INTRODUCTION
B ACKGROUND of the study
Despite the growing variety of products and services in the banking sector, credit remains a significant source of revenue, with credit risk having a major impact on financial performance Banks provide business loans, anticipating interest and principal repayments; however, high returns come with high risks, including bad debts from customers unable to meet their loan obligations, negatively affecting bank performance and reputation The global financial crisis of 2008-2009 and the European bad debt crisis of 2010 highlighted serious concerns regarding credit activities that neither technological innovation nor systematic credit risk management could fully address As noted by Charles (2013), the rise in non-performing loans has made risk control in credit activities a critical issue, compelling bank managers to balance risk and return while appropriately allocating resources to risk-related areas.
1.1.1 Credit Management in The Vietnam Banking Sector
Between 2001 and 2010, Vietnam's banking system saw significant growth, with average deposit and credit rates reaching 28% and 31%, respectively, driven by an expansionary monetary policy and high investment demand However, from early 2011 onwards, these indicators sharply declined due to ongoing challenges in the banking sector, exacerbated by the global crisis, which resulted in unstable interest rates and frequent changes in credit policy.
In recent years, the Vietnamese banking system has experienced a significant rise in non-performing loans (NPLs) due to rapid credit growth following the 2008 global financial crisis, a credit squeeze in 2011, and the subsequent collapse of stock and real estate markets According to the State Bank of Vietnam (SBV), the implementation of a restructuring scheme for credit institutions from 2011 to 2015 has helped maintain stability and safety within the system, with the NPL ratio kept below three percent However, despite notable progress in the restructuring efforts and NPL resolution, several challenges and weaknesses persist within the banking system.
Reliability and Accessibility of Data
Banks face significant challenges in collecting and maintaining accurate data from potential borrowers, leading to concerns about data reliability According to Nguyen (2016), gaps in accounting standards contribute to unmonitored errors in financial statements, causing discrepancies among businesses As a result, banks often rely more on personal relationships and collateral assessments rather than solely on financial statements for credit evaluations To address these issues, the State Bank of Vietnam introduced Circular No 02/2013/TT-NHNN (Circular 02) in early 2015, establishing a new and uniform standard for loan classification that aims to enhance the reporting of bad debts within the banking sector.
Reporting issues affect not only businesses but also banks, leading to a distorted view of the financial system's health While banks' annual reports are typically reliable, they lack complete transparency According to the State Bank of Vietnam (SBV), non-performing loans (NPLs) were estimated at VND 161.86 trillion, representing over 3.8% of total outstanding loans in November 2014 In contrast, rating agencies like Moody's and Fitch suggest that the actual figures could be as high as 15% The inconsistency in classifying bad debts and the overall lack of transparency present significant challenges for Vietnam's banking system in accurately measuring NPLs.
The banking system in Vietnam faces criticism for its lack of professionalism in credit risk management, primarily due to its relationship-based approach to lending According to Tran (2008), lending decisions are heavily influenced by personal relationships, despite some formal credit risk assessments This reliance on subjective factors leads to inadequate risk evaluation, making it challenging to accurately determine the risk levels of potential loans Consequently, risks are frequently underestimated, resulting in the acceptance of high-risk borrowers, while loan portfolios are not effectively diversified to optimize the balance between risk and required returns (Tran, 2012).
In Vietnam, bank loans are often evaluated primarily for profitability, with insufficient attention to risk, leading to the acceptance of high-risk borrowers for potential financial gain (Tran, 2012) This issue is compounded by inadequate judgment from credit officers, lack of reliable credit data, and pressure to meet sales targets, which can result in the approval of undesirable loans Additionally, some lenders engage in fraudulent activities by creating loans for non-existent borrowers Despite these challenges, there is a notable absence of statistics on bad loans stemming from poor work ethics in the banking sector.
The ownership structure of banks in Vietnam poses significant challenges to loan quality, as highlighted by Leung (2009), who noted that state-owned enterprises (SOEs) often influence joint-stock commercial banks to grant loans to their subsidiaries without adequate credit risk assessments This practice contributes to the elevated levels of non-performing loans (NPLs) in the country Furthermore, the Vietnam Business Registration (2015) reported a notable increase in cross-ownership among banks since 2006, complicating the accurate measurement of NPLs due to issues with loan classification and provisioning.
Credit is essential for the growth of the banking sector and the overall economy Dr Le Xuan Nghia, former vice chairman of the National Financial Supervisory Commission, notes that Vietnamese commercial banks often grant loans reluctantly, even with high default risks, to support corporate borrowers Despite the challenges posed by these risks, banks in Vietnam continue to struggle with credit management due to the absence of a solid framework, a situation that has persisted since the global crisis of 2008-2009 As highlighted by Tran (2012), the reliance on credit growth for income not only jeopardizes individual banks but also poses significant threats to the entire banking system.
The inconsistent classification of loans presents a significant challenge in the banking sector According to 493/2005/QĐ-NHNN and its amendment in 18/2007/QĐ-NHNN, banks can choose between qualitative and quantitative methods for estimating non-performing loans (NPLs), leading to varied reporting practices The Vietnam Banking Association's Monetary and Financial Market Review (2013) indicates that the qualitative approach offers a more thorough assessment of NPLs; however, banks encounter several barriers in its implementation These include a lack of clear guidelines from the State Bank of Vietnam (SBV), insufficient facilities to assess bad loans holistically, the high resource demands of establishing a formal credit evaluation system, and a general preference for the quantitative approach, which results in a lower NPL ratio and reduced provisions for loan losses.
State intervention following the crisis
The State Bank of Vietnam has made significant strides in enhancing the banking sector by balancing local needs with potential changes from the Basel Committee on Banking Supervision (BCBS) and aligning with global standards While a promising new standard is being developed in Vietnam, it requires time for full implementation, necessitating flexibility in timelines and requirements Additionally, the SBV encourages banks to enhance their risk management practices beyond merely adhering to prudential regulations.
Established in mid-2013, the Vietnam Asset Management Company (VAMC) aimed to address the country's bad debt crisis by converting non-performing loans into local bonds By the end of 2013, VAMC had purchased 40 trillion VND in bad loans, followed by another 40 trillion VND in 2014, totaling approximately 250 trillion VND by August 2015 This initiative helped lower the non-performing loan ratio (NPLR) of the banking system to 2.58%, down from 2.78% in May While VAMC's efforts reduced the burden of non-performing loans on banks' balance sheets, the challenge remained in selling the converted bonds, with only 4% of purchased assets released by early 2015 In response, the government took measures to enhance the attractiveness of these bonds by offering them at discounted prices, aiding banks in their restructuring efforts.
Circular No 02/2013/TT-NHNN (Circular 02), which came into effect from early
In 2015, the implementation of Circular 02 established a uniform accounting standard for non-performing loans (NPLs), enhancing risk management for credit institutions and foreign bank branches This led to an increase in NPL ratios and a decline in charter capital, prompting banks to issue shares to meet new capital requirements Additionally, Decree 01, which replaced Decree 69/2007/ND-CP, raised the allowable equity stake of foreign investors in credit institutions from 15% to 20%, fostering greater efficiency through the transfer of knowledge and technology within the banking system.
1.1.2 Credit and Profitability in the Vietnam Banking Sector
The relationship between credit growth and bank profitability is closely tied to interest income, with banks experiencing high profitability during the pre-2011 credit growth period However, when rapid credit expansion is not supported by effective credit risk management, it can negatively impact banks Excessive credit growth combined with inadequate management leads to increased bad loan ratios, undermining the anticipated income from interest Unsettled loans result in higher operational costs for banks due to loan collection efforts and associated expenses, illustrating that poor credit management can significantly harm profitability.
Over the past decade, non-performing loans (NPLs) have significantly increased, negatively impacting bank profitability, including that of government-backed institutions Janssen (2014) noted that this surge in NPLs is largely due to the excessive credit expansion following Vietnam's WTO accession in 2007, which saw an average lending growth of 33% from 2004 to 2011 Unfortunately, this rapid credit growth coincided with a lax quality control system, particularly affecting state-owned enterprises, many of which have poor credit ratings Since the bad debt crisis of 2010, Vietnam has experienced a decline in credit growth, further pressuring bank profitability As illustrated in Figure 1-1, Vietnam stands out among regional peers with stagnant credit growth, as banks hesitate to lend to sectors exhibiting poor loan quality, leading to a continued decline in profitability due to unresolved NPLs.
Figure 1- 1 Vietnam Loans to GDP Chart 2008 - 2017
Research objectives
This research investigates the theoretical framework and practical aspects of credit risk management in Vietnam's banking sector, focusing on its impact on commercial banks' profitability It highlights that poor credit risk management can significantly hinder bank profits due to an emphasis on credit activities and the costs associated with debt collection By employing a quantitative approach, the study aims to establish the relationship between credit risk management and profitability, utilizing proxy ratios for each variable The findings from regression models will reveal the influence of credit risk management on bank profitability over the past decade, while also examining how various factors affect profitability and offering recommendations for improvement.
This article aims to explore the theory and practice of credit risk management (CRM) in banks, specifically focusing on its influence on the profitability of selected commercial banks in Vietnam Additionally, it examines the current CRM practices within these banks and offers recommendations for enhancing their effectiveness.
Methods and Area of the study
S This research uses qualitative method by collecting secondary data from financial statements, annual reports of commercial banks, SBV annual reports and related reports of other researchers.
S This study will be limited to the data analyzed within scope of 8 selected commercial banks in Vietnam during the period from 2006 to 2015.
Significance of the Study
This research aims to enhance the current literature on the banking sector in Vietnam by offering a quantitative perspective, filling a gap where previous studies have predominantly concentrated on individual banks The findings are expected to have practical implications, providing valuable insights for bank managers, investors, and supervisors, depending on the study's outcomes.
Risk management is essential for both banks and policymakers, as a robust banking system fosters national financial stability and strengthens economic resilience during crises Therefore, analyzing and quantifying the effects of risk management on bank profitability is crucial for financial institutions.
Structure of the Study
The research consists of five chapters, as follows:
This chapter introduces the credit risk management background and its practice inVietnamese banking sector.
LITERATURE REVIEW
Credit risk management in banks
Credit risk, as defined by Brown & Moles (2014), is the likelihood that a contractual party will not fulfill its obligations as per the agreed terms It is often referred to by various names, including default risk, performance risk, and counterparty risk, highlighting the different sources of these risks Effective management of credit risk involves the assessment and control of three key elements that contribute to its overall evaluation.
(i) Exposure (to a borrower that has likelihood to default on its debts, or face a disadvantageous situation that disturbs its ability to settle debts on time).
(ii) The probability of default
(iii) The recovery rate (recoverable amount in the event of default).
An effective credit management system is essential for minimizing credit risks and sustaining the overall health of a bank By implementing a robust credit framework, a bank not only safeguards itself from potential credit losses but also contributes to the stability of the entire banking system The failure of one bank can undermine public trust and negatively impact the performance of other financial institutions, highlighting the importance of strong credit practices.
Elements of credit risk management
Effective credit management relies on systematic credit assessment and the work ethics of credit officers, as highlighted by Gestel & Baesens (2009) Their strategies encompass risk transfer, avoidance, reduction of negative impacts, and accountability for risk consequences Lindergren (1987) emphasizes the importance of top management involvement and clear strategic planning in credit risk management, noting that success requires a formal credit scoring system supported by effective team communication and ethics Additionally, Gestel & Baesens (2009) advocate for close collaboration between credit evaluation, auditing, and internal risk control departments to ensure proper loan approval guidelines Overall, robust credit risk management integrates various measurement techniques to mitigate significant threats, such as credit concentration, discipline shortages, and aggressive underwriting of high-risk clients and products.
The credit evaluation process encompasses various approaches, including judgmental methods, expert systems, analytic models, statistical models, behavioral models, and market models, as noted by Brown & Moles (2014) Historically, Vietnamese banks primarily relied on judgmental methods due to a lack of analytic or statistical models, leading to subjective lending decisions and a high incidence of bad loans This reliance on personal experience and observation by credit assessors, coupled with the interconnected ownership of lending institutions, facilitated easy lending practices While these judgmental methods can result in errors, they may still prove beneficial in complex lending scenarios.
Financial statement analysis is a crucial component of expert systems, utilized by commercial banks in Vietnam, though its effectiveness is hampered by a lack of transparency in the accounting system In contrast, quantitative methods like analytic and statistical models are gaining popularity for their systematic and formal approaches, offering a comprehensive evaluation of borrowers The leading technique currently employed is credit scoring models, known for their rigor and transparency, as they integrate statistical data with expert judgment, with the Z-score model being the most widely used.
Advantages of having a sound credit management system
A comprehensive credit risk management (CRM) system provides banks with competitive advantages, enhancing profitability and operational efficiency According to Cebenoyan & Strahan (2004), an effective CRM improves a bank's reputation in the consumer and labor markets while increasing compliance with government regulations Their empirical analysis indicates that banks with advanced risk management systems enjoy greater credit availability, fostering the growth of productive assets and profits However, implementing a robust CRM requires significant investment in statistical models, automation, training, and other associated costs, including potential risks from third-party contractors (Lapteva, 2009) While this can strain the income statement in the short term, it ultimately reduces risk management costs and minimizes evaluation errors in the long run.
Researchers have employed various ratios to assess credit risk management, with the non-performing loan ratio (NPLR) being the most commonly used indicator While non-performing loans are an inevitable aspect of banking, a high NPLR can signify poor financial health and ineffective credit management practices Studies by Gizaw, Kebede & Selvaraj (2015) incorporate multiple ratios, including NPLR, capital adequacy ratio (CAR), loan and advance ratio (LAR), and loan loss provision ratio (LLPR), while Kodithuwakku (2015) focuses on non-performing loans and CAR Brewer et al (2006) also contribute to this discourse by analyzing credit risk through various metrics.
The Non-Performing Loan Ratio (NPLR) serves as a key indicator of credit risk management and is also crucial for assessing overall bank performance Poudel (2012) introduces alternative metrics, such as the Default Rate (DR) and Cost per Loan Asset (CLA), to evaluate credit risk management, moving away from conventional variable selections.
Boudriga (2009) emphasizes the importance of maintaining an acceptable capital adequacy ratio (CAR) to mitigate risk exposure in banks, as sufficient capital can decrease the likelihood of poor-quality loans The State Bank of Vietnam supports this theory by enforcing regulations that require banks to maintain CAR levels above 9% However, Rime (2001) presents a counterargument, highlighting a positive correlation between capital ratios and risks in Swiss banks from 1989 to 1995, which is echoed by Goddard et al (2004) in their study of European banks A disproportionately high CAR may indicate that banks are holding excess capital, potentially limiting resources available for credit risk management This complex relationship raises questions about whether a higher CAR is advantageous or harmful to the profitability of Vietnamese banks, a topic to be explored in subsequent chapters.
The Capital Adequacy Ratio (CAR) is the measure of a bank's capital in relation to its risk-weighted assets, indicating whether the bank has enough capital to absorb potential risks Following the 2008-2009 global financial crisis, governments have implemented stricter capital regulations to address the issues stemming from bad mortgages and mortgage-backed securities (Hyun & Rhee, 2011).
(2015), the higher CAR will protect banks from credit risks, however, exaggerated capital holding will eventually diminish the return on capital off banks.
According to Ferguson (2003, p.396), the Basel I required a minimum capital ratio of capital to risk-weighted assets of 8% to be implemented by the end of
In 1992, Basel established a framework categorizing bank capital into Tier 1 and Tier 2, with Tier 1 capital applied uniformly across international banks, while Tier 2 capital was tailored to each country's banking system (Maurice, 2004, p.22) However, Ferguson (2003, p 396) criticized this Accord for its oversimplification, noting that it assigned only four risk weights to various asset categories, leading to potential misrepresentations of credit quality For instance, loans to corporations, regardless of credit rating, were treated equally with a 100% risk weight, meaning an AAA-rated corporation's loan required the same regulatory capital as that of a BB-rated corporation This lack of differentiation rendered capital ratios less informative and encouraged banks to engage in arbitrage activities to exploit these regulatory gaps.
Figure 2- 1 Calculation of capital ratio under Basell II
Proposed changes to the capital ratio under Basel II suggest that banks can sell and securitize risky assets to avoid higher capital requirements This allows banks to focus on assets with lower capital requirements, potentially leading to insufficient capital reserves for their risky investments Consequently, some banks may maintain capital levels below the necessary threshold, despite meeting the 8% risk-weighted assets requirement.
In 2004, a new framework for bank capital was introduced and applied to
Internationally active banks operate under the Basel II framework, which is structured around three key pillars The first pillar focuses on minimum capital requirements, outlining how banks determine their regulatory capital While the minimum capital ratio remains at 8%, Basel II introduces a revised method for calculating risk-weighted assets.
Measure of risk exposure (Risk-weighted assets)
Basel II significantly transformed the management of credit risk by introducing more nuanced risk weights compared to Basel I, particularly for less sophisticated banks It implemented an internal ratings-based (IRB) approach, where risk weights and capital requirements are determined by individual banks' internal estimates Additionally, the advanced IRB approach allows banks to influence a larger portion of their capital requirements through their own calculations.
In Vietnam, the minimum Capital Adequacy Ratio (CAR) for commercial banks is currently set at 9% in line with Basel I standards The calculation of risk weights for assets follows a standardized approach, as outlined in Circular 36, which assigns specific risk weights to different banking assets This method was proposed for amendment in late 2014 to reduce banks' reliance on third-party credit risk assessments and to enhance the effectiveness of credit risk evaluation The revised approach aims to create a uniform calculation of risk-weighted assets across banks by utilizing customer information such as profitability and risk ratios As Vietnam seeks to align its banking regulations with international standards, these changes could significantly impact the banking sector The implications of the new requirements for Risk Weighted Assets (RWAs) and capital ratios remain uncertain; an increase in RWAs may necessitate banks to hold more capital and potentially limit their lending activities Consequently, banks may need to reassess their strategies between lower and higher risk ventures, driven by the need to strengthen capital management.
Profitability of commercial banks
Profitability is a key indicator of a bank’s ability to expand in capital and carry extra risks, and reflects the bank’s competitiveness and quality of management.
Bank profitability is influenced by a combination of macroeconomic and bank-specific factors Internal factors, such as effective fund utilization, expense management, capital management, and liquidity management, play a crucial role in shaping a bank's financial performance.
Effective credit risk management is crucial for maintaining loan quality in banking, as it significantly influences bank profitability The connection between credit risk management practices and the financial performance of banks will be explored in a subsequent section.
Commercial banks prioritize profit as a core objective of their strategic planning and performance (Ongore & Kusa, 2013) Enhanced banking functions directly correlate with improved financial performance (Nimalathasan, 2008) However, to maximize profits, banks must not only minimize operating costs but also manage increased risks (Ruziqa, 2013) Consequently, it is crucial for banks to assess the impact of various risk factors on their profitability and overall financial performance.
Bank profitability is typically assessed using financial ratios derived from financial statements, offering several advantages According to Guru et al (1999), these ratios are inflation invariant, making them less susceptible to price level fluctuations compared to nominal profits Additionally, utilizing ratios helps address cross-subsidization issues that arise in multi-service banking environments (Chirwa, 2003) The most commonly employed metrics for evaluating profitability across various industries are Return on Equity (ROE) and Return on Assets (ROA).
Return on equity (ROE) measures the overall profitability of the fixed income per dollar of equity (Saunders & Cornett, 2014) The formula is as follows:
Net Income ROE Total Equity Capital= m 1 Z ; ^——
Return on Equity (ROE) is a crucial metric for shareholders and potential investors, as a higher ROE signifies greater profitability and reflects effective bank management (Saunders & Cornett, 2014) However, an increase in ROE may not always convey positive implications, since it can stem from changes in either return or equity capital A rising ROE could result from a decrease in equity capital, potentially leading to violations of minimum capital regulations and indicating a risk to the bank's financial stability Therefore, it is advisable to analyze ROE by breaking it down into its components for a more comprehensive understanding.
Net Income Total Assets ROE = m ∕ 1 / — X _ZZ ^ ʌ ,
Total Assets Total Equity Capital
EM= Equity multiplier (a measure of leverage)
Net income is tax accounted.
A high Return on Equity (ROE) does not necessarily indicate superior operational performance, as an increase in equity multiplier (EM) can inflate the ROE ratio while simultaneously raising the bank's leverage, thereby escalating solvency risk.
Return on Assets (ROA) is a key profitability ratio that measures a company's efficiency in generating profit from its total assets, calculated by dividing net income by total assets This ratio effectively removes the impact of leverage, providing a clearer view of profitability The calculation of ROA can be broken down into several components, akin to the analysis of Return on Equity (ROE).
Net Income Total Operating Income ROA = „ ɪ ~—— x -" , ɪ -
Total Operating Income Total Assets
PM= Net income generated per dollar of total operating income;
The Amount of Income (AU) reflects the income generated per dollar of total assets before interest, and an increase in Return on Assets (ROA) can result from higher Profit Margin (PM) or AU PM, calculated as net income after operational expenses divided by gross revenue, showcases a bank's efficiency in cost control and expense management, which directly impacts profitability While AU indicates a bank's ability to generate income from its assets, high PM and AU may also suggest a reduction in payroll expenses, potentially indicating instability in management practices.
2011) This is the result of either budget cutting by downsizing or loss of elite employees (Saunders & Marcia, 2011), which implies further labor management problems.
ROE and ROA are the primary indicators of bank profitability, widely utilized in research despite their limitations While some authors have explored return on capital (ROC), it is less common Al Khouri (2011) employed ROA and ROE to analyze the relationship between risk and performance in the Gulf Cooperation Council banking sector, focusing on liquidity risk, capital risk, credit risk, and bank size Similarly, Alkhatib & Harsheh (2012) broadened the scope of financial performance in the Palestinian banking sector by incorporating ROA, price-to-book ratio, and economic value as proxies, revealing a significant relationship between bank size and ROA.
In their studies, Ruziqa (2013) and a 2009 analysis investigated financial performance in the banking sector of Malaysia and Indonesia, utilizing Return on Assets (ROA) and Return on Equity (ROE) as key indicators These two metrics are the most commonly employed measures in the industry, often used in conjunction to balance each other's limitations (Chirwa, 2003; Ongore & Kusa, 2013).
T HE EFFECT OF Credit risk management on Bank profitability
Numerous studies have explored the link between credit risk management and bank profitability, highlighting its vital role in ensuring financial stability Empirical evidence is essential for credit management professionals and policymakers to effectively monitor and allocate resources for system soundness While it is evident that poor credit risk management negatively impacts profitability, comprehensive analysis through financial ratios and econometric models is necessary for objective conclusions Kargi (2011) conducted a study using descriptive analysis and regression models on data from Nigerian banks between 2004 and 2008, finding a significant relationship between credit risk management and bank profitability The research indicated that an increase in loan volume, alongside low-quality loans and deposits, poses risks that could jeopardize profitability due to heightened risk exposure and potential liquidity issues Following similar methodologies, Epure and Lafuente further investigated this relationship.
(2012) studied Costa Rican commercial banks over a longer period 1998-2007 and found out that non-performing loans affect ROA in a reserve way, while
CAR induce positive impact on net interest margin (NIM).
Kargi (2011) and Epure & Lafuente (2012) are not the only two groups of authors that employ ratios and regression method to examine credit risk management.
Godlewski (2004) found that return on assets (ROA) effectively indicates profitability, aligning with findings by Epure & Lafuente Similarly, Felix & Claudine (2008) employed both ROA and return on equity (ROE) to assess profitability, yielding comparable outcomes In contrast, Kithinji (2010) examined the Kenyan banking sector and discovered no correlation between loan amounts, non-performing loans, and profitability, challenging prevailing research in this area His study suggests that other factors significantly influence the volatility of bank profits.
In their 2012 study on Taiwanese commercial banks, Chen & Pan utilized credit risk technical efficiency (CR-TE), credit risk allocative efficiency (CR-AE), and credit risk cost efficiency (CR-CE) to assess credit risk management Their focus extended beyond the relationship between credit risk management and profitability to evaluate the overall efficiency of credit risk management within the banks studied, revealing that only one bank demonstrated efficient credit risk management Additionally, Ahmad & Ariff (2007) underscored the significance of loan loss provisions, noting that credit risk levels in banks from emerging economies are generally higher than those found in developed economies.
State-owned banks are known for engaging in riskier projects and providing advantageous loans to small and medium enterprises, which can stimulate economic development, as noted by Salas & Saurina (2002) However, this risk-taking approach may lead to an increase in non-performing loans (NPLs) In their study, Sami & Magda (2006) explored the effects of capital regulations on the performance of Egyptian banks, focusing on capital adequacy's impact on intermediation costs and profitability Their findings indicate that higher capital adequacy enhances shareholder interest in portfolio management, resulting in increased intermediation costs and improved profitability.
RESEARCH METHODOLOGY
R ESEARCH APPROACH
This study employs a quantitative approach to examine the relationship between credit risk management and bank profitability among commercial banks in Vietnam Utilizing established mathematical models, the research aims to analyze the impact of credit risk proxies, such as Non-Performing Loan Ratio (NPLR) and Capital Adequacy Ratio (CAR), on profitability indicators like Return on Assets (ROA) and Return on Equity (ROE) The objective is to determine whether ineffective bad debt management has historically adversely affected bank profitability.
D ATA
This research aims to examine the relationship between credit risk management and the profitability of commercial banks in Vietnam from 2006 to 2015 The study focuses on eight major banks, most of which are publicly listed, enhancing the reliability of the published information These banks represent nearly 45% of the total assets in the Vietnamese banking sector and significantly influence the industry Consequently, the analysis derived from these institutions offers valuable insights applicable to the entire banking system Data for the study is sourced from the banks' annual reports and financial statements.
# Ticker Name of bank Total assets (as of
Joint-Stock Bank for Investment and Development
Bank for Foreign Trade of Vietnam
8 CTG Vietnam Bank for Industry and
A total of 42 banks are featured on their official websites Financial statements are compiled to extract relevant ratios from annual reports or calculated as necessary The following list highlights the banks selected for this research study.
Table 0-1 List of Banks Included in the Research Sample
Source: Researcher collect data from each bank’s official websites.
T IME Horizon
The research use secondary data which are collected from banks’ annual reports with high reliability among all sources since they went through auditing and
The study analyzes Annual Reports and manually calculated data from 2006 to 2015, a timeframe that encompasses the financial crisis, to ensure the feasibility of the research.
The year 2008 marked a significant period of economic growth in Vietnam, but the bad debt crisis that emerged in 2011 disrupted the flourishing banking sector This analysis will utilize trend analysis and multi-regression models to examine the impact of these events on the Vietnamese banking system.
FINDINGS
D ESCRIPTIVE S TATISTICS
Over the past decade, the sampled banks have maintained an average non-performing loan ratio (NPLR) of about 2.2%, alongside a capital adequacy ratio (CAR) of 12.56% Additionally, they have achieved an average return on equity (ROE) of 16.69% and a return on assets (ROA) of 1.29%.
Table 0-2 Descriptive Statistics by Banks
Yea r NPLR CAR LTD LEVRG CRGWT
BIDV has the highest Non-Performing Loan Ratio (NPLR) at 3.413%, significantly higher than CTG's 1.006% The bank struggles with its Capital Adequacy Ratio (CAR), consistently meeting the minimum government requirement of 9% since 2010, which reflects a notable level of credit risk Additionally, BIDV's commitment to a high leverage ratio indicates it is taking on greater risks compared to its peers This high NPLR contributes to BIDV's low profitability, evidenced by a Return on Assets (ROA) of just 0.855% In contrast, Vietinbank has the lowest NPLR, while ACB boasts the highest profitability with a Return on Equity (ROE) exceeding 26%.
The two formerly state-owned banks, VCB and BIDV, exhibit concerning levels of Non-Performing Loan Ratios (NPLR) and Capital Adequacy Ratios (CAR), indicating they may face greater credit risks compared to their counterparts Additionally, VCB and Vietinbank struggle to meet the minimum CAR requirement of 9%, while joint-stock commercial banks such as ACB, EIB, MBB, MSB, and SHB maintain CAR well above this threshold This situation suggests a potential correlation between ownership status and CAR; however, it is regrettable that this variable was not included in the analysis due to sample size limitations.
Table 0-3 Descriptive Statistics by Years
In recent years, banks have experienced a decline in profitability, with the average Return on Equity (ROE) dropping from over 20% until 2011 to around 8% in 2014 and 2015 A similar trend is evident in the Return on Assets (ROA), highlighting the challenges faced by the banking sector.
In 2014, the banking sector faced significant challenges, marked by a Non-Performing Loan Ratio (NPLR) of 2.801%, only slightly better than the 2.964% recorded in 2012 This trend, illustrated in Figure 4-1, highlights the dual pressures of tightening profits and rising bad debts The year 2008 saw an unusual spike in Capital Adequacy Ratio (CAR) alongside a decline in Return on Equity (ROE), attributed to the global financial crisis Although there was a slight recovery in 2009, negative trends have persisted up to the present day.
Figure 4- 1 Variable Trends of NPLR, CAR, ROA, ROE across years
ROA ROE NPLR CAR LTD LEVRG CRGWTH SIZE
The table demonstrates the correlation between various variables, highlighting both the sign and degree of influence Notably, CAR and CRGWTH exhibit a positive correlation with ROA, while other indicators show a negative correlation Additionally, LEVRG, CRGWTH, and SIZE are positively correlated with ROE, whereas the remaining variables indicate a negative relationship Importantly, CAR displays an opposing correlation with other metrics.
Variable Coeffici Std Error t- Prob.
The correlation between Capital Adequacy Ratio (CAR) and Return on Assets (ROA) is negligible at 0.00679, indicating almost no relationship, while CAR exhibits a negative correlation of 0.309 with Return on Equity (ROE) This suggests that ROE may not consistently reflect changes in profitability, as variations in equity can influence ROE without necessarily indicating improvements or declines in operational efficiency Additionally, past research on CAR has yielded mixed findings; for example, Boudriga et al (2009) argued that higher CAR reduces a bank's risk exposure, whereas Rime (2001) and Goddard et al (2004) found a positive relationship between capital ratios and risk Further insights will be explored in the regression analysis.
CONCLUSIONS
C ONCLUDING Notes
This paper aims to analyze the influence of credit risk management on the profitability of commercial banks in Vietnam Despite the significance of this topic, existing quantitative studies are scarce, as most prior research has predominantly adopted qualitative methods or concentrated on specific banks rather than examining the entire banking sector This study seeks to address this gap in the literature.
By employing panel data of 8 banks over 10 years’ period between 2006 and
In 2015, the author analyzed the correlation between credit risk management indicators and profitability, measured by ROA and ROE Descriptive statistics revealed a decline in both non-performing loan ratios and profitability ratios over time Regression analysis confirmed that non-performing loans significantly impact profitability, highlighting the ongoing efforts of the State Bank of Vietnam (SBV) and individual banks to address the bad debt issue and push for further enhancements The decrease in the non-performing loan ratio to just over 2.9% in 2015, down from over 3.7% previously, can be partly credited to the Vietnam Asset Management Company (VAMC) actively purchasing bad debts However, improving the bad debt situation requires banks to strengthen their own credit control systems.
Empirical findings indicate that the relationship between Capital Adequacy Ratio (CAR) and profitability metrics such as Return on Equity (ROE) and Return on Assets (ROA) in Vietnamese banks is not significant, suggesting that higher CAR does not necessarily correlate with increased profitability Notably, the DROE model reveals that an increase in CAR may lead to decreased profitability in subsequent periods While banks must maintain a CAR of at least 9% as mandated by the government, they must also manage their CAR levels to avoid negative impacts on profitability To comply with regulations, banks should strategically adjust their CAR to ensure safety while maximizing profit potential Additionally, the lack of significant relationships may stem from the model's imperfections and the study's time frame, which includes periods of financial crisis that could distort ROE and ROA outcomes.
Research indicates a positive correlation between credit risk management and the profitability of commercial banks, as evidenced by the findings from two proxies: Capital Adequacy Ratio (CAR) and Non-Performing Loan Ratio (NPLR) In essence, improved credit risk management practices lead to enhanced profitability for commercial banks.
S UGGESTIONS FOR FURTHER RESEARCH
The research identified several gaps, particularly in Chapter 3, where key variables such as ownership structure and operational efficiency were not included These factors are crucial for comparing state-owned joint-stock banks with privately-owned banks and assessing cost management effectiveness Additionally, provisions for loan losses should be considered as a significant criterion for evaluating credit risk management The omission of these variables is largely due to a lack of accessible historical financial data from most banks Future studies could explore the connections between macroeconomic factors and bank profitability or bad debt ratios The current research indicates that the included bank-specific variables account for just over 40% of the changes in Return on Equity (ROE), leaving 60% attributable to excluded variables, macroeconomic influences, or random factors There is also potential for qualitative case studies focusing on individual banks or groups of banks to provide deeper insights.
Practical implications
Effective credit risk management is crucial for enhancing profitability in Vietnamese banks, highlighting the need for both the State Bank of Vietnam (SBV) and banking professionals to adopt stringent practices Managers are encouraged to implement modern techniques in credit risk management and diversify income-generating banking activities This study's findings may indicate potential income management strategies employed by bank managers.
Bad debts significantly impact bank profitability, prompting the State Bank of Vietnam (SBV) to implement measures such as purchasing low-quality loans for bank restructuring, while banks focus on debt collection To ensure sustainable financial performance, banks must adopt a long-term, systematic approach to bad debt management, which includes standardized credit risk management practices: risk planning, quantifying risks, and monitoring risk management activities Additionally, banks should adopt flexible customer segmentation to balance risk and profitability, recognizing that unsecured and risky loans often come with higher interest rates, potentially leading to increased profitability if managed effectively Consequently, banks are advised to establish their risk acceptance levels for different customer segments to create tailored risk management strategies and profit expectations.
Research indicates no significant relationship between Capital Adequacy Ratio (CAR) and Return on Equity (ROE) or Return on Assets (ROA), with previous studies yielding mixed results While a higher CAR serves as a risk cushion, it may also indicate that banks are reserving capital rather than utilizing it for operational activities, potentially leading to lower profitability Conversely, a lower CAR could negatively impact profitability, particularly if banks face increased expenses due to bad debt collection Currently, many banks are striving to maintain the required CAR level of 9%, with some mid-tier banks achieving stable CARs above 15% in recent years, even as overall profitability appears to have declined.
Estimating the necessary loan loss provisions is crucial for banks, as it is based on the anticipated losses from defaults These provisions serve as estimates for bank reporting, reflecting the uncertainty surrounding potential bad debts at the end of each period While provisions are essential for managing low-quality loans, excessive provisioning can distort a bank's financial performance In Vietnam, the issue of non-performing loans (NPLs) significantly affects banks' lending capabilities According to Tran et al (2015), banks faced substantial provisioning costs, amounting to approximately USD 6.5 billion from 2011 to 2013 and USD 2.8 billion in 2014, which represented about 7% of their total loan portfolios.
Loan-To-Deposit Ratio (LTD)
The findings in Chapter 4 indicate that a higher loan-to-deposit ratio negatively impacts both Return on Assets (ROA) and Return on Equity (ROE), suggesting that banks may experience reduced profitability when they lend more against their deposit amounts.
Loans are primarily financed through three sources: customer deposits, borrowings from other banks or the central bank, and equity capital Ideally, the duration of deposits should align with the terms of the loans However, since deposits are often short-term, this creates risks when depositors withdraw funds, potentially leaving loans unfunded To mitigate these risks, a balanced combination of long-term and short-term funding is essential to ensure a stable provision of loans.
Suggestions to state Bank of Vietnam
Effective credit risk management is crucial for enhancing bank profitability, prompting managers to focus on controlling non-performing loans (NPLs) and accurately assessing borrowers' repayment capabilities While this study did not establish a direct link between Capital Adequacy Ratio (CAR) and profitability proxies, CAR remains a vital component in managing commercial banks' risks and deserves significant attention.
In particular, the State Bank is suggested to reinforce its power by employing some of the ideas as follows.
The government must establish clear guidelines for bad loan accounting to ensure consistent Non-Performing Loan Ratios (NPLRs) across banks, as reliable data is essential for research Violations of laws and regulations should be met with appropriate penalties According to Dr Le Xuan Nghia, the state mandated banks to implement an Internal Rating system under the 493/2005/QD-NHNN regulation, based on Basel II's Foundation Internal Rating Based Approach (FIRB) or Advanced Internal Rating Based Approach (AIRB) However, by the end of 2011, only four banks—BIDV, MB, VCB, and ACB—had successfully adopted this internal rating system It is recommended that the State Bank impose strict penalties on non-compliant banks to enhance adherence and facilitate future improvements.
To enhance financial capability, the State Bank of Vietnam (SBV) mandates credit institutions to improve their capital quality, ensuring that charter capital meets legal requirements and that the Capital Adequacy Ratio (CAR) aligns with both national and international standards Prestigious institutions are encouraged to consider listing on foreign stock exchanges To control credit quality and reduce non-performing loans (NPLs), institutions must actively implement comprehensive NPL resolution strategies, including encouraging debt repayments, selling off debts and assets, pursuing legal action against delinquent borrowers, and utilizing risk provisions Furthermore, the Vietnam Asset Management Company (VAMC) should expedite NPL resolution under market mechanisms while implementing measures to prevent the emergence of new NPLs and enhance overall credit quality.
In addition to implementing NPL resolution measures as outlined in Government Decision 843 dated May 31, 2013, the central bank must strengthen its inspection and supervision of credit institutions to ensure compliance with regulations on credit extension, safe operations, and debt classification Collaborating with various ministries and sectors, the central bank will work to complete the legal framework and improve management practices by introducing regulations that enhance control over cross-ownership and adopt risk-based inspection and supervision of banking activities in line with international standards.
To enhance the effectiveness of the banking system, it is crucial for the State Bank of Vietnam (SBV) to focus on developing and promoting the Credit Information Center (CIC) The CIC serves as a governmental office that creates and manages a comprehensive credit information database, aiding lending institutions in evaluating loans By providing transparency through multi-party access to data on borrowers, the CIC helps banks identify high-risk clients However, as noted by Tran (2014), the current database primarily includes frequent borrowers and listed companies, limiting its scope Additionally, non-state credit rating databases like CRV, VietnamCredit, CRC, and VietnamReport also face similar limitations Therefore, adequate funding and promotion of the CIC are essential for it to establish itself as the primary credit database within the banking sector.
The central bank should draw on the experiences of other nations and seek guidance from international organizations like the World Bank to effectively restructure the banking system and address non-performing loan (NPL) challenges.
Limitations
The research analyzed eight commercial banks, focusing on five major domestic banks: BIDV, Vietinbank, VCB, ACB, and EIB However, this selection may not fully represent Vietnam's banking sector, as it excludes significant institutions like Agribank, potentially leading to biased market inferences Additionally, the study's model lacked data on ownership structure, which is crucial for understanding banks' profitability The choice of profitability indicators, specifically ROA and ROE, may also introduce bias, as these metrics can be influenced by capital and cost structures rather than actual business performance Spanning a decade, the study captures the banking sector's fluctuations, including growth phases, the global crisis, and subsequent recovery, highlighting the significant impact of macroeconomic factors, such as inflation, on bank profitability Consequently, the model's fit may not be entirely satisfactory due to these external influences.
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