Financial and Monetary Theory - Assignment

HANOI UNIVERSITY FACULTY OF MANAGEMENT AND TOURISM

Financial and Monetary Theory

OVERVIEW OF COMMERCIAL BANKS OPERATIONS IN VIET NAM

Tutor: Ms. Nguyn Hng Linh Tutorial: 1 AC-09 Students: Nguyn Th Huyn Mai Th Thy Khng D Kim Nguyn Th Nga 1

Financial and Monetary Theory - Assignment Nguyn Minh Trang

Table of content
I. OVERVIEW OF COMMERCIAL BANK OPERATION 1. Sources of fund5 2. Uses of fund.7 3. Off balance sheet transaction...9 II. BALANCE SHEETS STRUCTURE OF VIETCOMBANK 1. 5 years balance sheets.10 2. Sources of fund...11 3. Uses of fund....12 4. Off balance sheet.14 III. ASSET AND LIABILITY MANAGEMENT 1. ALM framework.15 2. Risk measurement techniques.15 IV. ASSET AND LIABILITY MANAGEMENT BY VIETCOMBANK 1. Asset management...16 2. Liability management..19 V. CAPITAL MANAGEMENT BY VIETCOMBANK. ...20 VI. ANSWER FOR THE QUESTIONS AT THE END OF THE PRESENTATION24 REFERENCES.27 APPENDIX...29

Financial and Monetary Theory - Assignment

Acknowledgement
First of all, we would like to express our heartfelt gratitude to all those who gave us the possibility to complete this report. We want to thank all Faculty of Management and Tourisms lecturers, tutors and staffs whose ideas gave an opportunity for our work to happen and for our skills to improve. We would thank Ms. Nguyen Quynh Anh our Financial and Monetary Theorys lecturer who inspired us with this interesting subject and also gave us many necessary advices on the topic we chose. We deeply indebted to our supervisor, Ms. Nguyen Huong Linh from Faculty of Management and Tourism whose suggestion, encouragement helped us to head on this report and presentation. We could not complete our work without her bountiful guiding, advising and reviewing. We would like to describe our cordial thanks to our seniors in Hanoi University who devoted themselves helping and sharing experiences during our working process. Last but not least, we would like to thank all of our friends at Faculty of Management and Tourism and English Department who made our working process much more pleasant and comfortable. We highly appreciate their enthusiastic assistance.

Financial and Monetary Theory - Assignment

Introduction
This report aims to investigate the opportunity to invest in banking industry in Vietnam. Recognizing the inevitable trend of globalization, one of the key objectives of Vietnam Government is to ensure the successful integration into the world economy, especially after the ratifying WTOs membership agreement on 11 January 2007.There is a reasonable concern in Vietnam banking industry that the full implementation of WTO obligations to open the domestic banking sector to compete with Western and other foreign banks will bring harmful effects on local banks. Therefore, this report was conducted to create an overview on the situation of Vietnam banking industry. Commercial banks play an important and irreplaceable role in banking industry. They provide various services to sectors of the economy, e.g., information services, liquidity services; transaction cost service...The effect of a disruption in provision of commercial bank sectors makes a case for monitoring the overall economy. Accordingly, to get a specific view on banking industry, we carried out a detailed analysis on commercial banks operations. This report focuses on Vietcombank as a typical example of commercial banks in Vietnam in the end of the financial year 2010. In order to conduct the report, annual reports, the annual general meetings for the financial year of 2006 to 2010 and external websites are carefully examined. As a result, the overview of Vietcombank business operations: sources of funds, uses of funds, off balance sheet transactions are clearly analyzed and presented. For better understanding of the bank, our team also conducted an extensive research on the balance sheet of Vietcombank for the last five years. After gathering all information, we analyzed the structure of these balance sheets, the major sources of funds, uses of funds for this bank. The report looks more specifically at the impact of each aspect of Vietcombank to get a general view on banking industry as a whole.

Financial and Monetary Theory - Assignment

I. OVERVIEW OF COMMERCIAL BANKSOPERATIONS IN VIET NAM In recent years, Vietnamese commercial banks have flourished in terms of number and size, playing an increasingly significant role in the economy. By definition, commercial banks are financial institutions specified in deposits and making loans. On one hand, commercial banks collect funds by holding deposits for individuals and businesses in the form of checking and savings accounts or certificates of deposit of varying maturities. On the other hand, they issue loans from their pool of deposits to borrowers and earn revenue from the differences in the interest rates. Commercial banks are an important channel directing the funds in the market from lenders to borrowers, thereby facilitate a healthy economy; and any bank failure would lead to unpredictable consequences. Therefore, commercial banks should be aware of their responsibilities in the national economic developments, whereas the Central bank and the government need to apply strict regulations in this section. In order to get a deeper understanding about the most popular and important financial institutions in Vietnam, it is necessary to carry out a throughout investigation into the operation of commercial banks. Having been considered as a precise and official picture reflecting the banks operation, the annual balance sheets provide us with information which is of vital importance in identifying the banks sources of fund, uses of funds and off balance sheet transaction. 1. Sources of funds First of all, it should be noted that different from many other organizations, the commercial banks sources of fund is also its liability. Bank's liabilities often include four major items. Deposits are the money owned by customers and therefore it is a liability of a bank. There can be various kinds of deposits and recurring deposits, consisting of checkable deposits and non transaction deposits (saving account, time deposits). Another important item in the liability of commercial banks is the bank capital. Apart from these, the banks borrowings, which can be from the Central bank and other commercial banks, are also treated as its liabilities. Deposits remain the largest source of funds for a commercial bank. The money collected can go toward paying on interest-bearing accounts, completing customer withdrawals and other transactions. In 2010 the total money supply from deposits held at Vietcombank totaled VND 258,706,643 .Checkable deposits and money market deposit accounts (MMDAs) are the lowest

Financial and Monetary Theory - Assignment

cost sources of fund but highest liquidity because they are payable on demand, making up about 17 percent of liability of Vietcombank since customer are willing to forgo their interest because of their liquidity preference. Therefore, to maintain these source of fund commercial banks are not only interested in the interest payment, but also charge fees for providing customers with services such as maintaining an account, offering overdraft protection and also monitoring customers' credit scores. Saving deposit and time deposit (included in non-transaction deposit) are primary sources of banks funds. Currently, the commercial banks stipulate account holders can perform six transfers per month in the form of online, telephone or overdraft transfers. This regulation allows banks to use the accounts' funds and still meet the withdrawal needs of the customers. Time deposit refers to a savings account or certificate of deposit that pays a fixed rate of interest until a given maturity date. Funds placed in a time deposit usually cannot be withdrawn prior to maturity or they can perhaps only be withdrawn with advanced notice and/or by having a penalty assessed. Another kind of source of funds is borrowed funds. For Vietnamese commercial banks, borrowed funds only make up small proportion of banks liability. It is obtained by borrowing from the federal fund, other banks and corporations. A commercial bank also builds a reserve fund with deposits so it can pay interest on accounts and complete withdrawals. Ideally, a bank's reserve fund should be equal to its capital. A bank builds its reserve fund by accumulating surplus profits during healthy financial years so that the funds can be used in leaner times. On average, a bank tries to accumulate approximately 12 percent of its net profit to build and maintain its reserve fund. Beside, some commercial banks that trading on the stock exchange can use shareholders' capital to receive the money it needs to stay in business. For example, if a company sells shares on the market, it increases both its cash flow and its share capital. This process is also known as equity financing. Banks can only report the amount of capital that was initially on their balance sheet. Appreciation and depreciation of shares do not count toward the total sum of a shareholder's capital.

Financial and Monetary Theory - Assignment

Moreover, a lot of commercial banks earn retained earnings or fees to help fund their business. Retained earnings can be collected through overdraft fees, loan interest payments, securities and bonds. Banks also charge fees for providing customers with services such as maintaining an account, offering overdraft protection and also monitoring customers' credit scores. Table 1: Banks sources of funds The structure of sources of fund of VCB, ACB, VTB represent for commercial banks. It shows the largest source of funds is deposit. In VCB deposit represents 77.99%, in ACB it is 67.85% and it makes for 81.71% in Vietinbank.

Sources of funds Borrowings: From SBV From other banks Non transaction deposits: Customer deposits Valuable papers issued Other liabilities Bank capital Total

VCB

ACB

Vietinbank

3.27% 8.2%

5.26% 14.65%

4.29% 2.5%

66.59% 11.4% 2.85% 7.69% 100%

53.85% 14% 4.91% 7.33% 100%

80.39% 1.32% 5.2% 6.3% 100%

2. Uses of funds Another component of balance sheet of commercial banks is uses of funds. These are considered as the banks assets, comprising cash, money at short notice, bills and securities

Financial and Monetary Theory - Assignment

discounted, bank's investments, loans sanctioned by the bank, etc. When a bank makes money available at short notice to other banks and financial institutions for a very short period of 1-14 days it is also treated as bank's assets. Apart from these items, bank always make money available to people on the form of loans and advances. They also become commercial bank's assets. Cash represents only 1.7% of assets of Vietcombank in 2010. That's because the commercial bank wants to put its money to work earning interest. If the bank simply sticks its cash in a vault and forgets about it, it will have a hard time making a profit. Thus, a bank keeps most of its money tied up in loans and investments, which are called "earning assets" in bankspeak because they earn interest. Commercial banks keep a certain portion of their assets in government backed securities this gives the bank diversity, stability and safety. The bank is also able to pledge these securities as collateral with the Federal Reserve or Federal Home Loan Bank for purposes of obtaining credit lines from these institutions whenever necessary. Banks may also purchase private labelbacked mortgage bonds, but this presents risk and possible defaults. Loans represent the majority of a bank's assets. A bank can typically earn a higher interest rate on loans than on securities, roughly 6%-8%. You can find detailed information about the rates earned on loans and investments in the financial statements. Loans, however, come with risk. If the bank makes bad loans to consumers or businesses, the bank will take a hit when those loans aren't repaid. Commercial banks make all types of loans to consumers and businesses. They are able to service their clientele with all types of lending transactions. On the other hand, business entities require start-up loans, SBV loans, business lines of credit, working capital loans and construction loans. Other assets, including property and equipment, represent only a small fraction of assets. A bank can generate large revenues with very few hard assets. Table 2: Banks uses of funds

Financial and Monetary Theory - Assignment

The table shows the biggest component of assets of commercial banks (VCB, ACB, Vietinbank ) is loans. It makes for 81.57%, 71.26%, and 65.53% in VCB, ACB and VTB respectively

Uses of funds Cash items Balances with SBV Securities: Trading securities Investments in securities Loans: To other banks To customers Long term investments Fixed assets Other assets Total 3. Off balance sheet transactions

VCB 1.7% 2.68%

ACB 5.77% 6.02%

Vietinbank 1.64% 10%

0.004% 10.67%

0.89% 11.28%

0.13% 18.74%

24.92% 56.65% 1.29% 0.52% 1.57% 100%

34.04% 37.22%

14.33% 51.2% 1.4%

1.38% 3.4% 100%

0.64% 1.92% 100%

The last component of commercial banks operation is off balance sheet items. It generates fee income without investing funds. These consist of contingent liabilities of a bank, direct credit substitutes in which a bank substitutes its own credit for a third party, including standby letters of credit; guarantee repayment of commercial paper or tax-exempt securities; risk participations in bankers' acceptances; sale and repurchase agreements; and asset sales with recourse against the seller; interest rate swaps; interest rate options and currency options, and so on. Contingent liabilities are possible future liabilities that will only become certain on the occurrence of some future event.

Financial and Monetary Theory - Assignment

Undrawn loans commitments include both obligations to pay, and other commitments to provide funds. Such commitment may include contractual offers to lend to bank borrowers. Although the borrower may not have drawn on such a line of credit, it still represents a potential liability for the bank

Table 3: Banks off balance sheet transactions In almost commercial banks, contingency liabilities commitment represents the biggest percentage in off balance sheet transactions.

Off balance sheet transactions Contingency liabilities commitment: Lending commitment

VCB

Vietinbank

67.36% Guarantees commitment Letters credit commitment 30.48% 19.21% 45.67%

Un-drawn loans commitment

2.16%

35.12%

II. BALANCE SHEETS STRUCTURE OF VIETCOMBANK 1. Balance sheet of Vietcombank during 5 year period from 2006 to 2010 (Appendix) For all the investors as well as managers of companies, the companys financial statements are very important to make decision. Among these financial statements, balance sheet is one of the most necessary and useful for investors and managers to evaluate the capital structure, asses risk and future cash flows; analyze the companys liquidity, solvency and financial flexibility.

10

Financial and Monetary Theory - Assignment

Below are the most up-dated balance sheets of Vietcombank during the 5-year period from 2006 to 2010. All of these balance sheets are consolidated so they are very reliable and trustworthy. Similar to any common balance sheets, Vietcombank balance sheets include 3 main parts and it has the characteristics that: total assets = total liabilities + owners equity. Liabilities are the sources of bank funds and assets are use of bank funds. Because Vietcombank is a commercial bank, it is understandable that the main activity of this bank is to take deposits and make loan. 2. Sources of fund As mentioned above, the main activity of Vietcombank is to take deposits and make loan. Hence, the biggest sources of fund of Vietcombank are from customer deposits. In 2006, Customer deposits was VND 111,916,337 million (71.82 % of total liabilities), increasing to VND 141,589,093 million in 2007. However, this increase made the proportion of deposits from customers in total liabilities increase by 5.23 %. From 2008 to 2010, though Vietcombank tried to attract customer deposits more to rise the amount of customer deposits, the proportion of this item in total liabilities decreased slightly to 71.42 %.The reason is that the proportion of deposits and borrowing from other credit institutions increased dramatically by 8.06 from 12.71% to more than 20.77 % .Due to the Government and the State Bank of Viet Nam fluctuated significantly during this period. In 2006, this item was 16,791,428 million VND (accounting for 10.78% of total liabilities), declining quickly to 4.5 % in 2008, then surprisingly rose to 9.06 % in 2009 and fell dramatically to 3.5 % in 2010.

Figure 1: VCBs major sources of funds

11

Financial and Monetary Theory - Assignment

Table 4: VCBs major sources of funds Sources of Funds Due to the Government and the SBV Due to other banks Customer deposits Valuable papers issued Other borrowed funds Other liabilities Bank capital Minority interest Total 2010 3.28% 19.36% 66.59% 1.16% 0.00% 2.85% 6.72% 0.04% 100% 2009 8.84% 15.20% 66.17% 0.00% 0.15% 3.02% 6.54% 0.04% 100% 2008 4.28% 11.91% 70.72% 0.25% 1.32% 5.19% 6.28% 0.05% 100% 2007 6.43% 9.09% 71.72% 1.63% 1.25% 2.97% 6.86% 0.04% 100% 2006 10.05% 7.28% 66.96% 5.20% 1.48% 2.21% 6.72% 0.04% 100%

3. Uses of funds

12

Financial and Monetary Theory - Assignment

It can be seen that the major use of fund of Vietcombank is Loans to customers, which is relevant for a commercial bank. More importantly, loans to customers increased both in the amount and in the proportion in total assets during the five-year period from 2006 to 2010, indicating that Vietcombank has strategy to increase loans to customers. This fact also suggests a profitable period of Vietcombank because banks make their profits primarily by issuing loans. In 2006, Loans to customers was 66,250,888 million VND (account for 39.64 % of total assets), then increasing to 171,124,824 million VND (comprise of 55.65 % of total asset). The second biggest use of fund of Vietcombank was due from other banks which constituted 31.25 % of total assets and decreased to 25.9 % during the period because of the increasing in proportion of loans to customer in total assets. The other uses of funds of Vietcombank are cash and cash equivalent on hand, trading securities, investment in securities, long term investment and fixed assets. Figure 2: VCBs major uses of funds

Table 5: VCBs major uses of funds Uses of funds 2010 2009 2008 2007 2006

13

Financial and Monetary Theory - Assignment

Cash and cash equivalents on hand Balances with the SBV Due from other banks Trading securities Loans to customers Investments in securities Long-term investments Fixed assets Other assets Total 1.70% 2.68% 25.90% 0.00% 55.65% 10.67% 1.29% 0.52% 1.78% 100% 1.76% 9.85% 18.57% 0.00% 53.62% 12.77% 1.42% 0.59% 1.41% 100% 1.57% 13.76% 13.67% 0.14% 48.91% 18.72% 1.37% 0.61% 1.25% 100% 1.62% 5.91% 21.07% 1.43% 48.34% 19.11% 0.84% 0.53% 1.14% 100% 1.45% 7.09% 31.25% 0.34% 39.64% 18.19% 0.58% 0.66% 0.80% 100%

4. Off balance sheet items Table 6: VCBs off balance sheet items Off balance sheet items 2006 (million VND) Lending commitment 1,766,133 Letters of credit commitments (2.88 %) 26,021,012 Others guarantees (42.45 % ) 33,505,945 Un-drawn loan commitments (54.67 % ) (52.48 % ) ( 0.66 % ) ( 0.84 % ) ( 2.15 % ) (46.35 % ) 45,038,952 (29.40 % ) 231,411 ( 29.41 % ) 380,811 ( 30.49 % ) 1,100,805 (1.18 %) 39,777,118 ( 70% ) 10,254,890 ( 69.75 % ) 13,338,765 (67.37 % ) 15,630,554 1,008,968 24,628,918 31,639,498 251 34,540,188 2007 2008 2009 2010

These off balance sheet items are Vietcombanks future obligation and might happen if conditions are met. Although these items are not shown in balance sheet, however their amount is relatively big and affect bank 14

Financial and Monetary Theory - Assignment profits so they also affects decision of investors and should be disclosed. In both 2006 and 2007 undrawn loan commitments is the biggest amount Of off balance sheet items (account for more than 50%). In contrast, from 2008 to 2010 the proportion of letters of credit commitments was highest in total of off balance sheet items

III. ASSET AND LIABILITY MANAGEMENT 1. Asset and liability management framework Asset liability management function in banks is not only a regulatory requirement but also an imperative for strategic bank management. Asset liability management (ALM) is essentially management of the timing and the value of the cash flow in banks and the consequential risks. ALM assumes critical significance in banking because the banks typically borrow short and lend long and therefore, the mismatch between cash inflows and cash outflows is inherent in banking. The fact that the banks are highly leveraged institutions with their operations being 10 to 12 times their own funds exacerbates the problem. Interest rate volatility and the high-voltage competition of the modern financial marketplace and exploding expectations from customers make the matters more difficult. Therefore, ALM becomes an essential strategy for survival by focusing on the dynamic relationship between the patterns of cash inflows and cash outflows.

The short term objective of ALM in a bank is to ensure liquidity while protecting the earnings and the long term goal is to maximize the economic value of the bank, i.e., the present value of banks expected net cash flows, defined as the expected cash flows on assets minus the expected cash flows on liabilities plus the expected net cash flows on off balance sheet positions. Other objectives of ALM are: maximizing profitability, minimizing of capital, ensuring structural liquidity and ensuring robustness in market risk management. 2. Risk measurement techniques

15

Financial and Monetary Theory - Assignment

There are various techniques for measuring exposure of banks to interest rate risks they include: gap analysis model, duration model, value at risk, simulation and capital adequacy ratio (CAR). a. Gap analysis model: Measures the direction and extent of asset-liability mismatch through either funding or maturity gap. It is computed for assets and liabilities of differing maturities and is calculated for a set time horizon. This model looks at the reprising gap that exists between the interest revenue earned in the bank's assets and the interest paid on its liabilities over a particular period of time. It highlights the net interest income exposure of the bank, to changes in interest rates in different maturity buckets. b. Duration model: Duration is an important measure of the interest rate sensitivity of assets and liabilities as it takes into account the time of arrival of cash flows and the maturity of assets and liabilities. It is the weighted average time to maturity of all the preset values of cash flows. Duration basically refers to the average life of the asset or the liability. c. Value at Risk: Refers to the maximum expected loss that a bank can suffer over a target horizon, given a certain confidence interval. It enables the calculation of market risk of a portfolio for which no historical data exists. It enables one to calculate the net worth of the organization at any particular point of time so that it is possible to focus on long-term risk implications of decisions that have already been taken or that are going to be taken. It is used extensively for measuring the market risk of a portfolio of assets and/or liabilities. d. Simulation: Simulation models help to introduce a dynamic element in the analysis of interest rate risk. Gap analysis and duration analysis as standalone tool for asset- liability management suffer from their inability to move beyond the static analysis of current interest rate risk exposures.

IV. ASSET AND LIABILITY MANAGEMENT BY VIETCOMBANK 1. Asset management a. Expanding loans to Small and medium enterprises (SMEs) to diversify risks. The list of credit of Vietcombank focuses on large enterprises (accounted for 60% of total loans) in which the state owned enterprises consists of 47%. These customers often have high level of credit risk, long project life cycle, and the ability to recover capital low so that the credit

16

Financial and Monetary Theory - Assignment

risk is generally higher than among SMEs. On the other hand, the loan portfolio of VCB focuses on manufacturing, exporting and services accounted for 60% of outstanding loans. Those sectors are easily affected by economic downturn, that leading to bad debt of VCB so high in 2008 (4.6%). However, with the recent recovery of the import-export trading, the debt ratio fell to 2.83% in 2010. Vietcombank virtually have no outstanding loans on real estate and investment securities because of their riskiness. Unlike the large customers, the loans to individual customers have different risk. When the credit is tightening to ensure the credit growth of 25% by government, the most affected customers are individuals. Because of that, on average of three years from 2007 to 2009, personal lending grew 21.3%, only slightly better than growth in total loans of banks (20.5%), so the proportion of loans to individual customers with significant improvement only oscillations around 9.5% -10%. Because of the riskiness of the above two types of loans, Vietcombank are restructuring in positive way that change loan from big business group to small and medium enterprises (SMEs). The clientele of SMEs rose significantly over 2009 and 2010. In 2009, this group increased 35%, which is 1.4 times growth in total loans. The first six months in 2010, this rate increased 16%, double the growth rate of total loans. This trend is also the long-term strategy of Vietcombank: expanding group of customers to small and medium enterprises to diversify risks.

Figure 3: Outstanding loan according to customers 6/30/2010

17

Financial and Monetary Theory - Assignment

b. Classify debt and estimate allowance for doubtful account carefully. At the second quarter of 2000, Vietcombank was the first bank apply the classification of debt standard rank results of each customers according to internal credit rating system) combined with quantitative (real ability of their customers to repay the loan at the classification time). With the application of new credit rating system, bad debt increased dramatically (4.1% at the second quarter of 2010) in contrast 2.5% at 12/31/2009. The debt under standard rose sharply from 0.3% to 23% of total outstanding debt, however, debt that had potential capital loss down from 1.9% to 1.5% of the total outstanding loss. The Board management of Vietcombank expressed a cautious attitude in loan classification and allowance for uncollectible accounts. The loans (including loans to state enterprises e.g Vinashin) are re-evaluated according to the internal crediting system and the bank also estimated the allowance for bad debt expense carefully so that the quality of assets can be ensured.

Figure 4: The bad debt of VCB over several years

c. Investment portfolio is quite conservative and safe. Investment portfolio is quite conservative and safe. And debt securities are accounted for 99.7%. The short term investment of Vietcombank accounted for only 8% and the provision rate is quite low (3%). Vietcombank mainly invest in banking, finance and insurance, especially, there are some investments with low cost at big banks like Eximbank, Military bank, Gia Dinh bank During 9/2010, Vietcombank liquidated some investments to ensure adequate capital above 9% and the ratio of capital contribution to other credit institutions must not exceed 11% charter capital of this organization (According to Circular 13/2010/TT-NHNN). Spcefically, they sold 5 million stocks of EIB (8.76% to 8.19%) and 1 million stock PVD (reduce the ownerstock in Gia Dinh bank from 15.1% to 3.83%). Selling those stocks brought Vietcombank 150 billion

18

Financial and Monetary Theory - Assignment

profit and reduced the riskiness of asset investment.

2. Liability management a. Balance of raising capital from residents and economic organizations. Before 2009, Vietcombank borrowed mainly from economic organizations (accounting for 68%) in which, statedown companies consisted the largest proportion (32%). However, in 2009, 2010, borrows from residents rose significantly at 35% and 28.5% respectively. The reason why they were trying to borrow from personal sector is that if several large corporations began declining deposits at the bank, the bank would suffer big withdrawing and may not cover the gap quickly that can lead to bankruptcy. To offset the decline in deposits of large economic organizations, Vietcombank mobilized the source of funds rising from individual customers to reduce risk.

Figure 5: Sources of funds (individuals, organizations)

31.12.2007

31.12.2010
Organisation

31% 69%

48%

Organisation

Personal

52%

Personal

b. Maintaining loan/ deposit at the safe rate. The loan/ deposit ratio of VCB usually at 78-84% (compared with the average ratio of 20 biggest banks is 88%). However, when looking at STB, ACB, TCB, MB (corresponding ratio in 2009 are 70%, 55%, 61%, 67%) this is high level of loan/ deposit and it illustrates that the bank less diversify in risky market like securities and investment. With the application of circular 13/2010/NHNN amended by 19/2010/NHNN, estimated supply of credit will be reduced about

19

Financial and Monetary Theory - Assignment

25%

V. CAPITAL MANAGEMENT BY VIETCOMBANK Capital adequacy management is of vital importance to banks in general and Vietcombank in particular. The bank capital plays such a role because it not only can serve as a protection against unexpected losses but also help prevent bank failure, a situation in which the bank cannot satisfy its obligations to pay its depositors and other creditors and so goes out of business. When bank failure happens, it would initiate the domino effect that has profound impacts on the whole banking system, leading to a systematic collapse of banking industry and throw the national economy into a financial crisis. The larger the bank, the more serious the impacts of its failure are. To avoid this situation, in 2006, Vietnamese government has issued Decree No 141, requiring Vietnamese commercial banks to maintain minimum chartered capital of VND 3 trillion (about USD 154 million) effective December 31, 2011; extended at the end of 2010 from the original deadline of December 31, 2010. As the banks are now forced to hold a large amount of capital, they have more to lose if they fail and are thus more likely to pursue less risky activities. By reducing the banks incentives to take on risk, this Decree aims at making the banking industry bigger and stronger to be more competitive in the integration period. Increasing the chartered capital to meet the governments requirement in the context of currently lackluster stock market is by no mean an easy task for many small and medium banks; however, this is not the main problem for Vietcombank, Vietnams second largest partly private lender by assets. From the banks balance sheets in recent years, it can be seen that the chartered capital of Vietcombank (up to VND 13.22 trillion in 2010) is well above the minimum level set by the government. However, Vietcombank is facing another legal obstacle, originating from the Circular No 13 issued by the SBV in May 20th, 2010. According to Circular 13, all credit institutions, excluding foreign bank branches, shall maintain a capital adequacy ratio of 9% between their own capital and their total risk-weighted assets. The capital adequacy ratio is determined as follows: Own capital Total risk-weighted assets

Capital adequacy ratio = In which:

20

Financial and Monetary Theory - Assignment

- Own capital is the total of tier-1 capital and tier-2 capital, minus deductibles. o Tier-1 capital can absorb the banks losses without its having to cease to trading, including the charter capital, the charter capital supplementation reserve fund, the operation development investment fund, retained earnings, and surplus shares permitted to be accounted as capital under law, minus the portion used for purchasing treasury stocks. o Tier-2 capital can absorb the banks losses when a winding-up occurs and is less secure than tier-1 capital. Amounts constituting tier-2 capital include: 50% of the credit balance of the account of fixed assets re-valuated under law, 40% of the credit balance of the account of financial assets re-valuated under law, the financial reserve fund, convertible bonds and debt instruments meeting some specific conditions. o Deductibles from own capital include the debit balance of the account of fixed assets re-valuated under law and the debit balance of the account of financial assets re-valuated under law - Total risk-weighted assets are the total value of assets determined based on the extent of risk and the value of corresponding assets of off-balance-sheet commitments determined based on the extent of risk. Figure 6. Vietcombanks CAR (from 2005 to 2010)

21

Financial and Monetary Theory - Assignment

Before 2008, Vietcombank always maintained capital adequacy ratio (CAR) above 8% in accordance with the requirement from Vietnamese government. This level of CAR also met the international requirement of Basel II accord. However, it is not until when the Circular 13 was issued that Vietcombank began to face problems with its capital adequacy ratio. Since 2009, the new guidelines on the identification of central bank equity (Dispatch No 7634/NHNN-TCKT on 30/09/2009) have raised obstacles for Vietcombanks capital management, for this document stated some new regulations in the calculations of tier-1 and tier-2 capital, including many deductibles that had negative effects on Vietcombanks CAR. As a result, in 2009, there were some periods when the banks real CAR even dropped below 8%. Under the huge pressure of meeting the CAR of 9% taking effect on October 1 st 2010, Vietcombank has conducted many positive restructuring of portfolio assets, among which there are three main measures that had been effectively applied. First of all, in many recent years, Vietcombank has decided to decrease the banks assets by minimizing Trading securities and decreasing Investment in securities as can be observed earlier from Figure 2. Notably, in 2010 the bank had already sold out 19% of its stake in Gia Dinh Bank and 1.26% of its stake in Eximbank. Secondly, for years Vietcombank has continued raising retained earnings to increase the capital. Lastly, the bank even boosted capital by issuing common stock. According to Vietcombank, the current chartered capital of VND 12 trillion reaches only 81% of the approved equitisation plan, and the low chartered capital caused low ownership capital, leading to the decrease of CAR, limited operation scale and weak competition capacity. Therefore, in early August 2010, Vietcombank issued shares to raise its registered capital by 9.3 % to VND 13.22 trillion. In March 2011, the bank once again offered shares to the existing shareholders, increasing capital by 33% to nearly VND 17.6 trillion. After the capital increase, the bank's CAR has reached 9%. Recently, in August 2011, Vietcombank continued to raise its chartered capital to VND 19.7 trillion after finishing the stock issue to pay the 2010s dividends. The banks CAR in 2011 is expected to reach over 10%.

22

Financial and Monetary Theory - Assignment

Conclusion
This report provides an understanding of the operation of Vietcombank in particular and banking industry in Vietnam in general. After carefully analyzing the data of Vietcombank, we had concluded those following aspects of Vietcombank: sources of funds, uses of funds, off balancing sheet transactions. Sources of funds include 3 main kinds, as we mention in the overview, deposits, saving deposit, time deposit and borrowed funds. Among them, deposits are the largest source. Similarly, we found out the 2 main uses of funds of commercial banks in general: Cash and loans. There are also several assets but they only take small fraction. Last but not least, our report also examines one of the most important components of banks operations, off balance sheet transactions. For further understanding on baking industry of Vietnam, the report conveys the balance sheet structure of Vietcombank and also the changes in it. Moreover, the asset liabilities management is wisely observed and presented in both general and detailed cases. In conclusion, this report helps investors have a vivid picture of banking management and its prospect.

23

Financial and Monetary Theory - Assignment

ANSWER FOR THE QUESTIONS AT THE END OF THE PRESENTATION 1. What are the main components of bank capital? The main components of bank capital are: new equity (stocks), retained earnings and reserves (bad debt reserve). Issuing new equity is the way bank obtain new capital and cost of equity are often the most expensive cost in raising bank capital so the bank only issue new equity when it is really necessary. Retained earnings are the accumulated net income that has been retained for reinvestment in the business rather than being paid out in dividends to stockholders. Net income that is retained in the business can be used to acquire additional income - earning assets that result in increasing income in future years, cost of retained earnings is the retain stockholders require on the companys common stock ,it is normally cheaper than the cost of issuing new equity. The reserve requirement is a central bank regulation that sets the minimum reserves each commercial bank must hold (rather than lend out) of customer deposits and notes. It is normally in the form of cash stored physically in a bank vault or deposit make with a central bank.

2. Which is the main factor in asset and liability? Why? Main component of liability side: A bank obtains funds by borrowing and by issuing other liabilities such as deposit. Sources of funds include: checkable deposit, non-transaction deposits (time deposit and saving deposit), borrowings and bank capital. The largest sources of funds are deposits that accounted for more than half of the liability account. Some reasons that explain deposits consist the biggest amount in liability are: + Checkable deposits: are the bank accounts that allow the owner of the account to write checks to third parties. Checkable deposits include all accounts on which checks can be drawn: noninterest-bearing checking accounts (demand deposits), interest-bearing negotiable order of withdrawal accounts, and money market deposit accounts. Checkable deposits are the lowestcost source of bank funds because depositors are willing to forgo some interest to have access to liquid asset that can be used to make purchase. However, the bank cost of maintaining checkable

24

Financial and Monetary Theory - Assignment

deposits is high. This includes all cost of processing, preparing, sending out monthly statements, providing efficient tellers. + Non-transaction deposits: are primary source of bank funds. There are two types of nontransaction deposits: saving accounts and time deposits. Owner cannot write checks on nontransaction deposits, but the interest rates paid on these deposits are usually higher than those on checkable deposits. In saving account, funds can be added or withdrawn at any time, transactions and interest payments are recorded in a monthly statement or by a passbook held by the owner of the account. For time deposits, they have a fixed maturity length, ranging from several months to over five years, and assess substantial penalties for early withdrawal so it is less liquid for the depositors and it requires high interest rate. At the high cost, this is still common and important, because of the stable source of fund for bank. Main component of asset side: A bank uses funds that it has acquired by issuing liabilities to purchase income- earning assets. The primary uses of bank's fund are loans. Bank makes profit by lending out money to their customers with higher interest rate than when the bank receives deposits. In recent years, loans have generally produced more than half of bank revenues. However, loans are typical less liquid than other assets, because they cannot be turned into cash until the loan matures. Loans also have higher probability of default than other assets. Because of the lack of liquidity and have higher default risk, the bank earns its highest return on loans. 3. What is the role of capital management in commercial bank? Capital adequacy management is of vital importance to commercial banks in general and Vietcombank in particular. Specifically, the bank capital plays three important roles: preventing bank insolvency, ensuring returns for equities holders and meeting the regulatory requirement. Firstly, bank capital not only can help prevent bank failure but also serve as a protection against unexpected losses. Specifically, when an unexpected deposit outflow occurs, the bank capital can absorb the losses without forcing the bank to cease to trading. In case the losses are so large that a winding-up happens, bank capital can be used to satisfy the banks obligations to pay its depositors and other creditors, thereby making deposits safer and ensuring the stakeholders

25

Financial and Monetary Theory - Assignment

interests. As a result, it is understandable that commercial banks keep a certain amount of capital to reduce the likelihood of insolvency. Secondly, the bank capital has a significant effect on the returns to equity holders. Considering the formula to calculate the returns on equities: ROE = ROA x EM (in which EM = assets/ equity capital), it can be seen that given a specific amount of returns on assets, a lower bank capital will result in a higher the return for the owners of the bank. Therefore, bank capital has both benefits and costs: while a high amount of capital guarantees the owners investment, it can also reduce the returns on equities. It is important for banks to strike a balance between these two critical criteria. Last but not least, the bank capital is considered to be an important tool through which the Central Bank can regulate commercial banks. In the current dynamic market, when a bank failure happens, it would initiate the domino effect that has profound impacts on the whole banking system, leading to a systematic collapse of banking industry and throw the national economy into a financial crisis. The larger the bank, the more serious the impacts of its failure are. To avoid this situation, in 2006, Vietnamese government has issued Decree No 141, requiring Vietnamese commercial banks to maintain a minimum chartered capital of VND 3 trillion (about USD 154 million) effective December 31, 2011; extended at the end of 2010 from the original deadline of December 31, 2010. As the banks are now forced to hold a large amount of capital, they have more to lose if they fail and are thus more likely to pursue less risky activities. By reducing the banks incentives to take on risk, this Decree aims at making the banking industry bigger and stronger to be more competitive in the integration period. In short, commercial banks should maintain a certain amount of capital as it is required by law and also as a prevention of bank failure. Along with that, they should bear in mind that too much capital may lower the returns for equity holders. However, , with the uncertainty in Vietnamese economic context in this period, it is recommended that banks should put the priority on guaranteeing the interest of clients and investors in the long run by holding more capital.

4. What are banks have the charter capital less than 3 trillion in Viet Nam?

26

Financial and Monetary Theory - Assignment

To avoid systematic collapse of banking industry, in 2006, Vietnamese government has issued Decree No 141, requiring Vietnamese commercial banks to maintain minimum chartered capital of VND 3 trillion (about USD 154 million) effective December 31, 2011; extended at the end of 2010 from the original deadline of December 31, 2010. However, there are still some banks have the charter capital less than 3 trillion. Accordingly, GiaDinh Bank issued 100 million shares (equivalent to 1,000 billion) for existing shareholders, the value of VND 10,000 / share. With the banks of this type, increasing the charter capital to the regulated floor is not too difficult. However, many small and medium-sized banks (charter capital at 3,000 billion or more) are experiencing difficulties in the charter capital increase as planned (adopted in the annual shareholders meeting). Saigon Bank is a good example when making plans to increase capital to 3,500 billion this year and shareholders have been through in the first session. However, despite going to turn to quarter IV/2011, but Saigon Bank cannot deploy plans to issue shares for the capital increase. NamA Bank also plans to increase its chartered capital to 3,700 billion at the end of this year, but to this point, there is no move for the issuance of new shares.

REFERENCES 27

Financial and Monetary Theory - Assignment

Vietcombanks performance in 2005.(n.d.).Retrieved September 20, 2011 from http://www.vietcombank.com.vn/en/annual%20report/2005/4-Vietcombank-Performance2005.pdf Vietcombanks IPO: No Later than Q2/2007. (2006). Retrieved September 2011 from http://www.saigon-gpdaily.com.vn/Business/Stock_Market/2006/7/50058/ VCB :Chngtimongmunnimytvigithpnhtcth. (n.d.).Retrieved September 2011 from http://tintuc.xalo.vn/00954504692/VCB_Chung_toi_mong_muon_niem_yet_voi_gia_thap_nhat_co_the.html Vietcombanks performance in 2008.(n.d.). Retrieved September 19, 2011 from http://www.vietcombank.com.vn/En/annual%20report/2008/Performance%20in%202008.p df Vietnamese bank a helicopter view. (2011). Retrieved September 15, 2011 from http://stox.vn/medialib/files/Lan.Duong/StoxPlus_Vietnamese%20Banks_Full%20Data%2 0Coverage_Issue%201_Jul%202011.pdf Vietcombank to boost capital via share issue. (2010). Retrieved September 15, 2011 from http://www.itpc.gov.vn/investors/news/2010/09/2010-0908.194298/MISNews_view/?set_language=en Asset Liability Management. (2010). Retrieved September 19, 2011 from http://en.wikipedia.org/wiki/Asset_liability_management Asset and Liabilities Management. The Institutional Approach to ALM by Commercial Banks in Poland: a Special Focus on Risk Management. (n.d.). Retrieved September 19, 2011 from http://ideas.repec.org/p/sec/cnstan/0185.html Asset Liability Management in banks (AML).(n.d.). Retrieved September 29, 2011 from http://www.allbankingsolutions.com/alm.htm Balance Sheet of Commercial Bank - Liabilities and Assets.(n.d.). Retrieved September 27, 2011 from http://kalyan-city.blogspot.com/2010/09/balance-sheet-of-commercial-bank.html Vietcombanks performance in 2009. (2009). Retrieved September 29, 2011 from http://www.vietcombank.com.vn/AnnualReports/2009/vietcombank_AR09_100622%20En glish.pdf Vietcombank annual report 2010. (2010). Retrieved September 29, 2011 from http://www.vietcombank.com.vn/en/annual%20report/2010/Annual20Report%202010.pdf

Vietcombank Financial statement 2006. (2006). Retrieved October 5, 2011 from http://www.vietcombank.com.vn/En/annual%20report/2006/10-Financial-Statements.pdf

28

Financial and Monetary Theory - Assignment

Vietcombank Financial statement 2007. (2007). Retrieved October 5, 2011 from http://www.vietcombank.com.vn/en/annual%20report/2007/Financial%20Statements.pdf

29