The Impact of Credit Risk in Personal Lending

Force majeure causes all reduce the ability to pay debt or even make it impossible to pay debt.

- Subjective causes from the borrower

The borrower's poor ability to predict business problems, poor management, intention to defraud bank staff, procrastination... are the causes of credit risks. Many borrowers are willing to take risks with the expectation of high profits. To achieve their goals, they are willing to find any means to deal with the bank, such as providing false information, bribing... Many borrowers do not calculate carefully, expand their investments excessively, or are unable to calculate carefully the possible uncertainties, and are unable to adapt and overcome difficulties in business. The remaining case is that borrowers borrow capital to do business with profit but still do not repay the debt on time. They procrastinate in the hope of being able to have their debt forgiven and use the loan as long as possible.

The cause lies in the management capacity of commercial banks.

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In addition to the subjective causes of the partner (customer), the subjective causes belonging to the Bank as listed by the Basel Committee (2000) show that the main source of credit risk is the level of risk concentration and unhealthy credit granting process. The level of concentration can be considered the most important cause in the issue of credit risk. Credit concentration risk exists when the level of credit risk of a content in the credit portfolio becomes relatively large compared to the capital or assets of the Bank. Credit concentration risk depends not only on the committed credit value, but also on the high rate of capital loss when the risk occurs.

Credit concentration risk is divided into two main groups: conventional credit concentration risk and credit concentration risk based on common or correlated risk factors. Conventional credit concentration risk occurs when credit is concentrated too much on a single customer, group of customers, or industry/sector such as real estate, oil, gas. Meanwhile, credit concentration risk due to the interrelationship of risk factors is related to specific factors, which can only be

discovered through analysis such as between emerging markets, credit risk and market risk, these risks with liquidity risk. Typical examples of this type of risk are the financial crisis in Asia in 1997 and the financial and economic crisis in the US from late 2007 to present. In this crisis, the connection between market risk and credit risk, as well as between this risk and liquidity risk, has created widespread capital losses.

Problems in the credit granting process are also a cause of credit risk, which is mainly related to the credit appraisal and monitoring process. Many banks find it difficult to conduct a thorough credit assessment process due to increasing competitive pressure in the banking sector. Due to this pressure, many banks tend to rely on a few simple criteria to grant credit. In addition, the lack of a system to test and evaluate new credit techniques has also caused many risks, specifically:

- Failure to regularly monitor and supervise customers or collateral. This leaves the Bank with no basis to take early action to prevent risks.

- Poor risk-based pricing techniques, focusing too much on non-price conditions (credit conditions such as documents, finance, collateral, etc.) This problem mainly affects the Bank's ability to compensate in case of risks.

- Be cautious with highly leveraged credit agreements. Therefore, when customers encounter business risks, their ability to support themselves with equity is low, and the risk is transferred to the Bank.

- Failure to plan for the worst case scenario leaves the Bank unprepared. In many cases, having a clear, well-publicized and regularly practiced action plan can help the Bank respond quickly and promptly and thus weather adverse shocks.

1.1.5 Impact of credit risk in personal lending

For banking activities

Credit risk in general and credit risk in lending to individual customers in particular directly affects business activities, reducing the bank's business profits. Regardless of the level, credit risk leaves losses for the bank.

Credit risk in lending to individual customers causes profits to decline: when it occurs at a mild level, the bank's profits decrease when it cannot recover loan interest, more seriously, the bank cannot collect both capital and interest, the debt is overdue with a high rate leading to losses and capital loss for the bank. On the other hand, today, personal credit activities account for a significant proportion of the total assets of a commercial bank, which is the main profit-generating activity of the bank. Therefore, if there is a risk in credit activities in lending to individual customers, the bank's profits will decrease.

Credit risk in lending to individual customers reduces the reputation of the bank: a bank with high credit risk in lending to individual customers shows that it is a poor business bank, which shows a high risk of losing capital, while the bank operates with capital mobilized from deposits and savings of the population, so the people will lack confidence in the business ability and repayment ability of the bank. As a result, the bank's ability to mobilize capital is difficult. At the same time, foreign banks also avoid it, do not grant credit limits, do not open credit relationships...

Credit risk in lending reduces the liquidity of banks: personal credits have risks that make repayment difficult, while banks have to pay savings and deposits of residents when due. When credit risk is at a low level, banks have enough ability to pay, but when credit risk occurs at a serious level, when the reputation of the bank is reduced, leading to increased withdrawals of money from residents, the liquidity of the bank is seriously reduced.

Credit risk in personal lending can lead to bankruptcy: when personal credit risk occurs in a prolonged and irreversible situation, with

The impact on the above three aspects to a certain extent will push the bank to the brink of bankruptcy.

For the economy:

Banks operate in the field of credit and currency business as intermediaries of economic life, they have direct and regular relations with economic organizations, so banking business encounters risks that inevitably cause impacts on the economy and socio-economic life. Risks cause banks' profits to decrease, from which banks are unable to meet capital needs of customers and make late payments to lenders. Therefore, in the economy, risks cause production to stagnate, businesses have to close, goods are not enough to meet market demand, to some extent causing commodity prices to skyrocket, which is one of the causes of inflation. On the other hand, banks often establish a tight system with connections to each other, when a bank encounters a risk, it is at risk of bankruptcy, easily leading to a crisis of the entire banking system, causing instability in the monetary market. Especially in the context of a developing economy, all payment and transaction activities of customers are carried out through banks, but businesses mainly rely on bank capital, so when banks encounter major risks, it can cause delays in customer payments, directly hindering the capital circulation process, inevitably reducing business profits of the enterprise.

To achieve high profits, attract more customers, and improve competitiveness, commercial banks always seek to expand credit activities, provide more products and services to customers, but at the same time, banks also face more risks. These risks always have the potential to increase costs, reduce profits, cause losses or capital loss, leading to a shortage of capital to pay deposits to customers. Commercial banks, due to their inability to collect debts and interest due, lead to insolvency. If serious and prolonged, it can easily cause a chain reaction effect, threatening a series of other commercial banks as customers rush to withdraw their deposits, causing the economy to fall into a financial and monetary crisis.

In summary, credit risks in lending to individual customers of a bank occur at different levels: at the lightest level, the bank's profits are reduced when it cannot recover loan interest, at the most severe level, the bank cannot collect interest and principal, the debt is bad with a high rate leading to the bank's loss and capital loss. If this situation persists and cannot be remedied, the bank will go bankrupt, causing serious consequences for the economy in general and the banking system in particular. Therefore, it requires bank managers to be extremely cautious and take appropriate measures to minimize risks in lending.

1.2 Credit risk management in personal lending of commercial banks

1.2.1 Concept of credit risk management

According to the modern perspective, credit risk management is the process of developing and implementing credit management and business strategies and policies to maximize profits within the acceptable risk level. Controlling credit risk at an acceptable level is the process by which commercial banks strengthen preventive measures, limit and reduce overdue debts and bad debts in credit business, in order to increase credit revenue, reduce risk compensation costs, and achieve efficiency in credit business in both the short and long term. “Effective credit risk management is an important part of the overall risk approach and is considered to play a vital role in the long-term success of the Bank” (Basel Committee on Banking Supervision, 2000).

According to Associate Professor, Dr. Dinh Xuan Hang and Master Nguyen Van Loc in the textbook "Credit Management of Commercial Banks" of the Academy of Finance (2012): " Credit risk management in banks is the synthesis of measures and policies to grasp the occurrence and quantify potential losses, thereby finding ways to minimize or eliminate these losses".

Thus, credit risk management is the process by which banks plan, organize, implement, monitor and control all credit granting activities, in order to maximize the bank's profits with an acceptable level of risk.

Controlling risks at an acceptable level is when commercial banks strengthen measures to prevent, limit and reduce overdue debts and bad debts in credit business, in order to increase credit revenue, reduce risk compensation costs, and achieve efficiency in credit business in both the short and long term.

1.2.2 Objectives and principles of credit risk management in lending to individual customers

1.2.2.1 Objectives of personal customer credit risk management

Credit activities are one of the main activities that bring the majority of profits to commercial banks. Personal credit risk management aims to limit personal credit risks and continuously improve the credit quality of commercial banks even in volatile market conditions, with increasing risks affecting the needs of individuals and households. More specifically, personal credit risk management aims to reduce credit risk ratios, increase the safety level of business operations through policies, management measures, and monitoring personal credit activities safely and effectively.

In addition, personal credit risk management also ensures that credit business is carried out in accordance with State regulations and legal regulations.

1.2.2.2 Principles of personal customer credit risk management

The Basel Committee was established by the central bank governors of the G10 in 1975. It comprises senior representatives of the banking supervisory authorities and central banks of Belgium, Canada, France, Germany, Italy, Japan, the Netherlands, Sweden, the United Kingdom and the United States. The Committee meets annually at the Bank for International Settlements in Washington or in Basel, Switzerland. The Committee's permanent secretariat is also located in Washington, DC, United States.

The principles of credit risk management recommended by the Basel Committee focus on the following issues:

Principle 1: Create an appropriate credit environment

- The Basel Committee requires the Board of Directors to approve and periodically (at least once a year) review credit risk strategies and credit risk policies for SMEs. This strategy must include the level of risk acceptance and the expected response capacity if any types of credit risks for SMEs occur. On this basis, the Board of Directors is responsible for implementing the credit risk management strategy and developing policies and procedures to detect, measure, monitor and control credit risks in the lending activities for SMEs.

Principle 2: Practice sound credit granting

- Banks need to clearly define healthy credit granting criteria (customer objects, terms and conditions of credit granting, etc.). Banks need to establish credit limits for each type of customer to cover different types of credit risks but can be compared and monitored based on internal credit ratings for each customer. Banks need to have a clear process for approving customer credit with the participation of marketing departments, credit analysis departments and credit approval departments as well as clear responsibilities of participating departments, and at the same time need to develop a team of experienced and knowledgeable customer credit risk management staff to make prudent judgments in assessing, approving and managing customer credit risks.

- Banks need to establish credit limits for each type of customer to create different types of credit risks that can be compared and monitored in the bank's accounting books and business accounting books, on-balance sheet and off-balance sheet.

Principle 3: Maintain an effective management, measurement and monitoring process

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- Banks need to have an effective system for managing scientific and technological credit portfolios.

effectively, have a monitoring system for the conditions related to each KHCN credit, including determining the appropriate size of provisions, building and using an internal risk rating system in KHCN credit risk management.

The rating system should be appropriate to the nature, size and complexity of the bank's operations.

- Banks need to have information systems and analytical techniques to help management assess credit risks for on- and off-balance sheet activities; and have a system to monitor the structure and overall quality of the credit portfolio.

Principle 4: Ensure adequate control over KHCN credit risk

- Banks need to establish a system of independent and continuous assessment of the bank's credit risk management processes and the results of these assessments need to be communicated to the Board of Directors and senior management.

- The process of granting credit to science and technology must be strictly managed, the loan amount must be within safety standards and allowable limits. Internal control must promptly report to management levels about exceptions in policies, procedures and limits.

Banks need to have early warning systems for deteriorating loans, management of problem loans and similar situations.

1.2.3 Content and process of credit risk management in personal customer lending

The risk management process includes 4 contents: identification, measurement, control, and loss handling. Although there are segments in the credit risk management process, a consistent principle is that the stages divided in the process must always be closely related to each other, forming a continuous cycle to ensure risk control according to the set goals. Once RRTD is determined, it needs to be analyzed, measured, and management and monitoring measures put in place. Also in the monitoring and management process, the credit risk management system must be able to identify and find new risks and the risk management work is repeated.

Effective credit risk management does not mean that risks do not occur, but that risks can occur but occur at a predictable level and the Bank has prepared sufficient resources to offset those possible risks.

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