Theoretical Basis of Risk and Credit Risk Management at Commercial Banks

CHAPTER 1: THEORETICAL BASIS OF RISK AND CREDIT RISK MANAGEMENT AT COMMERCIAL BANKS

1.1.1. Concept

Maybe you are interested!

Some different concepts of credit risk are as follows:

According to Thomas P.Fitch: Credit risk is the risk that occurs when a borrower fails to pay its debt according to the contractual agreement, leading to a delay in the debt repayment obligation. Along with interest rate risk, credit risk is one of the main risks in bank lending activities.

According to Hennie van Greuning - Sonja Brajovic Bratanovic: Credit risk is defined as the risk that a borrower will not be able to pay interest or repay the principal within the time specified in the credit contract. This causes problems with the cash flow and affects the liquidity of the Bank.

From the above definitions, we can draw the following basic contents about credit risk: Credit risk is a type of risk that arises in the process of granting credit by the bank, manifested in reality through the customer's inability to repay or repay the debt on time to the bank.

Pursuant to Circular 02/2013/TT-NHNN, dated January 21, 2013, regulating the 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, "Credit risk in the banking operations of a credit institution is the possibility of loss in the banking operations of a credit institution due to customers not performing or not being able to perform their obligations as committed".

Thus, it can be said that credit risk can appear in relationships in which the bank is the creditor, but the debtor does not perform or is not capable of performing the debt payment obligation when due. It occurs in the process of lending, discounting negotiable instruments and valuable papers, financial leasing,

Bank guarantee and factoring. This is also known as default risk and default risk, which is a type of risk related to the quality of a bank's credit operations.

Based on the cause of risk, credit risk is divided into the following types of risk:

Transaction risk: is a form of credit risk that arises due to limitations in the transaction process and loan approval, customer assessment. Transaction risk has 3 main parts: selection risk, guarantee risk and operational risk.

Selection risk : is the risk related to the credit assessment and analysis process, when the bank selects effective loan options to make lending decisions.

Collateral risk : arises from collateral standards such as terms in the loan contract, types of collateral, guarantor, method of collateral and loan level based on the value of collateral.

Operational risk : is the risk associated with loan management and lending activities, including the use of risk rating systems and techniques for handling problem loans.

Portfolio risk: is a form of credit risk that arises due to limitations in managing the bank's loan portfolio, divided into 2 types: intrinsic risk and concentration risk.

Intrinsic risk : comes from factors, unique characteristics, and distinct characteristics within each borrower or economic sector or field. It comes from the characteristics of the borrower's operations or capital usage.

Concentration risk : is the case where a bank concentrates too much lending capital on a number of customers, lends too much to businesses operating in the same industry or economic sector; or in the same certain geographical area; or the same type of high-risk loan.

1.1.2. Causes of credit risk

1.1.2.1. Causes from the customer side

The sad reality is that there are many customers who have very feasible business plans and very favorable business fields. However, when they start to have enough capital to implement the plan, due to limited management capacity and operating experience, they are not able to respond to market fluctuations, leading to business activities not being as effective as planned.

Using loan capital for the wrong purpose: Customers intentionally create fake loan withdrawal documents that the bank cannot detect for many reasons, in order to use the loan capital for purposes other than those stated in the loan plan. Using loan capital for the wrong purpose in many cases is because the borrower is willing to accept risks with the expectation of high profits, but the results are not as expected. There are also cases where customers are unable to repay loans at other banks, and deliberately find ways to borrow capital from this bank and roll over the debt, which is the reason why customers do not have the source of debt repayment to pay the debt on time and in full to the bank.

Credit risks arise from the borrower's poor ability to predict business problems, poor management, intentional bank fraud, and procrastination in paying debts. Many people borrow money from banks to participate in risky projects hoping to earn high profits. To achieve their goals, they are willing to find any means to deal with banks such as providing false information, bribing bank staff, etc. In addition, there are customers who do not carefully calculate the uncertainties that may occur in business, and are unable to adapt and overcome business difficulties.

Many businesses lack the capacity to manage finances and do not have valid collateral, so they are not qualified to secure bank loans. They have created fake documents and data to deceive the bank to get credit. In these cases, if the bank does not detect them, the possibility of credit risk is very high. Borrowers take advantage of the bank's inability to control all of their business activities, so they use

Loans are not for the purposes stated in the credit contract. Thus, the entire appraisal value before the bank lends becomes meaningless and credit risks can occur at any time.

In the remaining cases, the borrower makes a profit in business but still does not repay the bank on time. They delay in the hope of being able to default on the debt, or use the loan as long as possible. This is a manifestation of moral hazard, we can also see that moral hazard leads to credit risk.

1.1.2.2. Subjective causes from the Bank

Loose lending policies and procedures: Credit orientation has not reached strategic level, has not thoroughly followed the market principle of acceptable profit and risk, has been caught up in economic syndrome, following trends, following economic development slogans, finding every way to compete, snatching the market in industries, customer groups without realizing that the bank has no expertise in this field or has not prepared enough potential for this industry.

Credit granting techniques are still poor, not modern and diverse, such as determining credit limits for customers is too simple, the term is not suitable. Credit risk management and post-lending control are not focused on, just a formality.

Lack of information: The bank has not yet built a complete customer data system, and there are no channels to cross-check information. Credit analysis and lending decisions are almost entirely based on information provided by customers and personal relationships.

Poor staff quality, lack of qualifications to evaluate customers or poor evaluation, intentional mistakes... are some of the causes of credit risks in commercial banks. Bank staff have to approach many industries, many subjects, many territories, many countries. Therefore, to make good loans, they must understand customers, the field in which customers do business, the environment in which customers live. They must be able to predict problems related to borrowers... Thus, they must be trained and self-trained thoroughly, continuously and

comprehensive. When credit officers lend to customers who are not qualified to evaluate customers, credit risks always lurk around them. Living in a "money" environment, many employees cannot avoid the temptation of money. They lend to customers who are not qualified to borrow money from the bank, bringing great risks to the bank and even embezzling the bank. Thus, the quality of bank employees, including qualifications and professional ethics, is not guaranteed to be the cause of credit risks. Besides, there is also an aspect where banks show weakness in the management of bank staff, which also causes credit risks. Any bank that is lax in credit risk management will certainly always have to deal with credit risks.

Regulations on credit limits for one customer are not respected. According to the current mechanism, commercial banks only lend to enterprises with the total amount of credit contracts not exceeding 15% of the bank's equity, but many banks violate this. Compliance with the regulations on transferring overdue debt has not been implemented in accordance with the regulations of the State Bank. Some banks, because they are afraid of high overdue debt ratios, do not transfer many loans that should have been transferred to overdue debt, but instead extend the debt many times, roll over the debt, that is, lend new debt to collect old debt. This is really dangerous in terms of monetary business. Therefore, in reality, the overdue debt accounts for a large proportion, but is reflected in the books at a lower rate.

Besides, we cannot deny that credit information is an indispensable and very important factor in credit management. Although there is always asymmetric information in the market, searching for information about bank customers will be a valuable reference source to propose the right measures for credit investment or necessary measures to monitor and manage potential customers. In many cases, the information is not thoroughly investigated, so it is incorrect or incomplete. The phenomenon of a customer borrowing from many banks is quite common, but banks do not know about it because they do not have complete information. Only when it is exposed and the customer is unable to pay, do the banks realize it, and by then it is too late. In fact, in some credit institutions today, the provision of credit information is still limited, while credit operations are

The application requires increasingly high levels of business management, and the competitive environment is increasingly complex and fierce. Full and timely information shortening the appraisal time is also a factor contributing to victory in competition.

Finally, internal control also plays an important role in credit risk management. Neglecting this work means that credit risks occur on a large scale. Internal control is through this work to help staff operate work in accordance with mechanisms, regulations and laws. If internal control is not performed or is not performed regularly and promptly, errors and deviations in credit activities will not be detected in time, so credit risks will occur.

In a market economy, a bank is also a business, so competition between banks to promote the development of banking services is an objective factor. To gain an advantage in competition, many banks lower credit standards to attract customers without paying attention to the efficiency of the loan capital. This is an unhealthy type of competition, it increases risks in credit activities. Many banks even pursue the number of loans as much as possible, focusing on quantity but not on credit quality. On the other hand, there is a point that commercial banks are currently facing: the phenomenon of capital stagnation while not being able to approve loans, or for that reason, many credit officers lend without having time to learn about customers.

1.1.2.3. Objective causes

These causes affect borrowers (customers), making it difficult for them to do business and lose their ability to pay the bank. For example: natural disasters such as storms, floods, droughts, earthquakes, fires, etc., theft, fraud, robbery, etc., causing loss of bank assets. For these risks, banks prevent them by purchasing property insurance, increasing direct protection, and educating bank staff. In addition, we must also mention the causes arising from changes at the macro level, which are beyond the control of banks and customers. It can be said that these causes occur frequently, and both customers and banks can only predict them to prevent them in order to minimize them.

losses, but cannot eliminate them. In the case of banks, customers are not prepared in advance, losses are inevitable, of course including credit risks. A typical example is: an agricultural bank lends money to farmers to develop poultry, but at that time, there is a bird flu epidemic in the locality, the farmer has to destroy the entire poultry flock. Thus, the farmer cannot pay the debt to the bank on time, causing credit risks. Obviously, objective causes originating from the external environment often directly affect the borrower. However, there are also borrowers who, with their own capacity, are able to predict, adapt, or overcome difficulties, and can still repay both principal and interest to the bank.

Natural disasters, fires, wars, epidemics: These are risks that both customers and banks cannot foresee for their credit, customers encounter difficulties that affect their ability to repay bank loans. For customers with strong financial potential, it takes time to stabilize the business process to be able to repay bank loans, and for customers with weak potential, the credit is very likely to fall into bad debt. Although this type of risk can be limited by purchasing insurance, when this type of risk occurs, customers and banks also have to spend a lot of time to get the insurance money from insurance companies to fulfill their obligation to repay bank loans.

1.1.2.4. Other causes

Causes from domestic environment

Economic environment: the economic environment has a strong impact on the banking sector as well as businesses in the economy. When the economy is growing steadily, businesses operate effectively and are able to repay their debts to banks. On the contrary, when the economy falls into a state of instability and recession, businesses face many difficulties in their business operations, production stagnates, purchasing power decreases, and goods are stagnant. This has made businesses operate less effectively and affected their ability to repay their debts to banks. Vietnam is in the process of economic transformation, so it has a strong impact on the economy.

greatly affects the operation of banks. Credit activities must follow market principles, borrowing to lend, interest rates must ensure that costs are covered and business is profitable. Credit must ensure three principles: purpose, security and repayment, but the economic environment has many vestiges of subsidies, of the centralized bureaucratic subsidy mechanism.

Political environment: A stable political environment will create favorable conditions for businesses to develop. On the contrary, if businesses are always in a state of war, economic embargo, political instability, widespread social evils, etc., these are all indirect causes of credit risk.

Legal environment: The State builds a strict and effective legal corridor that will improve economic relations between economic organizations as well as between those organizations and banks. On the contrary, a loose legal system will create many loopholes, causing tricks, fraud and mutual damage, causing damage to banks. However, in reality, in our country, documents related to the operations of commercial banks are still lacking, redundant, overlapping, loopholes and inappropriate. Not creating autonomy for commercial banks and their branches, but also not assigning responsibility to them, easily creating conditions for arbitrary implementation by functional agencies, law enforcement agencies, evasion of responsibility, and procrastination by borrowers. Not suitable with banking practices in the world as well as the market mechanism that Vietnam is transforming into. Low legal effectiveness, slow to correct unreasonable things.

Causes from the international environment: The current trend of regional and world economic integration has a great impact on economic activities. On the one hand, it facilitates economic exchange, increases the country's socio-economic efficiency, but on the other hand, it creates fierce competition. If businesses do not operate effectively, they will immediately go bankrupt and will certainly have a negative impact on banking activities. Economic relations expanding to other countries have created economic constraints, potentially posing systemic risks. The financial and monetary crisis in the region

Comment