The Content Of Risks Management In Business Of Commercial Banks According To The Basel Accord

1.2.2. The content of risks management in business of commercial banks according to the Basel Accord

Activities of a bank are usually funded from two sources, loans or equity. Bank loans (including deposits) are the liabilities that if would not be paid on time, it could push the bank into the repay inability status. In contrast, the owner's investment may be profit or loss but do not push banks into the inability to pay debts as above. So, in terms of other factors equal, the proportion of a bank's activities are funded by greater equity, the bank will be able to continue to pay debts in the difficult economic period.

This argument forms the basis for the banking supervisory experts evaluate capital adequacy ratio as a basic element determining the safety and effectiveness of the bank. The bank which often maintain sufficient capital and capital is added from a higher result, is a stable, healthy and effective bank. The undercapitalized banks with low net worth will be easily to fragile when faced with risks or changes of the business environment. With the above arguments, the main content of the Basel Accord in 1988 focused on the regulations on capital as well as system risk ratio for each type of banks’ assets. The Basel Committee believed that these provisions were useful framework for banks in activities of risks managing and monitoring, at the same time as the basis for banks to issue policies, procedures and practices of risk management in banking activities.

Basel I consists of 3 parts: Part 1 talks about the elements that constitute the capital; Part 2 refers to the systematic risk proportion and Section 3 discusses the target capital ratio.

Basel II is structured, including three pillars: (1) minimum capital requirements, is an extension of the standardized rules set out in the Treaty of 1988, (2) Supervisory process on safety capital ratios and internal assessment process, and (3) The application of market principles to encourage the disclosure of information as well as perform safe banking business practices.

Basel II requires banks to maintain a large amount of capital enough to cover their risky activities, including credit risk, market risk and operational

risk.. Accordingly, Basel II provides a capital ratio, the numerator is the bank's own capital and a denominator is assets at risk (measure risks in banking activities). Minimum capital ratio prescribed in Basel II is 8%.

Basel II refers to three types of risks in banking activities. In addition to credit risk and market risk have been defined in the 1988 Treaty of capital, Basel II adds a further risk is operational risk.

Second pillar based on a series of detailed instructions, which clearly states the need for banks to assess the capital in relation to their general risk level, and on the inspection agencies, supervisors must review the results of this assessment and have the appropriate measures in case of necessity. The purpose of this is not only to ensure banks have enough capital to cover risks in the business, but also to encourage banks to build and apply risk management techniques better.

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The purpose of the third pillar "market principles" in the new treaty is intended to complement the minimum capital requirements in the first pillar and the role of head of inspection agencies in the second pillar. An important characteristic of the new Treaty of capital is that banks are given more autonomy authorities in determining their capital requirements based on internal assessment system. Therefore, market discipline in the third pillar of the new treaty will help the market participants can have better conditions to evaluate information on the level of risk and size of bank’s capital, thereby creating conditions for banks and inspection agencies manage risk more efficient, further improving the stability of individual banks in particular and the banking system in general.

Basel III revises and adds some contents to Basel II. As a whole, Basel III strengthens capital requirements of banks and introduces new regulations on the banking liquidity and banking leverage. The standard capital and new capital buffers will require banks hold more capital and have higher quality capital than the capital under the current provisions of Basel II. Basel III provides some new regulations on the rate of ordinary shares, preserve capital reserves, reserves for counter-cyclical, the stable liquidity ratio and the stabilization reserve rate.

Member countries will start implementing roadmap convert the new capital standards on 01/01/2013, means that these countries will have to convert the above standards into national law or regulation before the 01/01/2013, and Basel III also provides a specific schedule for implementation of capital requirements under Basel III.

1.3. The situation of application the Basel Accord in commercial banks of some countries in the world

According to the Basel Committee, Basel I has been applied in over 100 countries and is known as the standards on commercial banks’ safety operation monitoring and supervisory by world banking industry.

Among the member countries of the Basel Committee, with participation in the construction of the Basel II content, these countries had indirectly admitted responsibility and commitment to apply Basel II, although some countries only committed partially applied. The countries of the European Union (EU) applied the regulations on safe minimum capital in Basel II under the new law which launched by the European Commission (EC).

Based on the practical application of the Basel II on risk management in several countries around the world, the author draws some specific lessons in applying Basel. International experience shows readiness to apply the Basel and Basel II in particular depends on a number of factors such as:

(i) Status of banks’risks management system;

(ii) Expected costs/benefits;

(iii) Pressure level of central banks;

(iv) The rival banks’ preparation of Basel implementation.

Under central bank’s perspective, the factors will be considered when preparing to appy the new accord including:

(i) The nation priorities;

(ii) Readiness level of the legal framework and management;

(iii) Accounting standards;

(iv) Human resources and professional team;

(v) Soundness of coporate governance;

(vi) Market discipline;

(vii) The presence and level of reliability of the credit rating companies;

(viii) Equality playing issues.

CHAPTER 2: SITUATION OF VIETNAMESE COMMERCIAL BANKS’ RISK MANAGEMENT IN BUSINESS

2.1. Overview of Vietnamese commercial banking system

Vietnamese commercial banking systerm has formed and developed since 1990, now become an extensive network. Operation mechanism: two levels in which the State Bank manages all aspects related to banking activities. According to the State Bank’s data, until June 2011, there were 53 banks, including 5 state banks, 1 social policy bank, 37 private joint sotck commercial banks, 5 joint venture banks, 5 banks with 100% foreign owned, 48 foreign bank branches in Vietnam and 48 representative offices of foreign banks. Until now, there has been 3 of 5 state banks equitized, including Vietcombank, Vietinbank and BIDV, but the Sate still owns the large shares. Therefore, the author arranged three banks above into group of state commercial banks.

Among the financial institutions mentioned above, 5 state commercial banks accounted for nearly 60% market share overall banking services with the dense network of branches, transaction offices, automated teller machines, credit card payment machines,… nationwide.

About the operational capacity of Vietnamese commercial banking system:

- Capital raising: capital raising activities of credit institution system has increasing growth rate per month and the whole 2011, the capital raising growth rate was higher than credit growth rate. Compared to passed years, the proportion of state banks’ capital raising have tended to decrease from about

80% in the early 2000s, to now only account for nearly 45%. One of the causes of the decline in the market share is the rise of joint stock commercial bank system. The joint-stock commercial banks create a relative competitive advantage by improving service quality, diversifing the types of products and services, improving the financial capacity and in particular to increasing interest rate higher.

- Credit plays an important role in the monetary circulation of the economy. In pass ten years, Vietnam has an average credit growth rate in high group of the world, approximately 32%, higher than GDP growth rate of the same period.

- Total payment: total payment (M2) has increased continuously over months in accordance with changes in growth of credit and capital raising. According to the banking operation report issued in December 2011 by the State Bank, total payment to the date of 21st December 2011 increased 9.27% compared to the end of 2010, with the target set by Resolution 11 was 15-16%, in which cash circulating outside the banking system rose 5.49%.

- Earning growth rate: the average earning growth rate in 2008 reached 26%, in 2009 reached 47%, in 2010 reached over 25% and in 2011 reached

about 35%.

2.2. The situation of Vietnamese commercial banks’ risk management in business according to Basel Accord

In recent years, Vietnamese commercial banks have make attetion to risk management activities as part of business strategy in order to increase the level of operation safety and promote competitive advantage, by investing in technology to meet the standards of risk management. A lot of banks has found solutions in risk management through the foreign consultant units such as McKinsey, Deloitte, Ernst&Young,… However, in general, risk management model of Vietnamese comercial banking system has not same sets, individual nature and not really effective.

2.2.1. The situation of Vietnames commercial banks’ capital management under Basel Accord

The rate of minimum capital adequacy (capital adequacy ratio) to ensure that banking operation was safe under the first pillar of Basel Accord is calculated as follows:

CAR = (Tier 1 capital + Tier 2 capital)/ Risk weighted assets

With this approach, to evaluate the situation of capital management in Vietnamese commercial banks compared with the Basel formula, Thesis evaluates, reviews each factor of formula above including equity capital and other risks affect to asset quality of commercial banks in Vietnam.

The State Bank of Vietnam has issued several documents providing the equity capital as 457/2005/QD-NHNN Decision which regulated on safety ratios in credit institutions’ operation, 13/TT-NHNN Circular which regulated on safety ratios in credit institutions’ operation, 19/TT-NHNN Circular, 22/2011/TT-NHNN Circular, 33/2011/TT-NHNN which modified some contents of Circular 13.

- About the own capital situation:

Group of state commercial banks: at the time of the year 2000, the bad debt situation was too high, might lead to the bankruptcy of the state commercial banks, the state commercial banks built Restructuring Program which is concentrated on improving finanical situation by increasing own capital scale and handling bad loans. After funding by the Government, total equity of five banks increased to more than 18,000 billion VND in total equity of the entire Vietnamese commercial bank system was 35,000 billion VND (counted for 51%).

Group of stock commercial banks: from 2000 until now, the joint-stock commercial banks has better performance and could increased capital themselves. In addition, joint-stock commercial banks also constantly replenished their own capital through issuing shares, leading to rapidly

increasing equity over the years, contributing significantly enhance safety operational ratio of joint-stock commercial banks.

The capital of Vietnamese commercial banks at present has improved but is still lower a lot compared to the capital of an average foreign bank or financial group. The charter capital is limitted will cause a lot of difficulties in supplying investment capital, particularly for large projects. Moreover, Vietnam is in the integration process, especially Vietnam officially joined the World Trade Organization (WTO), the competiors which are foreign banks with a strong influx of capital, the capital scale of Vietnamese commercial banks certainly have to increase further to ensure either safety opreation ratio or business expansion ability, in order to meet the new requirements from the market.

- About the risk management:

Credit risk: Among the business activities of comercial banks, credit is the primarily activity but high risk. The efficiency achieved is not match the actual risk level has continued to be the reasons threat to the operation of commercial banks. According to the report of the State Bank of Vietnam, total outstanding loans of banking system at 31st December 2011 was about

3.120.000 billion VND, in which the bad debt ratio is about 3.6%. However, according to Fitch – one of three the most prestigious financial assessment institution in the world, the real debt quality of Vietnamese banks remain weak, the result of lax accounting standards compared to international IFRS standards. If the loan was rigorously classified to IFRS standards, the banks’capacity to meet new capital requirements will become more difficult.

The commercial banks made a number of measures to control credit risk, such as: promulgating and reoranizing new documents to manage credit risk better; bulding and applying credit scoring system; classifying debt; risk provisioning; setting secure credit limit and the maximum credit limit for customers and strategic business factor.

Market risk: in the case of Vietnam, besides the provisions on foreign exchange transactions, Vietnam has not yet issued regulations on risk market as

stocks, futures, options contract and the derivative. It is noted that Vietnam has not applied the Basel Accord’s principles on adjusting minimum capital adequacy ratio for market risk because market risk in Vietnam has not yet played a critical role in banking risk of credit institutions. Besides, the experience and skills of banking supervision on market risk and derivative products are also limited.

Operational risk: the Vietnamese commercial banks are not aware of all types of operational risk, therefore, there is not a bank which has appropriate and redundant provision for this risk type. However, it can be stated that operational risk for Vietnamese commercial banking system is now very high, especially when the fiancial currencies banking market is in the process of international economic integration. Operational risk can be transferred directly to a serious loss, even in some cases to shake the entire financial and monetary system of the country.

Liquidty risk: Liquidity risk management activities in Vietnamese commercial banks are stills weak due to the objective and subjective reasons. Currently, some banks have adopted capital transfer valuation tool FTP which helps to control interest rate risk and liquidity risk efficiently.

Bottom line: It can be seen that the Vietnamese commercial banks have made great efforts in raising equity capital and most stock commercial banks have achieved capital adequacy ratio (CAR) of 8%, but if compared to the calculation of the safety factor of Basel including market risk, there is very few commercial banks in Vietnam achieved the capital adequacy ratio above 8%.

2.2.2. The situation of inspections, monitoring and compliance with legal provisions of Vietnam banking system according to Basel Accord

Currently, the State Bank of Vietnam has set up an inspection and supervision organization structure fairly as distributed functional model. The supervision function does not focus on one department. It is scattered and taken by the different department of the Vietnam State Bank. Supervisory method in banking is compliance inspections method. This method is limited and not suitable with the currently development situation.