The Impact of Bad Debt on the Operations of Credit Institutions

The amount of money that a credit institution provides to a customer for a certain period of time as agreed upon by the parties, and when this period expires, the credit institution has the right to recover the amount of money provided but has difficulty in recovering the principal and interest. The value of this property right depends on the amount of money that the credit institution has provided to the customer and the interest determined according to the interest rate agreed upon in the credit contract between the credit institution and the customer. Because this property right can be transferred in civil transactions, the credit institution can completely sell it to organizations and individuals in need. However, because bad debts are debts that are difficult to recover and have high potential risks, the purchase and sale price needs to be recalculated according to appropriate valuation methods to ensure the rights of the parties.

In Article 3 of Circular 02/TT-NHNN of the Governor of the State Bank dated January 21, 2013: Regulations on classification of assets, provisioning levels, methods of setting up risk provisions and the use of provisions to handle risks in the operations of credit institutions and foreign bank branches, bad debt is defined as follows: "Bad debt (NPL) is debt belonging to groups 3, 4, and 5". And also in Article 10 of this Circular, it is understood that group 3 is the substandard debt group, group 4 is the doubtful debt group and group 5 is the debt group with the possibility of losing capital.

Through the above analysis, it can be understood that bad debt from lending activities of credit institutions is a type of property right formed when the customer's debt repayment obligation to the credit institution is not performed or is not fully performed after a period of time prescribed by law or the credit institution determines that the customer is very likely to no longer be able to perform the debt repayment obligation.

Thus, compared to the definition of "bad debt" from a financial and business perspective, the definition of "bad debt" in the legal sense, although also agreeing on the overdue nature of the debt, does not seem to emphasize the aspects of debt accounting and the purpose of reducing costs as well as enhancing the business management efficiency of the Lender (CI). Instead, legal scholars emphasize the legal nature of bad debt by viewing bad debt from a legal perspective, as: the property rights of the creditor; the debt repayment obligation not performed by the debtor; the creditor's right to recover the debt. And these rights and obligations must always be viewed in conjunction with a

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a certain statutory time threshold before which the debt cannot be considered “bad debt”.

1.1.2. Characteristics of bad debt

- Bad debt from lending activities of credit institutions in the legal sense refers to bank debts that satisfy the following three conditions: (1) the customer (Borrower) does not fulfill the debt repayment obligation to the credit institution (Lender); (2) the delay in performing the debt repayment obligation has exceeded a statutory period of time; and (3) the Lender perceives a risk of inability to recover the debt at the time the debt repayment obligation is delayed to the above time threshold.

- Bad debt is a legal obligation that has not been performed. It is the obligation of the borrower to pay principal and interest to the credit institution. This obligation arises on the basis of the loan contract established between the credit institution and the customer. In principle, this obligation arises from the time the loan contract matures but is not performed properly and fully by the borrower, but that does not mean that all obligations to repay debt not on time are bad debts. Any debt is only assessed as bad debt when the customer fails to perform his/her obligations after a certain period of time or the credit institution itself determines that the customer is unlikely to be able to repay the debt due to insolvency or the business owner absconding.

- Bad debt is a type of asset in civil transactions, so credit institutions have full rights to choose the option of selling to organizations and individuals in need, except in cases where there is a previous agreement between the credit institution and the borrower not to sell bad debt. Thus, bad debt is not a waste asset, worthless or "completely bad" as the name of this type of debt implies. If properly assessed, bad debt can become a potential "commodity" on the market and buying and selling bad debt can become a profitable business for debt buying and selling service businesses.

- These are debts without collateral or the collateral is not enough to repay the debt. That means the bank cannot fully recover the debt because it is very difficult for the debtor to make a profit from the business.

The business or debtor fails to contact the bank for payment or circumstances indicate that the majority of the debt will be uncollectible.

- Subjects of bad debt (Borrowers): are borrowers who must be able to repay the debt or must have collateral at the time of borrowing. In addition, loans of these subjects often must have collateral.

1.1.3. Causes of bad debt

Understanding the causes and origins of bad debt to understand and draw accurate conclusions is an indispensable task to solve bad debt. Only by thoroughly analyzing the causes of bad debt can appropriate solutions be proposed. Researchers have found many diverse and rich causes. However, in general, they can be arranged and packaged into the following groups of causes:

1.1.3.1. Causes from the customer side

Because the customer is the one who is granted credit, the one who directly uses the loan, the cause from the customer is the main cause of credit risk - the biggest risk of the credit institution. The reason why the customer causes bad debt is:

* Moral hazard from the customer side

- Customers use capital for purposes other than those stated in the loan application and in the credit contract signed between the credit institution and the customer. The loan is not used to develop production and business but for purposes that contain more risks, causing capital loss, leading to a reduction or loss of the ability to repay the loan. Many customers use the credit institution's money to rotate capital into the wrong business objects or handle short-term loans to invest in fixed assets or real estate business, so they cannot repay the loan on time.

- Customers intentionally defraud and appropriate capital from credit institutions: Some customers take advantage of loopholes in the law to calculate and defraud and appropriate capital, borrowing without intention.

intended to pay right from the start of the loan application. Some customers deliberately delay in fulfilling their commitments in the credit contract.

* Cash flow or solvency difficulties

In the course of doing business, many enterprises have made inaccurate judgments about the development trends of the market, leading to the expansion of production scale in overheated developing industries without careful assessment. The consequence is an imbalance in supply and demand. Some enterprises, when implementing large projects, divide the project into smaller projects to seek funding from different banks, thereby making it easier for enterprises to borrow capital from credit institutions as well as reducing the control of credit institutions. These factors make it difficult for credit institutions to control loans, leading to bad debt in credit activities of credit institutions.

In addition, due to the poor level and capacity of business management of enterprises, it reduces business efficiency, even causes losses, leading to difficulties in cash flow, reducing the ability to pay debts. Many enterprises participate in trading too many products, borrow capital to expand production and business beyond their management capacity, or mispredict market demand, import too large a quantity of goods, leading to a backlog of goods, capital backlog, leading to a situation of unpaid debts.

1.1.3.2. Causes from the credit institution

* Adverse selection problem of credit institutions

Credit institutions decide to lend based on loan applications and some other credit information from outside sources, but there is always information that customers have hidden, or because credit institutions cannot predict the actual use of loan capital of customers. This leads to the decision to lend to the wrong customers, lending to customers with high-risk investment portfolios. Once this customer encounters financial difficulties, the money that the credit institution lends is also difficult to recover.

This problem occurs because:

- Poor quality of credit information: Credit institutions' information sources are limited, lacking a system to provide accurate and complete credit information. In addition to information provided by customers, credit officers also face many difficulties with customer information channels such as the difficulty in verifying all the information that customers provide to the bank. Some officers want to push the risk to other banks by only providing good information about that customer when your bank asks.

- The professional qualifications of credit officers are still limited: when appraising loan projects, credit officers are weak in professional skills, have poor ability to analyze financial reports combined with lack of information about customers, so they cannot fully assess the feasibility of the project.

- The professional ethics of credit officers are not high: Banking is a special business, it needs to be based on trust and creditworthiness, so ethics must be put first and in some aspects it is mandatory. The ethics of officers is one of the most important factors to solve the problem of limiting credit risks. Some credit officers help customers falsify loan documents, or raise the value of mortgaged assets too high compared to reality to have a decision to lend according to procedures.

* Credit institutions loosen credit approval conditions

In reality, the competition to attract customers forces banks to loosen credit conditions: loan/value ratio of collateral, unsecured loans, and mortgages of goods are not closely monitored; loan/capital demand ratio... The pressure of hot growth has forced some banks to loosen credit conditions to compete to attract customers in recent years and as a result, the bad debt ratio in credit activities of commercial banks is increasing.

* Lack of monitoring and debt management after lending

When a credit institution lends, the loan must be actively managed to ensure that it will be repaid. Debt monitoring is one of the most important responsibilities of credit officers in particular and of credit institutions in general. However,

Many credit institutions have a habit of focusing a lot of effort on pre-lending appraisal without paying due attention to checking and controlling capital after lending. This is partly due to the psychological factor of some credit officers being afraid of causing trouble for customers, and partly because the business management information system at enterprises cannot provide timely and complete information that credit institutions require.

* The mechanism for handling bad debt in credit activities still has many shortcomings.

Bad debt in credit activities of credit institutions in Vietnam has existed for a long time, but the process of handling bad debt in credit activities of credit institutions is ineffective, the reason is that the mechanism for handling bad debt in credit activities of credit institutions is not really reasonable, and still reveals many limitations.

1.1.3.3. Causes from the political and economic environment

* Socio-economic developments in the country:

To a greater or lesser extent, production and business activities are always directly or indirectly affected by the socio-economic environment, such as changes in interest rates, exchange rates, and global and regional economic crises.

In a healthy growing economy, with large production and consumption potential of society, production and business activities have good conditions to develop. However, in an economy in crisis, on the decline, with high inflation, stagnant production, declining investment, and reduced income of all members of society, the ability to develop production and business is very poor, strongly affecting the business activities of credit institutions. The negative impact of such socio-economic situation will affect the debt repayment ability of enterprises, organizations and individuals, causing negative impacts on the ability of credit institutions to recover credit capital.

* Changes in State policy:

It is a change in politics, adjustment of policies, regimes, and laws of the State. Those changes and adjustments are very necessary in the development process of the country, but depending on the place and time, they will strongly impact business activities.

of enterprises, directly affecting the ability of customers to repay credit to credit institutions. Due to the nature of credit institutions' business activities, they are related to many different ministries, sectors and fields. Therefore, any change in the State's policy mechanism can also affect the performance of credit institutions, especially credit activities - a major business activity of credit institutions.

* Legal environment:

This is a very important factor affecting the possibility of overdue debt. The national legal system with laws and sub-law documents that are not fully synchronized, do not ensure a healthy competitive environment for business organizations, is the direct cause leading to risks in business production of enterprises, causing overdue debts for credit institutions.

1.1.3.4. Other causes

Natural disasters and epidemics destroy production and business: These are objective events that cannot be predicted, they have a direct impact and greatly affect the production and business activities of enterprises. Many times these events cause credit institutions to lose all their loans and cannot recover their debts. Natural disasters and epidemics do not exclude anyone, they affect the ability to implement production and business plans and the debt repayment plan of borrowers.

1.1.4. Impact of bad debt on the operations of credit institutions

1.1.4.1. For credit institutions.

- Bad debt will increase the operating costs of credit institutions, thus reducing the profits of credit institutions. The increased operating costs of credit institutions include both risk provision costs and operating costs for bad debt recovery. The problem of bad debt has forced credit institutions to use a significant amount of resources for bad debt recovery and handling, such as provisioning, debt collection, liquidation of mortgaged assets, etc. instead of using human and financial resources to provide credit and serve the market. Existing assets that act as collateral at credit institutions are increasingly damaged, causing the use value and value of the assets to gradually decrease over time. In addition, maintenance, upkeep, management, and supervision make credit institutions spend a considerable amount of money. Because the assets

The collateral has low liquidity, so it affects the decline in profits, at the same time the quality of assets is reduced and the provision for loans increases. This leads to an increase in the cost of using borrowed capital. The increase in bad debt ratio will reduce the profitability of credit institutions. 3

- Bad debt will not clear the source of capital for lending: With the increasing bad debt situation, not only do credit institutions try to find every way to prevent good debts (group 1) from jumping the group and becoming overdue debt (group 2) or becoming bad debt (group 3 - 5), but credit institutions are also very careful in lending new loans due to the declining financial status of enterprises, lack or absence of mortgages and collateral, high inventories disrupting the capital turnover and current assets, making it difficult to prove the source of repayment as well as the feasibility of many projects.

- High bad debt can push credit institutions into a state of capital loss, liquidity loss and loss of public trust. When bad debt increases, it means that the "investment" capital will be frozen and cannot be recovered. If the loan capital cannot be recovered, the ability to pay will decrease. The payment crisis is the cause that easily leads to the bankruptcy of credit institutions. Moreover, bad debt disrupts the capital turnover of credit institutions: bad debts, doubtful debts and debts with the possibility of losing capital prevent the cash flow back to credit institutions and can quickly create a state of illiquidity if the amount of bad debt increases.

- Bad debt will reduce the financial capacity of credit institutions, thus affecting the stability of the financial sector. Due to the increase in bad debt ratio, the profits of credit institutions will therefore decrease. This will seriously affect the financial capacity and healthy survival of credit institutions, especially for small credit institutions that will be very susceptible to bankruptcy. Profits are not achieved with bad debts for many quarters and credit institutions themselves become debtors with huge debts and are forced to go bankrupt or be merged.

3 Nguyen Thi Thu Cuc, "Bad debt management at the Bank for Agriculture and Rural Development of Vietnam",

PhD Thesis in Economics, Academy of Finance, Hanoi, 2015, p.21.

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