LV Thạc sỹ_Evaluation of credit risk management in ACB Bank duyen hai branch

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NATIONAL ECONOMICS UNIVERSITY
ADVANCED EDUCATIONAL PROGRAM
*****************************

Bachelor thesis
Evaluation of credit risk management in Asian Commercial Bank
(ACB) Duyen Hai branch


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Table of Contents
Chapter 1. INTRODUCTION ……………………………………..…………..1
1.1. Objectives of the thesis.....................................................................1
1.2. Overview of the subjected bank........................................................2
1.2.1.Overview of Asian Commercial Bank (ACB)............................2
1.2.2. Overview of ACB Duyen Hai branch........................................3
1.3. Data collection and methodology.....................................................5
1.3.1Data collection.............................................................................5
1.3.2. Methodology..............................................................................7
Chapter 2. LITERATURE REVIEW……………………………………………
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2.1. Bank and credit activities..................................................................8
2.2. Credit risk........................................................................................10
2.2.1. Definition.................................................................................10
2.2.2. Types of credit risk...................................................................11
2.2.3. Sources of credit risk...............................................................13
2.3. Credit risk management..................................................................16
2.3.1. Role of credit risk management...............................................16

2.3.2. Principles of credit risk management.......................................17
2.3.3. Credit risk measurement..........................................................20


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2.3.4Risk mitigation and transfer techniques.....................................24
Chapter 3. EMPIRICAL
FINDINGS…………………………………………..31
3.1. Performance of credit activities at Asian Commercial Bank (ACB)
Duyen Hai branch in the last 3 years...............................................................31
3.1.1. Overview of credit activities at the branch..............................31
3.1.2Credit risk at ACB Duyen Hai branch.......................................33
3.2. Credit risk management at Asian Commercial Bank (ACB) Duyen
Hai branch........................................................................................................38
3.2.1. External management...............................................................38
3.2.2. Internal management at the Asia commercial bank.................44
Chapter 4. RECOMMENDATION FOR CREDIT RISK MANAGEMENT IN
ACB DUYEN HAI BRANCH…….…………………………...……………….59
4.1. Orientation of overall operation at Duyen Hai branch....................59
4.2. Orientation for credit activity at Duyen Hai branch.......................60
4.3. Recommendation for credit risk management at Asian Commercial
Bank Duyen Hai branch...................................................................................61
4.3.1. Promote professional employee training and utilize rationally
human resource............................................................................................61
4.3.2. Disperse credit risk..................................................................62
4.3.3. Concentrating on borrower information collecting practice....63


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Chapter 5. CONCLUSION, LIMITATION AND RECOMMENDATION FOR
FURTHER STUDY…………………………………………………………….65
5.1. Conclusion......................................................................................65
5.2. Limitation........................................................................................66
5.3. Recommendation for further study.................................................67


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ABSTRACT
Banking industry is a crucial part in any economies. It goes without saying
that with the presence of banking firms, such developed countries as the United
State can achieve their success today. However, inherent in banking industries
are a lot of uncertainty that can cause vast damage to their members. The most
noticeable and current example of this is the financial crisis 2008 stemmed from
failure in banking system of the United State and the debt crisis in Europe from
2010 until now.
In a small country like Vietnam, banking industry also have to face similar
risk and may encounter same problem as what banks in other developed country
did. Especially, when most of Vietnamese banks rely heavily on credit activities
to generate profits, credit risk is the issue that matter the most. The main
concerns of this thesis is to find out what a typical Vietnamese commercial bank
is doing with their credit risk management and recommend solution to improved
their weaknesses.
How well a bank is doing with its credit risk management is first
determined by the performance of its credit activities. That means in order to
evaluate credit risk management, the first task is to evaluate the performance of
the bank’s credit activities. Then, through various data, the reason for the
performance of the bank will be revealed.

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ABBREVIATION
1.
2.
3.
4.
5.
6.
7.

ACB: Asian Commercial Bank
BIDV: Bank for investment and development of Vietnam
CIC: Credit information center
HNX: Hanoi Stock exchange
SBV: State bank of Vietnam
USD: United state dollars
VND: Vietnam dong


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LIST OF FIGURES
Figure 1: Composition of branch's credit in 2009......................................38
Figure 2: Composition of branch's credit in 2010......................................39
Figure 3: Composition of branch's credit in 2011......................................39
Figure 4: Division of jurisdiction in ACB..................................................52

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List of tables
Table 1 Credit performance at Duyen Hai branch.....................................35
Table 2credit risk at Duyen Hai branch.....................................................37
Table 3: Quality structure of branch's credit..............................................40
Table 4: Internal regulation on interest rate...............................................50
Table 5: Criteria weight in corporate borrower rating...............................56
Table 6: Individual borrower information..................................................57
Table 7: Ranking scale of individual borrower..........................................58
Table 8: Collateral rating scale...................................................................59
Table 9: Individual borrower rating...........................................................59
Table 10: Corporate borrower rating criteria.............................................68
Table 11: Corporate borrower rating scale.................................................70


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Chapter 1.

INTRODUCTION

1.1. Objectives of the thesis
Financial institutions always plays important role in every economy. No
country can achieve its growth objectives without the support from commercial
banks and other institutions that also provide banking services to the public. With

the main function of receiving money deposit from money supplier and lending
it to money user, banks works as intermediaries in the money market. Without
banks, the process of transferring money from people with excess of money to
people in need of money will be obstructed by many barriers such as the lack of
information, geographical distance, etc. However this industry is also very risky.
As intermediaries in money market, banks make loans to a large number of
borrowers in remarkable amount of money while their own capital is relatively
very small. Certain incidents, hence, can cause trouble to the bank when the loss
of their loan may exceed their capital and force them to go bankrupt.
In Vietnam, banking is a very flourishing industry but are facing many
difficulties. Currently, 25 years after the economic reform, there are about 40
Vietnamese commercial joint stock banks, 3 state-owned commercial banks and
many other foreign banks. All of them are contributing to Vietnamese economic
achievement in the recent years. However, Vietnamese banking industry are
confronting many challenges, one of which is how to ensure the lowest risk in
credit activity. When the impact of 2007-2009 global crisis is still present all
over the world, credit quality is a tricky problem. High inflation, the climbing of
interest rate and input cost and fluctuation of USD and gold in global market


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make it very difficult for Vietnam companies and small business to gain access
to bank’s money. For commercial banks, they have to be extremely cautious in
giving loan there is great odd that borrowers may encounter problem and failed
to fulfill their credit obligation in this scenario.
So the question so far is that how commercial banks are doing on
managing their credit risk portfolio. With this question in mind, this thesis
examined the real situation at a branch of Vietnam Asian Commercial Bank
located in Haiphong city. Specifically, the branch is Duyen Hai branch where the

writer was an intern.
1.2. Overview of the subjected bank
1.2.1.Overview of Asian Commercial Bank (ACB)
In June 04, 1993, Asian Commercial Bank’s foundation was official
announced and regulated in licenses number 0032/NH-GP issued by SBV in
April 24, 1993 and 533/GP-UB issued by People committee of Ho Chi Minh
city.
ACB and its subsidiaries operate mainly in mobilizing money supplier’s
deposits in various forms of maturities and paying methods, making loan to
money users, payment services, discounting securities, trading foreign currency
and gold, stock brokerage and trading and providing various corporate financial
services such as banker acceptance, financial leasing and financial consultant,
etc. ACB went public in 31/10/2006 and their stock was officially traded on
HNX in 21/11/2006.


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1.2.2. Overview of ACB Duyen Hai branch
Foundation of Duyen Hai branch was regulated in license 3156/GCT.
Duyen Hai branch locates at 15 Hoang Dieu street, Minh Khai, Hong Bang,
Haiphong.
Structure of Duyen Hai branch
Structure of Duyen Hai branch includes director and specialized
departments:
 Transaction and inventory department
 Enterprise customer department
 Individual customer department
 Accounting department
 Administrating department

 Collateral legalizing and validating department
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Main obligation of Duyen Hai branch:
The branch’s requirements of ACB system are:


Reserving assets mandated to the branch by ACB head quarter.

Those assets include land and equipments which are invested by the system’s
money.



Develop human resource, train employees to improve staff’s

performance, generate profits for the bank and better the bank’s image in
customers’ mind


Implement communication and report as regulated by SBV and

ACB head quarter.


Implement business plan as specified in ACB’s business objectives.



Improve banking practice and recommend ACB head quarter about

better practice in banking business, apply modern technology in daily activities
of the branch.
Main businesses of Duyen Hai branch
Duyen Hai branch mobilizes funds as regulated by SBV and ACB. This
means the branch receiving deposits from the public in short, medium and long
maturity. Deposit can be in both domestic and foreign currency.
Other business of Duyen Hai branch is making loan to individual and
corporate customers. The branch’s loan can be long, medium and short term
based on the structure of mobilized funds.

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Duyen Hai branch also implements and manages banker acceptance and
international payment service based on instructions from State Bank of Viet Nam
and ACB head quarter.
1.3. Data collection and methodology
1.3.1Data collection
a. Secondary data
Secondary data are facts and figures collected by someone other than the
researcher himself. These data can be used for purposes different from the
researcher’s. (Ghauri & Gronhaug 2010, 90) For instance, a student doing
research on economic growth factors can take a line graph showing GDP data in
the 2000-2010 period from the national statistics bureau. Secondary data, in fact,
usually help the researcher a lot in the beginning phase of their study, especially
when the research problem is not familiar. The literature in the theoretical
background section is the very first example of secondary data. Secondary data
can be obtained through numerous sources. Some divide the sources into
publication (books, journal articles, etc.) and electronic (websites, emails,
anything from the internet). Others like Saunders, Lewis and Thornhill (2009)
gives these categories: documentary (books, reports, newspapers, transcripts,
voice recordings, video recordings, etc.), survey-based (any data collected using
survey strategy), and multiple source (documentary combined with

survey-

based combined) secondary data. Another way of classification is: internal and
external sources (Ghauri & Gronhaug 2010, 97).
Secondary data are particularly useful to this thesis. A teacher’s materials
at school triggered an interest in the author to write something in risk

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management. Intense review of books, articles, academic journals (publications)
or electronic sources related to the topic during one month has helped to
narrowed down the research problem to credit risk management in a commercial
bank. Accidentally, the writer went through an article about risk management
framework improvements in Vietnamese small commercial banks and would
really love to study more. In Vietnam, disclosure of information in banking
business is an extremely sensitive issue. Primarily the researcher has to base her
analysis on information provided by the bank in published annual reports or
news and existing regulation documents. Without secondary data, this thesis
would never become a reality.
b. Qualitative and quantitative data
Qualitative data is information which does not provide a numerical
measure of attributes, characteristics or properties of phenomenon. In other
words, qualitative data focus on the description of quality: it deals with the
aspect of things that can not be expressed in a reasonable numerical way.
In this research, qualitative data is very important. It includes data on the
current credit risk managing practice at the branch like regulatory documents or
internal controlling practice that is currently implemented by the bank. In the
scope of this research, qualitative data helps in:
- Gathering details of the subject bank‟s credit policies: how the policies
look like and if they contain fundamental information.
- Discovering how credit unit in the transaction office work and whether
its operation complies with the policies


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- Understanding how well the transaction office is performing based on
comparing historical data and figures from year to year
- Detecting the credit employees‟ understanding of and attitudes towards
the bank‟s formal policies.
In addition to qualitative data, the research also utilizes quantitative data.
The term quantitative data is used to describe a type of information that can be
counted or expressed numerically. This type of data is often collected in
experiments, manipulated and statistically analyzed. Quantitative data can be
represented visually in graphs, histograms, tables and charts.
In this research, quantitative data is mainly obtained from the subject
bank’s annual reports. Specifically, from the numbers presented by the bank in
their balance sheet and income statements, the branch’s performance will be
revealed both directly through analysis of trends and portion of numbers and
indirectly through deriving certain ratios and examine them.
1.3.2. Methodology
The main objectives of this study is to examining the current risk
managing practices at one of ACB branches and derive a evaluation of those
practices. In order to achieve these objectives, the methodology is used in this
thesis is reviewing current literature on bank’s credit activities and credit risk
management, examining current performance of credit activities at the subject
branches and recommending on how to the bank’s practice.
Banking activities are one of the most complicated things on earth always
of a great concern of researchers all over the world. They have been doing many
works on issues problems associated with banking sector. This thesis, in


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particular, will give a review on such works, which revolve around the main aim
of the thesis - credit risk. Various works on how to define a bank, what credit

activities are, what credit risk is as well as the tools to deal with credit risk will
be discussed.
The critical point when evaluating performance of credit risk management
of a bank is that we must look at how well they are performing. As a result, the
empirical finding part of this thesis will focus on two main issues: making a
analysis of the current situation of the credit activities at Duyen Hai branch, and
based on the result of this analysis drawing a conclusion on the effectiveness of
the bank’s practice.
This thesis also includes a recommendation part where some solution to
improve ACB’s credit risk managing practice is suggested. The weakness in the
branch’s practice will be revealed, and the recommendations must be based on
the bank’s current orientation.


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Chapter 2.

LITERATURE REVIEW

2.1. Bank and credit activities
Kent, as cited in a Ljubljana’s 2004 work, defined bank as “an
organization whose principle operations are concerned with the accumulation of
temporarily idle money of general public for the purpose of advancing to other
for expenditure”. This definition gives the basic idea of banking principle: a bank
works as an intermediary whose job is to facilitate the lending procedure
between people with excess of money and people in need of money. In Vietnam,
commercial banks as well as other financial institutions are regulated in
“Financial institution law 2010” (47/2010/QH12). According to this document,
commercial bank is defined as a financial institution that is able to perform

banking procedures, including receiving deposits, making loans and providing
payment services. Among these functions, the most important to a bank are
receiving deposits and making loans. While receiving deposits provides banks
raw material and represent the ultimate source of profitability (Peter and Sylvia,
2009), granting loans is the process of making profit of banks.
Banks’ granting loan activity is an example of credit services that financial
institutions provide their customers. Ciby (2005) defined credit as a transaction
between creditor and debtor in which creditor transfers money and monetary
equivalent goods to debtor, in exchange for promised reimbursement of face
value and interest. This definition describes credit quite precisely. It shows that
banks and other financial institutions do not provide credit for free but charge a
certain amount of interest. This interest can be considered as operating revenue
in traditional banking firms. The advantage of collecting interest creates an


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incentive for financial institutions. This incentive compensate for possible gains
from the fund lent if invested elsewhere.
Credit plays an important role in the economy. To each borrower,
borrowing is the most convenient way to obtain capital and the most important
measure to maximize wealth, adjust tax and reserve business control. To the
whole economy, credit helps utilize most effectively the idle fund in the society.
Also, because well-managed credit stimulates growth of each individual, it
finally stimulates the growth of the whole economy.
2.2. Credit risk
2.2.1. Definition
According to David (1997),a risk of bank is defined as a reduction in
firms’ value due to changes in business environment.In their daily business
banks are very likely to encounter events that affect them negatively. David

(1997) identified 4 main risks that a typical bank may have: market risk; credit
risk, operational risk and performance risk. Besides those, there are also
regulatory risk and environmental risk that influence daily banks operation
(Raghavan 2003). In an article written by Anh Tuan (2012) on [newspaper
name], the writer indicated 3 main risks present in Vietnamese banking sector.
They are credit risk, liquidity risk and regulatory risk. Regarding the importance
of management of risks, Kaminsky and Reignhart (1999) thought that credit risk
was the largest element of risk in the book of most banks.
Credit risk is defined formally as “the potential that a bank borrower or
counterparty will fail to meet its obligations in accordance with agreed term”
(Basel 1999a). In Vietnamese regulation, credit risk is defined in Decree


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493/2005/QĐ NHNN as the possibility of losses in banking activities, resulting
from customers’ unwillingness or inability to meet their obligation. The
explanation for the importance of credit risk is that banks rely heavily on credit
activities to generate profitability. If banks are ambitious and want to attain large
profit, they have to make large amount of loan and endure high level of credit
risk. The critical question for most bankers is that given certain level of risk,
what the adequate level of return is (Ciby 2005)

2.2.2. Types of credit risk
Basing on the source of risk, Raghavan (2003) believed that credit risk
comprises of transaction risk and portfolio risk
Transaction risk also called firm credit risk (Ciby 2005) refers to the
failure in the banks’ process of assessing and approving loan to individual
customers. Raghavan divided transactional risk again into three components:
-

Selection risk: selection risk is problems in the banks’ process

of selecting appropriate project to finance
-

Collateral risk: collateral risk originates from the failure to

collateralize a loan or to put legal claim on collateral assets.
-

Operational risk: operational risk refers to the problems in

managing loans and lending activity. Specifically, difficulties in internal credit
rating and treating bad debts are symptom of operational risk in banks.
Portfolio risk is risk arises from the performance of banks’ portfolio of
loan. This type of credit risk contains 2 components:


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-

Intrinsic risk: credit loss may develop from the sectorial and

operating characteristics of the borrowers
Concentration risk: when bank’s loan portfolio is too concentrated
in a group of borrowers, an economic sector or a geographical region, it is said to
have concentration risk.
The above risks do not take into account the loans involving counterparty

from different region of the world. In fact, modern banks do not provide credit to
only domestic borrowers but also to foreign customers. According to Ciby
(2005), this practice exposes banks to settlement risk, sovereign risk and foreign
exchange risk.
-

Settlement risk is explained by Ciby (2005) as sometimes banks’

counterparties failed to deliver their payment at the settlement date. Horcher
(2005) points out that settlement risk is often related with foreign exchange
trading, where “payments in different money centers are not made
simultaneously and volumes are huge”. One outstanding example of settlement
risk is the case of a German bank Bankhaus Herstatt. In 1974, this bank was
suspended. A lot of money was stuck in its account around the world and it failed
to transfer money to it counterparty.
Sovereign risk arises due to the impact of deteriorating foreign
economic, social and political conditions on overseas transactions and sovereign
risk refers to the possibility that governments may enforce their authority to
declare debt to external lenders void or modify the movements of profits, interest
and capital under some economic or political pressure (Casu, Girardone and
Molyneux 2006).
Foreign exchange risk exposes banks to the possibility that value of
banks’ credit in different currency may deteriorate in value if exchange rate shifts


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negatively. For example, an importing company wants to borrow USD from
Asian Commercial Bank (ACB) to pay to its American exporter. If at the
expiration of the loan, USD

2.2.3. Sources of credit risk
Generally, credit risk is related to the traditional bank lending activities,
while it also comes from holding bonds and other securities. Basel (1999a)
reports that for most banks, loans are the largest and most obvious source of
credit risk; however, throughout the activities of a bank, which include in the
banking book as well as in the trading book, and both on and off the balance
sheet, there are also other sources of credit risk. Various financial instruments
including acceptances, interbank transactions, financial futures, guarantees, etc
increase banks’ credit risk. Therefore, it is indispensable to identify all the credit
exposures-- the possible sources of credit risk for most banks, which can also
serve as a starting point for the following parts of this work.
c. On-Balance Sheet Exposures


Loans

According to Saunders and Cornett (2006), the major types of bank loans
are commercial and industrial (C&I), real estate, consumer and others.
Commercial and industrial loans can be made for periods from a few weeks to
several years for financing firms’ working capital needs or credit needs
respectively. Real estate loans are primarily mortgage loans whose size, price
and maturity differ widely from C&I loans. Consumer loans refer to those such


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as personal and auto loans while the so called other loans include a wide variety
of borrowers such as other banks, nonblank financial institutions and so on.
Credit risk is the predominant risk in bank loans. Over the decades the

credit quality of many banks’ lending has attracted a large amount of attention.
The only change is on the focus of the problems from bank loans to less
developed countries and commercial real estate loans to auto loans as well as
credit cards, which is an American example. Since the default risk is usually
present to some degrees in all loans (Saunders and Cornett 2006), the individual
loan and loan portfolio management is undoubtedly crucial in banks’ credit risk
management.


Nonperforming Loan Portfolio

According to Hennie (2003), nonperforming loans are those not generating
income, and loans are often treated as nonperforming when principal or interest
is due and left unpaid for 90 days or more. Thus the nonperforming loan
portfolio is a very important indication of the bank’s credit risk exposure and
lending decisions quality.


Debt Securities

Besides lending, credit risk also exists in banks’ traditional area of debt
securities investing. Debt securities are debt instruments in the form of bonds,
notes, certificates of deposits, etc, which are issued by governments, quasigovernment bodies or large corporations to raise capital. In general, the issuer
promises to pay coupon on regular basis through the life of the instrument and
the stated principal will be repaid at maturity time. However, the likelihood that


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the issuer will default always exists, resulting in the loss of interest or even the

principal to banks, which can be a damaging impact.
d. Off-Balance Sheet Exposures
Since the 1980s, off-balance sheet commitments have grown rapidly in
major banks, among which there are swaps, forward rate agreements, bankers’
acceptances, revolving underwriting facilities, etc. (Hull 1989). Those
commitments give rise to new types of credit risk from the possibility of default
by the counterparty. In this section, some of the off-balance sheet credit
exposures will be introduced, among which the first one is related to derivative
contracts.
 Derivatives Contracts
According to Saunders and Cornett (2006), banks can be dealers of
derivatives that act as counterparties in trades with customers for a fee.
Contingent credit risk is quite likely to be present when banks expand their
positions in derivative contracts. Since the counterparty may default on payment
obligations to truncate current and future losses, risk will arise, which leaves the
banks unhedged and having to substitute the contract at today’s interest rates and
prices. This is also more likely to happen when the banks are in the money and
the counterparty is losing heavily on the contract. Comparatively, the type of
credit risk is more serious for forward contracts and swap contracts, which are
nonstandard ones entered into bilaterally by negotiating parties. While trading in
options, futures or other similar contracts may expose banks to lower credit risk
since contracts are held directly with the exchange and there are margining
requirements. However, the credit risk is also not negligible.


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 Guarantees and Acceptances
Bank Guarantee is an undertaking from the bank which ensure that the
liabilities of a debtor will be met, while a banker’s acceptance is an obligation by

a bank to pay the face value of a bill of exchange on maturity(Basel 1986). It is
stated by Basel (1986) that since guarantees and acceptances are obligations to
stand behind a third party, they should be treated as direct credit substitutes,
whose credit risk is equivalent to that of a loan to the final borrower or to the
drawer of the instrument. In this sense,it is clear that there is a full risk exposure
in these off balance sheet activities.
 Loan Commitments
A loan commitments are formal offers by a lending bank with the explicit
terms under which it agrees to lend to a firm a certain maximum amount at given
interest rate over a certain period of time. In this activity,contingent credit risk
exists in setting the interest or formula rate on a loan commitment. According to
Saunders and Cornett (2006),banks often include a risk premium based on its
current measurement of the creditworthiness of the borrower, and then in the
case that the borrowing firm gets into trouble during the commitment period, the
bank will be exposed to dramatic declines in borrower creditworthiness, since
the premium is preset before the downgrade.
2.3. Credit risk management
2.3.1. Role of credit risk management
Series of bank scandal at the end of 20th century motivated delegators of
banking sector in G-10 countries to create Basel Committee, hoping that this