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Here are some principles on how to prevent and limit risky credit. When noticing
high level or risk, the first thing for a financial institution to do is to closely
supervise customers activities. Bank should send frequent supervisors to directly
work with customers so that any problem arisen could be corrected and reported
timely to senior managers.
Because efforts made at an early stage will effectively prevent banks from
litigations and loan losses. It is advisable for bank to take proactive effort in
dealing with customers to carry out remedial plans. This can be achieved by
maintaining frequent contact and internal records of follow-up actions.
On top of that, to make sure that bank have enough amounts for loan
recoverable, bank needs to update and reevaluate available collateral. In this
process, security and legal documents should also be reviewed so that to ensure
the completeness and validity of contracts and guarantee.
Besides, banks can also request borrowers for additional collateral.
If contract terms allow, the lender can ask for more assets throughout
the loan period when it seems that there is an increased amount of risks.
The last thing is to frequently review and monitor problem credits. This review
should update the status of loan accounts and progress of the remedial plans. Any
changes made on problem loan should be reported to the senior management so
that they could come up with proper strategy and actions.
In the next part, I will go into details some specific action in order to handle credit
risk default when its likely to happen. To handle credit risk means to reduce risk
and to relieve the amount of loss if default takes place. There are several different
ways in which banks can do this.
The 1st way is to define solutions for troubled debt restructuring. This is the
process in which bank modifies and relax the terms of loan agreement so that
borrowers will be more financially able to repay debts. For example, bank can
reschedule debt, which means delaying the due date of required payment or they
can reduce payment amounts by extending the payment period or increasing the
number of payments. By doing this, bank does not only help borrowers overcome
economic downturn but also help bank itself reduce bad debts and minimize the
eventual loss
The 2nd and the arguably most effective way is to classify loans and credit loan
loss provision. Loan classification generally refers to the process banks use to
review their loan portfolios and assign loans to categories or grades based on the
perceived risk and other relevant characteristics of the loans. This process enables
banks to monitor the quality of their loan portfolios and to take remedial action
when necessary. (.) Here is the table of debt classification in VN, you can see
that debts from class 3-5 are considered bad debts and are the main sources of
credit risk. About loan loss provision, it is an expense set aside as an allowance for
bad loans. So that, in the event of credit default, bank will not suffer loss in the
cash flow but it can use that amount set aside to cover the loss. So you can see
that the timely review of loan quality for both classification and provisioning is the
key to keep management up to date to the quality of loan portfolio
Besides that, banks can mitigate losses by putting up property for auction, suing
against financially inept customers or selling debts to debt buyers or debt
collecting agencies. There are basically 2 ways how debt trading works. These
debt collectors can help bank handling debts by buying debts from bank at
discount price then charge the customer full amount or bank can ask them to
collect debts and pay them a percentage of the money they collect.
Another approach to relieve debts is debt-for-equity swap. This method is still
uncommon in Vietnam and mostly employed by credit debt and asset trading
corporation. Basically debt-for-equity swap is the process in which debt is
exchanged for a predetermined amount of equity. Both sides benefit from this
approach as the borrower can relieve a portion of its debt and the creditor has
chance to restructure its company with new source of equity.