Bad Debt at Commercial Banks

(ii) One-time repayment loan : This is a type of loan in which the customer only has to repay the principal and interest once upon maturity, applicable to small loans with short terms.

(iii) Demand repayment loan : This is a type of loan in which customers can repay the loan at any time, applicable to overdraft loans, credit cards, etc.

1.1.2.7. Based on the borrower

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(i) Business credit : This is a type of credit granted to business customers with loan values that are often very large, so this is also called wholesale credit.

(ii) Personal and household credit : These are credits granted to customers who are individuals and households with loan values that are usually small for consumption purposes.

(iii) Credits to financial institutions : These are credits granted to banks, insurance companies, finance companies or other financial institutions. These loans become the borrower's capital, so they can be used to repay debts or re-lend.

1.1.3. The role of bank credit

1.1.3.1. For the economy

(i) The basic economic role of bank credit is to circulate capital from those (individuals, households, companies and governments) who have surplus capital (due to spending less than income) to those who have a deficit (due to spending more than income). The need for loans is not only for business investment but also to satisfy immediate consumption needs because savers are often not at the same time those who have high-profit investment opportunities. Thus, without banks, the circulation of capital among economic entities will be blocked. Therefore, the channel of capital circulation through banks is very important in promoting the efficiency of the economy.

(ii) Bank credit is not only limited to the traditional function of transferring capital from places with surplus capital to places with shortage of capital, but also helps to effectively allocate financial resources in the economy. Through bank credit, capital from those lacking effective investment projects is transferred to those with more effective investment projects but lacking capital. The result is economic growth, job creation and high labor productivity.

(iii) Through investing credit capital in key economic sectors and areas, the development of those sectors will be promoted, forming a modern, reasonable and effective structure.

(iv) Bank credit contributes to the circulation of money and goods, regulates the market, controls currency value and promotes the expansion of economic exchanges between countries.

(v) Bank credit brings in large revenues for the state budget through taxes and interest from government capital investment trusts.

(vi) Bank credit is a channel for transmitting state-funded capital to rural agriculture, contributing to hunger eradication, poverty reduction, and socio-political stability.

1.1.3.2. For customers

(i) Bank credit promptly meets customers' capital needs in terms of quantity and quality. With advantages such as safety, convenience, speed, easy access and the ability to meet large capital needs, bank credit satisfies customers' diverse needs.

(ii) Bank credit helps investors grasp business opportunities, enterprises have capital to expand production, and individuals have enough financial capacity to cover expenses to improve their quality of life.

(iii) Bank credit binds the customer's responsibility to repay the principal and interest within a certain period of time as agreed. Therefore, it forces the customer to make efforts and utilize all his/her capabilities to use the loan capital effectively, speeding up the process.

production process, bringing profit to the business and ensuring debt repayment obligations to the bank.

1.1.3.3. For banks

(i) Credit is a traditional activity, accounting for a large proportion of total assets and providing the main source of income for banks (from 70% - 90%). Although the proportion of credit activities is on a downward trend, bank credit is still the most important capital use for each bank.

(ii) Through credit activities, banks diversify their asset portfolio and minimize risks.

(iii) Through credit activities, banks can expand other types of services such as payment, deposit attraction, foreign exchange trading, consulting...

1.2. BAD DEBT AT COMMERCIAL BANKS

1.2.1. Concept of bad debt

Bad Debt (Non-Performing Loan) is a loan that the creditor determines cannot be recovered and is removed from the creditor's list of receivables. For banks, bad debt means loans to customers, usually businesses, that cannot be recovered because the business is operating at a loss or going bankrupt... Bad debt is considered another expense that directly reduces the income stream of the lending business.

Credit is an activity that always has many potential risks, credit activities are also considered as a risk management business to generate profits in banking business. There are many causes leading to credit risk, but in general, credit risk can be understood as the bank's inability to recover all principal and interest when the loan is due. And when a loan cannot be recovered or there is a risk of not being able to recover principal and interest, it is called a bad debt.

According to the IMF, “a loan is generally considered nonperforming when: interest and principal payments are more than 90 days overdue; or more than 90 days' worth of interest has been refinanced, capitalized, or delayed by agreement; or payments are less than 90 days overdue but there are other good reasons to doubt that payments will be made in full. ”

Thus, bad debt is basically determined based on two factors: (i) overdue for more than 90 days and (ii) doubtful ability to repay. This is considered the definition according to the International Accounting Standards (IAS) currently widely applied in the world.

According to the International Financial Reporting Standards (IFRS) and IAS 39, which have just been issued by the International Accounting Standards Board and recommended for application in some developed countries in early 2005. Basically, IAS 39 only focuses on the repayment capacity of loans regardless of whether the overdue period is less than 90 days or not overdue. The method to assess the repayment capacity of customers is often the method of analyzing future cash flows or rating loans (customers). This system is considered accurate in theory, but practical application is difficult. Therefore, this system is being revised by the International Accounting Standards Board.

1.2.2. Signs of bad debts

In practice, business failure is often manifested through several warning signs. Some are subtle, others are very obvious. Banks need to have a way to recognize the early signs of a problem loan and take necessary actions to prevent and handle it. Signs of a problem credit can be divided into the following groups:

1.2.2.1. Signs from customers' production and business activities

During the customer accounting process, the trend of the customer's accounts through a process to provide the bank with some important signs including: Issuance of certified or dishonored checks; Difficulty in paying salaries; Declining deposit account balances; Increasing average usage in accounts; Frequent requests for working capital support to be able to pay debts when due; Inability to carry out cost cutting activities; Increasing trade debts or inability to pay debts when due.

Lending activities such as: Frequent increase in borrowing levels; Late payment of principal and interest; Requesting loans exceeding expected needs…

Financial methods: Using a lot of short-term funding for long-term development activities; Accepting the use of the most expensive funding sources (for example: regularly using factoring operations...); Reducing payables and increasing receivables; Payment ratios developing in a negative direction...

Difficulties in product development; Changes in the market: exchange rates, interest rates, loss of major suppliers or customers, new competitors, changes in tastes... Changes in government policies such as: tax policies, conditions for establishment and operation...

Customer products are highly seasonal; There are signs of cutting costs on repairs and replacements…

1.2.2.2. Signs belong to customer management

Frequent changes in the structure of the management system or board of directors. The management system is always in disagreement because of the purpose, management, and operation are arbitrary or too decentralized. The client's planning style shows:

i) Planned by a Board of Directors (BOD) or CEO with little or no experience; Lack of concern for the interests of shareholders and creditors; Frequent staff transfers.

ii) There are unreasonable management costs: excessive focus on impressive costs such as very modern office equipment, expensive means of transport, the board of directors having a lavish lifestyle, confusing business costs and personal costs.

1.2.2.3. Signs from financial information

Incomplete preparation of financial data or delay, delay of financial reports and analysis shows: Unbalanced increase in regular debt ratio; Increased sales but decreased profit or no profit; Mismatched working capital accounting accounts; Quantity of goods increased faster than sales …

There are also other non-financial signs: These are signs that credit officers can recognize with the naked eye, such as: Ethical issues, even the appearance of the business owner shows these things; Visible deterioration of the business location; Storage of too many, damaged, outdated goods...

1.2.3. Classification of bad debts of Vietnamese commercial banks

According to Decision 493/2005/QD-NHNN of the State Bank, bad debt is defined as debt belonging to group three (substandard debt), group four (doubtful debt) and group five (debt with potential loss of capital), specifically:

1.2.3.1. According to the "Quantitative" method

- Group 3 (Substandard debt) includes debts that are assessed by Credit Institutions (CIs) as being unable to recover principal and interest when due. These debts are assessed by CIs as being likely to lose a portion of principal and interest, including: Debts overdue from 90 to 180 days; Debts with restructured repayment terms overdue less than 90 days according to the restructured term; Other debts are classified into Group 3 according to the provisions of Clause 3 and Clause 4 of this Article.

- Group 4 (Doubtful debt) includes debts that are assessed by credit institutions as having a high risk of loss, including: Debts overdue from 181 to 360 days; Debts with restructured repayment terms overdue from 90 to 180 days according to the restructured term.

Other debts are classified into group 4 according to the provisions of Clause 3 and Clause 4*.

- Group 5 (Debts with potential loss of capital) includes debts that credit institutions assess as irrecoverable and losing capital, including: Debts overdue for more than 360 days; Debts frozen pending Government settlement; Debts with restructured repayment terms overdue for more than 180 days according to the restructured term; Other debts classified into group 5 according to the provisions of Clause 3 and Clause 4*.

* Clause 3: In case a customer has more than one (01) debt with a credit institution and any debt is transferred to a higher risk debt group, the credit institution is required to classify the remaining debts of that customer into higher risk debt groups corresponding to the risk level.

* Clause 4: In case of debts (including debts within the term and debts with restructured repayment terms within the term according to the restructured debt term) for which the credit institution has sufficient basis to assess that the customer's ability to repay has declined, the credit institution shall proactively decide to classify such debts into higher risk debt groups corresponding to the risk level.

1.2.3.2. According to the "Qualitative" method

For the first time, the "qualitative" method is allowed to be applied to qualified credit institutions under Decision 493. According to this method, debts are also divided into five groups corresponding to the five debt groups according to the quantitative debt classification method, but not necessarily based on the number of overdue days of unpaid debts, but based on the internal credit rating system and risk provisioning policy of the credit institution approved by the State Bank. The debt groups include:

i) Group 1 : Standard debt, including debt assessed as having the ability to fully recover principal and interest on time;

ii) Group 2 : Debts requiring attention, including debts that are assessed as having the ability to fully recover principal and interest but show signs of customers' declining ability to repay;

iii) Group 3 : Substandard debt, including debt assessed as having no possibility of recovering principal and interest when due;

iv) Group 4 : Doubtful debt, including debt assessed as having a high probability of loss; and

v) Group 5 : Debt with potential loss of capital, including debt assessed as irrecoverable or loss of capital.

1.2.4. Causes of bad debt

A loan becomes a bad debt when the lender cannot collect on time or there is a risk of not being able to collect the principal and interest on time. Therefore, the cause of bad debt may arise due to the borrower's ability to repay and/or the borrower's will to repay; or because the lender did not perform properly from the beginning; or due to objective reasons from the economic environment.

1.2.4.1. Causes from the borrower's side

Most bad debts are caused by the customers' decision to borrow. Sometimes, borrowers try to prove their eligibility and ability to borrow without thinking about the future and the payments they have to make in accordance with their income. And so, the credit culture here is that customers want to borrow large loans not because of wise financial decisions but sometimes they act according to trends, according to others. That can easily lead to bad loans.

1.2.4.2. Causes from the commercial banks

(i) Bank management system : Banks also play an important role as a cause of bad debts. A well-governed and effectively managed bank will have to develop a credit policy that is consistent with its objectives (adjusting lending levels and lending conditions) in the current market conditions to reduce the risk of bad debts. Banks

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