LV thạc sỹ_Solution to improve credit risk management in Vietinbank

ACKNOWLEDGEMENT
Firstly, I would like to express my profound thanks to Dr…
Finally, I would like to take this opportunity to extend my great gratitude to
my beloved parents, family members and close friends for their support and
encouragement not only during the period of this minor thesis but also for my whole
life.


TABLE OF CONTENTS
INTRODUCTION
1. The necessary of the topic
2. The purpose of the internship thesis
3. The scope and scale of the internship thesis
4. Research method
5. The structure of the internship thesis
CHAPTER 1: THE FUNDAMENTALS OF CREDIT RISK MANAGEMENT
IN COMMERCIAL BANKS..................................................................................1
1.1. The credit risk.....................................................................................................1
1.1.1. Basic concepts of credit risk........................................................................1
1.1.2. Characteristics of credit risk.........................................................................2
1.1.3. The main signal to identify credit risk..........................................................3
1.1.4. The cause of credit risk................................................................................7
1.2. The credit risk management..............................................................................10
1.2.1. Basic Concepts of credit risk management................................................10
1.2.2. The necessary of credit risk management...................................................11
1.3 The methods to manage credit risk....................................................................13
1.3.1. Setting limitation of the loan amount.........................................................13
1.3.2. Classification of loans................................................................................14
1.3.3. Provision and allowance for credit losses..................................................15
1.4. Model used to evaluate credit risk....................................................................15
1.4.1. Qualitative model: 6C................................................................................15

1.4.2. Quantitative model: credit scoring.............................................................17
CHAPTER 2: THE SITUATION OF CREDIT RISK MANAGEMENT IN
VIETINBANK AND VIETINBANK- NAM THANG LONG BRANCH..........22
2.1. Basic policies of credit risk management in Vietinbank...................................22
2.1.1. The lending policy of Vietinbank...............................................................22


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2.1.2. The policy of credit risk management in Vietinbank..................................25
2.1.3. Policies on loan classifications and risk provision.....................................28
2.1.4. Organization structure of and operating structure of credit risk management
............................................................................................................................. 30
2.1.5. The supervision and inspection of credit risk management in Vietinbank..36
2.2. The summary of different types of credit risk and the causes of these types in
Vietinbank...............................................................................................................37
2.2.1. The summary of different types of credit risk............................................37
2.2.2. The causes of the types..............................................................................38
2.3. Information of Vietinbank- Nam Thang Long branch as an example of good
branch in credit risk management............................................................................40
2.3.1. The foundation and development of Vietinbank- Nam Thang Long branch
............................................................................................................................. 40
2.3.2. The organization structure of Vietinbank- Nam Thang Long branch.........43
2.3.3. Overview of the credit activities in Vietinbank- Nam Thang Long branch in
five years from 2005 to 2009...............................................................................44
CHAPTER 3: THE SOLUTION TO IMPROVE THE CREDIT RISK
MANAGEMENT IN VIETINBANK...................................................................47
3.1. The general viewpoint of Vietinbank about credit risk management................47
3.2. The solution to improve the credit risk management in Vietinbank and
Vietinbank- Nam Thang Long branch.....................................................................48

3.2.1. The solutions to manage risk in credit activities........................................49
3.2.2. The solutions to improve the ability and ethics of credit employee...........52
3.3. Some recommendations....................................................................................53
3.3.1. Recommendations to the head-office of Vietinbank...................................53
3.3.2. Recommendations to the State Bank of Vietnam.......................................54
3.3.3. Recommendations to the Government.......................................................55
CONCLUSION......................................................................................................56


ABBREVIATION
GDP

Gross Domestic Product

L/C

Letter Credit

NPL

Non- performing loans

SBV

State bank of Vietnam

Vietinbank

Vietnam Joint Stock Commercial Bank For Industry And Trade

LIST OF TABLE

Table 1.1Scoring criteria for individual customers..................................................18
Table 2.1 Rates of credit risk provisions according to the groups rated by Vietinbank
compared to Price Waterhouse Coopers’ consultation.............................................29
Table 2.2 Distribution of credit approval authorization through each period...........33
Table 2.3 Authorization verdict for lending and guaranty by groups of brach............34
Table 2.4 Basic data in the nine years 2001-2009 of the branch .............................41
Table 2.5 Business results in the five years 2005-2009 of the branch .....................44


INTRODUCTION
1. The necessary of the topic
In the period of economic renovation, our economy has made many positive
changes. GDP growth is maintained at a high rate, people's lives are improved.
Along with the changes of the country, banking sector has also reformed
perceptively with significant improvement in the organization and operation.
Banking sector and particularly commercial banks play an important role in the
achievement of economies day by day.
In the process of reform and restructuring, along with some traditional
services, commercial banks have been gradually changing their activities for
example the banks have moved to a variety of products and services, developed new
product applications in the business. However, the credit activity of the banks is still
considered as the key in business operation and takes a high proportion of the
profits of every commercial bank. Credit operation has contributed a positive role
for the development of the banking sector and all the economy, is a tool for
financing the economy. It also is contributing to industrialization and modernization
of the country. However, it also reveals the limitations and risks that banks must
face today.

The high- level competition of commercial banks in the market economy
makes risks especially credit risk tends to increase more rapidly and more difficultly
in controlling. Therefore, the issue of improving credit risk management is
increasingly needed. The author clearly realizes that fact in the period of internship
in Vietinbank system in general and Vietinbank- Nam Thang Long branch in
particular.
Therefore, the internship thesis “Solution to improve credit risk management
in Vietnam Joint Stock Commercial Bank For Industry And Trade” is researched


and written. The author hopes that the thesis will contribute reasonable view for
Vietinbank as well as banking sector in Vietnam in this period.

2. The purpose of the internship thesis
- Review some theories of credit risk in commercial banks in the market
economy.
- Analysis the real situations of credit risk in Vietinbank and VietinbankNam Thang Long branch. Then, the author assesses the limitation and the causes of
credit risk.
- Propose some solutions and make some recommendations to reduce credit
risk management.

3. The scope and scale of the internship thesis
Thesis focuses on studying and evaluating the current situation of credit risk
management in Vietinbank. Moreover, the author uses data from Vietinbank- Nam
Thang Long branch as an example to help the internship thesis be more
comprehensive and practical.
Research focuses on the period from 2000 to 2010. However, because of the
financial year 2010 has not ended yet, only the data up to the end of 2009 is used.

4. Research method

- Combining many research methods such as: synthesis, analysis, statistics…
- Exchanging ideas, asking for the advice from those who have experience in
credit risk management in Vietinbank- Nam Thang Long branch (the internship
place).
- Source of data is from the reports of Vietinbank and Vietinbank- Nam
Thang Long branch.


5. The structure of the internship thesis
The internship thesis contains some parts as the following:
-

Introduction part.
Chapter 1: The fundamentals of credit risk management in commercial

-

banks
Chapter2: The situation of credit risk management in Vietinbank and

-

Vietinbank- Nam Thang Long branch.
Chapter 3: The solution to improve the credit risk management in

-

Vietinbank.
Conclusion part.

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CHAPTER 1: THE FUNDAMENTALS OF CREDIT RISK
MANAGEMENT IN COMMERCIAL BANKS
1.1. The credit risk of commercial banks
1.1.1. Basic concepts of credit risk of commercial banks
Commercial bank is an institution which accepts deposits, makes business
loans, and offers related services. Commercial banks also allow for a variety of
deposit accounts, such as checking, savings, and time deposit. These institutions are
run to make profit and owned by a group of individuals. While commercial banks
offer services to individuals, they are primarily concerned with receiving deposits
and lending to businesses.
In the market economy context, the operations of commercial banks are very
sensitive to any socio-economic fluctuations, which can cause disturbance to the
business of banking. For banks, although credit supply is the basic economic
function which often provides the main income to the bank, it still has to follow the
rule above and always contains risks.
There are many concepts of credit risk that can be quoted as follows:
Saunders and H. Lange, two highly regarded consultants in banking and
finance defines that: "Credit risk is the potential loss when a bank grants credit to a
customer, that is, there is the possibility that the income stream expected from the
loan cannot be fulfilled on both the amount and duration."
Timmothy W. Koch, Professor of Finance at the University of South Carolina
defines that: "Credit risk is the potential change of net income and market value of
capital coming from the situation in which debt is not paid or paid late."
Credit risk as defined by the Basle Committee of Bank for International
Settlements: "Credit risk is the possibility that the borrower or counterparty does not
perform their obligations under the terms agreements."

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Under the Decision 493/2005/QĐ- NHNN by the bank governor, credit risk
is defined as follows: "credit risk in the banking activities of credit institutions is the
possibility of losses in the banking activities of credit institutions as the customers
fail to perform or are unable to perform its obligations under the commitment."
There can be many different ways to define credit risk, but all concepts of
credit risk are converging with one another in nature, which is: Credit risk is the
possibility (probability) of economic losses occurring to banks as borrowers do not
pay debts on time or fully repay the debt (principal and interest). Credit risk may
cause financial losses for commercial banks, reducing net income and market value
of capital, in severe cases it can lead to losses and at higher levels can lead to
bankruptcy.
Credit risk is associated with credit operation - an important activity of
banks, in which the scale of profitable assets which are allocated to loans is the
largest. Therefore when granting credit, banks often try to analyze the elements of
the borrower to ensure the highest level of safety.
To improve the credit quality, banks need to make operational measures
before, during and after lending. The task of preventing, restricting and handling
risks also includes all measures from executive management, control, professional
processes, handling bad debts to provisioning and handling risks. Limiting credit
risks is the overall of all measures to minimize the damage to banks in credit
operations. These measures will be presented more clearly in the following sections.

1.1.2. Characteristics of credit risk
Credit is the most important activity with the largest scale of commercial
banks based on the opposite choices between two entities, which are the borrowers
and the banks. The borrowers are willing to take risks for the use of capital for their
business opportunities. On the other hand the banks want the maximum safety for

their capital. This is the expression of asymmetric information between the two


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entities, thus it contains a very high risk to the banks. As bank credit is a specific
funding activity with high risk, the banks always try to analyze the elements of the
borrowers so that the safety level is the highest. In general, the banks only make
lending decisions when they finish their analysis and find that the credit risk will
not happen. However, no business banking genius can accurately predict whether
the problems will occur or not. Customer’s ability to repay their loan may be altered
by many factors. Moreover, many bank officers do not have the ability to perform
proper credit analysis. Therefore, in view of the entire bank management, credit risk
is inevitable, objective, preventable and limited but cannot be excluded.

1.1.3. The main signal to identify credit risk
In credit operation, loans always carry potential risks, but they do not just
happen suddenly without any warning. Therefore, for most cases, loans that are
gradually turning bad all show various warning signs of imminent troubles. If loan
officers want to detect problem loans, they must continuously scrutinize the loans
through the use of capital to determine the factors signaling potential risks. Below
are some signs of possible risks to the loan.
First: Customers do not pay principal and interest on time
This is the most visible sign to banks, as it reflects a very high possibility of
risk. The return of principal and interest is the basic criterion for assessing credit
quality, if customers fail to pay principal and interest on time as committed in the
credit contract then credit risks are bound to happen.
Second: Customers delay in submitting financial reports
Financial report is one of the most important documents that help credit
officers to evaluate and decide whether they need the assistance from the authorities

competent for the loan. The financial reports (balance sheet, cash flow statement,
income statement) help banks assess the customers’ financial capacity and demand


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for capital. On that basis, the bank will take appropriate measures and policies to
customers.
Delaying in submitting financial reports can be caused by many issues, so banks
also need to consider them. The customers may have problems, or their financial
condition is in trouble... Thus, they deliberately try to delay in submitting reports to
have time for amending and adjusting the data, thus reflecting incorrect business
results. Therefore, information about customers is inaccurate and the banks may
make lending decisions containing high potential risks.
Third: The enterprise’s quality of products and services declines
For enterprises, quality of products and services plays an important role to
their success; it is a criterion to evaluate the results of the business operations. In the
process of tracking enterprises, if bank officers find that the ability to sell their
products meets difficulty, inventories rise, sales decrease, debts increase, then it
reflects the declining of the enterprises’ competitiveness, problems in the
enterprises’ repayment capacity, meaning credit risks are possible.
Fourth: Difficult-to-define borrowing purposes
Each customer when asking for loans has to clearly define their purpose for
the loans, which is one of the bases for banks to consider granting credit. For
customer raising unclear purposes for their loans, the possibility of them using the
loans inappropriate with the purpose when they proposed for the loans could
happen. Therefore, the repayment capacity is not high and credit risks can occur.
Fifth: In credit relationships with more than one bank
In their business operations, customers usually have transactions with only
one bank. However, when customers expand relationships with many banks, the

customers need to be considered, as maybe the customers meet difficulty in paying
the loans on time, so they have to borrow from many banks for funding; or maybe


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they get in relationship with another bank just to avoid the control of capital
payment from the lending bank, therefore avoiding repaying the debts when they
are due.
Sixth: Unusual change in the organizational structure or under investigation
by the authorities
The executive management of the customers plays an important role in their
business operations. Whenever there is an unusual change in the organizational
structure; it is usually because the customers are facing such problems as losses or
lawsuits. If the new executive board does not have the good will to repay the debts
of the old board and considers it is the old board’s own problem to solve then credit
risks can easily occur.
In case the customers of the banks are being investigated by law enforcement
agencies, then the risks can easily occur as business operations are stalled,
enterprises’ asset are susceptible to be blockaded by law enforcement agencies.
Seventh: The customers’ partners are facing risk, bankruptcy, prosecution
In the market economy, trade relationships always happen, therefore when
partners of the customers are facing risks; the repayment capability of enterprises is
very low, leading to credit risks for the banks.
In this case, customers find it very difficult to refund money to the bank if
they do not have enough reserved cash.
Eighth: Natural disasters, socio-political fluctuations
Natural disasters, socio-political fluctuations always affect the business
operations of enterprises, especially for enterprises that activities depend on nature,
so when those fluctuations occur, enterprises may encounter difficulties in production,

affecting the repayment capability to banks, thus credit risks can occur easily.


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Ninth: Abnormal transaction relationship between customers and banks
Regular borrowing level increases, requests for loans exceed projected
production while demand has not changed, or demand for a loan no matter the
interest rate is high or low.
Tenth: Other signs of risk
Customers expand their business too quickly while their investment capital is
not sufficient, so they borrow funds for their business, creating imbalance between
their assets and equity, thus risks can occur.
Customers always make decisions immediately and hastily in their business
operations.
The disappearance or decreasing in price of mortgage, pledge or guarantee
when credit risks occur also makes the full recovery of debts difficult.
Customers purchasing prior to arranging financial capacity is a sign of risk
for banks, especially in investing in fixed assets. Because when customers have not
been able to prepare the financial resources but still decide to purchase, so if after
the purchasing they cannot arrange the financial resources, they will have to use
other sources to pay for such purchases, thus reducing their repayment capability of
the debts.
Family business management: All important positions in the enterprise are
occupied by relatives in the family; all decisions about the business are personal
regardless of the collective opinion. Spending, purchasing decisions are all made by
one person, thus it is very likely to lead to corruption and profiteering, business
operations of the enterprise are neglected; enterprise can easily suffer losses,
affecting its repayment capability to the bank.

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1.1.4. The cause of credit risk
1.1.4.1. Objective causes
Objective causes are causes such as natural disasters, war, or changes in
macroeconomic policies (import export policies, tariffs ...) affecting the borrowers,
making them reduce or lose their repayment capability to the banks. They are
beyond the control of the customers and the banks.
When these changes happen regularly and continuously affect the customers
as well as the banks, they can both facilitate or restrain the borrowers. Many
borrowers with their skills are able to predict, adapt or overcome difficulties. There
are cases when the borrowers suffer some losses but still maintain the ability to
repay the bank on time. However, most customers suffer losses from objective
causes have their repayment capability reduce, or are even unable to pay debts.
1.1.4.2. Causes by the customers
Limitation of the borrowers’ knowledge in the prediction of business issues,
weaknesses in management, bank staff’s intention of fraud ... are the causes of
credit risk. Many borrowers are willing to take risk with expectations of high
profits, so to achieve their goals they are willing to try all the tricks to cope with
banks such as providing false information, bribing bank officials ... Many borrowers
do not calculate carefully, prefer to expand investment scale, unable to calculate the
uncertainties that can occur, unable to adapt and overcome the difficulties in their
business. The rest are borrowers that make profit but still do not repay on time, they
delay payments, hoping that the creditors will erase their loans or simply that they
can take up the loan as long as possible. Sometimes customers are cheaters, they
borrow money and run away.


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1.1.4.3. Causes by the banks
In addition to the subjective causes by the customers, subjective causes by
the banks analyzed by the Basel Committee (2000) show that credit risk usually
occurs in two main areas, which are the concentration level and issues in the credit
granting process.
Concentrations level can be regarded as the most important cause of the
credit risk issue. Credit concentration risk exists when the level of credit risk in a
content of the credit portfolio becomes relatively large compared to the capital or
assets of the bank. Credit concentration risk does not only depend on the value of
the committed credit, but also on the high loss rate of capital when the risk occurs.
Credit concentration risk can be divided into two categories: normal credit
concentration risk and credit risk due to the risk factors which are common or
associated with each other. Normal credit concentration risk usually happens when
credit is concentrated too much on one customer, customer group, or sector /
industry such as the real estate sector. Meanwhile, credit concentration risk due to
the association of risk factors links to many specific factors and can only be
discovered through analysis. Example for this type of risk was the financial crisis in
Asia in 1997. In this crisis, the relation between market risk and credit risk, as well
as between credit risk and liquidity risk, has created profit losses or capital losses
across Asia.
Concentration risk often occurs due to the strategic planning process,
especially in developing countries, where banks identify and select a number of
industry / sector or priority customer groups and from there optimistically grant
credit to those customers. And credit risk often occurs to large banks because the
large capital value enables these banks to grant credit with very high value for a
client without violating the provisions of law.


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Problems in the credit granting process is also a cause of credit risk, which is
primarily related to the evaluation and credit monitoring process. Many banks find
it very hard to implement a thoroughly credit assessment process because of the
increasing competitive pressure in the banking sector. Due to this pressure, many
banks tend to rely on some simple criteria for granting credit. Besides, the absence
of system for testing and evaluating new credit techniques has caused many risks.
Other causes related to the credit process, including:
- Lack of re-evaluation of credit quality. Therefore, banks cannot get
information promptly and accurately about their credit status, or to put it in another
way, banks do not evaluate correctly the level of risk over time.
- Not tracking and supervising regularly the customers or collaterals. This
makes the banks have no basis to take early measures to prevent risks.
- Not applying interest rates based on risks. This problem mainly affects the
offset ability of banks in case there is risk (through the risk provisioning operation).
- Not taking into account the business cycle of the economy, the life cycle of
commercial products, especially for banks with a high level of concentration in real
estate. This is the weakness in the credit portfolio management.
- No draft plans in the worst case, making banks lack of careful preparation.
In many cases, a clear action mechanism used to disseminate and train the bank’s
staff regularly can help the bank respond quickly, in time and therefore may
overcome adverse shocks.
These causes can be found at any commercial banks in Vietnam. The issues
may come from the lack of communication and cooperation between different parts
in commercial banks. Sometimes, it may come from the low level of management
of the leaders.


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1.2. The credit risk management
1.2.1. Basic Concepts of credit risk management
According to the modern opinion which is applied universally at banks,
credit risk management is the process of formulating and implementing strategies,
policies and credit business management in order to maximize profits within the
acceptable risk level. Controlling credit risk at an acceptable level is that
commercial banks strengthen the measures to prevent, limit and lower delinquency
debts, bad debts in the credit business, thus increasing sales, lowering costs to offset
risks and achieving efficiency in the credit business. "Efficiency in the credit risk
management is an important component of the overall risk approach and is
considered a crucial role in the success of banks in the long term" (Basel Committee
on Banking Supervision, 2000).
In summary, the concept of credit risk management can be addressed at
different angles, but the essence is the same and we can interpret the concept of
credit risk management as the process of bank developing the planning, organizing,
implementing and supervising all the credit operations to maximize the profits of
banks with an acceptable risk level.
The process of credit risk management can be classified into four steps
as follows:
- Detecting credit risk is the realization of the risks existing in credit
operations. The development of technology, market and the globalization tendency
increase the number of risks and also the possibility of risks happening. Therefore
an effective system of risk management is a system able to identify all the risks that
exist in credit. Banks need to handle the risk situation of the credit portfolio, and
they need to clearly define what credit risk is.


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- Learning, measuring and analyzing is the next step after the risks are discovered.

In fact these steps are quite close together and are often done collectively in the
operating process. The purpose of this step is to let the entire risk management
apparatus understand accurately and consistently that the risks are identified,
analyze clearly the cause and the most important reason is to quantify the level of
risk that can happen to the bank.
- Monitoring: Once identified, analyzed and established the measurement
indicators, the risks need be monitored regularly. The purpose of this step is to let
the risk management apparatus know how the risk status of bank changes over time.
- Managing, reporting, and controlling risk: This is the step that shows the
most clearly the strategy as well as the bank's opinion about the credit risk. First
bank needs to build a system of management tools to limit risks such as risk limits,
authorization levels, credit granting standards, credit rating ... Then a policy about
resource preparation to compensate for the expected risks.
Credit risk control is the independent monitoring of credit risk and managing
it, the credit risk control process must ensure an independent assessment to comply
with the credit goals and directions of the bank’s leadership.

1.2.2. The necessary of credit risk management
Credit risk management is always a necessary task that cannot be missed for
commercial banks. According to the study of the Kaminsky, in the period from 1970
to 1995, there was on average one banking crisis each year in the world, and in the
period 1980 to 1995 this ratio was 1.44.
Some major causes of the increasing risks in bank’s business operations:
First: the process of liberalization and loosening regulation of banking
activities in the whole world. In recent decades, the trend of globalization,
economic liberalization, promoting competition has become more common.


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Increase in competition means that risk and bankruptcy will also increase. In the
banking sector, competition reduces the difference in margin interest rates. This
effect makes the banks increasingly tend to expand their business scale to offset the
drop in profits, however expanding the credit scale also means that credit risk might
increase. Besides, the elimination rule competition will increase the level of
bankruptcy of the banks’ customers, leading to the banks’ damage.
Second, with the business operations of banks tend to be more and more
complex and multi-functional, the growing technology along with the integration
trend and fierce competition, all have increased the level of risks and hazards. In the
field of credit, credit products are developing strongly, far exceeding the traditional
credit products. Credit products based on the development of technologies such as
credit cards, personal loans ... always contain new risks. But under competitive
pressure, the expansion and diversification of products as well as the scope of credit
operations become more urgent, vital to banks. With the variety and complexity of
the credit products as well as the credit risks, it is required that credit risk
management must be focused on and upgraded.
Third, for developing countries, especially countries in a transition state like
Vietnam, the economic environment is not stable, the legal system is developing,
the transparency level of information is low, therefore the banking operations is
even riskier than normal, therefore doing a good job of credit risk management at
the very beginning is a very important task.
In fact, the credit risk management operation is expressed specifically
through the credit risk management policy and the organizational model used to
implement that policy.


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1.3 The methods to manage credit risk
1.3.1. Setting limitation of the loan amount

Credit limit has many different methods and approaches. Within the scope of
this graduation thesis, the author would like to mention three basic limits, which
are: credit limit for large customers, credit limit for related customer groups, Credit
limit according to sectors or geographic areas.
Credit limit for large customers: The law system in all countries has made
regulations about this limit to prevent commercial banks from focusing too much on
one customer or a group of customers. This limit is set on the basis of the bank's
capital; usually the loan balance on a customer does not exceed 10-25% of a
commercial bank’s capital. In fact, in countries with a developed market economy,
banks often set the limit lower than the amount prescribed by law.
In this process of setting limits, banks have to calculate the total amount of
all outstanding loans in the forms of risk-containing credits, such as payment
guarantees, L/C, financial leasing…
Credit limit for related customer groups: Currently the related customer
group criterion is still being debated by banks and they have not fully agreed on the
building criteria. However, the current maximum limit for customer groups is
particularly important in the lending of banks; this type of customer has become
popular for some banks tending to use lending method based on credit rather than
traditional and commercial procedures and conditions. A bank with good credit risk
management is a bank that usually constructs limits for its related customer groups
based on its customer management system. As usual, the lending limit for the
related customer groups does not exceed 50% of the bank’s equity and 60% if the
guarantee balance is taken into account, or at a tight control deciding and
considering by the board of directors.


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Credit limit by industry or sector: This policy controls the maximum
outstanding loans to an industry or sector, or even to a geographic area (region,

country). It also prevents credit losses from a series of customers meeting
difficulties of the same reason. However, establishing a system of statistical report
information according the standard of industry or sector; or the borrowers
themselves have diversified businesses will make it hard for banks to classify based
on the criteria above.

1.3.2. Classification of loans
Banks may have different classifications of loans, but usually there are five
groups used to classify, which are: standard loan or conventional loan; watchful
loan; loan below standard; troublesome loan; loan causing capital loss/damage, the
last three are considered bad debts (non-performing loans).
Refers to the criteria for loan classification by Price Waterhouse Coopers in
annex 03 to assess the credit quality of commercial banks, it can be seen that a
consensus is needed for the definitions of certain loans:
- Overdue loans are loans that some or all of the loan principal and/or interest
have expired.
- Bad debt (NPL) is a loan which belongs to group 3, 4, 5 defined in Article 6
of the document 493/2005/ QĐ-NHNN, dated 22/04/2005 by the bank governor.
- Debt in which the repayment term is restructured is a debt that financial
institutions approve the adjustment or extension of the loan repayment term as they
evaluate the customers’ capacity to repay the debt as scheduled in the contract
reduced. However, after that banks have sufficient basis to evaluate customers
whether they have the ability to repay the full principal and interest with the the
restructured repayment term.


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1.3.3. Provision and allowance for credit losses
Provisioning to offset risk is to help banks actively cope with losses if there

is any. Price Waterhouse Coopers suggests the rate of the provision for credit risks
for all loan groups as follows: group 1 (standard loan)- deduct 1%, group 2- 2%,
group 3- 25%, group 4 (troublesome loan)- 50%, group 5 (capital loss loan)-100%.
There are two ways to use reserve fund to offset credit risk. The first one is
to keep the bad debts remain on the balance sheet and only use the reserve fund
until there is no longer any available treatment or it is unable to recover the debts.
The second way is to take out all the bad debts off the balance sheet on the basis of
using the reserve fund to "clear internal debts".
Another rule needs to be followed is that bank must recourse debt to the end
to offset the loss caused by the debt that bank has to handle with reserve fund.
Information about the handling of debts under the “clearing internal debts” criterion
must be secured.

1.4. Model used to evaluate credit risk
1.4.1. Qualitative model: 6C
When considering a loan application, credit officers and assessment officers
must answer three questions:
Question 1: Is the borrower creditworthy? How to know that?
Question 2: Can the credit contract be structured to secure the loans as well
as enable the customers to use the loans effectively?
Question 3: Does the bank have the right to the customer’s property and
income in case the loan faces problems and whether the bank can quickly recover
the capital with low costs or not?


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To answer the three questions above, many commercial banks in Vietnam as
well as in the world often study six aspects (6C) of the loan application.
Character: Credit officers must gather evidences that customers have clear

objectives when applying for loans and serious repayment plans. Responsibility,
honesty and serious borrowing purpose are the standards creating the “character” of
customers. If the credit officers feel that the customers are not honest, the loan will
not be carried out as if it is approved it will probably become a bad debt.
Capacity: Credit officers have to make sure that customers have the legal
status of the loan contract. Loan officers must be sure that the representative
commissioned by the company to carry out the agreements and sign credit contract
must have the board of directors’ approval of the company's loan application in
accordance with the provisions of law.
Cash flow: This is an important content for a loan application and often focus
on the question: Does the borrower have the ability to generate a sufficient cash
flow to repay the debt or not? Borrowers generally have three sources that can be
used to pay debt: Cash flow from sales or earnings, cash flow from selling assets,
mobilized funds from issuing debts or stocks. Any source of the three sources above
can be used to meet the cash demand to pay the bank’s debts. However, banks
always concern and give the most prominence to the cash flow generated from sales
and consider it a major source for debt repayment.
Collateral: In the assessment of collateral for loans, credit officers must ask
the question: Does the borrower own any assets with net value matching the loan?
Credit officers must be very sensitive to characteristics such as usage time, current
status and level of specialization reflected in the customer’s asset. Here, technology
plays an important role. If the customer’s assets are too outdated, the value of their
mortgage will be reduced as the banks may have difficulty in finding people to buy
back the properties if the loan is not repaid.


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Conditions: Credit officers must identify the trend of recent developments of
customers as well as the industry in which the customers are active, and realize the

impact of the changes in the economy to the loan. A loan seems to be very good on
paper but its value may decline due to the customer's sales or income decrease
during the economic downturn or the interest rates rise due to pressure of inflation.
To be able to analyze this content, banks are required to store data and information
from newspapers, magazines, research reports about the industries in which bank
serve primarily.
Control: the final factor in assessing the reliability of a customer is the
control; it focuses on such questions as: Does the change when there are new policy
rules affect the borrowers adversely and do the customers meet the standards of
credit quality set by the bank management agencies?
1.4.2. Quantitative model: credit scoring
Today, many banks have advanced in the scoring of borrowers on the basis of
detailed criteria of quantitative and qualitative indicators to be conducted. However,
because of the limited framework of the thesis, the author will only mention the
non-financial indicators and financial indicators of the corporate customer groups
and individual customer groups:
(+) General principles of summing credit scores for enterprises:
- In the non-financial indicators, depends on the importance of each indicator
the bank will assign a certain weight for each, and the total weight is 100%.
- The financial indicators with 11 indicators of four groups are calculated by
weighting, same as the non-financial indicators and the general indicators.
- After calculating and summing the scores of the non-financial indicators
(A) and financial indicators (B), banks continue to apply weights (%) to these two