Concept of Risk Management in Commercial Banking Operations

+ Portfolio risk: is a form of credit risk that arises due to limitations in managing the bank's loan portfolio, divided into 2 types: intrinsic risk and concentration risk.

+ Intrinsic risk: comes from factors, unique characteristics, and distinct characteristics within each borrower or economic sector or field. It comes from the characteristics of the borrower's operations or capital usage.

+ Concentration risk: is the case where the bank concentrates too much lending capital on a number of customers, lends too much to businesses operating in the same industry or economic sector; or in the same certain geographical area; or the same type of high-risk loan.

1.2.3. Credit risk measurement indicators.

Maybe you are interested!

1.2.3.1. Quantitative indicators.

 Overdue debt and overdue debt ratio

Overdue debt is a debt that a customer cannot pay when the agreed due date is stated in the credit contract. When a debt is not paid on the due date, the entire remaining principal of the contract will be converted into overdue debt. Overdue debt is the most important measure of the health of the institution. It affects all major areas of the bank's operations.

Overdue debt ratio = (Overdue debt/Total debt) x 100%

This is the basic indicator to evaluate RRTD. The lower this indicator is, the better. On the contrary, it cannot be assessed that when this indicator exceeds the general standard of the industry, it is bad. In order to be able to assess more accurately the situation of overdue debt of the bank, it is necessary to evaluate along with the indicator of the turnover of these overdue debts, the ability to resolve overdue debts. Because, the rate of overdue debt is high but the ability to resolve overdue debts or the turnover of overdue debts is high, the possibility of the bank encountering RRTD will be low and vice versa, the bank will encounter RRTD.

 Ratio of bad debt to total outstanding debt

Bad debt is debt that is likely to lose almost 100% of its capital, usually it is classified in the last group in the debt classification table and must have 100% provision. Bad debt is usually smaller in scale than overdue debt and substandard debt, but it plays a very important role for managers to know how much debt is currently irrecoverable. Therefore, to ensure the safety of banking operations, it is necessary to always pay attention to keeping this ratio at the lowest possible level to avoid credit risks. Calculation formula:

Bad debt ratio = (Bad debt balance/Total debt balance) x 100%

The above ratios all indicate the loan balance with the possibility of loss on the total outstanding balance, but do not let managers know the level of loss if the loans are at risk. To evaluate this criterion, we consider the following indicators:

 Interest rate on total outstanding debt

Suspended interest is the overdue interest that the credit institution has not yet collected. Suspended interest shows the weakening of the customer's ability to pay. The higher this ratio shows the higher the credit risk. Calculation formula:

Interest rate = (Total interest/Total outstanding debt) x 100%

 Ratio of substandard debt to total outstanding debt

The concept of substandard debt depends on the specific regulations of each bank, however, banks usually define substandard debt as debt showing signs of weakening the customer's ability to repay such as changes in the executive board, the Board of Directors; decline in production and business activities, revenue, profit decline, increased inventory, other debts of the same customer at the credit institution or at another credit institution are overdue, ... Thus, the substandard debt ratio gives managers a more comprehensive view than the overdue debt ratio, and the larger this ratio, the greater the potential risk of the credit portfolio. Calculation formula:

Non-standard debt ratio = (Non-standard debt balance/Total debt balance) x

100%

 Ratio of secured loans to total outstanding loans

As we know, collateral is the final basis for credit institutions when a loan is at risk, so the larger this ratio is, the smaller the loss level of the credit institution.

Loan ratio with collateral = (Loan balance with collateral/Total outstanding debt) x 100%

 Ratio of RRTD provision made at the end of the period compared to total outstanding debt

Credit risk reserve is the amount of money set aside to cover possible losses due to the failure of a commercial bank's customers or partners to fulfill their obligations as committed. The higher this ratio, the worse the bank's credit quality and the higher the loss the bank may face because the risk reserve is set aside based on the outstanding loan balance minus the value of the collateral then multiplied by the risk reserve ratio. Formula:

Ratio of provisioned DPRR at the end of the period to total outstanding debt = (Provisioned DPRR at the end of the period/Total outstanding debt) x 100%.

The above ratios all show the level of risk and the possibility of future losses from loans of credit institutions, but they do not reflect the level of losses of credit institutions in the past. To consider the level of losses of credit institutions in the past, we use the following indicators:

 Ratio of off-balance sheet debt to total outstanding debt

Off-balance sheet debt is debt that has been handled with risk by risk reserve fund and is recorded in off-balance sheet accounts for monitoring. Normally, after all measures have been used to recover the debt such as foreclosing on collateral... if it is still not enough, the risk reserve fund is used to compensate and this debt is recorded in off-balance sheet account. The higher this ratio is, the greater the previous loss level of the credit institution.

Risk compensation ratio = (Risk compensation reserve/Total outstanding debt) x 100%

1.2.3.2. Qualitative indicators.

In addition to the RRTD measurement indicators that can be calculated as above, there are other criteria for measuring RRTD that cannot be measured and calculated specifically:

- Correct management and administration policies, development strategies suitable to the bank's business operations in each period.

- Modern equipment and technology systems support professional work conveniently and effectively.

- A team of professional staff with qualifications, capacity and professional ethics, this is the final and most important factor in all banking activities.

- Scientific credit process, suitable for reality, ensuring strict management of credit granting process, convenient for customers and ensuring credit for the bank.

- The reputation that the bank has built in the economy and relationships with traditional customers.

- Macroeconomic instability: Frequent policy changes, high inflation, unstable political situation... all create macroeconomic instability, negatively affecting borrowers. Therefore, macroeconomic instability is considered a content reflecting credit risk.

1.2.4. Causes of RRTD.

There are many causes of credit risk. Credit risk management needs to identify specific causes and ways of causing credit risk in order to have measures to limit it.

1.2.4.1. The cause belongs to the bank.

Poor staff quality, not qualified to evaluate customers or poor evaluation, intentionally making mistakes... are some of the causes of RRTD. Bank employees have to approach many industries, many regions, even many countries. To lend well, they must understand customers, the field in which customers do business, the environment in which customers live. They must be able to predict problems related to borrowers... Thus, they need to be trained and self-trained thoroughly, continuously and comprehensively. When credit officers lend to customers that they do not have enough qualifications to understand thoroughly, RRTD always lurks around them. Living in a "money" environment, many bank employees cannot avoid the temptation of money. They help customers drain the bank by giving fake loans, lending

wrong purpose... Thus, the quality of bank employees including qualifications and professional ethics is not guaranteed to be the cause of RRTD. The situation of banks chasing sales and profit targets regardless of potential risks from loans is also the cause of risks in bank lending.

1.2.4.2. The cause is subjective to the borrower.

- Using capital for the wrong purpose, not having goodwill in repaying loans

Most customers who borrow money from banks have specific and feasible business plans. The number of businesses that misuse capital and intentionally defraud banks to appropriate assets is not much. However, the cases that arise are extremely serious, involving the reputation of officials and negatively affecting other customers. There are cases where borrowers still earn interest but still do not repay the bank on time. They procrastinate in the hope of being able to default on their debts or use the loan as long as possible.

- Poor business management skills

The borrower's poor ability to anticipate business problems and poor management are the causes of credit risks. Many borrowers have not carefully calculated possible uncertainties and are unable to adapt and overcome business difficulties.

- Weak and opaque corporate finances:

Many borrowers are willing to take risks with the expectation of high profits. To achieve their goals, they are willing to find all means to deal with banks such as providing false information, bribing, etc. When bank staff create financial analysis tables of enterprises based on data provided by customers, they often lack practicality and authenticity. This is also the reason why banks always consider mortgaged assets as the last resort to prevent credit risks.

1.2.4.3. Force majeure

Force majeure causes that affect borrowers, causing them to lose their ability to pay the bank. For example: Natural disasters, wars, or changes

macro level (changes in government, economic policies, tariff barriers...) beyond the control of both borrowers and lenders.

These changes occur frequently, continuously impacting borrowers, creating either advantages or disadvantages for borrowers. Many borrowers, with their own abilities, are able to predict, adapt to, or overcome difficulties. In other cases, borrowers may suffer losses but are still able to repay the bank on time, with both principal and interest. However, when the impact of force majeure on borrowers is severe, their ability to repay is impaired.

1.2.5. Impact of credit risk.

1.2.5.1. Impact of credit risk on banks.

When encountering credit risks, banks cannot collect the credit capital granted and the loan interest, but the bank must pay the principal and interest on the mobilized money when due, which causes the bank to lose balance in revenue and expenditure. When debt cannot be collected, the credit capital turnover decreases, making the bank's business ineffective. When encountering credit risks, banks often fall into a state of liquidity loss, causing loss of trust from depositors, affecting the bank's reputation, and being reprimanded by superiors. For subordinates, due to credit risks, there is no money to pay salaries to employees, so those with capacity will be transferred, causing difficulties for the bank.

In short, a bank's credit risk occurs at different levels: at the lightest level, the bank's profits are reduced when it cannot recover loan interest, at the most severe level, the bank cannot collect interest and principal, the debt is overdue with a high rate, leading to the bank's loss and capital loss. If this situation persists and cannot be remedied, the bank will go bankrupt, causing serious consequences for the economy in general and the banking system in particular. Therefore, it requires bank managers to be extremely cautious and take appropriate measures to minimize risks in lending.

1.2.5.2. Impact of credit risk on the economy

Banking activities are related to businesses, industries and individuals, so when a bank encounters credit risk or goes bankrupt,

Depositors in other banks panic and rush to withdraw money from other banks, causing difficulties for the entire banking system. Bankruptcy of banks will affect the production and business situation of enterprises, not having money to pay salaries, leading to difficulties in workers' lives. Moreover, the panic of banks greatly affects the entire economy. It causes economic recession, rising prices, decreasing purchasing power, increasing unemployment, and social instability. In addition, credit risks also affect the world economy because today the economy of each country depends on the regional and world economy. Experience shows that the Asian financial crisis (1997) and the recent South American financial crisis (2001-2002) have shaken the world. On the other hand, the relationship between currencies and investments between countries develops very quickly, so credit risks in one country directly affect the economies of related countries.

1.3. Credit risk management.

1.3.1. Concept of risk management in commercial banking operations

trade

Banking business is very sensitive, related to many fields.

different aspects of the economy, affected by many objective and subjective factors such as economics, politics, society. The fact that banks continuously expand their networks, introduce new services and products as well as apply modern technology requires a synchronous operational risk management strategy to manage and minimize risks during operations. Moreover, banks do not only mobilize capital and lend but also many other areas such as payment, guarantee, foreign exchange trading, securities, joint venture capital... Therefore, it can be said that banking risks are very diverse: interest rate risk, foreign exchange risk, liquidity risk, credit risk... Among all the above types of risks, credit risks are the largest and most complex type of risk, occurring at a worrying level. In addition, banking activities are also related to the activities of businesses, industries and individuals, so when a bank encounters credit risks or goes bankrupt, the confidence of depositors in other banks is also reduced, leading to

Withdrawing money from banks, causing difficulties for the entire banking system. Therefore, commercial banks need to focus on credit risk management.

Credit risk management is the use of professional measures to control credit risks, limit negative consequences in credit activities, minimize losses and prevent banking operations from collapsing.

 The role of credit risk management in commercial banking operations.

Currently, credit risk management plays an extremely important role for banks in particular and the financial system in general. The assessment, appraisal and good management of loans and disbursement plans will limit the credit risks that banks will encounter, and will inevitably reduce bad debts for banks specifically:

- Forecast and detect potential risks: detect unfavorable events, prevent unfavorable situations that have occurred and are occurring and can spread widely.

- Resolve the consequences of risks to limit damage to the bank's assets and income. This is a strictly logical process. Therefore, governance is needed to ensure consistency.

- Risk prevention is carried out by bank employees and leaders. In a bank, employees think and act differently, which can be contradictory or obstructive. Therefore, management is needed so that everyone acts in a unified manner.

Management sets specific goals to help the bank stay on track. There must be a specific and effective action plan in line with the set goals.

So for the commercial banks themselves, good risk management will help commercial banks ensure capital safety, interest, and income from decline, help develop credit activities and thereby contribute to creating momentum for growth in other business activities of the bank.

Comment