Perfecting the Last Line of Defense (Internal Control) in the 3 Lines of Defense Model, Perfecting the Early Warning System for Credit Risk (Ews) to

(The number of customers has increased significantly for businesses in the same industry and geographical area).

According to international practice and Basel II standards, the calculation of the probability of default PD must also follow a quantification process similar to the process of building an internal credit rating system, including:

(i) Select appropriate forecasting methodology (statistical modeling method, constrained expert method, and expert method);

(ii) Develop a PD quantification process (sample selection, correlation estimation, correlation fitting, new correlation application to credit portfolio). From the above data, input into a predefined model, from which the expected loss (EL) and unexpected loss (UL) can be accurately calculated according to the linear/probit model.

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To carry out these tasks, Vietnam Technological and Commercial Joint Stock Bank needs to set a minimum target of gradually increasing from 60% to 75% of the group of credit portfolios that start applying the internal credit rating system to gradually switch to the A-IRB approach in 2020. In addition, to ensure the quantitative model accurately predicts EL and UL, Vietnam Technological and Commercial Joint Stock Bank needs to conduct Stress-testing (predicting the exact amount of loss that the bank faces in the worst market conditions) and Back-testing (ensuring the system accurately predicts results and is effective). In Vietnam, for the first time in 2010, the State Bank mentioned the Stress-testing model in Circular 13/2010/NHNN-TT, but it only stopped at the introduction level. By Circular 13/2018/TT-NHNN, the establishment of stress test scenarios has been defined and specifically regulated. Circular 13 stipulates that the risk management department of commercial banks must establish at least 2 stress test scenarios, which are the business as usual scenario and the stress scenario in the next stress test. The selected scenarios must ensure the possibility of occurrence based on the analysis of past events and forecast developments.

macroeconomics; calculating the impact of assumptions on liquidity, capital adequacy ratio in each scenario; preparing reports on stress test results (including quantitative data and qualitative analysis and assessment). Completing stress-testing and back-testing will help Vietnam Technological and Commercial Joint Stock Bank promote risk control and identification, provide additional risk aspects for other risk management tools, and improve capital and liquidity management capacity. In particular, Vietnam Technological and Commercial Joint Stock Bank needs to pay attention to future changes in economic conditions when assessing each credit as well as assessing the entire credit portfolio, and assessing credits under stress. Based on the results of the stress test, Vietnam Technological and Commercial Joint Stock Bank must assess the compliance with the solvency ratio, the ratio of outstanding loans to total deposits, the ratio of short-term capital used for medium- and long-term loans, other restrictions to ensure safety in operations according to internal regulations, make a contingency plan in case of failure to meet liquidity requirements; calculate economic capital in the scenario of adverse developments to determine target capital. In order to perform stress-testing and back-testing according to Basel standards, the requirements for Vietnam Technological and Commercial Joint Stock Bank are to develop policies and procedures in written form to manage the stress testing program, prepare a strong infrastructure that is flexible enough to adapt to different stress tests, and continuously maintain and update the stress testing framework.

At the same time, to meet the technical standards for building a standard credit risk quantification model according to international practices with complex data structures, ensuring that the Gini coefficient reaches the model reliability threshold (over 70%), Vietnam Technological and Commercial Joint Stock Bank must complete the development data set and the verification data set, perform data extraction and cleaning activities with the participation of data owners and the technology department. This is still one of the difficulties that Vietnam Technological and Commercial Joint Stock Bank must face due to the standard risk quantification data field.

A-IRB needs to be collected from many different sources and a long historical data period (at least 5 years). To complete the credit risk measurement model, there needs to be close coordination between the model building unit and the Departments/Offices/Business Centers, as well as appropriate investment in technology and human resources.

Make full use of the system of reports/forecast results from the credit risk forecasting and quantification model to serve credit risk management:

Vietnam Technological and Commercial Joint Stock Bank needs to use results from credit risk forecasting and quantification models, Stress-testing, Back testing to support credit risk management in some aspects such as:

(i) Credit rating for customers aims to assess the probability of default, calculate the expected loss, and from there, price the loan (risk-based pricing) differently for each type of customer. To compensate for RRTD, banks collect interest at the interest rate applied by banks, showing the level of risk that the bank must bear.

(ii) Accurate determination of EL will help Vietnam Technological and Commercial Joint Stock Bank accurately determine the loan value. This will effectively serve the implementation of the credit swap process, or securitization of loans of Vietnam Technological and Commercial Joint Stock Bank in the future.

(iii) Based on the expected loss level, the bank will set aside provisions for expected losses. This is a utility that Vietnam Technological and Commercial Joint Stock Bank has not used yet, although Vietnam Technological and Commercial Joint Stock Bank has built a model and calculated PD. Vietnam Technological and Commercial Joint Stock Bank is currently still using provisions according to Circular 02/2013/TT-NHNN (provisions are made according to debt groups, not according to customer classes). Debt classification and provisions are made according to uniform policies and procedures, in compliance with international standards.

Basel II helps banks identify risky loans early, thereby finding solutions to limit bad debt.

(iv) Determining estimated losses, especially determining PD - the probability of customer default, will help banks improve the quality of monitoring and re-rating customers after lending.

Improve the quality of human resources operating credit risk measurement tools

In order to build, develop and operate credit risk measurement tools, Vietnam Technological and Commercial Joint Stock Bank needs a team of specialized personnel responsible for researching, building or applying models to quantify risks. This department has an independent function, separating authority and responsibility from business staff to ensure the objectivity of measurement results, including:

(i) A team of experienced analysts with in-depth understanding of banking operations, building a bank credit portfolio, and making necessary changes to ensure that the credit rating system is consistent with the bank's credit policies and strategies;

(ii) Quantifying credit risks according to statistical and probabilistic models requires specialists trained in statistical foundations, knowledge of econometrics and models. This team ensures the construction of a unified model, consistent with the characteristics of the bank's database, and develops the system in accordance with the regulations of the management agency and international practices (Basel I, II, III). Currently, Vietnam Technological and Commercial Joint Stock Bank is still dependent on consultants and software, and does not have qualified human resources;

(iii) Commercial banks need to establish a periodic inspection process to ensure the level of accurate and objective measurement of indicators in the credit rating system and credit risk quantification models.

3.2.3. Complete the last line of defense (Internal control) in the 3-line-of-defense model, complete the credit risk early warning system (EWS) to improve credit risk control capacity.

Completing the last line of defense (KSNB) in the 3 lines of defense model

To improve the capacity to control credit risks, the key thing that Vietnam Technological and Commercial Joint Stock Bank needs to implement is to increase the ability to meet the requirements of the internal audit apparatus according to Basel II practices and standards. Currently, the State Bank has issued Circular 13/2018/TT-NHNN effective from January 1, 2019, creating a complete and synchronous legal framework for senior management supervision, internal control, risk management, internal assessment of capital adequacy and internal audit of commercial banks. This Circular helps banks comply with international standards and practices, contributing to improving the effectiveness of the State Bank's inspection and supervision of commercial banks, in order to reduce losses, risks of insolvency and collapse of the banking system. However, Circular 13 also creates certain challenges for Vietnam Technological and Commercial Joint Stock Bank, posing solutions that Vietnam Technological and Commercial Joint Stock Bank needs to implement in the coming time to perfect the internal audit apparatus:

Firstly, the internal audit model of Vietnam Technological and Commercial Joint Stock Bank is built in accordance with the scale of the bank, ensuring that the internal audit apparatus is connected and interacts with the organizational layers of the bank's risk management apparatus. According to international practice, the internal audit department must be authorized by other positions of the bank, in order to ensure objectivity, timely detection and handling of issues in the bank's risk management work;

Second, the internal audit method needs to be standardized and risk-oriented through the identification and assessment of key risks in the bank's operations. According to the definition of IIA [4], internal audit

Risk-based internal audit is an approach that links internal audit work to an organization’s overall risk management mechanism. This approach helps internal audit provide assurance to the board of directors that risk management processes are operating effectively and do not exceed the organization’s risk tolerance. Currently, the internal audit plan of Vietnam Technological and Commercial Joint Stock Bank is mainly based on credit and operational risk assessment, not including other risks in the bank’s operations. Therefore, Vietnam Technological and Commercial Joint Stock Bank needs to consider issues in the annual internal audit plan such as building an organization-level risk list, identifying units that may be audited, and planning the audit (appropriate internal audit frequency and internal audit planning). In addition, developing an audit program for the risk management system including the risk management framework, risk appetite, types of credit, operational, market, liquidity, concentration and interest rate risks in the banking book and internal assessment of capital adequacy is a real challenge for commercial banks.

Third, Vietnam Technological and Commercial Joint Stock Bank conducts an assessment of the current situation, analyzes the differences of the internal audit department compared to the provisions of Vietnamese law and international practices, specifically in the following aspects: organizational structure of internal audit; qualifications and skills of personnel; internal audit policies, procedures, methods; information technology... Then, Vietnam Technological and Commercial Joint Stock Bank needs to develop a methodology, make a strategic plan, annual plan, internal audit framework program, reporting forms, develop evaluation standards for audit findings, design an audit program for the risk management system including stress testing.

Fourth, the internal audit team of Vietnam Technological and Commercial Joint Stock Bank needs to improve its capacity to fully meet the requirements of internal audit. In order for the internal audit team to improve its capacity in both quantity and quality, Vietnam Technological and Commercial Joint Stock Bank needs to develop a recruitment and training policy. At the same time,

At the same time, Vietnam Technological and Commercial Joint Stock Bank also needs to combine the use of its own personnel to conduct internal audits with hiring external personnel to help the bank quickly access specialized knowledge and resolve temporary staff shortages.

Fifth, Vietnam Technological and Commercial Joint Stock Bank needs to consider investing in software and tools to support internal audit work, and build an early warning monitoring system to help internal audit promptly detect unusual signs. The internal audit function needs to apply information technology to support audit management and data analysis to optimize resources and operational efficiency.

Completing the early warning system for credit risks (Early warning system - EWS)

The credit risk early warning system is a data integration and processing system that aims to automatically review all debts and detect cases of possible quality deterioration, thereby helping banks take effective measures to manage the quality of their credit portfolio.

The EWS credit risk early warning system is based on risk signs of customers, customer loans such as declining business situation, financial indicators, customer debt repayment cash flow showing signs of abnormality, adverse market fluctuations. The system uses modern calculation techniques, statistical models from historical data to create a list of customers who are likely to encounter difficulties. This list of customers will then be analyzed by business units, and reviewed by experts from specialized departments at the head office.

Currently, among Vietnamese commercial banks, Vietnam Joint Stock Commercial Bank for Industry and Trade is one of the banks that has completed the EWS risk early warning system. This system automatically reviews the debt portfolio and detects cases of quality deterioration within 6 months, and automatically provides a list of potential risky customers every quarter for business units, risk departments, inspections, and internal controls to coordinate.

review. The system pre-installs a number of appropriate response measures, corresponding to the risk level of customers, so that business departments can proactively select and promptly implement them, thereby contributing to helping Vietnam Joint Stock Commercial Bank for Industry and Trade manage credit effectively, becoming one of the banks with a transparent and good quality credit portfolio thanks to early control of group two debts (strengthening management, actively reducing outstanding debt...). The process of the Vietnam Joint Stock Commercial Bank for Industry and Trade EWS system presented by the researcher in chapter 1 is a useful lesson for Vietnam Joint Stock Commercial Bank for Industry and Trade.

Building an EWS system is a step to optimize credit risk management activities, thereby helping Vietnam Technological and Commercial Joint Stock Bank prepare conditions for the application of Basel II Accord according to the advanced A-IRB method. Therefore, Vietnam Technological and Commercial Joint Stock Bank needs to soon complete the construction of an EWS credit risk early warning system, in which the early warning risk indicators need to cover the main causes of default for customers such as: business prospects, financial situation, payment capacity, collateral and credit profile, changes in management or strategy... At the same time, increase the use of indicators that can be calculated automatically such as limit utilization rate, number of overdue days, cash flow fluctuations... to increase efficiency, ensuring data is updated in real time. In addition, to maximize the effectiveness of the EWS system, Vietnam Technological and Commercial Joint Stock Bank needs to issue a policy framework on early warning, which clearly defines the functions and tasks of each department, implementation process and operating mechanism, ensuring regular exchange and updates between functional departments on risk signs and algorithms suitable for continuous and complex changes from reality. In addition, to save time, costs and most importantly, master the system and technology, the completion of the EWS credit risk early warning system requires research and development cooperation between departments.

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