Credit Risk Monitoring in Commercial Banks

Group 1: (Standard debt) includes: Debts that are due and that credit institutions assess as having the ability to fully recover principal and interest on time; Debts that are overdue for less than 10 days and that credit institutions assess as having the ability to fully recover overdue principal and interest and fully recover both principal and interest on time remaining; Debts classified into group 1 according to regulations.

Group 2 (Debts requiring attention) includes: Debts overdue from 10 to 90 days; Debts with first adjusted repayment terms (for customers who are enterprises, credit institutions must have a record of customer assessment of the ability to fully repay principal and interest on the first adjusted term); Debts classified as group 2 debt according to regulations.

Group 3 (Substandard debt): Debts overdue from 91 to 180 days; Debts with restructured repayment terms for the first time, except for debts with restructured repayment terms for the first time classified into group 2 according to regulations; Debts with interest exempted or reduced due to customers' inability to pay full interest according to the credit contract; Debts classified into group 3 according to regulations

Group 4 (Doubtful debt) includes: Debts overdue from 181 to 360 days; Debts with restructured repayment terms for the first time overdue less than 90 days according to the first restructured repayment term; Debts with restructured repayment terms for the second time; Debts classified into group 4 according to regulations;

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Group 5 (Debts with potential loss of capital) includes: Debts overdue for more than 360 days; Debts with restructured repayment terms for the first time overdue for 90 days or more according to the first restructured repayment term; Debts with restructured repayment terms for the second time overdue according to the second restructured repayment term; Debts with restructured repayment terms for the third time or more, including not overdue or overdue; Frozen debts, debts awaiting settlement; Debts classified into group 5 according to regulations.

(2) Credit risk rating: Banks need to establish a risk rating system for their credit portfolios. The rating system helps banks to make an overall assessment of their loan portfolio, to detect early loans that are likely to cause losses to the bank, and to determine the level of risk reserve funds. Risk levels may vary between banks.

(3) Collateral quality rating: As a second source, along with determining the risk level of each customer, the bank assesses the quality of the loan collateral to get a complete view of the loan and subsequent decisions.

(4) Credit risk measurement indicators: According to the traditional method, credit risk is measured through the following indicators: Overdue debt and the ratio of overdue debt to total outstanding debt; Bad debt and the ratio of bad debt to total outstanding debt. In which, overdue debt is a debt in which part or all of the principal or interest is overdue; Bad debt is a debt in groups 3,4,5 according to the provisions of Circular 02.

Overdue debt ratio

Overdue debt ratio = (Overdue debt balance / Total outstanding loans)*100%

Current regulations of the State Bank allow overdue debt of commercial banks not to exceed 5%, meaning that out of 100 VND of capital that the bank lends, the maximum overdue debt allowed is only 5 VND.

The “Overdue Debt” ratio reflects the outstanding principal and interest that have not been collected. Overdue debt shows how many dong are overdue for every 100 dong of current outstanding debt. This is a basic indicator of the quality of a bank’s credit operations. A high overdue debt ratio indicates low credit quality; conversely, a low overdue debt ratio indicates high credit quality.

Non-performing loan (NPL) is a loan for which part or all of the principal and/or interest is overdue. Another approach is that NPL is credit that is not repaid on time, is not allowed and is not eligible for debt extension. To ensure strict management, NPL in the Vietnamese commercial banking system is classified by time and divided by maturity into the following groups:

Debt overdue less than 90 days - Debt requiring attention; Debt overdue from 90 to 180 days - Substandard debt; Debt overdue from 181 to 360 days - Doubtful debt; Debt overdue over 361 days - Debt with potential loss of capital.

The “Overdue Debt” ratio only reflects the actual overdue balances, but does not reflect the entire scale of outstanding debt at risk of overdue. To overcome this drawback, people use the “total outstanding debt ratio with overdue debt” indicator as follows:

Ratio of total outstanding debt with overdue debt

Total debt ratio with overdue debt = (Total debt with overdue debt/ Total debt) * 100%

Because the indicator "Total outstanding debt with overdue debt" includes all outstanding debt of a customer (including due and not yet due) since the first overdue debt appeared, it more accurately reflects the credit risk level (quality) of the bank.

Indicator "Customers with overdue debt"

Rate of customers with overdue debt = (Total number of overdue customers/Total number of customers with outstanding debt) * 100%

This indicator shows how many of every 100 customers who borrow money are overdue. If this ratio is high, it reflects that the bank's credit policy is ineffective. In addition, if this indicator is lower than the "Overdue Debt" indicator, it indicates that overdue debt is concentrated among large customers; conversely, if this indicator is higher than the "Overdue Debt" indicator, overdue debt is concentrated among small customers.

Indicator "Overdue debt structure"

Short-term debt overdue ratio = (Short-term debt overdue/Short-term debt)*100% Long-term debt overdue ratio = (Long-term debt overdue/Long-term debt)*100%

Ability to recover overdue debt

To more accurately assess credit quality, people also classify overdue debt according to two criteria.

Recoverable overdue debt = (Recoverable overdue debt/Overdue debt) *100%

Uncollectible overdue debt = (Uncollectible overdue debt/Overdue debt)*100%

Ratio of bad debt to total outstanding loans

Normally, bad debt is debt that is overdue for at least 90 days. According to Circular 02/2013/TT-NHNN, dated January 21, 2013, regulating the classification of assets, provisioning levels, methods of setting up risk provisions and the use of provisions to handle risks in the operations of credit institutions and foreign bank branches, bad debt of credit institutions includes the following debt groups: Substandard debt group: Debts that are assessed by credit institutions as being unable to recover principal and interest when due and are likely to lose a portion of principal and interest. Including: Debts that are overdue from 90 to 180 days; Debts with restructured repayment terms that are overdue for less than 90 days according to the restructured term; Doubtful debt group: Debts that are assessed by credit institutions as having a high probability of loss. Including: Debts that are overdue from 181 to 360 days; Debts with restructured repayment terms overdue from 90 days to 180 days according to the restructured term; Debt group with potential loss of capital: Debts that are assessed by credit institutions as being irrecoverable or 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. According to current regulations, this ratio must not exceed 3%.

Credit risk factor

Credit risk ratio = (Total outstanding loans/ Total assets)*100%

This ratio shows the proportion of credit items in assets, the larger the credit item in total assets, the greater the profit but at the same time the credit risk is also very high. Normally, the total outstanding loans of the bank are divided into 3 groups: The group of outstanding loans of bad quality: are loans with a high level of risk but can bring high income to the bank. This is the credit that accounts for a low proportion of the total outstanding loans of the bank; The group of outstanding loans of good quality: are loans with a low level of risk but can bring low income to the bank. These are also the credits that account for a low proportion of the total outstanding loans of the bank; The group of outstanding loans of average quality: are loans with an acceptable level of risk and a net income

return to the bank is moderate. This is the credit that accounts for an overwhelming proportion of the total outstanding loans of the bank.

Credit risk provision ratio

Credit risk provision ratio = (Credit risk provision/Average outstanding debt)

Depending on the risk level, credit institutions must set aside DPRR from 0 to 100% of the value of each loan (after deducting the value of the revalued collateral). Thus, if a bank has a riskier loan portfolio, the provisioning ratio will be higher. Normally, this ratio fluctuates between 0 and 5%.

Loan Portfolio Concentration Ratio

A bank's loan portfolio is a collection of loans owned by the bank, arranged according to different criteria, structured according to a certain ratio, serving the bank's management purposes.

The loan portfolio is a tool for managers to orient credit granting activities, to ensure the healthiness, specialization, and diversity of loan assets, helping banks minimize risks to the maximum extent and achieve the desired profits. In that sense, the loan portfolio exists in the form of a plan (implementation orientation) and is managed throughout the bank's operations. Through the design of the planned loan portfolio, managers give an expected figure of the proportion of outstanding loans of each economic sector/geographic region... in the overall portfolio. This is important in the lending orientation of the bank. A planned loan portfolio that demonstrates diversity in accordance with the bank's strength, potential, compliance with legal regulations and development orientation is an important premise for the bank to achieve its goals and affirm its position in the currency trading market. The loan portfolio performance report is a tool for managers to view and analyze loans made from different perspectives, creating conditions for assessing the overall quality of the entire portfolio, thereby having reasonable adjustment measures according to market developments to achieve the bank's planned goals.

Loan portfolio by term: The bank's loan portfolio can be built according to term criteria, in which the proportion of short-term, medium-term and long-term loans is reasonably designed, showing the relationship between the term structure of capital use and the term structure of capital sources, in order to limit liquidity risks, interest rate risks, and ensure compliance with legal regulations.

Loan portfolio by economic sector: Loan portfolio by this criterion is very important for commercial banks, both in the planning stage as well as in the implementation organization. Loan portfolio by economic sector forms a necessary orientation for the credit investment process of the bank. Which sectors need to be focused on, expanded, which sectors need to be reduced, etc. will be shown through the determined proportion of each sector in the total outstanding debt of the portfolio. Loan portfolio by economic sector clearly reveals the bank's viewpoint: focusing on priority areas of specialization or diversifying lending. From the perspective of risk limitation, the more diverse the loan portfolio by sector, the better. However, this sometimes goes against the policy of specialization to dominate the market of some banks.

Geographical loan portfolio: The construction of the loan portfolio proportion by geographical area reflects the bank's viewpoint in forming the target market, in accordance with the conditions of facilities, operating network as well as the control capacity of the lending staff. In the process of monitoring the geographical loan portfolio, the bank will evaluate the investment efficiency of each area in comparison with other areas, from which it will make appropriate adjustments, ensuring the planned target.

Loan portfolio by customer type: Each customer type will have different characteristics (in terms of organizational structure, legal responsibility capacity, etc.). Therefore, in order to orient safe and effective investment, banks always have a reasonable division of loan items by customer type, ensuring the necessary safety from the perspective of the entire portfolio.

Loan Portfolio by Currency: Similar to the loan portfolio by economic sector, the loan portfolio by currency not only reflects the viewpoint,

not only helps the bank to orient itself in finding domestic/foreign target markets, but also helps the bank to assess the potential risk level when there is a fluctuation of foreign currency compared to domestic currency.

Loan portfolio by investment sector: Loan portfolio by investment sector is often divided into two large sectors: production and non-production. Each sector is divided into many types. For example, in production, there are agriculture, industry, trade, etc. In non-production, there are loans for securities trading, real estate trading, consumer loans, etc. This is a way to design a portfolio to orient investment lending in large sectors, suitable for development in different stages of the economy, ensuring compliance with legal regulations.

1.2.3.4. Credit risk monitoring in commercial banks

Risk monitoring includes tasks such as: monitoring the customer's actual production and business practices and the implementation of the terms in the credit contract signed with the customer. Monitoring aims to detect signs of actual risks, negative fluctuations in the customer's production and business in order to identify potential risks and take timely measures. Monitoring methods are very diverse, the following are some methods commonly used in banking.

Monitoring customer account activities at the bank: Changes in balances and transactions in customers' deposit and loan accounts reflect the situation of product consumption, cash flow, use of loan capital and debt repayment. Abnormal changes in accounts reflect difficulties in customer financial management, leading to difficulties in customer payment.

Periodic financial report analysis: The analysis results will show signs of reduced debt repayment ability or signs of contract violations by customers.

Checking loan guarantees: Through regular reports on the status of collateral or direct on-site inspection of customers. For mortgaged assets, banks also need to consider whether the use of assets is reasonable as committed.

or not. As for guarantee security, it is necessary to consider the content of supervision of the guarantor as well as the borrower.

Monitor other information: In addition, it is necessary to check the place of residence, place of production and business, and information from the mass media.

1.2.3.5. Measures to control credit risk in Commercial Banks

Basel Committee on Banking Supervision General Principles in Credit Risk Management

Basel II Agreement was born to replace the International Banking Capital Agreement (Basel

I) was implemented in 1988 (commonly known as the Cook ratio) by the Basel Committee on Banking Supervision to help banks manage risks more effectively. The principles in credit risk management of the agreement include:

Establish a suitable credit environment:

Principle 1: Approve and review the Credit Risk Strategy periodically, taking into account issues such as: acceptable risk levels, profitability levels.

Principle 2: Implement the Credit Policy Strategy. Develop credit policies. Develop procedures for individual loans and the entire credit portfolio to identify, assess, manage and control credit risk.

Principle 3: Identify and manage credit risk in all products and activities. Ensure that new products and activities undergo adequate procedures, appropriate controls and are fully approved.

Operate under a sound credit granting process:

Principle 4: Full credit granting criteria include: Understanding of the borrower, credit goals and structure, and payment sources.

Principle 5: Establish general credit limits for: individual customers, groups of related borrowers, on and off the balance sheet.