Apply basel II in risk management in vietnam case study of asia commercial bank , luận văn thạc sĩ

MINISTRY OF EDUCATION AND TRAINING
UNIVERSITY OF ECNOMICS HOCHIMINH CITY
---- K ---

ĐỖ THỊ NGỌC SƯƠNG

APPLY BASEL II IN RISK
MANAGEMENT IN VIETNAM CASE
STYDY OF ASIA COMMERCIAL BANK

MAJOR: BANKING AND FINANCE
MAJOR CODE: 60.31.12
MASTER THESIS
SUPERVISOR
ASSOCIATE PROFESSOR Dr. TRƯƠNG TẤN THÀNH

Faculty of Banking
Ho Chi Minh City – 2010


-i-

CERTIFICATE
I certify that the substance of this thesis has not already been submitted for any
degree and is not currently being submitted for any other degree or qualification.
I also certify that, to the best of my knowledge, any help received in preparing this
thesis, and all sources used have been acknowledged in this thesis.
Signature: Do Thi Ngoc Suong ______________
Date: ___________________________________

- ii -

ACKNOWLEDGEMENTS
I owe a debt of gratitude to many people who helped me complete this thesis. I
would like to acknowledge the help of all.
First of all I would like to express my deepest acknowledgement to my supervisor,
Dr. Truong Tan Thanh, for his valuable advice and recommendations.
I acknowledge Mr. Tran Van Tam, his assistants from Credit Policy and
Management Department of Asia commercial bank (ACB) with reference material.
I would particularly like to thank the following friend for her support related to
material: Ms. Ho Nguyen Thuy Duong from Asia commercial bank.
Finally, to my parents, I wish to extend my loving thanks for their encouragement.


- iii -

ABSTRACT
Vietnam has gradually integrated into the global economy after officially becoming
a member of the world trade organization (WTO) at the end of 2006. Together with
the process of economy liberalization, the priority of economic sectors is financial
banking industry. These opportunities help Vietnamese banks get favorable
conditions in banking activities, but face with a lot of difficulties and show
weaknesses. Vietnamese banks can take advantage of capital, modern technology,
management experience, and to develop the comparative advantage of Vietnamese
banking to catch up with international competition and outreach foreign markets.
However, commercial banks will face more competitive pressure, shows poor
performance (weak financial resources, small scale, low quality and efficiency, low
professional skill in management, low technology, and high risk), especially are
more prone to adverse impact of external shocks (economic crisis, war, etc.). This
reflects weak capability in reducing risks. As Governor Nguyen Van Giau said

Monday (04/05/2009) in an interview published on the government website “The
central bank would continue its efforts to keep the banking system secure and
review banking and risk management regulations to comply with international
standards”, after 23 banks around the world were taken over or went bankrupt in the
first quarter 2009.
This thesis examines a particular case of a joint-stock commercial bank in Vietnam
to see the way they manage their risk: credit risk, operational risk and market risk.
Objectives of this thesis are:
(1) To study the methods of risk management in Basel I and Basel II.
(2) To study the level of Basel I and Basel II application in risk management at
ACB in participate and at Vietnamese commercial banks in general.
(3) To contribute some recommendations for the improvement of risk
management at ACB and to expand for other commercial banks.


- iv -

In terms of structure, the thesis has six chapters:
Chapter 1 reviews the research background, significance and scope of the
study.
Chapter 2 reviews literature of risk management in Basel I and Basel II.
Objectives of this chapter will provide a brief overview of the characteristic of
the 1988 Basel I Capital Accord, touching on its limitations and the reasons that
prompted its revision in to the new 2004 Basel II Capital Accord.
Chapter 3 presents Asia Commercial Bank, a joint-stock commercial bank in
Vietnam.
Chapter 4 presents descriptive findings of risk management practices at ACB.
Objectives of this chapter are:
(1) To observe the process of risk management at ACB for a period of time
(from the beginning of 2006 until now).

(2) To evaluate the capacity of ACB’s risk management.
Chapter 5 presents the tendency in risk management of Asian banks in general,
of Vietnamese banks in participate.
Finally, the thesis ends with Chapter 6. This chapter will give some
recommendations to improve its risk management system for ACB in
participate, for Vietnamese banks in general.


-v-

TABLE OF CONTENTS
CERTIFICATE ...................................................................................................................... i
ACKNOWLEDGEMENTS ................................................................................................... ii
ABSTRACT ..........................................................................................................................iii
TABLE OF CONTENTS ...................................................................................................... v
LISTS OF TABLES ........................................................................................................... viii
LIST OF FIGURES ............................................................................................................. ix
GLOSSARY OF TERMS AND ABBREVIATIONS .......................................................... xi
CHAPTER ONE: INTRODUCTION TO THE STUDY ..................................................... 1
1.1.
1.1.1.
1.1.2.
1.1.3.
1.1.4.

1.2.
1.2.1.
1.2.2.

RESEARCH BACKGROUND ...................................................................................... 1

Banking landscape ..................................................................................................................... 1
Risk ............................................................................................................................................ 1
Risk management ....................................................................................................................... 3
Benefits with the risk management ............................................................................................ 3

RESEARCH PROBLEM ............................................................................................... 4
Research questions ..................................................................................................................... 4
Research objectives .................................................................................................................... 5

1.3.

METHODOLOGY ......................................................................................................... 5

1.4.

SIGNIFICANCE AND SCOPE OF THE STUDY ...................................................... 6

1.5.

STRUCTURE OF THE STUDY ................................................................................... 7

CHAPTER TWO: LITERATEUR REVIEW ....................................................................... 8
2.1

INTRODUCTION .......................................................................................................... 8

2.2

OVERVIEW.................................................................................................................... 8

2.2.1.
2.2.2.
2.2.3.

Basel I ........................................................................................................................................ 9
Basel II ..................................................................................................................................... 11
Innovations of Basel II in comparison to Basel I ..................................................................... 14

2.3
THE STUDY OF APPLYING BASEL I AND BASEL II IN RISK
MANAGEMENT ....................................................................................................................... 16
2.4
2.4.1.
2.4.2.

2.5

THE EFFECTS AND BENEFITS IN BASEL I AND BASEL II APPLICATION 18
The effects................................................................................................................................ 18
The benefits.............................................................................................................................. 20

CONCLUSION ............................................................................................................. 21

CHAPTER 3: ASIA COMMERCIAL BANK (ACB) ........................................................ 22
3.1.
3.1.1.
3.1.2.
3.1.3.

3.2.

OVERVIEW OF ACB.................................................................................................. 22
Milestones ................................................................................................................................ 22
Growth path ............................................................................................................................. 24
ACB’s operations ..................................................................................................................... 27

ACB’S FINANCIAL PERFORMANCE .................................................................... 30


- vi 3.2.1.
3.2.2.
3.2.3.

3.3.

Profitability (%) ....................................................................................................................... 30
Liquidity................................................................................................................................... 31
Charter capital, equity, secure capital ratio .............................................................................. 31

CONCLUSION ............................................................................................................. 32

CHAPTER 4: RISK MANAGEMENT AT ASIA COMMERCIAL BANK (ACB) .......... 34
4.1.

RISK MANAGEMENT OVERVIEW AT ACB ......................................................... 34

4.2.

RISK ANALYSIS .......................................................................................................... 36

4.2.1. Credit risk ................................................................................................................................ 36
4.2.1.1.
Policy on credit risk ........................................................................................................ 36
4.2.1.1.1 Observation of regulations and loan limits ................................................................ 36
4.2.1.1.2 Measures and outlook for loan quality....................................................................... 37
4.2.1.2.
Analysis on credit risk .................................................................................................... 41
4.2.1.2.1. Observation of regulations and loan limits................................................................ 41
4.2.1.2.2. Credit quality............................................................................................................. 43
4.2.1.3.
ACB’s limitations in credit risk management................................................................. 50
4.2.2. Market risk ............................................................................................................................... 50
4.2.2.1.
Policy on market risk ...................................................................................................... 50
4.2.2.2.
Analysis on market risk .................................................................................................. 53
4.2.2.2.1. Observation of regulations and limits ....................................................................... 53
4.2.2.2.2. Measure and outlook risk market .............................................................................. 55
4.2.2.3.
ACB’s limitations in market risk management............................................................... 61
4.2.3. Operational risk ........................................................................................................................ 62

4.3.

RISK MANAGEMENT DEVELOPMENTS AND COMPLIANCE ....................... 63

4.4.

CONCLUSION ............................................................................................................. 64

CHAPTER 5: TENDENCY IN RISK MANAGEMENT OF ASIAN BANKS IN
GENERAL, OF VIETNAMESE BANKS IN PARTICIPATE ......................................... 65
5.1.

TENDENCY IN RISK MANAGEMENT OF ASIAN BANKS ................................ 65

5.1.1. Basel II Implementation schedule in Asia................................................................................ 65
5.1.2. Capital adequacy requirements in Asia .................................................................................... 68
5.1.3. Challenges on risk management for Asia................................................................................. 70
5.1.3.1.
Challenges on credit risk ................................................................................................ 70
5.1.3.2.
Operational risk challenges ............................................................................................ 71
5.1.3.3.
Challenges for regulators ................................................................................................ 72
5.1.4. The future of Basel II (Basel III).............................................................................................. 72

5.2.

TENDENCY IN RISK MANAGEMENT OF VIETNAMESE BANKS .................. 73

5.2.1. Legal and regulations ............................................................................................................... 73
5.2.2. Financial performance.............................................................................................................. 76
5.2.2.1
Profitability..................................................................................................................... 76
5.2.2.2
Liquidity ......................................................................................................................... 77
5.2.2.3
Efficiency ....................................................................................................................... 78
5.2.2.4

CAR ................................................................................................................................ 79
5.2.2.5
Asset Quality .................................................................................................................. 80
5.2.3. Risk management ..................................................................................................................... 81
5.2.3.1
Bank for Investment and Development of Vietnam (BIDV) .......................................... 81
5.2.3.2
TECHCOMBANK (TCB) .............................................................................................. 84
5.2.4. Rating of Moody's .................................................................................................................... 88
5.2.5. Implementation challenges for Vietnamese bank system ........................................................ 88
5.2.5.1.
Cost of implementation .................................................................................................. 88
5.2.5.2.
Inadequate supervisory capacity ..................................................................................... 89
5.2.5.3.
Accurate credit risk factor estimation and calibration across many different portfolios 89
5.2.5.4.
A sound approach to operational risk ............................................................................. 89


- vii 5.2.5.5.
An efficient strategy for data gathering and management .............................................. 90
5.2.5.6.
An overarching economic capital framework for enterprise risk management .............. 90
5.2.5.7.
Approach-related challenges .......................................................................................... 90
5.2.4.7.1. Standardize Approach-related challenges ................................................................. 90
5.2.4.7.2. IRB Approach-related challenges ............................................................................. 91

5.3.

5.3.1.
5.3.2.

CONCLUSIONS ........................................................................................................... 92
Asia .......................................................................................................................................... 92
Vietnam .................................................................................................................................... 93

CHAPTER 6: RECOMMENDATIONS ............................................................................ 95
6.1.

STATE BANK OF VIETNAM (SBV) ........................................................................ 95

6.2.

JOINT-STOCK BANKS .............................................................................................. 96

6.3.

ACB ................................................................................................................................ 98

6.4.

IMPLICATION FOR FURTHER STUDY .............................................................. 100

BIBLIOGHAPHY ............................................................................................................. 102


- viii -

LISTS OF TABLES

Table 1.1: Benefits with the risk management ...................................................................................4
Table 2.1: Pillar 1 ..............................................................................................................................12
Table 2.2: Pillar 2 ..............................................................................................................................12
Table 2.3: Pillar 3 ..............................................................................................................................13
Table 2.4: Compare (IRB) between Basel I and Basel II ................................................................14
Table 2.5: Compare (standard) between Basel I and Basel II.........................................................15
Table 2.6: “Ripple Effect” of Basel II ..............................................................................................19
Table 3.1: ACB’s products and service.............................................................................................25
Table 3.2: ACB’s business performance structure in 2009 .............................................................26
Table 3.3: ACB’s net income structure in 2008 and 2009 ...............................................................26
Table 3.4: ACB’s growth orientations ..............................................................................................26
Table 3.5: ACB’s subsidiaries (As of 31st December 2009) ............................................................28
Table 3.6: ACB’s profitability from 2004 to 2009 ............................................................................31
Table 3.7: ACB’s liquidity from 2004 to 2009 ..................................................................................31
Table 3.8: ACB’s charter capital, equity, secure capital ratio from 2004 to 2009..........................32
Table 4.1: ACB’s observation of regulations and loan limits (As of 31st December 2009) ............42
Table 4.2: ACB’s provision for loans from 2007 to 2009 ................................................................43
Table 4.3: ACB’s daily reserves (As of 31st December 2009) ..........................................................54
Table 4.4: ACB’s liquidity option (As of 31st December 2009) ........................................................54
Table 4.5: ACB’s components of tier 1 and tier 2 capitals, and risk weighted assets from 2007 to
2009 ....................................................................................................................................................55
Table 4.6: ACB’s factors of market risk sensitivity (As of 31st December 2009) ............................58
Table 5.1: Approaches and options of Basel II in Asia ...................................................................65
Table 5.2: Basel II implementation schedule in Asia ......................................................................67
Table 5.3: Capital adequacy requirements in Asia ..........................................................................68
Table 5.4: The future of Basel II ......................................................................................................72
Table 5.5: Vietnamese banks' rating of Moody's .............................................................................88


- ix -

LIST OF FIGURES
Figure 1.1: The structure of risk ........................................................................................................2
Figure 2.1: The structure of the Basel II Framework .....................................................................13
Figure 2.2: Basel II affects a variety of constituents, whose needs for information are
interdependent ...................................................................................................................................18
Figure 3.1: ACB’s business performance from 2004 to 2009 .........................................................25
Figure 3.2: ACB’s organizational chart ...........................................................................................27
Figure 3.3: ACB’s shareholder structure (As of 31st December 2009) ...........................................28
Figure 3.4: ACB’s branch network growth from 2004 to 2009.......................................................29
Figure 3.5: ACB’s branches nationwide (As of 31st December 2009) ............................................29
Figure 3.6: ACB’s human resource development from 2004 to 2009.............................................30
Figure 3.7: ACB’s current ratio, ROE, ROA from 2004 to 2009 ....................................................31
Figure 4.1: ACB’s organizational chart in risk management .........................................................34
Figure 4.3: ACB’s analysis by group from 2005 to 2009 ................................................................44
Figure 4.4: ACB’s analysis by collateral from 2006 to 2009..........................................................45
Figure 4.5: ACB’s analysis by types of customers from 2004 to 2009 ...........................................46
Figure 4.6: ACB’s analysis by types of loans from 2004 to 2009 ...................................................47
Figure 4.7: ACB’s analysis by industry from 2004 to 2009............................................................48
Figure 4.8: ACB’s analysis by contingencies and commitments from 2004 to 2009 ....................48
Figure 4.9: ACB’s analysis by types of geography from 2004 to 2009 ..........................................49
Figure 4.10: ACB’s analysis by types of maturity from 2004 to 2009............................................49
Figure 4.11: CAR of some commercial bank ...................................................................................57
Figure 4.12: ACB’s liquidity gap into relevant maturity grouping from 2006 to 2009 ..................59
Figure 4.13: Group’s exposure to interest rate risk from 2007 to 2009 ..........................................60
Figure 4.14: ACB’s exposure to foreign currency exchange rate risk from 2006 to 2009 ............61
Figure 5.1: Vietnamese banks' net interest margin from 2003 to 2008 ..........................................76
Figure 5.2: Vietnamese banks' return on average total assets from 2003 to 2008 .........................77
Figure 5.3: Vietnamese banks' loan to deposit ratios from 2003 to 2008 .......................................78
Figure 5.4: Vietnamese banks' cost/income ratios from 2003 to 2008 ...........................................79

Figure 5.5: Vietnamese banks' CAR from 2003 to 2008 .................................................................79
Figure 5.6: Vietnamese banking system's asset quality from 2006 to 2008....................................80


-xFigure 5.7: Vietnamese banks' asset quality from 2003 to 2008 .....................................................81
Figure 5.8: BIDV’s organizational chart in risk management .......................................................82
Figure 5.9: TCB’s organizational chart in risk management .........................................................85
Figure 6.1: ACB’s building credit MIS on loan portfolio ...............................................................99


- xi -

GLOSSARY OF TERMS AND ABBREVIATIONS
ACB

: Asia Commercial Bank

Agribank

: Vietnam Bank for Agriculture and Rural Development

AMA

: Advanced Measurement Approach

ASEAN

: Associations of the organization of Southeast Asian Nations

BASEL

: Basel Capital Accord

BCBS

: Basel Committee on Banking Supervision

BIA

: Basic Indicator Approach

BIDV

: Bank for Investment and Development of Vietnam

BFSR

: Bank Financial Strength Rating

CAR

: Capital Adequacy Ratio

CCF

: Credit Conversion Factor

EAB

: East Asian bank

EAD

: Exposure at default

ECAI

: External Credit Assessment Institutions

FSI

: Financial Stability Institute

IMA

: Internal Model Approach

IRBF

: Internal Ratings Based Foundation

IRBA

: Internal Ratings Based Advanced

KRI

: Key Risk Indicators

LGD

: Loss given default

LTD

: Loan to Deposit

MDB

: Multilateral Development Banks

MIS

: Management Information System

NPL

: Non – Performing Loan

OECD

: Organization for Economic Cooperation and Development

OTC

: Over the counter

PD

: Probability of default

PSE

: Public Sector Entities


- xii -

RWA

: Risk Weight Asset

SA

: Standardized Approach

SCB

: Standard Chartered Bank

SMEs

: Small and Medium Enterprises

SOCBs

: State –Owned Commercial Banks

ST

: Short-term

TA

: Technical Assistance Project

TCB

: Techcombank

TCBS

: The Complete Banking Solution

Vietinbank

: Vietnam joint stock commercial bank for industry and trade

WTO

: World Trade Organization


-1-

CHAPTER ONE: INTRODUCTION TO THE STUDY
1.1.

RESEARCH BACKGROUND

1.1.1.

Banking landscape



After the implementation of the “doi moi” policy initiated by the Vietnam's Communist
Party in 1986, the economy has gradually moved to market mechanism with socialist
orientation, and integration to the world economy. Those reforms were of strategic
importance in the past, and promoted the formulation and development of new economic
relations as well as new infrastructure. As a result, the banking system was gradually
improved and became more effective intermediation of financial resources.



Vietnam’s banks suffer from low public confidence, regulatory and managerial
weakness, high levels of non-performing loans (NPL), non-compliance with the Basel
capital standards, and the absence of international auditing. Since 1992 Vietnam’s
banking system has consisted of a combination of state-owned, joint-stock, jointventure, and foreign banks, but the state-owned commercial banks predominate, and
they suffer from high levels of NPL, most of them to state-owned enterprises.
Consequently, in September 2005 Vietnam decided to equitize all five state-owned
banks—a change from previous plans to equitize only two of them. In addition, Vietnam
plans to boost the transparency of its financial system by establishing a credit-rating
agency and performance standards for joint-stock banks.

1.1.2.


Risk

Risk is the potential for the occurrence of an event that may incur losses for the bank. In
other words, risk is about exposure to uncertainty. It includes credit risk, market risk,
operational risk, strategic risk, business risk, country risk, sustainable lending risk,
reputation risk. These risks are interdependent:


-2Reputational
risk
Credit
risk
Strategic risk

Market
risk

Operational
risk

Country
risk

Strategic
risk

Sustainable
lending risk
Business risk
Compliance risk

Figure 1.1: The structure of risk

Source: Young Cho (2009)


Credit risk is the risk of loss due to a debtor's non-payment of a loan or other line of
credit (either the principal or interest (coupon) or both). In other words, risk that
counterparty may not pay amounts owned when they fall due. It arises from:
+

Loans extended to customers; or

+

The replacement cost under foreign exchange, interest rate and derivative products;
or

+


Settlement under foreign exchange, interest rate and derivative products; etc.

Market risk is the risk that the value of an investment will decrease due to moves in
market factors. There are three major forms of market risk:
+

Price risk: the risk of losses from movements in the level and volatility of prices for
interest rates, foreign exchange, equities and commodities.

+

Liquidity risk: the risk that amounts due for payment cannot be paid due to the lack

of available funds.

+

Discontinuity (gap) risk: the risk of losses arising from market prices “gapping”
rather than moving in a continuous fashion.



An operational risk is the risk of loss due to actions on or by people, processes,
infrastructure or technology or similar operational factors which have an operational
impact including fraudulent activities. As such, it is a very broad concept including e.g.
fraud risks, legal risks, physical or environmental risks, etc. The Basel Committee


-3-

defines operational risk as: "The risk of loss resulting from inadequate or failed internal
processes, people and systems or from external events."


Reputation risk is the risk that reputation of an organization will be adversely affected.
Reputation risk can occur as a result of a single event or incident.



Strategic risk is the risk that a bank adopts an inappropriate strategy which results in the
bank incurring significant costs and failing to achieve business targets. For example,
expansion in to a geographic market or expansion into a new business segment or
expansion into a new product area, etc.



Compliance risk is the risk of non-compliance with legal or regulatory requirements.
Regulatory requirements can apply to the banks’ country of incorporation and its country
of operation. The bank will need to ensure its operations are in compliance with both
sets of regulations.



Sustainable lending risk is the risk that can emanate either directly from our own actions
as a bank or in-directly as a fall out of our counterparty’s actions, should they not be in
compliance of legislation or take actions that are not acceptable to their regulators. It is
part of the total risk associated with lending; it should not be seen as a standalone risk. It
needs to be identified, mitigated where possible, and if appropriate priced for, as well all
other risks.

1.1.3.

Risk management

Risk management is a methodology and series of procedures used to identify measure,
monitor and control risks arising from the business operations of a bank. Risk management
isn’t about avoidance of risk. Banking activities are pursued for profit but do inevitably
result in occasional losses. An effective risk management process will ensure the return is
adequate relative to the risk that is being taken.
1.1.4.

Benefits with the risk management

The future of banking will undoubtedly rest on risk management dynamics. Only those
banks that have efficient risk management system will survive in the market in the long run.
Because risk management brings following benefits:


-4-

Table 1.1: Benefits with the risk management
Aligning risk appetite and strategy
Linking growth, risk and returns
Improved:
Risk management

Improving risk exposure
Reducing operational surprises
Managing risk
Exploiting opportunities

-

P&L

-

Balance sheet

-

Stakeholder
value

-

Reputation

-

Human resource

-

Governance

Rationalizing resources

Source: Young Cho (2009)
1.2.

RESEARCH PROBLEM

The problems mentioned in this research study are to describe characteristics of risk
management in Basel I and Basel II in general and at ACB in participate. Simultaneous
combination of the experiences of some countries in process of applying Basel I and Basel
II in risk management, this study will provide recommendations to increase internal risk
management practices for Vietnamese commercial banks in general and for ACB in
participate.
1.2.1.

Research questions

The research study will answer for the following questions:
a.

What are risk management in Basel I and Basel II?

b.

How do ACB in participate and Vietnamese commercial banks in

general manage risk?
c.

What's the tendency in manage risks at Vietnamese banks in participate

and at Asian banks in general?
d.

What are the recommendations for improvement of risk management in

Vietnamese banking system?


-5-

1.2.2.

Research objectives

To finalize the research problem and answer the research questions mentioned above, the
research study has the following objectives:

a.

To study the literature of risk management in Basel I and Basel II and

the experiences of some countries in process of applying Basel I and Basel II in
risk management:
i. What challenges for Vietnamese bank system are in apply Basel II?
ii.
b.

What do Vietnamese banks prepare in apply Basel II?

To investigate and describe characteristics of risk management at ACB

in participate and Vietnamese commercial banks in general.
c.

To provide some recommendations for the improvement of risk

management at ACB and other commercial banks in Vietnam.
1.3.


METHODOLOGY

Zikmund (1997, p.37) discusses that business research can be classified on the basis of
either technique or function. Experiments, surveys, observation and secondary data are
just a few common research techniques. Classifying them on the basis of purpose or
function allows us to understand how the nature of the problem influences the choice of
research method. The nature of the problem will determine whether the research is

exploratory, descriptive or causal:
+

Exploratory research is usually conducted to clarify ambiguous problems.

+

Descriptive research is designed to describe characteristics of a population or
phenomenon. Descriptive research seeks to determine the answers to who, what,
when, where, and how questions.

+

Causal research is conducted to identify cause-and-effect relationships among
variables where the research problem has already been narrowly defined.



Choosing a type of research depends upon the research questions that the researcher
wants to answer. Selection of research design is based on the advantages and
disadvantages of each kind of research designs and circumstances in which the research
problem is defined.


-6-



In term of data sources, there are two main sources of data: primary data and secondary
data. Zikmund (1997, p.46) defined secondary data as data previously collected and

assembled for some project other than the one at hand; primary data are data gathered
and assembled specifically for the project at hand.



In this study, major secondary data were mainly used to derive characteristics of risk
management at ACB in participate and Vietnamese commercial banks in general and to
derive the methods of risk management in Basel I and Basel II.



Due to limitations of time and funds; the difficulties in approach and collect information
of whole banking system, the target population in this research could not cover all
commercial banks in Vietnam, it only include state commercial bank, joint-stock bank,
not include foreign bank branch and joint-venture bank. The samples include about 3
banks with representative of state commercial bank, big joint-stock bank and small and
medium joint-stock bank. This information will be analyzed and processed. The
objective of this method is to answer the research questions: How do ACB in participate
and Vietnamese commercial banks in general manage risk?



The secondary data method was used to examine Basel I and Basel II’s characteristics in
risk management. One of the objectives of collecting data related to risk management
practices, which are collected from researches, thesis on the websites and annual reports
from state bank in general and a number of joint-stock banks’ reports in participate.
These data will select to help in having a best objective analysis. The objective of this
method is to answer the research questions: What challenges for Vietnamese bank
system are in apply Basel II? What do Vietnamese banks prepare in apply Basel II?



The secondary data method was used to examine the tendency in manage risks at
Vietnamese banks in participate and at Asian banks in general, the author will provide
recommendations for improvement of risk management in Vietnamese banking system.

1.4.


SIGNIFICANCE AND SCOPE OF THE STUDY

Banks are often thought to be a source of systemic risk because of their central role in
the payments system and in the allocation of financial resource, combine with the
fragility of their financial structure. Banks are highly leveraged with relatively short-


-7-

term liabilities, typically in the form of deposits, and relatively illiquid assets, usually
loans to firms or household. Specially, in international integration, banking risk and
sensitivity of the domestic financial market in front of the volatile world market will
increase. International integration increases capital flows and thus risks for the banking
system, while the management mechanism and banking supervision is incompatible to
the international practices, remains ineffective in ensuring the strict adherence to the
laws on banking and the systemic safety, especially in prevention and early warning of
banking risks. So, researching and examining the methods of risk management in Basel I
and Basel II is very significant. It helps for encouraging better and more systematic risk
management practices. It’s mainly objectives were to promote the soundness and
stability of the international banking system and to ensure a level playing field for
internationally active banks.



Due to limitations of time and funds; the difficulties in approach and collect information
of whole banking system, this research could not cover all commercial banks in
Vietnam, it only selects some typical bank, include state commercial bank, joint-stock
bank, not include foreign bank branch and join-venture bank. Besides, the limitation of
the thesis only research the standards of safety capital (Pillar 1: Minimum capital
requirement) which will help for the banks in risk management. The standards of Pillar 2
(supervisory review process) and Pillar 3 (market disclosure) will not in scope of this
study.

1.5.

STRUCTURE OF THE STUDY

This research is structured into 6 chapters. Chapter 1 introduces the research including
research background, research problem, research questions, research objectives and
significance for the research. Chapter 2 provides literature review of risk management in
Basel I and Basel II. Chapter 3 presents a joint-stock commercial bank in Vietnam (ACB).
Chapter 4 presents descriptive findings of risk management practices at ACB. Chapter 5
presents the tendency in risk management of Asian banks in general, of Vietnamese banks
in participate. Chapter 6 points out recommendations to improve their risk management
system for ACB in participate, for Vietnamese commercial banks in general.


-8-

CHAPTER TWO: LITERATEUR REVIEW
2.1


INTRODUCTION
Nowadays, in the same tendency, the world banks’ risk management activities are being
directed toward in obeying the standards of Basel II. About forming, Basel II is a G-10
countries’ agreement. It sets out the details of the agreed framework for measuring
capital adequacy and the minimum standard to be achieved which the national
supervisory authorities represented on the Committee intend to implement in their
respective countries. The standards of Basel II are recognized an international
unification in measuring capital and capital standards. Many countries in ASEAN
established action plan and schedule for implementing Basel II. Singapore established in
2008; Philippine, Indonesia, Thailand and Malaysia will have a plan in establishing
Basel II in 2010.



No exception, especially when Vietnam has become a member of WTO and has
gradually integrated into the global economy. It’s an indispensable event for Vietnamese
banks obey the standards of Basel II, not early not late. So, what’s risk? What’s risk
management? What’s Basel II? Why does this tendency exist? It can explain by the
standards of Basel I and Basel II.

2.2


OVERVIEW
Basel committee on banking supervision was established by central banks of G-10
countries in 1974. Committee has no supranational supervisory or legislative power.
Agreements must be implemented within each country via local legislature and enforced
by local supervisors. This has potential home, host issues, particularly for Basel II.



Basel capital accord covering credit risk was issued in 1988. It established a minimum
ratio of required Tier 1 capital to risk weight assets. Risk weighted assets (RWA)
assigned only for credit risk, based on simplistic categorization of types of assets and
obligors. And its validity is from 1992.


-9-



An accord amendment was issued in 1996, covering the market risk of trading
portfolios. RWA assigned for market risk, based on either the standardized approach or
on scaled VAR derived from an internal simulation model. And its validity is from 1997.



Basel II proposals were introduced in June, 1999. Proposal enhances measurement of
RWA for credit risk (to make risk weights more sensitive) and requires capital charge
for operational risk. Discussions, industry feedback and revisions are ongoing, as
January, 2001: Secondary Consultative Package – CP2; April, 2003: Third Consultative
Package – CP3.



The “Final” framework issued by Basel committee in June 26, 2004. Revised version of
the accord issued in November 2005. And its validity is from January, 2007.

2.2.1.



Basel I

To understand and appreciate the basic goals of Basel II and the strategy for achieving
these goals, it is important to understand the shortcomings of the current Basel Capital
Accord (Basel I).



The Basel I Capital Accord, published in 1988, represented a major breakthrough in the
international convergence of supervisory regulations concerning capital adequacy. It’s
mainly objectives were to promote the soundness and stability of the international
banking system and to ensure a level playing field for internationally active banks.



The framework defined the constituents of “regulatory capital” and set the risk weights
for different categories of on- and off-balance sheet exposures. The minimum ratio of
regulatory capital to total risk-weighted assets (RWA) was set at 8%, of which the ‘core
capital’ element (a more restrictive definition of eligible capital known as Tier I capital)
would be at least 4%.



Banks are required to set aside a minimum amount of capital to cover unexpected risk
and losses on credit risk and market risk. It is measured by Capital Adequacy Ratio
(CAR):
Total capital (Tier I + Tier II)
CAR =

Credit risk adjusted assets (RWA)

≥ 8%


- 10 -



In addition, the Tier I core capital component of total capital has its own minimum
guideline. The Tier I (core) capital ratio is calculated as:
Core capital (Tier I)
Tier I (core) capital ratio =



Credit risk adjusted assets (RWA)

≥ 4%

Basel I principles include strengthen the soundness and stability of the international
banking system and create minimum risk-based capital adequacy requirements based on
types of counterparties dealt with. So, Basel I bring the benefits reduced global systemic
risk without suppressing competition and increased banks’ capital.



However, with changes in market environment, such as growing complexity of the
financial products, credit risk mitigation techniques have become popular, innovation in

risk measurement and management practices. Basel I become primitive as a tool to
capture real economic risks, with following reasons:
+

Lack of sufficient risk differentiation for individual loans. The weights did not
sufficiently differentiate credit risk by counterparty (i.e. financial strength) or loan
(e.g. pledged collateral, covenants, maturity) characteristics. For example, the
capital charge for all corporate exposures was the same irrespective of the
borrower’s actual rating. This implied that banks with the same capital adequacy
ratio (CAR) could have very different risk profiles and degrees of risk exposure.

+

No recognition of diversification benefits. Standard portfolio theory recognizes the
risk reduction benefits attained from diversification. However, because Basel I was
based on the ‘building blocks’ approach, there was no distinction or difference in
capital treatment between a well-diversified (less risky) loan portfolio from one that
is very concentrated (and hence riskier).

+

Inappropriate treatment of sovereign risk: Basel I’s capital treatment for sovereign
exposures made little economic sense, and the mechanical application of these rules
often created perverse incentives and led to the mispricing of risks. For example,
lending to OECD governments became more attractive because it incurred no


- 11 -

regulatory capital charge, even though this group included countries with

substantially different credit.
+

Few incentives for better overall risk measurement and management: The lack of
emphasis on other risk types (e.g. interest rate, operational, business) and on
financial infrastructure issues (e.g. accounting, legal framework) did not provide
adequate incentives to encourage complementary improvements in banks’ risk
governance and measurement. As a result, there was often an excessive reliance on,
and a false comfort from, a high capital adequacy ratio. Subsequent experience has
shown that such a ratio, by itself, is meaningless in the absence of other supporting
measures.

2.2.2.


Basel II

Following the publication of successive rounds of proposals between 1999 and 2003,
active and broad consultations with all interested parties, and related quantitative impact
studies, the Basel Committee members agreed in mid-2004 on a revised capital adequacy
framework (Basel II). The framework will be implemented in most G-10 countries as of
year-end 2006, although its most advanced approaches will require one further year of
impact studies or “parallel running” and will therefore be available for implementation
one year later. For banks adopting the IRB approach for credit risk or the AMA for
operational risk, there will be a capital floor following implementation of the framework
as an interim prudential arrangement.



The main objective of the framework is to further strengthen the soundness and stability

of the international banking system via better risk management, by bringing regulatory
capital requirements more in line with (and thus codifying) current bank good practices.
This will be achieved by making credit capital requirements significantly more risk
sensitive and by introducing an operational risk capital charge. The intention is to
broadly maintain the aggregate level of capital requirements, but provide incentives to
adopt the more advanced risk-sensitive approaches of the revised framework. These
changes are implemented by changing the definition of Risk Weighted Assets (i.e., the
denominator of the CAR) while leaving most of the other elements of Basel I


- 12 -

unchanged, such as the focus on accounting data, the definition of eligible capital, the
8% minimum CAR requirement and the 1996 market risk amendment to the Capital
Accord.


Basel II consists of a broad set of supervisory standards to improve risk management
practices, which are structured along three mutually reinforcing elements or pillars:
+

Pillar 1, which addresses minimum requirements for credit, market and operational
risks.
Table 2.1: Pillar 1
Total eligible capital
≥ 8%
Credit risk + Market risk + Operational risk



Standardized approach (SA)



IRBF Approach



IRBA Approach



Standardized approach
(SA)



Internal model approach  Standardized approach (SA)
(IMA)
 Advanced
measurement
approach (AMA)



Basic indicator approach
(BIA)

Source: Workshop Program between SBV and JICA
+

Pillar 2, which provide guidance on the supervisory oversight process.
Table 2.2: Pillar 2
BANKS

REGULATORS

Have internal systems and models to  See that the requirements of Pillar 1 are
evaluate their capital requirements in
effectively respected, and evaluate the
parallel to the regulatory framework and
appropriateness of the internal models set up
integrating the banks' particular risk
by the banks.
profile.
 If the regulators consider that capital is not
sufficient, they can take various actions to
 Integrate the types of risks not covered
remedy the situation, such as (1) requiring the
(or not fully) by Pillar 1, such as
bank to increase its capital base, or (2)
reputation risk and strategic risk,
restricting the amount of new credits that can
concentration credit risk, interest rate
be granted, but measures can also focus on (3)
risk in the banking book (IRRBB)
increasing the quality of internal controls and
policies.


Source: Workshop Program between SBV and JICA