Causes of Risks in Credit Activities of Banks

In essence, lending is a form of credit, in which a commercial bank delivers or commits to delivering to a customer a sum of money, to be used for a specific purpose, within a certain period of time with the principle of repaying both principal and interest. Thus, after the end of the loan term, the customer must repay the principal and interest to the bank. Due to many different reasons, the customer may not fulfill the obligation to repay the principal and interest on time to the bank. This causes risks to the bank, leading to the bank having to implement risk handling measures such as adjusting the repayment period, extending the debt, etc.

Fifth, the risk of the secured transaction being invalid or valid but the secured assets cannot be processed to recover the debt.

When conducting lending activities for customers, commercial banks can agree to apply or not apply loan security measures. In case of applying loan security measures, commercial banks may also face risks due to invalid loan security transactions61 , or even if the loan security transaction is valid but the collateral cannot be processed to recover the debt. That also means that

Such lending relationship is considered unsecured. In this case, when the customer violates the repayment obligation, the commercial bank will have difficulty recovering the principal and interest, causing credit risk for the commercial bank.

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Sixth, the risk that commercial banks cannot transfer bad debts to customers who are debt buyers.

In the credit contract, when bad debts appear, the bank can transfer these bad debts to the asset management company (debt handling company). The result of this transfer is that the debt buyer is the one who takes the right of the commercial bank to handle the debt. However, the transfer of these bad debts is not easy from both a theoretical and practical perspective. From a theoretical perspective, this transfer must be carried out according to the principles of the contract, so it is voluntary, equal, goodwill, cooperative, honest and upright. The transfer of debts will be agreed upon by the commercial bank and the debt buyer. From a practical perspective, the debt buyer will not buy the debt if they find it unprofitable and bad debt handling is difficult, especially now that the operating mechanism of asset handling companies is

(AMCs) have not been fully exploited 62 . Therefore, commercial banks may not transfer

bad debts, from which risk handling will be difficult, causing damage to the bank.

Risks in bank guarantee operations

Besides the common risks of HDCTD, bank guarantees also have their own risks.

61 Do Van Chinh, “Discussion on settlement of mortgage contracts, guarantees using land use rights and house ownership rights attached to land”, Law Journal, No. 03/2011, p. 40.

62 Dao Thi Ho Huong, “Issues to note in handling bad debt in Vietnam”, Banking Magazine, No. 11, June 2012, pp. 32,33.

Firstly, when the commercial bank performs financial obligations on behalf of the customer, but the customer does not repay the commercial bank as agreed.

Bank guarantee is a form of credit granting, under which the credit institution commits to the beneficiary that the credit institution will perform financial obligations on behalf of the customer when the customer fails to perform or does not fully perform the committed obligations; the customer must accept the debt and repay the credit institution according to the agreement. However, when the bank has performed financial obligations on behalf of the customer but the customer does not repay the bank as committed. This is the credit risk of the bank in the bank guarantee activity. The reason for the customer not to repay may be: (i) the customer is unable to perform the obligation; (ii) the customer intentionally fails to perform the obligation; (iii) the customer believes that he has not violated the obligation to the beneficiary, so when the bank makes payment according to the request of the beneficiary, the guaranteed party refuses to repay.

Second, when there are disputes between the commercial bank and the guaranteed party, the beneficiary of the guarantee.

This is considered a fairly common risk in bank guarantee activities. There are three parties involved in a bank guarantee relationship: the guarantor is the commercial bank; the guaranteed party is the customer of the commercial bank and the guarantee recipient. In this relationship, the parties may have conflicts of rights and interests, leading to disputes. In this case, the bank faces operational risks or legal risks.

Third, the risk to commercial banks when fake guarantee certificates appear

This is considered one of the factors causing legal risks and reputational risks for commercial banks. Indeed, in some cases, the person signing the guarantee certificate is not authorized according to the provisions of law or the internal regulations of the bank. In addition, some cases of guarantee certificates have forged signatures, forged bank seals as well as other violations. Especially in recent times, economic crimes in the banking sector have tended to increase with increasingly sophisticated, cunning and complicated methods and tricks, causing consequences and great damage 63 , or fraudulent acts

Fraud in guarantees such as forging bid guarantees from banks, forging documents to withdraw bid guarantees from banks... 64

Risks in discounting securities

The specific risks of discounting valuable papers are as follows:

Firstly, after discounting valuable papers for customers, the bank cannot exercise its right of recourse against the discountee who is the bank's customer.

63 Mai Thi Le Quyen, “Improving the effectiveness of the fight against economic crimes in the banking sector”, Communist Magazine online, July 14, 2017.

64 Vo Hoang Quan, “On handling fraudulent behavior in bid security”, People's Court Magazine, No. 3, February 2016, pp. 12,13.

In essence, discounting is the purchase with a term or purchase with a reservation of the right to claim the beneficiary's negotiable instruments and other valuable papers before the payment due date. Whether the subject of the discount is a negotiable instrument or other valuable papers, they are all relationships of buying and selling property rights - debt claims 65. After discounting, the commercial bank has the right to claim the beneficiary of the valuable papers (the person discounted is the customer of the bank). However, the exercise of this right by the commercial bank may encounter difficulties due to the beneficiary's inability to pay or bankruptcy...

Second, after discounting valuable papers for customers, the bank is not paid by the obligated party (which can be the drawee for a bill of exchange, the drawer for a promissory note) as committed.

When discounting is performed, the valuable paper has not yet reached the payment deadline. The discounted party transfers the valuable paper to the commercial bank so that the bank can exercise the right to request the person with the payment obligation. However, risks will arise for the commercial bank when the party to whom the valuable paper is drawn refuses to pay.

Third, risks arise when banks discount counterfeit securities.

When performing discounting activities, commercial banks need to check the conditions for discounting valuable papers such as: payment term, discount interest rate, conditions on the discountee, the issuer of valuable papers... However, risks may arise if the valuable papers discounted by the bank are fake because the bank does not follow the correct discounting procedures and operations, or because the bank staff lack experience and have low qualifications...

Risks in factoring operations

In factoring activities, risks that arise include:

Firstly, after making factoring payments to the seller (service provider), the bank cannot collect money from the buyer (service user), and at the same time has no ability to claim from the seller.

Factoring is a form of credit provision for the seller or buyer through the repurchase with the right to claim receivables or payables arising from the purchase and sale of goods and provision of services under the contract for the purchase and sale of goods and provision of services. When implementing factoring for the seller, the bank must advance the credit capital as agreed and will be repaid by the buyer according to the contract for the purchase and sale of goods and provision of services. In case the buyer fails to fulfill the payment obligation, the bank will exercise the right to claim against the seller. In case the seller also fails to fulfill the payment obligation due to various reasons, the bank will face credit risk.

65 Hoang Minh Thai, “Discussing new points of the law on discounting transfer instruments”, Journal of Law, No. 5/2013, p. 37.

Second, after making factoring payments to the buyer (service user), the bank is not reimbursed the credit capital by the buyer.

In case the bank makes factoring payments for the buyer through the bank purchasing payables arising from contracts for the sale of goods and provision of services, the bank may face risks when the factored party does not repay the credit capital that the commercial bank has advanced. This is also considered a credit risk of the commercial bank.

Risks in credit card issuance

In the process of issuing credit cards, commercial banks may encounter the following risks:

Firstly, the commercial bank is not allowed to pay the amount in the credit card account by the credit card user.

When issuing credit cards to customers, the commercial bank advances a credit amount for the customer to use according to the terms agreed upon by the parties. After that, the credit card user will have to fulfill the obligation to pay the principal and interest of the use of that credit card. In case the card user does not pay or is unable to pay the commercial bank, the bank will face credit risk.

Second, commercial banks may face risks when credit cards are counterfeited.

In the process of issuing and using credit cards, there are many participants such as commercial banks (credit card issuing banks, credit issuers), credit card users (credit recipients), credit card accepting units... In the process of performing this process, commercial banks may encounter risks due to counterfeit cards, stolen or lost cards, leading to disputes between parties, card users being taken advantage of, units accepting counterfeit card payments...

Third, commercial banks may encounter risks during the process of credit card use.

In the process of using credit cards, commercial banks may encounter risks due to technical problems leading to customer complaints and lawsuits. In addition, risks may arise when there are security errors leading to the bank and customers being exploited. In addition, there may be risks for banks due to ethical factors of bank employees or card users.

In summary: risks in credit activities of commercial banks in Vietnam are quite diverse, they not only appear in credit activities in general, but also appear in each specific activity such as lending, guarantee, discount, factoring, issuing and using bank cards.

2.1.1.4. Causes of risks in credit granting activities of commercial banks

a) Group of causes from legal regulations

Risks in credit activities of commercial banks come from many different causes, first of all from legal regulations.

Indeed, the credit activities of commercial banks are potentially risky and complex activities, subject to the regulation of many different provisions of law. Therefore, if the law is issued promptly, comprehensively, consistently and appropriately, it will create conditions for the safe and effective implementation of credit activities. On the contrary, if the law is not complete, has many limitations and shortcomings, it will adversely affect the safety of credit activities of commercial banks. This can be considered the cause of risks in credit activities of commercial banks. In addition, the policies of the State and localities also have a significant impact on economic activities in general and credit activities of commercial banks in particular.

b) Group of causes from the process of law enforcement

The group of causes from the process of law application is shown through the main contents such as the level and legal knowledge of the subjects in the credit granting relationship is still limited; the awareness and consciousness of the bank leaders as well as credit officers are still limited and weak, such as the bank does not comply with credit procedures, does not comply, implement, and use the provisions of the law seriously. In addition, there are also acts of violating the credit granting contract, the credit recipient is not willing to repay the debt, even commits fraud...).

c) Other causes

In addition to the two groups of causes mentioned above, there are other groups of causes arising in the process of implementing credit contracts of commercial banks. This group of causes includes: objective causes from unfavorable business environment (frozen real estate market, global economic crisis...), or causes from unfair competition, impacts from political, economic, geographical, social factors... (see Appendix 1). In addition, it is necessary to mention the limited financial capacity of commercial banks, the weak management and operation capacity of commercial banks, commercial banks prioritize profit goals and ignore (or limit) the safety factor in their credit contracts.

2.1.1.5. Consequences of risks in credit granting activities of commercial banks

Risks in the banking sector leave negative consequences and impacts not only on the credit institutions themselves, but also harm the national financial and monetary system, the global economy and affect the interests of other entities such as depositors . 66 Risks in the banking sector of commercial banks leave the following basic consequences:

For commercial banks, low-level risks in credit activities cause loss of business opportunities, reduce the bank's reputation, reduce the ability to accumulate capital, and reduce the bank's strength. According to Dr. Pham Huu Hong Thai, when the bad debt ratio increases, it will lead to the profitability of the banks.

66 Ho Chi Minh City University of Law (2012), Banking Law Textbook , Hong Duc Publishing House, p. 89.

67. At a high level, risks can push banks to the risk of bankruptcy. The history of commercial banks in the world has witnessed many large banks going bankrupt and its consequences are not even limited to one country but also spread to many countries in the region and even the whole continent. For example, subprime lending in the United States in the period of 2002-2006 is considered the main cause of the global financial crisis in the period of 2007-2009. Initially, subprime lending was a solution to the problem of excess capital to maximize the profits of banks and financial institutions in general. However, excessive subprime lending led to loss of control over credit quality, leading to a series of bankrupt banks such as Metropolitan Savings Bank, Bear Stearns, Lehman Brothers..., the credit crisis was really bad.

The 2007 US financial crisis and subsequent global financial crisis 68 .

For borrowers, the risks in credit contracts cause borrowers to completely lose funding from banks, business opportunities will slip away, assets will be foreclosed, and borrowers will face the risk of bankruptcy.

For the socio-economy, the risk in the credit contract proves that the borrower has not been able to effectively implement the investment as set out when borrowing credit from commercial banks. Therefore, the expected socio-economic benefits received are not available, production and circulation of goods will stagnate, the function of being a tool to regulate the economy will be weakened. The rights of depositors will not be guaranteed.

In summary, through the above analysis, we see that credit activities are the basic activities of commercial banks. Its existence is inevitable and plays a very important role in the market economy. However, credit activities of commercial banks have many potential risks, arising from many causes and leaving behind extremely serious consequences. Therefore, the state as well as commercial banks themselves need to have a mechanism to ensure credit safety in this activity.

2.1.2. Concept, evaluation criteria and content of safety assurance in credit granting activities of commercial banks

2.1.2.1. Concept of safety assurance in credit activities of commercial banks

Ensuring safety in credit activities of commercial banks is a complex legal issue. Researching the nature of ensuring safety in credit activities of commercial banks is very important in determining legal regulation on this issue.

As analyzed above, in the credit institution, commercial banks always have to face many different types of risks. Those risks leave huge consequences for banks as well as the entire socio-economic system. In the most general understanding, the appearance of risks and

67 Pham Huu Hong Thai, “The impact of bad debt on bank profitability”, article in Business Knowledge Bookshelf, Thanh Nien Publishing House, page 100.

68 Nguyen Ba Minh, “Global financial crisis: developments, causes and lessons learned,” Journal of Economic Research, No. 384, May 2010, p. 7.

Its consequences are the loss of safety and efficiency in the operations of commercial banks. However, it is necessary to have a reasonable and scientific approach to ensuring safety in the credit activities of commercial banks, including the relationship between safety assurance and risk as well as other relevant factors in the credit activities of commercial banks.

Scientists mainly focus on researching the aspects of safety assurance in banking activities in general and credit activities in particular on the basis of risk limitation, risk management, risk governance and risk control.

In essence, risk mitigation is the act of keeping and preventing risks from exceeding certain limits. Thus, it is only a part of the safety assurance in the credit activities of commercial banks. In case the risk exceeds a certain limit, there must be an appropriate way of handling it, which risk mitigation alone cannot overcome.

Although there are differences in nature, function, meaning, and process, in general, risk management and risk management are both purposeful processes of bank administrators aimed at ensuring safety in credit activities. Meanwhile, risk control tends to focus on tools, techniques, or strategies to avoid, minimize, and limit risks.

If safety in credit activities is considered as a state of not being endangered by internal and external factors at an acceptable level of risk, then ensuring safety in credit activities is the activity of certain entities to maintain (or maintain) safety, protect credit activities from damage caused by internal and external factors of the bank, and at the same time maintain an acceptable level of risk. In other words, ensuring safety in credit activities of commercial banks can be understood as implementing certain methods or measures to ensure stability, avoid risks and losses in credit activities of commercial banks. According to this understanding, ensuring safety in credit activities means implementing measures to prevent and handle risks in credit activities of commercial banks. The main entities implementing safety in credit activities are commercial banks. In addition, the State Bank also plays an important role in ensuring the safety of credit activities of commercial banks, because the State Bank is a ministerial-level agency of the Government, the Central Bank of Vietnam, with the function of state management of currency and banking activities, the function of the central bank, including ensuring the safety of banking activities in general.

Safety and risk are two opposing sides in the same banking business entity, because the higher the risk, the lower the safety and vice versa. In fact, when a bank grants a loan to a customer for the purpose of profit, it proves that the bank has accepted a certain risk and this is the contradiction between the risk ratio and the profitability of the loan, the contradiction between the profit target and the

safe spending. Normally, the higher the profitability of a loan, the higher the risk of risk and vice versa 69 .

In general business activities and in particular the credit activities of commercial banks, it is not possible to understand and identify safety assurance with the elimination of risks or a state of no risk, because any banking business is associated with risks. Therefore, many people believe that banking management is essentially risk management and that bank managers consider business and risk management as their profession. 70 . The content of risk management includes risk identification; risk measurement; risk monitoring; risk mitigation. 71 .

A category that has a similar meaning to safety in HDCTD is “financial security”, which is a basic concept to indicate a stable, safe and strong financial status 72 . Safety is understood as a state of not being in danger from internal and external influences. Maintaining safety means not harming oneself, and at the same time preventing and resisting destructive attacks from the outside. Strength is the basis for stability and safety, a weak financial status cannot maintain stability and ensure safety 73 . In the author's opinion, “security” and “safety” are closely related terms, but not identical, because both terms refer to a “state” of a certain subject (or activity) in which it is not in danger from internal and external factors. However, the term security is different from safety in that it refers to levels of

The degree of resistance or protection from harmful agents and is widely used in many areas of socio-economic life, while safety is understood in terms of being protected from dangers within the acceptable range of risks. At the same time, financial security is understood in a broader sense, because it not only includes safety in credit activities, but also includes safety in other financial activities such as securities, insurance, etc.

From the above analysis and within the scope of the thesis, the author believes that ensuring safety in credit granting activities of commercial banks is the use of a system of measures and methods in preventing and handling risks to maintain the stability, health and efficiency of credit granting activities of commercial banks, contributing positively to socio-economic development.

69 Nguyen Thi Thuy (2000), Tlđd (No. 26) , p. 12.

70 Truong Quang Thong (2010), Commercial bank management, Finance Publishing House, p. 173.

71 Tran Anh Thiet, “Market risk management – theoretical and practical issues for Vietnamese commercial banks”, Journal of Economic Research, No. 393, February 2011, p. 23.

72 Vu Dinh Anh, Tlđd (No. 1), p. 36.

73 Vu Dinh Anh, Tlđd (No. 1), p. 36.

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