Risk is the greatest where the probability of occurrence or non-occurrence is equal. It can be said that the nature of a commercial bank’s activities today is risk acceptance and risk management. Moreover, banks are always forced to face with risk at any economic stage. Specially, risk has a huge effect on not only banks themselves but also the economy. Unfortunately, risk is an inherent objective factor which cannot be eliminated. We are just able use some methods or tools to limit its appearance and lighten the damage caused by it.
Thus, accurate recognition and assessment of risk issues of banks in the right way is really crucial. All of banks have to manage risks because they want their organizations to survive, they want to have an efficient and uninterrupted operation, ability of identifying and achieving acceptable level of risk, earning stability of the banks, continued and sustained growth. In this assignment, risk management is going to be applied to Vietcombank and discussed in detail through mainly two categories: credit risk management and market risk management.
Besides, other issues of risk management such as operational risk, regulatory risk, environmental risk, Basel’s new capital accord and Capital Adequacy Ratio are also referred in brief. 1. 2. Introduction to Vietcombank (VCB) Vietcombank is short for Joint stock commercial Bank for Foreign Trade of Vietnam. Established on April 1st, 1963 as a State-owned Commercial Bank with paid-up capital up to 3,955 billion Vietnamese Dongs, Vietcombank is the largest total asset joint stock commercial bank, the oldest commercial bank for external affairs in Vietnam and one of the third largest banks in Vietnam beside Agribank and BIDV as well.
In addition, Vietcombank is interbank forex payment center for over 100 domestic banks and foreign banks’ branches operating in Vietnam, the first commercial bank in Viet Nam to deal foreign currencies, always takes the largest market share in the interbank forex market, the full member of: Vietnam Bankers Association, Asia Bankers Association, SWIFT, and Visa, MasterCard. Currently, Vietcombank also possessed 58 branches, 1 stock exchange floor, 87 exchange offices and 2 subsidiaries within Vietnam with 6,500 employees.
With great endeavors and efforts, despite difficulties in business environment, Vietcombank still maintained a high and stable growth speed for years. Its credit activities secure good quality banking services have continuously been improved and verified in a bid to effectively meet customers’ needs. Furthermore, risk management system of Vietcombank is also interested to develop. That has contributed a significant part in Vietcombank’s success. Obviously, Vietcombank can be taken as an illustration for risk management in Vietnamese banks.
This essay is going to indicate a few outstanding points of risk management of Vietcombank and put them in Vietnamese banking environment in general. 2. CREDIT RISK (or Default Risk) Credit Risk is the risk that the counterparty will fail to perform or meet the obligation or the agreed terms. Credit Risk is the major component of risk management system and is inherent to the business of lending funds to the operations linked closely to market risk variables. There are two types of credit risk: transaction risk and portfolio risk.
Transaction risk is the risk relating to specific trade transactions, sectors or groups. Portfolio risk is the risk arising from lending to sectors related to the core competencies of the bank/concentrated credits to a particular sector/lending to a few big borrowers. According to R. S. Raghavan’s opinion, there are several useful tools of Credit Risk Management. 1. Exposure Ceiling: Banks regulate their own threshold for each kind of customer or each purpose of borrowing. For example: Bank A has fund B for lending. Bank A divides fund B into some small parts with different portion.
Assuming that individual borrower can borrow 20% from fund B, group or organization customer can borrow 80%; customers investing in estate can be allowed to borrow 30% from fund B, customers intending to buy houses or cars can have 20%, manufacturing businesses can have 40%, etc. Those figures are the maximum amount of money a bank can lend each type of its clients. 2. Review/ Renewal: Multi-tier credit approving authority, constitution wise delegation of powers discriminatory time schedule for review/ renewal, Hurdle rates and Bench marks for fresh exposures and periodicity for renewal based on risk rating, etc. are formulated. . Risk Rating Model: Set up comprehensive risk scoring system on a six to nine point scale. Clearly define rating thresholds and review the ratings periodically preferably at half yearly intervals. Rating migration is to be mapped to estimate the expected loss. 4. Portfolio Management: Using an efficient framework to manage customer portfolios and then preserve the desired portfolio quality and integrate portfolio reviews with credit decision-making process. 5. Risk based scientific pricing: Link loan pricing to expected loss. High-risk category borrowers are to be priced high. Build historical data on default loss.
Allocate capital to absorb the unexpected loss. 6. Loan Review Mechanism: Picking up of warning signals and giving recommendation of corrective action with the objective of improving credit quality. Identify loans with credit weaknesses. Determine adequacy of loan loss provisions. Ensure adherence to lending policies and procedure. Looking at Vietnamese banking business situation, a number of causes leading to Credit Risk can be seen clearly. -Objective risks from country’s conditions and legal environment. -Subjective risks: + From customers: . Use loans for improper purposes . Unwillingness to pay debts . Poor management ability Poor financial situation + From banks: . Loose inspection . Lack of qualification, professional knowledge, and ethics staff . Inadequate supervision and management for loans . Weak cooperation between Vietnamese commercial banks Because banks’ activities are mainly credit activities, Credit Risk is the top problem for banks. Vietcombank is not an exception. This bank has been seriously paying attention to the problem by making a detail Credit Risk Management Policy which is only showed a part as below. -Do not concentrate too much on a client, an industry/field, an organization, a currency or a location. When approving a credit contract, there must be at least 3 people who have authority and responsibility to make final decisions to ensure objectivity. -Specify line of credit (LOC) for each customer -Regulate the maximum exposure ceiling for each brand of the bank -Segmenting for investment -Authority division in credit operation -Improving information system to effectively manage customer portfolio -Propose credit plans. Credit plan is a detail expression of the target credit operation during a year. Objectives of the plan is usually account outstanding at the end of the year, credit growth and detail for each branch f the bank In the circumstance that banking is still in development stages and risk management is still fresh in Vietnam, Vietcombank’s credit risk management policy has not been enough to become perfect but complying with the policy is a significant effort of Vietcombank. At the present, Vietcombank is trying to learn valuable experiences and the good from not only the world’s banking industry but also from domestic banks to gradually reach to the best risk management ability and the most efficient banking operation in the future. 3. MARKET RISK
Beside credit risk, market risk is also a big problem being received a lot of interest from Vietcombank and other Vietnamese banks as well. Market Risk is defined as the risk to a bank’s financial condition that could result from adverse movements in market price. Three types of Market Risk are Liquidity Risk, Interest Rate Risk, and Foreign Exchange Rate. Market Risk Management provides a comprehensive and dynamic frame work for measuring, monitoring and managing liquidity, interest rate, foreign exchange and equity as well as commodity price risk of a bank that needs to be closely integrated with the bank’s business strategy.
As mentioned in the introduction, risks in the banking sector not only have an impact within the industry but also spread to the economy of a country, and of global sometimes. Market risk is like a circle in which its components interact to each other and affect the economy. 3. 1. LIQUIDITY RISK To commercial banks in Vietnam, liquidity risk is one of the most disturbing. Any when money is withdrawn from a bank, the bank has to face liquidity risk. Liquidity refers to the ability of meeting the demand for use of available capital for business operation at all times as deposit payment, loans, payments, capital transactions, etc.
Liquidity Risk is the Risk arising due to the potential for liabilities to drain form the bank faster. When a bank has a low liquidity level, it will get losses, stagnant business activity if in a short time, or will lose the payment ability and go to bankrupt if in a long time. Liquidity Risk comes from many different causes. For example: focusing long-term credit to some big customers or focusing funds on deposits mobilized a large number of customers and when they withdrew suddenly, which can lead to loss of liquidity.
From 2008 to now, the liquidity of the banking system is always a problem that the Government, State Bank of Vietnam (SBV) have been directed attention and warned. To ensure affordability of all time banks must supervise daily funds/ reserves their liquidation. The level of funds/ reserves of each commercial bank is very different, it depends on many factors such as the reputation of banks in the market, and population, policies for rediscount, the refinancing of banks; credit quality, etc. 3. 2. INTEREST RATE RISK Interest rate risk is the risk arising from fluctuation of interest rate.
When discussing to the interest rate, four types of interest rate should be mentioned: floating interest rate, fixed interest rate; savings interest rate and credit interest rate. In reality, if there is any risk for all of these types, the customers who deposit or borrow will suffer more than banks. According to a Vietnamese electronic newspaper ‘dantri. com’, the article ‘Long-lasting Interest Rate and Foreign Exchange Rate Risk: How do enterprises react? ’ posting on August 17, 2011, in average, 80% of the capital of a business is bank credit.
Therefore, interest rate risk will have a large effect on personal investments or operation activities of firms. Taking the two first kinds of interest rate as examples. Floating interest rate is “an interest rate that is allowed to move up and down with the rest of the market or along with an index”. Fixed interest rate is “the interest rate of a debt obligation stays constant for the duration of the agreement”. (investopedia. com). Floating interest rate goes up or down depending on the market, so in the countries having developed economy, this interest rate is often stable and quite low.
But recently in Vietnam, floating interest rate has been quite intermittent and tended to increase. So if a company has a loan with floating interest rates, the increase in payments for the bank is unavoidable. It seems like fixed interest rate is safer. For example: assuming that company A signs a contract with a bank, borrows 100,000,000 VND with fixed interest rate of 24% in four years. It means that in four years that company only needs to pay 24% interest each year even though interest rate in the market much increases.
But that cannot be firmed because the reason why interest rate in Vietnam has been continuously increasing relates to the recent inflation. If inflation is decrease, the economy is back to normal, and then the rate for lending of banks will decline. If company A has a long-term loans with the high fixed interest rates like that, A will have to pay the interest higher than the interest informed in the market at that time after Vietnamese government controls inflation situation. This is the risk cannot be accurately calculated in advance.
However, signing contracts with interest rate conditions with banks after considering the market situation can help businesses better manage the occurring risks arising and have a guarantee for operation of the businesses. Vietcombank provide lending services with the interest rate regulated by the laws of Socialist Republic of Vietnam. Savings interest rate and credit interest rate will be discussed in part 3. 4 – the relationship between market risks and the economy in Vietnam 3. 4. 3. 3. FOREIGN EXCHANGE RATE Foreign exchange rate constantly changes.
Foreign currency trading always has lots of potential risks. These risks may arise when banks make transactions of foreign currencies in order to serve their customers or themselves. Hence, both banks and their customers are affected by this type of risk. In Vietnam, the following objects need the transactions related to foreign exchange rate: individuals have needs for change currency for personal purposes, foreign enterprises come to Vietnam to invest, the banks have needs for exchange or trading and import-export businesses. In particular, forex risk affects import businesses most.
In the latest new in ‘Vietnam news’ e-newspaper on August 25, 2011: “According to the office’s preliminary statistics, export turnover in August decreased by 10. 9 percent over the previous month to US$8. 3 billion. In contrast, imports rose 10. 7 percent to US$9. 1 billion. ” Vietnam is a deficit country. Import companies usually imports a large amount of goods, pays for the suppliers by foreign currencies, receives VND after selling those goods. If the rate between our currency and other countries’ currencies is big like USD or EU and VND, risk is very huge and clear. 3. 4.
Relationship between liquidity, interest rate and foreign exchange rate and the economy in Vietnam The liquidity of Vietnamese banking market Vietnam is very low. The reason is that Vietnam is a developing country with the limited amount of cash. Currently, banks are lack of money for lending. They have been increasing interest rate to increase the liquidity because of the lack of capital. In particular, although Circular 02/2011/TT-NHNN on 3/3/2011, Vietnamese government clearly stipulated that 14% per year is the maximum of savings interest rate, in fact, banks are trying to push that figure up to 18% (19% somewhere) to attract depositors.
However, credit interest rate has to go up also as a certain consequence. This leads to borrowing ability and the quantity of borrowers decrease because the borrowers have to take to account the relationship between the interest rate given by banks and the profit they expect to earn. As a result, the amount of money which banks can pay back to their depositors will decline, and then the liquidity of the banks will gradually go down too and lastly, the banks will go bankrupt. Vietnam is in high inflation period now, economists offer a solution to control inflation which is raising interest rate of banks.
If do so, an amount of money from market will be attracted to banks and the government can manage it. This amount of attracted money will increase the value of Vietnam Dong. Thereby, foreign exchange rate will be more stable. In particular, the gap between VND and strong foreign currencies will be shorter. Anyway, it can be seen clearly that the solution being used by Vietnamese banking industry is a two-bladed sword, too dangerous, but Vietnam still have to use it with the hope of curbing country’s inflation, make interest rate level lower and gradually stabilize in the near future. . OTHER ISSUES 4. 1 OPERATIONAL RISK Operational risk arises from failure of operating system in the bank, especially breakdown in internal control due to certain reasons like fraudulent activities, natural disaster, human error, omission or sabotage etc. This is the problem which not only Vietnamese banks but also banks around the world have to face to. To Vietcombank, well training its staff, closely monitoring activities within the bank and always place a reserve fund for unforeseen disaster are visible actions for the effort to manage and control operational risks. . 2 POLITICAL RISK In general, Political Risk is the risk arises due to introductions of service tax or increase in income tax, freezing the assets of the bank by the legal authority etc. In Vietnam, beside the changes of tax, there are many risks existing in the legal environment such as: local law enforcement agencies perform inefficiently; The State Bank of Vietnam inspects and supervises banks’ activities ineffectively; information systems are insufficient. 4. 3. ENVIRONMENTAL RISK Rapid and unpredictable change of the world market – Certain risk of financial liberalization process and international integration – The massive onslaught of smuggled goods – Lack of reasonable planning, investment allocation cause investment overproduction in some sectors All those things are objective risks which have a big impact on the operation of each single bank and the whole Vietnamese banking as well. Banking industry cannot manage these risks by itself. It needs help from the government and the people. 5. CONCLUSION
Besides all of things mentioned above, Vietcombank and other Vietnamese banks have to cope with many another risks such as: system risk, human risk, or technology risk and so on. There are so many unpredictable changes which can occur in the business of an enterprise. Therefore, Risk Management is an extremely hard work but every business, not only banks, has to do. However, good risk management is not only a source of competitive advantage and a tool to create value, but also contributes to the business strategy more effectively.
If a business is aware of the importance of risk management and try to do it, the business will have the ability to stand still and develop regardless how the world changes. Vietcombank has been a bank like that. Aware of its weaknesses not only in risk management, attempt to overcome difficulties and constantly learn good experience and knowledge, Vietcombank grows day by day and strongly develops. In fact, as stated in part 4. – Political risk, Vietnam has not had a mechanism of full disclosure of businesses and banks’ information in Vietnam. In addition, Vietnamese banks rarely public their operational information voluntarily, fully and clearly. Therefore, finding information is a really hard work. The amount of information about Vietcombank which our group found out is still insufficient to illustrate the risk management topic though Vietcombank is Vietnam’s leading bank.
However, this assignment is done with the desire to provide a certain perspective on risk management in Vietnam banking environment through vietcombank as an example. 6. REFERENCES Risk management in banks article – r. s. raghavan Handbook for credit of VCB – Document for internal circulation in Vietnamese http://dantri. com. vn/c76/s76-508714/rui-ro-lai-suat-va-ty-gia-keo-dai-doanh-nghiep-ung-pho-ra-sao. htm http://www. investopedia. com/terms/f/floatinginterestrate. asp#axzz1X0bD5iLh http://vietnambusiness. asia/trade-deficit-falls-back-in-august/