2. Credit risk assessment:
Traditional lending products
Short-term
Loans
• Seasonal lines of credit
• Special purpose loans (temporary needs)
• Secured or unsecured
Mid & Long-term
Loans
• Mature in more than 1 year
• Purchase fixed assets or another company,
refinance debt, etc.
• Often secured
Revolving
Loans
• Like a seasonal credit line
• Interest rate usually “floats”
Public Debt
• Bonds, debentures, notes
• Sinking fund and call provisions
• Covenants
6-2
3.2 Managing Credit
1/17/2024 2
3. Credit analysis:
Evaluating the borrower’s ability to repay
Understand
the business
Step 1: • Business model and strategy
• Key risks and success factors
• Industry competition
Evaluate
accounting quality
Step 2: • Spot potential distortions
• Adjust reported numbers as needed
Evaluate current
profitability and health
Step 3: • Examine ratios and trends
• Look for changes in profitability, financial
conditions, or industry position.
Prepare “pro forma”
cash flow forecasts
Step 4: • Develop financial statement forecasts
• Assess financial flexibility
Due diligence
Step 5:
• Kick the tires
Comprehensive risk
assessment
Step 6: • Likely impact on ability to pay
• Assess loss if borrower defaults
• Set loan terms
6-3
1/17/2024 3
4. The Credit Rating Process
More risk
Less investors
are willing to
pay
Investor’s belief about credit
risk influence the price paid
– and thus the amount
borrowed
The higher the
credit rating
The lower is
the default risk
Three agencies (Moody’s, Standard &
Poor’s, and Fitch) assess and grade the
creditworthiness of companies and public
entities that sell debt to investors. Credit
ratings are letter-based grades (AAA, BBB)
that express the rating agency’s opinion
about default risk.
6-4
1/17/2024 4
6. 6
3.2 Managing Credit
3.2.1 Credit Risk
• Risk is inherent in banking and is unavoidable.
The basic function of bank management is risk
management.
• Credit risk arises when a bank cannot get back
the money from loan or investment.
• Credit risks in banking activity mean loss which
able to happen with respect to debts of banks
because customers fail to implement or have no
capacity to implement part or whole their
obligations as committed.
1/17/2024
7. 7
3.2 Managing Credit
3.2.1 Credit Risk
◼ Credit risk is the risk caused by the eventual
default of borrowers on their obligations to
the bank and is also the risk of loss of
present bond values due to the degradation
of the issuer. This last one is also called risk
of degradation.
1/17/2024
8. 8
3.2 Managing Credit
3.2.1 Credit Risk
The level of non performing loans is recognized
as a critical indicator for assessing banks’ credit
risk, asset quality and efficiency in the allocation
of resources to productive sectors. Non-
performing assets are a leading indicator of credit
quality. Include:
• Non-accrual loans are those whose cash flows stream is so
uncertain that the bank does not recognize income until
cash is received
• Restructured loans are those whose interest rate has been
lowered on the maturity increased because of problem with
borrower.
1/17/2024
9. 9
3.2 Managing Credit
3.2.1 Credit Risk
The assets of a bank whether a loan or investment carries
credit risk. Credit risk is the risk of losing money when loans
default. Credit risk or default risk gives rise to problems to
bank management. The principal reason for bank failures is
bad loans. Banks can raise their credit standards to avoid
high risk loans. Guarantees and collateral can reduce risk.
After the loan is made compliance can be ensured by
monitoring the behavior of the borrower which reduces risk.
Credit risk can be transferred by selling standardized loans.
Loans portfolio can be diversified by making loans to a variety
of firms whose returns are not perfectly and positively
correlated.
1/17/2024
10. 10
3.2 Managing Credit
3.2.1 Credit Risk
The banks should put in place the loan
policy covering the methodology for
measurement, monitoring and control of
credit risk.
Banks are expected to evolve
comprehensive credit rating system that
serves as a single point indicator of diverse
risk factors of counter parties in relation to
credit and investment decisions.
1/17/2024
11. 11
3.2 Managing Credit
3.2.1 Credit Risk
NATURE OF CREDIT RISK
Among the transactions risk the most important are
liquidity risk and credit risk. Credit risk is inherent
in banking. Banks are successful when the risks
they take are reasonable, controlled and within
their financial resources and competence. Credit
risk covers all risks related to a borrower not
fulfilling his obligations on time. Even where assets
are exactly matched by liabilities of same maturity,
the same interest rate conditions and the same
currency, the only on balance sheet risk remaining
would be credit risk.
1/17/2024
12. 12
3.2 Managing Credit
3.2.1 Credit Risk
NATURE OF CREDIT RISK
Credit risk exposure is measured by the current
mark to market value. The magnitude of credit risk
depends on the likelihood of default by the counter
party, the potential value of outstanding contracts,
the extent to which legally enforceable netting
arrangements allow the value of offsetting contracts
with that counter party to be netted against each
other or the value of the collateral held against the
contracts.
1/17/2024
15. 15
3.2 Managing Credit
3.2.1 Credit Risk
The 6 C’s of Credit
The evaluation of the loan request by the bank involves the
6 C’s of credit.
• Character (borrowers personal characteristics such as
honesty, attitudes about willingness and commitment to pay
debts).
• Capacity (the success of business).
• Capital (financial condition).
• Collateral.
• Conditions (economic).
• Compliance (laws and regulations).
1/17/2024
16. 16
3.2 Managing Credit
3.2.1 Credit Risk
◼ Granting credit and monitoring the resulting
default risk is the primary activity of banks.
As credit risk is difficult to “hedge” or remove
from the balance sheet (for most banks in
the world anyway), it is self-evident that the
most effective credit risk management policy
is to operate a sound loan origination policy.
1/17/2024
17. 17
3.2 Managing Credit
3.2.2 Classification of assets
❖ Interpretation of terms
◼ Risk provisions mean the amounts set up and
accounted into the operational cost in order to provide for
losses which may happen for debts of credit institutions,
foreign banks’ branches. Risk provisions include specific
provisions and general provisions.
• Specific provisions mean the amount set up in order to
provide for losses which may happen for each specific
debt.
• General provisions mean the amounts set up in order to
provide for losses which may happen but have not
defined when setting up specific provisions.
1/17/2024
18. 18
3.2 Managing Credit
3.2.2 Classification of assets
❖ Interpretation of terms
◼ Overdue debt means a debt which part or
whole of its principal and interest has become
overdue.
◼ Bad debt (NPL) means debts which have been
classified as those in Groups 3, 4 and 5.
◼ Rate of bad debt means rate of bad debts in
comparison with total debts of from group 1 to
group 5.
1/17/2024
19. 19
3.2 Managing Credit
3.2.2 Classification of assets
◼ Banks have been instructed that they should
not charge and take interest on non-
performing assets to the income account.
◼ Classification of assets into these categories
had to be done taking into account the degree
of well-defined credit weaknesses and extent
of dependence on collateral security for
realization of dues. The health code system of
classification of assets would, however
continue as a management information tool.
1/17/2024
20. 20
3.2 Managing Credit
3.2.2 Classification of assets
◼ Banks implement classification of debts (excluding
payments under off-balance sheet commitments)
according to 05 groups as follows:
a) Group 1 (standard debts)
b) Group 2 (debts, which need attention)
c) Group 3 (sub-standard debts)
d) Group 4 (doubtful debts)
e) Group 5 (potentially irrecoverable debts)
1/17/2024
21. 21
3.2 Managing Credit
3.2.2 Classification of assets
Taking into account the time-lag
between an account becoming doubtful
of recovery, its recognition as such, the
realization of the security and the
erosion over time in the value of security
charged to the banks, banks are
required to make provision against sub-
standard assets, doubtful assets and
loss assets.
1/17/2024
22. 22
3.2 Managing Credit
3.2.2 Classification of assets
❖ Specific levels of setting up provisions:
◼ Amount of specific provision required to set up for
each customer shall be calculated under the
following formula:
Ri = (Ai - Ci) x r
• Ai: The original balance i;
• Ci: the deducted value of security assets, financial leasing
assets (hereinafter referred to as security assets) of debt i;
• r: rate of specific provisions required to set up under group
as prescribed in clause 2 this Article.
• If Ci > Ai, Ri shall be calculated equal to 0.
1/17/2024
23. 23
3.2 Managing Credit
3.2.2 Classification of assets
❖ Specific levels of setting up provisions:
◼ Ratio of specific provisions required to set up for
each debt group (r) as follows:
a) Group 1: 0%;
b) Group 2: 5%;
c) Group 3: 20%;
d) Group 4: 50%;
e) Group 5: 100%.
1/17/2024
24. 24
3.2 Managing Credit
3.2.2 Classification of assets
❖ Specific levels of setting up provisions:
❑ The maximum deduction rate for security assets:
a) Deposit of customer in Vietnam dong: 100%;
b) Gold bar, except gold bar specified in point i this clause;
deposit of customer in foreign currency: 95%;
c) The Government’s bonds, negotiable instruments, valuable
papers which are issued by itself; saving card, deposit
certificates, exchange bills, treasury bills issued by other credit
institutions, foreign banks’ branches:
- With remaining term of less than 1 year: 95%;
- With remaining term of between 1 year and 5 years: 85%;
- With remaining term of more than 5 years: 80%.
1/17/2024
25. 25
3.2 Managing Credit
3.2.2 Classification of assets
❖ Specific levels of setting up provisions:
❑ The maximum deduction rate for security assets:
d) Securities which are issued by other credit institutions and
listed on the Stock Exchange: 70%;
dd) Securities which are issued by other enterprises and listed
on the Stock Exchange: 65%;
e) Securities which are unlisted on the Stock Exchange,
valuable papers, except clauses specified in point c this clause,
and issued by credit institutions which have registered
securities listing on the Stock Exchange: 50%;
Securities which are unlisted on the Stock Exchange, valuable
papers, and issued by credit institutions which fail to register
securities listing on the Stock Exchange: 30%;
1/17/2024
26. 26
3.2 Managing Credit
3.2.2 Classification of assets
❖ Specific levels of setting up provisions:
❑ The maximum deduction rate for security assets:
g) Securities which are unlisted on the Stock Exchange,
valuable papers issued by enterprises which have registered
securities listing on the Stock Exchange: 30%;
Securities which are unlisted on the Stock Exchange,
valuable papers issued by enterprises which fail to register
securities listing on the Stock Exchange: 10%;
h) Real estate: 50%;
i) Gold bar which has no listing price, other gold and other
security assets: 30%.
1/17/2024
27. 27
3.2 Managing Credit
3.2.2 Classification of assets
❖ The general provision :
The amount of general provision which have to set
up is defined by 0.75% of total balances of debts
from group 1 to group 4.
1/17/2024
