credit risk provisioning fees, bad debt handling costs and other related costs. The decrease in revenue and increase in costs cause the bank's profits to decrease.
Impact on the bank's ability to pay: bad debt slows down the bank's capital circulation process due to slow loan recovery time or even loss of capital. Meanwhile, the bank is still responsible for paying for customers' deposits. This will put the bank at risk of insolvency.
Reduced bank reputation: when a bank has a high bad debt ratio, which means that the bank has a high level of asset risk, the bank is at risk of losing its reputation in the market. This puts the bank at a disadvantage in competing with other banks. Information about a bank with a high level of risk is often reported by the press and spread among the people, no one wants to put money in such a risky bank.
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For the economy, the impact of bad debt is an indirect impact through the organic relationship: bank - customer - economy. Accordingly, bad debt affecting the business activities of banks will also affect the development of the economy. Too high bad debt will limit the ability to exploit capital and the ability to provide banking services to the economy. On the other hand, bad debt arising from customers and inefficient production and business will affect the entire economy, affecting the growth and development of the economy due to capital stagnation and stagnant production and business.
1.2. Prevention and handling of bad debt at commercial banks:
1.2.1. The role of preventing and handling bad debt at commercial banks:
Bad debt is inevitable in the credit activities of banks. If at a large level, bad debt will cause damage to the economy and the profits of banks. Therefore, bad debt handling is extremely necessary for banks. Bad debt handling helps to improve financial health and reduce credit risks for credit institutions. Thereby helping credit institutions develop business and increase profits.
Bad debt causes banks' capital to stagnate, unable to be recovered to continue lending capital, and unable to increase credit growth. This affects the supply of capital to the economy, because of the lack of capital, production and business stagnates, and the economy cannot develop. Handling bad debt not only helps banks reduce credit risks but also opens up capital sources for economic development.
Bad debt in credit activities of credit institutions is inevitable and constantly arises. After handling old bad debt, new bad debt arises, so preventing bad debt is also a very important task that credit institutions must carry out throughout the business process. Handling bad debt must go hand in hand with measures to prevent bad debt from continuing to arise. If we only stop at handling bad debt without solutions to improve the quality of operations and minimize operational risks of banks, after a while, bad debt will accumulate again and the scale will become larger and larger.
1.2.2. Bad debt prevention:
1.2.2.1. Building a credit risk management model:
Building a credit risk management model is to build a way to manage the overall credit risk of a bank, which shows how to organize management, implement credit processes, identify, measure, and control credit risks to control risks within an allowable limit according to the principle of profit maximization.
Nowadays, many banks in the world have begun to pay attention to determining for themselves a suitable risk management model to improve risk management efficiency instead of introducing scattered risk management methods as before.
Building a credit risk management model helps banks have a more accurate view of the bank's future business prospects, thereby being able to plan appropriate business policies. Compared to indicators reflecting business reality such as revenue, profitability, interest and fees, etc., risk is predictive. Talking about risk means talking about uncertain events. And in fact, people can ignore future results to focus more on immediate goals. Taking risks lightly means that banks may have to suffer heavy losses in the future. Therefore, paying attention to applying a risk management model means that bankers have made risk an urgent issue in business activities in addition to profit goals even when the risk has not yet occurred.
Specifically, in building a credit risk management model, it is necessary to address the basic issues of how the management model will operate (centralized or decentralized) and how to measure risk (qualitative or quantitative).
1.2.2.2. Implement credit procedures well:
The credit process is a synthesis of the bank's principles and regulations in granting credit. The credit process establishes specific steps from preparing credit application documents to terminating the credit relationship. It is a synchronous process, continuous in nature, in a certain order and closely related and intertwined. The credit process usually includes the following steps: preparing credit application, disbursement, monitoring and debt collection and liquidation when the credit contract ends.
In other words, the credit process is a summary table describing the bank's work from receiving a customer's loan application until deciding to lend, disburse, collect debt and liquidate the credit contract.
Credit activities themselves always contain potential risks, so when considering lending, banks must strictly implement credit management processes. Establishing a credit process and constantly improving it is especially important for a bank. A reasonable credit process will help the bank improve credit quality and minimize credit risks. This will help the bank avoid the risk of bad debts arising, and at the same time promptly detect and correct errors and shortcomings in the bank's business operations.
Based on this requirement, the construction of effective procedures and processes is always an urgent requirement. The credit handbook needs to specify, detail, and clearly define the procedures, processes, and sequences of all work related to credit activities, from the time of receiving a loan application until the full recovery of principal and interest of that loan. The construction of a credit handbook aims to make credit activities carried out in a systematic and unified manner.
1.2.2.3. Checking and monitoring credit activities:
Check and monitor to ensure that the borrower does not do risky things with the bank's money. The bank conducts checks on the use of loan capital after disbursement, and periodically checks the borrower's production and business activities. This is a mandatory requirement in the credit process of any commercial bank.
Banks need to use various measures to check and monitor loans such as: conducting regular checks and monitoring of all loans, and also conducting irregular checks on loans with high risk signs; carefully and thoroughly developing plans, programs, and inspection process content, ensuring that the most important aspects of each loan are checked; closely and regularly managing
In order to effectively monitor problem loans, strengthen supervision when detecting unhealthy signs related to loans. In case the economic growth rate declines or industries that account for a large proportion of the bank's loan portfolio face major problems, the bank needs to strengthen credit control measures.
Another aspect of credit inspection and supervision is internal inspection and control. Internal inspection and control activities are carried out by a department independent of credit activities, which is the internal inspection department, with the function of providing objective assessments of credit activities. On that basis, the internal inspection department performs the function of advising the professional department and is a management tool for the bank's leadership.
1.2.2.4. Building an internal credit rating system:
The internal credit rating system is a process of assessing a customer's ability to fulfill financial obligations to a bank such as paying interest and principal on loans when due or other credit conditions to assess and determine the risk in the bank's credit activities. The level of credit risk varies from customer to customer and is determined through a scoring process, based on the financial and non-financial information available to the customer at the time of credit scoring and customer rating.
The subject of credit rating includes parameters and data of customers participating in borrowing capital at commercial banks. Commercial banks do not use the rating results to show the value of the borrower but only give current opinions based on risk factors, from which there are appropriate credit policies and lending limits. The high rating of the borrower does not show the ability to fully recover the principal and interest, but is only the basis for making the right decision on adjusted credit.
the expected level of credit risk associated with a borrower customer and all of that customer's loans.
Internal credit rating is based on the principle of mainly credit analysis based on the customer's historical awareness and willingness to repay, assessing the debt repayment potential by measuring the customer's financial capacity. From there, comprehensive and unified risk assessment is based on the rating symbol system.
In credit rating analysis, it is also necessary to pay attention to qualitative analysis to supplement the shortcomings of quantitative analysis. The analysis indicators can be changed in accordance with general environmental factors.
The credit rating system helps commercial banks manage risks, control the creditworthiness of customers and establish appropriate credit and management policies to minimize possible credit risks. As a result, commercial banks can effectively evaluate their loan portfolios by monitoring changes in outstanding debt and classifying debts in each group of ranked customers, thereby adjusting the portfolio in the direction of prioritizing resources to the group of safe customers. This can limit bad debts arising for commercial banks.
1.2.3. Bad debt handling:
Once a debt has been identified as bad debt, it is immediately transferred to the bad debt handling department. The bank can use the following methods to handle bad debt:
1.2.3.1. Assigning debt collection responsibilities to credit officers:
For debts with subjective causes from credit staff, the bank will resolutely use measures to assign responsibility for debt collection to that person. In case the debt cannot be collected, the wrongdoer will have to compensate the bank and also receive other forms of discipline. In cases that cause consequences
In case of serious consequences, the bank may apply stronger measures such as dismissal or lawsuit.
If the debts are not due to the credit officers' fault, the bank can also apply measures to link debt collection with the tasks of the credit officers to improve the efficiency of debt collection. In addition, the bank can build a reward and punishment mechanism in debt collection to promote the creativity of those responsible.
1.2.3.2. Debt collection organization from customers:
This measure is applied to bad debts that are recoverable. The bank considers the customer's recovery ability, then negotiates with the customer on the implementation solution as well as the customer's commitment requirements. On that basis, the bank can apply the following options:
Debt extension: This is a beneficial option for both customers and banks. Customers can avoid the pressure of debt repayment to continue doing business while banks can reduce overdue debt. However, this measure is limited by the bank's allowed lending period.
Adjust the debt maturity by postponing and/or reducing the principal amount payable for the debt maturity, but not reducing the total amount payable.
The bank may consider extending additional credit to help customers overcome difficulties and at the same time create the possibility of recovering the previous debt. This is not an optimal solution because it is highly risky.
Converting bad debts into equity capital for joint stock enterprises. Banks apply this measure when customers face business risks due to objective reasons but have prospects of recovery. In practice, banks often use this measure for enterprises that are temporarily in decline or have encountered disasters.
Non-serious business emergencies or for customers with large debts that still have a chance of recovery.
1.2.3.3. Handling of secured assets:
When bad debts cannot be restructured, customers are slow to pay or are unable to pay, the bank will proceed to liquidate the secured assets. To support the implementation of the contract, the bank often requires customers to commit to mortgage, pledge or guarantee from a third party. The bank sells the secured assets on the market, or through an asset auction service center or to a debt trading company.
1.2.3.4. Sale of debts:
Debt sale is the transfer of creditor rights for debts that are currently outstanding or are being monitored off-balance sheet at the bank to domestic and foreign organizations or individuals who have a need to buy debts. The transfer of debt is carried out simultaneously with the transfer of obligations of the debtor and related parties. A debt can be sold in part or in whole, sold to many debt buyers and can be bought and sold many times. The method of debt sale can be carried out through auctioning debts according to regulations on asset auctions or through direct negotiation between the seller and the buyer or through a broker. The debt purchase and sale price can be agreed upon directly by the parties or through a broker or the highest price in the case of debt sold by auction.
This measure is used by banks to recover bad debts, overcome and handle outstanding debts, clean up and make the balance sheet healthy, ensure the bank operates safely, effectively and develops sustainably. Normally, the current debt purchases of commercial banks are bad debts, outstanding debts that have been around for a long time, difficult to handle by conventional measures while other measures banks do not have enough financial capacity or legal corridor to implement.