The proportion of state capital ownership and other shareholders) therefore makes it difficult to cover every detailed aspect of credit risk management of each commercial bank.
9. Structure of the thesis
In addition to the introduction, conclusion and list of references, the thesis is summarized as follows:
The structure consists of 3 chapters:
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The Role of Risk Management in Credit Activities at Commercial Banks
Chapter 1: Theoretical basis of credit risk management of banks
commerce
Chapter 2: Current status of credit risk management at commercial banks
Vietnam Trade
Chapter 3: Basic solutions to improve credit risk management at
Vietnamese commercial banks
CHAPTER 1
THEORETICAL BASIS OF CREDIT RISK MANAGEMENT AT COMMERCIAL BANKS
1.1 CREDIT RISK IN COMMERCIAL BANK ACTIVITIES
TRADE
1.1.1 Concept of risk in commercial banking activities
Commercial banks are a special type of enterprise. Therefore, in their business activities, commercial banks are also affected by many complex types of risks. Risks in commercial banking activities are the possibility of unexpected losses, reducing the income or equity value of the bank.
Risks in commercial banking activities can be classified according to the following criteria [ Bui Dieu Anh (2013) Banking Business Activities textbook, Phuong Dong Publishing House ]:
Classification by risk nature includes:
+ Financial risks are risks that cause financial losses to the bank. The bank can measure the value of the loss from these losses, such as credit risk, interest rate risk, etc.
+ Non-financial risks are risks that cause damage to the bank but the loss from which is difficult to measure, such as reputation risk, legal risk
Classified according to the origin of risk, there are the following types of risks:
+ Credit risk is a type of risk that appears in transactions between banks and their partners, mainly credit transactions between banks and borrowers.
+ Interest rate risk is a type of risk that arises from adverse fluctuations in market interest rates affecting the structure between liabilities and assets at the bank. Interest rate risk appears in all activities related to interest income and interest expenses of the bank.
+ Exchange rate risk is a type of risk that arises from adverse fluctuations in the exchange rate between the domestic currency and foreign currency, affecting the bank's foreign exchange position. Foreign exchange risk occurs in all activities that result in the bank's foreign currency trading.
+ Liquidity risk is the risk that arises when a bank is unable to meet customers' demands for withdrawals and loans or can meet them at a high cost, leading to a decrease in the bank's profits. Liquidity risk can be a consequence of the above-mentioned credit, interest rate, and exchange rate risks.
Classification according to the Basel Committee's perspective includes the following types:
+ Market risk, including specific types such as interest rate risk, foreign currency risk, equity risk, option risk, commodity risk. Market risk is understood as the possibility of loss occurring on and off the bank's balance sheet arising from price fluctuations in the market. Market risk is the sum of the above-mentioned component risks.
+ Credit Risk is the possibility of loss when there is a violation from the bank's partner. According to the Basel Committee's point of view, credit risk can be understood as Counterparty Risk that appears when there is a violation of agreements between the bank and its partner in their transactions.
+ Operational Risk is understood as the possibility of loss due to internal causes (processes, systems, operations, etc.) and external objective causes (such as fraud, for example).
In addition to the above classification criteria, depending on specific conditions, banks can apply different risk classification methods to serve the management of bank operations.
1.1.2. Concept of credit risk
Credit risk is a matter of particular concern not only within the scope of banks.
customers but also in the whole economy. There are many concepts of credit risk, including:
According to two economists A. Saunder and H. Lange [ Financial Institutions Management – A Modern Perpective ], credit risk is defined as “the potential loss when a bank grants credit to a customer, meaning the possibility that the expected income streams from the bank's loan cannot be fully realized in both quantity and time.”
According to the Basel Committee, "Credit risk is the possibility that a borrower or a bank's counterparty will not fulfill its agreed commitments" [ Basel Committee on Banking Supervision (September 2000), Principal for the Management of Credit Risk ] . According to this concept, credit risk has a fairly wide scope, not only in the credit relationship between the bank and the customer but also in other activities such as investment and derivatives that the bank performs. However, as introduced in the scope of the research topic, the thesis only studies credit risk in the credit granting activities of the bank, so credit risk can be simply understood as the violation of non-repayment of debt from the borrower.
According to the understanding of Vietnamese banks, "Credit risk is the possibility of loss in banking activities of a credit institution due to customers not performing or not being able to perform their obligations as committed" [Decision 493/2005/QD-NHNN dated April 22, 2005 ] .
Thus, from many different and diverse definitions, we can summarize the content of
Credit risks are as follows:
Credit risk is the risk that a creditor, obligor or counterparty fails to perform or is unable to perform part or all of its obligations as committed.
1.1.3. Structure of credit risk
The components of credit risk include (i) Transaction risk and (ii) Portfolio risk [ Ho Dieu (2002), Banking management, Statistical publishing house ] .
1.1.3.1. Transaction risk
Transaction risk has three components: selection risk, hedging risk and
profession
+ Selection risk is the risk related to the process of credit appraisal and analysis of the bank to select customers to grant credit. In this process, the bank is very susceptible to making wrong choices due to the phenomenon of "asymmetric information" appearing.
+ Security risks arise from standards that ensure transactions between banks and customers are conducted smoothly and safely for the bank. Regulations or standards on collateral, counterpart equity, and agreements on credit contracts are intended to limit risks during this period.
+ Operational risk is the risk related to operations in the process of implementing a credit loan. Here, errors of credit officers in the process of disbursing and monitoring the credit loan can be the starting point for risks arising from customer ethics. For example, neglecting to monitor after disbursement can cause the borrower to misuse the loan, causing loss of loan money. Ignoring the necessary legal procedures before disbursement can also be the cause of capital misappropriation from the customer.
1.1.3.2. Portfolio risk
Portfolio risk is divided into two types: intrinsic risk and collective risk.
Concentration risk
+ Intrinsic risks arise from factors that are specific to each borrower or economic sector. For example, risk events from natural disasters, crop failures typical of the agricultural sector, or inventory stagnation in the industrial and construction sectors... Because they are closely linked to the subject/object granted credit, intrinsic risks are factors that cannot be eliminated.
+ Concentration risk comes from concentrating capital on a few customers, a few narrow economic sectors, a few types of loans or a geographical area, which goes against the principle of diversification to spread risks. Also because of the presence of intrinsic risks and the inability to eliminate intrinsic risks, diversification to limit and control
Concentration risk control is essential for banks in the credit granting process.
use
1.1.4. Causes of credit risk
1.1.4.1. Credit risks due to objective reasons
Risks due to unstable economic environment
+ The inevitable risks of the financial liberalization and international integration process. The financial liberalization and international integration process can increase bad debt by creating a fiercely competitive environment, causing most businesses and regular customers of banks to face the risk of loss and the harsh selection rules of the market. In addition, the competition of domestic and international commercial banks in the economic integration environment also causes domestic banks with weak management systems to face the risk of increased bad debt because most customers with large financial potential will be attracted by foreign banks.
+ Lack of planning and rational allocation of investment has led to a crisis of excess investment in some industries. This situation can also lead to excessive concentration of credit investment by commercial banks in some “trendy” economic sectors, such as real estate business, securities business… and the inevitable consequence is that credit risk is concentrated in the portfolio of commercial banks.
+ A market economy will inevitably lead to competition, businesses will look for the most profitable industries to invest in and will leave those that do not bring them profits and therefore there is a shift of capital from one industry to another and this is also an objective phenomenon. In developing countries, including Vietnam, competition occurs spontaneously, completely without reasonable planning, cooperation, division of labor, labor specialization, demonstrating the inability of professional associations and macro-regulation of the State.
+ The world economic crisis affects the domestic macroeconomic situation, leading to instability in financial indicators such as high inflation and imbalance.
International balance of payments, unstable exchange rates... can be factors that lead to direct or indirect risks (through customers) for banks.
Risks due to unfavorable legal environment
+ Overlapping and ineffectiveness of the state legal system, weak legal corridor, frequent changes and lack of uniformity, slow law enforcement can be one of the objective causes leading to risks for commercial banks. This is inevitable in underdeveloped or developing countries.
+ Ineffective inspection, examination and supervision activities of the banking supervision agency. This is a factor that has a two-way impact on the operations of commercial banks. On the positive side, if the banking supervision agency operates effectively, it will create a good effect, serving as a remote warning of risks for commercial banks. On the contrary, the inertia and weakness of the banking supervision agency can create a mentality of dependence and lack of initiative among commercial banks in risk prevention, leading to delays in handling risks and very low remedial results.
+ The management and information provision system, supporting the operations of commercial banks are still inadequate. The management policies of the State Bank and agencies related to the operations of the banking system are short-term, formal, and have a coercive orientation rather than scientific in management. This is also a challenge for the banking system in expanding and controlling credit for the economy in the absence of a corresponding information system. If commercial banks try to chase after achievements, expand credit in an asymmetric information environment, it will increase the risk of bad debt for the banking system.
Risks arising from customer credit relationships
+ The borrower's business management ability is weak. When businesses borrow money from banks to expand their business scale, most of them focus their investment capital on physical assets, but few businesses are bold enough to innovate their management style and invest in a business monitoring, finance, and accounting system according to the right standards. The business scale is too large compared to the management mindset, which is the cause of the failure.
bankruptcy of viable business plans that could have been successful in reality.
+ Weak and opaque corporate financial situation: In businesses with small assets and capital, the debt-to-equity ratio is often high, indicating low financial autonomy, so the risk for sponsors such as banks is quite high. In addition, in most underdeveloped countries, the awareness of law compliance is not good, the habit of recording accounting books completely, accurately, and clearly is still not strictly and honestly followed by businesses. Therefore, when assessing the financial situation, banks make financial analyses of businesses based on data provided by businesses, which often lack practicality and authenticity. This is also the reason why banks always consider collateral as the final support to prevent credit risks.
+ Other reasons such as: customers using loan for wrong purposes, business
inefficient business, no goodwill in debt repayment.
1.1.4.2. Credit risks due to subjective causes
Risk groups stem from strategies and policies of commercial banks.
trade
+ Because banks focus too much on profits, placing higher expectations on profits than on the safety of loans, or banks are in a hasty growth phase, chasing sales to increase market share, leading to disregard or lowering of lending standards or conditions, giving rise to many low-quality debts.
+ Due to inappropriate lending strategies, focusing too much credit on a narrow economic sector or industry, or on a group of customers.
+ Due to not thoroughly researching the market and lacking market information, lending policies and target markets are unreasonable, focusing on areas that are not the bank's strengths.
Risk group arising from the operational capacity of the bank
+ Due to not following the credit granting process properly, skipping important steps
leading to uncontrolled risks from the borrower and the loan.