LV thạc sỹ_Credit risk management in VID public bank

Credit risk management - Case study of VPB
EXECUTIVE SUMMARY
Risk in banking activities is very diverse and complex in every services from
business cards, deposits, trade finance, trade in foreign exchange … with many different
levels, but has far-reaching and serious the most is credit risk. Credit is the basic created
the greatest amount of profit as well as the biggest losses for bank. Therefore, in order
to successfully maximize their value, commercial banks not only continue constantly
seeking solutions in conjunction with increasing profits such as market share expansion,
products diversification and improvement in service quality… but also must focus on
research and application of policies in risk management to protect development of the
bank and minimize potential losses.
Before the context of increasingly growing both in breadth and complexity of
credit risk in recent times, to ensure the safety of banking activities a revolutionary
change took place and become the international standard in strategic activities of the
world financial sector as well as banking sector. Accordingly, credit risk management
not the main traditional policy of increasing revenue and cutting costs has become an
important policy which plays a key element for long-term success of the bank.
This stems from the reality that after a long run by improving profitability and
market share by any means, without calculation, to offset all the risks hidden, most
banks have suffered serious consequences such as the decline in quality or serious
decline in income from credit portfolio. The experience of failure occurred on a large
scale, in many countries that have led to profound changes above historic management
and administration of banks.
The study used Basel Principle and Guide approach to assess, evaluate credit risk
management in bank. In accordance with theoretical framework, the study found out
suitable actions that the bank should take in this situation.
The study showed that the bank has not managed credit risk well with their own
credit risk management committee and clearly model. Another analysis on credit
operation from 2008 to 2011 was conducted and indicated that NPL of the Bank is
rather high in recent time due to economic recession and real estate bubble.
With these result, the thesis aims to evaluate current VPB’s credit risk

management. Based on the evaluation, in accordance with Credit Risk Management
theories, the thesis proposes recommendations for VPB to improve its Credit Risk
Management activities

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Credit risk management - Case study of VPB
TABLE OF CONTENT

EXECUTIVE SUMMARY..............................................................................................I
TABLE OF CONTENT..................................................................................................II
LIST OF ABBREVIATION..........................................................................................IV
LIST OF FIGURE AND TABLES................................................................................V
INTRODUCTION...........................................................................................................1
1.1. RATIONALE OF THE STUDY......................................................................................1
1.2. RESEARCH OBJECTIVES/RESEARCH QUESTIONS......................................................1
1.3. RESEARCH METHODOLOGY.....................................................................................2
1.4. RESEARCH SCOPE (PLACE, TIME…)........................................................................3
1.5. STRUCTURE OF THE PROJECT..................................................................................3
CHAPTER I: THEORETICAL FRAMEWORK OF CREDIT RISK
MANAGEMENT OF COMMERCIAL BANKS..........................................................4
I.1. CONCEPT OF CREDIT RISK AND CREDIT RISK MANAGEMENT...................................4
I.1.1. Concept of credit risk.......................................................................................4
I.1.2. Concept of credit risk management..................................................................6
I.2. BASIC PRINCIPLES OF CREDIT RISK MANAGEMENT..................................................7
I.2.1. Establishing an appropriate credit risk environment.......................................7
I.2.2. Operating under a sound credit granting process...........................................8
I.2.3. Maintaining an appropriate credit administration, measurement and
monitoring process....................................................................................................8

I.2.4. Ensuring adequate controls over credit risk....................................................9
I.2.5. The role of supervisors.....................................................................................9
I.3. CREDIT RISK MANAGEMENT PROCESS.....................................................................9
I.4. IMPACTING FACTORS ON CREDIT RISK MANAGEMENT...........................................12
I.4.1 Concentrations................................................................................................12
I.4.2 Credit Process Issues......................................................................................13
CHAPTER II: CREDIT RISK MANAGEMENT AT VID PUBLIC BANK..........17
II.1. OVERVIEW OF VID PUBLIC BANK.......................................................................17
II.2. CREDIT RISK MANAGEMENT IN VID PUBLIC BANK.............................................18
II.2.1. Credit operation of VPB during period 2008 - 2011....................................18
II.2.2. Structure of credit in VPB:............................................................................19
I.2.3. Credit risk in VPB from 2008 – 2011.............................................................22
II.3. ASSESSMENT OF CREDIT RISK MANAGEMENT USED IN VPB................................25
CRM STRATEGY AND POLICIES....................................................................................26
II.3.1. Good points...................................................................................................27
II.3.2. Shortcoming and reasons..............................................................................28
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Credit risk management - Case study of VPB
CHAPTER III: RECOMMENDATIONS TO IMPROVE CREDIT RISK
MANAGEMENT IN VPB.............................................................................................29
III.1. IMPROVING THE CREDIT RISK MANAGEMENT STRATEGY ....................................29
III.2. IMPROVING CREDIT POLICIES..............................................................................29
III.3. IMPROVING THE CREDIT RISK MANAGEMENT STRUCTURE..................................30
III.4. CONTROL CREDIT GRANTING PROCESS...............................................................30
III.5. IMPROVING THE QUALITY OF THE CRM OFFICERS AND CREDIT STAFFS............31
CONSLUSION...............................................................................................................32
REFERENCES................................................................................................................33

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Credit risk management - Case study of VPB
LIST OF ABBREVIATION

BIDV

Bank for Investment and Development of Vietnam

BM

Branch Manager

BOD

Board of Directors

CB

Commercial Bank

CR

Credit Risk

CRM

Credit Risk Management

DGD

Deputy General Director

D/P

Discretionary Power

FI

Financial Institution

GD

General Director

IRR

Internal Risk Rating

NPL

Non- performing Loan

SBV

State Bank of Viet Nam

SM

Net interest income

SME

Small and Medium Enterprise

VPB

VID Public Bank

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Credit risk management - Case study of VPB

LIST OF FIGURE AND TABLES
Figure 1.1: CRM System of a commercial bank.............................................................10
Table 2.1: Financial Highlights of VPB from 2008 to 2011............................................17
Table 2.2: Loans and Advances of VPB from 2008 to 2011...........................................18
Table 2.3: Loans portfolio by term of VPB from 2008 to 2010......................................19
Table 2.4: Loans by industry sectors of VPB from 2008 to 2010...................................20
Table 2.5: Loans by industry sectors of VPB from 2008 to 2010...................................21
Table 2.6: Loans by industry sectors of VPB from 2008 to 2010...................................22
Table 2.7: Type and value of collaterals from customers from 2008 to 2010.................23

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Credit risk management - Case study of VPB
INTRODUCTION

1.1. Rationale of the study
Credit is an arrangement whereby bank acting at the request and on the instructions
of a customer or on its own behalf to make a payment to or to the order of a third party
or is to accept and pay bills of exchange drawn by the beneficiary. In an economy banks
play the role of an intermediary that channels resources from the surplus group to the
deficit group. So obviously, one of the core functions of commercial banks is to sanction
credit facility to its customers as per requirement.
Risk is inherent in all aspects of a commercial operation; however for Banks and
financial institutions, credit risk is an essential factor that needs to be managed. Credit
risk is the possibility that a borrower or counter party may fail to meet its obligations in
accordance with agreed terms. Credit risk therefore, arises from the bank’s dealings with
or lending to corporate, individuals and other banks or financial institutions.
VID Public Bank is a joint venture bank between Bank for Investment and
Development of Viet Nam (BIDV) and Public Bank Berhad, Malaysia (PBB),
established in 1992.
For 19 years in operation, with prudent principle as well as enthusiastic & welltrained staff force and enormous support from PBB in term of management skills, VPB
(VPB) has achieved remarkable results stably. However, in the present fierce
competition in banking industry as well as global economic problem, VPB has also
encountered many difficulties and risks. Therefore, in order to survive and improve
sustainable development, quality of credit risk management activities should be in top
priority.
In general, recent years VPB’s credit activity recorded well with the Loans and
Advance was USD 250M as at 30/9/2011, increase as compared to that figure of August
2011. However, due to the bad economic situation with high credit risk, the nonperforming loan as at 30 June 2011 was deteriorated as compared to May which
increased NPL ratio to around 6.3%, higher than the banking industry’s NPL of below
5%.
The bank also continues pushing more effort in NPL recovery by keeping more
careful and prudent in loans and maintaining USD loans for good importers/ exporters
to make use of our USD funds. However, this has reinforced the urgent setting and the
importance of credit risk management in VPB. Based on the above mentioned,

significant of main theoretical and practical work that is the reason for me to select the
theme: "Credit risk management in VID Public Bank" to write Master thesis.
1.2. Research objectives/Research questions
The objectives of the study are to study and analyze the fact findings in credit risk
management of VPB. Then, on the basis of that assessment the thesis proposed solutions

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Credit risk management - Case study of VPB
and recommendations to improve operations credit risk management at the Bank in the
near future towards sustainable development.
The key research question is: “How does VPB manage its credit risk?”
This key research question is cleared by following questions:


How is the credit risk management process in commercial banks?



What are components/elements of credit risk management?



Which are fact findings of credit risk management of VPB?



What are good points and shortcoming in CRM in VPB?



What are recommendations to improve CRM in VPB?

1.3. Research methodology
Research methodology contains the data used and the research data collection techniques.

Thesis used the group method of research and theoretical analysis such as: classification
and systematization of the theory, practical study and analysis.
Information collected to furnish this report is both from primary and secondary sources.
It is mainly based upon secondary sources.


Secondary data are collected from the literature (books, journals, previous
research papers, electronic sites, etc.), the State Bank of Vietnam’s regulation
database and database of VPB, the bank’s reports such as: Annual Report,
Audited Financial Statement, Profit & Loss, Balance sheets; loans & deposits
reports…



Primary data are gathered by the researcher through both qualitative and
quantitative methods. An in-depth interview was conducted with Manager of
Credit Department and two credit staffs in VPB to gain insight into the office’s
daily credit operations. Interviewing questions was also designed in order to
provide data of CRM in VPB.
Object
Quantity
Content
Manager of Credit

1
 Is there any independent CRM committee in
Department
VPB? Under whom? How VPB control credit
risk?
 Why did the rate of NPL of the Bank increase
in compare with the previous time? What are
the impacted factors?
Credit officers
2
 How is the process of a loan approval?
 How is the process of CRM in VPB? How
many steps? What are they?
 How is credit operation during 2008 – 2011?
 How much are bad debts in recent years? What
is the ratio of bad debts/total outstanding loans?
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Credit risk management - Case study of VPB
1.4. Research scope (place, time…)
The thesis concentrated on credit risk management at VPB with data collected from
2008 – 2011
1.5. Structure of the project
Introduction
Brief explanations of the objectives that author choose this topic for final project.

Chapter I: Theoretical Framework
Chapter I emphasis on the theories supporting this thesis, including: definitions on credit
risk, credit risk management; basic principles of CRM; the process of CRM as well as

factors effecting to CRM

Chapter II: Credit Risk Management at VID Public Bank
Chapter II concentrated to VPB’s operation, credit activities and its credit risk
management based on theories mentioned in chapter I to point out good points as well
as shortcomings in CRM at VPB.
Chapter III: Recommendations to improve credit risk management at VID Public
Bank
Upon assessment in chapter II, author gave some recommendations to improve CRM at
VPB.
Conclusion
The researcher explain again the reason why this theme was chosen to write Master
thesis

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Credit risk management - Case study of VPB

CHAPTER I: THEORETICAL FRAMEWORK OF CREDIT RISK
MANAGEMENT OF COMMERCIAL BANKS
I.1. Concept of credit risk and credit risk management
I.1.1. Concept of credit risk
I.1.1.1 Definition of credit risk
Credit is defined by the Economist Dictionary of Economics as “the use or possession
of goods or services without immediate payment” and it “enables a producer to bridge
the gap between the production and sale of goods” and “virtually all exchange in
manufacturing, industry and services is conducted on credit”.1
Consequently, credit generates debt that a party owes the other. The former is called a
debtor or borrower. The latter is a creditor or lender. Certainly, the debtor will have to

pay an extra amount of money for delaying the payment. In that circle, both debtor and
creditor expect a return which is worth their paying more and waiting, respectively.
So, it is clear why credit exists and how important it is to the economy. Firms or
individuals that run short of capital need credit to continue or expand their
businesses/investments. The ones that have excess money, on the other hand, never
want to keep it in the safes. As a result, all are growing and making more money.
Demand and supply together exist but do they meet each other? Here borne financial
intermediaries who act as the bridge between credit suppliers and clients. Now in this
innovative phase of the global financial-services industry, numerous types of financial
institutions have joined the credit supplier group: insurance companies, mutual funds,
investment finance companies, etc. Nevertheless, banks are still the dominant source
that both individuals and corporates seek credit from.
In banks, credit failures are not rare and they critically affect the bank’s liquidity, cash
flows and eventually, profit and shareholders’ dividends. Banks call them ‘bad debts’.
Modern banking no longer experiences credit risk solely in its traditional activity of
loan making. In reality, credit risk falls in a broader scope.
There are many concepts of credit risk given in the legislation or in the
publications of the research institutions or practices in the banking sector. According to
Clause 1, Article 2, Decision 493/2005/QD-NHNN dated 22/04/2005 of SBV, the
"credit risk is the possibility of losses in the banking activities of credit institutions due
to customer fails to perform or inability to perform duties according to their
commitment".
Credit risk is the first of all risks in terms of importance 2. Default risk, a major source of
loss, is the risk that customers default, meaning that they fail to comply with their
obligations to service debt. Default triggers a total or partial loss of any amount lent to
the counterparty. Credit risk is also the risk of a decline in the credit standing of an
obligor of the issuer of a bond or stock. Such deterioration does not imply default, but it
1

Colquitt, Joetta. 2007 Credit Risk Management: How to Avoid Lending Disasters & Maximize

Earnings, p 4
2
Joel Bessis, Risk Management in Banking, Second Edition, John Wiley&Sons, Ltd, 2002, p13-15.

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Credit risk management - Case study of VPB
does imply that the probability of default increases. The view of credit risk differs for
the banking portfolio and the trading portfolio.
I.1.1.2. Credit risk indicators
Credit risk is the current and prospective risk to earnings or capital arising from an
obligor’s failure to meet the terms of any contract with the Bank or otherwise to
perform as agreed. Credit risk is found in all activities in which success depends on
counterparty, issuer, or borrower performance. It arises any time bank funds are
extended, committed, invested, or otherwise exposed through actual or implied
contractual agreements, whether reflected on or off the balance sheet.3
Quantity of Credit Risk Indicators
The quantity of credit risk is derived from the absolute amount of credit exposure and
the quality of that exposure. How much credit exposure a bank has is a function of:


The level of loans and other credit/credit-equivalent exposures relative to total
assets and capital and The extent to which earnings are dependent on loan or
other credit/credit-equivalent income sources.



Banks that have higher loans-to-assets and loans-to-equity ratios and that depend
heavily on the revenues from credit activities will have a higher quantity of

credit risk.

To determine the quantity of credit risk, the quantitative and qualitative risk indicators
should be reviewed. These indictors can be rapid growth; high past-due levels, exceeds
historical norms, or changes in trends or changes in portfolio mix.
The following evaluation factors, as appropriate, should be used when assessing the
quantity of credit risk. As assessment of low, moderate, or high should reflect the
Bank’s standing relative to existing financial risk benchmarks and or historical
standards, and should take into consideration relevant trends in risk direction. The rate
of change as well as the base level of risk from which change occurs should also be
considered.
Some evaluation factors:

3



The level of loans outstanding relative to total assets



The ratio of loans to equity capital



Underwriting policies incorporate conservative collateral requirements. Are
collateral valuations timely and well supported?



Interest earned relative to total loans



Coverage of problem and noncurrent loans and loan losses

www.bankersonline.com/tools/riskmgt_creditrisk.doc

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Credit risk management - Case study of VPB


Provision expense



The level of loans past due 30 to 89 days



The level of noncurrent loans 90 day + past due and nonperforming



Classified loans



Loan losses to total loans

Quality of Credit Risk Indicators
The quality of exposure is a function of the risk of default and risk of loss in assets and
exposures comprising the credit exposure. The following indicators, as appropriate,
should be used when assessing the quality of credit risk management: Strong,
Satisfactory or Weak.


How does lending policies establish and communicate portfolio objectives, risk
tolerances, and loan underwriting and risk selection standards?



How does Bank identifies, approves, tracks, and reports significant policy,
underwriting, and risk selection exceptions individually and in aggregate?



How is credit analysis both at underwriting and periodically thereafter?



How are Internal or outsourced risk rating and problem loan identification
systems?



How does Management information system (MIS) provide portfolio
information?



How is diversification management? Is concentration limits are set at reasonable
levels?



How is credit culture? Is the Board and Management’s tolerance for risk wellcommunicated and fully understood?



Are strategic and/or business plans consistent with a conservative risk appetite
and promote an appropriate balance between risk-taking and growth and
earnings objectives?



Are staffing levels and expertise appropriate for the size and complexity of the
loan portfolio?

I.1.2. Concept of credit risk management
I.1.2.1. Definition of credit risk management
In banking, credit risk is taken for granted as a fundamental feature of the institutions. If
an organization refuses to acknowledge the inherent risk, it is not in the lending
industry. Wherever risk survives, its enemy, risk management, will also exist and fight

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Credit risk management - Case study of VPB
against it. Credit risk management is simply the procedure implemented by
organizations with the aim of diminishing or avoiding credit risk.
Credit risk management has been a hot topic of debate as it is one of the fastest evolving
practices thanks to institutional developments in the credit market, diversification of
financial institutions participating in the lending business and modern technologies.
I.1.2.2. The important of credit risk management
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 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 organization4.
A key reason why the correct management of credit risk is so important is because
banks have such a limited capacity to absorb loan losses. In broad terms, the capacity of
a bank to absorb a loan loss comes, in the first instance, from income generated by other
profitable loans and, in the second instance, by bank capital.
I.2. Basic principles of credit risk management
Depending on the nature and complexity of the credit activities, each Financial
Institution will build their own credit risk management appropriate with that
organization. According to Basel Committee on Banking Supervision, Basel September
2000, full credit risk management program will have to mention five basic elements: (i)
Establishing an appropriate credit risk environment; (ii) Operating under a sound credit
granting process, (iii) Maintaining an appropriate credit administration, measurement
and monitoring process, (iv) Ensuring adequate controls over credit risk, (vi)The role of
supervisors.
I.2.1. Establishing an appropriate credit risk environment
Principle 1: The board of directors should have responsibility for approving and
periodically (at least annually) reviewing the credit risk strategy and significant credit

risk policies of the bank. The strategy should reflect the bank’s tolerance for risk and the
level of profitability the bank expects to achieve for incurring various credit risks.
Principle 2: Senior management should have responsibility for implementing the credit
risk strategy approved by the board of directors and for developing policies and
procedures for identifying, measuring, monitoring and controlling credit risk. Such
policies and procedures should address credit risk in all of the bank’s activities and at
both the individual credit and portfolio levels.
4

Source: Principle 1 for the Assessment of Banks’ Management of Credit Risk, Principles for the
management of credit risk, Basel, September 2000, page 3

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Credit risk management - Case study of VPB
Principle 3: Banks should identify and manage credit risk inherent in all products and
activities. Banks should ensure that the risks of products and activities new to them are
subject to adequate risk management procedures and controls before being introduced
or undertaken, and approved in advance by the board of directors or its appropriate
committee.
I.2.2. Operating under a sound credit granting process
Principle 4: Banks must operate within sound, well-defined credit-granting criteria.
These criteria should include a clear indication of the bank’s target market and a
thorough understanding of the borrower or counterparty, as well as the purpose and
structure of the credit, and its source of repayment.
Principle 5: Banks should establish overall credit limits at the level of individual
borrowers and counterparties, and groups of connected counterparties that aggregate in
a comparable and meaningful manner different types of exposures, both in the banking
and trading book and on and off the balance sheet.

Principle 6: Banks should have a clearly-established process in place for approving new
credits as well as the amendment, renewal and re-financing of existing credits.
Principle 7: All extensions of credit must be made on an arm’s-length basis. In
particular, credits to related companies and individuals must be authorized on an
exception basis, monitored with particular care and other appropriate steps taken to
control or mitigate the risks of non-arm’s length lending.
I.2.3. Maintaining an appropriate credit administration, measurement and
monitoring process
Principle 8: Banks should have in place a system for the ongoing administration of their
various credit risk-bearing portfolios.
Principle 9: Banks must have in place a system for monitoring the condition of
individual credits, including determining the adequacy of provisions and reserves.
Principle 10: Banks are encouraged to develop and utilize an internal risk rating system
in managing credit risk. The rating system should be consistent with the nature, size and
complexity of a bank’s activities.
Principle 11: Banks must have information systems and analytical techniques that
enable management to measure the credit risk inherent in all on- and off-balance sheet
activities. The management information system should provide adequate information on
the composition of the credit portfolio, including identification of any concentrations of
risk.
Principle 12: Banks must have in place a system for monitoring the overall composition
and quality of the credit portfolio.

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Credit risk management - Case study of VPB
Principle 13: Banks should take into consideration potential future changes in economic
conditions when assessing individual credits and their credit portfolios, and should
assess their credit risk exposures under stressful conditions.

I.2.4. Ensuring adequate controls over credit risk
Principle 14: Banks must establish a system of independent, ongoing assessment of the
bank’s credit risk management processes and the results of such reviews should be
communicated directly to the board of directors and senior management.
Principle 15: Banks must ensure that the credit-granting function is being properly
managed and that credit exposures are within levels consistent with prudential standards
and internal limits. Banks should establish and enforce internal controls and other
practices to ensure that exceptions to policies, procedures and limits are reported in a
timely manner to the appropriate level of management for action.
Principle 16: Banks must have a system in place for early remedial action on
deteriorating credits, managing problem credits and similar workout situations.
I.2.5. The role of supervisors
Principle 17: Supervisors should require that banks have an effective system in place to
identify measure, monitor and control credit risk as part of an overall approach to risk
management. Supervisors should conduct an independent evaluation of a bank’s
strategies, policies, procedures and practices related to the granting of credit and the
ongoing management of the portfolio. Supervisors should consider setting prudential
limits to restrict bank exposures to single borrowers or groups of connected
counterparties.
I.3. Credit risk management process
All the principles mentioned above in part I.2 should be used in evaluating a
bank’s credit risk management system.
It is established in the financial economics literature that the CRM system of a CB is
made up of credit policy and strategies that provide general and detailed operational
guidelines. It also includes the facilitating factors such as quality of staff, information
and technology as in Figure 1.1 below.5

5

www.emeraldinsight.com/1746-8809.htm (Credit risk management system of a commercial bank in

Tanzania)

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Credit risk management - Case study of VPB

CRM Policy

CRM Strategies

CRM Process
Risk Identification
Risk Measurement
Risk Assessment
Risk Monitoring
Risk Control

Level of Loan Losses

Facilitating Factors
Quality of Staff
Education Level
Experience
Training Attended
Information and Technology
Participation in CRM policy and
Strategies

Figure 1.1: CRM System of a commercial bank

The management of CR in banking industry follows the process of risk identification,
measurement, assessment, monitoring and control. It involves identification of potential
risk factors, estimate their consequences, monitor activities exposed to the identified
risk factors and put in place control measures to prevent or reduce the undesirable
effects. This process is applied within the strategic and operational framework of the
bank.
Risk Identifications
The basis for an effective credit risk management process is the identification of
existing and potential risks inherent in any product or activity. Consequently, it is
important that banks identify all credit risk inherent in the products they offer and the
activities in which they engage. Such identification stems from a careful review of the
credit risk characteristics of the product or activity.
Banks must develop a clear understanding of the credit risks involved in more complex
credit-granting activities (for example, loans to certain industry sectors, asset
securitization, customer-written options, credit derivatives, credit-linked notes). This is
particularly important because the credit risk involved, while not new to banking, may
be less obvious and require more analysis than the risk of more traditional creditgranting activities.
Pressure for increased profitability, marketing considerations and a vastly more complex
financial environment has resulted in innovative credit instruments and approaches to
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Credit risk management - Case study of VPB
credit. Measuring the risks attached to each credit activity permits the determination of
aggregate exposures to counterparties for control and reporting purposes, concentration
limits and risk/reward returns.
Risk Measurement
Banks should have methodologies that enable them to quantify the risk involved in
exposures to individual borrowers or counterparties. Banks should also be able to
analyze credit risk at the product and portfolio level in order to identify any particular

sensitivities or concentrations. The measurement of credit risk should take account of
follows:
(i) the specific nature of the credit (loan, derivative, facility, etc.) and its contractual
and financial conditions (maturity, reference rate, etc.);
(ii)

the exposure profile until maturity in relation to potential market
movements;

(iii)the existence of collateral or guarantees; and (iv) the potential for default based
on the internal risk rating.
The analysis of credit risk data should be undertaken at an appropriate frequency with
the results reviewed against relevant limits. Banks should use measurement techniques
that are appropriate to the complexity and level of the risks involved in their activities,
based on robust data, and subject to periodic validation.
Risk Assessment
Banks must establish a system of independent, ongoing assessment of the bank’s credit
risk management processes and the results of such reviews should be communicated
directly to the board of directors and senior management.
Risk Monitoring
Banks need to develop and implement comprehensive procedures and information
systems to monitor the condition of individual credits and single obligors across the
bank’s various portfolios. These procedures need to define criteria for identifying and
reporting potential problem credits and other transactions to ensure that they are subject
to more frequent monitoring as well as possible corrective action, classification and/or
provisioning.
An effective credit monitoring system will include measures to:


ensure that the bank understands the current financial condition of the borrower

or counterparty;



monitor compliance with existing covenants;



assess, where applicable, collateral coverage relative to the obligor’s current
condition;

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Credit risk management - Case study of VPB


identify contractual payment delinquencies and classify potential problem
credits on a timely basis; and



direct promptly problems for remedial management.

Otherwise, An important tool in monitoring the quality of individual credits, as well as
the total portfolio, is the use of an internal risk rating system. A well-structured internal
risk rating system is a good means of differentiating the degree of credit risk in the
different credit exposures of a bank.
Risk Control
To ensure adequate controls over credit risk, Banks must:



Establish a system of independent, ongoing assessment of the bank’s credit risk
management processes and the results of such reviews should be communicated
directly to the board of directors and senior management.



Ensure that the credit-granting function is being properly managed and that
credit exposures are within levels consistent with prudential standards and
internal limits. Banks should also establish and enforce internal controls and
other practices to ensure that exceptions to policies, procedures and limits are
reported in a timely manner to the appropriate level of management for action.



Have a system in place for early remedial action on deteriorating credits,
managing problem credits and similar workout situations.

I.4. Impacting factors on credit risk management
Most major banking problems have been either explicitly or indirectly caused by
weaknesses in credit risk management. Basel committee (2000) has pointed out that
severe credit losses in a banking system usually reflect simultaneous problems in
several areas, such as concentrations, failures of due diligence and inadequate
monitoring.
I.4.1 Concentrations
Concentrations are probably the single most important cause of major credit problems.
Credit concentrations are viewed as any exposure where the potential losses are large
relative to the bank’s capital, its total assets or, where adequate measures exist, the
bank’s overall risk level. Relatively large losses may reflect not only large exposures,

but also the potential for unusually high percentage losses given default.
Credit concentrations can further be grouped roughly into two categories:


Conventional credit concentrations would include concentrations of credits to
single borrowers or counterparties, a group of connected counterparties, and
sectors or industries, such as commercial real estate, and oil and gas.

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Credit risk management - Case study of VPB


Concentrations based on common or correlated risk factors reflect subtler or
more situation-specific factors, and often can only be uncovered through
analysis. Disturbances in Asia and Russia in late 1998 illustrate how close
linkages among emerging markets under stress conditions and previously
undetected correlations between market and credit risks, as well as between
those risks and liquidity risk, can produce widespread losses.

Examples of concentrations based on the potential for unusually deep losses often
embody factors such as leverage, optionality, correlation of risk factors and structured
financings that concentrate risk in certain tranches. For example, a highly leveraged
borrower will likely produce larger credit losses for a given severe price or economic
shock than a less leveraged borrower whose capital can absorb a significant portion of
any loss. The risk in a pool of assets can be concentrated in a securitization into
subordinated tranches and claims on leveraged special purpose vehicles, which in a
downturn would suffer substantial losses.
The recurrent nature of credit concentration problems, especially involving

conventional credit concentrations, raises the issue of why banks allow concentrations
to develop. First, in developing their business strategy, most banks face an inherent
trade-off between choosing to specialize in a few key areas with the goal of achieving a
market leadership position and diversifying their income streams, especially when they
are engaged in some volatile market segments. This trade-off has been exacerbated by
intensified competition among banks and non-banks alike for traditional banking
activities, such as providing credit to investment grade corporations. Concentrations
appear most frequently to arise because banks identify “hot” and rapidly growing
industries and use overly optimistic assumptions about an industry’s future prospects,
especially asset appreciation and the potential to earn above-average fees and/or
spreads. Banks seem most susceptible to overlooking the dangers in such situations
when they are focused on asset growth or market share.
Banking supervisors should have specific regulations limiting concentrations to one
borrower or set of related borrowers, and, in fact, should also expect banks to set much
lower limits on single-obligor exposure. Most credit risk managers in banks also
monitor industry concentrations. Many banks are exploring techniques to identify
concentrations based on common risk factors or correlations among factors. While small
banks may find it difficult not to be at or near limits on concentrations, very large
banking organizations must recognize that, because of their large capital base, their
exposures to single obligors can reach imprudent levels while remaining within
regulatory limits.
I.4.2 Credit Process Issues
Many credit problems reveal basic weaknesses in the credit granting and monitoring
processes. While shortcomings in underwriting and management of market-related

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Credit risk management - Case study of VPB
credit exposures represent important sources of losses at banks, many credit problems

would have been avoided or mitigated by a strong internal credit process.
Many banks find carrying out a thorough credit assessment (or basic due diligence) a
substantial challenge. For traditional bank lending, competitive pressures and the
growth of loan syndication techniques create time constraints that interfere with basic
due diligence. Globalization of credit markets increases the need for financial
information based on sound accounting standards and timely macroeconomic and flow
of funds data. When this information is not available or reliable, banks may dispense
with financial and economic analysis and support credit decisions with simple indicators
of credit quality, especially if they perceive a need to gain a competitive foothold in a
rapidly growing foreign market. Finally, banks may need new types of information,
such as risk measurements, and more frequent financial information, to assess relatively
newer counterparties, such as institutional investors and highly leveraged institutions.
The absence of testing and validation of new lending techniques is another important
problem. Adoption of untested lending techniques in new or innovative areas of the
market, especially techniques that dispense with sound principles of due diligence or
traditional benchmarks for leverage have led to serious problems at many banks. Sound
practice calls for the application of basic principles to new types of credit activity. Any
new technique involves uncertainty about its effectiveness. That uncertainty should be
reflected in somewhat greater conservatism and corroborating indicators of credit
quality. An example of the problem is the expanded use of credit-scoring models in
consumer lending in the United States and some other countries. Large credit losses
experienced by some banks for particular tranches of certain mass-marketed products
indicate the potential for scoring weaknesses.
Some credit problems arise from subjective decision-making by senior management of
the bank. This includes extending credits to companies they own or with which they are
affiliated, to personal friends, to persons with a reputation for financial acumen or to
meet a personal agenda, such as cultivating special relationships with celebrities.
Many banks that experienced asset quality problems in the 1990s lacked an effective
credit review process (and indeed, many banks had no credit review function). Credit
review at larger banks usually is a department made up of analysts, independent of the

lending officers, who make an independent assessment of the quality of a credit or a
credit relationship based on documentation such as financial statements, credit analysis
provided by the account officer and collateral appraisals. At smaller banks, this function
may be more limited and performed by internal or external auditors. The purpose of
credit review is to provide appropriate checks and balances to ensure that credits are
made in accordance with bank policy and to provide an independent judgment of asset
quality, uninfluenced by relationships with the borrower. Effective credit review not
only helps to detect poorly underwritten credits, it also helps prevent weak credits from
being granted, since credit officers are likely to be more diligent if they know their work
will be subject to review.
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Credit risk management - Case study of VPB
A common and very important problem among troubled banks in the early 1990s was
their failure to monitor borrowers or collateral values. Many banks neglected to obtain
periodic financial information from borrowers or real estate appraisals in order to
evaluate the quality of loans on their books and the adequacy of collateral. As a result,
many banks failed to recognize early signs that asset quality was deteriorating and
missed opportunities to work with borrowers to stem their financial deterioration and to
protect the bank’s position. This lack of monitoring led to a costly process by senior
management to determine the dimension and severity of the problem loans and resulted
in large losses.
In some cases, the failure to perform adequate due diligence and financial analysis and
to monitor the borrower can result in a breakdown of controls to detect credit-related
fraud. For example, banks experiencing fraud-related losses have neglected to inspect
collateral, such as goods in a warehouse or on a showroom floor, have not authenticated
or valued financial assets presented as collateral, or have not required audited financial
statements and carefully analyzed them. An effective credit review department and
independent collateral appraisals are important protective measures, especially to ensure

that credit officers and other insiders are not colluding with borrowers.
In addition to shortcomings in due diligence and credit analysis, bank credit problems
reflect other recurring problems in credit-granting decisions. Some banks analyze
credits and decide on appropriate non-price credit terms, but do not use risk-sensitive
pricing. Banks that lack a sound pricing methodology and the discipline to follow
consistently such a methodology will tend to attract a disproportionate share of underpriced risks. These banks will be increasingly disadvantaged relative to banks that have
superior pricing skills.
Many banks have experienced credit losses because of the failure to use sufficient
caution with certain leveraged credit arrangements. As noted above, credit extended to
highly leveraged borrowers is likely to have large losses in default. Similarly, leveraged
structures such as some buyout or debt restructuring strategies, or structures involving
customer-written options, generally introduce concentrated credit risks into the bank’s
credit portfolio and should only be used with financially strong customers. Often,
however, such structures are most appealing to weaker borrowers because the financing
enables a substantial upside gain if all goes well, while the borrower’s losses are limited
to its net worth.
Many banks’ credit activities involve lending against non-financial assets. In such
lending, many banks have failed to make an adequate assessment of the correlation
between the financial condition of the borrower and the price changes and liquidity of
the market for the collateral assets. Much asset-based business lending (i.e. commercial
finance, equipment leasing, and factoring) and commercial real estate lending appear to
involve a relatively high correlation between borrower creditworthiness and asset
values. Since the borrower’s income, the principal source of repayment is generally tied
to the assets in question, deterioration in the borrower’s income stream, if due to
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Credit risk management - Case study of VPB
industry or regional economic problems may be accompanied by declines in asset
values for the collateral. Some asset based consumer lending (i.e. home equity loans,

auto financing) exhibits a similar, if weaker, relationship between the financial health of
consumers and the markets for consumer assets.
A related problem is that many banks do not take sufficient account of business cycle
effects in lending. As income prospects and asset values rise in the ascending portion of
the business cycle, credit analysis may incorporate overly optimistic assumptions.
Industries such as retailing, commercial real estate and real estate investment trusts,
utilities, and consumer lending often experience strong cyclical effects. Sometimes the
cycle is less related to general business conditions than the product cycle in a relatively
new, rapidly growing sector, such as health care and telecommunications. Effective
stress testing which takes account of business or product cycle effects is one approach to
incorporating into credit decisions a fuller understanding of a borrower’s credit risk.
More generally, many underwriting problems reflect the absence of a thoughtful
consideration of downside scenarios. In addition to the business cycle, borrowers may
be vulnerable to changes in risk factors such as specific commodity prices, shifts in the
competitive landscape and the uncertainty of success in business strategy or
management direction. Many lenders fail to “stress test” or analyze the credit using
sufficiently adverse assumptions and thus fail to detect vulnerabilities.

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Credit risk management - Case study of VPB

CHAPTER II: CREDIT RISK MANAGEMENT AT VID PUBLIC BANK
II.1. Overview of VID Public Bank
VPB is the first joint-venture bank granted recognition award from Prime Minister in
1992. The two joint- partners are the Bank for Investment & Development of Vietnam
and Public Bank Berhad (Malaysia). Below are some financial highlights of VPB in
periods.
Table 2.1: Financial Highlights of VPB from 2008 to 2011

Unit: 000’USD
Items

2008

2009

2010

Total Assets

288,709

354,918

389,663

362,833

Loans & Advances to customers

172,888

223,163

250,669

245,495

Amount owing to other depositors

196,789

238,405

249,124

198,626

73,552

74,428

75,857

75,897

7,005

6,895

7,229

7,125

13.9

9.3

9.6

6.58

3.5

2.8

2.6

1.96

46.6

36.6

34.0

33.43

Equity
Profit after taxation
Net return on equity (ROE) (%)
Return on average assets (ROA) (%)
Capital Adequacy ratio (%)

As at 09/2011

(Source: Annual reports of VPB from 2008 to 2010, Financial Statement quarter III 2011)
Table 2.1 shows the overview of financial status of VPB. This is a small commercial
bank with total assets below USD400Mil. Growth in deposits and loans through years

indicates the stable development of the bank. The bank maintains profit even in
difficulties of financial crisis in 2008 and 2009. Capital Adequacy ratios were rather
high. It shows the safety in operation of the bank. However, it also means that resources
of the banks were used ineffective. If these potential financial resources are used
reasonable, VPB can develop more in the future.
Total Profit as at 30 September 2011 was USD7.12Mil achieving 90% of the prorated
budget attributed to the increase in income from FX trading, low cost of fund on
borrowing from SBV and writing back of general provision.
Deposit position as at 30 September 2011 was USD199Mil recording a decrease of
USD50Mil or 20% compared to December 2010. Loans and Advance as at 30
September 2011 was USD245Mil recording a decrease of USD1.5Mil or 0.6%
compared to December 2010.

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Credit risk management - Case study of VPB
Some reasons for low growth rate


Mobilizing deposits in VND is in critical due to the tightening of monetary
policy implemented by State Bank of Vietnam (i.e. the cap on deposit interest
rate of 14% p.a. for all VND deposits and 2%/ 0.5% p.a. for USD deposit from
individuals and entities) and the shrinkage of the economy (i.e. high inflation,
high inventories, raising cost of input material/ labour).



The decline in our VND loans was inevitable due to the very tight liquidity
situation of the VND/ drop in VND deposits.



With the economic recession and high lending interest rates, existing customers
would not want to expand their business through bank’s loans. As such, it is
difficult for banks to improve the loan’s growth.



Lending restrictions in USD loans which were confined to the following
purposes only: Imports; Exports; Refinancing of overseas loans; foreign
investments. Moreover, SBV officially limits the demands for foreign currencies
in domestic transactions by issuing a new guideline on the mechanism for loans
in foreign currencies.

II.2. Credit risk management in VID Public Bank
II.2.1. Credit operation of VPB during period 2008 - 2011
As many of other Vietnam's commercial banks, credit is the basic service that generates
the majority of assets in total assets of VPB. Moreover, credit is also the main source of
income of the Bank and basis for bank’s further expansion and business development
activities such as capital mobilizing, trade finance, foreign exchange trading...
Table 2.2: Loans and Advances of VPB from 2008 to 2011
Value unit: 000’USD
2008
Items

Value

2009
Value

2010

Change
2009/2008

Value

Change

As at September 2011
Value

2010/2009

Loans & Advances
172,888 223,163 29.08% 250,669 12.33%
to customers

Change
2011/2010

245,495

(2.06%)

(Source: Annual reports of VPB from 2008 to 2010, Financial Statement quarter III 2011)
Through the above table, it is noted that the total outstanding loans and advances of
VPB continues to grow. Specifically, the rate of next year is higher than previous years,
namely 29.08% and 12.33% respectively in 2009 and 2010. Total Loans and Advances

as at 30 September 2011 that was USD245.5M recorded good level for the year 2011 in
compare with 2010.

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Credit risk management - Case study of VPB
However, in a more and more fierce banking environment, how to keep good growth
rate while control NPL well is big challenge for commercial banks in general and VPB
in particular.
II.2.2. Structure of credit in VPB:
Along with the growth of credit scale, structure of bank’s credit in recent times also
shifts towards positively by classification of term loan, customer ownership, business
group as well as credit lines used to avoid concentration of credit risk.
Loans by term
To minimize credit risk, VPB paid much attention to the harmonious development for
loans under different terms. The credit period is divided into 3 basic groups: short term,
medium and long term. Details will be showed in the table as follow:
Table 2.3: Loans portfolio by term of VPB from 2008 to 2010
Value unit: 000’USD
2008
Term

2009

Value

%

Value

Short term

73,961

42.78 106,006
%

Medium

49,125

Long term
Sub-total
loans

%
47.50
%

2010
Change
2009/2008

Value

Change
2010/2009

51.94

%

22.82%

28.41 49,039 21.97%
%

-0.17% 47,615 19.00%

-2.90%

49,801

28.81 68,118 30.52%
%

36.78% 72,856 29.06%

6.96%

172,88
8

100% 223,163

29.08% 250,66 1000%
9

12.33%

100%

43.33% 130,196

%

(Source: Annual reports of VPB from 2008 to 2010)
Overall, during 2008-2010, the structure of term loans in VPB is relatively stable
through the years. Usually short-term loan account for highest proportion in total loans
approximately 50% while this figure in long term is about 30%. During 2008-2010,
there’s growth in short term and long term loan while medium term loan reduce a little.
Focus on short term loans as the ratio of medium and long term loans is currently high.
In VPB, branches and the Car Loan Centre are instructed to be very selective in giving
out consumer loans such as home loans and car loans as these are long term loans in
VND. They will focus on control and recovery efforts of overdue car loans and home
loans.
Loan portfolio by industry sectors

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Credit risk management - Case study of VPB
Under PBB’s guidance, VPB has built direction of lending with reducing rate and
restrictions for high-risk industries such as: agriculture and mining, art, entertainment
and sports, extra-territory organizations and bodies ... The structure of credit by industry
sectors are shown in the table below:
Table 2.4: Loans by industry sectors of VPB from 2008 to 2010
Value unit: 000’USD
2008
Term

Value

2009
%

Value

%

2010
Change
2009/2008

Value

%

Change
2010/2009

Manufacturin
g

57,273 33.13% 85,364

38.25
%

49.05% 88,944

35.48
%

4.19%

Services and
trading

32,655

18.89 57,244
%

25.65
%

75.30% 45,809 18.27%

-19.98%

Construction
and real estate

22,209

12.85 26,767 11.99%
%

20.52% 31,631 12.62%

18.17%

Agriculture
and forestry

3,497 2.02%

2,734 1.23%

Transportation

5,604 3.24%

6,397 2.87%

Others

51,649 29.87% 44,657 20.01%

Total

172,88
8

100% 223,163

100%

-21.81%

3,723 1.49%

36.16%

14.15% 16,044 6.40% 150.80%
-13.54% 64,518

25.74
%

44.47%

29.08% 250,66
9

100%

12.33%

(Source: Annual reports of VPB from 2008 to 2010)
The data in the table above has demonstrated that VPB give a priority for key economic
sectors and their stability as manufacturing, Services and trading, Construction and real
estate. Among them manufacturing has the highest proportion in total loans (usually
around at 35%), after that services and trading (19%), construction and real estate
(12%). This ratio is currently being evaluated fairly in accordance with conditions of a
developing country like Vietnam today, support for promoting the development of
important economic sectors. It is noted that the structure by industry sectors is
maintained relatively stable throughout years. The diversified customer structure in
many industries has helped to ensure the stable development to the bank.

Loan portfolio by types of borrower
Types of borrower in VPB are divided into 4 groups: group of state owned enterprises,
Limited liability companies; Foreign invested enterprises; individual and other.

20