Academy of finance
Thesis

Graduation

TABLE OF CONTENTS
ACKNOWLEDGEMENT …………
ABSTRACT
LIST OF ABBREVIATIONS
LIST OF FIGURES AND TABLES
INTRODUCTION
1. Rationale...................................................................................................
2. Aims of the study......................................................................................
3. Scope of the study.....................................................................................
4. Methodology.............................................................................................
5. Structure of the study................................................................................
DEVELOPMENT
CHAPTER 1 : LITERATURE REVIEW
THEORETICAL BACKGROUND OF CREDIT RISKS IN CERDIT
INSTITUTIONS’ACTIVITIES
1.1. THE CREDIT ACTIVITIES OF CREDIT INSTITUTIONS....................
1.1.1. The concept of credit.........................................................................
1.1.1. The role of credit................................................................................
1.1.1. Types of credit....................................................................................
1.2. CREDIT RISKS IN CREDIT INSTITUTIONS’ ACTIVITIES................
1.2.1. What is risk?......................................................................................
1.2.2. Viewpoints on credit risk...................................................................
1.2.3. Types of credit risk.............................................................................
1.2.4. Causes of credit risks.........................................................................
1.2.5. Criteria for evaluating credit risks......................................................
1.2.6. The impact of credit risks on credit institutions’ activities................

2.5.1.3 Risk provisions ratio......................................................................
2.5.2 Evaluating the management of credit risks at central people’s credit
fund Hatay Branch.......................................................................................
2.5.2.1 Achievements.................................................................................
2.5.2.2 Weaknesses....................................................................................
2.5.2.3 Reasons for the CCF Hatay branch’s weaknesses.........................
2.6. DATA ANALYSIS AND FINDINGS........................................................
CHAPTER 3: IMPLICATION/RECOMMENDATIONS
3.1. ORIENTATIONS FOR CREDIT ACTIVITIES AT CENTRAL
PEOPLE’S CREDIT FUND – HA TAY BRANCH IN THE NEAR
FUTURE.........................................................................................................
3.1.1 Orientation for developing credit products and services.....................
3.1.2 Targets for the year 2011.....................................................................
3.2. SOLUTIONS TO MINIMIZE CREDIT RISK AT CENTRAL
PEOPLE’S CREDIT FUND – HA TAY BRANCH.....................................
3.2.1 Improving the quality of researches and analyzes of customers..........
3.2.2 Collecting adequate information on customers...................................
3.2.3 Tightening supervision over credits....................................................
3.2.4 Enhancing the quality of human resource...........................................
3.2.5 Diversifying credit portfolio...............................................................
3.2.6 Using appropriately credit assessment models....................................
3.2.7 Obeying Basel Committee’s principles...............................................
3.3. IMPLICATIONS.....................................................................................
3.2.1 Implications to the government and related sectors............................
3.2.2 Implications to the State Bank of Vietnam.........................................
2.2.3 Implications to CCF Hatay branch...................................................
CONCLUSION......................................................................................
Summary of the study......................................................................................
Suggestions for further study...........................................................................
REFERENCES

unfavorable events. This is dangerous when Vietnamese banks’ customer services
are still in their infancy and banks’ revenue depends heavily on lending activities
and credit growth is central to any bank’s profit. In addition, the control work
from the central bank, though playing a growing role, has not been protective
enough. Access to credit information and history is very limited. Thus, small
banks and credit funds are facing the big question of establishing a strong credit
risk management framework in order to maximize their profits and to gain
competitive advantage over their rivalries. Central people credit fund (CCF) - a
joint stock credit institution which is supervised by SBV is not an exception..
CFF provides financial services to LCFs and the general public, including SMEs,
farmers and CCF staff. Thus, its operation has all specific characteristics of an
commercial bank, especially in potential credit risk. This is where the research
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problem for this thesis arises. Instead of analyzing other credit institutions that
have quite more comprehensive risk management framework, the researcher is
far more worried about the practices in central people’s credit fund Hatay branch
which are still weak and less competitive in banking market . What could they
have done in order to prevent or at least lessen the bad impact of credit risks
happening?
In brief, all of the facts mentioned above have encouraged me to direct my study


Because of the limitation of the writer’s knowledge, experience and time, this
study only focuses on the management of credit risks in short, medium and long
term loans at CCF Hatay branch from 2008 to 2010
5. Organization of the study
Besides an Introduction giving a brief description of the research including the
reason for choosing topic, scope, aims and methods of the study and a
Conclusion which summarizes the main points of the study and gives suggestion
for further study, this thesis was divided into three main chapters:
Chapter 1 : Literature review providing a theoretical background of credit risks in
financial institutions’ activities
Chapter 2 : Method methodology showing the method used to evaluate the
practice of managing credit risk at CCF Hatay branch
Chapter 3 : Implication/ Recommendations suggesting some solutions to
minimize credit risks at the CCF Hatay branch.

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CHAPTER 1 : LITERATURE REVIEW
THEORETICAL BACKGROUND OF CREDIT RISKS IN CERDIT
INSTITUTIONS’ ACTIVITIES


Graduation

In order to manage and control a large scale of credit, credit is often classified
into different groups according to various criteria.
1.1.2.1 Time of credit
a. Short-term credit: is a type of credit which is advanced for a year or less with
an agreement that they will be repaired in one payment at the end of the period.
b. Medium and long-term credits: are those with maturities longer than one year.
Evidence of the transaction is the promissory note, either secured or unsecured.
Usually, such credits are repaid at specified intervals mutually agreed on by the
lender and borrower.
1.1.2.2 Subjects involving in credit activities
a. Private credit: is credit used by individuals and businesses in order to carry
on exchanges in the private sector of the economy.
Private credit includes:
-

Consumer credit: is the use of credit as a medium of exchange for
the purchase of finished goods and services by the ultimate user

-

Business credit: describes the credit relationship involved in
purchasing goods, raw materials, and inventory for resale, or obtaining
funds to start, maintain, and operate business activities, using credit as a
medium of exchange

b. Public credit: is credit extended or used directly by a government agency to
finance the goods, services, and welfare programs it offers to citizens.

expenses as purchasing inventories, paying taxes, and meeting payrolls.
e. Credits to individuals: include credit to finance the purchase of automobiles,
appliances, and other retail goods to repair or modernize homes, cover the cost of
medical care and other personal expenses, either extended directly to individuals
or indirectly through retailed dealers.
1.2 CREDIT RISKS IN CREDIT INSTITUTIONS’ ACTIVITIES
1.2.1 What is risk?
1.2.1.1 Definition
The economists define risk in many different ways, but all agreed that risk is
uncertainty or unreliability about the result in the future.
IN the financial world, credit institutions have to face a various range of risks.
Indeed, it is believed that the main business of each banking institution is to
manage these risks.
Some of the major risks that bankers are concerned with are credit risk,
operational risk, liquidity risk and legal risk, which are discussed below.
1.2.1.2 Types of risks of credit institutions
a. Credit risk

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“Credit risk is most simply defined as the potential that a bank borrower or

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1.2.2 Viewpoints on credit risk
Financial institutions’ credit capital often involves in all economic periods,
therefore, danger that are exposed to the economy as a whole are believed to be
the dangers to credit institutions as well. Although each bank has different
considerations for credit risk management, it is hardly denied that credit risk is an
inherent part of banking activities.
In addition to the above mentioned definition, credit risk also refers to the risk of
financial losses due to unexpected changes in the credit standard of debtors and
counterparty in a financial agreement. It occurs as an obstacle that prevents
businesses from increasing profits.
Heffernan ( 2005) has shown that “ credit risk comprises the possibility which as
asset or a loan is irrecoverable in the case of default, or the risk of delay in
repayment of the loan:. It is often the case in the business of lending that a
borrower knows more about its solvency than the lender, therefore, the financial
institution is being at an informational disadvantage. The lender may seek out its
solution by setting a credit line, rather than permitting the borrowers to access
their own loan size without any restriction. However, the quantitative exposure
limits company’s competitiveness in the market. For example, reducing a credit
line might make the volume of clients decrease and thereby gains lower profit.
Contrary to it, extended credit may lead to higher risk.
Some bankers argued that credit risk is mainly associated with the risk in
assessment process. For example, if a customer is unwilling to provide the bank

institution can only bank probabilistic assessments of the likelihood of default.
The loss suffered by a credit institution in the event of a customer; default is
usually significant and is determined largely by the details of the particular
contract or obligation.
 Excessive capital risk:
Excessive capital risk arises when a bank is able to mobilize a large amount of
capital from the public but there is not enough demand for loans from its
customers. In this case, there will probably be a growing imbalance between the
amount of capital and capital utilization. As a result, earnings from the loans’
interest can not compensate for bank’s operational costs and payments for
interest of customers’ deposits
 Capital shortage risk:
Contrary to the excessive capital risk, capital shortage risk occurs when a bank
is undercapitalized, which may lead to the loss of making payment ability. On the
one hand, the bank can not offer a wide range of credits. On the other hand, it has
to ask for capital from external sources with such a higher interest rate than that
of its own loans.
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1.2.4. Causes of credit risks
Commercial banks are still aware of their shortcomings and mismatches in the

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that providing unsuitable credit products for the local customers can also put
banks at risk.
1.2.4.2 Subjective causes
a. From borrowing customers
The level of credit risk may vary depending on different types of borrowers. In
the case of individual customers, there are a wide range of reasons why they are
unable to service their debts. For example, the borrower loses his/her job and
then has no financial resource to pay off a debt, or the debtor has to face
unpredictable problems such as an accident, service illness and other health
problems. A customer’s delinquency can also result from his/her failure in
managing personal finance or using the lending fund properly.
In the case of corporate customers, causes for a bank’s credit risk are more
complicated. In running their business, these enterprise clients usually have to
encounter serious financial difficulties which take root from the nature of supply
and demand. For instance, when the price of raw material goes up, a
manufacturer will have to run the risk of either higher operation cost or lower
profit rate. Besides, if the supply of material in the market is inadequate, the
company will hardly meet the demand for products of consumers as well as
satisfy the ordered amount according to its business contracts. This will
consequently effect the company’s reputation and competitiveness. In addition,
an enterprise may have to deal with other non-financial problems, such as weak
management skill of its directors, depression of the economy as a whole, and

In addition, staffs’ immorality and disobedience to banking principles often lead
to negative consequences to commercial bank.
1.2.5 Criteria for evaluating credit risks
1.2.5.1 Banking criteria
The ultimate goal of credit risks management is to minimize potential credit
risks at an acceptable level to the bank. In order to assess risks properly,
commercial banks must have to the ability to measure risks. there are often
helpful ratios used to measure credit risks.
a. Overdue debt ratio
Overdue debt ratio =

Total overdue debt
Total oustanding debts

Overdue debts are debts of which part or the whole principle and interest are
overdue. Indeed, the higher this overdue debt ratio is the greater credit risks a
bank has to face. In this case, the bank may suffer from increasing cost of
supervising and controlling debt collection, and more importantly, the loss of
other loans to customers who have better payment ability.
b. Bad debt ratio

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particularly the probability of default of the borrower. One of the most commonly
used is the liner discriminant model which is known as a part of Z – credit
scoring models. The model will help risk managers either calculate a “ score”
representing the borrower’s probability of default or sort those into different
default risk classes..
a. Linear discriminant model – “ Z – credit scoring model”
In order to employ this scoring model, the banker must identify objective
economic and financial measures of risk for any particular class of borrowers.
For customer debt, the objective characteristics may include income, assets, age,
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and occupation. For commercial debt, cash flow information and financial ratios,
such as the debt to total assets ratio which measures the percentage of the firm’s
assets that are financed with debt and total asset turnover ratio which measures
how efficiently a firm utilizes its assets, are usually key factors.
The discriminant model divides borrowers into high or low default risks classes
depending on their observed characteristics ( Xj).
The following example considers the discriminant model developed by E. I.
Altman for publicly traded manufacturing firms in the Unites States. The
indicator variable Z measures the default risk classification of a commercial
borrower as a whole. This is contingent on the values of various financial ratios

Graduation

constant variables estimated in the model are no always the same due to changing
real financial conditions of borrower as well as the economy. In addition, the
model has ignored important, hard-to-quantify factors, such as reputation of the
borrower and long-term relationships between banks and their debtors, which
may play a crucial role in the default or no default decision.
b. The policy on customer rating of CCF
Besides linear discriminant model, there are also various methods for
commercial banks to estimate or “ score” their customers’ creditworthiness. A
specific example of those methods is the CCF's policy on customer rating.
From December 1st 2006, all of the branches and transaction departments of CCF,
including Hatay branch, have followed this customer rating policy in order to
implement diversified customer policies adapted to a variety range of clients of
CCF. The policy based on 60 criteria including financial and non-financial ones.
Financial criteria contain:
- Profitability ratios which comprise of gross Profit Margin, Operating Profit
Margin, Net Profit Margin, Return on Assets and Return on Equity measure
how a firm’s returns compare to its sales, asset investments, and equity.
- Liquidity ratios which consist of Current ratio and Quick Ratio measure the
ability of the borrower to meet its short-term obligations.
- Asset activity ratios which include Inventory Turnover ratio and Total Asset
Turnover measure how efficiently a company uses its assets.
- Debt ratios include debt to total Assets ratio, Debt to Equity ratio and EBIT /
Interest expense ratio.
- Besides, there are also several non- financial criteria including:
- Management expertise, professional knowledge and experience of the board of
directors who involve directly in day-to-day activity of a company.
- Human resources of the firm; its vision and business strategies in the five-year
period; its average growth rate during the past 3 years.


2
3

AA
A

ability to pay off their debts is extremely reliable.
Customers rated AA are also very reliable
Customers rated A are more susceptible to negative impacts
of external factors and economic conditions than the AAA
and AA ones, but their ability to pay off debts is still highly

4

BBB

evaluated.
BBB-rated-customers have adequate conditions to pay back
all debts. However, economic and external changes have

5

BB

more influence on the customer’s ability to fix their debts.
Caution is necessary for this group of customers. Although
they are not likely to run the risk of default like those from B
to D group, they are facing potential risks which affect their


Thesis

9

C

Graduation

default.
C-rated-customers have close to or already declared
bankruptcy, but their payment on the financial obligations is

10

D

currently continued.
This is the worst group in which customers actually face a
default.

Being on the status of customers from the above rating system, CCF has
implemented five main groups of customer policy.
A wide range of policies is developed which is suitable for each group of
customers. The ultimate goal of adopting these policies is to minimize credit
risks in the most effective way.
1.2.6 The impact of credit risks on banking activities
It is widely known that profit and risk are parallel factors in any business
activities, particularly in trading currencies. Business entities which can earn a
huge profit, such as commercial bank and credit institutions, in turn have to take
considerable credit risks.

When the level of credit risks dramatically increase beyond the bank’ s
expectation, a threat of bankruptcy is unavoidable.
1.3 SOME EXAMPLES OF GOVERNMENT REGULATIONS IN
CONTROLLING RISKS OF CREDIT INSTITUTIONS
Regulatory policies play a fairly important role in reducing risks and
enhancing risk management operation. Vietnam is not a member of the Basel
Committee on Bank Supervision and therefore, has not adopted Basel Accords
yet. However, the State Bank of Vietnam is trying to issue policies that require
the banks to direct their operations more and more closely to international
standards. Indeed, Vietnamese bank are doing their best in that direction.
For the scope of this thesis, there is not enough time to mention all policies but
only to analyze the most basic ones.
1.3.1. Provision on lending by credit institutions
On 31.12.2001, the Vietnamese central bank issued the Decision No.
1627/2001/QD-NHNN on the provision lending by credit institutions to clients
Recently, Circular No. 13/2010/TT-NHNN dated 20.05.2010

revised the

regulations on lending activities:
 Loan interest rate:
This interest is agreed between the credit maker and its customer in accordance
with regulations of the SBV. Importantly, the interest rate for overdue debts must

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lending decisions.
1.3.2. Regulations on Classification of Debts and Loss provision

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The rules concerning debt classification and loan loss reserve are covered by
the Decision No. 493/2005/QD-NHNN dated 22.04.2005 and Decision No.
18/2007/QD-NHNN issued on 25.04.2007. The systematic categorization of
debts or loans makes it easier for banks to calculate non-performing loans and
loss provision.
 Local people credit funds shall be obliged to carry out debts classification to
applicable groups as follows:
Group 1 includes: good debts which are paid within maturity
Group 2 includes: noticing debts including those are overdue for nearly 90 days.
Group 3 includes: debts overdue from 90 to 180 days
Group 4 includes: suspicious debts which are overdue from 181 to 360 days
Group 5 : defaults debts which are overdue for more than 360 days
 Loss provision is utilized when the borrowers are unable to repay the debt.
Two types of loss provision specified in the decision are general and specific
provisions:
General provisions are the guard against losses inherent in a credit

d) Category 4: 50%;
Generally, decision 493 has set up higher standard for credit risk management
with respect to loan loss provision. Despite the complex changes that they have
to adopt, proper practices in accordance with this decision will ultimately
enhance the credit institutions’ operation efficiency.
In the next chapter, credit risks which Vietnam credit institution in general and
Central people's credit fund Hatay branch in particular often face will be
discussed in more detail

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CHAPTER 2: RESEARCH METHODOLOGY
2.1. RESEARCH QUESTIONS
In order to further understand how the objectives of this study will be
achieved, three following research questions are introduced:
1. Which types of credit risks could pose potential dangers to CCF Hatay branch?
2. How effective are credit risk management practices in the CCF Hatay branch?
What is their strength and weaknesses?
3. What could CCF Hatay have done in order to prevent or at least lessen the bad
impact of credit risks happening?
2.2. SUBJECTS OF THE STUDY

The CCF’s initial equity is over VND 110 billions , it is estimated that up to
2011 the equity would be increased to VND 3000 billions that expected to be
transformed into a commercial bank.
CCF provides financial services to LCFs and the general public, including
SMEs, farmers and CCF staff. The CCF’s operating network covers 53
provinces, cities with 24 branches that directly take care, intermediate fund for
nearly 1000 LCFs through the country to strengthen the linking network.
The key target is mutual help within the network, help LCFs in communes
developing firmly. In addition it provides technical assistance to LCFs and has
been acting as focal point for the network in its relations with SBV, domestic and
international organizations. Its annual report comes out in two languages,
Vietnamese and English, and reports on CCF, the PCFs and VAPCF. It is audited
by Deloitte.
Since 2004 CCF is an active member of the Asian Confederation of Credit
Unions (ACCU), which is part of the World Council of Credit Unions
(WOCCU).
Figure 1: Apex structure of the People’s Credit Fund network

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