Causes of Credit Risk at Commercial Banks

- Selection risk: This is the risk related to the Bank's credit assessment and analysis process to select customers for credit. During this process, the Bank is very likely to make mistakes when analyzing and evaluating customers with many loopholes and lacking comprehensiveness.

- Guarantee risk: This is the risk arising from guarantee standards. The cause of this risk is due to the lack of strict and clear guarantee terms in the loan contract; the list of secured assets lacks specificity; the guarantee method and asset handling method still have many shortcomings...

- Operational risk: Risks related to lending activities and loan management. Here, errors of credit officers can lead to customers using capital for the wrong purpose or misappropriating capital from customers. For example: Bank staff ignoring necessary legal procedures before disbursement can be the cause of misappropriating capital from customers or poor post-disbursement supervision can cause borrowers to have the intention to use capital for the wrong purpose, causing loan loss.

• Portfolio risk

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Portfolio risk is a form of credit risk that arises due to limitations in managing the bank's loan portfolio. Portfolio risk is divided into two types: intrinsic risk and concentration risk.

- Intrinsic risk: Originates from factors that are unique to each borrower or economic sector. It originates from the characteristics of the borrower's operations or capital use, so intrinsic risk is a factor that cannot be eliminated. For example, natural disasters or crop failures in the agricultural sector, inventory congestion in the industrial sector.

- Concentration risk: This risk occurs when credit activities are concentrated on a small number of customers, a number of specific industries, a number of types of loans or a certain geographical area. This is contrary to the principle of diversification to prevent risks.

1.1.1.5. Causes of credit risk at commercial banks

+ Causes come from customers

• Customer's financial capacity

It can be seen that the first and core factor affecting the customer's ability to repay debt is the financial factor. If a business has strong financial potential, an unsuccessful transaction will not cause the business to lose its ability to repay debt, but when financial conditions weaken, the business will face more difficulties. Financial factors affecting the business's ability to repay debt include:

- Liquidity is reflected through indicators such as quick payment ability, current payment ability... High payment ability will reduce the customer's profitability but low payment ability will increase the possibility that the bank will have to deal with other fixed assets of the customer to recover capital.

- Profitability: ROA, ROE, EPS... This is a measure of the financial success of the borrower. However, the bank needs to properly assess the future prospects of the business, not just based on the success of the business in the past financial years.

- Financial leverage: High leverage increases the profitability of the business but also increases the risk for the business. Depending on the nature of each loan, banks may require higher collateral and interest rates to compensate for the risk that the bank may encounter from the loan.

- Cash flow: The cash flow statement is a picture that gives banks a comprehensive view of the cash movement of the investment, business, and financial activities of the enterprise during the fiscal year. All enterprises with positive cash flow from production and business activities can repay bank loans even in financial periods with business losses, while profitable enterprises with negative cash flow cannot repay their debts to the bank.

• Customer's business and management capacity

The management capacity of an enterprise is a factor that has a great impact and is the core factor affecting the enterprise's ability to repay debts. Weak level in

Predicting economic problems, weaknesses in management and business of the borrower, slow adaptation when the business environment changes, causing business losses and inability to repay debts to the bank. Enterprises with high qualifications and management capacity always know how to do the best for their business, when facing difficulties, the loan term can be extended but the ability to repay debts is always guaranteed.

• Customer ethics

Borrowers deliberately use tricks to defraud banks, misuse loans or invest in overly risky projects with the expectation of high profits without the bank's approval. To achieve their goals, they are willing to find any means to deal with banks such as providing false information, bribing bank officials...

In some cases, although their business is profitable, customers delay paying their debts or pay them late to the bank in the hope of defaulting on their debts or using the loan as long as possible.

Customer ethics affect the debt collection of banks. However, this ethical factor is not easy to assess when the current information sources in Vietnam are only unofficial and currently, most banks grant credit mainly based on emotional recognition.

Risk from customers is the main cause of risk in credit business activities of commercial banks. Prevention is very difficult and complicated. However, this cause can be grasped and dealt with if commercial banks perform well in monitoring, checking and managing customers before, during and after disbursement.

+ The cause comes from the bank

• Credit policy and credit granting process

Credit policy is a policy that reflects the funding platform of a bank, it is also a general guideline for bank staff to create a common unity in credit activities to limit risks and increase profitability. Credit policy must include general orientation in lending, regulations on loan guarantees, customer selection list in each stage... A good credit policy must be a smart application of credit principles appropriate to changes in economic factors and environment. The work of staff

The credit department (CBTD) is to whom to lend, what type of product to apply, under what conditions... When credit policies are only established as procedures, inconsistently, and carelessly, it will certainly cause credit risks for banks.

The current credit granting process is potentially high risk because loans are not reviewed independently from the customer department. Having one department perform all the functions of lending, debt collection, appraisal and risk management will overload and increase the risk of ethical hazards among credit officers.

• Credit officer capacity

When lending, credit officers will have to come into contact with many businesses operating in different industries, in different regions, even in many different countries... To lend well, they must understand the customer, the field in which the customer operates, the environment in which the customer lives and be able to predict problems related to the borrower... When credit officers lend to customers for whom they do not have enough information or do not really understand the customer, the customer's financial capacity, but simply based on the business plan or collateral, then credit risk is very likely to occur.

• Moral hazard of bank staff

Living in a "money" environment, many bank officers cannot avoid the temptation of money. The credit department is the place that directly evaluates loan projects and customers' ability to repay debts, as well as directly inspects warehouses, mortgaged assets, supervises disbursement, checks loan usage, and is the direct contact point with customers. Therefore, if professional ethics are not good and the credit department helps customers embezzle their bank, the consequences will be very serious.

• Not diversifying your portfolio

Changes in the borrower's business cycle are inevitable, so if the bank focuses on financing a group of customers in one industry or one region, the risk will be very high. In addition, failure to maintain the investment ratio for each industry and type of loan over time in its overall loan portfolio in accordance with the bank's strategy, source structure and capacity will put the bank at risk of losing control of loans and high credit risk is inevitable.

+ Causes of external environmental impact

RRTD can occur due to unusual changes in the market beyond the judgment of the bank as well as the borrower such as: economic cycles, changes in interest rates and exchange rates, changes in government policies, real estate market... These changes occur frequently and continuously affect borrowers, creating both advantages and difficulties for borrowers. When the impact of these force majeure causes is severe, the borrower's ability to repay the debt is reduced, the bank will face the risk of not being able to recover the debt.

• Economic cycle

During the period of economic growth, all business sectors are generally more favorable, the debt recovery rate increases, the capital demand increases, causing the outstanding debt to the economy to also increase, causing the bad debt and overdue debt ratio to decrease. However, when the economy grows poorly, all business sectors face difficulties, in which high-end business sectors, tourism services, construction materials production, real estate business... will face more difficulties than essential business sectors such as food, foodstuff, consumer goods, fuel... Loans, especially medium and long-term loans, which are decided easily during the growth period will become difficult to collect in the following years. Therefore, banks need to pay attention to this factor when making lending decisions.

• Interest rates, inflation

When inflation exceeds a certain limit, the State Bank can adjust by increasing the base interest rate. When interest rates increase, credit activities become riskier because high interest rates force borrowers to undertake riskier business plans or encourage higher-risk customers to borrow from banks.

• Policy risk

An unstable business environment will indirectly weaken the financial condition of borrowers because borrowers cannot be proactive in their business strategies. This will affect customers' ability to repay debts, increasing the bank's credit risk.

Among the causes of RRTD, the cause originating from the external environment is the most difficult to prevent, but the loss caused by it often accounts for the largest.

The proportion is not large. In addition, banks can also reduce losses if they predict trends correctly to implement a reasonable risk diversification policy.

1.1.1.6. Impact of credit risk on banking operations and the economy

+ For banking activities

First, credit risk reduces the bank's income. When a debt is considered overdue, the bank's income immediately decreases, partly because it cannot collect interest or principal as committed, while still having to pay interest to the mobilized source, partly due to management and supervision costs. On the other hand, if overdue debts become difficult to collect or cannot be collected, the handling of secured assets always encounters legal and valuation difficulties, so the case that the bank can recover the debt when selling the assets is very unlikely.

Second, credit risk reduces the bank's ability to pay. A high ratio of overdue debt to total outstanding debt not only reduces the bank's income but also reduces its capital, and at the same time reduces the bank's ability to pay. Then the bank will have to borrow on the interbank market at high interest rates, because mobilizing from residential deposits often takes a long time. If this situation continues with a series of depositors withdrawing money, the bank will be forced to close and declare bankruptcy.

Third, credit risk reduces the reputation and competitiveness of banks. When banks are unable to pay and have to borrow from many different sources, the bank's reputation in the financial market will be seriously reduced. Moreover, the high ratio of overdue debt to total outstanding debt is also an important indicator to negatively assess the bank's operating situation, which will affect the psychology of the bank's partners, leading to more difficult capital mobilization and many obstacles in competing with other banks. In the current trend of openness and fierce competition, almost all Vietnamese commercial banks are trying to open transaction points in regions and areas throughout Vietnam, and offer product and service programs to best serve their customers. Banking activities always put reputation first.

top, minimize all bad or bad information on the mass media that affects the bank's operations. If a commercial bank has a high ratio of bad debt to total debt, there is information about the bank not being able to collect debt or the bank is put under special control by the State Bank, the reputation of that bank will be seriously reduced. At that time, no individual or organization will establish a relationship to use the services of that bank because they do not know whether the capital they put into the bank is safe and profitable or not.

+ For the economy

The activities of commercial banks are highly socialized because they involve many different industries and components in the economy. Therefore, when a bank goes bankrupt, it will affect the remaining parts of society, first of all other banks, because there is a close relationship in operation, so the collapse of a bank can lead to the collapse of the remaining banks. In addition, the production and business of enterprises are interrupted due to lack of capital, depositors cannot get their money back. These consequences also reduce public confidence in the stability and soundness of the financial system, as well as the effectiveness of the Government's monetary policies. In a market economy, banking activities involve many economic sectors from individuals, households, economic organizations to other credit institutions. Therefore, the banking business results reflect the production and business results of the economy and of course it depends greatly on the production and business organization of enterprises and customers. Banking activities cannot have good results when the economic activities are not good or in other words, banking activities will have many risks when economic activities have many risks. Risks occur leading to instability in the monetary market, causing difficulties for production and business enterprises, negatively affecting the economy and social life.

Most banks today are using short-term capital to finance long-term debt, which means that the time it takes for banks to collect debt from customers cannot be as fast as the time it takes for customers to withdraw money. Thus, banks are all

must face liquidity risks, that is, risks of incompatibility in terms of capital and capital use. Once credit risks occur, leading to impacts on the reputation and solvency of the bank, people and organizations will rush to withdraw money and end relationships, or there are also cases where there is false information about banking activities, which also affects the bank's business capital.

These effects are chain reactions. If a commercial bank experiences a loss of liquidity as mentioned above, it will cause chain reactions to the economy as follows:

+ When the bank's liquidity is reduced, the bank will not be able to continue to finance legal entities and individuals and will have to recover capital before maturity. Thus, the subjects receiving capital finance are greatly affected in their business operations.

+ Chain reaction to other commercial banks: When public confidence in a bank declines, they will gradually lose confidence in other banks, thereby causing a chain reaction of capital withdrawal at other banks.

+ Chain reaction to other economic sectors: bank failures lead to economic recession, reduced purchasing power, increased unemployment, and social instability.

1.1.2. Characteristics and role of credit risk management

1.1.2.1. Characteristics of credit risk management of commercial banks

* Credit risk characteristics

- Indirect credit risk: In credit relations, when banks lend capital to customers, there is a separation between ownership and the right to use currency for a certain period of time. Therefore, if customers use capital for the wrong purpose or use capital ineffectively, leading to losses, credit risk appears. In other words, credit risks in customers' business are the main cause of credit risk for banks.

- Credit risk is diverse and complex: Each credit facility of the bank to customers has its own characteristics and has different potentials. Credit risk has many different causes, so preventing and handling credit risk must pay attention to all signs of risk, originating from many sides, to have appropriate measures.

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