Solution to Complete Internal Capital Adequacy Assessment Framework According to Basel II at Vietnam Joint Stock Commercial Bank for Industry and Trade

Implementing ICAAP requires a large financial resource, for example, the amount of money spent to implement Basel II at US banks in 2004 was around 25 million USD to 50 million USD. Therefore, to implement ICAAP well, banks must have strong financial resources.

Next, the number of credit rating companies in Vietnam is still low. By 2021, Vietnam only had two new credit rating companies licensed to provide credit rating services, FiinRatings and Saigon Thinh Phat. Meanwhile, credit rating companies play an important role for VietinBank in providing data to banks so that banks can implement standardized RR and credit measurement methods.

CONCLUSION OF CHAPTER 2

Ensuring capital safety, effective operation, meeting the requirements set by the State Bank as well as approaching international standards in capital management are issues that many commercial banks are interested in and implementing, including VietinBank. Based on the analysis of the current status of ICAAP implementation at VietinBank through aggregated data, survey data and interviews, the researcher has pointed out the results achieved, limitations and difficulties in the implementation process. This is the foundation for the researcher to propose solutions and recommendations in chapter 3.

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Chapter 2 has completed the study of practical issues in implementing ICAAP at VietinBank, specifically:

Firstly, an overview of risk management and capital safety at VietinBank, including the legal basis for implementation and actual implementation at the bank.

Second, evaluate the current status of ICAAP implementation at VietinBank based on analysis of implementation conditions and implementation content.

Third, based on the analyzed situation, the researcher has a general assessment of the achieved results and analyzes the limitations and difficulties.

Chapter 3: SOLUTIONS TO IMPROVE THE INTERNAL CAPITAL SAFETY ASSESSMENT FRAMEWORK ACCORDING TO BASEL II AT VIETNAM JOINT STOCK COMMERCIAL BANK FOR INDUSTRY AND TRADE

3.1. ORIENTATION FOR COMPLETING THE INTERNAL CAPITAL SAFETY ASSESSMENT FRAMEWORK ACCORDING TO BASEL II AT VIETNAM JOINT STOCK COMMERCIAL BANK FOR INDUSTRY AND TRADE

VietinBank's Development Strategy for the period 2021 - 2030, with a vision to 2045, strives to become "A leading multi-functional, modern and efficient bank in Vietnam, by 2030 in the Top 20 strongest banks in the Asia - Pacific region; by 2045, the strongest and most prestigious bank in Vietnam, leading in the Asia - Pacific region and highly prestigious in the world" with the mission of "Being a pioneer bank in developing the country on the basis of bringing optimal value to customers, shareholders and employees" . In its long-term development strategy and annual plan, VietinBank always focuses on sustainable profit growth and responsible resource deployment, including implementing risk management plans and measures in operations, developing comprehensive financial solutions, and green credit growth. The focus of VietinBank's risk management in the next phase is to complete the Basel II program according to the bank's plan and apply it to management and operations. In particular, the important goal is to complete the items to comply with Circular 41, Circular 13 and other regulations of the management agency related to capital safety. At the same time, VietinBank continues to apply ICAAP to evaluate the effectiveness of operations with RR adjustment. Accordingly, to build an effective capital management framework, the following specific goals need to be achieved:

(i) Strategically:

- Ability to identify, measure and report all material risks; have a process for assessing overall capital adequacy against the risk profile and a strategy to maintain that capital level.

- Always maintain the required minimum capital adequacy ratios, while maintaining a prudent “capital cushion”.

- Mobilize sufficient capital to meet the bank's overall business strategy; integrate capital allocation decisions into strategic planning and financial planning.

(ii) In terms of organizational structure:

- Build an effective internal control model for the capital assessment process.

- Raise awareness of the Board of Directors and the Executive Board on the relationship between overall business strategy and capital planning, ensuring that the business strategy is consistent with the bank's capital capacity.

(iii) In terms of policy mechanism:

Develop a comprehensive system of policy documents on risk management, measurement, calculation and synthesis of economic capital.

(iv) In terms of information technology infrastructure:

- Build an IT system to measure capital safety according to regulatory standards, internal standards and support other extended features.

- Develop extended features of the capital adequacy calculation system, serving Basel II use-tests, for example RR-based pricing, efficiency assessment.

(v) In terms of people:

Building high-quality, systematic, inheritable human resources with sufficient capacity to implement long-term and highly complex projects.

(vi) In terms of communication and training:

- The bank links the development of ICAAP with the development of a consistent RR culture; changes mindset, provides training on RR culture and emphasizes the impact of RR culture. RR culture needs to be disseminated, understood and implemented consistently throughout the bank.

- Raise bank-wide awareness of capital requirements under forecast economic conditions and various hypothetical stress scenarios.

3.2. SOLUTIONS TO IMPROVE THE INTERNAL CAPITAL SAFETY ASSESSMENT FRAMEWORK ACCORDING TO BASEL II AT VIETNAM JOINT STOCK COMMERCIAL BANK FOR INDUSTRY AND TRADE

3.2.1. Group of solutions to complete the content of the Internal Capital Safety Assessment Framework

3.2.1.1. Solutions for identifying, assessing key risks and determining risk appetite

Develop a process for calculating and evaluating economic capital, a process for building KVRR for the entire chain. There needs to be a policy to ensure KVRR is effectively transmitted throughout the system as well as specify KVRR into RR limits, specifically:

- VietinBank needs to have information systems and analytical techniques that allow the Board of Management to measure potential credit risk in all on- and off-balance sheet activities. Specifically, VietinBank needs to have a methodology that allows quantifying credit risk related to a customer as well as analyzing credit risk at the product and portfolio levels to identify any concentration or sensitivity of the portfolio. VietinBank must establish methods, processes, controls; collect data and establish IT systems to support credit risk assessment, internal credit risk rating and quantitative estimates of PD, LGD and EAD.

- VietinBank must have specific definitions, processes and assessment criteria to assess customer and transaction RR according to the internal rating system. VietinBank must clearly indicate in its credit policy the relationship between customer categories in terms of the level of RR that each category offers. The measured and recognized RR must increase when the credit quality decreases by one category. The policy must clearly indicate the RR of each category in terms of the description of the RR PD for customers in that category as well as the criteria used to distinguish that level of RRTD. VietinBank needs to allocate capital to the loan portfolio based on appropriate rating assessment, avoiding concentration on both the scale of customer rating and the scale of loan rating.

- VietinBank must have a sustainable system to verify the accuracy and consistency of the rating system, process, and estimates of all relevant RR factors. VietinBank must demonstrate to the supervisor that the internal verification process allows VietinBank to evaluate the internal rating capacity and RR estimation system in a consistent and meaningful manner. VietinBank must use quantitative verification tools and compare with appropriate external data sources.

3.2.1.2. Risk measurement solutions

Issue guidance on measurement and capitalization methods for other RRs in pillar 2; guidance on stress testing of RRs, assessment of capital adequacy in case of stress and implementation of appropriate action plans. This is a requirement for banks to conduct rigorous and comprehensive tests on Basel II stress testing. Specific solutions are as follows:

a. Credit Risk Measurement

To meet the requirements of BCBS in “International Convergence of Capital Measurement and Capital Standards” (BCBS, 2006) and overcome the limitations in practical implementation, based on the results of surveys and interviews with experts, the author proposes some solutions as follows:

- For normal RRTD: VietinBank needs to aim to build capital calculations based on RR parameters from internal estimation models PD, LGD, EAD and M, in which:

Loans to corporate and financial institutions:

+ FIRB: VietinBank must provide PD estimates; LGD, EAD, M estimates for corporate customers are prescribed by the regulatory agency.

+ AIRB: all RR parameters are estimated by VietinBank's internal model. This is the method currently applied by most countries and regions with developed financial systems such as Japan, Europe, the US, and Australia.

Retail Loans: VietinBank must provide estimates of PD, LGD and EAD. VietinBank needs to continue accumulating data to conduct validation of the developed models.

- For equity securities risks and counterparty credit risks: due to the small scale of receivables arising from equity securities risks and counterparty credit risks (including: equity securities investment, proprietary trading, repo, reverse repo, derivative products to hedge risks) at VietinBank, to ensure the allocation of resources to build models for other important types of risks, VietinBank can continue to use the simple RR weighting method according to the instructions and requirements for calculating capital for each period of the management agency.

- Internal estimates of PD, LGD and EAD must incorporate all relevant, significant and available data, information and methods. VietinBank may use internal data and data from external sources. VietinBank must demonstrate that the data used to build the model are representative of VietinBank's actual customers and loans. VietinBank is responsible for satisfying the requirements of supervisory agencies that a model has good predictive ability and that capital requirements will not be affected by the use of the model. The model's criteria must be multidimensional and reasonable. The model must be accurate in rating customers and loans and must not be biased towards any type of customer or loan. For each identified (retail) loan group, VietinBank must be able to provide quantitative criteria on the RR characteristics (PD, LGD, and EAD) for that credit package.

- VietinBank needs to use internal ratings, default and loss estimates (PD, LGD) in: credit approval, risk management, internal capital allocation, provision calculation, stress testing, loan valuation... thereby ensuring the effectiveness and accuracy of RR measurements. Customers and loans need to be re-rated annually because the rating results are the basis for RR assessments and other applications. Specific loans, especially those with high RR, need to be monitored more frequently. The bank needs to re-rate customers if important information about the customer or loan is discovered.

- VietinBank needs to develop collateral policies that are linked to the regulations on risk mitigation using standard methods or, further, LGD loss estimation from historical data, thereby minimizing the actual risk level and statutory capital requirements. However, collateral, guarantees or clearing payments must meet Basel standards to be recognized as valid. Therefore, VietinBank needs to refer to Basel regulations and the State Bank of Vietnam to have appropriate collateral policies.

- In addition to the statutory capital calculation model, VietinBank also needs to build an internal capital estimation model for other RRs. These models aim to reflect statutory capital models that have not been taken into account such as concentrated RRs, reputation RRs, etc. and at the same time update more closely with market and customer developments.

b. Measuring market risk

- VietinBank should issue a process for independent price validation separate from daily market valuation. This is a process in which market prices or model inputs are regularly validated for accuracy. Market price or model input validation should be conducted by a department independent of the business department at least monthly (or more frequently, depending on the nature of the market/business activities). This should be conducted as regularly as daily market valuation, since the objective of independent status assessment is to detect any errors or subjective trends in valuation, thereby helping to eliminate inaccurate valuations.

- Where market valuation is not possible, VietinBank may use a model valuation if this is appropriate. Supervisors will consider the following factors in assessing the prudence of a model valuation: Senior management should be aware of the elements of the business book being valued by the model and understand the materiality of the impact on the information in the RR or business performance reports; market inputs should be clearly sourced and, to the extent possible, consistent with market prices (as discussed above). The relevance of the market inputs to the specific position being valued should be regularly assessed.

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