore
may not be applied to other kinds of risks and may not be applied to the whole
Vietnam banking system.


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1.6. Research methods
The nature of the problem influences the types of business research. According
to Zikmund (1997), based on the purpose of research, there are three types of
business research: exploratory, descriptive and causal research.
-

Exploratory research is the initial research conducted to clarify and define
the nature of a problem.

-

Descriptive research is the research designed to describe characteristics of a
population or a phenomenon.

-

Causal research is the research conducted to identify cause-and-effect
relationships among variables where the research problem has already been
narrowly defined.
This research is designed to explore and evaluate the credit risk management

practice of BIDV in order to enhance the effectiveness of its credit risk management
system. So, exploratory research is the most appropriate research type for the study
and case study method is the exploratory research technique used to obtain
information to the research problem.
A case study is conducted at BIDV, qualitative approach is used, both primary
data and secondary data are collected. A survey is chosen to investigate and
describe the practice of credit risk management of BIDV. A questionnaire is
designed and asked directly to interviewees to collect data related to credit risk
management practice of BIDV.
Secondary data is used to investigate the policy, strategy and procedures of
BIDV in credit granting and credit risk management. It is used to evaluate the
compliance with international standards and regulations of the State Bank of
Vietnam. Secondary data is in documents relative to credit and credit risk of BIDV.
This data is collected from BIDV branches and the website of BIDV.

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1.7. Structure of the study
This research consists of six chapters. The structure of this research is
presented as follows:
Chapter 1: Introduction
This chapter provides the background to the research, the contribution of the
research, research methods and outlines the limitations of the research.
Chapter 2: Theoretical framework
This chapter presents a theoretical framework relating to the subject of this
thesis. It includes some theoretical concepts and definitions relating to credit risk
management. Besides, it shows the standards for credit risk management
recommended by the Basel Committee on Banking Supervision and regulations of
the State Bank of Vietnam that govern the lending activity and credit risk
management.
Chapter 3: Research methods
This chapter discusses the methodological approach used for the thesis. It
presents the reason why a case study is chosen and how data, information and
literature are collected.
Chapter 4: An introduction to Bank for Investment and Development of
Vietnam (BIDV)
This chapter makes an overview of Bank for Investment and Development of
Vietnam (BIDV), its activities over the period 2006-2010. It makes a brief
assessment of banking practice of BIDV by showing main indicators over years and
comparing the indicators with those of some other leading banks in Vietnam
banking market.

7

Chapter 5: Data analysis and findings
This chapter analyzes credit and credit risk policies, credit organization and
practice of BIDV, the way BIDV manage credit activities and credit risk arising
from the activities, the efficiency of credit policies of BIDV. From that an
assessment will be made.
Chapter 6: Conclusions and recommendations
The conclusions about the whole thesis and the recommendations upon the
problems identified will be discussed in this chapter.


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CHAPTER 2
THEORETICAL FRAMEWORK
2.1. Introduction
This chapter mentions theoretical framework relating to risk management in
general and credit risk management in particular. The chapter consists of six
sections. The first section makes an introduction to the chapter, the second section
presents an overview of risk and risk management in banks, the third section refers
to credit risk and credit risk management in banks, the fourth section reviews
standards of credit risk management of Basel Committee on Banking Supervisions,
common practices of credit risk management in banking, the fifth section presents
regulations of State Bank of Vietnam on credit risk management, the six section
presents some knowledge on credit risk management, the last section provides some
conclusions to the chapter.
2.2. Risk and risk management in banks
According to Shelagh Heffernan (2005), banking risk is the volatility of net
cash flows of a branch, a division of a bank or the whole bank. The objective of a

single bank is to add value to its equity by maximizing the risk-adjusted return to
shareholders. Banks accept risk to make profit. For a bank, risk-adjusted return
depends severely on risk management policy and practice. Risk management is the
core operation any bank.
There are a lot of risks in banking practice that affect the profitability of
banks. Gup (Commercial banking, 2005, P. 12) lists nine risks needing to be
supervised, namely credit, interest rate, operational, liquidity, price, compliance,
foreign exchange, strategic and reputation risks.


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Credit risk is the risk to earnings and capital that banks have to absorb due to
the borrower is unable to or unwilling to pay its debt. This affects the lender holding
the loan contract, as well as other lenders to the debtor. Therefore, the
creditworthiness of the debtor as well as the market value of the collateral is of great
interest to the bank. Credit risk is the gap between the performance and expected
value. Accordingly, it can be diversifiable, but cannot be eliminated completely.
This is because a part of credit risk stems from market risk. This arises to banks that
do business in local markets and take on highly illiquid assets. In such cases, banks
are of difficulty in transferring credit risk and estimating potential loss.
Interest rate risk is the risk to earnings and capital due to the movements of
interest rates. Banks and borrowers bear interest rate risk. Banks have the risk of
reduced revenues due to the decline in interest rates. Borrowers suffer higher costs
due to interest rates increasing. However, interest rate exposure produces chances of
gains as well.
Operational risk is the risk to earnings and capital arising from malfunctions
of the information system, reporting systems, internal risk-monitoring rules and
internal procedures designed to take timely corrective actions, or the compliance
with internal risk policy rules (Joel Bessis, 2002). Operational risk relates to the

problems of accurately processing, settling, and taking or making delivery on trades
in exchange for cash. This is the risk of direct or indirect loss resulting from
inadequate or failed internal processes, people and systems or from external events.
It also arises in system failures and compliance with banking regulations.
Liquidity risk is the risk to earnings and capital that a bank cannot meet its
obligations to depositors and the needs of borrowers by turning asset into cash
quickly, being able to borrow fund when needed. This is often associated with an
unexpected event, loss of confidence, or a crisis of national balance of payments


10

such as a currency crisis. In some cases, a low liquidity ratio may lead banks to
bankruptcy.
Price risk is the risk to earnings and capital stemming from market value
variation, especially the fluctuation of exchange rate. This risk can be hedged, but
cannot be diversified away. It appears in various forms. For banks, price risk arises
from the fluctuations of interest rates and the value of currencies.
Compliance risk is the risk to earnings and capital arising from violations of
laws, rules, regulations, and so on. Compliance risk may arise from activities of an
institution's management or employees. Fraud, violations of laws and regulations
may lead to huge loss.
Foreign exchange risk is the risk to earnings and capital arising from changes
in foreign exchange rates.
Reputation risk is the risk to earnings and capital stemming from negative
public opinion of the bank. Negative public opinion may arise from poor service,
failure to serve credit needs, and for other reasons. This may lead to a loss of market
share.
Every bank faces these kinds of risks to a particular extent. The banking
industry regards the issue of risk management as the need to control the risks which

make up most of their risk exposure. Consequently, the main tasks of banking risk
management are to manage these kinds of risks.
2.3. Credit risk and credit risk management in banks
2.3.1. Credit risk
There are many definitions of credit risk. Basel Committee on Banking
Supervision (2000, p. 1), defines credit risk as the potential that a bank borrower or


11

counterparty will fail to meet its obligations in accordance with agreed terms.
Benton E. Gup (2005, P. 12) states that credit risk is the risk to earnings and capital
that an obligor may fail to meet the terms of any contract with the bank. Credit risk
is the primary cause of bank failures, and it is the most visible risk facing bank
managers.
According to Decision 493/2005/QĐ-NHNN dated 22/04/2005 of the State
Bank of Vietnam, credit risk is the probability that a default event occurs in banking
practice of a credit institution due to the borrower is unable to or unwilling to meet
its obligations as committed.
For most banks, loans are the largest and most obvious source of credit risk.
However, there are many other sources of credit risk in banking activities both on
and off the balance sheet. Banks are facing credit risk in various financial
instruments other than loans, including acceptances, interbank transactions, trade
financing, foreign exchange transactions, financial futures, swaps, bonds, equities,
options, and in the extension of commitments and guarantees, and the settlement of
transactions. In this thesis, credit risk is narrowed down to main credit activities
namely loans and guarantees.
Credit risk arises from the possibility that a counterparty is either unwilling to
perform on an obligation or its ability to perform such obligation is deteriorated
causing financial losses to the bank. Losses originate from total default due to

inability or unwillingness of counterparty to meet commitments relating to lending,
trading, settlement and other financial transactions, losses may also stem from
reduction in value due to deterioration in credit quality. Credit risk arises from a
bank’s dealing with individuals, businesses or financial institutions. Credit risk may
originate from activities on or off the balance sheet.
Credit risk results in direct accounting losses. In addition, it causes economic
exposures consisting of opportunity costs, transaction costs and expenses relating to


12

non-performing assets. Credit risk may also expose banks to liquidity risk. Credit
risk is the most substantial risk in terms of losses. It is the principal cause of bank
failures.
Credit risk may be divided into three types: default risk, exposure risk and
recovery risk. Default risk is the risk arising due to a default by the counterparty,
which declares bankruptcy, goes into liquidation or otherwise defaults on the loan;
exposure risk is the risk that exposure at default is greater than the amount
originally expected; recovery risk is the risk that the recovery rate actually recorded
after the liquidation of the insolvent counterparty’s assets is less than the amount
originally estimated, because the liquidation value was lower than estimated or
simply because the recovery process took longer than expected.
Because credit expansion is the principal of banking operation, the major part
of banking risk management is credit risk management. It applies to bank loans and
investment portfolio. Credit risk management combines decision making,
monitoring and reporting process. Loans in default or close to default become nonperforming. Usually, loan becomes non-performing after being default for three
months. Non-performing loan rate shows the proportion of the default or near to
default loans to the actual performing loans. It indicates the efficiency of the credit
risk management employed in the bank. A low non-performing loan rate shows an
effective credit risk management policy.

2.3.2. Credit risk management
Credit risk management is the process of credit risk approach in a scientific,
comprehensive and systematic manner to identify, control, prevent and mitigate the
damage, loss, adverse effects of credit risk.
The goal of credit risk management is to maximize a bank's risk-adjusted rate
of return by maintaining credit risk exposure within acceptable parameters. Banks


13

need to manage the credit risk inherent in the entire portfolio as well as the risk in
individual credits or transactions. Banks should also consider the relationships
between credit risk and other risks. The effective management of credit risk is a
critical component of a comprehensive approach to risk management and essential
to the long-term success of any banking organization (BCBS, 2000, P.1).
Retail lending approach is different from that of corporate lending because
corporates have financial reports that generate financial ratios while individuals
don’t. This makes retail lending more difficult than corporate lending due to lack of
information. However, lending to corporations involves large sums of money and
every failure may lead to serious consequences whereas retail loan defaults rarely
have severe adverse effects on a bank.
Credit risk is managed in various ways. Tony Van Gestel (2009, P. 42)
introduces four techniques for credit risk management as the followings:
-

Selection

-

Limitation

-

Diversification

-

Credit enhancement
A good selection strategy is a good pricing of the products. It is also a good

selection of the counterparties and products which require good credit procedures,
qualified credit officers and credit committees where important credit decisions are
made. For counterparties with higher default risk, more collateral and more
stringent covenants on asset sales are asked for to reduce recovery risk.
Limitation restricts the exposure of the bank to a particular customer; it
prevents the bank from insolvency due to losses of lending to one customer or a
group of customers. The State Bank of Vietnam regulates that the total outstanding
credit of a commercial bank extended to a single client must not exceed 15% of its


14

own capital and the total outstanding credit of a commercial bank extended to a
single client and affiliated persons must not exceed 25% of its own capital (article
128 of the Law on Credit Institutions). Each bank makes a credit extension limit to
a single customer based on financial capacity and demand for business activities of
the customer. Besides, the bank limits the authority of each credit officer and
committee. Large loans must be verified by many levels of credit authority.
Diversification offsets the volatility created by an increase in the number of
risky loans. Diversification strategy spreads credit in order to avoid a concentration

on credit risk. The bank diversifies its credit portfolio by making loans to various
borrowers of different types, industry sectors and geographies in order to reduce the
overall riskiness of the loan portfolio with assets of negatively correlated.
In order to mitigate credit risk, banks may use credit protection by buying
credit derivative products or credit insurance. Besides, with higher credit risk
counterparts, banks also require more collateral. Collateral is the second source of
repayment. Collateral helps to reduce recovery risk.
Default risk of individual loans is assessed by qualitative and quantitative
methods. Qualitative method is used when the bank is unable to obtain information
on a potential borrower, quantitative method uses financial data to measure and
predict the probability of default of a borrower.
Qualitative approach use checklists to take account of specific issues of the
borrower. Shelagh Heffernan (2005) uses the following checklist to evaluate credit
risk:
-

Credit history.

-

The borrower’s leverage ratio – how much the loan applicant has already
borrowed relative to his/her assets.

-

The wealth of the borrower.