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ICAAP Internal Capital Adequacy Assessment Framework of Vietnam Joint Stock Commercial Bank for Industry and Trade - 2



Abbreviation

Full meaning (English and Vietnamese)


State Bank of Vietnam on regulations on limits and safety ratios in the operations of banks and foreign bank branches.

VietinBank

Vietnam Joint Stock Commercial Bank for Industry and Trade

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ICAAP Internal Capital Adequacy Assessment Framework of Vietnam Joint Stock Commercial Bank for Industry and Trade - 2


LIST OF TABLES, CHARTS, GRAPHS, AND DRAWINGS



TT

Tables, figures, charts

Page

1

Table 1. Survey data description

23

2

Table 1.1. Comparison of Basic Internal Approach and Advanced Internal Approach

51

3

Table 2.1. Summary of CAR ratio at VietinBank in the period 2016 - 2020

86

4

Table 2.2. Summary of capital leverage ratios, ROA, ROE at VietinBank in the period 2016 - 2020

86

5

Table 2.3. Summary of methods for measuring risk types at VietinBank

102

6

Figure 1.1. Independent Regulatory Review Process (SRP)

40

7

Figure 1.1: The three pillars of the Basel II Accord

28

8

Figure 1.2: Relationship between Risk Control and Finance

33

9

Figure 1.3: Simulation of the basic components of ICAAP

36

10

Figure 1.4: Simulation of effective measurement methods

39

11

Figure 1.5: Illustration of Risk Dashboard

47

12

Figure 1.6: KVRR frame

48

13

Figure 1.7: Formula for calculating capital for RRTD according to the IRB method

50

15

Figure 1.8: Overview of the risk-based capital planning and allocation process

55

16

Figure 1.9: Efficiency curve for optimizing banking portfolio

57

17

Figure 1.11: Barrier and target profits in RR-adjusted profit assessment

58

18

Figure 1.11: Basic interest rate components

59

19

Figure 1.12: SREP for ICAAP

68

20

Chart 2.1: Assessment of the Board of Directors' interest in implementing ICAAP at VietinBank

87

21

Chart 2.2: Assessment of the level of interest of units in implementing ICAAP at VietinBank

88



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Tables, figures, charts

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22

Chart 2.3: Assessment of the adequacy of internal regulations and procedures on ICAAP at VietinBank

97

23

Figure 2.4: Factors affecting ICAAP implementation

98

24

Chart 2.5: Assessment of the process of measuring key risks and integrating and comprehensively managing all types of risks at VietinBank

99

25

Chart 2.6: Factors affecting the risk quantification process at VietinBank

114

26

Chart 2.7: Subjective difficulties in implementing ICAAP at Vietinbank

138

27

Chart 2.8: Objective difficulties in implementing ICAAP at Vietinbank

141

INTRODUCTION


1. Urgency of the research topic

In banking business, capital plays an important role because it is the basic business object, directly affecting the operational efficiency of that bank. The basic role of capital is to ensure business operations for the bank, limit unwanted risks and strengthen customer confidence (Kristian, 2010). Therefore, ensuring capital for business operations at the bank is an issue that has been and is being concerned by bank administrators as well as the banking industry.

In 1988, with the aim of strengthening the international banking system, the first Basel Capital Accord (Basel I) was born and regulated the RR-based Capital Ratio. According to this standard, banks must retain capital equal to at least 8% of total assets. Basel I is considered the first accord on capital standards. However, with changes in the banking management and business mechanism, Basel I has arisen many shortcomings, no longer suitable such as the RR characteristics of each bank, the diversity of important RR, and the requirements for the risk management system. To overcome the above shortcomings, Basel II was born, gradually shifting from a ratio-based capital regulation mechanism, towards a capital regulation that will rely more on internal data, practices and models. Pillar 2 is the focus of Basel II, requiring banks to maintain capital to ensure credit risk, market risk and operational risk. In addition, banks need to fully implement ICAAP (The World Bank Group, 2018). The purpose of ICAAP is to identify, measure, and control all of a bank's material risks and calculate the amount of capital needed to provide for these risks as well as other risks that may arise in the future to ensure financial stability (Rosaria, 2015). For commercial banks, ICAAP helps improve the bank's risk management capacity, optimize capital use efficiency, support business activities, and strengthen the stability of the banking system. The implementation of ICAAP includes the following components: Identifying and assessing material risks and risk exposures; Quantifying and synthesizing risks and capital; Assessing capital adequacy, planning and management; Capital use (measurement of efficiency based on risks); Capital monitoring and reporting (BCBS, 2006).

In the strong globalization trend, especially the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) and the EU-Vietnam Free Trade Agreement (EVFTA) have been signed, it is very necessary for businesses in general and the banking industry in particular in Vietnam to meet international standards. The reason is that the domestic market is no longer as highly protected as before, banks will have to compete both domestically and globally. Regarding the regulations on ICAAP, the Basel Convention is an international standard in banking activities that has been and is being applied by the State Bank. In order to specify this standard, the State Bank has issued Circular 41 regulating the capital adequacy ratio for the entire banking industry and Circular 13 regulating the operational control system and requiring that by January 1, 2021, all domestic banks must meet the 3 pillars of Basel II, including ICAAP. In addition, Resolution 51/NQ-CP dated June 19, 2017 of the Government on the issuance of the Government's action program to implement Resolution 07-NQ/TW dated November 18, 2016 of the Politburo on the policy and solutions for restructuring the state budget and managing public debt to ensure a safe and sustainable national financial system requires that by 2020, commercial banks must apply the capital adequacy ratio according to Basel II standards. Up to now, in addition to the purpose of meeting the requirements of the State Bank in risk management, a number of commercial banks have implemented ICAAP to comprehensively assess capital, including supervision by senior management of risk management, risk profiles, business plans, capital plans as well as coordination between units in capital stress testing, calculating required capital levels for key risks under normal and stressed conditions. Obviously, ICAAP helps banks establish business strategies that ensure harmony between the three factors of profit, RR and capital management. Therefore, in recent times, this has been an issue that many banks have paid attention to, researched and piloted to ensure capital safety, effective operation, meet the requirements set by the State Bank as well as approach international standards in capital management.

Since January 2013, VietinBank has built a risk management structure in accordance with international practices in general (according to the three-line control principle of Basel II) and ICAAP requirements in particular. Although it was implemented quite early, up to now, VietinBank has not yet completed the three pillars of Basel II, including ICAAP. Besides

In June 2021, the State Bank approved VietinBank to increase its charter capital from

37,234 billion VND to 48,058 billion VND and become the bank with the largest charter capital in the system. The requirement for VietinBank at this time is to strengthen capital management while still ensuring efficiency. To do this, one of the first and foremost requirements of the bank is to soon have a solution to complete the implementation of ICAAP. This is an important premise to help increase the reputation of VietinBank, improve the efficiency of capital management and strengthen the trust of investors, shareholders and management agencies. This is the basis for promoting research on the implementation of ICAAP at VietinBank, assessing the implementation status as well as having appropriate policy implications. To date, no research on capital safety management at VietinBank has been carried out.

Based on the above practical problem, the researcher chose the topic : "Internal Capital Adequacy Assessment Framework (ICAAP) of Vietnam Joint Stock Commercial Bank for Industry and Trade" for research as absolutely necessary.

2. Overview of research situation

Regarding ICAAP, up to now, many scientific research projects have been carried out in the world and classified into many different lines. On the contrary, there are not many in-depth domestic studies on this issue. Some research projects can be mentioned as follows:

2.1. Foreign research

In the world, many studies related to the construction of ICAAP have been conducted, which can be classified into 2 research trends as follows:

2.1.1. Research on theoretical issues related to the Internal Capital Adequacy Assessment Framework

2.1.1.1. Concept of Internal Capital Adequacy Assessment Framework

The concept of ICAAP was first mentioned in Basel II in June 2004, then the complete version was issued in 2006 (BCBS, 2006). Based on the theoretical foundation of BCBS, banks around the world based on the practice of the banking system in their country have proposed other concepts of ICAAP, specifically the Central Bank of Trinidad and Tobago (2020) said that ICAAP is a continuous process of risk management and arrangements to minimize losses.

of material RR as well as ensuring adequate capital. In particular, the reserve capital must ensure compensation for losses when RR occurs under any business conditions of the bank. From another perspective, the European Central Bank (2018) defines ICAAP as a set of capital risk assessments, controlling material RRs based on a suitable risk management system and a pre-determined risk management strategy. In addition, the Central Bank of Slovenia (2010), the Central Bank of Austria in the Woschnagg study (2008) also presented different concepts of ICAAP.

2.1.1.2. Meaning and purpose of implementing the Internal Capital Adequacy Assessment Framework

Regarding the purpose of implementing ICAAP, Resti (2008) argues that bank managers need to embrace pillar 2 as an opportunity to make strategic investments in risk management and tools that can deliver value to shareholders, not just as a regulatory compliance task. In addition, ICAAP will build a modern value-based performance measurement system and will promote a number of processes and tools that are not closely monitored by Basel. In agreement with this view, in the study of Nijathaworn (2009) it is stated that ICAAP meets the requirements of a functional system to support banks in controlling RR limits and RR status, creating a safe corridor for the existence and sustainable development of banks and is becoming increasingly urgent.

In another research aspect, the purpose of ICAAP is considered to be the identification, assessment, measurement, control of all the bank's important RRs and the calculation of the amount of capital needed to reserve for these RRs as well as other RRs that may arise in the future. Accordingly, based on the bank's strategy, KVRR, assessment of internal factors, assessment of external factors, the bank identifies RR events, classifies RRs, determines the possibility of RRs occurring, determines the level of impact, and draws a RR map (Rosaria, 2015). ICAAP not only helps banks improve their capacity to manage key risks including credit risk, market risk, and operational risk, but also manage other risks related to banking operations such as concentrated risk, credit risk, bank book risk, reputation risk, strategic risk, etc. On the basis of maintaining risks within acceptable parameters through a proactive risk management process, starting from identifying, analyzing, measuring, and implementing risk mitigation/control measures, banks achieve their goal of maximizing their value (OFSI, 2010).

The important role of ICAAP is to strengthen the link between the bank's risk position, risk management process, risk mitigation system and capital management (Woschnagg 2008). Many authors have argued that managers should consider ICAAP as a component of the internal management process of banks (both at the strategic and short-term levels) (Pilková and Králik (2011), Woschnagg (2008) and Resti (2008)). Some authors have pointed out that pillar 2 and ICAAP should be embedded in the bank's business and organizational processes (Pilková and Králik (2011), Woschnagg (2008)).

2.1.1.3. Contents of implementing the Internal Capital Adequacy Assessment Framework

Regarding the ICAAP process, BCBS (2006) stated that the implementation of ICAAP includes the following main contents: (i) Identifying and assessing material risks and KVRR; (ii) Quantifying and synthesizing RR and capital; (iii) Assessing capital adequacy, planning and management; (iv) Capital use (measurement of efficiency based on RR); (v) Capital monitoring and reporting. KVRR was mentioned in the study of FSB (2013), which is the level of synthesis and type of RR that a financial institution is willing to accept within its RR capacity to achieve strategic goals and business plans. When referring to KVRR, two related basic concepts are often mentioned, which are: KVRR Framework (RAF) and KVRR Statement (RAS) (Bromiley et al., 2015).

Regarding the quantification and synthesis of RR and capital, RR quantification is an objective basis for making management decisions for each transaction, each portfolio, each unit and the entire bank. RR measurement results must be updated regularly to support the Board of Management in deciding to apply timely and appropriate RR management measures to the RR situation in each period. At the same time, the bank needs to quantify capital corresponding to RR. Economic capital is calculated and allocated to each type of RR (BCBS, 2006). In this process, stress testing is indispensable. According to BCBS (2009), stress testing is a set of different techniques used by financial institutions to measure potential vulnerabilities under extreme and exceptional but plausible events. The results of stress tests often assess changes in financial indicators of capital, loss levels (solvency stress test), and liquidity safety ratios (liquidity stress test). In other words, stress tests help management agencies and financial institutions proactively deal with the worst possible situations. Stress tests are used as a tool

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