Factor affecting risk exposure and profitability of the commercial banks operating in vietnam

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MINISTRY OF EDUCATION AND TRAINING UNIVERSITY OF ECONOMICS HOCHIMINH CITY Ta Thi Xuan Hoa FACTORS AFFECTING RISK EXPOSURE AND PROFITABILITY OF THE COMMERCIAL BANKS OPERATING IN VIETNAM MASTER’S THESIS Ho Chi Minh City 2010 MINISTRY OF EDUCATION AND TRAINING UNIVERSITY OF ECONOMICS HOCHIMINH CITY Ta Thi Xuan Hoa FACTORS AFFECTING RISK EXPOSURE AND PROFITABILITY OF THE COMMERCIAL BANKS OPERATING IN VIETNAM MASTER’S THESIS In Banking Code: 60.31.12 Supervisor Assoc. Prof. Dr. Bui Thi Kim Yen Ho Chi Minh City 2010 i DECLARATION This is to certify that: • the thesis contains no material which has been accepted for the award to the candidate of any other degree or diploma except where due reference is made in the text of the thesis. • to the best of candidate’s knowledge contains no material previously published or written by another person except where due reference is made in the text of the thesis. Ta Thi Xuan Hoa Signature: Date: ii ACKNOWLEDGEMENT I would like to express my attitude to many individuals who helped me to complete this thesis. First of all I would like to express my deepest acknowledgement to my supervisor, Assoc. Prof. Dr. Bui Kim Yen for her valuable advice and recommendation. I would like to express my gratitude to my English teacher, Mr. John William Hall who helped me in improving English speaking skills. I would like to express my gratitude to Ms. Ly Thi Minh Chau, who helped me a lot in providing reference materials, giving me valuable time, invaluable advice, assistance, support and recommendation. I would like to express my gratitude to Dr. Vo Xuan Vinh, who helped me a lot in data analysis, giving me valuable time, support and recommendation. In the process of data collection for this research, many individuals contributed to the task and I am particularly grateful for their contributions. I am greatly indebted to Mr. Nguyen Huu Nhan, Mr. Nguyen Ngoc Tan for their support during the time of this thesis. I would also like to thank Mr. Ngo Tran Kien Quoc and Mr. Ho Phi Diep who helped me to collect data, and to conduct personal interview. I would like to thank the people who have been working in The State bank of Vietnam, Ho Chi Minh City Branch for providing secondary data relating activities of commercial banks in Vietnam in general and supporting my study leave to enable me to complete the thesis. It allowed me to concentrate on the completion of my thesis. Finally I wholeheartedly thank and acknowledge the most important people in my life, my parents and my husband, for their total support, encouragement and patience in my completing the thesis. iii ABSTRACT The basic principles of bank management have highlighted the need to balance between liquidity, asset, liability, capital adequacy, credit and interest rates risks in order to mitigate the loss in earnings. Thus, the factors that may affect these risks are important indicators to formulate appropriate strategies for better bank management. It is therefore the purpose of this study to identify the factors that contribute to the risks that are faced by banks. The factor analysis conducted indicated that liquidity and interest rate, market, business operation, credit are the factors affecting banks’ risk exposure. Hence, banks have to seriously consider these factors in formulating an effective risk management strategy to minimize any possibility of loss in income and to avoid bank failure. This thesis is to examine factors affecting banks’ risk and the relationship between financial risks and profitability of the commercial banks in Vietnam. The objectives of the thesis are to investigate and analyze factors affecting banks’ risk exposure and relationship between financial risks on profitability of commercial banks in Vietnam to contribute some implications for management strategy of banks in Vietnam. From that, the recommendations are given to not only commercial banks but also SBV. These recommendations are both “situated” recommendations and “strategic” recommendations. This creates the important and necessary perquisites for the business of commercial banks in Vietnam safer, more stabilized and more efficiency. Key words: bank risk, financial risk, profitability iv TABLE OF CONTENTS Chapter Title Page Declaration i Acknowledgement ii Abstract iii TABLE OF CONTENTS iv LIST OF TABLES AND FIGURES vii LIST OF ABBREVIATIONS ix Chapter 1 INTRODUCTION 1 1.1 1.2 1.3 1.4 1.5 1.6 Introduction Research Background Research problems Research questions Research objectives Research Methodology 1.6.1 Secondary Data and Limitations 1.6.2 Questionnaires 1.7 Significance and scope of the Research 1.8 Structure of the Research 1.9 Conclusion Chapter 2 LITERATURE REVIEW 2.1 2.2 2.3 Introduction Bank’s risk Characteristics of bank’s risks 2.3.1 Credit risk 2.3.2 Liquidity Risk 2.3.3 Market Risk 2.3.4 Interest Rate Risk 2.3.5 Operational risk 2.3.6 Capital risk 2.4 Analyzing bank performance with financial ratios 2.4.1 Rate of return on equity (ROE) 2.4.2 Rate of return on asset (ROA) 1 2 3 4 4 4 4 5 5 5 7 9 9 10 13 13 15 18 20 21 24 26 27 28 v 2.5 2.6 Relationship between financial risk factors and profitability Previous study 2.6.1 Factors affect to bank’s risks exposure 2.6.2 Effects of financial risks on profitability 2.7 Conclusion Chapter 3 OVERVIEW OF BANKING INDUSTRY 3.1 Introduction 3.2 Overview of banking industry 3.3 Banking industry in Vietnam 3.4 The bank regulatory environment 3.4.1 Law on credit institutions 3.4.2 Deposit insurance 3.4.3 Reserve requirement 3.4.4 Some other regulations 3.5 Conclusion Chapter 4 RESEARCH METHODOLOGY 28 29 29 30 33 34 34 35 36 38 38 38 39 41 46 47 4.1 Introduction 4.2 Research design 4.3 Variable definition 4.3.1 Dependable variables 4.3.2 Independent variables 4.4 Model development for the study 4.5 Hypothesis statement 4.6 Data collection method 4.7 Data transformation 4.8 Conclusion Chapter 5 DATA ANALYSIS AND FINDINGS 47 48 49 49 49 50 50 51 52 52 53 5.1 Introduction 5.2 Links between data analysis and research objectives and research questions 5.3 Descriptive findings of the research study 5.3.1 Sample descriptions 5.3.2 Descriptive findings 5.4 Associate analysis and findings of the research study 5.4.1 Analysis of findings on factors affecting banks’ risk exposure 5.4.2 Testing research model and hypotheses 53 54 55 55 65 70 70 71 vi 5.5 Conclusion Chapter 6 75 76 CONCLUSION AND IMPLICATIONS 76 6.1 Introduction 76 6.2 Conclusions related to research questions 77 6.2.1 Summary of all hypothesis 77 6.2.2 Conclusion related to research questions 78 6.3 Implications for the commercial banks in Vietnam 79 6.3.1 Implication 1. Implication for the State Bank of Vietnam 79 6.3.2 Implication 2. Viewpoint of risk management role 81 6.3.3 Implication 3. Developing and updating the risk management strategy in more details 82 6.3.4 Implication 4. Improving the efficiency of risk management in the bank 83 6.4 Limitations for the research study 87 6.5 Implications for further research 88 REFERENCES 89 Appendix 93 vii LIST OF TABLES AND FIGURES Figures Figure 1.1 Structure of chapter 1 Figure 1.2 Structure of the Research Figure 2.1 Structure of chapter 2 Figure 2.2 Bank goal and risks Figure 2.3 The link between liquidity and other typical risks Figure 2.4 Two broad categories of operational risk Figure 3.1 Structure of chapter 3 Figure 3.2 Market shares of Vietnamese banks Figure 4.1 Structure of chapter 4 Figure 4.2 Hypothesis Figure 5.1 Structure of chapter 5 Figure 5.2 Age group of respondents Figure 5.3 Distribution of working experience Figure 5.4 Distribution of Ownership Figure 5.5 Distribution of educational level Figure 5.6 Distribution of educational background Figure 6.1 Structure of chapter 6 Tables Table 3.1 Deposits of the commercial banks in Ho Chi Minh City Table 3.2 Reserve requirement rate in 2004-2008 Table 3.3 Current Reserve Requirement Rate Table 3.4 Changes of interest rate for reserve deposit in VND at State bank of VN Table 3.5 Changes of base rate from 2008 Table 3.6 Provision rates Table 5.1 Respondents’ characteristics Tables 5.2 Interest rate risk ratio viii Table 5.3 Summary of interest rate risk ratios Table 5.4 Liquidity risk ratios Table 5.5 Summary of liquidity risk ratios Table 5.6: Credit risk ratio Table 5.7 Summary of credit risk ratios Table 5.8: Capital risk ratio Table 5.9 Summary of Capital risk ratios Table 5.10 ROA Table 5.11 Summary of ROA Table 5.12 ROE Table 5.13 Summary of ROE Table 5.14 Summary Statistics of the Explanatory Variables Table 5.15 Liquidity and interest rate Table 5.16 Domestic market Table 5.17 International market Table 5.18 Internal Operation Table 5.19 External Operation Table 5.20 Credit Table 5.21 Factors affecting banks’ risk exposure Table 5.22 Correlation Matrix of the Explanatory Variables Table 6.1 Summary of all hypotheses ix LIST OF ABBREVIATIONS ACB Asia Commercial Bank ALCO Asset Liability Committee BIDV Bank for Investment and Development of Vietnam BODs Board of Directors CAR Capital Adequacy ratio CDs Certificate of deposits CEO Chief Executive Officer CIC Credit Information Center EAB Dong A Bank EFA Exploratory Factor Analysis FX Foreign Exchange ICT Information and communicative technology IT Informatics technology L/Cs Letters of Credit MLR Multiple Linear Regression MM Money Market NIM Net interest margin P&L Profit and Loss ROA Rate of return on assets ROE Rate of return on equity RP Repurchase Agreement RPs Repurchase Agreements SBV State Bank of Vietnam SMEs Small and Medium Enterprises SOE State –owned enterprise SPSS Statistical Package for Social Science VND Vietnamese dong WB World Bank 1 CHAPTER 1 INTRODUCTION 1.1 Introduction This chapter provides a general introduction to the research study. The purpose is to establish foundations for following chapters and the study as a whole, by providing a general picture of the study. This chapter is structured into eight sections as presented by figure 1.1. 2 Figure 1.1: Structure of chapter 1 1.1 Introduction 1.2 Research Background 1.3 Research Problem 1.4 Research question 1.5 Methodology 1.6 Justification for the study 1.7 Significance and scope of the study 1.8 Structure of the study 1.9 Conclusions 1.2 Research Background In the past two decades, the banking industry has evolved from a financial intermediation between depositors and borrowers, to a “one-stop” centre for a range of financial services like insurance, investments and mutual funds. The advancement 3 of information and communicative technology (ICT) is accountable for the evolution of banking services, in particular, online banking. The development in ICT has not only provided vast banking opportunities previously beyond reach, but also heightens the competition and risks faced by banks in the financial system. The banks’ primary business in lending and investment are risky business. Banks are exposed to uncertainty and instability of the financial market as interest rate fluctuations, exchange rate variation and economic volatility could all lead to insolvency, bankruptcy and financial crisis. The present adverse effect of the sub-prime crisis in the US, for instance, has crumbled giant investment bankers like Bear Stearns and Lehman Brothers and shook the insurance company American International Group (AIG). Hence, proper understanding on the factors that constitute banks’ risks exposure will mitigate and minimize banks’ loss in earnings and capital due to risks and financial crisis. Besides, the intensified global competition and the liberalization of banking rules and regulations have also changed the current banking system by providing greater opportunities of banks’ risk diversification. Therefore, it is the purpose of this study to determine the factors that will affect the banks’ risks taking in the banking industry and impacts of financial risks on theirs profitability. The identification of these factors would be beneficial in constructing effective risk management strategies in the banks and to minimize a loss in income. In addition, an understanding on the association of risk involved in the banking industry will also help banks formulate appropriate strategy that will escalate positive and minimize negative impact of associated risks. 1.3 Research problems Right now, the Vietnam banking system is facing to serious difficulties in regard to uncertainty and instability of the financial market as interest rate fluctuations, exchange rate variation and economic volatility. It made many commercial banks had been chaotic and potential bankruptcy; threat the safety of whole banking system and national economy. This has put the country in difficult situation when it is on the way to modernize and industrialize the nation and integrate with international 4 environment. This research study is to investigate and identify factors affecting banks’ risk exposure and relationship between financial risks and profitability of the commercial banks in Vietnam. 1.4 Research questions The research study will answer for the following research questions: 1. What factors affect banks’ risk exposure in Vietnam? 2. What is relationship between financial risks (liquidity risk, interest rate risk, capital risk, credit risk) and profitability of the commercial banks in Vietnam? 1.5 Research objectives In solving the research problem and answering the research questions mentioned above, the research study has the following objectives: • To investigate and describe factors affecting banks’ risk exposure in Vietnam • To develop models the impacts of financial risks on commercial banks’ profitability • To contribute to knowledge of factors affecting banks’ risk exposure and the relationships of financial risks and commercial banks’ profitability 1.6 Research Methodology In this research, casual and descriptive are used in combination research 1.6.1 Secondary Data and Limitations The study uses secondary data from official publications of State Bank of Vietnam (SBV), World Bank (WB). Moreover, data from other publications such as journals, magazines, newspaper, banks’ annual reports and foreign banks’ researches are also used in this study. It should be noted that the quality of Vietnam’s data is poor and short in term of time series. More especially, obtaining the data related to Vietnam‘s banking sector is a very difficult task because of non-transparency in this sector. It is also widely known 5 that the validity of the published information by Vietnamese journals, newspapers, annual reports and Government documents varies greatly, thus, resulting in the difficulty of obtaining internal validity. 1.6.2 Questionnaires Questionnaires were constructed based on the objectives of the research and after exploring bank executive opinions about different aspects of the current risk management in Vietnam‘s banking system. Based on the relationship with the author, respondents were selected as bank’s executives, officers in risk management department at different local banks as well as foreign banks doing business in Vietnam. The number of respondents was 150 and most of them were willing to reply the questionnaires. The questionnaire is in Appendix. 1.7 Significance and scope of the Research Identifying the factors that may affect these risks are of importance and the impact of financial risks has had an effect on profitability of the commercial banks. This study highlights that these indicators are implied for banks to formulate appropriate strategies for better bank management. This study is to bring some applications in developing risk management strategy in commercial banks in Vietnam. It will help banks in constructing effective risk management strategies in the banks and to minimize a loss in income. 1.8 Structure of the Research In term of research structure, the thesis has six chapters (Figure 1.2). The thesis begins by defining the research problem and questions, and providing a justification for the research study. Chapter one also reviews the research background, significance and scope of the study. Chapter two reviews banks’ risk in theory, ratios to evaluate profitability of the commercial banks. Objectives of this chapter are to review the theories related to banks’ risk and profitability of the commercial banks, to review previous research related to the areas of banks’ risk and profitability of the 6 commercial banks and to build a model of the impact of financial risks (liquidity risk, interest rate risk, market risk and capital risk) on profitability. Chapter three examines the overview of banking industry. The objective of this chapter is to review overview of banking industry and banking regulatory environment which affect management strategy of the commercial banks in Vietnam, Chapter four discusses aspects of the research methodology including research design, data collection and data analysis methods, and hypothesis testing to support the model. Objectives of this chapter are: (1) to justify the research methodology of this study, (2) to explain research methodology used in the study, and (3) to demonstrate how research design, and data collection and analysis can be utilized in this study to answer the research questions outlined in the chapter 1. Data analysis and findings are presented in chapter five. This chapter presents descriptive findings of factors and findings of the research study related to testing the model of profitability. Objectives of this chapter are (1) to systematically present the descriptive findings of the research study, (2) to interpret significance of these findings based on data analysis, (3) to present the results of testing the model of commercial banks’ profitability, and (4) to explain how the model, developed from a literature review, was supported by data analysis. Finally, the thesis ends with chapter six. This chapter will give some conclusions and implications for banks in Vietnam to avoid bank failure. 7 Figure 1.2: Structure of the Research Chapter 1: Introduction to the Study Chapter 2: Literature Review Chapter 3: Overview of banking Industry Chapter 4: Research Methodology Chapter 5: Data Analysis and Findings Chapter 6: Conclusions and Implications 1.9 Conclusion This research examines the factors affecting banks’ risk exposure and the relationship between financial risks and profitability of the commercial banks in Vietnam. To date, there is no significant research related to factors affecting banks’ risk exposure and impacts of financial risks on profitability in Vietnam. This research is designed as a combination of descriptive and casual research in which a sample of 150 banks’ executives, officers in risk management department at different local banks as well as 8 foreign banks doing business in Ho Chi Minh City for personal interview and a sample of 10 banks in Vietnam for analyzing impacts of financial risks on profitability. Gathered data will be processed by Excel, the Statistical Package for Social Science (SPSS) and EView 7.0 are the main computer software utilized in data analysis. Findings of this study will be applied to increase efficiency of risk management of commercial banks in Vietnam. To provide an in-depth picture of business environment in which commercial banks operate, chapter 3 will present information on background of banking industry, the bank regulatory environment in Vietnam whereas chapter 2 reviews the literature of bank’ risks. 9 CHAPTER 2 LITERATURE REVIEW 2.1 Introduction This chapter is a review of the literature on banks risk in theory. The objectives of this chapter are to review previous research related to the area of banks’ risk. This chapter is structured into 5 sections (Figure 2.1) Figure 2.1: Structure of chapter 2 2.1 Introduction 2.2 Bank’s Risks 2.3 Characteristics of Bank’s Risks 2.4 Analyzing Bank Performance with Financial Ratios 2.5 Relationship between financial risk factors and profitability 2.6 Previous studies 2.7 Conclusions
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