INTRODUCTION
Rationale of the study
Since the 1986 Renovation, the Vietnamese economy has undergone remarkable transformation, fostering a more open business environment that encourages economic participation A standout development during this period has been the significant advancement of the banking system.
From 1986 to 2016, the Vietnamese banking system experienced significant growth in both quantity and quality, with 46 active banks, of which 87% are commercial banks Today, banks serve not only as sources of funding but also provide a wide range of services that support the establishment, operation, and development of various economic entities.
Banks play a crucial role in the economy, necessitating reliable funding sources, facilities, and, most importantly, skilled human resources Every banking operation is managed and monitored by employees, making it essential for banks to employ well-qualified staff to mitigate risks Additionally, as banks expand and engage in more business activities, they face increased risks associated with customer interactions.
Among those customers exists people who intentionally or unintentionally want to take benefit for them will do something harmful to banks
Moral hazard poses a significant threat to banks as the economy and banking system evolve This risk can lead to severe consequences for individuals, organizations, and the broader economy, making it a complex issue that is challenging to manage effectively.
This graduation thesis aims to highlight the significant issue of moral hazard within the Vietnamese commercial banking system The author aspires to provide a comprehensive analysis of the current situation and offer potential recommendations to address the moral hazard problem effectively.
1 Statistic from SBV hazard problem in banking system Hopefully this small study could contribute to the endless knowledge about banks.
Research objectives
This graduation thesis aims to achieve two primary objectives First, it seeks to analyze the trends, forms, participants, and impacts of moral hazard issues affecting Vietnamese commercial banks, while also examining the effectiveness of existing solutions and the approaches taken by responsible parties Second, in light of the concerning realities and the advantages and disadvantages of previous preventative measures, the author intends to propose more practical recommendations to address and prevent moral hazard problems.
Scope of the study
Moral hazard is an economic concept that can arise in various sectors, but this study will specifically focus on its implications within the banking industry.
This article explores the causes and consequences of moral hazard within the banking system, focusing on its recent implications in Vietnam It also presents potential solutions to effectively address this issue in the current Vietnamese banking landscape.
Research methodology
In order to reach the targets and objectives set above, a wide range of information sources and several methods of analyzing should be used
The theoretical knowledge is retrieved from classes, lectures, and studied further in academic books, journals
This article presents a comprehensive analysis of significant issues by examining notable cases that have led to severe consequences The information is meticulously gathered and analyzed from various sources, including newspapers, journals, magazines, breaking news, and statistical records, to provide an in-depth understanding of the topic.
Thesis structure
Apart from Chapter 1 – Introduction which states the reason why the study was conducted, what it was for, and how it was done, this graduation thesis contains 3 parts:
Literature review – Theoretical Knowledge of Moral Hazard in
Commercial banks
Banks were established to address the need for an entity that effectively utilizes funds and facilitates the funding process within the financial system, thereby fulfilling the requirements of the financial market.
In the United States, a bank is defined as a business that accepts deposits withdrawable on demand, such as through checks or electronic transfers, and provides loans for commercial purposes Specifically, a commercial bank is a type of bank that offers deposit services and extends loans to both businesses and individuals, and will be referred to simply as a bank in this context.
In Vietnam, bank is legalized to be a credit institution which conducts all banking activities namely: taking deposits, providing credits and payment services, along with other business activities for profit 2
A commercial bank is a financial institution that offers essential services, including accepting deposits, providing business and auto loans, mortgage lending, and basic investment products like savings accounts and certificates of deposit Typically, traditional commercial banks operate as physical establishments featuring tellers, safe deposit boxes, vaults, and ATMs.
Since the inception of the banking system, banks have provided essential services, including accepting deposits, issuing loans, facilitating currency exchange, discounting various types of financial instruments, and offering credit services to support government and corporate business activities.
2 Law No47/2010/QH12 of June 16, 2010 on Credit Institutions
In today's fluctuating global economy, banks are increasingly integrating into the economic landscape by expanding their range of services, which now include insurance, underwriting, equipment leasing, securities trading, and international trade financing.
Vietnam's commercial banks have experienced remarkable growth and have become vital components of the country's developing economy, fulfilling essential roles that will be explored in the following section.
Commercial banks play a vital role in the economy by offering a range of essential services and actively participating in business activities Their significance can differ based on the size and state of the national economy, but regardless of scale, commercial banks typically fulfill key functions such as serving as intermediaries, providing payment services, managing risks, and performing various other roles.
Commercial banks play a crucial role as intermediaries by connecting savers with investors, facilitating the flow of funds for new projects They encourage both individuals and institutions to save, effectively addressing the liquidity needs of various economic entities Additionally, commercial banks help mitigate risks and lower transaction costs, making financial activities more efficient.
Commercial banks engage in asset allocation by mobilizing funds through debt issuance, which they then invest in profitable projects or other assets Beyond merely connecting surplus funds with those in need, they also serve as brokers, acting as agents for investors to attract and manage funds for reinvestment This dual role benefits both the banks and their clients, as commercial banks leverage their informational advantages to manage funds more effectively and minimize risks Additionally, their involvement in business transactions can lower costs, thanks to their economies of scale in screening and monitoring borrowers.
Commercial banks offer a secure and convenient method for customers to make payments through current or checking accounts Payments can be processed via various channels, including tele-transmission, which allows for direct transfers between accounts based on customer orders This system supports both paper and electronic orders, enabling transactions through the internet or mobile devices Additionally, customers can use electronic cards like ATM cards, VISA, MASTER CARD, or PAYPAL for automatic payments at the point of sale Writing cheques is another option, allowing beneficiaries to collect funds directly from the issuing bank.
Banks' payment services enhance trading activities by enabling businesses to make large payments safely and efficiently With advancements in the international banking system, central banks can transfer currencies through Nostro and Vostro accounts This has led to the development of collection payment methods, where banks facilitate the transfer of funds from importers to exporters, streamlining the process Consequently, trading becomes more accessible, contributing to a more efficient economy.
Commercial banks play a crucial role as intermediaries in the government's macroeconomic interventions, acting as a policy transmission channel For instance, when the central bank aims to implement a loose currency policy, it purchases securities from commercial banks, leading to lower interest rates and favorable conditions for investors, ultimately benefiting the domestic economy Additionally, the central bank can influence the money supply by affecting commercial banks' ability to create demand deposits This delegated monitoring by commercial banks allows the government to regulate the financial market and the broader economy without resorting to excessive administrative measures, which can often lead to negative perceptions and inflexibility.
Asymmetric information in commercial bank system
The theory of asymmetric information, developed in the 1970s and 1980s, serves as a credible explanation for market phenomena that traditional general equilibrium economics fails to address Essentially, it posits that an imbalance of information between buyers and sellers can result in inefficient market outcomes.
Asymmetric information in trading occurs when one party has access to more or superior information than the other, often placing the less informed party at a disadvantage This imbalance typically arises when sellers possess greater knowledge than buyers, though the opposite scenario can also occur Such disparities in information can lead to harmful situations, where the informed party may exploit the uninformed party's lack of knowledge, ultimately impacting the fairness and integrity of the transaction.
In the banking sector, information asymmetry refers to the unequal distribution of crucial information that impacts decision-making in loan agreements When an entrepreneur seeks funding to bring a business idea to life, they typically present a business plan to a bank Despite the bank's efforts to conduct thorough due diligence before approving the loan, the entrepreneur inherently possesses a deeper insight into the potential returns and risks associated with their venture than the lender does.
2.2 The consequences of asymmetric information
Asymmetric information can lead to inefficient outcomes, particularly in the banking sector This thesis will examine the impact of asymmetric information specifically within the credit segment of the banking industry.
Asymmetric information initiates a downward economic spiral for entities, creating imbalances that lead to adverse selection and moral hazards These vulnerabilities can culminate in market failure, defined as situations where individuals or firms acting in pure self-interest yield inefficient outcomes.
Adverse selection refers to unethical practices that exploit asymmetric information prior to a transaction This phenomenon occurs when high-risk firms, which have poor investment channels and greater inherent risks, are more likely to secure loans compared to low-risk firms that offer better investment opportunities and possess lower inherent risks.
Due to information asymmetry, lenders struggle to distinguish between good and bad credit risks, leading them to impose a blanket premium on interest rates This practice discourages creditworthy firms from borrowing, as their strong credit history is undervalued, while riskier firms are attracted to the higher rates, knowing their cash flows warrant even steeper charges Consequently, lenders find themselves with a loan portfolio predominantly filled with high-risk borrowers.
Moral hazard refers to unethical behavior that exploits asymmetric information following a transaction, particularly in banking It typically arises after a borrower receives funds, leading them to potentially violate loan covenants by engaging in risky or "immoral projects" that lenders would deem unacceptable While these projects may offer high returns for the borrower, they also pose significant risks that could adversely affect the lender This situation is exacerbated by information asymmetry, as lenders often lack insight into the borrower's actions Additionally, moral hazard can manifest in various ways within commercial banking, warranting further exploration in subsequent discussions.
Despite technological advancements aimed at reducing asymmetric information, the challenge of moral hazard persists, particularly in the banking sector This complex issue warrants a deeper exploration of its definition and underlying causes.
Research methodology and data analysis – Reality of Moral
The trend of Moral hazard problem in Vietnam recently
In recent years, there has been a significant rise in criminal cases involving moral hazard within commercial banks, resulting in substantial financial losses The increasing involvement of high-ranking bank officials in these delinquencies highlights the complexity and sophistication of these crimes Organized crime networks now operate at multiple levels, employing various participants who collaborate to shield their activities Scammers and brokers often resort to bribing authorized bank officers to facilitate their schemes, creating a chain of corruption that poses serious challenges to the integrity of the banking system.
Figure 1: Banking Moral Hazard Cases in Vietnam from 2006 to 2015 5
Between 2006 and 2015, the Investigation Department of the Ministry of Public Security handled approximately 70 cases, resulting in the prosecution of 37 cases During this period, the Supreme People's Procuracy prosecuted 117 defendants for criminal activities within the banking sector, with credit fraud being the predominant offense, including instances of fraudulent appropriation.
5 Source: Ministry of Public Security – Statistic Department
Joint-stock commercial banks have been implicated in significant violations of lending procedures, including embezzlement and bribery, with 17 cases reported, accounting for 46% of total offenses State-owned banks experienced 10 cases, representing 27%, with Agribank alone responsible for 9 cases, or 25% The remaining violations were attributed to other types of banks, highlighting the need for stricter adherence to regulations set by the State Bank of Vietnam (SBV).
Recent statistics from Vietnam's Central Steering Committee on Anti-Corruption reveal a troubling trend: the number of customer delinquents is significantly lower than that of bank employees Out of 117 individuals prosecuted, 81 were bank officers, accounting for 69% of the total Furthermore, several cases involving losses amounting to thousands of billions VND have implicated bank staff and employers, highlighting a serious issue of embezzlement within commercial banks in Vietnam.
Figure 2: The Number of Moral Hazard Banking Criminals in Vietnam from
Between 2010 and 2012, significant financial losses were reported, with many cases originating earlier but only identified in 2012 Agribank notably topped the list, with over 4,000 billion VND unaccounted for during this period.
6 Source: Central Steering Committee on Anti-Corruption of Vietnam – Statistic Department
Huynh Thi Huyen Nhu's case stands out as a significant scandal in the banking sector, resulting in a staggering loss of 4,000 billion VND, affecting three major banks: ACB, which lost 719 billion VND, Navibank with 200 billion VND, and VIB with 180 billion VND Additionally, unethical behavior from both customers and bank employees has led to further fraudulent activities and violations within the industry Notably, while criminal cases in the banking sector represent only 0.22% of the total, they account for a remarkable 60% of the financial losses reported, highlighting the severity of the issue.
Figure 3: Banks’ losses announced in 2012 7 1.2 Recognizing common moral hazard behaviors a Customers’ moral hazard behaviors
Moral hazard issues primarily stem from credit fraud, where customers exploit borrowing to secure capital for business expansion or new projects Scammers often create false documents or misuse loans, presenting challenges for bank managers who may be aware of these tactics but struggle to anticipate when they will occur.
First , when one’s business falls into bad situation such as losses, customers would have the tendency of fraudulence VPBank has been a victim of this type
7 Source: http://vietstock.vn/2013/01/dinh-lua-dao-bao-nhieu-tien-cua-ngan-hang-da-ra-di-757-257003.htm
Vietnamese entrepreneurs returning from Russia are establishing new businesses in their homeland, often mortgaging properties to secure bank loans However, many face challenges leading to financial difficulties, prompting requests for loan restructuring Ultimately, these loans have accumulated to hundreds of billions, creating a situation where repayment becomes unfeasible.
Some individuals intentionally plan to defraud banks by meticulously preparing counterfeit documents and altering financial records A notable example is the Phuong Nam Company, which deceived multiple banks by manipulating business results to secure loans amounting to thousands of billions VND Additionally, fraudsters often modify the balances on financial instruments like passbooks and checkbooks to embezzle funds For instance, Tran Thi Hoa Anh from Hai Duong inflated her savings accounts from 0.5 and 5 million VND to 500 and 980 million VND, subsequently using these altered amounts to secure a loan exceeding 4 billion VND.
Criminals can create multiple fake companies to forge commercial contracts, enabling them to fraudulently borrow money A notable case is Duong Thanh Cuong, who orchestrated a series of frauds against Agribank, resulting in losses nearing 1,000 billion VND.
As Vietnam integrates into the global economy, it faces significant risks from foreign partners, particularly in import and export activities There is a potential for foreign companies to deceive Vietnamese firms by defaulting on contracts or engaging in fraudulent partnerships A notable instance of this occurred with Agribank and Lifepro Vietnam, where the Vietnamese company was defrauded of approximately 4,000 billion VND Additionally, the issue of moral hazard among bank staff further complicates the financial landscape, highlighting the need for vigilance and accountability in international business dealings.
Moral crimes committed by customers often require the complicity of bank staff, as bankers possess in-depth knowledge of banking procedures and system vulnerabilities This expertise makes it relatively easy for them to exploit their own institutions, especially when driven by greed or financial difficulties Consequently, various types of moral hazard activities frequently emerge among bankers.
Making fake loan applications of customers to borrow money
For example, in 2015, Bui Thi Tam – officer in DongA Bank, District 5, Ho Chi Minh City – made up more than 700 fake loan profiles to appropriate 160 billion VND
Taking advantage of the imperfect payment procedure such as in money transmitting or gifts transferring through bank to withdraw money
In 2007, Hoang Van Luan, a bank teller at Agribank Gia Lam, created fraudulent money receipts using random names and forged the treasurer's signature to illegally transfer 7 billion VND into his account at another bank, which he withdrew immediately.
Imitating depositors and bank tellers’ signatures, stealing private information to withdraw a part or all of the deposits
For example, in 2007, Le Hoai Phuong at BIDV Cau Giay stole customers’ passwords, access codes of Money Transaction Management Program to withdraw 28 billion VND
Receiving loans’ collaterals but using them to get other loans illegally instead of storing them at bank
For example, in 2011, Vu Thi Hong Diep - Agribank Tan Lap, Buon Ho, Dak Lak – usurped 07 deeds to land of customers to re-apply for loans accounted for 26 billion VND
Forging saving accounts, changing the balance on customer's savings books to appropriate banks’ funds
8 Aggregation form The Supreme People's Procuracy
In 2011, Tran Le Thuy, a bank teller at BIDV Dong Do, manipulated her relatives' passbook balance, increasing it from 190 million VND to an astonishing 272 billion VND, and subsequently withdrew the funds to invest in stocks, gamble, and cover personal expenses.
Taking advantage of loopholes in lending and mobilizing funds policies to get extra benefits
For example, in 2012, SBV set the ceiling rate for funds mobilization not to exceed 14% per year Seeing the potential of benefit, 23 bank officers at Agribank
Ba Ria – Vung Tau initiated the opening of 125 passbooks alongside 125 funds receipts to earn additional commissions Subsequently, these passbooks were mortgaged to secure multiple loans, allowing for profit from the interest rate differences Ultimately, these activities led to the misappropriation of nearly 5 billion VND.
Counterfeiting signatures, stamps, and documents to fraudulent appropriate
Severe cases of moral hazard in Vietnamese commercial bank system
This article examines notable financial crimes in Vietnam, specifically focusing on significant cases such as VDB Dak Lak – Dak Nong, Phuong Nam Company, Duong Thanh Cuong versus Agribank, Lifepro Vietnam versus Agribank, and the Huynh Thi Huyen Nhu case The analysis categorizes these cases based on the perspectives of customer-related causes and those attributed to bank staff.
2.1 Cases from the viewpoint of causes by customers a The VDB Dak Lak – Dak Nong case
In this case, the major defendants regarding businesses were: Cao Bach Mai – Director of Minh Nhat Ltd., and Tran Thi Xuan – Director of Nhat Tan Ltd
In 2008, Cao Bach Mai exploited the State's preferential export loan policies by providing funds to Nguyen Thi Loan, instructing her to have her nephew Hung establish Quan Heng Ltd in China Mai directed Hung to sign blank papers, which she then used to fabricate export contracts to secure loans from VDB Dak Lak – Dak Nong Additionally, Mai sold these signed blank papers to Tran Thi Xuan for 20 million VND each, facilitating her involvement in similar fraudulent activities The group further forged various documents, including purchase lists, cash payment bills, VAT invoices, and customs declarations, to obtain advance disbursements and withdraw funds from the bank.
The defendants orchestrated a scheme to obtain loans without collateral by colluding with Vu Viet Hung, the Director of VDB Dak Lak – Dak Nong Hung unlawfully transferred funds into the defendants' accounts at a different bank, allowing them to withdraw an equivalent amount as required collateral, which was then deposited back into their accounts at VDB Dak Lak – Dak Nong.
Within 2 years from 2008 to 2009, Cao Bach Mai used 71 export contracts to get
70 loans accounted for 1,005 billion VND 64 of the contracts were fake ones and
Tran Thi Xuan utilized 65 fraudulent export contracts to secure 64 loan agreements totaling 938.5 billion VND, following the actions of Cao Bach Mai, who appropriated 940 billion VND Ultimately, this scheme resulted in a misappropriation of 232 billion VND.
When their existing loan became due, Mai and Xuan struggled to make the payment To resolve their financial situation, they sought a new loan from another bank to cover the overdue amount They persuaded Nguyen Thi Van, Dang Thi Ngan, and Nguyen Thi Kim Loan to approach Orient Commercial Bank in Ho Chi Minh City for borrowing funds, utilizing forged deposit contracts with VDB as part of their scheme.
The OCB was defrauded of 530 billion VND, with notable amounts including 150 billion VND borrowed by Nhat Tan, 50 billion VND by Song Cau Cooperatives, 100 billion VND by Minh Nhat, 200 billion VND by Phat Long, and 30 billion VND by Thuy Ngan Additionally, Phuong Nam Company is currently in dispute with several commercial banks.
Phuong Nam Ltd., founded in 1998, later transformed into Phuong Nam Food Stuff Corporation Jsc (Phuong Nam Jsc.), specializes in the gathering and processing of shrimp, as well as trading shrimp feed and breeding materials The company's key shareholders include Lam Ngoc Khuan, the former Chairman, and Tran Thi.
My (Khuan’s wife), Lam Ngoc Han (Khuan’s daughter, Vietnamese American, former director of the company), and Huynh Phuc Que (Khuan’s grandchildren)
Between 2008 and September 2012, Khuan's business suffered a staggering loss of over 996 billion VND In response, he instructed his daughter and subordinates to commit multiple acts of fraud to secure bank loans This involved fabricating 19 financial reports that falsely indicated a profit of nearly 41 billion VND and inflating inventory values from 123 billion VND to 747 billion VND to meet mortgage requirements Furthermore, Khuan was charged with illegally duplicating original documents, such as raw shrimp purchase records and production cost balance sheets, which were then certified as "copied as original" and stamped by the company for submission to banks for loan disbursement.
From 2008 to 2011, Khuan and his wife invested over 28 billion VND in loans to construct a luxury villa in Soc Trang During this period, Khuan's daughter and chief accountant Lam Minh Man were also instructed to spend nearly the same amount.
In late 2011, Lam Ngoc Khuan and his wife fled to the USA under the pretense of seeking medical treatment after learning that their fraudulent activities involving 72 billion VND for fictitious foreign business trips and partner receptions were under investigation When banks realized that Phuong Nam JSC could not repay its debts, they summoned Khuan, deemed primarily responsible, to return and resolve the outstanding loans, but he was missing.
In July 2012, Lam Ngoc Han fled to the USA, leaving behind unresolved debts of 1,752 billion VND, with nearly 1,600 billion VND as principal owed to seven banks Investigations revealed that Lam Ngoc Khuan and Lam Ngoc Han were the key figures in a significant embezzlement scheme, directing Chief Accountant Lam Minh Man and Deputy Director Trinh Thi Ngoc Phuong to commit fraudulent acts to misappropriate over 785 billion VND in loans.
Figure 4: 7 Banks’ losses to Phuong Nam Company c Duong Thanh Cuong versus Agribank
Duong Thanh Cuong, a resident of Ho Chi Minh City, was sentenced to 20 years in prison in 1996 for multiple crimes, including property fraud, tax evasion, and bribery After serving 10 years, he was released early in 2006 and subsequently founded two construction companies, Tan Dai Phat Jsc and Thanh Phat Ltd., with registered capital amounting to hundreds of billions VND However, upon his return to society, Cuong engaged in even more significant fraudulent activities.
2007 to 2009, Duong Thanh Cuong set up another case in which Agribank Branch
6 lent him 1,300 billion VND Up to October 2012, Agribank Branch 6 had a loss of nearly 1,600 billion VND to this swindler
Starting in mid-2007, Tan Dai Phat partnered with the state-owned Dong Phuong Knitting Company, led by director Le Thanh Cong, to invest in the Commercial Service Centre and Apartment Building projects at 10.
Au Co Street in Tan Phu District, covering over 17,000 m², is owned by Dong Phuong Company, which formed a joint venture named Dong Phuong Phat Ltd To finance the project, Thanh Cuong utilized a temporary land use certificate for the property at 10 Au Co Street as collateral to secure a loan of 170 billion VND from Agribank Branch 6 However, using a temporary land use certificate as mortgage collateral is prohibited, yet Agribank proceeded to approve the loan despite this illegal practice.
In April 2008, Duong Thanh Cuong established Tan Phat Company and appointed his brother-in-law, Thai Cuong, as the director Cuong instructed Thai Cuong to use a temporary land use rights certificate, mortgaged to Agribank, to falsely complete transfer procedures at the Department of Environmental Resources This certificate was then improperly transferred to Tan Phat without Dong Phuong Phat's consent Subsequently, Thanh Cuong used the certificate to secure a loan of nearly 22,000 ounces of gold from Southern Bank and continued to borrow against it multiple times When he could no longer repay the loans, he forfeited the asset to the bank, even though the certificate remained collateral for Agribank Branch 6, where Cuong continued to seek extensions.
Addressing the existing problem of moral hazard
3.1 Prevailing policies and measurements in Vietnam
Globally, economies typically employ two main methods to address moral hazards The first method involves enhancing laws and regulations to deter violators, serving as a warning against unethical behavior A more effective approach, however, is the implementation of protocols, strategies, frameworks, and tools designed to improve information databases, thereby safeguarding the banking system from risks associated with immoral activities.
Vietnam's legal framework has historically targeted illicit economic activities, with many regulations extending to the banking sector It wasn't until 1997 that the Law on Credit Institutions was enacted to address these issues more comprehensively.
Counterfeiting seals and documents of agencies and organizations
Abuse of position and power while performing official duties
Fraudulent appropriation Violating lending regulations in credit institutions’ activities Irresponsibility causing severe consequences
In Vietnam, three businessmen faced a total of 5 years, 2 months, and 10 days of imprisonment for their involvement in moral hazard crimes, highlighting the serious consequences of such actions Despite the implementation of stringent laws and regulations, which have led to numerous life sentences and substantial financial penalties, the prevalence of moral hazard remains a challenge This indicates that existing legal measures may not be sufficient to deter individuals from engaging in unethical practices.
The Deposit Insurance policy was established to safeguard depositors in the event of bank failures, ensuring that when participating banks declare bankruptcy, a designated insurance organization compensates depositors according to legal guidelines This policy plays a crucial role in promoting the stability and healthy growth of the banking sector, helping banks manage risks, including moral hazards Currently, 40 commercial banks in Vietnam are enrolled in the deposit insurance scheme However, this safety net may lead depositors to prioritize higher interest rates over a bank's creditworthiness, potentially resulting in lax management practices Consequently, this overconfidence in deposit insurance can create opportunities for bank employees to engage in fraudulent activities and collusion.
To address moral hazard, Vietnam has implemented guidelines from the BCBS-IADI, focusing on deposit insurance compatibility as outlined in principle 2 By limiting insured deposit conditions, banks are incentivized to be cautious with their investments and lending practices, as they risk their own assets Consequently, banks must develop robust management and oversight systems to ensure effective monitoring of loans and investments Vietnam's Deposit Insurance has set an insurance cap of 50 million VND per deposit, signaling to banks that in the event of bankruptcy, they will bear the majority of the losses However, without diligent oversight, there remains a risk of unscrupulous employees exploiting deposit funds.
In the banking sector, two primary management models are prevalent: the focus model and the dispersion model In Vietnam, most banks adopt the focus model, which often leads to unprofessional operations and increases the risk of moral hazard, as staff frequently juggle multiple tasks In contrast, developed economies implement the separation model to mitigate risks and leverage the expertise of credit officers This model features distinct departments for credit authorization and management at headquarters, while branches maintain separate units for customer relations, credit analysis, and credit approval, reducing opportunities for embezzlement However, this approach is better suited for larger banks due to its resource-intensive nature Pioneers like VCB and BIDV have successfully adopted this model, with VCB achieving a bad debt rate of just 2.73% in 2013, outperforming shareholder expectations and the sector average Despite these measures, the potential for moral hazard persists if customers can bribe senior officers, incentivizing staff to engage in unethical behavior for financial gain.
Building corporation code of conduct
In Vietnam, several commercial banks have implemented their own business cultures to enhance customer perceptions, with a significant emphasis on employee moral standards However, these ethical standards tend to prioritize customer relations over employee commitment to the bank's interests Notably, former state-owned banks like Vietinbank, BIDV, and Vietcombank have established regulations regarding moral standards and codes of conduct, resulting in improved customer satisfaction and a shift away from their previous bureaucratic reputations Despite these advancements, the guidelines for employees regarding their focus on the bank's assets and credit remain vague, only addressing minor operational details Consequently, moral hazards continue to persist within these institutions.
3.2 Unsolved problems to deal with
After looking into the real cases related to moral hazard, and the prevalent actions to cope with them, the general problems could be drawn out:
Customers often seek to exploit banks for financial gain, employing straightforward tactics such as falsifying documents or leveraging their relationships with bank employees Therefore, the primary challenge for banks is to establish effective measures to protect themselves from such deceptive practices.
A significant number of banking issues stem from the misconduct of bank managers and staff, particularly within the credit department Employees often engage in illicit activities, knowingly approving loans for applicants who do not meet the necessary requirements or who have ulterior motives This misuse of funds can lead to financial losses, as improperly allocated resources may be seized and not returned Additionally, the influence of certain customers may tempt bankers to bend or violate rules to extend credit, highlighting a critical challenge that banks must address.
Many banks adopt lax credit and investment policies, neglecting fundamental lending principles and binding conditions This results in inadequate control over fund utilization, leading to insufficient loans and increased bad debts, as well as excessive credit granted to select customers In their pursuit of profitability through credit growth, banks must address the risk of moral hazard to ensure a more responsible lending environment.
Many banks have expanded their offerings to include complex services and products; however, they often fail to update their management and technology accordingly This disconnect hampers their ability to effectively manage these new offerings, highlighting the need for improved staff quality and training within the banking sector.
Bank employees often exploit their knowledge of banking processes to commit fraud, employing sophisticated tactics such as counterfeiting, creating fake accounts for loan applications, and unlawfully withdrawing funds from customers This misconduct is driven by greed and is facilitated by the staff's deep understanding of banking operations, highlighting the critical need for stringent ethical standards within the industry.
The moral hazard problem in Vietnamese commercial banks is worsening across multiple aspects, and current regulations are ineffective in addressing and preventing these issues There are minimal barriers to combat the problem, and while criminals may face charges, the full extent of damages remains unrepaired Given that moral hazard stems from human factors related to both customers and bank personnel, it is crucial to develop further solutions to tackle the unethical behaviors of customers, the dysfunctions within banks, and the misconduct of bank staff.
Recommendations and conclusions
Solutions carried out by banks
To effectively manage operations, commercial banks must implement appropriate policies, particularly in the loan segment where moral hazard is prevalent Addressing issues such as information asymmetry, adverse selection, and moral hazard is crucial Banks should focus on lending to qualified individuals while closely monitoring debts to mitigate potential risks and ensure financial stability.
The primary cause of the moral hazard problem stems from human behavior, highlighting the need for banks to prioritize effective management of their staff and customers.
1.1 Solution to customers regarding bank operation
To mitigate the risk of moral hazard, banks must implement robust internal prevention strategies Given the challenges in assessing the characteristics and ethical behavior of customers and investment partners, it is crucial for banks to establish stringent and effective regulations to safeguard their assets.
First of all, the bank should obey the corporate governance policy austerely
Good corporate governance is essential for fostering economic efficiency, sustainable growth, and financial stability, enabling companies to secure long-term investments while ensuring fair treatment for shareholders and stakeholders According to the OECD, banks must adhere to four key principles: establishing a robust corporate structure, defining management board roles and responsibilities, safeguarding shareholder rights and duties, and ensuring transparency and access to information Adhering to these principles enhances the effectiveness of bank management, as each board member is accountable for their actions Close monitoring of bank operations is crucial to facilitate timely responses to any issues Managing banks is particularly challenging due to their interactions with diverse economic entities, higher risks, and complex regulations; thus, a bank's failure can have widespread repercussions Therefore, good corporate governance is vital for maintaining a bank's reputation, value, and long-term viability.
Commercial banks must implement a robust internal control and auditing system to ensure adherence to their core objectives This internal control framework encompasses essential policies, procedures, and practices designed to maintain the bank's focus on its original goals Additionally, the internal auditing system plays a crucial role in objectively monitoring the bank's operations and providing guidance to management whenever issues arise.
To mitigate moral hazard issues in credit and investment, it is essential to establish clear rules and conditions for providing loans and making investments By controlling the allocation of funds, organizations can ensure responsible financial practices and minimize risks associated with mismanagement.
The G20/OECD Principles of Corporate Governance, established in September 2015, emphasize the necessity for strict compliance with legal and regulatory standards for all borrowing customers and investment projects Banks are only permitted to extend credit when customers meet specific conditions, and investments are contingent upon projects demonstrating effectiveness, profitability, and acceptable risk levels These principles ensure that all banking departments engage in thorough and careful decision-making processes Additionally, clearly defined clauses in lending and investment contracts facilitate the identification of faults or breaches, allowing for swift accountability.
Collateral assets are a crucial requirement in lending contracts, serving as a key factor in the loan process These assets must possess a certain value that aligns with the loan amount, ensuring they can cover the debt in the event of insolvency Stability is vital when selecting collateral, with preferred options including real estate, vehicles, financial documents, and savings accounts The more stable the collateral's value, the more secure the loan becomes Additionally, when borrowers provide high-value assets as guarantees, they are less likely to engage in moral hazard activities, thus protecting banks from potential risks associated with such behavior.
Post-disbursement monitoring is crucial for both loan management and investment oversight Banks must diligently track borrowers to prevent any misuse of funds and ensure compliance with loan agreements Regular updates on the borrower's financial status and other relevant information are essential to mitigate risks of unfavorable incidents These proactive measures are designed to guarantee that loans are repaid on time Similarly, for investments, it is vital to communicate any changes related to the funds, allowing banks to ensure prudent financial management.
1.2 Solution to banks’ human resources
Banking requires transparency and professionalism, as unqualified personnel can lead to poor business outcomes and increased moral hazards To mitigate these risks, banks must prioritize effective recruitment and robust training programs that cultivate high-quality talent and strong work ethics.
Banks must enhance staff awareness of their influential roles and the impact of their work on the institution's success Employees should understand that their contributions serve the bank's interests rather than personal gains Numerous incidents have shown that some bank personnel neglect the protection of the bank's assets, treating them with less care than their own property For instance, credit staff have occasionally granted loans to ineligible customers or for inappropriate purposes, leading to financial difficulties for those clients When faced with the consequences of their decisions, some staff members have chosen to resign out of fear of accountability.
To effectively prevent misconduct among bank staff, it is crucial to enhance employee awareness, establish a robust risk management system, and improve the skills of HR managers Implementing rules that prevent any single employee from holding multiple authorizations is essential Additionally, the accounting and auditing departments should be updated on a daily or regular basis Any signs of fraud or risk must be promptly reported to the management board to ensure swift action.
A key strategy employed by leading global banks is the cultivation of a strong enterprise culture, which encompasses values and behaviors that shape the organization’s unique social and psychological environment According to Ravasi and Schultz (2006), organizational culture consists of shared assumptions that dictate appropriate behaviors in various situations, offering a more appealing alternative to rigid rules and regulations This approach encourages employees to embrace professionalism and positive conduct, enhancing their overall experience Additionally, a well-defined culture not only guides current staff but also attracts potential employees who resonate with these values, thereby easing the recruitment process.
To enhance employee performance and mitigate moral hazards, banks should implement a balanced approach of rewards and penalties Serious penalties should be imposed on employees whose actions lead to significant damages for both the bank and its customers, potentially resulting in legal disputes Conversely, banks should recognize and reward employees based on their contributions, productivity, and attitude, offering valuable incentives and higher bonuses to foster motivation and encourage better work ethics.
Extra solutions needed from the government
Moral hazard in banking significantly impacts not just the banking sector but the overall economy, often leading to substantial government bailouts to stabilize financial systems This situation underscores the urgent need for effective management and stringent oversight to mitigate potential damages.
First of all, the government should harden the punishment for moral hazard behaviors
Fear of penalties can diminish individuals' motivations to engage in moral hazard However, due to gaps in laws and regulations, some criminals receive lenient sentences, allowing the greedy to exploit system flaws and evade consequences for their actions.
Secondly, it is compulsory to propose a high enough reserve requirement and minimum operating capital for banks
Commercial banks are compelled to reevaluate their investment portfolios due to reserve requirements, which mandate that they maintain a certain amount of capital at the central bank and in their own vaults for liquidity purposes Consequently, banks must utilize their idle funds for other investment opportunities, increasing their exposure to risk, as any losses will directly impact their own capital There are three primary types of reserve requirements and minimum working capital: one based on total assets relative to customer deposits, another following the Basel Accords which considers total and off-balance-sheet assets, and a third established in the USA in 1996 for large banks, which involves creating private models to calculate potential losses and setting provisions 2 to 3 times higher than those estimates.
In reality, calling for a minimum amount of capital can be easing providing that there is effective administration and an explicit accounting and auditing system
On the contrary, if the administrative system functions fruitlessly, basing on only the reserve requirement and minimum working capital cannot perform the best result
The third resolution serves as a crucial support mechanism to strengthen the effectiveness of the previously mentioned methods The government aims to implement measures such as establishing interest rate ceilings and floors, regulating loan classifications, narrowing investment segments, and maintaining precise accounting and auditing records.
Limiting interest rates helps prevent banks from excessively lowering rates to attract funds, which could lead to risky investments Additionally, restricting loan targets and investment ranges safeguards against easy lending to dishonest borrowers and mitigates risky project investments In the USA, banks are prohibited from holding common shares in corporations, while in some countries, significant investments require central bank approval Although strict regulations may challenge the banking system's growth, they are essential for maintaining market safety and economic stability.
Commercial banks are essential to the national economy, offering a wide range of irreplaceable services that support overall economic performance and development Any deficiencies or operational issues within a bank can adversely affect not only its own business but also the entire banking system, potentially leading to significant repercussions for the country's economy and spreading risks to other sectors.
Moral hazard poses a significant threat to the stability of banks and the broader economy, necessitating urgent measures to address this critical issue within commercial banks.
Addressing the moral hazard issue within Vietnam's banking system necessitates collaboration between banks and the government Effective control can only be achieved through favorable conditions and appropriate measures This cooperation will enhance the security of the banking environment, allowing banks to operate more efficiently Ultimately, this approach will help mitigate the challenges posed by a malfunctioning banking system, thereby supporting sustainable economic development in Vietnam.
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Asymmetric information in the banking sector significantly impacts loan agreements, leading to adverse selection and moral hazard Adverse selection occurs when lenders struggle to differentiate between high and low credit risks, causing good firms to withdraw from borrowing due to inflated interest rates Consequently, banks end up with a portfolio dominated by bad credit risks Moral hazard arises post-loan disbursement, where borrowers may invest in high-risk projects, undermining lender interests due to information asymmetry To mitigate these issues, effective strategies such as credit referencing, data sharing, government participation, and improved loan underwriting processes are essential for enhancing transparency and reducing risks in the banking sector.
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