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 i 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 RATIONALE OF THE STUDY 1.2 RESEARCH OBJECTIVES/RESEARCH QUESTIONS 1.3 RESEARCH METHODOLOGY 1.4 RESEARCH SCOPE (PLACE, TIME…) 1.5 STRUCTURE OF THE PROJECT 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 .4 I.1.2 Concept of credit risk management I.2 BASIC PRINCIPLES OF CREDIT RISK MANAGEMENT I.2.1 Establishing an appropriate credit risk environment .7 I.2.2 Operating under a sound credit granting process I.2.3 Maintaining an appropriate credit administration, measurement and monitoring process I.2.4 Ensuring adequate controls over credit risk I.2.5 The role of supervisors I.3 CREDIT RISK MANAGEMENT PROCESS 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 ii 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 iii 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 iv 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 v 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 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  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  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? 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 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 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 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 Colquitt, Joetta 2007 Credit Risk Management: How to Avoid Lending Disasters & Maximize Earnings, p Joel Bessis, Risk Management in Banking, Second Edition, John Wiley&Sons, Ltd, 2002, p13-15 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:  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 Credit risk management - Case study of VPB Table 2.5: Loans by industry sectors of VPB from 2008 to 2010 Value unit: 000’USD 2008 Term State owned enterprises Value 2009 % 1,382 0.80% Value % 1,252 0.56% Limited liability companies 93,372 54.01 122,72 % Foreign invested enterprises 35,736 20.67% 52,562 Individuals and others 42,397 24.52 46,626 20.89% % Total 172,88 100% 223,163 2010 Change 2009/2008 -9.46% Value % 9.97% 2010/2009 7,150 2.85% 471.21% 54.99 31.43% 130,311 51.99% % 23.55 47.09% % Change 61,410 6.18% 24.50 % 16.83% 51,799 20.66% 11.09% 100% 29.08% 250,669 100% 12.33% (Source: Annual reports of VPB from 2008 to 2010) Group of limited and liability companies (SME) is always a group of companies has the largest proportion of outstanding loans (account for more than 50% in total loan); next are Foreign invested enterprise and Individual and others account for around 20% The group of state owned enterprise has increase slightly in value and proportion from 0.8% in 2008 to 2.85% in 2010 In general, this customer structure loan is suitable with small scale commercial bank like VPB and subject to government’s policy for SMEs encouragement Loan portfolio by loan group VPB debt classification is made according to Decision No 18/2007/ QD-NHNN dated 25 April 2007 that was amendment and supplement of Decision No 493/2005/QDNHNN dated 22 April 2005 Accordingly, Banks classify loan into groups from to 5, in which group is standard loans and group 3, & are bad debt group 22 Credit risk management - Case study of VPB Table 2.6: Loans by group of VPB from 2008 to 2010 Value unit: 000’USD 2008 Term Group Group 2009 Value % Value 149,504 86.47 199,46 % 2010 Change % 2009/2008 Value % Change 2010/2009 89.38 % 33.42% 219,601 87.61% 10.09% 17,027 9.85% 18,041 8.08% 5.96% 18,963 7.56% 5.11% Group 3,338 1.93% 826 0.37% -75.27% 2,138 0.85% 158.94% Group 751 0.43% 1,451 0.65% 93.12% 6,070 2.42% 318.45% Group 2,266 1.31% 3,377 1.51% 49.01% 3,897 1.55% 15.39% NPL 6,355 3.67% 5,654 2.53% -11.03% 12,105 4.82 % 114% Total 172,887 100% 223,163 100% 29.08% 250,66 100% 12.33% (Source: Annual reports of VPB from 2008 to 2010) The data in the above table showed the ratio of bad debt in VPB is still in control lower than the banking industry’s NPL of 5% over time In 2008, the NPL is 3.67% and reduced in 2009 to 2.53% but in 2010, this ratio increased to 4.82% However, the current loan Group accounts for a very large portion in total loans for nearly 90% Overall, these figures are positive for VPB, have increased in value but have control well the proportion of debt problems I.2.3 Credit risk in VPB from 2008 – 2011 In credit risk groups that VPB faces Limited liability companies and Individual are the biggest risk for VPB In particular, concentration of credit into two major industries is Manufacturing and Services and trading was much, the proportion of sectors accounted for approximately 50% of total loans the credit Thus, we can say the concentration of risk in VPB is quite high lead to high credit risk Besides, the level of credit risk depends on type and value of collaterals from customer much 23 Credit risk management - Case study of VPB Table 2.7: Type and value of collaterals from customers from 2008 to 2010 Unit: 000’USD 2008 Term Value 2009 % Value 2010 % Value % Real Estate 187,248 57.37% 331,169 62.41% 399,524 63.37% Movable assets 115,716 35.45% 169,672 31.97% 198,866 31.54% 2,087 0.64% 6,764 1.27% 16,363 2.60% 21,349 6.54% 23,041 4.34% 15,676 2.49% 326,400 100.% 530,646 100% 630,430 100% Valuable papers Other secured assets Total (Source: Annual reports of VPB from 2008 to 2010) Ideally, banks will look to take collateral that will meet or exceed the term of the loan in order to fully protect them For example, in cases where there is a short-term loan, such as a line of credit, short-term assets like receivables and inventory are deemed acceptable securities In the case of a long-term loan, receivables and inventory would not be valid forms of collateral Certain collateral is more attractive to the bank according to the type of loan being sought Through the table no 2.7, we can see that, the major collaterals that VPB receives from customers for their loan are Real estate ( account for more than 60%) through years and movable assets ( most are vehicle like car, truck… account for more than 30%) Real estate is actually the preferred collateral when obtaining secured business credit This gives the bank the confidence that there will be no default on the loan, and in the event there is, then they will secure the property that is used as collateral in order to recover their investment Real estate, under normal circumstances is understood to maintain its present value or to even grow in value periodically Therefore, banks view real estate as the best collateral for secured business credit, with the expectation that if they must sell Thus, prudent policy in VPB’s credit activities is right strategy when they prefer loans for manufacturing sector that collateral by real estate Banks also accept movable assets as securities However, in banking parlance movable assets are considered to be a very high risk security The major risk is possibility of the same movables being mortgaged to another financial institution The management cost on movables on post disbursement is high as this process has to be continued until the full recovery of the advance However, in VPB major movable assets used as collaterals are vehicle so it is less risk for banks since the bank obtains the original certification of registration 24 Credit risk management - Case study of VPB Table 2.8: Non-performing loan from 2008 to 2010 Unit: % Term 2008 2009 2010 Net non-performing loan ratio 3.67% 2.53% 4.82% Loan loss coverage 34.3% 49.8% 30.6% (Source: Annual reports of VPB from 2008 to 2010) Reviewing data in previous table in 2.1, Gross loans and advances increased by 29.1% or USD50.27 million to USD223.16 million in 2009 from USD172.89 million in 2008, reflecting the Bank’s concerted efforts in implementing effective marketing strategies to achieve a strong loans growth In addition, the Bank’s net non-performing loans (NPL) ratio has improved significantly from 3.67% as at 31 December 2008 to 2.53% as at 31 December 2009 as a result of the Bank’s prudent lending and credit policies In 2010 the gross loans and advances increased by 12.33% or USD27.51 million to USD250.67 million in compare with USD223.16 million in 2009 while NPL is also increase times This takes challenge for VPB that how to balance credit development and control NPL? Banks also use the loan-loss coverage ratio to define the quality of its assets and how well it protects itself from losses caused by problematic loans The higher this ratio is, the better the bank is handling itself in regards to loans This ratio in VPB is quietly safe (more than 30% in studied period, especially reached 49.8% in 2009) Table 2.9: Loan Classification 2011 Value unit: 000’USD Term 31/03/2011 30/06/2011 30/09/2011 Value % Value % Value % Total loan 226.38 100% 224.40 100% 235.70 105% Group 198.50 88% 196.42 88% 206.48 92% Group 15.94 7% 13.64 6% 13.91 6% Group 2.21 1% 4.32 2% 2.25 1% Group 6.35 3% 5.94 3% 2.87 1% Group 3.37 1% 4.08 2% 10.19 5% Overdue 27.88 12.32% 27.98 12.47% 29.22 13.02% NPL 11.94 5.27% 14.34 6.39% 15.31 6.82% (Source: Credit report of VPB as at 30.9.2011) In general, overdue loan ratio (from group to group 5) relative increases over the quarter I, II and III/2011 at the 12.32%, 12.47% and 13.02% in which Binh Duong is 25 Credit risk management - Case study of VPB branch with highest overdue debt ratio compared to others is 20.07%, followed by Ho Chi Minh branch 17.72% and Dong Nai 17.16% It is noted that NPL ratio was 6.82% in the third quarter, up slightly from last quarter's ratio is 6.39% In the fifth group debt increased most from 2% to 5% mainly because customers were transferred from group to group This NPL is highest in studied period in VPB, higher than the banking industry’s NPL of below 5% This has reinforced the urgent setting and the importance of credit risk management in VPB and imperative of the topic when I choose to write my thesis Main reasons for VPB’s increase in NPL are due to customer’s weaker performance as an impact of economic recession However, some of the subjective reasons include:  Lack in control of loan utilization purposes In some cases, applicants were not the actual borrowers and as such, they not care about loan repayment  Late detection of signs of credit risk In many NPL cases, branches only detect the customer’s problems after they arise II.3 Assessment of credit risk management used in VPB The most important types of financial risk to which the Bank is exposed are credit risk and market risk The Bank is subject to credit risk through its lending and investing activities and in cases where it acts as an intermediary on behalf of customers or other third parties or issues guarantees The risk that counterparties might default on their obligations is monitored on an ongoing basis To manage the level of credit risk, the Bank attempts to deal with counterparties of good credit standing, and, when appropriate, obtains collateral The Bank’s primary exposure to credit risk arises through its loans and advances The amount of credit exposure in this regard is represented by the carrying amounts of the assets on the balance sheet In addition, the Bank is exposed to off balance sheet credit risk through commitments to extend credit and guarantees issued Concentrations of credit risk (whether on or off balance sheet) that arise from financial instruments exist for groups of counterparties when they have similar economic characteristics that would cause their ability to meet contractual obligations to be similarly affected by changes in economic or other conditions The major concentrations of credit risk arise by location and type of customer in relation to the Bank’s investments, loans and advances, commitments to extend credit and guarantees issued The Bank has significant exposures to certain industries As in my interview with the Manager of Credit department, he said that “VPB’s Risk Management Committee has been established recently in 2011, with GD as Chairman, DGDs, Managers of Credit, Accounts, Internal Audit as members The committee oversees both Credit and Operational Risk matters and is under the GD But actually it 26 Credit risk management - Case study of VPB is not actively operating now.” However, the establishment of Risk management committee in VPB will be good foundation for credit risk management in coming time CRM strategy and policies Discretionary Power (Details provided in annex), which is given to various approving authority levels (i.e BM, DGD, GD, any Standing Member, Standing Committee including SMs) by type of facility, loan limit, overall capping limit and collateral It shows the Bank’s prudence in credit activities, approving power is decentralized upon position level to minimize risk However, such decentralization also contains shortcoming as higher level in management is not always consistent with better experience in approving loans Credit noting, which is one of VPB’s distinctive features as compared to other banks i.e loan, after being approved by a D/P holder, will be submitted to the next D/P level for noting E.g loan approved by BM to be noted by DGD, loan approved by GD to be noted by one SM, etc By doing this, head office / higher level can detect irregularities or risky lending for necessary preventive or remedial actions and avoid future recurrence Credit rating (by using Customer Credit Rating or CRR score sheet), including scoring on customer (e.g years in business, line of business, management’s experience, banking record, etc.), collateral (types and margin of advance), financials (e.g profitability, liquidity, gearing, etc.) Each factor will be given a certain weightage and the final score is the weighted average of all factors It also imposes penalty for other risk factors (e.g operating in industry with perceived higher risk like construction, textile, etc or using unaudited report for financial scoring, etc.) If the score is too low (below 46), the loan will be rejected or approval will be subject to satisfaction of strong overriding factors to support Other policies (e.g credit review, security documentation, loan classification, making and utilization of provision, etc.) are quite similar to other banks Currently, VPB are classifying loans on quantitative basis (or age of the loan, as per Article of SBV Decision 493) CRM Process The credit risk management process in VPB at present is subject to State Bank’s regulations and Public Bank’s Guidelines Bases on that VPB issued Credit Handbook in 2006 as an internal guiding for management levels and credit officers’ reference and implementation Actually, it is difficult to divide CRM process in VPB into steps However, we can say that VPB’s CRM is performed at all levels, from branches to head office and top management in the following credit activities:  Loan marketing (e.g SMO/SMS should look for prospective customers in line with the bank’s lending direction, who can meet the bank’s lending conditions, etc) 27 Credit risk management - Case study of VPB  Credit processing and approval (including noting – as explained above)  Loan release and utilization  Credit review  Loan monitoring & control (e.g reminder / follow-up for repayment, loan rehabilitation – rescheduling, restructuring, loan take-over, etc.)  Loan collection & recovery (e.g liquidation of collateral, court petition, enforcement of security, etc.) Based on the gerneral assessment, the researcher draw some main good points and shortcoming in VPB’s credit risk management as below II.3.1 Good points Having inherited the prudent lending culture from PBB and BIDV, the Bank is always regarded as one of the most cautious and prudent banks in Vietnam with low nonperforming loans The Bank remains trying to complete the credit risk management system as much as possible A Risk Management Committee has been established in 2011 in the whole effort to retain and reduce the NPL in struggle economic context Specific achievements have been achieved in recent time as follows: Firstly, under SM’s direction, credit operations of VPB were developed on the basis of a reasonable balance between the goal of growth and risk management Credit operation has increased respectively through years while NPL was retained in a acceptable level Secondly, a detailed policy in D/P contributes to the maintenance and development of credit activities safely Moreover, the establishment and operation of risk management committee has brought many benefits to the credit of VPB Thanks to this committee, leaders of VPB can promptly advise their direction of credit in each branch generally and specifically Meanwhile, BOD could review, grasp advantages and warn risk in order to develop credit activities in VPB safely Thirdly, with a sense of credit management and monitoring is an important factor in maintaining the safe and soundness of bank credit operation, VPB has built a process of inspection and supervision of credit information, specific credits to make sure, the credit was granted are being tracked, monitored closely According to general assessment, the process is quite consistent with the current state of VPB as well as characteristics of the economy and customer characteristics Risk assessment on overall customer basis instead of project basis (like most local banks), VPB assesses the repayment capacity of the borrower as a whole, not only from the project As such, a project may appear good but it does not mean easy approval if the customer’s repayment capacity is doubtful Last but not least, frequent credit review (based on credit rating, e.g grade A/B customers are subject to annual reviews, grade C or lower subject to half-yearly 28 Credit risk management - Case study of VPB reviews, etc.) and credit noting practice - VPB’s distinctive features as mentioned above are helpful tools to manage credit risk in VPB II.3.2 Shortcoming and reasons Lack of a comprehensive & systematic policy on credit risk management As most of Vietnam's commercial banks, VPB don’t not have a comprehensively CRM strategy throughout the system to set goal-oriented for credit activities in each period Lack of credit risk strategy, a plan for sustainable development, long-term success will always beyond the reach of banks In VPB, there are many operational guidelines regarding CRM (e.g on credit rating, on loan monitoring, etc.) but they are not consolidated in a complete policy document This is because VPB mostly adopts practices & guidelines from PBB without building up its own CRM policy Lack of close control on customer’s loan utilization purposes Although risk management committee was established but in fact this committee has not operated actively to monitor the bank credit activities for ensuring quality of credit risk management In most cases, VPB’s loan releases are subject to supporting documents evidencing the genuine transactions without follow-up by site visitation to customers’ business places (e.g factories, warehouses, etc.) like other banks However, this can be maneuvered by customers As a result, branches may only detect the misuse of fund or adversity in customer’s operations during credit review, which may be too late This is partly due to lack of manpower to conduct such regular site visitation Collateral valuation by bank staff Though branches are using external values to value our collateral, many are still valued by our own staff, which may be risky if the valuing staff is not well versed in valuation As a result, proceed from the liquidation of collateral may not be sufficient to cover the credit risk Relaxation in information checking & verification Branches tend to rely on documents and info provided by customer without much crosschecking and verification with other sources As such, some customers have easily “cheated” the bank to get loans which subsequently turned bad Lack of internal control at branch level In many cases, credit risk was only detected when overdue loan surfaces Such risk can be prevented if each branch has at least one compliance officer who will counter-check the branch’s transactions to identify potential risk factors Absence of a legal department with competent staff to handle petition cases As branches are now working directly with relevant bodies (e.g court, execution department, etc.) it may be ineffective, time consuming and sometimes more costly 29 Credit risk management - Case study of VPB CHAPTER III: RECOMMENDATIONS TO IMPROVE CREDIT RISK MANAGEMENT IN VPB III.1 Improving the credit risk management strategy The important of a credit risk management strategy has been mentioned in theoretical part to establish an appropriate credit environment But the fact that credit risk management strategy has been not reflected and paid high attention in business strategy and action plan of VPB VPB don’t not have a comprehensively CRM strategy throughout the system to set goal-oriented for credit activities in each period Lack of credit risk strategy, a plan for sustainable development, long-term success will always beyond the reach of banks Hence the Bank should determine the level of credit risk that it can bear It should develop a risk management strategy that is consistent with its credit risk tolerance and business goals In formulating this strategy, VPB should consider the following: o the business cycle stage it is operating in; o the nature of its business and its relevant credit market segments; o the portfolio mix that balances its willingness to bear concentration risk with sufficient diversification; and o the business targets it has set for particular lending segments Furthermore, BOD should periodically review this credit risk strategy and any changes and concerns should be effectively communicated to all relevant staffs III.2 Improving credit policies A good CRM system must be placed in an appropriate risk environment Risk environment of commercial banks consists of two main factors are credit risk strategy and credit policies Framework for managing credit risk along with general credit strategy, the main basic credit policy, is an important integral part of the CRM system The fact that in VPB, there are many operational guidelines regarding CRM (e.g on credit rating, on loan monitoring, etc.) but they are not consolidated in a complete policy document This is because VPB mostly adopts practices & guidelines from PBB without building up its own CRM policy As such, VPB should work out a consolidated CRM policy, which is to be implemented at all levels of the bank, from top management to staff These policies should lay down the conditions and guidelines for the granting, maintenance, monitoring and management of credit, at both the individual transaction and portfolio levels It should be documented, well-defined, consistent with prudent practices and regulatory requirements, and adequate for the nature and complexity of the Bank’s activities Furthermore, VPB should review significant and frequent policy exceptions to 30 Credit risk management - Case study of VPB determine the potential impact on its credit risk profile as well as the effectiveness of those guidelines III.3 Improving the credit risk management structure Structure of risk management is the backbone of the risk management system of banks, not only credit risk management According to international practice, to ensure the success of credit risk management, the independence of risk management committee and its key role in decision making process is basic principle that banks have adhered to At VPB, Risk Management Committee has been established recently in 2011, with GD as Chairman, DGDs, and Managers of departments: Credit, Accounts, Internal Audit to manage both Credit and Operational Risk matters But actually it is not actively operating now This committee including head of business departments only but has not pointed out the role of each and subordinates specifically Therefore, control of lending as well as entire investment portfolio has not been evaluated correctly and timely in relation to the risks and returns accordingly Moreover, credit risk management at VPB is currently embedded into daily operations (e.g in credit processing, credit review, loan follow-up, collection & recovery activities, etc.) Thus, the structural reform of credit risk management committee is priority tasks of VPB to establish risk management and control functions, independent of the credit originating function VPB should also consider placing at least one compliance officer at each branch And set up legal department (or division) with professional and competent staff to consult the management & branches in legal aspects III.4 Control Credit granting process As mentioned in “Shortcomings” part, in most cases, VPB’s loan are released basing on supporting documents provided by customers without direct visit to customers’ business places (e.g factories, warehouses, etc.) like other banks And many VPB’s collateral is valued by their own staff not external value This can lead to insufficient assessment on customer’s operations and liquidity of the collateral during credit review, which may be too late to detect risky in customer’s collateral or customer’s misuse of fund or their adversity then Hence, VPB should closely control loan utilization purposes through both supporting documents and regular site visitation as well as improve their control in loan processing (especially in customer’s selection and verification of information) as follows: - To enhance account management of customers to ensure that their additional financing needs are considered and processed timely - To expedite loan processing & follow up closely with relevant approving authorities for approval / decision on the submitted applications - To continue maintaining close rapport with relevant bodies (e.g public notary, registration department, etc.) to ensure smooth & speedy documentation for loan release 31 Credit risk management - Case study of VPB - To constantly monitor and review the utilization of the existing credit facilities of corporate customers, especially those are presently enjoying credit facility with other banks - To constantly update information on customer’s operations, review the facilities & monitor the loan utilization to avoid NPL from arising III Improving the quality of the CRM officers and credit staffs People are always key factor to the success of all activities in society The commercial bank is not exceptional People play an important role in creating high quality credit services which directly impact to the success of the bank Therefore, in order to take effect in banking activity generally and CRM particularly, it should pay attention to the quality of human resources, especially CRM officers and credit staff s Starting from the situation that VPB has not focused on developing and maintaining a CRM team and incomplete criteria to evaluate risk has led to inefficient CRM Especially in the context of CRM committee has just established, there is lack of qualified and experience officers Therefore, VPB should regularly assess and rearrange personnel in departments, especially in CRM committee and credit department at both head office and branch level The assessment should be based on both quantitative and qualitative criteria such as competency, qualifications, experience, job position, moral, sense of responsibility… associated with the specific job description at each position to arrange personnel appropriately It requires VPB to arrange more training activities for staff, both in-house and external training to improve our staff’s knowledge & skills 32 Credit risk management - Case study of VPB CONSLUSION The thesis introduced credit risk management operations at VPB The paper begins with theory that triggers my interest in this specific field Climbing concerns about the banking system’s credit risk management both in overall banking industry and VPB recent time are main reasons behind this interesting topic selection What the researcher wants to figure out after the research has been clearly defined with five research questions relevant to research objectives In brief, risk is inherent in every daily activity but can always be managed Banking organizations are natural risk takers Banking risks can be grouped into three groups: financial risks (related to the financial position or financing forms), operational risks (related to internal inadequacies) and environmental risks (associated with external changes) Credit risk arises when the borrowing party fails to repay the debts (partly or wholly) to the lending party Credit risk belongs to financial risk category and is one of the biggest risks in banking business as lending is core to any banking services The question of credit risk management has continuously been studied about and improved Banks usually handle credit risk with a well-established credit culture showing their attitudes towards credit risk, a structured credit organization and firm personnel base, and a comprehensive set of policies governing credit activities in the whole group However, one had better not ignore the impacts of the credit market on a bank’s credit risk management Besides the conditions in the market that may favor or hinder credit risk management development, regulatory environment created by the central bank also has its significant role Risk management is a separate function in the bank’s organization structure and plays a growingly significant role within the bank’s activities As a small joint venture bank in the market, VPB faces many credit risk management difficulties, such as increasing competitive pressure due to irrational division of market, poor relationship-based lending practices, and lack of credit information and history However,VPB has developed its own credit culture, issued a lot of documents regarding credit operations, and organized the credit staffs in a hierarchy The limitation of the project is that I cannot develop credit risk management policies in more details within the large scope and time constrain Further work needs more technical skills and I should study more from banks success in credit risk management Nevertheless, I believe that the study could enhance the credit risk management and improve NPL situation of VPB in the coming time 33 Credit risk management - Case study of VPB REFERENCES Andrew Fight (2004), Credit risk management Basel Committee on Banking Supervision (2000), Principles for the management of Credit risk Basel Committee on Banking Supervision (2000), Range of practice in banks’ internal rating system, Discussion Paper Basel Committee on Banking Supervision (2006), International Convergence of Capital Measurement and Capital Standards, Revised Framework Comprehensive Version Colquitt, Joetta 2007 Credit Risk Management: How to Avoid Lending Disasters & Maximize Earnings: 3rd Edition Mc Graw – Hill USA Joel Bessis (2002), Risk Management in Banking, Second Edition, John Wiley&Sons, Ltd, Monetary Authority of Singapore (2006), Guidelines on Risk Management Practice -Credit Risk OeNB &FMA (2004) Guidelines on Credit Risk Management, Credit Approval Process and Credit Risk Management State bank of Pakistan (2005), Risk management: Guidelines for Commercial Banks & DFIs 10 VID PUBLIC BANK, Credit Handbook 11 VID PUBLIC BANK 2008 Annual Report for the year ended 31 December, 2008 Unpublished report Hanoi, Vietnam.82 12 VID PUBLIC BANK 2009 Annual Report for the year ended 31 December, 2009 Unpublished report Hanoi, Vietnam.126 13 VID PUBLIC BANK 2010 Annual Report for the year ended 31 December, 2010 Unpublished report Hanoi, Vietnam 128 14 VID PUBLIC BANK, 2011 Financial Statements as at September 2011 34 Credit risk management - Case study of VPB APPENDIX LOAN CLASSIFICATION BY GROUP Decision No 493/2005/QD-NHNN dated 22 April 2005 issued by State Bank of Vietnam, which was amended and supplemented by Decision No 18/2007/ QD-NHNN dated 25 April 2007 issued by State Bank of Vietnam, requires a specific allowance to be made for loans and advances on a quarterly basis based on loan grading 35 Credit risk management - Case study of VPB APPENDIX II LIMITS FOR DISCRETIONARY POWERS TO APPROVE CREDIT FACILITIES SUBJECT TO PERIODIC REVIEW WITHOUT ANY CHANGES TO TERMS AND CONDITIONS Discretionary Limits per Customer Name Branch Manager USD1M Deputy General Director General Director Any one of the Standing Committee Standing Members of the Board USD1.5M Discretionary from BIDV or PBB Discretionary Discretionary Note: All Reviews with adversities have to be submitted to both SMs from BIDV and PBB for official noting/signing 36 ... the lending party Credit risk belongs to financial risk category and is one of the biggest risks in banking business as lending is core to any banking services The question of credit risk management. .. 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... 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