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Financial and Monetary Theory - Assignment

1

HANOI UNIVERSITY

FACULTY OF MANAGEMENT AND TOURISM

Financial and Monetary Theory

OVERVIEW OF COMMERCIAL BANKSOPERATIONS 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

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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

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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 Anhour 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.

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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.

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I. OVERVIEW OF COMMERCIAL BANKSOPERATIONS IN VIET NAMIn 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 ofdeposit 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 fundsFirst 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
http://www.investorglossary.com/bank.htmhttp://www.investorglossary.com/deposit.htmhttp://www.investorglossary.com/deposit.htmhttp://www.investorglossary.com/bank.htm

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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 fixedrate 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.

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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 VCB ACB Vietinbank

Borrowings:

From SBV

From other banks

3.27%

8.2%

5.26%

14.65%

4.29%

2.5%

Nontransaction deposits:

Customer deposits

Valuable papers issued

66.59%

11.4%

53.85%

14%

80.39%

1.32%

Other liabilities 2.85% 4.91% 5.2%

Bank capital 7.69% 7.33% 6.3%

Total 100% 100% 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

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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 bank-

speak 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 label-

backed 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 therates 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
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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 VCB ACB Vietinbank

Cash items 1.7% 5.77% 1.64%

Balances with SBV 2.68% 6.02% 10%

Securities:

Trading securities

Investments in securities

0.004%

10.67%

0.89%

11.28%

0.13%

18.74%

Loans:

To other banks

To customers

24.92%

56.65%

34.04%

37.22%

14.33%

51.2%

Longterm

investments1.29% 1.4%

Fixed assets 0.52% 1.38% 0.64%

Other assets 1.57% 3.4% 1.92%

Total 100% 100% 100%

3. Off balance sheet transactions

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 liabilitiesare possible future liabilities that will only become certain on theoccurrence of some future event.

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Undrawn loans commitmentsinclude both obligations to pay, and other commitments toprovide 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 VCB Vietinbank

Contingency liabilities commitment:

Lending commitment

Guarantees commitment

Letters credit commitment

67.36%

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.

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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

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Table 4: VCBs major sources of funds

Sources of Funds2010 2009 2008 2007 2006

Due to the Government and the SBV 3.28% 8.84% 4.28% 6.43% 10.05%

Due to other banks 19.36% 15.20% 11.91% 9.09% 7.28%

Customer deposits 66.59% 66.17% 70.72% 71.72% 66.96%

Valuable papers issued 1.16% 0.00% 0.25% 1.63% 5.20%

Other borrowed funds 0.00% 0.15% 1.32% 1.25% 1.48%

Other liabilities 2.85% 3.02% 5.19% 2.97% 2.21%

Bank capital 6.72% 6.54% 6.28% 6.86% 6.72%

Minority interest 0.04% 0.04% 0.05% 0.04% 0.04%

Total 100% 100% 100% 100% 100%

3. Uses of funds

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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, longterm 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

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Cash and cash equivalents on hand 1.70% 1.76% 1.57% 1.62% 1.45%

Balances with the SBV 2.68% 9.85% 13.76% 5.91% 7.09%

Due from other banks 25.90% 18.57% 13.67% 21.07% 31.25%

Trading securities 0.00% 0.00% 0.14% 1.43% 0.34%

Loans to customers 55.65% 53.62% 48.91% 48.34% 39.64%

Investments in securities 10.67% 12.77% 18.72% 19.11% 18.19%

Long-term investments 1.29% 1.42% 1.37% 0.84% 0.58%

Fixed assets 0.52% 0.59% 0.61% 0.53% 0.66%

Other assets 1.78% 1.41% 1.25% 1.14% 0.80%

Total 100% 100% 100% 100% 100%

4. Off balance sheet items

Table 6: VCBs off balance sheet items

Off balance sheet items

(million VND)2006 2007 2008 2009 2010

Lending commitment 251

Letters of credit commitments1,766,133

(2.88 %)

1,008,968

(1.18 %)

24,628,918

( 70% )

31,639,498

( 69.75 % )

34,540,188

(67.37 % )

Others guarantees26,021,012

(42.45 % )

39,777,118

(46.35 % )

10,254,890

(29.40 % )

13,338,765

( 29.41 % )

15,630,554

( 30.49 % )

Un-drawn loan commitments33,505,945

(54.67 % )

45,038,952

(52.48 % )

231,411

( 0.66 % )

380,811

( 0.84 % )

1,100,805

( 2.15 % )

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

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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 assetsminus 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

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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

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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

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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

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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)

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

69%

31%

31.12.2007

Organisation

Personal

52%48%

31.12.2010

OrganisationPersonal

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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 20 th, 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:

Capital adequacy ratio =Own capital

Total risk-weighted assets

In which:

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- Own capital is the total of tier-1 capital and tier-2 capital, minus deductibles.oTier-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.

oTier-2 capital can absorb the banks losses when a winding-up occurs and is lesssecure 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.

oDeductibles from own capital include the debit balance of the account of fixedassets 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 ofrisk 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)

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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 1st

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%.

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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.

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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 eachcommercial 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: non-

interest-bearing checking accounts (demand deposits), interest-bearing negotiable order of

withdrawal accounts, and money market deposit accounts. Checkable deposits are the lowest-

cost 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

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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 non-

transaction deposits: saving accounts and time deposits. Owner cannot write checks on non-

transaction 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

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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 onguaranteeing 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?

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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

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VCB :Chngtimongmunnimytvigithpnhtcth. (n.d.).Retrieved September 2011 fromhttp://tintuc.xalo.vn/00-

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glish.pdfVietcombank annual report 2010. (2010). Retrieved September 29, 2011 from

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