Technology Level, Professional Staff Capacity

Analyzing and making accurate forecasts of future interest rates can limit the risks of interest rate changes by creating appropriate sensitivity gaps that match the predictions of future interest rates. Furthermore, banks that actively manage RRLS can gain profits when interest rates change in line with their predictions.

1.2.4. Factors affecting the management of interest rates at commercial banks

1.2.4.1. Technology level, professional staff capacity

The first step in the RRLS control process is to gather data to describe the current financial situation of the bank. Every measurement system, whether a gap report or an economic value simulation model, requires information on the RRLS. The bank should have a comprehensive management information system (MIS) to allow for timely and accurate access to information.

To describe the RRLS associated with a bank's business, a bank needs information for each type of financial instrument or investment portfolio on:

- Current balances and interest rate covenants related to the portfolio.

- The contractual or expected terms of the instrument or portfolio relating to principal amounts, interest rate adjustment dates and maturity dates.

- For adjustable rate terms, the interest rate portfolio used for re-pricing, as well as instruments with caps or floors....

Along with the level of technology, the awareness of RRLS is also a factor affecting the process of RRLS management. Banks need to have specialized training courses for risk management officers to improve their professional qualifications. The level of staff in QTRRLS is also an important factor affecting the Bank's QTRRLS.

1.2.4.2. Legal environment and development of financial markets

The development of a financial market affects the management of interest rates in that when the financial market develops, new tools will be created to hedge interest rates. Furthermore, when the financial market develops, interest rates will fluctuate more and therefore the need for management of interest rates will also become more diverse.

As the State Bank pays much attention to various types of risks in the banking system, risk management and supervision as well as the legal environment also greatly affect the management of interest rate risks at commercial banks.

1.2.4.3. Forecasting information system on market situation and interest rates

As presented in the above section, with a system of information and accurate forecasts of interest rate fluctuations, commercial banks will be very proactive in managing interest rate risks.

1.3. EXPERIENCE IN LOSS MANAGEMENT AT SOME FOREIGN BANK BRANCHES IN VIETNAM

1.3.1. At HSBC bank branch, Vietnam

This HSBC bank branch uses the value-to-loss (VaR) and P&L (Profit and Loss) methods to manage RRLS, VaR tells HSBC what the worst case scenario of RRLS is and VaR measures the magnitude of P&L movements on the worst days.

For example: VaR at HSBC: HSBC Singapore's VaR is $7 million

More precisely, with a 99% probability, the 10-day VaR value of the bank's Trading Book is $7 million, which means that HSBC Singapore, all of its trading positions cannot lose more than $7 million in the next 10 days, with a 99% probability. However, on the other hand, with a 1% probability, HSBC can lose more than $7 million.

This VaR figure can increase or decrease on a daily basis based on the effects of:

- Trading Positions at HSBC Singapore

- Changes in interest rates (Market Volatility)

- Performance of portfolios and other positions in Singapore.

VaR is a market volatility applied to capital positions. VaR assumes that we are stuck in today's position. The change in VaR value is caused by changes in market interest rates on the capital positions that the bank holds. VaR value uses past data to predict the near future.

How does HSBC calculate VaR?

HSBC does not use the change in Profit and Loss (P&L) to calculate VaR because P/L does not explain what will happen and how to hedge the risk, but HSBC uses P&L for Back Testing purposes.

VaR is calculated as = PVBP* market volatility

VaR = Risk (Position) * Volatility (Market)

= PVBP position/market* [  market/day * (t day/250)* 1/2*  confidence]

So to calculate VaR we have to use PVBPs, this will separate VaR and P&L values into two parts, based on market states and changes (Market Volatility).

How Banks Use VaR in Risk Management

The bank has calculated the relationship between VaR and regulatory capital.

Capital = VaR (10 – days)*Regulatory Factor

Example: 99% probability , 10 days, VaR of HSBC Singapore is $7 million Assuming Regulatory Factor = 3.8 HSBC Singapore needs at least: $26.6 million capital = $7 million*3.8

If the bank does not have sufficient capital, it needs to report the above exceptional case to the Hong Kong Head Office or reduce its holding position. This will automatically reduce the VaR value and at the same time reduce the capital requirement.

The responsibility for RRLS lies with the Treasury Head, the Risk Management Director and the CFO. They need to manage it more closely and need to recognize RRLS earlier.

1.3.2. At Calyon Bank branch, Ho Chi Minh City

This bank (name withheld) manages RRLS using Head Office software, based on the following 3 methods:

a. Cash Flow Gap-Mismatch

b. Interest rate sensitivity method (Sensitivities)

c. Value at risk (VaR)

The interest rate basis used to quantify bank interest rates in Vietnamese Dong (VND) is the widely published interest rates including VNIBOR interest rates for terms up to 1 year and Government Bonds interest rates for terms greater than 1 year.

For USD, it is the interest rate on the Vietnamese market on REUTER news agency. For EUR, it is the interest rate of this currency's terms on the Vietnamese market.

a. Cash Flow Gap-Mismatch limit within 1 week, i.e. the limit that the capital department can be Negative or Positive per maturity for each currency. This limit is used to manage both interest rate risk and liquidity risk.

The purpose of this limit is to ensure that the bank can maintain continuous operations for a minimum of 1 week if a crisis occurs that seriously affects the bank's capital and during this 1 week the bank will take measures to handle the crisis. The bank has a sensitive interest rate gap limit for terms from O/N to 5 years.

To manage liquidity risk, banks have the following types of cash flow limits: 7-day limit (Long/Short), 1-month limit, general limit (in general) including Cook Weighted Assets (Basel 1) and Risk Weighted Assets (Basel 2)

Specifically, the bank stipulates the maximum cash in/out limit (Cash IN/OUT) in the next 7 days, cash IN/OUT in the next 30 days.

b. The interest rate sensitivity limit per interest rate point (Basic Point=bp), which shows how much the bank will gain or lose on its existing positions when interest rates change by 0.01%. The sensitivity limit is calculated by software based on parameters such as cash flow gap and overnight interest rates of each currency.

The sensitivity limit is valid for only the next business day and represents the profit/loss difference when interest rates change by 1 basis point for the entire balance sheet of the bank.

Banks set these interest rate sensitivity limits

c. Value-to-loss (VaR) limits: a measure of the risk of loss on individual and all items in a bank's balance sheet. These limits will be used to compare losses against market prices (Mark-to-Market).

VaR value is calculated on the software system and VaR has 5 functions: risk management, quantitative management, financial management, financial reporting and calculating the amount of capital required. VaR is extremely important because it will help save capital (Economic Capital), test the sensitivity of the market (stress testing), test and predict the level of withdrawal (back-testing), predict the level of deficit (expected shortfall).

Interest rate sensitivity limits (VaR) are calculated for each foreign currency, for example, the limits for VND and other foreign currencies are as follows:

Limit for VND

EUR100,000
Limit with USD	EUR 200,000
Limit with EUR	EUR300,000
Limit with JPY	EUR100,000
Total VaR limit	300,000 EUR

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When the VaR limit exceeds the allowable limit, the QTRR software will generate warnings to inform the transaction staff as well as the management staff. At this time, the bank needs to close its capital positions so that the VaR value is within the allowable limit. When closing these capital positions, the interest rate sensitivity gaps of the maturities automatically decrease.

Profit centers at the Branch such as: FX Desk, MM Desk, Forward Desk, Derivatives all sell positions to each other and do not hold positions (Internal Squaring). For example: FX sells USD for VND, it will send VND to the MM department and must borrow USD from the MM department.

The bank's software system is called: GCE=Global Central Exposure. The system allows tellers to know at any time how much credit limit any customer has left. At any time, dealers can know how much credit limit a customer has used and how much credit limit is left.

The risk management system is located at the Paris headquarters and is always online, updating data continuously. This system is rented by the headquarters and is used for the entire system of branches of the Bank worldwide. The rental cost is quite high, about several million EUR/1 month.

1.3.3. Comments on RRLS management at the two bank branches above

The application of the method of managing RRLS using the loss value method is the newest method in the world today, other methods such as the interest rate sensitivity gap method (Repricing Gap), PVBP, Economic Duration Gap are previous methods, however, they all have different advantages and disadvantages. In the second case, a foreign bank branch in Ho Chi Minh City has applied many other methods at the same time to manage RRLS. Reality has proven that the above branches manage RRLS quite effectively using the most modern methods today. However, it must also be recognized that in the financial statements of banks, the base currency is the US dollar (different from commercial banks in Vietnam, which use the Vietnamese dong), the interest rate fluctuations are different between the two currencies and these are branches and headquarters of these banks located in other countries, so the application of RRLS management is also somewhat different for Vietnamese commercial banks.

The advantages in the QLRRLS method of these 2 foreign bank branches are: (1) Applying advanced QTRR methods, (2) Having very modern software with very high costs, having been tested at the Head Office so the reliability is quite high, (3) Having a systematic and standardized QTRRLS process, (4) Managing RRLS by VaR is the most modern method today, (5) has proven its effectiveness in the Vietnamese market.

The experience that Vietnamese commercial banks can apply is that in the current situation of Vietnamese commercial banks when the charter capital is not high, RRLS will have a huge impact on the bank's profits and equity, so the application of modern management methods is very necessary. However, the investment cost for software is relatively high (if purchased) and also requires a team of highly qualified technical and professional experts to be able to write this software themselves (if writing the software themselves).

CHAPTER 2

CURRENT STATE OF INTEREST RATE RISK MANAGEMENT IN

VIETNAM COMMERCIAL BANKS 2007-2009 PERIOD

2.1. OVERVIEW OF BANKING SYSTEM IN VIETNAM

2.1.1. Structure of the Vietnamese Banking System

The Vietnamese banking system in 1988 consisted of four state banks: the Bank for Foreign Trade of Vietnam - VCB, the Bank for Investment and Development of Vietnam (BIDV), the Industrial and Commercial Bank and the Agricultural Bank, which were separated from the State Bank to carry out commercial activities. In May 1989, the Council of Ministers passed two decisions: 1- The State Bank of Vietnam continued to carry out its traditional functions and manage the entire banking system in Vietnam and 2- banks, credit funds and financial companies in Vietnam carried out banking activities. The State Bank of Vietnam had a very close relationship with the Ministry of Finance.

Along with the open economic policy starting in 1986 and policies to attract investment in Vietnam, the number of credit institutions has increased rapidly. Currently, the Vietnamese banking system includes the following credit institutions: 03- State-owned commercial banks (Agricultural Bank, BIDV, Mekong Housing Development Bank), 02 partially joint-stock commercial banks (VietcomBank, Vietinbank), 01 Vietnam Bank for Social Policies, 01 development bank, 38 Vietnamese joint-stock commercial banks, 05 joint-venture banks, 05 foreign-owned banks (HSBC, SCB, Shinhan, ANZ, Calyon), 45-branches of foreign banks in Vietnam, 16-finance companies, 13-financial leasing companies, 47-representative offices of foreign banks in Vietnam, 01 People's Credit Fund and 1029 People's Credit Funds.

2.1.2. Business environment of Vietnam's banking system

Currently, state-owned banks hold a position in the banking system and the Government always holds a controlling percentage. The equitization of

The state-owned banks have been slow to take off. For example, after equitization, the government still holds 91% of the capital at Vietcombank and 89% at the Industrial and Commercial Bank. The four state-owned commercial banks still account for about 60% of the total assets of the entire banking system. Meanwhile, joint stock banks, joint venture banks, finance companies, leasing companies and People's Credit Funds account for only about 20, 11, 7, and 2% respectively.

Chart 2.1. Market share of Vietnamese banks

Source: Reuters

In addition to state-owned commercial banks, joint stock commercial banks in Vietnam have affirmed their position in the Vietnamese banking system. From 2001 to 2008, the rate of increase in legal capital was 64%/year, the largest figure in the whole system. Total assets of joint stock commercial banks also increased on average by about 56%/year. Joint stock commercial banks have also received attention from foreign investors. The number of foreign investors holding shares in joint stock commercial banks has increased. However, Vietnam still limits the maximum holding rate of foreign partners for