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 Introduction 1 1.2 Research Background 2 1.3 Research problems 3 1.4 Research questions 4 1.5 Research objectives 4 1.6 Research Methodology 4 1.6.1 Secondary Data and Limitations 4 1.6.2 Questionnaires 5 1.7 Significance and scope of the Research 5 1.8 Structure of the Research 5 1.9 Conclusion 7 Chapter 2 LITERATURE REVIEW 9 2.1 Introduction 9 2.2 Bank’s risk 10 2.3 Characteristics of bank’s risks 13 2.3.1 Credit risk 13 2.3.2 Liquidity Risk 15 2.3.3 Market Risk 18 2.3.4 Interest Rate Risk 20 2.3.5 Operational risk 21 2.3.6 Capital risk 24 2.4 Analyzing bank performance with financial ratios 26 2.4.1 Rate of return on equity (ROE) 27 2.4.2 Rate of return on asset (ROA) 28 v 2.5 Relationship between financial risk factors and profitability 28 2.6 Previous study 29 2.6.1 Factors affect to bank’s risks exposure 29 2.6.2 Effects of financial risks on profitability 30 2.7 Conclusion 33 Chapter 3 OVERVIEW OF BANKING INDUSTRY 34 3.1 Introduction 34 3.2 Overview of banking industry 35 3.3 Banking industry in Vietnam 36 3.4 The bank regulatory environment 38 3.4.1 Law on credit institutions 38 3.4.2 Deposit insurance 38 3.4.3 Reserve requirement 39 3.4.4 Some other regulations 41 3.5 Conclusion 46 Chapter 4 RESEARCH METHODOLOGY 47 4.1 Introduction 47 4.2 Research design 48 4.3 Variable definition 49 4.3.1 Dependable variables 49 4.3.2 Independent variables 49 4.4 Model development for the study 50 4.5 Hypothesis statement 50 4.6 Data collection method 51 4.7 Data transformation 52 4.8 Conclusion 52 Chapter 5 DATA ANALYSIS AND FINDINGS 53 5.1 Introduction 53 5.2 Links between data analysis and research objectives and research questions 54 5.3 Descriptive findings of the research study 55 5.3.1 Sample descriptions 55 5.3.2 Descriptive findings 65 5.4 Associate analysis and findings of the research study 70 5.4.1 Analysis of findings on factors affecting banks’ risk exposure 70 5.4.2 Testing research model and hypotheses 71 vi 5.5 Conclusion 75 Chapter 6 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 [...]... • 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... 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... 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, ... 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... 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. .. 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. .. 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... 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... 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... factor in deciding whether he/she will try to manage his/her risks The essence of risk is the uncertainty of outcome The term exposure refers to the combination of the probability of all potential events and the magnitude of their impact The Chinese symbol for risk is a combination of two symbols one for danger and one for opportunity (Damodaran 2003) In general terms, people often think of risks as the . 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. 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) . 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