Definition of Bad Debt and Overdue Debt

1.4.1 Definition of bad debt and overdue debt

The State Bank issued Decision No. 493/2005/QD-NHNN dated April 22, 2005 on regulations on debt classification, provisioning and use of reserves to handle credit risks in banking activities of credit institutions, defining overdue debt and bad debt as follows:

According to Clause 05, Article 2, “Overdue debt is a part or all of the principal and/or interest that is overdue”. This definition clearly states that the principal and/or interest that is due for payment but has not been fully paid will be transferred to overdue debt. In this decision, the State Bank has issued debt classification and overdue debt is classified into groups 2, 3, 4 and 5. Specifically, the debt classification is presented in the section below.

Clause 06, Article 02 “Bad debt (NPL) is debt belonging to groups 3, 4 and 5 specified in Article 6 or 7 of this regulation”.

The above definition shows that bad debt is also overdue debt and overdue debt includes bad debt.

1.4.2 Indicators for classifying overdue and bad debts

Recently, the State Bank has issued decisions such as 1627/2001/QD-NHNN, decision 127/2005/QD-NHNN, decision 493/2005/QD-NHNN and 18/2007/QD-NHNN stipulating that the debt classification for each customer is not simply a debt classification based on the number of overdue days of the loan but also based on qualitative and requiring commercial banks to build their own credit rating system. That is the basis for determining bad debt and overdue debt and evaluating credit activities. Therefore, for easier understanding, I present the debt classification of each loan to facilitate the determination of overdue debt and bad debt in the following calculation formulas.

How to classify debt

According to Decision No. 127/2005/QD-NHNN dated February 3, 2005 of the Governor of the State Bank of Vietnam on amending and supplementing a number of articles of the Lending Regulations of

Credit institutions for customers issued under Decision No. 1627/2001/QD-NHNN dated December 31, 2001 of the Governor of the State Bank stipulates the classification of overdue debt as follows: For loans that are not repaid on time, which are assessed by credit institutions as being unable to repay on time and are not approved for restructuring the repayment term, the principal balance of that credit contract is overdue debt and the entire principal balance of the customer whose debt is restructured is considered overdue debt. In this decision, the State Bank also defined debt restructuring as follows: Debt restructuring is the act of a credit institution adjusting the repayment term and extending the loan term for customers' loans; Adjusting the repayment term means that the credit institution agrees to change the repayment term of the principal and/or interest of the loan within the previously agreed loan term in the credit contract, without changing the final repayment term; Loan extension means that the credit institution agrees to extend the repayment period of the principal and/or interest of the loan, exceeding the previously agreed loan term in the credit contract.

Previously, debt classification was based only on the number of overdue days. Decision 127/2005/QD-NHNN introduced a more stringent classification of overdue debt than before, such as when a customer is not overdue but has a debt restructuring, the customer's debt is transferred to overdue debt. However, debt classification is based only on the time factor and does not mention that commercial banks set their own criteria to assess the risk of customers and classify debt accordingly.

According to Decision 493/2005/QD-NHNN dated April 22, 2005 of the Governor of the State Bank of Vietnam on promulgating the Regulations on debt classification, provisioning and use of reserves to handle credit risks in commercial banking activities of credit institutions and Decision No. 18/2007/QD-NHNN dated April 25, 2007 of the Governor of the State Bank of Vietnam on amending and supplementing a number of articles of the regulations on classification, provisioning and use of reserves to handle credit risks in banking activities of credit institutions issued under Decision No. According to Decision 493/2005/QD-NHNN dated April 22, 2005 of the Governor of the State Bank of Vietnam, debt classification is divided into the following 5 groups:

Group 01 (standard debt) includes:

- Debts that are due and that the credit institution assesses as having the ability to fully recover both principal and interest on time;

- Debts overdue for less than 10 days and which the credit institution assesses as having the ability to fully recover overdue principal and interest and fully recover the remaining principal and interest within the remaining due date;

- Debts are classified into group 1 according to other debt classification regulations (see Other debt classification regulations ).

Group 2 (Debts requiring attention) includes :

- Debts overdue from 10 days to 90 days;

- Debts with first adjusted repayment terms (for customers who are enterprises or organizations, the credit institution must have a record of the customer's assessment of the ability to fully repay the principal and interest on the first adjusted term)

- Debts are classified into group 2 according to other debt classification regulations (see Other debt classification regulations ).

Group 3 (Substandard debt) includes :

- Debts overdue from 91 days to 180 days;

- Debts with restructured repayment terms for the first time, except for debts with adjusted repayment terms for the first time classified into group 2 as above.

- Debts with interest waived or reduced due to customers' inability to pay interest

full according to the credit agreement;

- Debts are classified into group 3 according to other debt classification regulations (see Other debt classification regulations ).

Group 4 (Doubtful debt) includes:

- Debts overdue from 181 days to 360 days;

- Debts with first-time restructured repayment terms that are overdue less than 90 days according to the first restructured repayment term;

- Debts with restructured repayment terms for the second time;

- Debts are classified into group 4 according to other debt classification regulations (see Other debt classification regulations ).

Group 5 (Debt with potential loss of capital) includes :

- Debts overdue for more than 360 days;

- Debts with restructured repayment terms for the first time that are overdue for 90 days or more according to the first restructured repayment term;

- Debts with a second restructured repayment term that are overdue according to the second restructured repayment term;

- Debts with restructured repayment terms for the third time or more, whether not overdue or overdue;

- Debts frozen and debts awaiting settlement;

- Debts are classified into group 5 according to other debt classification regulations (see Other debt classification regulations ).

Other debt classification regulations:

Credit institutions may reclassify debts into lower-risk debt groups in the following cases:

- For overdue debts, credit institutions reclassify them into lower risk debt groups (including group 1) when they fully meet the following conditions:

+ Customers must fully pay the overdue principal and interest (including interest applied to overdue principal) and the principal and interest of the following repayment periods within a minimum period of six (06) months for medium and long-term debts, three (3) months for medium and long-term debts.

(03) months for short-term debts, from the date of full payment

overdue principal and interest;

+ Have documents and records proving the reasons for the debt being overdue.

has been processed, fixed.

+ The credit institution has sufficient basis (information, attached documents) to assess that the customer is able to fully repay the principal and interest on time.

- For debts with restructured repayment terms, credit institutions reclassify them into lower-risk debt groups (including group 1) when they fully meet the following conditions:

+ Customers must fully repay the principal and interest according to the restructured repayment period within a minimum period of six (06) months for medium and long-term debts, and three (03) months for short-term debts, from the date of full repayment of principal and interest according to the restructured period;

+ There are documents and records proving that the reasons for the debt having to be restructured have been handled and resolved;

+ The credit institution has sufficient basis (information, accompanying documents) to assess that the customer is capable of fully repaying the remaining restructured principal and interest on time.

Credit institutions must transfer debts to higher risk groups in the following cases:

- All outstanding debts of a customer at a credit institution must be classified into the same debt group. For customers with two (02) or more debts at a credit institution, if any debt is classified into a group with higher risk than other debts, the credit institution must reclassify the customer's remaining debts into that highest risk group.

- For syndicated loans, the lead credit institution must classify the debt for the syndicated loan according to the provisions of this Article and must notify the results of debt classification to the credit institutions participating in the syndicated loan. In case the syndicated loan customer has one or more other debts at the credit institution participating in the syndicated loan that have been classified into the debt group

If the debt group of the syndicated loan is not classified by the lead credit institution, the credit institution participating in the syndicated loan shall reclassify the entire outstanding debt (including the outstanding debt of the syndicated loan) of the syndicated loan customer into the debt group classified by the lead credit institution or by the credit institution participating in the syndicated loan, depending on which debt group has higher risk.

- Credit institutions must proactively classify debts into debt groups with higher risks according to the credit institution's assessment when one of the following cases occurs:

+ There are adverse developments that negatively impact the environment and business sector of the customer;

+ Customer debts classified by other credit institutions into debt groups with higher risk levels (if information is available);

+ The customer's financial indicators (regarding profitability, solvency, debt-to-equity ratio and cash flow) or the customer's debt repayment ability continuously decline or fluctuate greatly in a downward direction;

+ Customers do not provide complete, timely and honest financial information as required by credit institutions to assess customers' ability to repay debts.

For guarantees, payment acceptances and irrevocable loan commitments with specific implementation dates (collectively referred to as off-balance sheet commitments), credit institutions must classify them into the following groups:

- When a credit institution has not yet fulfilled its obligations under its commitments, the credit institution classifies and sets aside provisions for off-balance sheet commitments as follows:

+ Classify into group 1 if the credit institution assesses that the customer is capable of fully performing the obligations as committed;

+ Classified into group 2 or higher depending on the credit institution's assessment if the credit institution assesses that the customer is unable to fulfill the obligations as committed.

- When a credit institution must perform its obligations under a commitment, the credit institution classifies payments on behalf of guarantees and payments on acceptance of payment into debt groups according to the provisions stated above with the number of overdue days calculated from the date the credit institution performs its obligations under the commitment as follows:

+ Classified into group 3 if overdue less than 30 days;

+ Classified into group 4 if overdue from 30 days to 90 days;

+ Classified into group 5 if overdue for 91 days or more.

Compared to Decision No. 493/2005/QD-NHNN, Decision No. 18/2007/QD-NHNN stipulates that debt classification is more complicated and more responsive to the actual situation. It refers to qualitative criteria and requires credit institutions to develop a separate credit rating system for each credit institution to more accurately assess the credit activities of branches/transaction offices and report to the State Bank every 6 months on the progress of developing this rating system. However, each commercial bank needs to have its own credit rating system to limit overdue debts and bad debts that affect its business activities and create conditions for commercial banks to develop better.

1.4.3 Criteria for evaluating credit activities

Credit activities are reflected through many criteria. I would like to present some main criteria as below to facilitate the evaluation of credit activities in the following section.

Overdue debt ratio:

The overdue debt ratio is the percentage of total overdue debts compared to total outstanding debts at a certain point in time, usually the end of the month, quarter, or year. This indicator is calculated according to the following formula:

Overdue debt

Overdue debt ratio =

Total outstanding credit

x 100% ≤ 5%

According to the above debt classification, overdue debt according to the above formula is understood as debt classified into groups 02 to 05. According to international practice, this ratio of no more than 5% is considered good.

Bad debt ratio:

The bad debt ratio is the percentage of total bad debts compared to total outstanding debts at a certain point in time, usually the end of the month, quarter, or year. This indicator is calculated according to the following formula:

Bad debt

Bad debt ratio = x 100% ≤ 2%

Total outstanding credit

According to the above classification, bad debt in the above formula is understood as debt group 03 to 05 (NPL - Non performance loan). According to Decision 06/2008/QD-NHNN dated March 12, 2008, commercial banks achieve maximum credit score when the ratio of bad debt to total outstanding debt is less than or equal to 2%.

 Credit structure :

According to Article 15 of Decision 457/2005/QD-NHNN dated April 19, 2005, the maximum ratio of short-term capital that credit institutions can use for medium- and long-term lending is 40%.

Medium and long term loans


Short-term capital mobilization	<= 40%

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