Basic Issues of Credit Risk Management of Commercial Banks.

Regularly researching risk management in general and RRTD in particular, the researcher found that this research could positively contribute to Agribank in strengthening RRTD management according to the set strategic goals.

8. Limitations of the study

The research content of the thesis is mainly carried out in the conditions, time, research ability of a PhD student and the personal budget used for research is limited, while the research field of RRTD management in general and RRTD management at Agribank in particular is very large, complex and related to many banks, many fields of capital investment and many customers, many legal documents of the State, of the banking industry and other relevant levels and sectors. Therefore, to have a comprehensive and logical research for commercial banks nationwide requires a broader, deeper research and especially a long time with a larger research force and appropriate funding. At the same time, the research content of this thesis is based on a state-owned commercial bank, whose credit activities are mainly agricultural and rural areas, while Vietnamese commercial banks are quite diverse and currently mainly joint-stock commercial banks, with different groups in terms of charter capital size, the proportion of capital ownership of the State and other shareholders, traditional customers and traditional markets, so it is difficult to cover.

9. Structure of the thesis

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In addition to the introduction, list of tables, conclusions, list of related scientific works of the authors that have been published, list of references, appendixes, the main content of the thesis is structured into three chapters:

Chapter 1: Basic issues of credit risk management of Commercial Banks.

Chapter 2: Current status of credit risk management at Vietnam Bank for Agriculture and Rural Development.

Chapter 3: Solutions to enhance credit risk management at the Bank for Agriculture and Rural Development of Vietnam.

Chapter 1

BASIC ISSUES OF CREDIT RISK MANAGEMENT OF COMMERCIAL BANKS

1.1. Credit risk of commercial banks

1.1.1. Bank credit activities

1.1.1.1. Concept of credit

According to Vu Van Hoa and colleagues (2007), credit with the most general concept is a borrowing relationship with repayment, purpose and time limit, born and existed through many different economic and social forms, with different levels of development. When the private ownership of means of production was formed, at the same time appeared the exchange relationship of goods, means of production, ... between different subjects. During this period, credit was implemented in the form of borrowing in kind - goods. According to the development process of history, credit has gradually changed to the form of borrowing in currency.

In essence, credit is a manifestation of an economic relationship associated with the process of creating and using a sum of capital to satisfy temporary capital needs for reproduction and life, according to the principle of repayment, purpose, and security in various forms, including credit, mutual trust, etc.

When commercial banks were officially established and developed, credit was really the main activity, considered a basic function. Most of the outstanding credit balances at commercial banks accounted for a very high proportion of the total assets and income of commercial banks.

According to the Law on Credit Institutions 2010 (Law No. 47/2010/QH12), some related terms are defined as follows: “ Credit granting is an agreement for an organization or individual to use a sum of money or a commitment to allow the use of a sum of money on the principle of repayment through lending, discounting, financial leasing, factoring, bank guarantees and other credit granting operations ”. (Source: National Assembly, 2010, Law on Credit Institutions).

“Lending is a form of credit, in which the lender delivers or commits to deliver to the customer a sum of money to be used for a specific purpose within a certain period of time as agreed upon with the principle of repayment of both principal and interest.”

From the above content, according to the thesis's perspective, bank credit is understood as follows: Credit is a transaction of assets (money or goods) between the lender (bank) and the borrower (individuals, businesses and other entities).

other economic), in which the lender transfers assets to the borrower for use for a certain period of time according to the agreement, the borrower is responsible for unconditionally repaying the principal and interest to the lender when the payment is due .

1.1.1.2. Nature of credit

Credit is the transfer of the right to use a sum of money or assets (in kind) from one subject to another, without changing their ownership. Credit always has a term and must repay both the principal and interest, the credit value is not only preserved but also increased thanks to credit interest.

Credit activities are basic and traditional activities for most commercial banks. The inherent characteristics of credit are high potential risks.

The basis for deciding on a credit is the bank's confidence in the customer's ability to pay, trust, mutual confidence or having a suitable form of credit guarantee.

1.1.1.3. Credit principles

Customers must use the loan for the purpose agreed upon in the credit contract; when there is a need for a loan, customers must have a specific plan and be eligible for the bank to consider lending.

Customers must repay the principal and interest on time as agreed in the contract.

credit

To have a source of money for lending, banks must mobilize from idle money sources in the population and economic organizations. All mobilized money must pay interest and have a certain repayment period. Therefore, if customers borrow capital from banks but cannot pay the principal and interest to the bank when the due date comes, what will happen to the bank? The bank will have real difficulty in its payment ability because it has no money to pay customers (principal and interest on deposits) and will lose public trust. If a bank cannot pay when a few customers come to withdraw money, it can expect help from the direction of the government and the State Bank, so the bank will still be safe. But when the public's trust is too great, most of the deposit customers will come to withdraw money, leading to difficulties for the bank. At that time, no matter how strong a bank is, it will be forced to close, thereby spreading to other banks like an oil spill.

covering all commercial banks and creating a chain reaction of collapse, the economy will be in chaos.

Repayment of credit is the most important condition to achieve the business goals of the bank. To fully recover the loan, the bank must carefully assess the business plan, financial capacity, and reputation of the customer to apply the appropriate lending method. To limit risks, the bank lending to customers must have collateral (can lend on credit to traditional customers with long-term reputation), because that is the second source of debt collection when the customer's business fails, the bank can still recover the loan from the sale of the customer's collateral.

1.1.1.4. Forms of commercial bank credit

a. By loan purpose

Based on the purpose of the customer's loan, loans are often divided into the following types:

- Real estate loans: Are loans related to the purchase and construction of real estate such as: Housing, land, real estate in the industrial, commercial and service sectors.

- Industrial and commercial loans: Are short-term loans to supplement working capital for businesses to cover expenses such as: purchasing goods, raw materials, paying salaries...

- Agricultural loans: Loans to cover costs in the agricultural sector such as: fertilizers, seeds, animal feed, etc. to support planting, harvesting and livestock raising activities.

- Personal loans: Are credits granted to individuals with the main purpose of shopping, consumption, small-scale investment...

- Financial institution loans: Are credits granted to banks, insurance companies, finance companies and other financial institutions.

Accurately identifying and classifying the purpose of borrowing and the use of customers' loans is very important for banks in managing credit quality as well as RRTD. Based on the structure of different lending sectors, banks will balance and reasonably allocate bank capital sources to sectors encouraged by the State to develop, with low risks and bringing good profits to the bank.

b. According to loan term

Based on the customer's loan term, the bank classifies loans into 3 types, specifically:

- Short-term loans: Are loans with a term of less than 12 months used to offset the shortage of working capital of economic organizations and short-term spending needs of individuals.

- Medium-term loans: This is a form of loan with a term of 01 to 05 years, mainly used to invest in fixed assets, invest in machinery and equipment, build new small-scale projects and recover capital quickly. Besides being used to invest in fixed assets, it is also a source of regular working capital for businesses.

- Long-term loans: Are loans with a term of over 5 years. Loans to meet investment needs for production and business or long-term projects such as: Building new factories, building houses, investing in building transport infrastructure...

The size of bank loans by term must be balanced and appropriate to the size and term of mobilized capital. Classification by loan term will help banks to adjust in the direction of tightening or expanding the size of different loan terms. Medium and long-term lending often has higher risks due to the effects of exchange rate factors, inflation, etc. In a developed financial market, economic organizations will find sources of loans for their medium and long-term capital needs in the capital market and commercial banks will then focus on providing short-term capital to the economy. Therefore, the general trend is that the outstanding balance of medium and long-term loans will gradually decrease with the development of the financial market.

c. By credit rating

Based on the customer's creditworthiness, the bank will apply different credit guarantee policies, specifically:

- Unsecured loans: This type of loan does not require collateral, pledge or third party guarantee, and the loan is based solely on the customer's own reputation. For good customers who are honest in business, have good financial capacity and effective management, the bank can grant credit based on the customer's own reputation without needing an additional second source of debt collection.

- Secured loans: In this case, the customer will use the assets he owns such as: House, architectural structures, machinery and equipment, cars, other fixed assets... or the guarantee of one or more third parties to ensure and commit to repaying the principal and interest according to the customer's credit contract. When the customer does not fulfill the commitment, the bank can consider this as a channel to recover part of its capital.

Classifying credit by creditworthiness will help banks assess the quality of their own customer base. If the bank's customer base is of good quality, the proportion of unsecured loans to total outstanding loans will increase and vice versa.

d. By credit origin

- Direct lending: The bank provides capital directly to those in need, and the borrower directly repays the loan to the bank. In direct lending, the bank's risk is lower because the bank meets directly with the customer, thereby having a more intuitive view of the customer, assessing the customer's reputation and financial capacity to make the right decision.

- Indirect lending: Is a loan made through the purchase of contracts or documents that have arisen and are still within the payment period. Commercial banks often provide indirect loans in the following types: Trade discounts, purchasing corporate debts, etc.

e. By method of repayment

- Installment loan: This is a type of loan in which the bank allows customers to repay the principal in installments within the agreed credit period. This is a high-risk type of loan because customers often mortgage goods purchased in installments, so the installment loan interest rate is usually the highest interest rate in the bank's lending interest rate range.

- Non-installment loan: Is a type of loan that is paid once over a period of time.

agreed, usually applicable to working capital loans.

- Loans that are repaid on demand: This is a type of loan that does not have a specific term. The bank can request or the borrower can voluntarily repay the debt at any time when they have income, but must give notice a reasonable amount of time in advance. This time can be agreed upon in the contract.

g. According to the value form of credit

- Cash loans: Is a form of lending in which the value form of credit is granted in cash. This is the main type of lending by banks and is carried out using different techniques such as: Advance credit, overdraft, installment credit, etc.

- Asset lending: Is a form of lending using assets. This form of lending is very popular and diverse. For banks, asset lending is commonly applied as lease-purchase assets. According to the lending method, banks or financial leasing companies (subsidiaries of banks) directly provide assets to borrowers called lessees and periodically the lessee repays the loan including principal and interest.

In addition to the above types of loans, banks also perform guarantee services for customers using their reputation. For this service, the bank does not have to provide money, but when the guaranteed person fails to fulfill the contractual obligations, the bank must replace them to fulfill the payment obligation. For this reason, people call the act of committing to guarantee by the bank a signature credit. Signature credit has the following types: Acceptance credit; documentary credit and bank guarantee.

1.1.2. Credit risk of commercial banks

1.1.2.1. Concept of credit risk

a. Concept of risk

Risk is uncertainty. However, not all uncertainty is risk. Uncertainty whose probability of occurrence can be estimated is called risk, while uncertainty whose probability of occurrence cannot be estimated is called uncertainty. According to the modern point of view, risk can be difficulties, disadvantages, or favorable conditions, opportunities.

To measure risk, people use expected value. Expected value is the weighted average value of a variable, the weight here is the probability of that variable occurring; the deviation between the actual value of that variable and the variance is the standard deviation. The measure of risk is the standard deviation, which is the difference between the actual value of a variable and its expected value.

Banks are financial intermediaries that trade in currency and provide convenient banking services. Risks in banking operations are understood as

are developments that cause difficulties, disadvantages, costs or losses to the bank.

According to Nguyen Kim Anh (2010), “ Risks in banking business are losses that occur unexpectedly and have a negative impact on banking business activities ”. The thesis agrees with this point of view because it is comprehensive and complete.

b. Types of commercial banking risks

There are many ways to classify risks in banking operations. Bui Dieu Anh believes that risks in commercial banking operations can be classified according to the following criteria:

- Classification by risk nature includes:

+ Financial risks are risks that cause financial losses to the bank. The bank can measure the value of the loss from these losses, such as credit risk, interest rate risk, etc.

+ Non-financial risks are risks that cause damage to the bank but the loss from which is difficult to measure, such as reputation risk, legal risk.

- Classified according to the origin of risk, there are the following types of risks:

+ Credit risk is a type of risk that appears in transactions between banks and their partners, mainly credit transactions between banks and borrowers.

+ Interest rate risk is a type of risk that arises from adverse fluctuations in market interest rates affecting the structure between liabilities and assets at the bank. Interest rate risk appears in all activities related to interest income and interest expenses of the bank.

+ Exchange rate risk is a type of risk arising from adverse fluctuations in the exchange rate between the domestic currency and foreign currency affecting the foreign exchange position of the bank. Foreign exchange risk appears in all activities that generate foreign currency trading of the bank.

+ Liquidity risk is the risk that arises when a bank is unable to meet customers' demands for withdrawals and loans or can meet them at a high cost, leading to a decrease in the bank's profits. Liquidity risk can be a consequence of the above-mentioned types of RRTD, interest rates, and exchange rates.

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