Presentation 5: Credit risk management of commercial banks in Vietnam: facts and issues

1. What are the credit risks and how to manage credit risks? Illustrate by one example of
one commercial bank/commercial banks in Vietnam and comments on the efficiency of the
risk mitigations?
1.1 What are credit risks
• Definition:
+ Credit risk is the possibility of a loss resulting from a borrower's failure to repay a loan or meet
contractual obligations. Traditionally, it refers to the risk that a lender may not receive the owed
principal and interest, which results in an interruption of cash flows and increased costs for
collection.
+ Losses can arise in a number of circumstances, for example:
- A consumer may fail to make a payment due on a mortgage loan, credit card, line of credit,
or other loan.
- A company is unable to repay asset-secured fixed or floating charge debt.
- A business or consumer does not pay a trade invoice when due.
- A business does not pay an employee's earned wages when due.
- A business or government bond issuer does not make a payment on a coupon or principal
payment when due.
- An insolvent insurance company does not pay a policy obligation.
- An insolvent bank won't return funds to a depositor.
- A government grants bankruptcy protection to an insolvent consumer or business.
+ Although it's impossible to know exactly who will default on obligations, properly assessing
and managing credit risk can lessen the severity of loss. Interest payments from the borrower or
issuer of a debt obligation are a lender's or investor's reward for assuming credit risk.
In banking, credit risk is a major factor in determination of interest rate on a loan: longer the term
of loan, usually higher the interest rate. Also called credit exposure.
+ Credit risks are calculated based on the borrower's overall ability to repay a loan according to
its original terms. To assess credit risk on a consumer loan, lenders look at the five Cs: credit
history, capacity to repay, capital, the loan's conditions, and associated collateral.
• A credit risk can be of the following types:
+ Credit default risk — The risk of loss arising from a debtor being unlikely to pay its loan
obligations in full or the debtor is more than 90 days past due on any material credit obligation;
default risk may impact all credit-sensitive transactions, including loans, securities and derivatives.
+ Concentration risk — The risk associated with any single exposure or group of exposures with
the potential to produce large enough losses to threaten a bank's core operations. It may arise in
the form of single name concentration or industry concentration.
+ Country risk — The risk of loss arising from a sovereign state freezing foreign currency
payments (transfer/conversion risk) or when it defaults on its obligations (sovereign risk); this type
of risk is prominently associated with the country's macroeconomic performance and its political
stability.
1.2 How to manage credit risk:
1.2.2 Concept of credit risk management
Credit risk management (CRM) is a process from strategic planning to implementation, control
and review the performance, prevention and constrain credit risk. In other words, “CRM is the
process of identification, analysis and measurement, implementation of related strategies to
mitigate the level of credit risk, control and review credit risk” (Can Van Luc, 2013).
The goal of credit risk management is to maximize a bank’s risk-adjusted rate of return by
maintaining credit risk exposure within acceptable parameters.
1.2.3 Credit risk management procedures
The procedure of credit risk management is shown as a life cycle which is included 4 cycles:
Figure: CRM procedure

(Source: Can Van Luc, 2013)

Credit risk identification:
This content of this stage is identification of credit risks which the bank can face up with and
attitude of bank with respect to acceptance of credit risk levels and/or types. After that, the criteria
for deciding acceptable credit risks is formed in order to avoid waste of time in credit assessment
and credit approval process. Bank’s appetite for credit risks is usually based on the business
objectives, strategies and credit policies.
The methods of risk identification are included: objective – based method, “as/if sensitivity”
analysis method, experience-based method and hybrid method.
Credit risk analysis/measurement:
In this stage, qualitative and quantitative credit assessments, industry/competitor analysis, trend
analysis are conducted by analysts
As for qualitative analysis: to assist in the process and to act as a template, many such assessments
use a set of elements to subjectively determine the credit quality of the entity being assessed. A
common model of credit assessment is the ‘6C’s of credit’. These are:
Character, Capacity, Capital, Conditions, Collateral, Confidence.
As for quantitative analysis: the credit rating and credit scoring are the methods by which the
banks have judgments whether the banks grant credit to the customers or not and the banks have
policies related to credit granting and interest rate based on the results given by these methods.
+ Credit scoring:
Credit scoring is a technique using statistical data of research to assess the level of credit risk with
customers. Banks use credit scores to (1) evaluate the potential risk posed by lending money to
consumers and to mitigate losses due to bad debt; (2) to determine who qualifies for a loan, at what
interest rate, and what credit limits; (3) to determine which customers are likely to bring in the
most revenue.
The credit scoring is based on the financial and non-financial performance of clients in the past to
develop credit scoring models. The higher score client getting is equivalent to the lower credit risk.
Some financial indicators in credit scoring are: liquidity indicators, operation indicators, indicators
of debt balance, income indicators….
Some non-financial indicators are used in credit scoring such as: Repayment ability from cash
flows; management capacity and internal environment; relationship history with banks; external
factors; other factors based on specified industry.
+ Credit rating:
Credit rating evaluates the credit worthiness of borrowers. This evaluation is made by a credit
rating agency of the borrower's ability to repay loans and the probability of default.
In the U.S, credit rating agencies such as Standard & Poor's (S & P) and Moody's Investor Service
and Fitch are very reputable. For example, S& P consider factors such as the type of credit
provided; the type of collateral and other factors to evaluate the enterprise from the highest AAA
to the lowest is C, which lower rank is accompanied with the higher credit risk.
In Vietnam, rating corporate clients is usually performed by their commercial banks. It means that
credit rating can not reflect objectively creditworthiness of customers because ranking results can
be affected by recognition and subjective criteria set out by the bank. Therefore, credit rating in
Vietnam should be implemented by an independent organization.
Internal credit rating system in Vietnam commercial banks has normally focused on 3 subjects:
corporate customers, individual and household customers, financial institutions.
Credit risk mitigation:
After analysis and measurement stage, credit risk mitigation should be performed. It is the
employment of various methods to reduce the risks to lenders, banks and other business which
offer credit. In the commercial banks, methods to reduce risk are included:
+ Applying credit principles (under Basel committee…) and complying credit policies and
procedures.
+ Setting and observing credit limits for each client’s group, type of currency (VND, USD…),
industry, nation (using mostly in trade finance), term…
+ Formulating and implementing effective CRM strategies, policies and procedures.
+ Building “risk culture” in all branches of commercial banks
+ Improving and effectively exploring quality of customer’s database and credit information.
+ Using credit derivatives (such as securitization, credit default swaps….)
+ Risk - participation arrangements.
Credit risk control and review:
Control procedure: Good control and review system in order to discover early signals of credit
risks will provide prompt actions for reducing credit risk in the commercial banks.
According to Basel II, “Banks must have independent credit risk control units that are responsible
for the design and selection, implementation and performance of their internal rating systems. The
unit(s) must be functionally independent from the personnel and management functions
responsible for originating exposures” and “Internal audit or an equally independent function
must review at least annually the bank’s rating system and its operations, including the operations
of the credit function…”
Loan classification: the classification will help bank monitor and evaluate level of credit risk for
each loan, each customer to have urgent solutions. Loan classification up to international standards
and bad debt management is the basis to set up appropriate provision for each loan and the proper
system of control and supervision.
Bad debt management: In order to manage bad debts, firstly the banks will restructure loans based
on repayment schedule and the feasibility of customer’s business. The loan restructure methods
are additional lending, debt reschedule, receivership….. Secondly the banks will liquidate by using
of loan provisions, NPL sale, liquidation of collateral assets in the case that the borrowers can not
able to repay overdue debt.
Nowadays, one unit specializing in bad debts which is separated from credit department because
of the increase of bad debt is established. It concentrates on solving overdue debts and giving
advices to managers in controlling credit risk.

1.3 Illustrate by one example of one commercial bank/commercial banks in Vietnam and
comments on the efficiency of the risk mitigations?
First and foremost, Vietcombank is one of the 10 banks selected by the SBV to implement
Basel II in Vietnam and the basis for the expectation of success is that Vietcombank has been able
to:
(i) designing risk culture and appetite O.O
(ii) reviewing and consolidating risk management apparatus towards to international practices;
(iii) separating functions of 3 Lines of Defense in risk management
(iv) forming an organizational structure in data management;
(v) building and/or reviewing document systems, credit risk management policies, credit risk
quantitative models (such as Probability of Default (PD) models; Loss given default (LGD)
models, etc).
In more detail, in order to mitigate credit risk, Vietcombank has:
- Completed credit operating model toward centralizing and specializing by functions and
separating business and risk management in conformity with international practices, conditions in
Vietnam and development strategy of Vietcombank.
- Built and completed an early warning system to timely detect risks that may occur and can
have prompt actions in customer management to minimize risks, as well as increase inspection and
supervision efficiency.
• Result:
- NPL reduce steadily over years.
- The NPL always lower than average, signify a stability quality of loan portfolios.
- One of only 5 lenders in the banking system that have successfully buy back NPLs from
VAMC.
• Comment:
VCB has been one of the most aggressive Vietnamese banks in upgrading its risk management
capability, including credit risk management. Being one of the few banks in Vietnam that can
utilize advanced risk management tools, VCB can be said to have top-notch risk management.
2. What is VAMC? How did VAMC help banks in credit risk management?
VAMC is an abbreviation of Vietnam Asset Management Company. This company was founded
under the direct supervision of the SBV, with the aim to handle and buy bad debts from troubled
banks.
The VAMC helps banks in credit risk management by monitoring the restricting risk and control
expenses of credit institutions in handling NPLs. There are four main authorizations that the
VAMC was given, including:
–– to purchase bad debts,
–– to collect bad debts,
–– to sell bad debts and collaterals,
–– to restructure debts and enforce security.
Non-performing debts can be purchased by the VAMC from credit institutions through two
methods:
1. Buying NPLs according to the book value or the market price for special bonds issued by the
VAMC,
2. Buying NPLs according to market price for funds proceedings of the bad debt sales